Sec. 1.163(j)-10 Allocation of interest expense, interest income, and other items of expense and gross income to an excepted trade or business.

(i) Purposes. Except as provided in §1.163(j)-6(m) or §1.163(j)-9(h), this section provides the exclusive rules for allocating tax items that are properly allocable to a trade or business between excepted trades or businesses and non-excepted trades or businesses for purposes of section 163(j). The amount of a taxpayer’s interest expense that is properly allocable to excepted trades or businesses is not subject to the section 163(j) limitation. The amount of a taxpayer’s other items of income, gain, deduction, or loss, including interest income, that is properly allocable to excepted trades or businesses is excluded from the calculation of the taxpayer’s section 163(j) limitation. See section 163(j)(6) and (j)(8)(A)(i); see also §1.163(j)-1(b)(1)(i)(H), (b)(1)(ii)(F), and (b)(3). The general method of allocation set forth in paragraph (c) of this section is based on the approach that money is fungible and that interest expense is attributable to all activities and property, regardless of any specific purpose for incurring an obligation on which interest is paid. In no event may the amount of interest expense allocated under this section exceed the amount of interest paid or accrued, or treated as paid or accrued, by the taxpayer within the taxable year.

(ii) Application of section. The amount of a taxpayer’s tax items properly allocable to a trade or business, other than interest expense and interest income, that is properly allocable to excepted trades or businesses for purposes of section 163(j) is determined as set forth in paragraph (b) of this section. The amount of a taxpayer’s interest expense and interest income that is properly allocable to excepted trades or businesses for purposes of section 163(j) generally is determined as set forth in paragraph (c) of this section, except as otherwise provided in paragraph (d) of this section. For purposes of this section, a taxpayer’s activities are not treated as a separate trade or business to the extent those activities involve the provision of real property, goods, or services to a trade or business of the taxpayer (or, if the taxpayer is a member of a consolidated group, the consolidated group). For example, if a taxpayer engaged in a manufacturing trade or business has in-house legal personnel that provide legal services solely with respect to the taxpayer’s manufacturing business, the taxpayer is not treated as also engaged in the trade or business of providing legal services. Similarly, if the taxpayer described in the previous sentence constructs or acquires real property solely for use by the taxpayer’s manufacturing business, the taxpayer is not treated as also engaged in a real property trade or business.

(i) In general. The rules of this section apply after a taxpayer has determined whether any interest expense or interest income paid, received, or accrued is properly allocable to a trade or business. Similarly, the rules of this section apply to other tax items after a taxpayer has determined whether those items are properly allocable to a trade or business. For instance, a taxpayer must apply §1.163-8T, if applicable, to determine which items of interest expense are investment interest under section 163(d) before applying the rules in paragraph (c) of this section to allocate interest expense between excepted and non-excepted trades or businesses. After determining whether its tax items are properly allocable to a trade or business, a taxpayer that is engaged in both excepted and non-excepted trades or businesses must apply the rules of this section to determine the amount of interest expense that is business interest expense subject to the section 163(j) limitation and to determine which items are included or excluded in computing its section 163(j) limitation.

(ii) Treatment of investment interest, investment income, investment expenses, and certain other tax items of a partnership with a C corporation or tax-exempt corporation as a partner. For rules governing the treatment of investment interest, investment income, investment expenses, and certain other separately stated tax items of a partnership with a C corporation or tax-exempt corporation as a partner, see §§1.163(j)-4(b)(3) and 1.163(j)-6(k).

