Sec. 1.163(j)-6 Application of the section 163(j) limitation to partnerships and subchapter S corporations.

(i) Non-excepted assets and excepted assets; or

(ii) Investment assets; or

(iii) Both.

(i) Business interest income from a partnership that is subject to section 163(j), except to the extent the partner is allocated excess business interest income from that partnership pursuant to paragraph (f)(2) of this section; and

(ii) The partner’s allocable share of the partnership’s floor plan financing interest expense, because such floor plan financing interest expense already has been taken into account by the partnership in determining its nonseparately stated taxable income or loss for purposes of section 163(j).

(i) In general. The purpose of this paragraph is to provide guidance regarding how a partnership must allocate its deductible business interest expense and section 163(j) excess items, if any, among its partners. For purposes of section 163(j)(4) and this section, allocations and determinations of deductible business interest expense and section 163(j) excess items are considered made in the same manner as the nonseparately stated taxable income or loss of the partnership if, and only if, such allocations and determinations are made in accordance with the eleven-step computation set forth in paragraphs (f)(2)(i) through (xi) of this section. A partnership first determines its section 163(j) limitation, total amount of deductible business interest expense, and section 163(j) excess items under paragraph (f)(2)(i) of this section. The partnership then applies paragraphs (f)(2)(ii) through (xi) of this section, in that order, to determine how those items of the partnership are allocated among its partners. At the conclusion of the eleven-step computation set forth in paragraphs (f)(2)(i) through (xi) of this section, the total amount of deductible business interest expense and section 163(j) excess items allocated to each partner will equal the partnership’s total amount of deductible business interest expense and section 163(j) excess items.

(ii) Relevance solely for purposes of section 163(j). No rule set forth in paragraph (f)(2) of this section prohibits a partnership from making an allocation to a partner of any item of partnership income, gain, loss, or deduction that is otherwise permitted under section 704 and the regulations under section 704 of the Code. Accordingly, any calculations in paragraphs (f)(2)(i) through (xi) of this section are solely for the purpose of determining each partner’s deductible business interest expense and section 163(j) excess items and do not otherwise affect any other provision under the Code, such as section 704(b). Additionally, floor plan financing interest expense is not allocated in accordance with paragraph (f)(2) of this section. Instead, floor plan financing interest expense of a partnership is allocated to its partners under section 704(b) and is taken into account as a nonseparately stated item of loss for purposes of section 163(j).

(iii) Exception applicable to publicly traded partnerships. Publicly traded partnerships, as defined in §1.7704-1, do not apply the rules in paragraph (f)(2) of this section to determine a partner’s share of section 163(j) excess items. Rather, publicly traded partnerships determine a partner’s share of section 163(j) excess items by applying the same percentage used to determine the partner’s share of the corresponding section 704(b) items that comprise ATI.

(i) Partnership-level calculation required by section 163(j)(4)(A). First, a partnership must determine its section 163(j) limitation pursuant to §1.163(j)-2(b). This calculation determines a partnership’s total amounts of excess business interest income, excess taxable income, excess business interest expense (that is, the partnership’s section 163(j) excess items), and deductible business interest expense under section 163(j) for a taxable year.

(ii) Determination of each partner’s relevant section 163(j) items. Second, a partnership must determine each partner’s allocable share of each section 163(j) item under section 704(b) and the regulations under section 704 of the Code, including any allocations under section 704(c), other than remedial items. Only section 163(j) items that were actually taken into account in the partnership’s section 163(j) calculation under paragraph (f)(2)(i) of this section are taken into account for purposes of this paragraph (f)(2)(ii). Partner basis items, allocations of investment income and expense, remedial items, and amounts determined for the partner under §1.163-8T are not taken into account for purposes of this paragraph (f)(2)(ii). For purposes of paragraphs (f)(2)(ii) through (xi) of this section, the term allocable ATI means a partner’s distributive share of the partnership’s ATI (that is, a partner’s distributive share of gross income and gain items comprising ATI less such partner’s distributive share of gross loss and deduction items comprising ATI), the term allocable business interest income means a partner’s distributive share of the partnership’s business interest income, and the term allocable business interest expense means a partner’s distributive share of the partnership’s business interest expense that is not floor plan financing interest expense. If the partnership determines that each partner has a pro rata share of allocable ATI, allocable business interest income, and allocable business interest expense, then the partnership may bypass paragraphs (f)(2)(iii) through (xi) of this section and allocate its section 163(j) excess items in the same proportion. See Example 1 through Example 16 in paragraphs (o)(1) through (16), respectively. This pro-rata exception does not result in allocations of section 163(j) excess items that vary from the array of allocations of section 163(j) excess items that would have resulted had paragraphs (f)(2)(iii) through (xi) been applied.

(iii) Partner-level comparison of business interest income and business interest expense. Third, a partnership must compare each partner’s allocable business interest income to such partner’s allocable business interest expense. Paragraphs (f)(2)(iii) through (v) of this section determine how a partnership must allocate its excess business interest income among its partners, as well as the amount of each partner’s allocable business interest expense that is not deductible business interest expense after taking the partnership’s business interest income into account. To the extent a partner’s allocable business interest income exceeds its allocable business interest expense, the partner has an allocable business interest income excess. The aggregate of all the partners’ allocable business interest income excess amounts is the total allocable business interest income excess. To the extent a partner’s allocable business interest expense exceeds its allocable business interest income, the partner has an allocable business interest income deficit. The aggregate of all the partners’ allocable business interest income deficit amounts is the total allocable business interest income deficit. These amounts are required to perform calculations in paragraphs (f)(2)(iv) and (v) of this section, which appropriately reallocate allocable business interest income excess to partners with allocable business interest income deficits in order to reconcile the partner-level calculation under paragraph (f)(2)(iii) of this section with the partnership-level result under paragraph (f)(2)(i) of this section.

(iv) Matching partnership and aggregate partner excess business interest income. Fourth, a partnership must determine each partner’s final allocable business interest income excess. A partner’s final allocable business interest income excess is determined by reducing, but not below zero, such partner’s allocable business interest income excess (if any) by the partner’s step four adjustment amount. A partner’s step four adjustment amount is the product of the total allocable business interest income deficit and the ratio of such partner’s allocable business interest income excess to the total allocable business interest income excess. The rules of this paragraph (f)(2)(iv) ensure that, following the application of paragraph (f)(2)(xi) of this section, the aggregate of all the partners’ allocations of excess business interest income equals the total amount of the partnership’s excess business interest income as determined in paragraph (f)(2)(i) of this section.

(v) Remaining business interest expense determination. Fifth, a partnership must determine each partner’s remaining business interest expense. A partner’s remaining business interest expense is determined by reducing, but not below zero, such partner’s allocable business interest income deficit (if any) by such partner’s step five adjustment amount. A partner’s step five adjustment amount is the product of the total allocable business interest income excess and the ratio of such partner’s allocable business interest income deficit to the total allocable business interest income deficit. Generally, a partner’s remaining business interest expense is a partner’s allocable business interest income deficit adjusted to reflect a reallocation of allocable business interest income excess from other partners. Determining a partner’s remaining business interest expense is necessary to perform an ATI calculation that begins in paragraph (f)(2)(vii) of this section.

(vi) Determination of final allocable ATI. Sixth, a partnership must determine each partner’s final allocable ATI. Paragraphs (f)(2)(vi) through (x) of this section determine how a partnership must allocate its excess taxable income and excess business interest expense among its partners.

(vii) Partner-level comparison of 30 percent of adjusted taxable income and remaining business interest expense. Seventh, a partnership must compare each partner’s ATI capacity to such partner’s remaining business interest expense as determined under paragraph (f)(2)(v) of this section. A partner’s ATI capacity is the amount that is 30 percent of such partner’s final allocable ATI as determined under paragraph (f)(2)(vi) of this section. A partner’s final allocable ATI is grossed down to 30 percent prior to being compared to its remaining business interest expense in this calculation to parallel the partnership’s adjustment to its ATI under section 163(j)(1)(B). To the extent a partner’s ATI capacity exceeds its remaining business interest expense, the partner has an ATI capacity excess. The aggregate of all the partners’ ATI capacity excess amounts is the total ATI capacity excess. To the extent a partner’s remaining business interest expense exceeds its ATI capacity, the partner has an ATI capacity deficit. The aggregate of all the partners’ ATI capacity deficit amounts is the total ATI capacity deficit. These amounts (which may be subject to adjustment under paragraph (f)(2)(viii) of this section) are required to perform calculations in paragraphs (f)(2)(ix) and (x) of this section, which appropriately reallocate ATI capacity excess to partners with ATI capacity deficits in order to reconcile the partner-level calculation under paragraph (f)(2)(vii) of this section with the partnership-level result under paragraph (f)(2)(i) of this section.

(viii) Partner priority right to ATI capacity excess determination.

(ix) Matching partnership and aggregate partner excess taxable income. Ninth, a partnership must determine each partner’s final ATI capacity excess. A partner’s final ATI capacity excess amount is determined by reducing, but not below zero, such partner’s ATI capacity excess (if any) by the partner’s step nine adjustment amount. A partner’s step nine adjustment amount is the product of the total ATI capacity deficit and the ratio of such partner’s ATI capacity excess to the total ATI capacity excess. The rules of this paragraph (f)(2)(ix) ensure that, following the application of paragraph (f)(2)(xi) of this section, the aggregate of all the partners’ allocations of excess taxable income equals the total amount of the partnership’s excess taxable income as determined in paragraph (f)(2)(i) of this section.

(x) Matching partnership and aggregate partner excess business interest expense. Tenth, a partnership must determine each partner’s final ATI capacity deficit. A partner’s final ATI capacity deficit amount is determined by reducing, but not below zero, such partner’s ATI capacity deficit (if any) by the partner’s step ten adjustment amount. A partner’s step ten adjustment amount is the product of the total ATI capacity excess and the ratio of such partner’s ATI capacity deficit to the total ATI capacity deficit. Generally, a partner’s final ATI capacity deficit is a partner’s ATI capacity deficit adjusted to reflect a reallocation of ATI capacity excess from other partners. The rules of this paragraph (f)(2)(x) ensure that, following the application of paragraph (f)(2)(xi) of this section, the aggregate of all the partners’ allocations of excess business interest expense equals the total amount of the partnership’s excess business interest expense as determined in paragraph (f)(2)(i) of this section.

