Accounting for Capital Losses and Foreign Currency Losses in Last Quarter of RIC'S Tax Year -- Temporary Regs Under Section 852

 CC:FI-86-88                                                                                                [4830-01]

 ACTION: Temporary regulations.

 SUMMARY: This document provides temporary regulations relating to the treatment by a regulated investment company of a net capital loss, a net long-term capital loss, or a net foreign currency loss attributable to periods after October 31 of a taxable year. The applicable tax law was amended by the Tax Reform Act of 1986 and by the Technical and Miscellaneous Revenue Act of 1988. These regulations provide guidance to regulated investment companies as to the proper manner of determining taxable income, earnings and profits, and the amount that may be designated as capital gain dividends for a taxable year. The text of the temporary regulations set forth in this document also serves as the text of the cross- reference notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register.

 EFFECTIVE DATE: These regulations are effective for taxable years of regulated investment companies ending after October 31, 1987.

 FOR FURTHER INFORMATION CONTACT: Lauren G. Shaw of the Office of Assistant Chief Counsel (Financial Institutions and Products), Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C. 20224 (Attention: CC:FI&P:2) or telephone 202-566-3828 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

These regulations are being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason, the collections of information contained in these regulations have been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget (OMB) under control number 1545-1094. The estimated average annual burden associated with the collections of information in these regulations is fifteen minutes per respondent.

 These estimates are an approximation of the average time expected to be necessary for a collection of information. They are based on such information as is available to the Internal Revenue Service. Individual respondents may require greater or less time, depending on their particular circumstances.

 For further information concerning these collections of information, and where to submit comments on these collections of information, the accuracy of the estimated burden, and suggestions for reducing this burden, please refer to the preamble to the cross- reference notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register.

BACKGROUND

 This document amends the Income Tax Regulations (26 CFR Part 1) under section 852 of the Internal Revenue Code of 1986 to reflect certain amendments made to the Code by the Tax Reform Act of 1986 (Pub. L. 99-514; 100 Stat. 2085) ("1986 Act") and by the Technical and Miscellaneous Revenue Act of 1988 (Pub. L. 100-647; 102 Stat. 3342) ("TAMRA"). These amendments to the regulations reflect the addition of section 852(b)(8) to the Code and the amendments made to sections 852(b)(3)(C) and 852(c) of the Code by sections 651(b)(2) and (3) of the 1986 Act and sections 1006(l)(3), (4) and (7) of TAMRA.

 These recent additions and amendments to the Code are designed to improve the coordination between the income tax provisions applicable to RICs and the provisions of new section 4982, which imposes an excise tax on a RIC which fails to distribute a certain amount of its income. The principal difficulty in coordinating the provisions is that section 4982 generally requires a RIC to use a 12-month period ending on October 31 in measuring its capital gains and losses and foreign currency gains and losses for excise tax purposes regardless of the accounting period the RIC uses in computing its taxable income. The recent Code changes provide for adjustments to a RIC's taxable income to take into account the October 31 excise tax closing date. Section 4982(e)(4) permits a RIC using a taxable year ending November 30 or December 31 to elect to use its taxable year for purposes of the excise tax rather than the October 31 closing date. The special income tax adjustments therefore do not apply to a RIC making the section 4982(e)(4) election because the same period is used for both income tax and excise tax purpose.

 Section 852(b)(3)(C) provides that, for purposes of determining the amount a RIC may designate as capital gain dividends for a taxable year to which an election under section 4982(e)(4) does not apply, the amount of the RIC's net capital gain shall be determined without regard to any net capital loss or net long-term capital loss attributable to the period after October 31 of the taxable year (the "post-October period"), and any such loss shall be treated as arising on the first day of the next taxable year (the "succeeding year"). Section 852(b)(3)(C) also provides that, to the extent set forth in regulations, these rules shall apply for purposes of determining a RIC's taxable income.

 Section 852(b)(8) provides that, to the extent provided in regulations, the taxable income of a RIC for a taxable year to which an election under section 4982(e)(4) does not apply shall be computed without regard to any net foreign currency loss attributable to its post-October period, and any such loss shall be treated as arising on the first day of the succeeding year.

 Section 852(c)(1) provides that any amount that is not allowable as a deduction in computing a RIC's taxable income for a taxable year does not reduce the RIC's earnings and profits for that year (although such amount may reduce its accumulated earnings and profits). A RIC's earnings and profits for a taxable year are thus determined without regard to any net capital loss, net long-term capital loss, or net foreign currency loss not included in computing the RIC's taxable income for that taxable year. In addition, section 852(c)(2) provides that, with respect to certain distributions made in a calendar year, a RIC's earnings and profits are determined without regard to any net capital loss or net foreign currency loss after October 31 of that year, adjusted as provided by regulations.

EXPLANATION OF THE REGULATIONS

 The regulations provide guidance relating to the determination of the amount that may be designated as capital gain dividends and to the determination of earnings and profits by a RIC having a net capital loss, a net long-term capital loss, or a net foreign currency loss attributable to the post-October period of a taxable year.

 In addition, the regulations provide procedures by which a RIC may elect to defer part or all of a net capital loss, a net long-term capital loss, or a net foreign currency loss attributable to its post-October period to the succeeding year for purposes of determining its taxable income. The regulations also provide guidance relating to the proper calculation of taxable income and earnings and profits for the years affected.

 Section 1.852-11T(c) of the regulations defines the term "post- October capital loss" to mean any net capital loss attributable to sales or exchanges after October 31 of a taxable year or, if there is no such net capital loss, any net long-term capital loss attributable to that period. In addition, section 1.852-11T(d)(1) defines the term "post-October currency loss" to mean any net foreign currency loss that is properly attributable to transactions after October 31 of a taxable year.

