Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 42.—Low-Income Housing Credit

Low-income housing credit; satis- factory bond; “bond factor” amounts for the period January through March 2004. This ruling announces the monthly bond factor amounts to be used by taxpayers who dispose of qualified low-income buildings or interests therein during the period January through March 2004.

Rev. Rul. 2004–16

In Rev. Rul. 90–60, 1990–2 C.B. 3, the Internal Revenue Service provided

guidance to taxpayers concerning the general methodology used by the Treasury Department in computing the bond factor amounts used in calculating the amount of bond considered satisfactory by the Secretary under § 42(j)(6) of the Internal Revenue Code. It further announced that the Secretary would publish in the Internal Revenue Bulletin a table of bond factor amounts for dispositions occurring during each calendar month.

Rev. Proc. 99–11, 1999–1 C.B. 275, established a collateral program as an alternative to providing a surety bond for taxpayers to avoid or defer recapture of

the low-income housing tax credits under § 42(j)(6). Under this program, taxpayers may establish a Treasury Direct Account and pledge certain United States Treasury securities to the Internal Revenue Service as security.

This revenue ruling provides in Table 1 the bond factor amounts for calculating the amount of bond considered satisfactory under § 42(j)(6) or the amount of United States Treasury securities to pledge in a Treasury Direct Account under Rev. Proc. 99–11 for dispositions of qualified low-income buildings or interests therein during the period January through March 2004.

DRAFTING INFORMATION

The principal author of this revenue ruling is Gregory N. Doran of the Office of Associate Chief Counsel (Passthroughs

For a list of bond factor amounts applicable to dispositions occurring during other calendar years, see: Rev. Rul. 98–3, 1998–1 C.B. 248; Rev. Rul.

2001–2, 2001–1 C.B. 255; Rev. Rul. 2001–53, 2001–2 C.B. 488; Rev. Rul. 2002–72, 2002–2 C.B. 759; and Rev. Rul. 2003–117, 2003–46 I.R.B. 1051.

2004-8 I.R.B. 503 February 23, 2004

close of the second calendar year following the calendar year of the allocation).

The commentator recommended revising §1.42–6(a)(2) of the proposed regulations to clarify that each building in a multi-building project receiving a projectbased carryover allocation under section 42(h)(1)(F) need not separately meet the 10 percent basis requirement. The commentator states that the proposed regulations appear to require that each building in a multi-building project that receives a project-based carryover allocation must meet the 10 percent basis requirement separately. The proposed regulations do not require that each building in a multi-building project satisfy the 10 percent basis requirement separately for project-based carryover allocations made under section 42(h)(1)(F). For allocations made under section 42(h)(1)(F), the 10 percent basis requirement is only required to be met on a project basis. The final regulations clarify this issue.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a new collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. The collection of information contained in this Treasury decision has been previously reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545–1102. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking that preceded this Treasury decision was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal authors of these regulations are Christopher J. Wilson and Lauren R. Taylor, Office of the Associate Chief

and Special Industries). For further information regarding this revenue ruling, contact Mr. Doran at (202) 622–3040 (not a toll-free call).

26 CFR 1.42–6: Buildings qualifying for carryover allocations.

T.D. 9110

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Section 42 Carryover and Stacking Rule Amendments

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations that amend several existing regulations concerning the low-income housing tax credit. The regulations primarily reflect changes to the law made by the Community Renewal Tax Relief Act of 2000 and affect owners of low-income housing projects who claim the credit and the State or local housing credit agencies who administer the credit.

DATES: Effective Date: These regulations are effective January 6, 2004.

Applicability Dates: For dates of applicability of these regulations, see §§1.42–12(a)(2) and (3), and 1.42–14(l)(2).

FOR FURTHER INFORMATION CONTACT: Lauren R. Taylor (202) 622–3040 or Christopher J. Wilson (808) 539–2874 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

On July 7, 2003, the IRS published a notice of proposed rulemaking in the Fed- eral Register (REG–131997–02, 2003–33 I.R.B. 366 [68 FR 40218]) proposing amendments to the Income Tax Regulations (26 CFR part 1) under section 42 of the Internal Revenue Code. These amendments provide guidance regarding

changes to section 42 made by the Community Renewal Tax Relief Act of 2000 (Public Law 106–554) (2000 Act) and make certain changes to the regulations to help facilitate the electronic filing (E-filing) of income tax returns.

One commentator submitted written comments in response to the notice of proposed rulemaking. A public hearing was scheduled for September 23, 2003, pursuant to a notice of public hearing published simultaneously with the notice of proposed rulemaking. The IRS received one request to speak at the public hearing. This request was withdrawn before the hearing date. On September 15, 2003, the IRS published a notice (68 FR 53926) canceling the public hearing on the proposed regulations. After consideration of the comments received, the proposed regulations are adopted as revised by this Treasury decision. The revisions are discussed below.

Explanation of Provisions

Section 42 provides for a low-income housing tax credit that may be claimed as part of the general business credit under section 38. In general, the credit is allowable only if the owner of a qualified low-income building receives a housing credit allocation from a State or local housing credit agency (Agency) of the jurisdiction where the building is located.