(xi) Final section 163(j) excess item and deductible business interest expense allocation. Eleventh, a partnership must allocate section 163(j) excess items and deductible business interest expense to its partners. Excess business interest income calculated under paragraph (f)(2)(i) of this section, if any, is allocated dollar for dollar by the partnership to its partners with final allocable business interest income excess amounts. Excess business interest expense calculated under paragraph (f)(2)(i) of this section, if any, is allocated dollar for dollar to partners with final ATI capacity deficit amounts. After grossing up each partner’s final ATI capacity excess amount by ten-thirds, excess taxable income calculated under paragraph (f)(2)(i) of this section, if any, is allocated dollar for dollar to partners with final ATI capacity excess amounts. A partner’s allocable business interest expense is deductible business interest expense to the extent it exceeds such partner’s share of excess business interest expense. See Example 17 through Example 21 in paragraphs (o)(17) through (21) of this section, respectively.

(i) Not treated as business interest expense of the partnership in the succeeding taxable year; and

(ii) Subject to paragraph (g)(2) of this section, treated as excess business interest expense, which is allocated to each partner pursuant to paragraph (f)(2) of this section.

(i) Solely for purposes of section 163(j), such excess business interest expense is treated as business interest expense paid or accrued by the partner in the next succeeding taxable year in which the partner is allocated excess taxable income or excess business interest income from such partnership, but only to the extent of such excess taxable income or excess business interest income; and

(ii) Any portion of such excess business interest expense remaining after the application of paragraph (g)(2)(i) of this section is excess business interest expense that is subject to the limitations of paragraph (g)(2)(i) of this section in succeeding taxable years, unless paragraph (m)(3) of this section applies. See Example 1 through Example 16 in paragraphs (o)(1) through (16) of this section, respectively.

(i) Corporate level limitation. In the case of any S corporation, the section 163(j) limitation is applied at the S corporation level, and any deduction allowed for business interest expense is taken into account in determining the nonseparately stated taxable income or loss of the S corporation. An S corporation determines its section 163(j) limitation in the same manner as set forth in §1.163(j)-2(b). Allocations of excess taxable income and excess business interest income are made in accordance with the shareholders’ pro rata interests in the S corporation pursuant to section 1366(a)(1) after determining the S corporation’s section 163(j) limitation pursuant to §1.163(j)-2(b). See Example 22 and Example 23 in paragraphs (o)(22) and (23) of this section, respectively.

(ii) Short taxable periods For rules on applying the section 163(j) limitation where an S corporation has a two short taxable periods or where its taxable year consists of two separate taxable years see §§ 1.1362-3(c), 1.1368-1(g), and 1.1377-1(b).

(i) Any item described in section 1363(b)(1); and

(ii) Any item described in §1.163(j)-1(b)(1), to the extent such item is consistent with subchapter S of the Code.

(i) Adjusted taxable income of S corporation shareholders. The ATI of an S corporation shareholder is determined in accordance with §1.163(j)-1(b)(1) without regard to such shareholder’s distributive share of any items of income, gain, deduction, or loss of such S corporation, except as provided in paragraph (m), and is increased by such shareholder’s distributive share of such S corporation’s excess taxable income.

(ii) Disposition of S corporation stock. If a shareholder of an S corporation recognizes gain or loss upon the disposition of stock of the S corporation, and the corporation the stock of which is being disposed of only owns non-excepted trade or business assets, the gain or loss on the disposition of the stock is included in the shareholder’s ATI. See §1.163(j)-10(b)(4)(ii) for dispositions of stock of S corporations that own--

(iii) Double counting of business interest income and floor plan financing interest expense prohibited. For purposes of calculating an S corporation shareholder’s section 163(j) limitation, the shareholder does not include--

(iv) [Reserved].

(i) The rules of this paragraph govern the S corporation’s business interest expense;

(ii) The S corporation must make an election under §1.382-6(b) with respect to such date if it also makes an election under §1.1368-1(g)(2) or a shareholder termination election to apply normal tax accounting rules, as applicable, with respect to such date; and

(iii) The S corporation may not make an election under §1.382-6(b) with respect to such date if it does not make an election under §1.1368-1(g)(2) or a termination election under §1.1377-1(b)(1), as applicable, with respect to such date.

(i) Continues to be carried forward at the S corporation level;

(ii) Is no longer subject to the section 163(j) limitation; and

(iii) Is taken into account in determining the nonseparately stated taxable income or loss of the S corporation.

(i) Facts. X and Y are equal partners in partnership PRS. In Year 1, PRS has $100 of ATI and $40 of business interest expense. PRS allocates the items comprising its $100 of ATI $50 to X and $50 to Y. PRS allocates its $40 of business interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 1, PRS’s section 163(j) limit is 30 percent of its ATI, or $30 ($100 x 30 percent). Thus, PRS has $30 of deductible business interest expense and $10 of excess business interest expense. Such $30 of deductible business interest expense is includable in PRS’s nonseparately stated income or loss, and is not subject to further limitation under section 163(j) at the partners’ level.

(iii) Partner-level allocations. Pursuant to §1.163(j)-6(f)(2), X and Y are each allocated $15 of deductible business interest expense and $5 of excess business interest expense. At the end of Year 1, X and Y each have $5 of excess business interest expense from PRS, which is not treated as paid or accrued by the partner until such partner is allocated excess taxable income or excess business interest income from PRS in a succeeding taxable year. Pursuant to §1.163(j)-6(e)(1), X and Y, in computing their limit under section 163(j), do not increase any of their section 163(j) items by any of PRS’s section 163(j) items. X and Y each increase their outside basis in PRS by $30 ($50 - $20).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $100 of ATI and $20 of business interest expense from its sole proprietorship. X’s section 163(j) limit is $30 ($100 x 30 percent). Thus, X’s $20 of business interest expense is deductible business interest expense. Y, in computing its limit under section 163(j), has $20 of business interest expense from its sole proprietorship. Y’s section 163(j) limit is $0 ($0 x 30 percent). Thus, Y’s $20 of business interest expense is not allowed as a deduction and is treated as business interest expense paid or accrued by Y in Year 2.

(i) Facts. The facts are the same as in Example 1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $200 of ATI, $0 of business interest income, and $30 of business interest expense. PRS allocates the items comprising its $200 of ATI $100 to X and $100 to Y. PRS allocates its $30 of business interest expense $15 to X and $15 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $60 ($200 x 30 percent). Thus, PRS has $100 of excess taxable income, $30 of deductible business interest expense, and $0 of excess business interest expense. Such $30 of deductible business interest expense is includable in PRS’s nonseparately stated income or loss, and is not subject to further limitation under section 163(j) at the partners’ level.

(iii) Partner-level allocations. Pursuant to §1.163(j)-6(f)(2), X and Y are each allocated $50 of excess taxable income, $15 of deductible business interest expense, and $0 of excess business interest expense. As a result, X and Y each increase their ATI by $50. Because X and Y are each allocated $50 of excess taxable income from PRS, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to a partner, X and Y each treat $5 of excess business interest expense (the carryforward from Year 1) as paid or accrued in Year 2. X and Y each increase their outside basis in PRS by $85 ($100 - $15).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $150 of ATI ($100 from its sole proprietorship, plus $50 excess taxable income) and $25 of business interest expense ($20 from its sole proprietorship, plus $5 excess business interest expense treated as paid or accrued in Year 2). X’s section 163(j) limit is $45 ($150 x 30 percent). Thus, X’s $25 of business interest expense is deductible business interest expense. At the end of Year 2, X has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2). Y, in computing its limit under section 163(j), has $50 of ATI ($0 from its sole proprietorship, plus $50 excess taxable income) and $45 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $5 excess business interest expense treated as paid or accrued in Year 2). Y’s section 163(j) limit is $15 ($50 x 30 percent). Thus, $15 of Y’s business interest expense is deductible business interest expense. The $30 of Y’s business interest expense not allowed as a deduction ($45 business interest expense, less $15 section 163(j) limit) is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2).

(i) Facts. The facts are the same as in Example 1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $0 of ATI, $60 of business interest income, and $40 of business interest expense. PRS allocates its $60 of business interest income $30 to X and $30 to Y. PRS allocates its $40 of business interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $60 (($0 x 30 percent) + $60). Thus, PRS has $20 of excess business interest income, $0 of excess taxable income, $40 of deductible business interest expense, and $0 of excess business interest expense. Such $40 of deductible business interest expense is includable in PRS’s nonseparately stated income or loss, and is not subject to further limitation under section 163(j) at the partners’ level.

(iii) Partner-level allocations. Pursuant to §1.163(j)-6(f)(2), X and Y are each allocated $10 of excess business interest income, and $20 of deductible business interest expense. As a result, X and Y each increase their business interest income by $10. Because X and Y are each allocated $10 of excess business interest income from PRS, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to a partner, X and Y each treat $5 of excess business interest expense (the carryforward from Year 1) as paid or accrued in Year 2. X and Y each increase their outside basis in PRS by $10 ($30 - $20).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $100 of ATI (from its sole proprietorship), $10 of business interest income (from the allocation of $10 of excess business interest income from PRS), and $25 of business interest expense ($20 from its sole proprietorship, plus $5 excess business interest expense treated as paid or accrued in Year 2). X’s section 163(j) limit is $40 (($100 x 30 percent) + $10). Thus, X’s $25 of business interest expense is deductible business interest expense. At the end of Year 2, X has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2). Y, in computing its limit under section 163(j), has $0 of ATI (from its sole proprietorship), $10 of business interest income, and $45 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $5 excess business interest expense treated as paid or accrued in Year 2). Y’s section 163(j) limit is $10 (($0 x 30 percent) + $10). Thus, $10 of Y’s business interest expense is deductible business interest expense. The $35 of Y’s business interest expense not allowed as a deduction ($45 business interest expense, less $10 section 163(j) limit) is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2).

(i) Facts. The facts are the same as in Example 1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $100 of ATI, $60 of business interest income, and $40 of business interest expense. PRS allocates the items comprising its $100 of ATI $50 to X and $50 to Y. PRS allocates its $60 of business interest income $30 to X and $30 to Y. PRS allocates its $40 of business interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $90 (($100 x 30 percent)) + $60). Thus, PRS has $20 of excess business interest income, $100 of excess taxable income, $40 of deductible business interest expense, and $0 of excess business interest expense. Such $40 of deductible business interest expense is includable in PRS’s nonseparately stated income or loss, and is not subject to further limitation under section 163(j) at the partners’ level.