 Section 1.852-11T(e) of the regulations provides that, for purposes of determining the amount a RIC may designate as capital gain dividends for a taxable year, any post-October capital loss for that year is disregarded. The post-October capital loss is treated as arising on the first day of the succeeding year.

 Section 1.852-11T(f)(1) of the regulations provides that a RIC may elect to compute its taxable income for a taxable year without regard to part or all of its post-October capital loss or post- October currency loss for that year. Under section 1.852-11T(f)(4), any part of a post-October capital or currency loss for a taxable year that a RIC elects to defer under section 1.852-11T(f)(1) is treated as arising on the first day of the succeeding year. Thus, that part of any post-October capital or currency loss for a taxable year that a RIC elects to defer under section 1.852-11T(f)(1) will be disregarded in computing the RIC's taxable income for that year, but will be taken into account in computing the RIC's taxable income for the succeeding year.

 Under section 1.852-11T(f)(5), an election to defer a post- October capital or currency loss under section 1.852-11T(f)(1) for purposes of determining a RIC's taxable income will not affect the amount of the RIC's gross income for that taxable year (or the succeeding year) for purposes of sections 851(b)(2) or (3).

 Section 1.852-11T(g)(1) of the regulations provides that a RIC's current earnings and profits for a taxable year are determined without regard to any post-October capital or currency loss for that year, but that a post-October capital or currency loss is generally taken into account in determining the RIC's accumulated earnings and profits. If a RIC elects to defer part or all of a post-October capital or currency loss for a taxable year for purposes of computing its taxable income, however, section 1.852-11T(g)(2) provides that, for all taxable years, the amount of loss deferred is taken into account in determining the RIC's current earnings and profits and accumulated earnings and profits as if the part of the loss so deferred had arisen on the first day of the succeeding year.

 Section 1.852-11T(g)(1) of the regulations also provides that, if with respect to a calendar year a RIC distributes amounts in excess of a limiting amount (the amount that would be the required distribution for the calendar year under section 4982 if "100 percent" were substituted for each percentage set forth in section 4982(b)(1)), then solely for purpose of characterizing those excess distributions the RIC's current earnings and profits are determined by taking into account any post-October capital loss or post-October currency loss.

 Section 1.852-11T(i)(1) provides that, in general, a RIC may elect to defer part or all of its post-October capital or currency loss by completing its income tax return (including any necessary schedules) for that taxable year in accordance with the instructions applicable to the election. However, if the applicable form and related instructions for the taxable year do not reflect these temporary regulations, a RIC must make an election to defer a post- October capital or currency loss by attaching a written statement to the return in the manner prescribed by section 1.852-11T(i)(2).

 Section 1.852-11T(j) provides a special transitional rule which permits a RIC to make a retroactive election to defer a post-October capital or currency loss under certain circumstances by following the procedures provided in that section. In addition, section 1.852-11T(j) permits a RIC to pay a retroactive dividend in an amount not in excess of the increase, if any, in the RIC's investment company taxable income or net capital gain that is attributable solely to the RIC's having made a retroactive election under this section. Section 1.852-11T(j) further provides that the deadline for making a retroactive election is December 31, 1990, and that a retroactive dividend must be declared on or before the date a retroactive election is made. A retroactive dividend must be paid (or treated as paid under section 852(b)(7)) on or before December 31, 1990.

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis 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, and, therefore, a final Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for the regulations was submitted to the Administrator of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The principal author of these temporary regulations is Lauren G. Shaw of the Office of Assistant Chief Counsel (Financial Institutions and Products), Internal Revenue Service. However, personnel from other offices of the Internal Revenue Service and Treasury Department participated in their development.

LIST OF SUBJECTS

26 CFR Part 1.851-1-1.860-1

 Income taxes, Investment companies, Real estate investment trusts.

26 CFR Part 602

 Reporting and recordkeeping requirements.

Treasury Decision 8287

ADOPTION OF AMENDMENTS TO THE REGULATIONS

The amendments to Parts 1 and 602 of Title 26 of the Code of Federal Regulations are as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS ENDING AFTER OCTOBER 31, 1987

Paragraph 1. The authority for Part 1 is amended by adding the following citation:

Authority: 26 U.S.C. 7805 * * * Section 1.852-11T is also issued under 26 U.S.C. 852(b)(3)(C), 852(b)(8), and 852(c).

Para. 2. A new section 1.852.11T is added to read as follows:

SECTION 1.852-11T TREATMENT OF CERTAIN LOSSES ATTRIBUTABLE TO PERIODS AFTER OCTOBER 31 OF A TAXABLE YEAR (TEMPORARY).

(a) OUTLINE OF PROVISIONS. This paragraph lists the provisions of this section.

 (a) Outline of provisions.

(2) LIMITATION ON APPLICATION OF SECTION. This section shall not apply to any post-October capital loss or post-October currency loss of a regulated investment company attributable to a taxable year for which an election is in effect under section 4982(e)(4) of the Code with respect to the company.

(c) POST-OCTOBER CAPITAL LOSS DEFINED. For purposes of this section, the term "post-October capital loss" means --

(1) Any net capital loss attributable to sales or exchanges after October 31 of a taxable year; or

(2) If there is no such net capital loss, any net long-term capital loss attributable to sales or exchanges after October 31 of a taxable year.

The amount of any net capital loss or any net long-term capital loss attributable to sales or exchanges after October 31 of a taxable year shall be determined in accordance with general tax law principles by treating the period beginning on November 1 of the taxable year of the regulated investment company and ending on the last day of such taxable year as though it were the taxable year of the regulated investment company.

(d) POST-OCTOBER CURRENCY LOSS DEFINED. For purposes of this section --

(1) POST-OCTOBER CURRENCY LOSS. The term "post-October currency loss" means any net foreign currency loss attributable to section 988 transactions that are properly attributable to the portion of the regulated investment company's taxable year after October 31.