In general, an allocation must be made not later than the close of the calendar year in which the building is placed in service. Under section 42(h)(1)(E), an allocation (carryover allocation) may be made to a “qualified building” that has not yet been placed in service, provided the building is placed in service not later than the close of the second calendar year following the calendar year of the allocation. Section 42(h)(1)(F) provides rules for multi-building projects receiving project-based carryover allocations. Following the changes made by the 2000 Act, section 42(h)(1)(E)(ii) defines a qualified building as any building that is part of a project if the taxpayer’s basis in the project (as of the later of the date which is 6 months after the date that the allocation was made or the close of the calendar year in which the allocation is made) is more than 10 percent of the taxpayer’s reasonably expected basis in the project (as of the

February 23, 2004 504 2004-8 I.R.B.

carryover allocation is treated as a valid allocation for the calendar year of allocation, but is included in the “returned credit component” for purposes of determining the State housing credit ceiling under section 42(h)(3)(C) for the calendar year following the calendar year of the allocation. See §1.42–14(d)(1).

(b) - * (4) - * Example 2 . (i) Facts . D, an accrual-method taxpayer, received a carryover allocation from Agency, the state housing credit agency of State X, on September 12, 2003. As of that date, D has not begun construction of the low-income housing building D plans to build and D does not have basis in the land on which D plans to build the building. From September 12, 2003, to the close of March 12, 2004, D incurs some costs related to the planned building, including architects’ fees. As of the close of March 12, 2004, these costs do not exceed 10 percent of D’s reasonably expected basis in the single-building project as of the close of 2005.

(ii) Determination of whether building is quali- fied . Because D’s carryover-allocation basis as of the close of March 12, 2004, is not more than 10 percent of D’s reasonably expected basis in the single-building project, the building is not a qualified building for purposes of section 42(h)(1)(E)(ii) and paragraph (a) of this section. Accordingly, the carryover allocation to D must be returned to the Agency. The allocation is valid for purposes of determining the amount of credit allocated by Agency from State X’s 2003 State housing credit ceiling, but is included in the returned credit component of State X’s 2004 housing credit ceiling.

(c) Verification of basis by Agency —(1) Verification requirement . An Agency that makes a carryover allocation to a taxpayer must verify that the taxpayer has met the 10 percent basis requirement of paragraph (a)(2) of this section.

(2) - * (3) Time of verification —(i) Allocations made before July 1 . For a carryover allocation made before July 1, an Agency may require that the basis certification be submitted to or received by the Agency prior to the close of the calendar year of allocation or within a reasonable time following the close of the calendar year of allocation. The Agency will need to verify basis as provided in paragraph (c)(2) of this section to accurately complete the Form 8610, “ Annual Low-Income Housing Credit Agencies Report,” and the Schedule A (Form 8610), “ Carryover Alloca- tion of Low-Income Housing Credit,” for the calendar year of the allocation. If the basis certification is not timely made, or supporting documentation is lacking, inadequate, or does not actually support the certification, the Agency should notify the

Counsel (Passthroughs and Special Industries), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.42–6 is amended by:

1. Revising paragraphs (a), (b)(4) Ex- ample 2, (c)(1), (c)(3), (d)(2)(viii), and (d)(4)(i).

2. Removing the word “September” from paragraph (b)(4) Example 1. and adding the word “May” in its place; removing the year “1993” each place it appears and by adding the year “2003” in its place; and removing the year “1995” and adding the year “2005” in its place.

3. Removing the language “by the close of the calendar year of the allocation” from the first and last sentences of paragraph (c)(2) and adding the language “by the close of the calendar year of the allocation (for allocations made before July 1) or by the close of the date that is 6 months after the date the allocation is made (for allocations made after June 30)” in its place.

4. Removing the language “, “Carryover Allocation of the Low-Income Housing Credit,”” from paragraph (d)(4)(ii).

5. Removing the language “before the close of the calendar year of the allocation” from the first sentence of paragraph (e)(2) and adding the language “by the close of the calendar year of the allocation (for allocations made before July 1) or by the close of the date that is 6 months after the date the allocation is made (for allocations made after June 30)” in its place.

The revisions read as follows:

§1.42–6 Buildings qualifying for carryover allocations.

(a) Carryover allocations —(1) In gen- eral . A carryover allocation is an allocation that meets the requirements of section 42(h)(1)(E) or (F). If the requirements of section 42(h)(1)(E) or (F) that are required

to be satisfied by the close of a calendar year are not satisfied, the allocation is not valid and is treated as if it had not been made for that calendar year. For example, if a carryover allocation fails to satisfy a requirement in §1.42–6(d) for making an allocation, such as failing to be signed or dated by an authorized official of an allocating agency by the close of a calendar year, the allocation is not valid and is treated as if it had not been made for that calendar year.

(2) 10 percent basis requirement . A carryover allocation may only be made with respect to a qualified building. A qualified building is any building which is part of a project if, by the date specified under paragraph (a)(2)(i) or (ii) of this section, a taxpayer’s basis in the project is more than 10 percent of the taxpayer’s reasonably expected basis in the project as of the close of the second calendar year following the calendar year the allocation is made. For purposes of meeting the 10 percent basis requirement, the determination of whether a building is part of a single-building project or multi-building project is based on whether the carryover allocation is made under section 42(h)(1)(E) (building-based allocation) or section 42(h)(1)(F) (project-based allocation). In the case of a multi-building project that receives an allocation under section 42(h)(1)(F), the 10 percent basis requirement is satisfied by reference to the entire project.