(i) In general. As provided in §1.163(j)-4(d), the computations required by section 163(j) and the regulations in this part under section 163(j) of the Code generally are made for a consolidated group on a consolidated basis. In this regard, for purposes of applying the allocation rules of this section, all members of a consolidated group are treated as one corporation. Therefore, the rules of this section apply to the activities conducted by the group as if those activities were conducted by a single corporation. For example, the group (rather than a particular member) is treated as engaged in excepted or non-excepted trades or businesses. In the case of intercompany obligations, within the meaning of §1.1502-13(g)(2)(ii), for purposes of allocating asset basis between excepted and non-excepted trades or businesses, the obligation of the member borrower is not considered an asset of the creditor member. Similarly, intercompany transactions, within the meaning of §1.1502-13(b)(1)(i), are disregarded for purposes of this section, as are the resulting offsetting items, and property is allocated to a trade or business based on the activities of the group as if the members of the group were divisions of a single corporation. Further, stock of a group member that is owned by another member of the same group is not treated as an asset for purposes of this section, and the transfer of any amount of member stock to a non-member is treated by the group as a transfer of the member’s assets proportionate to the amount of member stock transferred. Additionally, stock of a corporation that is not a group member is treated as owned by the group.

(ii) Application of excepted business percentage to members of a consolidated group. After a consolidated group has determined the percentage of the group’s interest expense allocable to excepted trades or businesses for the taxable year (and thus not subject to the section 163(j) limitation), this exempt percentage is applied to the interest paid or accrued by each member during the taxable year to any lender that is not a group member. Therefore, except to the extent paragraph (d) of this section (providing rules for certain qualified nonrecourse indebtedness) applies, an identical percentage of the interest paid or accrued by each member of the group to any lender that is not a group member is treated as allocable to excepted trades or businesses, regardless of whether any particular member actually engaged in an excepted trade or business.

(iii) Basis in assets transferred in an intercompany transaction. For purposes of allocating interest expense and interest income under paragraph (c) of this section, the basis of property does not include any gain or loss realized with respect to the property by another member in an intercompany transaction, as defined in §1.1502-13(b), whether or not the gain or loss is deferred.

(i) Applying the allocation rules of this section to all of the taxpayer’s disallowed disqualified interest in the taxable year(s) in which the disallowed disqualified interest was paid or accrued (the historical approach); or

(ii) Treating all of the taxpayer’s disallowed disqualified interest as if it were paid or accrued in the taxpayer’s first taxable year beginning after December 31, 2017 (the effective date approach).

(i) Example 1: Items properly allocable to a trade or business.

(ii) Example 2: Intercompany transaction.

(iii) Example 3: Intercompany sale of natural gas.

(iv) Example 4: Disallowed disqualified interest.

(i) Look-through rule. If a taxpayer receives a dividend, within the meaning of section 316, that is not investment income, within the meaning of section 163(d), and if the taxpayer satisfies the minimum ownership threshold in paragraph (c)(7) of this section, then, solely for purposes of allocating amounts received as a dividend during the taxable year to excepted or non-excepted trades or businesses under this paragraph (b), the dividend income is treated as allocable to excepted or non-excepted trades or businesses based upon the relative amounts of the payor corporation’s adjusted basis in the assets used in its trades or businesses, determined pursuant to paragraph (c) of this section. If at least 90 percent of the payor corporation’s adjusted basis in its assets during the taxable year, determined pursuant to paragraph (c) of this section, is allocable to either excepted trades or businesses or to non-excepted trades or businesses, all of the taxpayer’s dividend income from the payor corporation for the taxable year is treated as allocable to either excepted or non-excepted trades or businesses, respectively.

(ii) Inapplicability of the look-through rule. If a taxpayer receives a dividend that is not investment income, within the meaning of section 163(d), and if the taxpayer does not satisfy the minimum ownership threshold in paragraph (c)(7) of this section, then the taxpayer must treat the dividend as allocable to a non-excepted trade or business.

(i) Non-consolidated C corporations.

(ii) Partnerships and S corporations.

(i) Expenses, losses, and other deductions that are definitely related to a trade or business. Expenses (other than interest expense), losses, and other deductions (collectively, deductions for purposes of this paragraph (b)(5)) that are definitely related to a trade or business are allocable to the trade or business to which they relate. A deduction is considered definitely related to a trade or business if the item giving rise to the deduction is incurred as a result of, or incident to, an activity of the trade or business or in connection with property used in the trade or business (see §1.861-8(b)(2)). If a deduction is definitely related to one or more excepted trades or businesses and one or more non-excepted trades or businesses, the deduction is apportioned between the excepted and non-excepted trades or businesses based upon the relative amounts of the taxpayer’s adjusted basis in the assets used in those trades or businesses, as determined under paragraph (c) of this section.