(2) NET FOREIGN CURRENCY LOSS. The term "net foreign currency loss" means the excess of foreign currency losses over foreign currency gains.

(3) FOREIGN CURRENCY GAIN OR LOSS. The terms "foreign currency gain" and "foreign currency loss" have the same meaning as provided in section 988(b).

(e) LIMITATION ON CAPITAL GAIN DIVIDENDS -- (1) IN GENERAL. For purposes of determining the amount a regulated investment company may designate as capital gain dividends for a taxable year, the amount of net capital gain for the taxable year shall be determined without regard to any post-October capital loss for such year.

(2) AMOUNT TAKEN INTO ACCOUNT IN CURRENT YEAR -- (i) NET CAPITAL LOSS. If the post-October capital loss referred to in paragraph (e)(1) of this section is a post-October capital loss as defined in paragraph (c)(1) of this section, the net capital gain of the company for the taxable year in which the loss arose shall be determined without regard to any capital gains or losses (both long-term and short-term) from sales or exchanges after October 31 of the taxable year.

(ii) NET LONG-TERM CAPITAL LOSS. If the post-October capital loss referred to in paragraph (e)(1) of this section is a post- October capital loss as defined in paragraph (c)(2) of this section, the net capital gain of the company for the taxable year in which the loss arose shall be determined without regard to any long-term capital gain or loss from sales or exchanges after October 31 of the taxable year.

(3) AMOUNT TAKEN INTO ACCOUNT IN SUCCEEDING YEAR. If a regulated investment company has a post-October capital loss (as defined in paragraph (c)(1) or (c)(2) of this section) for any taxable year, then, for purposes of determining the amount the company may designate as capital gain dividends for the succeeding year, the net capital gain for the succeeding year shall be determined by treating all gains and losses taken into account in computing the post-October capital loss as arising on the first day of the succeeding year.

(f) REGULATED INVESTMENT COMPANY MAY ELECT TO DEFER CERTAIN LOSSES FOR PURPOSES OF DETERMINING TAXABLE INCOME -- (1) IN GENERAL. A regulated investment company may elect, in accordance with the procedures of paragraph (i) of this section, to compute its taxable income for a taxable year without regard to part or all of any post- October capital loss or post-October currency loss for that year.

(2) EFFECT OF ELECTION IN CURRENT YEAR. The taxable income of a regulated investment company for a taxable year to which an election under paragraph (f)(1) of this section applies shall be computed without regard to that part of any post-October capital loss or post- October currency loss to which the election applies.

(3) AMOUNT OF LOSS TAKEN INTO ACCOUNT IN CURRENT YEAR -- (i) IF ENTIRE AMOUNT OF NET CAPITAL LOSS DEFERRED. If a regulated investment company elects, under paragraph (f)(1) of this section, to defer the entire amount of a post-October capital loss as defined in paragraph (c)(1) of this section, the taxable income of the company for the taxable year in which the loss arose shall be determined without regard to any capital gains or losses (both long-term and short-term) from sales or exchanges after October 31 of the taxable year.

(ii) IF PART OF NET CAPITAL LOSS DEFERRED -- (A) IN GENERAL. If a regulated investment company elects, under paragraph (f)(1) of this section, to defer less than the entire amount of a post-October capital loss as defined in paragraph (c)(1) of this section, the taxable income of the company for the taxable year in which the loss arose shall be determined by including an amount of capital loss from sales or exchanges after October 31 of the taxable year equal to the amount of the post-October capital loss that is not deferred. No amount of capital gain from sales or exchanges after October 31 of the taxable year shall be taken into account in the determination.

(B) CHARACTER OF CAPITAL LOSS NOT DEFERRED. The capital loss includible in the taxable income of the company under this paragraph (f)(3)(ii) for the taxable year in which the loss arose shall consist first of any short-term capital losses to the extent thereof, and then of any long-term capital losses, attributable to sales or exchanges after October 31 of the taxable year.

(iii) IF ENTIRE AMOUNT OF NET LONG-TERM CAPITAL LOSS DEFERRED. If a regulated investment company elects, under paragraph (f)(1) of this section, to defer the entire amount of a post-October capital loss as defined in paragraph (c)(2) of this section, the taxable income of the company for the taxable year in which the loss arose shall be determined without regard to any long-term capital gains or losses from sales or exchanges after October 31 of the taxable year.

(iv) IF PART OF NET LONG-TERM CAPITAL LOSS DEFERRED. If a regulated investment company elects, under paragraph (f)(1) of this section, to defer less than the entire amount of a post-October capital loss as defined in paragraph (c)(2) of this section, the taxable income of the company for the taxable year in which the loss arose shall be determined by including an amount of long-term capital loss from sales or exchanges after October 31 of the taxable year equal to the amount of the post-October capital loss that is not deferred. No amount of long term capital gain from sales or exchanges after October 31 of the taxable year shall be taken into account in the determination.

(v) IF ENTIRE AMOUNT OF POST-OCTOBER CURRENCY LOSS DEFERRED. If a regulated investment company elects, under paragraph (f)(1) of this section, to defer the entire amount of a post-October currency loss, the taxable income of the company for the taxable year in which the loss arose shall be determined without regard to any foreign currency gains or losses attributable to transactions after October 31 of the taxable year.

(vi) IF PART OF POST-OCTOBER CURRENCY LOSS DEFERRED. If a regulated investment company elects, under paragraph (f)(1) of this section, to defer less than the entire amount of a post-October currency loss, the taxable income of the company for the taxable year in which the loss arose shall be determined by including an amount of foreign currency loss attributable to transactions after October 31 of the taxable year equal to the amount of the post-October currency loss that is not deferred. No amount of foreign currency gain attributable to transactions after October 31 of the taxable year shall be taken into account in the determination.