(i) Allocation made before July 1 . If a carryover allocation is made before July 1 of a calendar year, a taxpayer must meet the 10 percent basis requirement by the close of that calendar year. If a taxpayer does not meet the 10 percent basis requirement by the close of the calendar year, the carryover allocation is not valid and is treated as if it had not been made.

(ii) Allocation made after June 30 . If a carryover allocation is made after June 30 of a calendar year, a taxpayer must meet the 10 percent basis requirement by the close of the date that is 6 months after the date the allocation was made. If a taxpayer does not meet the 10 percent basis requirement by the close of the required date, the carryover allocation must be returned to the Agency. Unlike a carryover allocation made before July 1, if a taxpayer does not meet the 10 percent basis requirement by the close of the required date, the

2004-8 I.R.B. 505 February 23, 2004

Form 8609 reflecting the 2004 allocation of $50,000 and files the original of this Form 8609 with the Form 8610 that it files for the 2004 calendar year. Agency retains copies of the Forms 8609 that are issued to X.

Example 2. - * *

• • • • (iv) Agency retains the original of the binding agreements, election statements, and carryover allocation documents. Agency accounts for the binding agreement, election statement, and 2003 carryover allocation on the Schedule A (Form 8610) that it files for the 2003 calendar year. Agency also accounts for the binding agreement, election statement, and 2004 carryover allocation on the Schedule A (Form

8610. that it files for the 2004 calendar year. After each separate new building is placed in service, and assuming other necessary requirements for issuing a Form 8609 are met (for example, taxpayer has certified all sources and uses of funds and development costs for the building under §1.42–17), the Agency will issue to X a copy of the Form 8609 reflecting the 2003 carryover allocation of $70,000 and a copy of the Form 8609 reflecting the 2004 carryover allocation of $50,000, respectively. Agency files the original of each Form 8609 with the Form 8610 that reflects the calendar year each Form 8609 is issued. Agency retains copies of the Forms 8609 that are issued to X.

(b) - * (4) - * (ii) Agency . The Agency must retain the original of the election statement and a copy of the Form 8609 that reflects the election statement. The Agency must file an additional copy of the Form 8609 with the Agency’s Form 8610 that reflects the calendar year the Form 8609 is issued.

Par. 4. Section 1.42–12 is amended by revising paragraph (a) to read as follows:

§1.42–12 Effective dates and transitional rules.

(a) Effective dates —(1) In general . Except as provided in paragraphs (a)(2) and (a)(3) of this section, the rules set forth in §§1.42–6 and 1.42–8 through 1.42–12 are applicable on May 2, 1994. However, binding agreements, election statements, and carryover allocation documents entered into before May 2, 1994, that follow the guidance set forth in Notice 89–1, 1989–1 C.B. 620 (see §601.601(d)(2)(ii)(b) of this chapter) need not be changed to conform to the rules set forth in §§1.42–6 and 1.42–8 through 1.42–12. (2) Community Renewal Tax Relief Act of 2000 —(i) In general . Section 1.42–6(a), (b)(4)(iii) Example 1 and Ex- ample 2, (c), (d)(2)(viii), and (e)(2) are applicable for housing credit dollar amounts

taxpayer and try to get adequate documentation. If the Agency cannot verify before the Form 8610 is filed that the taxpayer has satisfied the 10 percent basis requirement for a carryover allocation made before July 1, the allocation is not valid and is treated as if it had not been made and the carryover allocation should not be reported on the Schedule A (Form 8610).

(ii) Allocations made after June 30 . An Agency may require that the basis certification be submitted to or received by the Agency prior to the close of the date that is 6 months after the date the allocation was made or within a reasonable period of time following the close of the date that is 6 months after the date the allocation was made. The Agency will need to verify basis as provided in paragraph (c)(2) of this section. If the basis certification is not timely made, or supporting documentation is lacking, inadequate, or does not actually support the certification, the Agency should notify the taxpayer and try to get adequate documentation. If the Agency cannot verify that the taxpayer has satisfied the 10 percent basis requirement for a carryover allocation made after June 30, the allocation must be returned to the Agency. The carryover allocation is a valid allocation for the calendar year of the allocation, but is included in the returned credit component of the State housing credit ceiling for the calendar year following the calendar year of the allocation.

(d) - - (2) - - (viii) For carryover allocations made before July 1, the taxpayer’s basis in the project (land and depreciable basis) as of the close of the calendar year of the allocation and the percentage that basis bears to the reasonably expected basis in the project (land and depreciable basis) as of the close of the second calendar year following the calendar year of allocation;

• • • • (4) Recordkeeping requirements —(i) Taxpayer . When an allocation is made pursuant to section 42(h)(1)(E) or (F), the taxpayer must retain a copy of the allocation document. The Form 8609 that reflects the allocation must be filed for the first taxable year that the credit is claimed and for each taxable year thereafter throughout the compliance period,

whether or not a credit is claimed for the taxable year.