(iii) Partner-level allocations. Pursuant to §1.163(j)-6(f)(2), X and Y are each allocated $10 of excess business interest income, $50 of excess taxable income, and $20 of deductible business interest expense. As a result, X and Y each increase their business interest income by $10 and ATI by $50. Because X and Y are each allocated $10 of excess business interest income and $50 of excess taxable income from PRS, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to a partner, X and Y each treat $5 of excess business interest expense (the carryforward from Year 1) as paid or accrued in Year 2. X and Y each increase their outside basis in PRS by $60 ($80 - $20).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $150 of ATI ($100 from its sole proprietorship, plus $50 excess taxable income), $10 of business interest income, and $25 of business interest expense ($20 from its sole proprietorship, plus $5 excess business interest expense treated as paid or accrued in Year 2). X’s section 163(j) limit is $55 (($150 x 30 percent) + $10). Thus, $25 of X’s business interest expense is deductible business interest expense. At the end of Year 2, X has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2). Y, in computing its limit under section 163(j), has $50 of ATI ($0 from its sole proprietorship, plus $50 excess taxable income), $10 of business interest income, and $45 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $5 excess business interest expense treated as paid or accrued in Year 2). Y’s section 163(j) limit is $25 (($50 x 30 percent) + $10). Thus, $25 of Y’s business interest expense is deductible business interest expense. Y’s $20 of business interest expense not allowed as a deduction ($45 business interest expense, less $25 section 163(j) limit) is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2).

(i) Facts. The facts are the same as in Example 1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $100 of ATI, $11.20 of business interest income, and $40 of business interest expense. PRS allocates the items comprising its $100 of ATI $50 to X and $50 to Y. PRS allocates its $11.20 of business interest income $5.60 to X and $5.60 to Y. PRS allocates its $40 of business interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $41.20 (($100 x 30 percent) + $11.20). Thus, PRS has $0 of excess business interest income, $4 of excess taxable income, and $40 of deductible business interest expense. Such $40 of deductible business interest expense is includable in PRS’s nonseparately stated income or loss, and is not subject to further limitation under section 163(j) at the partners’ level.

(iii) Partner-level allocations. Pursuant to §1.163(j)-6(f)(2), X and Y are each allocated $2 of excess taxable income, $20 of deductible business interest expense, and $0 of excess business interest expense. As a result, X and Y each increase their ATI by $2. Because X and Y are each allocated $2 of excess taxable income from PRS, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to a partner, X and Y each treat $2 of excess business interest expense (a portion of the carryforward from Year 1) as paid or accrued in Year 2. X and Y each increase their outside basis in PRS by $35.60 ($55.60 - $20).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $102 of ATI ($100 from its sole proprietorship, plus $2 excess taxable income), $0 of business interest income, and $22 of business interest expense ($20 from its sole proprietorship, plus $2 excess business interest expense treated as paid or accrued). X’s section 163(j) limit is $30.60 ($102 x 30 percent). Thus, X’s $22 of business interest expense is deductible business interest expense. At the end of Year 2, X has $3 of excess business interest expense from PRS ($5 from Year 1, less $2 treated as paid or accrued in Year 2). Y, in computing its limit under section 163(j), has $2 of ATI ($0 from its sole proprietorship, plus $2 excess taxable income), $0 of business interest income, and $42 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $2 excess business interest expense treated as paid or accrued in Year 2). Y’s section 163(j) limit is $0.60 ($2 x 30 percent). Thus, $0.60 of Y’s business interest expense is deductible business interest expense. Y’s $41.40 of business interest expense not allowed as a deduction ($42 business interest expense, less $0.60 section 163(j) limit) is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $3 of excess business interest expense from PRS ($5 from Year 1, less $2 treated as paid or accrued in Year 2).

(i) Facts. In Year 1, X, Y, and Z formed partnership PRS. Upon formation, X and Y each contributed $100, and Z contributed non-excepted and non-depreciable trade or business property with a basis of $0 and fair market value of $100 (Blackacre). PRS allocates all items pro rata between its partners. Immediately after the formation of PRS, Z sold all of its interest in PRS to A for $100 (assume the interest sale is respected for U.S. Federal income tax purposes). In connection with the interest transfer, PRS made a valid election under section 754. Therefore, after the interest sale, A had a $100 positive section 743(b) adjustment in Blackacre. In Year 1, PRS had $0 of ATI, $15 of business interest expense, and $0 of business interest income. Pursuant to §1.163(j)-6(f)(2), PRS allocated each of the partners $5 of excess business interest expense. In Year 2, PRS sells Blackacre for $100 which generated $100 of ATI. The sale of Blackacre was PRS’s only item of income in Year 2. In accordance with section 704(c), PRS allocates all $100 of gain resulting from the sale of Blackacre to A. Additionally, PRS has $15 of business interest expense, all of which it allocates to X. A has $50 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS’s section 163(j) limit is 30 percent of its ATI, or $30 ($100 x 30 percent). Thus, PRS has $15 of deductible business interest expense and $50 of excess taxable income. Such $15 of deductible business interest expense is includable in PRS’s nonseparately stated income or loss, and is not subject to further limitation under section 163(j) at X’s level.

(iii) Partner-level allocations. Pursuant to §1.163(j)-6(f)(2), X is allocated $15 of deductible business interest expense and X’s outside basis in PRS is reduced by $15. A is allocated $50 of excess taxable income and, as a result, A increases its ATI by $50. Because A is allocated $50 of excess taxable income, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to a partner, A treats $5 of excess business interest expense (the carryforward from Year 1) as paid or accrued in Year 2. PRS’s $100 of gain allocated to A in Year 2 is fully reduced by A’s $100 section 743(b) adjustment. Therefore, at the end of Year 2, there is no change to A’s outside basis in PRS.

(iv) Partner-level. A, in computing its limit under section 163(j), has $0 of ATI ($50 from its sole proprietorship, plus $50 excess taxable income, less $100 ATI reduction as a result of A’s section 743(b) adjustment under §1.163(j)-6(e)(2)) and $25 of business interest expense ($20 from its sole proprietorship, plus $5 excess business interest expense treated as paid or accrued in Year 2). A’s section 163(j) limit is $0 ($0 x 30 percent). Thus, all $25 of A’s business interest expense is not allowed as a deduction and is treated as business interest expense paid or accrued by A in Year 3.

(i) Facts. X and Y are equal partners in partnership PRS. At the beginning of Year 1, X and Y each have an outside basis in PRS of $5. In Year 1, PRS has $0 of ATI, $20 of business interest income, and $40 of business interest expense. PRS allocates its $20 of business interest income $10 to X and $10 to Y. PRS allocates $40 of business interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 1, PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $20 (($0 x 30 percent) + $20). Thus, PRS has $0 of excess business interest income, $0 of excess taxable income, $20 of deductible business interest expense, and $20 of excess business interest expense. Such $20 of deductible business interest expense is includable in nonseparately stated income or loss of PRS, and not subject to further limitation under section 163(j) by the partners.

(iii) Partner-level allocations. Pursuant to §1.163(j)-6(f)(2), X and Y are each allocated $10 of deductible business interest expense and $10 of excess business interest expense. After adjusting each partner’s respective basis for business interest income under section 705(a)(1)(A), pursuant to §1.163(j)-6(h)(1), X and Y each take their $10 of deductible business interest expense into account when reducing their outside basis in PRS before taking the $10 of excess business interest expense into account. Following each partner’s reduction in outside basis due to the $10 of deductible business interest expense, each partner has $5 of outside basis remaining in PRS. Pursuant to §1.163(j)-6(h)(2), each partner has $5 of excess business interest expense and $5 of negative section 163(j) expense. In sum, at the end of Year 1, X and Y each have $5 of excess business interest expense from PRS which reduces each partner’s outside basis to $0 (and is not treated as paid or accrued by the partners until such partner is allocated excess taxable income or excess business interest income from PRS in a succeeding taxable year), and $5 of negative section 163(j) expense (which is suspended under section 704(d) and not treated as excess business interest expense of the partners until such time as the negative section 163(j) expense is no longer subject to a limitation under section 704(d)).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $100 of ATI (from its sole proprietorship) and $20 of business interest expense (from its sole proprietorship). X’s section 163(j) limit is $30 ($100 x 30 percent). Thus, $20 of X’s business interest expense is deductible business interest expense. Y, in computing its limit under section 163(j), has $20 of business interest expense (from its sole proprietorship). Y’s section 163(j) limit is $0 ($0 x 30 percent). Thus, $20 of Y’s business interest expense is not allowed as a deduction in Year 1, and is treated as business interest expense paid or accrued by Y in Year 2.

(i) Facts. The facts are the same as in Example 7 in paragraph (o)(7)(i) of this section. In Year 2, PRS has $20 of gross income that is taken into account in determining PRS’s ATI (in other words, properly allocable to a trade or business), $30 of gross deductions from an investment activity, and $0 of business interest expense. PRS allocates the items comprising its $20 of ATI $10 to X and $10 to Y. PRS allocates the items comprising its $30 of gross deductions $15 to X and $15 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $6 ($20 x 30 percent). Because PRS has no business interest expense, all $20 of its ATI is excess taxable income.

(iii) Partner-level allocations. Pursuant to §1.163(j)-6(f)(2), X and Y are each allocated $10 of excess taxable income. Because X and Y are each allocated $10 of excess taxable income from PRS, X and Y each increase their ATI by $10. Pursuant to §1.704-(1)(d)(2), each partner’s limitation on losses under section 704(d) must be allocated to its distributive share of each such loss. Thus, each partner reduces its adjusted basis of $10 (attributable to the allocation of items comprising PRS’s ATI in Year 2) by $7.50 of gross deductions from Year 2 ($10 x ($15 of total gross deductions from Year 2 / $20 of total losses disallowed)), and $2.50 of excess business interest expense that was carried over as negative section 163(j) expense from Year 1 ($10 x ($5 of negative section 163(j) expense treated as excess business interest expense solely for the purposes of section 704(d) / $20 of total losses disallowed)). Following the application of section 704(d), each partner has $7.50 of excess business interest expense from PRS ($5 excess business interest expense from Year 1, plus $2.50 of excess business interest expense that was formerly negative section 163(j) expense carried over from Year 1). Excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to the partner. As a result, X and Y each treat $7.50 of excess business interest expense as paid or accrued in Year 2.

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $110 of ATI ($100 from its sole proprietorship, plus $10 excess taxable income) and $27.50 of business interest expense ($20 from its sole proprietorship, plus $7.50 excess business interest expense treated as paid or accrued in Year 2). X’s section 163(j) limit is $33 ($110 x 30 percent). Thus, $27.50 of X’s business interest expense is deductible business interest expense. At the end of Year 2, X has $0 of excess business interest expense from PRS ($5 from Year 1, plus $2.50 treated as excess business interest expense in Year 2, less $7.50 treated as paid or accrued in Year 2), and $2.50 of negative section 163(j) expense from PRS. Y, in computing its limit under section 163(j), has $10 of ATI ($0 from its sole proprietorship, plus $10 excess taxable income) and $47.50 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $7.50 excess business interest expense treated as paid or accrued in Year 2). Y’s section 163(j) limit is $3 ($10 x 30 percent). Thus, $3 of Y’s business interest expense is deductible business interest expense. The $44.50 of Y’s business interest expense not allowed as a deduction ($47.50 business interest expense, less $3 section 163(j) limit) is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess business interest expense from PRS ($5 from Year 1, plus $2.50 treated as excess business interest expense in Year 2, less $7.50 treated as paid or accrued in Year 2), and $2.50 of negative section 163(j) expense from PRS.