(4) AMOUNT OF LOSS TAKEN INTO ACCOUNT IN SUCCEEDING YEAR. If a regulated investment company has a post-October capital loss or a post-October currency loss for any taxable year and an election under paragraph (f)(1) is made for that year, then, for purposes of determining the taxable income of the company for the succeeding year, all capital gains and losses taken into account in determining the post-October capital loss, and all foreign currency gains and losses taken into account in determining the post-October currency loss, that are not taken into account under the rules of paragraph (f)(3) of this section in determining the taxable income of the regulated investment company for the taxable year in which the loss arose shall be treated as arising on the first day of the succeeding year.

(5) EFFECT ON GROSS INCOME. An election by a regulated investment company to defer any post-October capital loss or any post-October currency loss for a taxable year under paragraph (f)(1) of this section shall not affect the amount of the gross income of such company for such taxable year (or the succeeding year) for purposes of section 851(b)(2) or (3).

(g) EARNINGS AND PROFITS -- (1) GENERAL RULE. The earnings and profits of a regulated investment company for a taxable year are determined without regard to any post-October capital loss or post- October currency loss for that year. If a regulated investment company distributes with respect to a calendar year amounts in excess of the limitation described in the succeeding sentence, then, with respect to those excess amounts, for the taxable year with respect to which the amounts are distributed, the earnings and profits of the company are computed without regard to the preceding sentence. The limitation described in this sentence is the amount that would be the required distribution for that calendar year under section 4982 if "100 percent" were substituted for each percentage set forth in section 4982(b)(1).

(2) SPECIAL RULE -- TREATMENT OF LOSSES THAT ARE DEFERRED FOR PURPOSES OF DETERMINING TAXABLE INCOME. If a regulated investment company elects to defer, under paragraph (f)(1) of this section, any part of a post-October capital loss or post-October currency loss arising in a taxable year, then, for both the taxable year in which the loss arose and the succeeding year, both the earnings and profits and the accumulated earnings and profits of the company are determined as if the part of the loss so deferred had arisen on the first day of the succeeding year.

(h) EXAMPLES. The provisions of paragraphs (e), (f), and (g) of this section may be illustrated by the following examples. For each example, assume that X is a regulated investment company that computes its income on a calendar year basis, and that no election is in effect under section 4982(e)(4).

EXAMPLE (1). X has a $25 net foreign currency gain, a $50 net short-term capital loss, and a $75 net long-term capital gain for the post-October period of 1988. X has no post-October currency loss and no post-October capital loss for 1988, and this section does not apply.

EXAMPLE (2). X has the following capital gains and losses from sales of exchanges during the periods indicated:

    Long-term           Short-term

(i) CAPITAL GAIN DIVIDENDS. X may designate up to $100 as a capital gain dividend for 1988 because X must disregard the $75 long-term capital gain and the $150 long-term capital loss for the post-October period of 1988 in computing its net capital gain for this purpose. In computing its net capital gain for 1989 for the purposes of determining the amount it may designate as a capital gain dividend for 1989, X must take into account the $75 long-term capital gain and the $150 long-term capital loss for the post-October period of 1988 in addition to the long-term and short-term capital gains and losses for 1989. Accordingly, X may not designate any amount as a capital gain dividend for 1989.

(ii) TAXABLE INCOME. X must include the $75 long-term capital gain and the $150 long-term capital loss for its post- October period of 1988 in its taxable income for 1988 because it did not make an election under paragraph (f)(1) of this section for 1988. Accordingly, X's taxable income for 1988 will include a net capital gain of $25 and a net short-term capital gain of $160. X's taxable income for 1989 will include a net capital gain of $60 and a net short-term capital gain of $70.

(iii) EARNINGS AND PROFITS. X must determine its earnings and profits for 1988 without regard to the $75 long-term capital gain and the $150 long-term capital loss for the post-October period of 1988. X must, however, include the $75 long-term capital gain and $150 long-term capital loss for the post- October period of 1988 in determining its accumulated earnings and profits for 1988. Thus, X includes $260 of capital gain in its earnings and profits for 1988, includes $185 in its accumulated earnings and profits for 1988, and includes $130 of capital gain in its earnings and profits for 1989.

EXAMPLE (3). Same facts as example (2), except that X elects to defer the entire $75 post-October capital loss for 1988 under paragraph (f)(1) of this section for purposes of determining its taxable income for 1988.

(i) CAPITAL GAIN DIVIDENDS. Same result as in example (2).

(ii) TAXABLE INCOME. X must compute its taxable income for 1988 without regard to the $75 long-term capital gain and the $150 long-term capital loss for the post-October period of 1988 because it made an election to defer the entire $75 post-October capital loss for 1988 under paragraph (f)(1) of this section. Accordingly, X's taxable income for 1988 will include a net capital gain of $100 and a net short-term capital gain of $160. X must include the $75 long-term capital gain and the $150 long- term capital loss for the post-October period of 1988 in its taxable income for 1989 in addition to the long-term and short- term capital gains and losses for 1989. Accordingly, X's taxable income for 1989 will include a net long-term capital loss of $15 and a net short-term capital gain of $70.

(iii) EARNINGS AND PROFITS. For 1988, X must determine both its earnings and profits and its accumulated earnings and profits without regard to the $75 long-term capital gain and $150 long-term capital loss for the post-October period of 1988. In determining both its earnings and profits and its accumulated earnings and profits for 1989, X must include (in addition to the long-term and short-term capital gains and losses for 1989) the $75 long-term capital gain and $150 long-term capital loss for the post-October period of 1988 as if those deferred gains and losses arose on January 1, 1989. Thus, X will include $260 of capital gain in its earnings and profits for 1988 and $55 of capital gain in its earnings and profits for 1989.

EXAMPLE (4). Same facts as example (2), except that X elects to defer only $50 of the post-October capital loss for 1988 under paragraph (f)(1) of this section for purposes of determining its taxable income for 1988.