• • • • Par. 3. Section 1.42–8 is amended by:

1. Revising the second sentence of paragraph (a)(6)(i), paragraph (a)(6)(ii), the sixth sentence of paragraph (a)(7) Ex- ample 1 . (ii), paragraphs (a)(7) Example 1 . (iv), (a)(7) Example 2 (iv) and (b)(4)(ii).

2. Removing the year “1993” each place it appears in paragraph (a)(7), Ex- ample 1 and Example 2 and adding the year “2003” in its place; removing the year “1994” each place it appears in paragraph (a)(7) and adding the year “2004” in its place.

3. Removing the second sentence of paragraph (a)(7) Example 1 . (iii), the third sentence of paragraph (a)(7) Example 2 (iii) and the third sentence of paragraph (b)(4)(i).

The revisions read as follows:

§1.42–8 Election of appropriate percentage month.

(a) - - (6) Procedures —(i) Taxpayer . - - The taxpayer must retain a copy of the binding agreement and the election statement.

(ii) Agency . The Agency must retain the original of the binding agreement and election statement and, to the extent required by Schedule A (Form 8610), “ Car- ryover Allocation of Low-Income Housing Credit,” account for the binding agreement and election statement on that schedule.

(7) - - Example 1. - * * (ii) - - - Because allocations were made for the building in two separate calendar years, Agency must issue two Forms 8609, “ Low-Income Housing Credit Allocation Certification,” to X. * * *

• • • • (iv) Agency retains the original of the binding agreement, election statement, and 2003 carryover allocation document. Agency accounts for the binding agreement, election statement, and 2003 carryover allocation on the Schedule A (Form 8610) that it files for the 2003 calendar year. After the building is placed in service in 2004, and assuming other necessary requirements for issuing a Form 8609 are met (for example, taxpayer has certified all sources and uses of funds and development costs for the building under §1.42–17), Agency issues to X a copy of the Form 8609 reflecting the 2003 carryover allocation of $100,000. Agency files the original of this Form 8609 with the Form 8610, “ Annual Low-Income Housing Credit Agencies Report,” that it files for the 2004 calendar year. Agency also issues to X a copy of the

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(d) - * (2) - * (iv) - - (A) Building not qualified within re- quired time period . - - - Also, a building that has received a post-June 30 carryover allocation is not qualified within the required time period if the taxpayer does not meet the 10 percent basis requirement by the date that is 6 months after the date the allocation was made (as described in §1.42–6(a)(2)(ii)).

• • • • (g) Stacking Order . Credit is treated as allocated from the various components of the State housing credit ceiling in the following order. The first credit allocated for any calendar year is treated as credit from the unused carryforward component of the State housing credit ceiling for the calendar year. After all of the credit in the unused carryforward component has been allocated, any credit allocated is treated as allocated from the sum of the population, returned credit, and national pool components of the State housing credit ceiling.
• • • • (i) - - (2) Unused housing credit carryover . The unused housing credit carryover of a State for any calendar year is the excess, if any, of—

(i) The unused carryforward component of the State housing credit ceiling for the calendar year; over

(ii) The total housing credit dollar amount allocated for the calendar year.

• • • • (k) Example . (1) The operation of the rules of this section is illustrated by the following examples. Unless otherwise stated in an example, Agency A is the sole Agency authorized to make allocations of housing credit dollar amounts in State M, all of Agency A’s allocations are valid, and for calendar year 2003, Agency A has available for allocation a State housing credit ceiling consisting of the following housing credit dollar amounts:

allocated after January 6, 2004. However, the rules in §1.42–6(a), (b)(4)(iii) Exam- ple 1 and Example 2, (c), (d)(2)(viii), and (e)(2) may be applied by Agencies and taxpayers for housing credit dollar amounts allocated after December 31, 2000, and on or before January 6, 2004. Otherwise, subject to the applicable effective dates of the corresponding statutory provisions, the rules that apply for housing credit dollar amounts allocated on or before January 6, 2004, are contained in §1.42–6 in effect on and before January 6, 2004 (see 26 CFR part 1 revised as of April 1, 2003).

(3) Electronic filing simplification changes . Sections 1.42–6(d)(4) and 1.42–8(a)(6)(i), (a)(6)(ii), (a)(7) Example 1 and Example 2, (b)(4)(i), and (b)(4)(ii) are applicable for forms filed after January 6, 2004. The rules that apply for forms filed on or before January 6, 2004, are contained in §1.42–6 and §1.42–8 in effect on and before January 6, 2004 (see 26 CFR part 1 revised as of April 1, 2003).

• • • • Par. 5. Section 1.42–14 is amended by:

1. Revising the section heading and paragraphs (a), (g), (i)(2), (k) and (l).

2. Removing paragraph (c) and the second to last sentence of paragraph (e).

3. Redesignating paragraph (b) as paragraph (c).

4. Adding a new paragraph (b).

5. Adding a new sentence at the end of paragraph (d)(2)(iv)(A).

The revisions and additions read as follows:

§1.42–14 Allocation rules for post–2000 State housing credit ceiling amount.