(i) Facts. X and Y are equal partners in partnership PRS, and are not members of a consolidated group. At the beginning of Year 1, X and Y each have $120 of outside basis in PRS. Neither X nor Y’s share of partnership liabilities exceeds the adjusted basis of its entire interest. In Year 1, X is allocated $20 of excess business interest expense, which reduces its outside basis from $120 to $100. In Year 2, X sells 80 percent of its interest in PRS to Z for $160. Immediately prior to the sale, X’s entire PRS interest had a fair market value of $200 and the transferred portion of the interest had a fair market value of $160.

(ii) Basis adjustment. Immediately before the sale to Z, X increases its basis in the portion of the interest sold by 80 percent of the amount of the excess of the amount of the basis reduction under paragraph (h)(2) of this section ($20) over the portion of any excess business interest expense allocated the partner under paragraph (f)(2) of this section that has previously been treated under paragraph (g) of this section as business interest expense paid or accrued by X ($0). Therefore, X’s basis in the portion of its interest sold is $96 (($100 x 80%) + ($20 x 80%)), and X’s gain is $64 ($160 - $96). Following the sale, X has $20 of outside basis in its remaining partnership interest and $4 of excess business interest expense.

(i) Facts. X and Y are equal partners in partnership PRS, and are not members of a consolidated group. At the beginning of Year 1, X and Y each have an outside basis in PRS of $10. Neither X nor Y’s share of partnership liabilities exceeds the adjusted basis of its entire interest. In Year 1, X is allocated $8 of excess business interest expense and $12 of loss from PRS. As a result, X has $4 of excess business interest expense, $4 of negative section 163(j) expense, $6 of allowable loss, $6 of loss suspended under section 704(d), and $0 of outside basis in PRS at the end of Year 1. In Year 2, X sells 50 percent of its interest in PRS to Z for $20. Immediately prior to the sale, X’s entire partnership interest had a fair market value of $40 and the transferred portion of the interest had a fair market value of $20.

(ii) Basis adjustment. Immediately before the sale to Z, X increases its basis in the portion of the interest sold by 50 percent of the amount of the excess of the amount of the basis reduction under paragraph (h)(2) of this section ($4) over the portion of any excess business interest expense allocated the partner under paragraph (f)(2) of this section that has previously been treated under paragraph (g) of this section as business interest expense paid or accrued by X ($0). Therefore, X’s basis in the portion of its interest sold is $2 (($0 x 50%) + $2), and X’s gain is $18 ($20 - $2). Following the sale, X has $0 of outside basis in its remaining partnership interest, $2 of excess business interest expense, $4 of negative section 163(j) expense, and $6 of loss suspended under section 704(d).

(i) Facts. X (a corporation), Y (an individual), and Z (an individual) are equal partners in partnership PRS. X, Y, and Z are subject to section 163(j). PRS is not subject to section 163(j) under section 163(j)(3). In 2021, PRS has $150 of trade or business income (not taking into account business interest income or business interest expense), $30 of business interest income, and $45 of business interest expense. PRS also has $75 of investment income and $60 of investment interest expense. PRS allocates its items of income, gain, loss, and deduction equally among its partners. X, Y, and Z each have $10 of business interest expense from their respective businesses.

(ii) Partnership-level. PRS is not subject to section 163(j) by reason of section 163(j)(3). As a result, none of PRS’s $45 of business interest expense is subject to the section 163(j) limitation.

(iii) Partner-level allocations. Because PRS is not subject to section 163(j) by reason of section 163(j)(3), PRS’s $45 of business interest expense does not retain its character as business interest expense for purposes of section 163(j). As a result, such business interest expense is not subject to the section 163(j) limitation at the level of either the partnership or partner. Additionally, pursuant to §1.163(j)-6(m)(1), each partner includes its share of non-excepted trade or business items of income, gain, loss, and deduction (including business interest expense and business interest income) of PRS when calculating its ATI. As a result, each partner increases its ATI by $45 (one third of $150 + $30 - $45). Also, X increases its ATI by an additional $25 because its items of investment income and loss from PRS are recharacterized as non-excepted trade or business income and loss at its level pursuant to §§1.163(j)-4(b)(3)(i) and 1.163(j)-10(b)(6). Further, X increases its business interest expense by its $20 allocation of investment interest expense from PRS pursuant to §§1.163(j)-4(b)(3)(i) and 1.163(j)-10(b)(6).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $70 of ATI and $30 of business interest expense. X’s section 163(j) limit is $21 ($70 x 30 percent). Thus, X has $21 of deductible business interest expense. X’s $9 of business interest expense not allowed as a deduction is treated as business interest expense paid or accrued by X in 2020. Y and Z, in computing their respective limits under section 163(j), each have $45 of ATI and $10 of business interest expense. Y and Z each have a section 163(j) limit of $13.50 ($45 x 30 percent). Thus, Y and Z each have $10 of deductible business interest expense.

(i) Facts. The facts are the same as in Example 11 in paragraph (o)(11)(i) of this section, except PRS has $200 of depreciation deductions in addition to its other items of income, gain, loss, and deduction.

(ii) Partnership-level. Same analysis as Example 11 in paragraph (o)(11)(ii) of this section.

(iii) Partner-level allocations. Because PRS is not subject to section 163(j) by reason of section 163(j)(3), PRS’s $45 of business interest expense does not retain its character as business interest expense for purposes of section 163(j). As a result, such business interest expense is not subject to the section 163(j) limitation at the level of either the partnership or partner. Additionally, pursuant to §1.163(j)-6(m)(1), each partner includes its share of non-excepted trade or business items of income, gain, loss, and deduction (including business interest expense and business interest income) of PRS when calculating its ATI; however, a net loss allocation of trade or business items from an exempt entity does not reduce a partner’s ATI. Because each of the partners has a net loss allocation of trade or business items from PRS, none of the partners adjust their ATI for the trade or business items of PRS. X, the corporate partner, increases its ATI by $25 because its items of investment income and loss from PRS are recharacterized as trade or business income and loss at its level pursuant to §§1.163(j)-4(b)(3)(i) and 1.163(j)-10(b)(6). Further, X increases its business interest expense by its $20 allocation of investment interest expense from PRS pursuant to §§1.163(j)-4(b)(3)(i) and 1.163(j)-10(b)(6).

(iv) Partner-level computations. In computing its limit under section 163(j), each partner has $0 of ATI and $10 of business interest expense. Each partner’s section 163(j) limit is $0 ($0 x 30 percent). Thus, each partner’s $10 of business interest expense is not allowed as a deduction and is treated as business interest expense paid or accrued by the partner in 2020. X, in computing its limit under section 163(j), has $25 of ATI and $30 of business interest expense. X’s section 163(j) limit is $7.50 ($25 x 30 percent). Thus, X has $7.50 of deductible business interest expense. X’s $22.50 of business interest expense not allowed as a deduction is treated as business interest expense paid or accrued by X in 2020. Y and Z, in computing their respective limits under section 163(j), each have $0 of ATI and $10 of business interest expense. Thus, Y and Z each have $10 of business interest expense not allowed as a deduction that is treated as business interest expense paid or accrued in 2020.

(i) Facts. X, Y, and Z are equal partners in partnership PRS. X, Y, and Z are each individuals subject to section 163(j). PRS is not subject to section 163(j) under section 163(j)(3). PRS has one excepted and one non-excepted trade or business. In Year 1, PRS has $200 of income and $10 of business interest expense from its excepted trade or business, and $60 of business interest income and $30 of business interest expense from its non-excepted trade or business. PRS allocates its items of income, gain, loss, and deduction equally among its partners. X, Y, and Z each have $10 of business interest expense from their respective businesses.

(ii) Partnership-level. PRS is not subject to section 163(j) by reason of section 163(j)(3). As a result, none of PRS’s business interest expense is subject to the section 163(j) limitation.

(iii) Partner-level allocations. Because PRS’s business interest expense is not subject to the section 163(j) limitation, such business interest expense is not subject to the section 163(j) limitation at the level of either the partnership or partner. Additionally, pursuant to §1.163(j)-6(m)(1), each partner includes its share of non-excepted trade or business items of income, gain, loss, and deduction (including business interest expense and business interest income) of PRS when calculating its ATI. Therefore, each partner increases its ATI by $10 (each partner’s share of $20 of non-excepted income less each partner’s share of $10 of non-excepted loss).

(iv) Partner-level computations. In computing its limit under section 163(j), each partner has $10 of ATI and $10 of business interest expense. Each partner’s section 163(j) limit is $3 ($10 x 30 percent). Thus, each partner has $3 of deductible business interest expense. Each partner has $7 of business interest expense not allowed as a deduction that is treated as business interest expense paid or accrued by the partner in Year 2.

(i) Facts. The facts are the same as in Example 5 in paragraph (o)(5)(i) of this section, except in Year 2 Y is not subject to section 163(j) under section 163(j)(3).

(ii) Partnership-level. Same analysis as Example 5 in paragraph (o)(5)(ii) of this section.

(iii) Partner-level allocations. Same analysis as Example 5 in paragraph (o)(5)(iii) of this section.

(iv) Partner-level computations. For X, same analysis as Example 5 in paragraph (o)(5)(iv) of this section. Y is not subject to section 163(j) under section 163(j)(3). Thus, all $42 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $2 excess business interest expense treated as paid or accrued in Year 2) is not subject to limitation under §1.163(j)-2(d). At the end of Year 2, Y has $3 of excess business interest expense from PRS ($5 from Year 1, less $2 treated as paid or accrued in Year 2).

(i) Facts. The facts are the same as in Example 5 in paragraph (o)(5)(i) of this section, except in Year 2 PRS and Y become not subject to section 163(j) by reason of section 163(j)(3).

(ii) Partnership-level. In Year 2, PRS is not subject to section 163(j) by reason of section 163(j)(3). As a result, none of PRS’s $40 of business interest expense is subject to the section 163(j) limitation at the level of either the partnership or partner.

(iii) Partner-level allocations. Because PRS is not subject to section 163(j) by reason of section 163(j)(3), PRS’s $40 of business interest expense does not retain its character as business interest expense for purposes of section 163(j). As a result, such business interest expense is not subject to the section 163(j) limitation at the level of either the partnership or partner. Additionally, pursuant to §1.163(j)-6(m)(1), each partner includes its share of non-excepted trade or business items of income, gain, loss, and deduction (including business interest expense and business interest income) of PRS when calculating its ATI. As a result, X and Y each increase their ATI by $35.60. Further, because PRS is not subject to section 163(j) by reason of section 163(j)(3), the excess business interest expense from Year 1 is treated as paid or accrued by the partners pursuant to §1.163(j)-6(m)(3). As a result, X and Y each treat their $5 of excess business interest expense from Year 1 as paid or accrued in Year 2, and increase their business interest expense by $5.