(i) CAPITAL GAIN DIVIDENDS. Same results as in example (2).

(ii) TAXABLE INCOME. X must compute its taxable income for 1988 without regard to the $75 long-term capital gain and $125 of the $150 long-term capital loss for the post-October period of 1988 because it made an election to defer $50 of the $75 post-October capital loss for 1988 under paragraph (f)(1) of this section. Accordingly, X's taxable income for 1988 will include a net capital gain of $75 and a net short-term capital gain of $160. X must include the $75 long-term capital gain and $125 of the $150 long-term capital loss for the post-October period of 1988 in its taxable income for 1989 in addition to the long-term and short-term capital gains and losses for 1989. Accordingly, X's taxable income for 1989 will include a net capital gain of $10 and a net short-term capital gain of $70.

(iii) EARNINGS AND PROFITS. X must determine its earnings and profits for 1988 without regard to the $75 long-term capital gain and the $150 long-term capital loss for the post-October period of 1988. X must include $25 of the $150 long-term capital loss for the post-October period of 1988 in determining its accumulated earnings and profits for 1988. In determining both its earnings and profits and its accumulated earnings and profits for 1989, X must include (in addition to the long-term and short-term capital gains and losses for 1989) the $75 long- term capital gain and $125 of the $150 long-term capital loss for the post-October period of 1988 as if those deferred gains and losses arose on January 1, 1989. Thus, X includes $260 of capital gain in its earnings and profits for 1988, includes $235 in its accumulated earnings and profits for 1988, and includes $80 of capital gain in its earnings and profits for 1989.

EXAMPLE (5). X has the following capital gains and losses from sales or exchanges made during the periods indicated:

     Long-term           Short-term

(i) CAPITAL GAIN DIVIDENDS. X may designate up to $100 as a capital gain dividend for 1988 because X must disregard the $150 long-term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and the $150 short-term capital loss for the post-October period of 1988 in computing its net capital gain for this purpose. In computing its net capital gain for 1989 for purposes of determining the amount it may designate as a capital gain dividend for 1989, X must take into account the $150 long-term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and the $150 short-term capital loss for the post-October period of 1988 in addition to the long-term and short-term capital gains and losses for 1989. Accordingly, X may designate up to $105 as a capital gain dividend for 1989.

(ii) TAXABLE INCOME. X must include the $150 long-term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and the $150 short-term capital loss for the post- October period of 1988 in its taxable income for 1988 because it did not make an election under paragraph (f)(1) of this section for 1988. Accordingly, X's taxable income for 1988 will include a net capital gain of $135 (consisting of a net long-term capital gain of $175 and a net short-term capital loss of $40). X's taxable income for 1989 will include a net capital gain of $60 and a net short-term capital gain of $70.

(iii) EARNINGS AND PROFITS. X must determine its earnings and profits for 1988 without regard to the $150 long-term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and the $150 short-term capital loss for the post- October period of 1988. X must, however, include the $150 long- term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and the $150 short-term capital loss for the post-October period of 1988 in determining its accumulated earnings and profits for 1988. Thus, X includes $160 of capital gain in its earnings and profits for 1988, includes $135 in its accumulated earnings and profits for 1988, and includes $130 of capital gain in its earnings and profits for 1989.

EXAMPLE (6). Same facts as example (5), except that X elects to defer the entire $25 post-October capital loss for 1988 under paragraph (f)(1) of this section for purposes of determining its taxable income for 1988.

(i) CAPITAL GAIN DIVIDENDS. Same result as in example (5).

(ii) TAXABLE INCOME. X must compute its taxable income for 1988 without regard to the $150 long-term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and the $150 short-term capital loss for the post-October period of 1988 because it made an election to defer the entire $25 post-October capital loss for 1988 under paragraph (f)(1) of this section. Accordingly, X's taxable income for 1988 will include a net capital gain of $100 and a net short-term capital gain of $60. X must include the $150 long-term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and the $150 short-term capital loss for the post-October period of 1988 in its taxable income for 1989 in addition to the long-term and short-term capital gains and losses for 1989. Accordingly, X's taxable income for 1989 will include a net capital gain of $105 (consisting of a net long-term capital gain of $135 and a net short-term capital loss of $30).

(iii) EARNINGS AND PROFITS. For 1988, X must determine both its earnings and profits and its accumulated earnings and profits without regard to the $150 long-term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and the $150 short-term capital loss for the post-October period of 1988. In determining both its earnings and profits and its accumulated earnings and profits for 1989, X must include (in addition to the long-term and short-term capital gains and losses for 1989) the $150 long-term capital gain, the $75 long- term capital loss, the $50 short-term capital gain, and the $150 short-term capital loss for the post-October period of 1988 as if those deferred gains and losses arose on January 1, 1989. Thus, X will include $160 of capital gain in its earnings and profits for 1988 and $105 of capital gain in its earnings and profits for 1989.

EXAMPLE (7). Same facts as example (5), except that X elects to defer only $20 of the post-October capital loss for 1988 under paragraph (f)(1) of this section for purposes of determining its taxable income for 1988.

(i) CAPITAL GAIN DIVIDENDS. Same result as in example (5).

(ii) TAXABLE INCOME. X must compute its taxable income for 1988 by including $5 of the $150 short-term capital loss for the post-October period of 1988, but without regard to the $150 long-term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and $145 of the $150 short-term capital loss for the post-October period of 1988 because it made an election to defer $20 of the $25 post-October capital loss for 1988 under paragraph (f)(1) of this section. Accordingly, X's taxable income for 1988 will include a net capital gain of $100 and a net short-term capital gain of $55. X must include the $150 long-term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and $145 of the $150 short-term capital loss for the post-October period of 1988 in its taxable income for 1989 in addition to the long-term and short-term capital gains and losses for 1989. Accordingly, X's taxable income for 1989 will include a net capital gain of $110 (consisting of a long-term capital gain of $135 and a net short- term capital loss of $25).