(a) State housing credit ceiling —(1) In general . The State housing credit ceiling for a State for any calendar year after 2000 is comprised of four components. The four components are—

(i) The unused State housing credit ceiling, if any, of the State for the preceding calendar year (the unused carryforward component);

(ii) The greater of— (A) $1.75 ($1.50 for calendar year 2001) multiplied by the State population; or

(B) $2,000,000 (the population component);

(iii) The amount of State housing credit ceiling returned in the calendar year (the returned credit component); plus

(iv) The amount, if any, allocated to the State by the Secretary under section 42(h)(3)(D) from a national pool of unused credit (the national pool component).

(2) Cost of Living Adjustment —(i) Gen- eral rule . For any calendar year after 2002, the $2,000,000 and $1.75 amounts in paragraph (a)(1)(ii) of this section are each increased by an amount equal to—

(A) The dollar amount; multiplied by (B) The cost-of-living adjustment determined under section 1(f)(3) for the calendar year by substituting “calendar year 2001” for “calendar year 1992” in section 1(f)(3)(B). (ii) Rounding . Any increase resulting from the application of paragraph (a)(2)(i) of this section which, in the case of the $2,000,000 amount, is not a multiple of $5,000, is rounded to the next lowest multiple of $5,000, and which, in the case of the $1.75 amount, is not a multiple of 5 cents, is rounded to the next lowest multiple of 5 cents.

(b) The unused carryforward compo- nent . The unused carryforward component of the State housing credit ceiling for any calendar year is the unused State housing credit ceiling, if any, of the State for the preceding calendar year. The unused State housing credit ceiling for any calendar year is the excess, if any, of—

(1) The sum of the population, returned credit, and national pool components for the calendar year; over

(2) The aggregate housing credit dollar amount allocated for the calendar year reduced by the housing credit dollar amounts allocated from the unused carryforward component for the calendar year.

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2004-8 I.R.B. 507 February 23, 2004

A. unused carryforward component . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50 B. population component . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 110 C. returned credit component. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10 D. national pool component . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 170

(2) In addition, the $10 of returned credit component was returned before October 1, 2003.

Example 1 —(i) Additional facts . By the close of 2003, Agency A had allocated $80 of the State M housing credit ceiling. Of the $80 allocated, $17 was allocated to projects involving qualified nonprofit organizations.

(ii) Application of stacking rules . The $80 of allocated credit is first treated as allocated from the unused carryforward component of the State housing credit ceiling. The $80 of allocated credit exceeds the $50 attributable to the unused carryforward component by $30. Because the unused carryforward component is fully utilized, no credit will be forfeited by State M to the 2004 National Pool. The remaining $30 of allocated credit will next be treated as allocated from the $120 in credit determined by aggregating the population, returned credit, and national pool components ($110 + 10 + 0 = $120). The $90 of unallocated credit remaining in State M’s 2003 State housing credit ceiling ($120 - 30 = $90) represents the unused carryforward component of State M’s 2004 State housing credit ceiling. Under paragraph (i)(3) of this section, State M does not qualify for credit from the 2004 National Pool.

(iii) Nonprofit set-aside . Agency A allocated exactly the amount of credit to projects involving qualified nonprofit organizations as necessary to meet the nonprofit set-aside requirement ($17, 10% of the $170 ceiling).

Example 2 —(i) Additional facts . By the close of 2003, Agency A had allocated $40 of the State M housing credit ceiling. Of the $40 allocated, $20 was allocated to projects involving qualified nonprofit organizations.

(ii) Application of stacking rules . The $40 of allocated credit is first treated as allocated from the unused carryforward component of the State housing credit ceiling. Because the $40 of allocated credit does not exceed the $50 attributable to the unused carryforward component, the remaining components of the State housing credit ceiling are unaffected. The $10 remaining in the unused carryforward component is assigned to the Secretary for inclusion in the 2004 National Pool. The $120 in credit determined by aggregating the population, returned credit, and national pool components becomes the unused carryforward component of State M’s 2004 State housing credit ceiling. Under paragraph (i)(3) of this section, State M does not qualify for credit from the 2004 National Pool.

(iii) Nonprofit set-aside . Agency A allocated $3 more credit to projects involving qualified nonprofit organizations than necessary to meet the nonprofit set-aside requirement. This does not reduce the application of the 10% nonprofit set-aside requirement to the State M housing credit ceiling for calendar year 2004.

Example 3 —(i) Additional fact . None of the applications for credit that Agency A received for 2003 are for projects involving qualified nonprofit organizations.

(ii) Nonprofit set-aside . Because at least 10% of the State housing credit ceiling must be set aside for projects involving a qualified nonprofit organization, Agency A can allocate only $153 of the $170 State housing credit ceiling for calendar year 2003 ($170 17 = $153). If Agency A allocates $153 of credit, the credit is treated as allocated $50 from the unused carryforward component and $103 from the sum of the population, returned credit, and national pool components. The $17 of unallocated credit that is set aside for projects involving qualified nonprofit organizations becomes the unused carryforward component of State M’s 2004 State housing credit ceiling. Under paragraph (i)(3) of this section, State M does not qualify for credit from the 2004 National Pool.

Example 4 —(i) Additional facts . The $10 of returned credit component was returned prior to October 1, 2003. However, a $40 credit that had been allocated in calendar year 2002 to a project involving a qualified nonprofit organization was returned to the Agency by a mutual consent agreement dated November 15, 2003. By the close of 2003, Agency A had allocated $170 of the State M’s housing credit ceiling, including $17 of credit to projects involving qualified nonprofit organizations.