(ii) Other deductions. Deductions that are not described in paragraph (b)(5)(i) of this section are ratably apportioned based on the gross income of each trade or business.

(i) Example 1: Allocation of income and expense between excepted and non-excepted trades or businesses.

(ii) Example 2: Allocation of partnership items from investment activity.

(i) In general. Except as otherwise provided in this section, §1.163(j)-6(m), or §1.163(j)-9(h), the amount of a taxpayer’s interest expense and interest income that is properly allocable to a trade or business is allocated to the taxpayer’s excepted or non-excepted trades or businesses for purposes of section 163(j) based upon the relative amounts of the taxpayer’s adjusted basis in the assets, as determined under paragraph (c)(5) of this section, used in its excepted or non-excepted trades or businesses. The taxpayer must determine the adjusted basis in its assets as of the close of each determination date, as defined in paragraph (c)(6) of this section, in the taxable year and average those amounts to determine the relative amounts of asset basis for its excepted and non-excepted trades or businesses for that year. It is not necessary to allocate interest expense or interest income under this paragraph (c) for purposes of determining a taxpayer’s business interest expense and business interest income if all of the taxpayer’s interest income and expense is allocable to excepted trades or businesses (in which case the taxpayer is not subject to the section 163(j) limitation) or if all of the taxpayer’s interest income and expense is allocable to non-excepted trades or businesses.

(ii) De minimis exception. If at least 90 percent of the taxpayer’s basis in its assets for the taxable year is allocable to either excepted or non-excepted trades or businesses pursuant to this paragraph (c), then all of the taxpayer’s interest expense and interest income for that year that is properly allocable to a trade or business is treated as allocable to either excepted or non-excepted trades or businesses, respectively.

(i) Facts. T is a calendar-year C corporation engaged in an electing real property trade or business, the business of selling wine, and the business of selling hand-carved wooden furniture. In Year 1, T has $100x of interest expense that is deductible except for the potential application of section 163(j). Based upon determinations made on the determination dates in Year 1, T’s average adjusted basis in the assets used in the electing real property trade or business (an excepted trade or business) in Year 1 is $800x, and T’s total average adjusted basis in the assets used in the other two businesses (which are non-excepted trades or businesses) in Year 1 is $200x.

(ii) Analysis. $80x (($800x / ($800x + $200x)) x $100x) of T’s interest expense for Year 1 is allocable to T’s electing real property trade or business and is not business interest expense subject to the section 163(j) limitation. The remaining $20x of T’s interest expense is business interest expense for Year 1 that is subject to the section 163(j) limitation.

(i) General rule. If an asset is used in more than one trade or business during a determination period, as defined in paragraph (c)(6) of this section, the taxpayer’s adjusted basis in the asset is allocated to each trade or business using the permissible methodology under this paragraph (c)(3) that most reasonably reflects the use of the asset in each trade or business during that determination period. An allocation methodology most reasonably reflects the use of the asset in each trade or business if it most properly reflects the proportionate benefit derived from the use of the asset in each trade or business. A taxpayer is not required to use the same allocation methodology for each type of asset used in a trade a business. Instead, a taxpayer may use different allocation methodologies for different types of assets used in a trade or business. If none of the permissible methodologies set forth in paragraph (c)(3)(ii) of this section reasonably reflects the use of the asset in each trade or business, the taxpayer’s basis in the asset is not taken into account for purposes of this paragraph (c).

(ii) Permissible methodologies for allocating asset basis between or among two or more trades or businesses. Subject to the special rules in paragraphs (c)(3)(iii) and (c)(5) of this section, a taxpayer’s basis in an asset used in two or more trades or businesses during a determination period may be allocated to those trades or businesses based upon--

(iii) Special rules.

(i) Calculation of adjusted basis.

(ii) Partnership interests; stock in non-consolidated C corporations.