(iii) EARNINGS AND PROFITS. X must determine its earnings and profits for 1988 without regard to the $150 long-term capital gain, the $75 long-term capital loss, the $50 short-term capital gain, and the $150 short-term capital loss for the post- October period of 1988. In determining its accumulated earnings and profits for 1988, X must include $5 of the $150 short-term capital loss for the post-October period of 1988. In determining its accumulated earnings and profits for 1989, X must include (in addition to the long-term and short-term capital gains and losses for 1989) the $150 long-term capital gain, the $75 long- term capital loss, the $50 short-term capital gain, and $145 of the $150 short-term capital loss for the post-October period of 1988 as if those deferred gains and losses arose on January 1, 1989. Thus, X includes $160 of capital gain in its earnings and profits for 1988, includes $155 in its accumulated earnings and profits for 1988, and includes $110 of capital gain in its earnings and profits for 1989.

EXAMPLE (8). X has the following capital gains and losses from sales or exchanges made during the periods indicated:

     Long-term      Short-term

(i) CAPITAL GAIN DIVIDENDS. X may designate up to $100 as a capital gain dividend for 1988 because X must disregard the $15 long-term capital gain, the $75 long-term capital loss, the $25 short-term capital gain, and the $10 short-term capital loss for the post-October period of 1988 in computing its net capital gain for this purpose. In computing its net capital gain for 1989 for purposes of determining the amount it may designate as a capital gain dividend for 1989, X must take into account the $15 long-term capital gain, the $75 long-term capital loss, the $25 short-term capital gain, and the $10 short-term capital loss for the post-October period of 1988 in addition to the long-term and short-term capital gains and losses for 1989. Accordingly, X may designate up to $85 as a capital gain dividend for 1989.

(ii) TAXABLE INCOME. X must include the $15 long-term capital gain, the $75 long-term capital loss, the $25 short-term capital gain, and the $10 short-term capital loss for the post- October period of 1988 in its taxable income for 1988 because it did not make an election under paragraph (f)(1) of this section for 1988. Accordingly, X's taxable income for 1988 will include a net capital gain of $40 and a net short-term capital gain of $75. X's taxable income for 1989 will include a net capital gain of $130 for 1989 (consisting of a net long-term capital gain of $160 and a net short-term capital loss of $30).

(iii) EARNINGS AND PROFITS. X must determine its earnings and profits for 1988 without regard to the $15 long-term capital gain, the $75 long-term capital loss, the $25 short-term capital gain, and the $10 short-term capital loss for the post-October period of 1988. X must, however, include the $15 long-term capital gain, the $75 long-term capital loss, the $25 short-term capital gain, and the $10 short-term capital loss for the post- October period of 1988 in determining its accumulated earnings and profits for 1988. Thus, X includes $160 of capital gain in its earnings and profits for 1988, includes $115 in its accumulated earnings and profits for 1988, and includes $130 of capital gain in its earnings and profits for 1989.

EXAMPLE (9). Same facts as example (8), except that X elects to defer the entire $45 post-October capital loss for 1988 under paragraph (f)(1) of this section for purposes of determining its taxable income for 1988.

(i) CAPITAL GAIN DIVIDENDS. Same result as in example (8).

(ii) TAXABLE INCOME. X must compute its taxable income for 1988 without regard to the $15 long-term capital gain, the $75 long-term capital loss, the $25 short-term capital gain, and the $10 short-term capital loss for the post-October period of 1988 because it made an election to defer the entire $45 post-October capital loss for 1988 under paragraph (f)(1) of this section. Accordingly, X's taxable income for 1988 will include a net capital gain of $100 and a net short-term capital gain of $60. X must include the $15 long-term capital gain, the $75 long-term capital loss, the $25 short-term capital gain, and the $10 short-term capital loss for the post-October period of 1988 in its taxable income for 1989 in addition to the long-term and short-term capital gains and losses for 1989. Accordingly, X's taxable income for 1989 will include a net capital gain of $85 (consisting of a net long-term capital gain of $100 and a net short-term capital loss of $15).

(iii) EARNINGS AND PROFITS. For 1988, X must determine both its earnings and profits and its accumulated earnings and profits without regard to the $15 long-term capital gain, the $75 long-term capital loss, the $25 short-term capital gain, and the $10 short-term capital loss for the post-October period of 1988. In determining both its earnings and profits and its accumulated earnings and profits for 1989, X must include (in addition to the long-term and short-term capital gains and losses for 1989) the $15 long-term capital gain, the $75 long- term capital loss, the $25 short-term capital gain, and the $10 short-term capital loss for the post-October period of 1988 as if those deferred gains and losses arose on January 1, 1989. Thus, X will include $160 of capital gain in its earnings and profits for 1988 and $85 of capital gain in its earnings and profits for 1989.

EXAMPLE (10). Same facts as example (8), except that X elects to defer only $30 of the post-October capital loss for 1988 under paragraph (f)(1) of this section for purposes of determining its taxable income for 1988.

(i) CAPITAL GAIN DIVIDENDS. Same result as in example (8).

(ii) TAXABLE INCOME. X must compute its taxable income for 1988 by including $5 of the $75 long-term capital loss and the $10 short-term capital loss for the post-October period of 1988, but without regard to the $15 long-term capital gain, $70 of the $75 long-term capital loss, and the $25 short-term capital gain for the post-October period of 1988 because it made an election to defer $30 of the $45 post-October capital loss for 1988 under paragraph (f)(1) of this section. Accordingly, X's taxable income for 1988 will include a net capital gain of $95 and a net short-term capital gain of $50. X must include the $15 long-term capital gain, $70 of the $75 long-term capital loss, and the $25 short-term capital gain for the post-October period of 1988 in its taxable income for 1989 in addition to the long-term and short-term capital gains and losses for 1989. Accordingly, X's taxable income for 1989 will include a net capital gain of $100 (consisting of a net long-term capital gain of $105 and a net short-term capital loss of $5).