(ii) Effect of three-month rule . Under the threemonth rule of paragraph (d)(2)(iii) of this section, Agency A may treat all or part of the $40 of previously allocated credit as returned on January 1, 2004. If Agency A treats all of the $40 amount as having been returned in calendar year 2004, the State M housing credit ceiling for 2003 is $170. This entire amount, including the $17 nonprofit set-aside, has been allocated in 2003. Under paragraph (i)(3) of this section, State M qualifies for the 2004 National Pool.

(iii) If three-month rule not used . If Agency A treats all of the $40 of previously allocated credit as returned in calendar year 2003, the State housing credit ceiling for the 2003 calendar year will be $210 of which $50 will be attributable to the returned credit component ($10 + $40 = $50). Because credit amounts allocated to a qualified nonprofit organization in a prior calendar year that are returned in a subsequent calendar year do not retain their nonprofit character, the nonprofit set-aside for calendar year 2003 is $21 (10% of the $210 State housing credit ceiling). The $170 that Agency A allocated during 2003 is first treated as allocated from the unused carryforward component of the State housing credit ceiling. The $170 of allocated credit exceeds the $50 attributable to the unused carryforward component by $120. Because the unused carryforward component is fully utilized, no credit will be forfeited by State M to the 2004 National Pool. The remaining $120 of allocated credit will next be treated as allocated from the $160 in credit determined by aggregating the

population, returned credit, and national pool components ($110 + 50 + 0 = $160). The $40 of unallocated credit (which includes $4 of unallocated credit from the $21 nonprofit set-aside) remaining in State M’s 2003 housing credit ceiling ($160 - 120 = $40) represents the unused carryforward component of State M’s 2004 housing credit ceiling. Under paragraph (i)(3) of this section, State M does not qualify for credit from the 2004 National Pool.

(l) Effective dates —(1) In general . Except as provided in paragraph (l)(2) of this section, the rules set forth in §1.42–14 are applicable on January 1, 1994.

(2) Community Renewal Tax Relief Act of 2000 changes . Paragraphs (a), (b), (c), (e), (i)(2) and (k) of this section are applicable for housing credit dollar amounts allocated after January 6, 2004. However, paragraphs (a), (b), (c), (e), (i)(2) and (k) of this section may be applied by Agencies and taxpayers for housing credit dollar amounts allocated after December 31, 2000, and on or before January 6, 2004. Otherwise, subject to the applicable effective dates of the corresponding statutory provisions, the rules that apply for housing credit dollar amounts allocated on or before January 6, 2004, are contained in this section in effect on and before January 6, 2004 (see 26 CFR part 1 revised as of April 1, 2003).

Mark E. Matthews, Deputy Commissioner for Services and Enforcement .

Approved December 19, 2003.

Pamela F. Olson, Assistant Secretary of the Treasury .

(Filed by the Office of the Federal Register on December 31, 2003, 11:59 a.m., and published in the issue of the Federal Register for January 6, 2004, 69 F.R. 502)

Section 162.—Trade or Business Expenses

Environmental remediation costs that are otherwise deductible under section 162 are includible in inventory costs under section 263A by a taxpayer that contaminated land with hazardous waste as part of

February 23, 2004 508 2004-8 I.R.B.

during which the amount is incurred within the meaning of § 1.446–1(c)(1)(ii). Pursuant to § 461(h), in determining whether an accrual method taxpayer has incurred an amount for any item during the taxable year, the all events test shall not be treated as met any earlier than when economic performance occurs.

Section 1.263A–2(a)(3)(i) provides that any cost required to be capitalized by § 263A must be capitalized regardless of whether the cost was incurred before, during, or after production.

Rev. Rul. 94–38, 1994–1 C.B. 35, analyzes whether costs incurred to clean up land and to treat groundwater that a taxpayer contaminated with hazardous waste from the taxpayer’s manufacturing business are capital expenditures. The ruling holds that the costs to clean up land used in the taxpayer’s manufacturing process and to treat groundwater are not capital expenditures because these costs do not prolong the useful life of the land or adapt the land to a new or different use. Therefore, costs incurred to clean up land and to treat groundwater that a taxpayer contaminated with hazardous waste from the taxpayer’s business are deductible by the taxpayer as business expenses under § 162. Costs properly allocable to constructing groundwater treatment facilities, however, are capital expenditures under § 263.

Rev. Rul. 98–25, 1998–1 C.B. 998, holds that costs incurred to replace underground storage tanks containing waste by-products under the circumstances in the ruling are not capital expenditures under § 263, but are ordinary and necessary expenses under § 162.

ANALYSIS

The discussion in Rev. Rul. 94–38 of Plainfield-Union Water Co. v. Com- missioner, 39 T.C. 333 (1962), nonacq., 1964–2 C.B. 8, demonstrates that the revenue ruling was intended to address whether the costs to clean up the land and to treat the groundwater are capital expenditures that must be capitalized into the basis of the land under § 263(a) or whether the costs are ordinary and necessary repair expenses under § 162. Rev. Rul. 94–38 does not address the treatment of these costs as inventory costs under § 263A. Similarly, Rev. Rul. 98–25 does not address whether amounts incurred to

the ordinary business operations of a manufacturing plant. See Rev. Rul. 2004-18, page 509.