(iii) Cash and cash equivalents and customer receivables. Except as otherwise provided in the last sentence of this paragraph (c)(5)(iii), a taxpayer’s basis in its cash and cash equivalents and customer receivables is not taken into account for purposes of this paragraph (c). This rule also applies to a lower-tier entity if a taxpayer looks through to the assets of that entity under paragraph (c)(5)(ii) of this section. For purposes of this paragraph (c)(5)(iii), the term cash and cash equivalents includes cash, foreign currency, commercial paper, any interest in an investment company registered under the Investment Company Act of 1940 (1940 Act) and regulated as a money market fund under 17 CFR 270.2a-7 (Rule 2a-7 under the 1940 Act), any obligation of a government, and any derivative that is substantially secured by an obligation of a government, or any similar asset. For purposes of this paragraph (c)(5)(iii), a derivative is a derivative described in section 59A(h)(4)(A), without regard to section 59A(h)(4)(C). For purposes of this paragraph (c)(5)(iii), the term government means the United States or any agency or instrumentality of the United States; a State, a territory, a possession of the United States, the District of Columbia, or any political subdivision thereof within the meaning of section 103 and §1.103-1; or any foreign government, any political subdivision of a foreign government, or any wholly owned agency or instrumentality of any one of the foregoing within the meaning of §1.1471-6(b). This paragraph (c)(5)(iii) does not apply to an entity that qualifies as a financial services entity as described in §1.904-4(e)(3).

(iv) Deemed asset sale. Solely for purposes of determining the amount of basis allocable to excepted and non-excepted trades or businesses under this section, an election under section 336, 338, or 754, as applicable, is deemed to have been made for any acquisition of corporate stock or partnership interests with respect to which the taxpayer demonstrates, in the information statement required by paragraph (c)(6)(iii)(B) of this section, that the acquisition qualified for such an election and that, immediately before the acquisition, the acquired entity had a regulatory liability for deferred taxes recorded on its books with respect to property predominantly used in an excepted regulated utility trade or business. Any additional basis taken into account under this rule is reduced ratably over a 15-year period beginning with the month of the acquisition and is not subject to the anti-abuse rule in paragraph (c)(8) of this section.

(v) Other adjustments. The Commissioner may make appropriate adjustments to prevent a taxpayer from intentionally and artificially increasing its basis in assets attributable to an excepted trade or business.

(i) Determination dates and determination periods.

(ii) Application of look-through rules. If a taxpayer that applies the look-through rules of paragraph (c)(5)(ii) of this section has a different taxable year than the partnership or non-consolidated C corporation to which the taxpayer is applying those rules, then, for purposes of this paragraph (c)(6), the taxpayer must use the most recent asset basis figures from the partnership or non-consolidated C corporation. For example, assume that PS1 is a partnership with a May 31 taxable year, and that C (a calendar-year C corporation that is ineligible to use the annual determination method for the taxable year) is a partner in PS1. PS1’s determination dates are February 28, May 31, August 31, and November 30. In turn, C’s determination dates are March 31, June 30, September 30, and December 31. If C looks through to PS1’s basis in its assets under paragraph (c)(5)(ii) of this section, then, for purposes of determining the amount of C’s asset basis that is attributable to its excepted and non-excepted businesses on March 31, C must use PS1’s asset basis calculations for February 28.

(iii) Reporting requirements.

(iv) Failure to file statement. If a taxpayer fails to file the statement described in paragraph (c)(6)(iii) of this section or files a statement that does not comply with the requirements of paragraph (c)(6)(iii) of this section, the Commissioner may treat the taxpayer as if all of its interest expense is properly allocable to a non-excepted trade or business, unless the taxpayer shows that there was reasonable cause for failing to comply with, and the taxpayer acted in good faith with respect to, the requirements of paragraph (c)(6)(iii) of this section, taking into account all pertinent facts and circumstances.

(i) Corporations.

(ii) Partnerships. A partner may look through to the assets of a partnership under paragraph (c)(5)(ii) of this section for purposes of allocating the partner’s basis in its partnership interest between excepted and non-excepted trades or businesses regardless of the partner’s direct and indirect interest in the partnership.