(iii) EARNINGS AND PROFITS. X must determine its earnings and profits for 1988 without regard to the $15 long-term capital gain, the $75 long-term capital loss, the $25 short-term capital gain, and the $10 short-term capital loss for the post-October period of 1988. In determining its accumulated earnings and profits for 1988, X must include $5 of the $75 long-term capital loss and the $10 short-term capital loss for the post-October period of 1988. In determining both its earnings and profits and its accumulated earnings and profits for 1989, X must include (in addition to the long-term and short-term capital gains and losses for 1989) the $15 long-term capital gain, $70 of the $75 long-term capital loss, and the $25 short-term capital gain for the post-October period of 1988 as if those deferred gains and losses arose on January 1, 1989. Thus, X includes $160 of capital gain in its earnings and profits for 1988, includes $145 in its accumulated earnings and profits for 1989, and includes $100 of capital gain in its earnings and profits for 1989 (consisting of a net long-term capital gain of $105 and a net short-term capital loss of $5).

EXAMPLE (11). X has the following foreign currency gains and losses attributable to transactions during the periods indicated:

 01/01-10/31/88                        200

(i) TAXABLE INCOME. X must compute its taxable income for 1988 by including the $100 foreign currency loss for the post- October period of 1988 because it did not make an election under paragraph (f)(1) of this section. Accordingly, X's taxable income for 1988 will include a net foreign currency gain of $100. X's taxable income for 1989 will include a net foreign currency gain of $150.

(ii) EARNINGS AND PROFITS. X must determine its earnings and profits for 1988 without regard to the foreign currency loss for the post-October period of 1988. X must, however, include the $100 foreign currency loss for the post-October period of 1988 in determining its accumulated earnings and profits for 1988. Thus, X includes $200 of foreign currency gain in its earnings and profits for 1988, includes $100 in its accumulated earnings and profits for 1988, and includes $150 of foreign currency gain in its earnings and profits for 1989.

EXAMPLE (12). Same facts as example (11), except that X elects to defer the entire $100 post-October currency loss for 1988 under paragraph (f)(1) of this section for purposes of determining its taxable income for 1988.

(i) TAXABLE INCOME. X must compute its taxable income for 1988 without regard to the $100 foreign currency loss for the post-October period of 1988 because it made an election to defer the entire $100 post-October currency loss for 1988 under paragraph (f)(1) of this section. Accordingly, X's taxable income for 1988 will include a net foreign currency gain of $200. X's taxable income for 1989 will include a net foreign currency gain of $50 because X must compute its taxable income for 1989 by including the $100 foreign currency gain for the post-October period of 1988 in addition to the foreign currency gains and losses for 1989.

(ii) EARNINGS AND PROFITS. For 1988, X must determine both its earnings and profits and its accumulated earnings and profits without regard to the $100 foreign currency loss for the post-October period of 1988. In determining both its earnings and profits and its accumulated earnings and profits for 1989, X must include (in addition to the foreign currency gains and losses for 1989) the $100 foreign currency loss for the post- October period of 1988 as if that deferred loss arose on January 1, 1989. Thus, X will include $200 of foreign currency gain in its earnings and profits for 1988 and $50 of foreign currency gain in its earnings and profits for 1989.

EXAMPLE (13). Same facts as example (11), except that X elects to defer only $75 of the post-October currency loss under paragraph (f)(1) of this section for purposes of determining its taxable income for 1988.

(i) TAXABLE INCOME. X must compute its taxable income for 1988 by including $25 of the $100 foreign currency loss for the post-October period of 1988, but without regard to $75 of the $100 foreign currency loss for the post-October period of 1988 because it made an election to defer $75 of the $100 post- October currency loss for 1988 under paragraph (f)(1) of this section. Accordingly, X's taxable income for 1988 will include a net foreign currency gain of $175. X's taxable income will include a net foreign currency gain of $75 for 1989 because X must compute its taxable income for 1989 by including $75 of the $100 foreign currency loss for the post-October period of 1988 in addition to the foreign currency gains and losses for 1989.

(ii) EARNINGS AND PROFITS. X must determine its earnings and profits for 1988 without regard to the $100 foreign currency loss for the post-October period of 1988. X must, however, include $25 of the $100 foreign currency loss for the post- October period of 1988 in determining its accumulated earnings and profits for 1988. In determining both its earnings and profits and its accumulated earnings and profits for 1989, X must include (in addition to the foreign currency gains and losses for 1989) the $75 of the $100 foreign currency loss for the post-October period of 1988 as if that loss arose on January 1, 1989. Thus, X includes $200 of foreign currency gain in its earnings and profits for 1988, includes $175 in its accumulated earnings and profits for 1988, and includes $75 of foreign currency gain in its earnings and profits for 1989.

(i) PROCEDURE FOR MAKING ELECTION -- (1) IN GENERAL. Except as provided in paragraph (i)(2) of this section, a regulated investment company may make an election under paragraph (f)(1) of this section for a taxable year to which this section applies by completing its income tax return (including any necessary schedules) for that taxable year in accordance with the instructions for the form that are applicable to the election.

(2) WHEN APPLICABLE INSTRUCTIONS NOT AVAILABLE. If the instructions for the income tax returns of regulated investment companies for a taxable year to which this section applies do not reflect the provisions of this section, a regulated investment company may make an election under paragraph (f)(1) of this section for that year by entering the appropriate amounts on its income tax return (including any necessary schedules) for that year, and by attaching a written statement to the return that states --

(i) The taxable year for which the election under this section is made;

(ii) The fact that the regulated investment company elects to defer all or a part of its post-October capital loss or post-October currency loss for that taxable year for purposes of computing its taxable income under the terms of this section;

(iii) The amount of the post-October capital loss or post- October currency loss that the regulated investment company elects to defer for that taxable year; and

(iv) The name, address, and employer identification number of the regulated investment company.