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $135.60 of ATI ($100 from its sole proprietorship, plus $35.60 ATI from PRS) and $25 of business interest expense ($20 from its sole proprietorship, plus $5 of excess business interest expense treated as paid or accrued in Year 2). X’s section 163(j) limit is $40.68 ($135.60 x 30 percent). Thus, $25 of X’s business interest expense is deductible business interest expense. Y is not subject to section 163(j) under section 163(j)(3). As a result, Y’s business interest expense is not subject to the section 163(j) limitation. Thus, all $45 of Y’s business interest expense ($20 from its sole proprietorship, plus $20 disallowed from year 1, plus $5 of excess business interest expense treated as paid or accrued in Year 2) is not subject to the section 163(j) limitation.

(i) Facts. The facts are the same as in Example 1 in paragraph (o)(1)(i) of this section, except that PRS's only trade or business is a real property trade or business for which PRS does not make the election provided for in section 163(j)(7)(B). In Year 2, when PRS’s only trade or business is still its real property trade or business, PRS makes the election provided for in section 163(j)(7)(B). Further, in Year 2, PRS has $100 of income and $40 of business interest expense. PRS allocates its items of income, gain, deduction, and loss equally between X and Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS is not subject to section 163(j) because its only trade or business is an excepted trade or business. As a result, none of PRS’s $40 of business interest expense is subject to the section 163(j) limitation at the level of either the partnership or partner.

(iii) Partner-level allocations. Because PRS is not subject to section 163(j), PRS’s $40 of business interest expense does not retain its character as business interest expense for purposes of section 163(j). As a result, such business interest expense is not subject to the section 163(j) limitation at the partners’ level. Pursuant to §1.163(j)-6(m)(1), the partners do not include their respective $50 shares of income from PRS when calculating their own ATI because such $50 is excepted trade or business income.

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $100 of ATI ($100 from its sole proprietorship) and $20 of business interest expense ($20 from its sole proprietorship). X’s section 163(j) limit is $30 ($100 x 30 percent). Thus, $20 of X’s business interest expense is deductible business interest expense. At the end of Year 2, X has $5 of excess business interest expense from PRS ($5 from Year 1). Y, in computing its limit under section 163(j), has $0 of ATI and $40 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1). Y’s section 163(j) limit is $0. Thus, Y’s $40 of business interest expense not allowed as a deduction is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $5 of excess business interest expense from PRS ($5 from Year 1).

(i) First, PRS determines its limitation pursuant to §1.163(j)-2. PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $50 (($100 x 30 percent) + $20). Thus, PRS has $0 of excess business interest income (EBII), $0 of excess taxable income, $50 of deductible business interest expense, and $10 of excess business interest expense. PRS takes its $10 of floor plan financing into account in determining its nonseparately stated taxable income or loss.

(ii) Second, PRS determines each partner’s allocable share of section 163(j) items used in its own section 163(j) calculation. B’s $10 of investment interest income is not included in B’s allocable business interest income amount because the $10 of investment interest income was not taken into account in PRS’s section 163(j) calculation. B’s $10 of floor plan financing interest expense is not included in B’s allocable business interest expense. The $300 of ATI from A’s sole proprietorship is not included in A’s allocable ATI amount because the $300 was not taken into account in PRS’s section 163(j) calculation.

(iii) Third, PRS compares each partner’s allocable business interest income to such partner’s allocable business interest expense. Because each partner’s allocable business interest expense exceeds its allocable business interest income by $20 ($30 - $10), each partner has an allocable business interest income deficit of $20. Thus, the total allocable business interest income deficit is $40 ($20 + $20). No partner has allocable business interest income excess because no partner has allocable business interest income in excess of its allocable business interest expense. Thus, the total allocable business interest income excess is $0.

(iv) Fourth, PRS determines each partner’s final allocable business interest income excess. Because no partner had any allocable business interest income excess, each partner has final allocable business interest income excess of $0.

(v) Fifth, PRS determines each partner’s remaining business interest expense. PRS determines A’s remaining business interest expense by reducing, but not below $0, A’s allocable business interest income deficit ($20) by the product of the total allocable business interest income excess ($0) and the ratio of A’s allocable business interest income deficit to the total business interest income deficit ($20/$40). Therefore, A’s allocable business interest income deficit of $20 is reduced by $0 ($0 x 50 percent). As a result, A’s remaining business interest expense is $20. PRS determines B’s remaining business interest expense by reducing, but not below $0, B’s allocable business interest income deficit ($20) by the product of the total allocable business interest income excess ($0) and the ratio of B’s allocable business interest income deficit to the total business interest income deficit ($20/$40). Therefore, B’s allocable business interest income deficit of $20 is reduced by $0 ($0 x 50 percent). As a result, B’s remaining business interest expense is $20.

(vi) Sixth, PRS determines each partner’s final allocable ATI. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Therefore, B has a positive allocable ATI of $0. Because A’s allocable ATI is comprised of $100 of income and gain and $0 of deduction and loss, A has positive allocable ATI of $100. Thus, the total positive allocable ATI is $100 ($100 + $0). PRS determines A’s final allocable ATI by reducing, but not below $0, A’s positive allocable ATI ($100) by the product of total negative allocable ATI ($0) and the ratio of A’s positive allocable ATI to the total positive allocable ATI ($100/$100). Therefore, A’s positive allocable ATI is reduced by $0 ($0 x 100 percent). As a result, A’s final allocable ATI is $100. Because B has a positive allocable ATI of $0, B's final allocable ATI is $0.

(vii) Seventh, PRS compares each partner’s ATI capacity (ATIC) amount to such partner’s remaining business interest expense. A’s ATIC amount is $30 ($100 x 30 percent) and B’s ATIC amount is $0 ($0 x 30 percent). Because A’s ATIC amount exceeds its remaining business interest expense by $10 ($30 - $20), A has an ATIC excess of $10. B does not have any ATIC excess. Thus, the total ATIC excess is $10 ($10 + $0). A does not have any ATIC deficit. Because B’s remaining business interest expense exceeds its ATIC amount by $20 ($20 - $0), B has an ATIC deficit of $20. Thus, the total ATIC deficit is $20 ($0 + $20).

(viii)

(ix) Ninth, PRS determines each partner’s final ATIC excess amount. Because A has an ATIC excess, PRS must determine A’s final ATIC excess amount. A’s final ATIC excess amount is A’s ATIC excess ($10), reduced, but not below $0, by the product of the total ATIC deficit ($20) and the ratio of A’s ATIC excess to the total ATIC excess ($10/$10). Therefore, A has $0 of final ATIC excess ($10 – ($20 x 100 percent)).

(x) Tenth, PRS determines each partner’s final ATIC deficit amount. Because B has an ATIC deficit, PRS must determine B’s final ATIC deficit amount. B’s final ATIC deficit amount is B’s ATIC deficit ($20), reduced, but not below $0, by the product of the total ATIC excess ($10) and the ratio of B’s ATIC deficit to the total ATIC deficit ($20/$20). Therefore, B has $10 of final ATIC deficit ($20 – ($10 x 100 percent)).

(xi) Eleventh, PRS allocates deductible business interest expense and section 163(j) excess items to the partners. Pursuant to paragraph (f)(2)(i) of this section, PRS has $10 of excess business interest expense. PRS allocates the excess business interest expense dollar for dollar to the partners with final ATIC deficits amounts. Thus, PRS allocates all $10 of its excess business interest expense to B. A partner’s allocable business interest expense is deductible business interest expense to the extent it exceeds such partner’s share of excess business interest expense. Therefore, A has deductible business interest expense of $30 ($30 - $0) and B has deductible business interest expense of $20 ($30 - $10). As a result of its allocations from PRS, A increases its section 704(b) capital account and basis in PRS by $80 to $180. As a result of its allocations from PRS, B decreases its capital account and basis in PRS by $20 to $80.

(i) First, PRS determines its limitation pursuant to §1.163(j)-2. PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $55 (($150 x 30 percent) + $10). Thus, PRS has $0 of excess business interest income, $50 of excess taxable income, $40 of deductible business interest expense, and $0 of excess business interest expense.

(ii) Second, PRS determines each partner’s allocable share of section 163(j) items used in its own section 163(j) calculation.

(iii) Third, PRS compares each partner’s allocable business interest income to such partner’s allocable business interest expense. Because A’s allocable business interest expense exceeds its allocable business interest income by $30 ($30 - $0), A has an allocable business interest income deficit of $30. Because B’s allocable business interest expense exceeds its allocable business interest income by $10 ($10 - $0), B has an allocable business interest income deficit of $10. C does not have any allocable business interest income deficit. Thus, the total allocable business interest income deficit is $40 ($30 + $10 + $0). A and B do not have any allocable business interest income excess. Because C’s allocable business interest income exceeds its allocable business interest expense by $10 ($10 - $0), C has an allocable business interest income excess of $10. Thus, the total allocable business interest income excess is $10 ($0 + $0 + $10).

(iv) Fourth, PRS determines each partner’s final allocable business interest income excess. Because A and B do not have any allocable business interest income excess, each partner has final allocable business interest income excess of $0. PRS determines C’s final allocable business interest income excess by reducing, but not below $0, C’s allocable business interest income excess ($10) by the product of the total allocable business interest income deficit ($40) and the ratio of C’s allocable business interest income excess to the total allocable business interest income excess ($10/$10). Therefore, C’s allocable business interest income excess of $10 is reduced by $10 ($40 x 100 percent). As a result, C’s allocable business interest income excess is $0.

(v) Fifth, PRS determines each partner’s remaining business interest expense. PRS determines A’s remaining business interest expense by reducing, but not below $0, A’s allocable business interest income deficit ($30) by the product of the total allocable business interest income excess ($10) and the ratio of A’s allocable business interest income deficit to the total business interest income deficit ($30/$40). Therefore, A’s allocable business interest income deficit of $30 is reduced by $7.50 ($10 x 75 percent). As a result, A’s remaining business interest expense is $22.50. PRS determines B’s remaining business interest expense by reducing, but not below $0, B’s allocable business interest income deficit ($10) by the product of the total allocable business interest income excess ($10) and the ratio of B’s allocable business interest income deficit to the total business interest income deficit ($10/$40). Therefore, B’s allocable business interest income deficit of $10 is reduced by $2.50 ($10 x 25 percent). As a result, B’s remaining business interest expense is $7.50. Because C does not have any allocable business interest income deficit, C’s remaining business interest expense is $0.