(iii) Inapplicability of look-through rule. For circumstances in which a taxpayer that satisfies the ownership threshold in this paragraph (c)(7) may not apply the look-through rules in paragraphs (b)(3) and (c)(5)(ii) of this section, see paragraph (c)(5)(ii)(D) of this section.

(i) Facts. T conducts an electing real property trade or business (Business X) and operates a retail store that is a non-excepted trade or business (Business Y). In Year 1, T issues Note A to a third party in exchange for $1,000x for the purpose of acquiring Building B. Note A is qualified nonrecourse indebtedness (within the meaning of §1.861-10T(b)) secured by Building B. T then uses those funds to acquire Building B for $1,200x, and T uses Building B in Business X. During Year 1, T pays $500x of interest, of which $100x is interest payments on Note A. For Year 1, T’s basis in its assets used in Business X (as determined under paragraph (c) of this section) is $3,600x (excluding cash and cash equivalents), and T’s basis in its assets used in Business Y (as determined under paragraph (c) of this section) is $800x (excluding cash and cash equivalents). Each of Business X and Business Y also has $100x of cash and cash equivalents.

(ii) Analysis. Because Note A is qualified nonrecourse indebtedness that is secured by Building B, in allocating interest expense between Businesses X and Y, T first must directly allocate the $100x of interest expense it paid with respect to Note A to Business X in accordance with paragraph (d)(2) of this section. Thereafter, T must allocate the remaining $400x of interest expense between Businesses X and Y under paragraph (c) of this section. After excluding $1,000x of T’s basis in Building B to reflect the amount of Note A (see paragraph (d)(4) of this section), and without regard to T’s $200x of cash and cash equivalents (see paragraph (c)(5)(iii) of this section), T’s basis in its assets used in Businesses X and Y is $2,600x and $800x (76.5 percent and 23.5 percent), respectively. Thus, $306x of the remaining $400x of interest expense would be allocated to Business X, and $94x would be allocated to Business Y.

(i) Facts. S is a member of a consolidated group of which P is the common parent. P conducts an electing real property trade or business (Business X), and S conducts a non-excepted trade or business (Business Y). In Year 1, P pays or accrues (without regard to section 163(j)) $35x of interest expense and receives $10x of interest income, and S pays or accrues (without regard to section 163(j)) $115x of interest expense and receives $5x of interest income (for a total of $150x of interest expense and $15x of interest income). For purposes of this example, assume that, pursuant to paragraph (c) of this section, $30x of the P group’s interest expense and $3x of the P group’s interest income is allocable to Business X, and the remaining $120x of interest expense and $12x of interest income is allocable to Business Y.

(ii) Analysis. Under paragraph (a)(4) of this section, 20 percent of the P group’s Year 1 interest expense ($30x / $150x) and interest income ($3x / $15x) is allocable to an excepted trade or business. Thus, $7x ($35x x 20 percent) of P’s interest expense and $2x ($10x x 20 percent) of P’s interest income is allocable to an excepted trade or business. The remaining $28x of P’s interest expense is business interest expense subject to the section 163(j) limitation, and the remaining $8x of P’s interest income is business interest income that increases the group’s section 163(j) limitation. In turn, $23x ($115x x 20 percent) of S’s interest expense and $1x ($5x x 20 percent) of S’s interest income is allocable to an excepted trade or business. The remaining $92x of S’s interest expense is business interest expense subject to the section 163(j) limitation, and the remaining $4x of S’s interest income is business interest income that increases the group’s section 163(j) limitation.

(i) Facts. S is a member of a consolidated group of which P is the common parent. P conducts an electing real property trade or business (Business X), and S conducts a non-excepted trade or business (Business Y). In Year 1, P pays or accrues (without regard to section 163(j)) $50x of interest expense, and S pays or accrues $100x of interest expense (without regard to section 163(j)). P leases 40 percent of space in Building V (which P owns) to S for use in Business Y, and P leases the remaining 60 percent of space in Building V to third parties. For purposes of allocating interest expense under paragraph (c) of this section, the P group’s basis in its assets (excluding Building V) used in Businesses X and Y is $180x and $620x, respectively. The P group’s basis in Building V for purposes of allocating interest expense under paragraph (c) of this section is $200x.