(j) TRANSITION RULES -- (1) IN GENERAL. For a taxable year ending before March 2, 1990 in which a regulated investment company incurred a post-October capital loss or post-October currency loss, the company may use any method that is consistently applied and in accordance with reasonable business practice to determine the amounts taken into account in that taxable year for purposes of paragraphs (e)(2), (f)(3), and (g) of this section and to determine the amount taken into account in the succeeding year for purposes of paragraphs (e)(3), (f)(4), and (g) of this section. For example, for purposes of paragraph (e), a taxpayer may use a method that treats as incurred in a taxable year all capital gains from sales or exchanges after October 31 of that year and an amount of capital loss for such period equal to the amount of such gains and that treats the remaining amount of capital loss for such period as arising on the first day of the succeeding year. Similarly, for purposes of paragraph (e)(3), a taxpayer may use a method that treats as arising on the first day of the succeeding year only the excess of the capital losses from sales or exchanges after October 31 over the capital gains for such period (that is, the net capital loss or net long-term capital loss for such period).

(2) RETROACTIVE ELECTION -- (i) IN GENERAL. A regulated investment company may make an election under paragraph (f)(1) for a taxable year with respect to which it has filed an income tax return on or before May 1, 1990 (a "retroactive election") by filing an amended return (including any necessary schedules) for that taxable year reflecting the appropriate amounts and by attaching a written statement to the return that complies with the requirements of paragraph (i)(2) of this section.

(ii) DEADLINE FOR MAKING ELECTION. A retroactive election may be made no later than December 31, 1990.

(3) AMENDED RETURN REQUIRED FOR SUCCEEDING YEAR IN CERTAIN CIRCUMSTANCES -- (i) IN GENERAL. If, at the time a regulated investment company makes a retroactive election under this section, it has already filed an income tax return for the succeeding year, the company must file an amended return for such succeeding year reflecting the appropriate amounts.

(ii) TIME FOR FILING AMENDED RETURN. An amended return required under paragraph (j)(3)(i) of this section must be filed together with the amended return described in paragraph (j)(2)(i).

(4) RETROACTIVE DIVIDEND. A regulated investment company that makes a retroactive election under this section for a taxable year may pay a dividend (a "retroactive dividend") with respect to that taxable year.

(5) DEDUCTION FOR DIVIDENDS PAID -- (i) IN GENERAL. Subject to the rules of sections 561 and 562, a regulated investment company shall include the amount of any retroactive dividend paid under paragraph (j)(4) of this section in computing its deduction for dividends paid for the year to which the retroactive dividend relates.

(ii) DECLARATION AND PAYMENT DATE. A retroactive dividend must be declared with respect to a taxable year on or before the date a retroactive election is made for that year under this section, and must be paid (or treated as paid under section 852(b)(7)) on or before December 31, 1990. No deduction for dividends paid shall be allowed under paragraph (j)(5)(i) of this section for any amount not paid (or treated as paid) on or before December 31, 1990.

(iii) LIMITATION ON ORDINARY DIVIDENDS. The amount of retroactive dividends (other than retroactive dividends qualifying as capital gain dividends) paid for a taxable year with respect to which a retroactive election is made under this section shall not exceed the increase, if any, in the investment company taxable income of the regulated investment company (determined without regard to the deduction for dividends paid (as defined in section 561)) that is attributable solely to the regulated investment company having made such election.

(iv) LIMITATION ON CAPITAL GAIN DIVIDENDS. The amount of retroactive dividends qualifying as capital gain dividends paid for a taxable year with respect to which a retroactive election was made under this section shall not exceed the increase, if any, in the amount of the excess described in section 852(b)(3)(A) (relating to the excess of the net capital gain over the deduction for capital gain dividends paid) that is attributable solely to the regulated investment company having made such election.

(v) EFFECT ON OTHER YEARS. A retroactive dividend shall not be includible in computing the deduction for dividends paid for --

(A) The taxable year in which such distribution is actually paid (or treated as paid under section 852(b)(7)); or

(B) Under section 855(a), the taxable year preceding the taxable year with respect to which a retroactive election was made.

(vi) EXAMPLE. The provisions of this paragraph (j)(5) may be illustrated by the following example:

EXAMPLE. X is a regulated investment company that computes its income on a calendar year basis. No election is in effect under section 4982(e)(4). X has the following income for 1988:

    FOREIGN CURRENCY GAINS AND LOSSES:

(ii) If X makes a retroactive election under this section to defer the entire $75 post-October currency loss and the entire $50 post-October capital loss for the post-October period of its 1988 taxable year for purposes of computing its taxable income, that deferral increases X's investment company taxable income for 1988 by $25 (due to an increase in foreign currency gain of $75 and a decrease in short-term capital gain of $50) to $200 and increases the excess described in section 852(b)(3)(A) for 1988 by $100 from $0 to $100. The amount that X may distribute as a retroactive dividend is limited to $25, and the amount that X may distribute as a retroactive capital gain dividend is limited to $100.

(k) EFFECTIVE DATE. The provisions of this section shall apply to taxable years ending after October 31, 1987.

PART 602 -- OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 3. The authority for Part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 4. Section 602.101(c) is amended by inserting in the appropriate place in the table:

"1.852-11T . . . 1545-1094".

* * * * *

There is a need for immediate guidance with respect to the provisions contained in this Treasury decision. For this reason, it is impracticable to issue this Treasury decision with notice and public procedure under section (b) of section 553 of Title 5 of the United States Code or subject to the effective date limitation of subsection (d) of that section.