Section 263A.—Capital- ization and Inclusion in Inventory Costs of Cer- tain Expenses

26 CFR 1.263A–1: Uniform capitalization of costs.

Costs incurred to clean up land that a taxpayer contaminated with hazardous waste by the operation of a manufacturing plant do not qualify for treatment under section 1341 because, under section 263A, the costs are inventory costs and do not satisfy the deduction requirement of section 1341(a)(2). See Rev. Rul. 2004-17, page 516.

26 CFR 1.263A–1: Uniform capitalization of costs. (Also § 162.)

Treatment of environmental remedi- ation expenses under section 263A. This ruling holds that amounts incurred to clean up land that a taxpayer contaminated with hazardous waste by the operation of a manufacturing plant must be included in inventory costs under section 263A of the Code. Rev. Ruls. 94–38 and 98–25 clarified. Rev. Proc. 2002–9 modified and amplified.

Rev. Rul. 2004–18

ISSUE

Are costs incurred to clean up land that a taxpayer contaminated with hazardous waste by the operation of the taxpayer’s manufacturing plant includible in inventory costs under § 263A of the Internal Revenue Code?

FACTS

X, a corporation using an accrual method of accounting, owns and operates a manufacturing plant that produces property that is inventory in X ’s hands. X ’s manufacturing operations discharge hazardous waste. In the past, X buried this waste on portions of X ’s land. The land was not contaminated by hazardous waste when purchased by X .

In order to comply with applicable federal, state, and local environmental requirements, X incurs costs (within the meaning of § 461(h)) to remediate the

soil and groundwater that had been contaminated by the hazardous waste, and to establish an appropriate system for the continued monitoring of the groundwater to ensure that the remediation removes all hazardous waste. The costs X incurs are not research and experimental expenditures within the meaning of § 174 or environmental management policy costs. The soil remediation and groundwater treatment restores X ’s land to essentially the same physical condition that existed prior to the contamination. During and after the remediation and treatment, X continues to use the land and operate the plant in the same manner as X did prior to the cleanup except that X disposes of any hazardous waste in compliance with environmental requirements.

LAW

Section 263A(a) provides that the direct costs and indirect costs properly allocable to property that is inventory in the hands of the taxpayer shall be included in inventory costs.

Section 1.263A–1(a)(3)(ii) of the Income Tax Regulations provides, in part, that taxpayers that produce tangible personal property must capitalize (1) all direct costs of producing the property, and (2) the property’s allocable share of indirect costs.

Section 1.263A–1(e)(3)(i) provides, in part, that indirect costs are properly allocable to property produced when the costs directly benefit or are incurred by reason of the performance of production activities. Cost recovery, production facility repair and maintenance costs, and scrap and spoilage costs, such as waste removal costs, are examples of indirect costs that must be capitalized to the extent the costs are properly allocable to produced property. See § 1.263A–1(e)(3)(ii) (I), (O) and (Q).

Section 1.263A–1(e)(4)(iv)(I) provides that costs incurred for environmental management policy generally are not allocated to production or resale activities (except to the extent that the costs of any system or procedure benefit a particular production or resale activity).

Section 1.263A–1(c)(2)(ii) provides that the amount of any cost required to be capitalized under § 263A may not be included in inventory or charged to capital account or basis before the taxable year

2004-8 I.R.B. 509 February 23, 2004

tions: (1) the scope limitations in section 4.02 of Rev. Proc. 2002–9 do not apply to a taxpayer that wants to make the change for its first taxable year ending after February 6, 2004; and (2) a taxpayer that files a Form 3115 in accordance with this revenue ruling to make the change in method of accounting for its first taxable year ending after February 6, 2004, may effect the change using either a § 481(a) adjustment as provided in sections 5.03 and 5.04 of Rev. Proc. 2002–9 or a cut-off method. For purposes of Line 1a of Form 3115 (revised December 2003), the designated number for the automatic accounting method change authorized by this revenue ruling is “77.” A taxpayer making the automatic change in method of accounting authorized by this revenue ruling and another automatic change in method of accounting under § 263A for the same taxable year may file one Form 3115 to make both changes, but must comply with the ordering rules of § 1.263A–7(b)(2) and must enter the automatic accounting method change numbers for both changes on Line 1a of Form 3115 (revised December 2003).

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 98–25 and Rev. Rul. 94–38 are clarified by providing that the otherwise deductible amounts at issue in Rev. Rul. 98–25 and Rev. Rul. 94–38 are subject to capitalization to inventory under § 263A.

Rev. Proc. 2002–9 is modified and amplified to include in the APPENDIX the automatic change provided in this revenue ruling.

DRAFTING INFORMATION

The principal author of this revenue ruling is John Moriarty of the Office of Associate Chief Counsel (Income Tax & Accounting). For further information regarding this revenue ruling, contact Mr. Moriarty at 202–622–4930 (not a toll-free call).