(ii) Analysis. Under paragraph (c)(3)(ii) of this section, the P group’s basis in Building V ($200x) is allocated to excepted and non-excepted trades or businesses in accordance with the use of space by Business Y (40 percent) and Business X (the remainder, or 60 percent). Accordingly, $120x of the basis in Building V is allocated to excepted trades or businesses (60 percent x $200x), and $80x is allocated to non-excepted trades or businesses (40 percent x $200x). After allocating the basis in Building V, the P group’s total basis in the assets used in excepted and non-excepted trades or businesses is $300x and $700x, respectively. Under paragraphs (a)(4) and (c) of this section, 30 percent ($300x / $1,000x) of the P group’s Year 1 interest expense is properly allocable to an excepted trade or business. Thus, $15x ($50x x 30 percent) of P’s interest expense is properly allocable to an excepted trade or business, and the remaining $35x of P’s interest expense is business interest expense subject to the section 163(j) limitation. In turn, $30x ($100x x 30 percent) of S’s interest expense is properly allocable to an excepted trade or business, and the remaining $70x of S’s interest expense is business interest expense subject to the section 163(j) limitation.

(i) Facts.

(ii) Analysis.

(i) Facts. P is the common parent of a consolidated group of which A and B are the only other members. A conducts an electing real property trade or business (Business X), and B conducts a non-excepted trade or business (Business Y). In Year 1, A pays or accrues (without regard to section 163(j)) $50x of interest expense and earns $70x of gross income in the conduct of Business X, and B pays or accrues (without regard to section 163(j)) $100x of interest expense and earns $150x of gross income in the conduct of Business Y. B owns Building V, which it uses in Business Y. For purposes of allocating the P group’s Year 1 business interest expense between excepted and non-excepted trades or businesses under paragraph (c) of this section, the P group’s basis in its assets (other than Building V) used in Businesses X and Y is $180x and $620x, respectively, and the P group’s basis in Building V is $200x. At the end of Year 1, B sells Building V to a third party and realizes a gain of $60x in addition to the $150x of gross income B earned that year from the conduct of Business Y.

(ii) Analysis.

(iii) Intercompany transaction. The facts are the same as in Example 4 in paragraph (e)(4)(i) of this section, except that A owns Building V and leases it to B in Year 1 for $20x for use in Business Y, and A sells Building V to a third party for a $60 gain at the end of Year 1. Under paragraphs (a)(4) and (c) of this section, all members of the P group are treated as a single corporation. As a result, the P group’s basis in its assets used in its trades or businesses is allocated between the P group’s excepted trade or business (Business X) and its non-excepted trade or business (Business Y) as though these trades or businesses were conducted by a single corporation. A lease between two divisions of a single corporation would produce no rental income or expense. Thus, the $20x of rent paid by B to A does not affect the P group’s ATI. Moreover, under paragraph (c) of this section, Building V is an asset used in the P group’s non-excepted trade or business (Business Y). Accordingly, although A owns Building V, the basis in Building V is added to the P group’s basis in assets used in Business Y for purposes of allocating interest expense under paragraph (c) of this section. In the same vein, when A sells Building V to a third party at a gain of $60x, the gain is included in the P group’s ATI because Building V was used in a non-excepted trade or business of the P group (Business Y) prior to its sale.

(i) Facts. S and T are members of a consolidated group of which P is the common parent. P conducts an electing real property trade or business (Business X), S conducts a non-excepted trade or business (Business Y), and T provides transportation services to Businesses X and Y but does not have any customers outside of the P group. For Year 1, T provides transportation services using a single bus with a basis of $120x.

(ii) Analysis. Under paragraph (a)(4) of this section, activities conducted by a consolidated group are treated as though those activities were conducted by a single corporation. Because the activities of T are limited to providing intercompany transportation services, T does not conduct a trade or business for purposes of section 163(j). Under paragraph (c)(3) of this section, business interest expense is allocated to excepted and non-excepted trades or businesses based on the relative basis of the assets used in those businesses. The basis in T’s only asset, a bus, is therefore allocated between Business X and Business Y according to the use of T’s bus by these businesses. Business X uses one-third of T’s services, and Business Y uses two-thirds of T’s services. Thus, $40x of the basis of T’s bus is allocated to Business X, and $80x of the basis of T’s bus is allocated to Business Y.