(vi) Sixth, PRS determines each partner’s final allocable ATI. Because A’s allocable ATI is comprised of $50 of items of deduction and loss and $0 of income and gain, A has negative allocable ATI of $50. A is the only partner with negative allocable ATI. Thus, the total negative allocable ATI amount is $50. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Therefore, A and C have a positive allocable ATI of $0. Because B’s allocable ATI is comprised of $200 of items of income and gain and $0 of deduction and loss, B has positive allocable ATI of $200. Thus, the total positive allocable ATI is $200 ($0 + $200 + $0). PRS determines B’s final allocable ATI by reducing, but not below $0, B’s positive allocable ATI ($200) by the product of total negative allocable ATI ($50) and the ratio of B’s positive allocable ATI to the total positive allocable ATI ($200/$200). Therefore, B’s positive allocable ATI is reduced by $50 ($50 x 100 percent). As a result, B’s final allocable ATI is $150.

(vii) Seventh, PRS compares each partner’s ATI capacity (ATIC) amount to such partner’s remaining business interest expense. A’s ATIC amount is $0 ($0 x 30 percent), B’s ATIC amount is $45 ($150 x 30 percent), and C’s ATIC amount is $0 ($0 x 30 percent). A does not have any ATIC excess. Because B’s ATIC amount exceeds its remaining business interest expense by $37.50 ($45 - $7.50), B has an ATIC excess amount of $37.50. C does not have any ATIC excess. Thus, the total ATIC excess amount is $37.50 ($0 + $37.50 + $0). Because A’s remaining business interest expense exceeds its ATIC amount by $22.50 ($22.50 - $0), A has an ATIC deficit of $22.50. B and C do not have any ATIC deficit. Thus, the total ATIC deficit is $22.50 ($22.50 + $0 + $0).

(viii)

(ix) Ninth, PRS determines each partner’s final ATIC excess amount. Because B has ATIC excess, PRS must determine B’s final ATIC excess amount. B’s final ATIC excess amount is B’s ATIC excess ($37.50), reduced, but not below $0, by the product of the total ATIC deficit ($22.50) and the ratio of B’s ATIC excess to the total ATIC excess ($37.50/$37.50). Therefore, B has $15 of final ATIC excess ($37.50 – ($22.50 x 100 percent)).

(x) Tenth, PRS determines each partner’s final ATIC deficit amount. Because A has an ATIC deficit, PRS must determine A’s final ATIC deficit amount. A’s final ATIC deficit amount is A’s ATIC deficit ($22.50), reduced, but not below $0, by the product of the total ATIC excess ($37.50) and the ratio of A’s ATIC deficit to the total ATIC deficit ($22.50/$22.50). Therefore, A has $0 of final ATIC deficit ($22.50 – ($37.50 x 100 percent)).

(xi) Eleventh, PRS allocates deductible business interest expense and section 163(j) excess items to the partners. Pursuant to paragraph (f)(2)(i) of this section, PRS has $50 of excess taxable income and $40 of deductible business interest expense. After grossing up each partner's final ATIC excess amounts by ten-thirds, excess taxable income is allocated dollar for dollar to partners with final ATIC excess amounts. Thus, PRS allocates its excess taxable income $50 to B. A partner’s allocable business interest expense is deductible business interest expense to the extent it exceeds such partner’s share of excess business interest expense. Therefore, A has deductible business interest expense of $30 ($30 - $0), B has deductible business interest expense of $10 ($10 - $0), and C has deductible business interest expense of $0 ($0 - $0).

(i) First, PRS determines its limitation pursuant to §1.163(j)-2. PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $30 ($100 x 30 percent). Thus, PRS has $30 of deductible business interest expense and $20 of excess business interest expense.

(ii) Second, PRS determines each partner’s allocable share of section 163(j) items used in its own section 163(j) calculation.

(iii) Third, PRS compares each partner’s allocable business interest income to such partner’s allocable business interest expense. No partner has allocable business interest income. Consequently, each partner’s allocable business interest income deficit is equal to such partner’s allocable business interest expense. Thus, A’s allocable business interest income deficit is $0, B’s allocable business interest income deficit is $25, and C’s allocable business interest income deficit is $25. The total allocable business interest income deficit is $50 ($0 + $25 + $25). No partner has allocable business interest income excess because no partner has allocable business interest income in excess of its allocable business interest expense. Thus, the total allocable business interest income excess is $0.

(iv) Fourth, PRS determines each partner’s final allocable business interest income excess. Because no partner had any allocable business interest income excess, each partner has final allocable business interest income excess of $0.

(v) Fifth, PRS determines each partner’s remaining business interest expense. Because no partner has any allocable business interest income excess, each partner’s remaining business interest expense equals its allocable business interest income deficit. Thus, A’s remaining business interest expense is $0, B’s remaining business interest expense is $25, and C’s remaining business interest expense is $25.

(vi) Sixth, PRS determines each partner’s final allocable ATI. Because C’s allocable ATI is comprised of $100 of items of deduction and loss and $0 of income and gain, C has negative allocable ATI of $100. C is the only partner with negative allocable ATI. Thus, the total negative allocable ATI amount is $100. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Therefore, C has a positive allocable ATI of $0. Because A’s allocable ATI is comprised of $100 of items of income and gain and $0 of deduction and loss, A has positive allocable ATI of $100. Because B’s allocable ATI is comprised of $100 of items of income and gain and $0 of deduction and loss, B has positive allocable ATI of $100. Thus, the total positive allocable ATI is $200 ($100 + $100 + $0). PRS determines A’s final allocable ATI by reducing, but not below $0, A’s positive allocable ATI ($100) by the product of total negative allocable ATI ($100) and the ratio of A’s positive allocable ATI to the total positive allocable ATI ($100/$200). Therefore, A’s positive allocable ATI is reduced by $50 ($100 x 50 percent). As a result, A’s final allocable ATI is $50. PRS determines B’s final allocable ATI by reducing, but not below $0, B’s positive allocable ATI ($100) by the product of total negative allocable ATI ($100) and the ratio of B’s positive allocable ATI to the total positive allocable ATI ($100/$200). Therefore, B’s positive allocable ATI is reduced by $50 ($100 x 50 percent). As a result, B’s final allocable ATI is $50. Because C has a positive allocable ATI of $0, C's final allocable ATI is $0.

(vii) Seventh, PRS compares each partner’s ATI capacity (ATIC) amount to such partner’s remaining business interest expense. A’s ATIC amount is $15 ($50 x 30 percent), B’s ATIC amount is $15 ($50 x 30 percent), and C’s ATIC amount is $0 ($0 x 30 percent). Because A’s ATIC amount exceeds its remaining business interest expense by $15 ($15 - $0), A has an ATIC excess of $15. B and C do not have any ATIC excess. Thus, the total ATIC excess is $15 ($15 + $0 + $0). A does not have any ATIC deficit. Because B’s remaining business interest expense exceeds its ATIC amount by $10 ($25 - $15), B has an ATIC deficit of $10. Because C’s remaining business interest expense exceeds its ATIC amount by $25 ($25 - $0), C has an ATIC deficit of $25. Thus, the total ATIC deficit is $35 ($0 + $10 + $25).

(viii)

(ix) Ninth, PRS determines each partner’s final ATIC excess amount. Pursuant to paragraph (f)(2)(viii)(C) of this section, each partner’s final ATIC excess amount is $0.

(x) Tenth, PRS determines each partner’s final ATIC deficit amount. Because C has an ATIC deficit, PRS must determine C’s final ATIC deficit amount. C’s final ATIC deficit amount is C’s ATIC deficit ($25), reduced, but not below $0, by the product of the total ATIC excess ($5) and the ratio of C’s ATIC deficit to the total ATIC deficit ($25/$25). Therefore, C has $20 of final ATIC deficit ($25 – ($5 x 100 percent)).

(xi) Eleventh, PRS allocates deductible business interest expense and section 163(j) excess items to the partners. Pursuant to paragraph (f)(2)(i) of this section, PRS has $20 of excess business interest expense. PRS allocates the excess business interest expense dollar for dollar to the partners with final ATIC deficits. Thus, PRS allocates its excess business interest expense $20 to C. A partner’s allocable business interest expense is deductible business interest expense to the extent it exceeds such partner’s share of excess business interest expense. Therefore, A has deductible business interest expense of $0 ($0 - $0), B has deductible business interest expense of $25 ($25 - $0), and C has deductible business interest expense of $5 ($25 - $20).

(i) First, PRS determines its limitation pursuant to §1.163(j)-2. PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $60 ($200 x 30 percent). Thus, PRS has $60 of deductible business interest expense and $80 of excess business interest expense.

(ii) Second, PRS determines each partner’s allocable share of section 163(j) items used in its own section 163(j) calculation.

(iii) Third, PRS compares each partner’s allocable business interest income to such partner’s allocable business interest expense. No partner has allocable business interest income. Consequently, each partner’s allocable business interest income deficit is equal to such partner’s allocable business interest expense. Thus, A’s allocable business interest income deficit is $0, B’s allocable business interest income deficit is $40, C’s allocable business interest income deficit is $60, and D’s allocable business interest income deficit is $40. The total allocable business interest income deficit is $140 ($0 + $40 + $60 + $40). No partner has allocable business interest income excess because no partner has allocable business interest income in excess of its allocable business interest expense. Thus, the total allocable business interest income excess is $0.

(iv) Fourth, PRS determines each partner’s final allocable business interest income excess. Because no partner has any allocable business interest income excess, each partner has final allocable business interest income excess of $0.

(v) Fifth, PRS determines each partner’s remaining business interest expense. Because no partner has any allocable business interest income excess, each partner’s remaining business interest expense equals its allocable business interest income deficit. Thus, A’s remaining business interest expense is $0, B’s remaining business interest expense is $40, C’s remaining business interest expense is $60, and D’s remaining business interest expense is $40.