(i) Facts. P, S, T, and U are domestic C corporations that are not members of a consolidated group. P directly owns 80 percent of the stock of each of S and T as measured by total voting power and value; an unrelated third party, X, owns the remaining 20 percent. In turn, S and T directly own 15 percent and 80 percent, respectively, of the stock of U as measured by total voting power and value; P directly owns the remaining 5 percent. P conducts both excepted and non-excepted trades or businesses. S and T conduct only non-excepted trades or businesses, and U conducts both excepted and non-excepted trades or businesses.

(ii) Analysis. Under paragraph (c)(7)(i)(A) of this section, a shareholder must look through to the assets of a domestic non-consolidated C corporation for purposes of allocating the shareholder’s basis in its stock in the corporation between excepted and non-excepted trades or businesses if the shareholder’s direct and indirect interest in the corporation satisfies the ownership requirements of section 1504(a)(2). For purposes of paragraph (c)(7)(i)(A) of this section, a shareholder’s stock ownership is determined by applying the constructive ownership rules of section 318(a). P directly owns 80 percent of each of S and T as measured by total voting power and value; thus, P must look through to the assets of S and T when allocating the basis in its stock of S and T. P directly owns 5 percent of the stock of U as measured by total voting power and value, and P constructively owns the other 95 percent; thus, P also must look through to U’s assets when allocating the basis in its U stock. S directly owns 15 percent of the stock of U, and S constructively owns only 5 percent through P; thus, S cannot look through to U’s assets when allocating the basis in its U stock. T directly owns 80 percent of the stock of U, and T constructively owns an additional 5 percent; thus, T must look through to U’s assets when allocating the basis in its U stock.

(iii) Dividend. The facts are the same as in paragraph (e)(6)(i) of this section, except that U distributes a $160x dividend pro rata to its shareholders. Thus, P receives $8x (5 percent of $160x) of the U dividend, S receives $24x (15 percent of $160x), and T receives $128x (80 percent of $160x). Under paragraph (c)(7)(i)(B) of this section, if a shareholder’s direct interest in a corporation satisfies the ownership requirements of section 1504(a)(2), the shareholder must look through to the activities of a domestic non-consolidated C corporation in determining whether dividend income is from an excepted or non-excepted trade or business. The constructive ownership rules do not apply in allocating dividends under paragraph (c)(7)(i)(B) of this section. P directly owns 5 percent of the stock of U as measured by vote and value, and S directly owns 15 percent of the stock of U as measured by vote and value; thus, neither P nor S is required to apply the look-through rules in allocating its dividend income from U, and all such income is allocable to non-excepted trades or businesses. T directly owns 80 percent of the stock of U as measured by vote and value; thus, T must allocate its U dividend in accordance with the activities of U’s excepted and non-excepted trades or businesses.

(i) Facts. U and V are members of a consolidated group of which P is the common parent. U conducts an electing farming business (Business F), and V conducts a farm equipment leasing business (Business L) that is a non-excepted trade or business. After the end of a farming season, the P group, with a principal purpose of shifting basis from Business L to Business F, has V sell to U all off-lease farming equipment that previously was leased out as part of Business L. Immediately before the start of the next season, U sells the farming equipment back to V for use in Business L.

(ii) Analysis. Under paragraph (c)(8) of this section, in the case of a disposition of assets undertaken with a principal purpose of artificially shifting the amount of basis allocable to excepted or non-excepted trades or businesses on a determination date, the additional basis or change in use will not be taken into account. Because V’s sale of farming equipment to U for storage in Business F’s facilities is undertaken with a principal purpose of shifting basis from Business L to Business F, the additional basis Business F receives from these transactions will not be taken into account for purposes of this section. Instead, the basis of the farming equipment will be allocated as though the farming equipment continued to be used in Business L.