(vi) Sixth, PRS determines each partner’s final allocable ATI. Because D’s allocable ATI is comprised of $400 of items of deduction and loss and $0 of income and gain, D has negative allocable ATI of $400. D is the only partner with negative allocable ATI. Thus, the total negative allocable ATI amount is $400. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Therefore, D has a positive allocable ATI of $0. PRS determines A’s final allocable ATI by reducing, but not below $0, A’s positive allocable ATI ($100) by the product of total negative allocable ATI ($400) and the ratio of A’s positive allocable ATI to the total positive allocable ATI ($100/$600). Therefore, A’s positive allocable ATI is reduced by $66.67 ($400 x 16.67 percent). As a result, A’s final allocable ATI is $33.33. PRS determines B’s final allocable ATI by reducing, but not below $0, B’s positive allocable ATI ($100) by the product of total negative allocable ATI ($400) and the ratio of B’s positive allocable ATI to the total positive allocable ATI ($100/$600). Therefore, B’s positive allocable ATI is reduced by $66.67 ($400 x 16.67 percent). As a result, B’s final allocable ATI is $33.33. PRS determines C’s final allocable ATI by reducing, but not below $0, C’s positive allocable ATI ($400) by the product of total negative allocable ATI ($400) and the ratio of C’s positive allocable ATI to the total positive allocable ATI ($400/$600). Therefore, C’s positive allocable ATI is reduced by $266.67 ($400 x 66.67 percent). As a result, C’s final allocable ATI is $133.33. Because D has a positive allocable ATI of $0, D's final allocable ATI is $0.

(vii) Seventh, PRS compares each partner’s ATI capacity (ATIC) amount to such partner’s remaining business interest expense. A’s ATIC amount is $10 ($33.33 x 30 percent), B’s ATIC amount is $10 ($33.33 x 30 percent), C’s ATIC amount is $40 ($133.33 x 30 percent), and D’s ATIC amount is $0 ($0 x 30 percent). Because A’s ATIC amount exceeds its remaining business interest expense by $10 ($10 - $0), A has an ATIC excess of $10. B, C, and D do not have any ATIC excess. Thus, the total ATIC excess is $10 ($10 + $0 + $0 + $0). A does not have any ATIC deficit. Because B’s remaining business interest expense exceeds its ATIC amount by $30 ($40 - $10), B has an ATIC deficit of $30. Because C’s remaining business interest expense exceeds its ATIC amount by $20 ($60 - $40), C has an ATIC deficit of $20. Because D’s remaining business interest expense exceeds its ATIC amount by $40 ($40 - $0), D has an ATIC deficit of $40. Thus, the total ATIC deficit is $90 ($0 + $30 + $20 + $40).

(viii)

(ix) Ninth, PRS determines each partner’s final ATIC excess amount. Pursuant to paragraph (f)(2)(viii)(D) of this section, each priority and non-priority partner’s final ATIC excess amount is $0.

(x) Tenth, PRS determines each partner’s final ATIC deficit amount. Because B has an ATIC deficit, PRS must determine B’s final ATIC deficit amount. B’s final ATIC deficit amount is B’s ATIC deficit ($28), reduced, but not below $0, by the product of the total ATIC excess ($0) and the ratio of B’s ATIC deficit to the total ATIC deficit ($28/$40). Therefore, B has $28 of final ATIC deficit ($28 – ($0 x 70 percent)). Because C has an ATIC deficit, PRS must determine C’s final ATIC deficit amount. C’s final ATIC deficit amount is C’s ATIC deficit ($12), reduced, but not below $0, by the product of the total ATIC excess ($0) and the ratio of C’s ATIC deficit to the total ATIC deficit ($12/$40). Therefore, C has $12 of final ATIC deficit ($12 – ($0 x 30 percent)). Pursuant to paragraph (f)(2)(viii)(D) of this section, D’s final ATIC deficit amount is $40.

(xi) Eleventh, PRS allocates deductible business interest expense and section 163(j) excess items to the partners. Pursuant to paragraph (f)(2)(i) of this section, PRS has $80 of excess business interest expense. PRS allocates the excess business interest expense dollar for dollar to the partners with final ATIC deficits. Thus, PRS allocates its excess business interest expense $28 to B, $12 to C, and $40 to D. A partner’s allocable business interest expense is deductible business interest expense to the extent it exceeds such partner’s share of excess business interest expense. Therefore, A has deductible business interest expense of $0 ($0 - $0), B has deductible business interest expense of $12 ($40 - $28), C has deductible business interest expense of $48 ($60 - $12), and D has deductible business interest expense of $0 ($40 - $40).

(i) First, PRS determines its limitation pursuant to §1.163(j)-2. PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $60 ($200 x 30 percent). Thus, PRS has $60 of deductible business interest expense, and $90 of excess business interest expense.

(ii) Second, PRS determines each partner’s allocable share of section 163(j) items used in its own section 163(j) calculation.

(iii) Third, PRS compares each partner’s allocable business interest income to such partner’s allocable business interest expense. No partner has allocable business interest income. Consequently, each partner’s allocable business interest income deficit is equal to such partner’s allocable business interest expense. Thus, A’s allocable business interest income deficit is $0, B’s allocable business interest income deficit is $50, C’s allocable business interest income deficit is $50, and D’s allocable business interest income deficit is $50. The total allocable business interest income deficit is $150 ($0 + $50 + $50 + $50). No partner has allocable business interest income excess because no partner has allocable business interest income in excess of its allocable business interest expense. Thus, the total allocable business interest income excess is $0.

(iv) Fourth, PRS determines each partner’s final allocable business interest income excess. Because no partner has any allocable business interest income excess, each partner has final allocable business interest income excess of $0.

(v) Fifth, PRS determines each partner’s remaining business interest expense. Because no partner has any allocable business interest income excess, each partner’s remaining business interest expense equals its allocable business interest income deficit. Thus, A’s remaining business interest expense is $0, B’s remaining business interest expense is $50, C’s remaining business interest expense is $50, and D’s remaining business interest expense is $50.

(vi) Sixth, PRS determines each partner’s final allocable ATI. Because D’s allocable ATI is comprised of $300 of items of deduction and loss and $0 of income and gain, D has negative allocable ATI of $300. D is the only partner with negative allocable ATI. Thus, the total negative allocable ATI amount is $300. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Therefore, D has a positive allocable ATI of $0. PRS determines A’s final allocable ATI by reducing, but not below $0, A’s positive allocable ATI ($50) by the product of total negative allocable ATI ($300) and the ratio of A’s positive allocable ATI to the total positive allocable ATI ($50/$500). Therefore, A’s positive allocable ATI is reduced by $30 ($300 x 10 percent). As a result, A’s final allocable ATI is $20. PRS determines B’s final allocable ATI by reducing, but not below $0, B’s positive allocable ATI ($50) by the product of total negative allocable ATI ($300) and the ratio of B’s positive allocable ATI to the total positive allocable ATI ($50/$500). Therefore, B’s positive allocable ATI is reduced by $30 ($300 x 10 percent). As a result, B’s final allocable ATI is $20. PRS determines C’s final allocable ATI by reducing, but not below $0, C’s positive allocable ATI ($400) by the product of total negative allocable ATI ($300) and the ratio of C’s positive allocable ATI to the total positive allocable ATI ($400/$500). Therefore, C’s positive allocable ATI is reduced by $240 ($300 x 80 percent). As a result, C’s final allocable ATI is $160. Because D has a positive allocable ATI of $0, D's final allocable ATI is $0.

(vii) Seventh, PRS compares each partner’s ATI capacity (ATIC) amount to such partner’s remaining business interest expense. A’s ATIC amount is $6 ($20 x 30 percent), B’s ATIC amount is $6 ($20 x 30 percent), C’s ATIC amount is $48 ($160 x 30 percent), and D’s ATIC amount is $0 ($0 x 30 percent). Because A’s ATIC amount exceeds its remaining business interest expense by $6 ($6 - $0), A has an ATIC excess of $6. B, C, and D do not have any ATIC excess. Thus, the total ATIC excess amount is $6 ($6 + $0 + $0 + $0). A does not have any ATIC deficit. Because B’s remaining business interest expense exceeds its ATIC amount by $44 ($50 - $6), B has an ATIC deficit of $44. Because C’s remaining business interest expense exceeds its ATIC amount by $2 ($50 - $48), C has an ATIC deficit of $2. Because D’s remaining business interest expense exceeds its ATIC amount by $50 ($50 - $0), D has an ATIC deficit of $50. Thus, the total ATIC deficit is $96 ($0 + $44 + $2 + $50).

(viii)

(ix) Ninth, PRS determines each partner’s final ATIC excess amount. Pursuant to paragraph (f)(2)(viii)(D) of this section, each priority and non-priority partner’s final ATIC excess amount is $0.

(x) Tenth, PRS determines each partner’s final ATIC deficit amount. Because B has an ATIC deficit, PRS must determine B’s final ATIC deficit amount. B’s final ATIC deficit amount is B’s ATIC deficit ($43.33), reduced, but not below $0, by the product of the total ATIC excess ($3.33) and the ratio of B’s ATIC deficit to the total ATIC deficit ($43.33/$43.33). Therefore, B has $40 of final ATIC deficit ($43.33 – ($3.33 x 100 percent)). Pursuant to paragraph (f)(2)(viii)(D) of this section, D’s final ATIC deficit amount is $40.

(xi) Eleventh, PRS allocates deductible business interest expense and section 163(j) excess items to the partners. Pursuant to paragraph (f)(2)(i) of this section, PRS has $90 of excess business interest expense. PRS allocates the excess business interest expense dollar for dollar to the partners with final ATIC deficits. Thus, PRS allocates its excess business interest expense $40 to B and $50 to D. A partner’s allocable business interest expense is deductible business interest expense to the extent it exceeds such partner’s share of excess business interest expense. Therefore, A has deductible business interest expense of $0 ($0 - $0), B has deductible business interest expense of $10 ($50 - $40), C has deductible business interest expense of $50 ($50 - $0), and D has deductible business interest expense of $0 ($50 - $50).

(i) Facts. A and B are equal shareholders in X, a subchapter S corporation. In Year 1, X has $100 of ATI and $40 of business interest expense. A has $100 of ATI and $20 of business interest expense from its sole proprietorship. B has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) S corporation-level. In Year 1, X’s section 163(j) limit is 30 percent of its ATI, or $30 ($100 x 30 percent). Thus, X has $30 of deductible business interest expense and $10 of disallowed business interest expense. Such $30 of deductible business interest expense is includable in X’s nonseparately stated income or loss, and is not subject to further limitation under section 163(j). X carries forward the $10 of disallowed business interest expense to Year 2 as a disallowed business interest expense carryforward under §1.163(j)-2(c). X may not currently deduct all $40 of its business interest expense in Year 1. X only reduces its accumulated adjustments account in Year 1 by the $30 of deductible business interest expense in Year 1 under §1.163(j)-6(l)(7).

(iii) Shareholder allocations. A and B are each allocated $35 of nonseparately stated taxable income ($50 items of income or gain, less $15 of deductible business interest expense) from X. A and B do not reduce their basis in X by the $10 of disallowed business interest expense.

(iv) Shareholder-level computations. A, in computing its limit under section 163(j), has $100 of ATI and $20 of business interest expense from its sole proprietorship. A’s section 163(j) limit is $30 ($100 x 30 percent). Thus, A’s $20 of business interest expense is deductible business interest expense. B, in computing its limit under section 163(j), has $20 of business interest expense from its sole proprietorship. B’s section 163(j) limit is $0 ($0 x 30 percent). Thus, B’s $20 of business interest expense is not allowed as a deduction and is treated as business interest expense paid or accrued by B in Year 2.

(i) Facts. The facts are the same as in Example 22 in paragraph (o)(22)(i) of this section. In Year 2, X has $233.33 of ATI, $0 of business interest income, and $30 of business interest expense. A has $100 of ATI and $20 of business interest expense from its sole proprietorship. B has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) S corporation-level. In Year 2, X’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $70 ($233.33 x 30 percent). Because X’s section 163(j) limit exceeds X's $40 of business interest expense ($30 from Year 2, plus the $10 disallowed business interest expense carryforwards from Year 1), X may deduct all $40 of business interest expense in Year 2. Such $40 of deductible business interest expense is includable in X’s nonseparately stated income or loss, and is not subject to further limitation under section 163(j). Pursuant to §1.163(j)-6(l)(7), X must reduce its accumulated adjustments account by $40. Additionally, X has $100 of excess taxable income under §1.163(j)-1(b)(17).

(iii) Shareholder allocations. A and B are each allocated $96.67 of nonseparately stated taxable income ($116.67 items of income or gain, less $20 of deductible business interest expense) from X. Additionally, A and B are each allocated $50 of excess taxable income under §1.163(j)-6(l)(4). As a result, A and B each increase their ATI by $50.

(iv) Shareholder-level computations. A, in computing its limit under section 163(j), has $150 of ATI ($100 from its sole proprietorship, plus $50 excess taxable income) and $20 of business interest expense (from its sole proprietorship). A’s section 163(j) limit is $45 ($150 x 30 percent). Thus, A’s $20 of business interest expense is deductible business interest expense. B, in computing its limit under section 163(j), has $50 of ATI ($0 from its sole proprietorship, plus $50 excess taxable income) and $40 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from its sole proprietorship in Year 1). B’s section 163(j) limit is $15 ($50 x 30 percent). Thus, $15 of B’s business interest expense is deductible business interest expense. The $25 of B’s business interest expense not allowed as a deduction ($40 business interest expense, less $15 section 163(j) limit) is treated as business interest expense paid or accrued by B in Year 3.

(i) Facts. On January 1, 2020, L and M form LM, a publicly traded partnership (as defined in §1.7704-1), and agree that each will be allocated a 50 percent share of all LM items. The partnership agreement provides that LM will make allocations under section 704(c) using the remedial allocation method under §1.704-3(d). L contributes depreciable property with an adjusted tax basis of $4,000 and a fair market value of $10,000. The property is depreciated using the straight-line method with a 10-year recovery period and has 4 years remaining on its recovery period. M contributes $10,000 in cash, which LM uses to purchase land. Except for the depreciation deductions, LM's expenses equal its income in each year of the 10 years commencing with the year LM is formed. LM has a valid section 754 election in effect.

(ii) Section 163(j) remedial items and partner basis items. LM sells the asset contributed by L in a fully taxable transaction at a time when the adjusted basis of the property is $4,000. Under §1.163(j)-6(e)(2)(ii), solely for purposes of §1.163(j)-6, the tax gain of $6,000 is allocated equally between L and M ($3,000 each). To avoid shifting built-in gain to the non-contributing partner (M) in a manner consistent with the rule in section 704(c), a remedial deduction of $3,000 is allocated to M (leaving M with no net tax gain), and remedial income of $3,000 is allocated to L (leaving L with total tax gain of $6,000).

(i) Facts. The facts are the same as Example 24 in paragraph (o)(24) of this section except the property contributed by L had an adjusted tax basis of zero. For each of the 10 years following the contribution, there would be $500 of section 704(c) remedial income allocated to L and $500 of remedial deductions allocated to M with respect to the contributed asset. A buyer of M’s units would step into M’s shoes with respect to the $500 of annual remedial deductions. A buyer of L’s units would step into L’s shoes with respect to the $500 of annual remedial income and would have an annual section 743(b) deduction of $1,000 (net $500 of deductions).

(ii) Analysis. Pursuant to §1.163(j)-6(d)(2)(ii), solely for purposes of §1.163(j)-6, a buyer of L’s units immediately after formation of LM would offset its $500 annual section 704(c) remedial income allocation with $500 of annual section 743(b) adjustment (leaving the buyer with net $500 of section 743(b) deduction). As a result, such buyer would be in the same position as a buyer of M’s units. Each buyer would have net deductions of $500 per year, which would not affect ATI before 2022.

(i) Facts. X and Y are partners in partnership PRS. In Year 1, PRS had $200 of excess business interest expense. Pursuant to §1.163(j)-6(f)(2), PRS allocated $100 of such excess business interest expense to each of its partners. In Year 2, X lends $10,000 to PRS and receives $1,000 of interest income for the taxable year (self-charged lending transaction). X is not in the trade or business of lending money. The $1,000 of interest expense resulting from this loan is allocable to PRS’s trade or business assets. As a result, such $1,000 of interest expense is business interest expense of PRS. X and Y are each allocated $500 of such business interest expense as their distributive share of PRS’s business interest expense for the taxable year. Additionally, in Year 2, PRS has $3,000 of ATI. PRS allocates the items comprising its $3,000 of ATI $0 to X and $3,000 to Y.

(ii) Partnership-level. In Year 2, PRS’s section 163(j) limit is 30 percent of its ATI plus its business interest income, or $900 ($3,000 x 30 percent). Thus, PRS has $900 of deductible business interest expense, $100 of excess business interest expense, $0 of excess taxable income, and $0 of excess business interest income. Pursuant to §1.163(j)-6(f)(2), $400 of X’s allocation of business interest expense is treated as deductible business interest expense, $100 of X’s allocation of business interest expense is treated as excess business interest expense, and $500 of Y’s allocation of business interest expense is treated as deductible business interest expense.

(iii) Lending partner. Pursuant to §1.163(j)-6(n), X treats $100 of its $1,000 of interest income as excess business interest income allocated from PRS in Year 2. Because X is deemed to have been allocated $100 of excess business interest income from PRS, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess business interest income is allocated from such partnership to a partner, X treats its $100 allocation of excess business interest expense from PRS in Year 2 as business interest expense paid or accrued in Year 2. X, in computing its limit under section 163(j), has $100 of business interest income ($100 deemed allocation of excess business interest income from PRS in Year 2) and $100 of business interest expense ($100 allocation of excess business interest expense treated as paid or accrued in Year 2). Thus, X’s $100 of business interest expense is deductible business interest expense. At the end of Year 2, X has $100 of excess business interest expense from PRS ($100 from Year 1). X treats $900 of its $1,000 of interest income as investment income for purposes of section 163(d).

(i) Facts. X and Y are equal partners in partnership PRS. Further, X and Y share the profits of PRS equally. In 2019, PRS had ATI of $100. Additionally, in 2019, PRS had $100 of section 704(b) income which was allocated $50 to X and $50 to Y (PRS did not have any section 704(c) income in 2019). In 2020, PRS’s only items of income, gain, loss or deduction was $1 of trade or business income, which it allocated to X pursuant to section 704(c).

(ii) Partnership-level. In 2020, PRS makes the election described in §1.163(j)-6(d)(5) to use its 2019 ATI in 2020. As a result, PRS has $100 of ATI in 2020. PRS does not have any business interest expense. Therefore, PRS has $100 of excess taxable income in 2020.

(iii) Partner-level allocations. PRS allocates its $100 of excess taxable income to X and Y pursuant to §1.163(j)-6(f)(2). To determine each partner’s share of the $100 of excess taxable income, PRS must determine each partner’s allocable ATI (as defined in §1.163(j)-6(f)(2)(ii)). Because PRS made the election described in §1.163(j)-6(d)(5), PRS must determine the allocable ATI of each of its partners pursuant to paragraph (d)(5). Specifically, PRS determines each partner’s share of allocable ATI based on PRS’s 2019 section 704 income, gain, loss, and deduction. PRS had $100 of section 704(b) income in 2019 which was allocated $50 to X and $50 to Y. Therefore, in 2020, X and Y are both allocated $50 of excess taxable income (50% x $100).

(i) Facts. X, a partner in partnership PRS, was allocated $20 of excess business interest expense from PRS in 2018 and $10 of excess business interest expense from PRS in 2019. In 2020, PRS allocated $16 of excess taxable income to X.

(ii) Analysis. X treats 50 percent of its $10 of excess business interest expense allocated from PRS in 2019 as §1.163(j)-6(g)(4) business interest expense. Thus, $5 of §1.163(j)-6(g)(4) business interest expense is treated as paid or accrued by X in 2020 and is not subject to the section 163(j) limitation at X’s level. Because X was allocated $16 of excess taxable income from PRS in 2020, X treats $16 of its $25 of excess business interest expense as business interest expense paid or accrued pursuant to §1.163(j)-6(g)(2). X, in computing its limit under section 163(j) in 2020, has $16 of ATI (as a result of its allocation of $16 of excess taxable income from PRS), $0 of business interest income, and $16 of business interest expense ($16 of excess business interest expense treated as paid or accrued in 2020). Pursuant to §1.163(j)-2(b)(2)(i), X’s section 163(j) limit in 2020 is $8 ($16 x 50 percent). Thus, X has $8 of business interest expense that is deductible under section 163(j). The $8 of X’s business interest expense not allowed as a deduction ($16 business interest expense subject to section 163(j), less $8 section 163(j) limit) is treated as business interest expense paid or accrued by X in 2021. At the end of 2020, X has $9 of excess business interest expense from PRS ($20 from 2018, plus $10 from 2019, less $5 treated as paid or accrued pursuant to §1.163(j)-6(g)(4), less $16 treated as paid or accrued pursuant to §1.163(j)-6(g)(2)).

(i) Facts. X is a partner in partnership PRS. At the beginning of 2018, X’s outside basis in PRS was $100. X was allocated $20 of excess business interest expense from PRS in 2018 and $10 of excess business interest expense from PRS in 2019. X sold its PRS interest in 2019 for $70.

(ii) Analysis. X treats 50 percent of its $10 of excess business interest expense allocated from PRS in 2019 as §1.163(j)-6(g)(4) business interest expense. Thus, $5 of §1.163(j)-6(g)(4) business interest expense is treated as paid or accrued by X in 2020 and is not subject to the section 163(j) limitation at X’s level. Pursuant to paragraph (h)(3) of this section, immediately before the disposition, X increases the basis of its PRS interest from $70 to $95 (add back of $20 of EBIE from 2018 and $5 of remaining EBIE from 2019). Thus, X has a $25 section 741 loss recognized on the sale ($70 - $95).