Section 472.—Last-in, First-out Inventories

26 CFR 1.472–1: Last-in, first-out inventories

LIFO; price indexes; department stores. The December 2003 Bureau of

replace underground storage tanks must be included in inventory costs under § 263A.

The holding of Rev. Rul. 94–38 that the costs to construct a groundwater treatment facility must be capitalized under §§ 263(a) and 263A rather than deducted under § 162 demonstrates the distinction between capital expenditures and costs that are more in the nature of repairs than capital improvements. As with other types of deductible business costs, such as labor costs, taxes, rent, and supplies, once repair costs are determined to be deductible under § 162, a taxpayer with inventories must still apply the rules of § 263A to determine whether the repair costs must be included in inventory. Section 1.263A–1(e)(3). In addition, if repair costs must be capitalized under §§ 263(a) and 263A to a depreciable asset, a taxpayer with inventories must still apply the rules of §§ 263A to determine whether the depreciation expense must be included in inventory. Section 1.263A–1(e)(3)(ii)(I). In this situation, X incurs environmental remediation costs to clean up land that was contaminated as part of the ordinary business operations of X ’s manufacturing of inventory. X ’s environmental remediation costs are incurred by reason of X ’s production activities within the meaning of § 1.263A–1(e)(3)(i). The costs are properly allocable to property produced by X that is inventory in X ’s hands under § 1.263A–1(e)(3)(i). Accordingly, X must capitalize the otherwise deductible environmental remediation costs by including the costs in inventory costs in accordance with § 1.263A–1(c)(3). Similarly, costs incurred to replace underground storage tanks and depreciation cost recoveries of the groundwater treatment facility must be included in inventory costs to the extent properly allocable to inventory.

HOLDING

Environmental remediation costs are subject to capitalization under § 263A. Therefore, costs incurred (within the meaning of § 461(h) and § 1.263A–1(c)(2)(ii)) to clean up land that a taxpayer contaminated with hazardous waste by the operation of the taxpayer’s manufacturing plant must be included in inventory costs under § 263A.

TRANSITION RULE

This paragraph applies to costs that would have been properly deducted in the taxable year but for the requirement to capitalize the costs to inventory under § 263A, and for which the taxpayer’s method of accounting was to deduct the costs. The Internal Revenue Service will not challenge the treatment of environmental remediation costs to which this paragraph applies as deductible expenses rather than as costs properly capitalized to inventory under § 263A in any taxable year ending on or before February 6, 2004. Therefore, the treatment of environmental remediation costs to which this paragraph applies as amounts properly capitalized to inventory under § 263A will not be raised as an issue in any taxable year ending on or before February 6, 2004, and, if the treatment of such environmental remediation costs as deductible expenses rather than as amounts properly capitalized to inventory under § 263A has already been raised as an issue in examination or before Appeals or the Tax Court in a taxable year ending on or before February 6, 2004, the issue will not be further pursued. The Service will not impose penalties on taxpayers or preparers for treating environmental remediation costs to which this paragraph applies as deductible expenses rather than as costs properly capitalized to inventory under § 263A in taxable years ending on or before February 6, 2004.

CHANGE IN METHOD OF ACCOUNTING

A taxpayer using a method of accounting that does not comply with this revenue ruling is using an impermissible method of accounting. Any change in a taxpayer’s treatment of environmental remediation costs to conform with this revenue ruling is a change in method of accounting to which the provisions of §§ 446 and 481 and the regulations thereunder apply. A taxpayer changing its method of accounting to comply with this revenue ruling must file a Form 3115 in accordance with the automatic change in method of accounting provisions of Rev. Proc. 2002–9, 2002–1 C.B. 327, as amplified, clarified and modified by Rev. Proc. 2002–54, 2002–2 C.B. 432, and Rev. Proc. 2002–19, 2002–1 C.B. 696, with the following modifica

February 23, 2004 510 2004-8 I.R.B.

The Department Store Inventory Price Indexes are prepared on a national basis and include (a) 23 major groups of departments, (b) three special combinations of the major groups - soft goods, durable goods, and miscellaneous goods, and (c) a store total, which covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco, and contract departments.

Labor Statistics price indexes are accepted for use by department stores employing the retail inventory and last-in, first-out inventory methods for valuing inventories for tax years ended on, or with reference to, December 31, 2003.

Rev. Rul. 2004–19

The following Department Store Inventory Price Indexes for December 2003

were issued by the Bureau of Labor Statistics. The indexes are accepted by the Internal Revenue Service, under § 1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86–46, 1986–2 C.B. 739, for appropriate application to inventories of department stores employing the retail inventory and last-in, first-out inventory methods for tax years ended on, or with reference to, December 31, 2003.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Groups Dec. 2002 Dec. 2003

Percent Change from Dec. 2002

to Dec. 2003 ^¹

1. Piece Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 465.6 473.7 1.7
2. Domestics and Draperies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 561.8 543.9 -3.2
3. Women’s and Children’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 640.1 629.7 -1.6
4. Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888.0 847.8 -4.5
5. Infants’ Wear . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 612.4 586.4 -4.2
6. Women’s Underwear. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 536.7 509.6 -5.0
7. Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 345.3 344.1 -0.3
8. Women’s and Girls’ Accessories . . . . . . . . . . . . . . . . . . . . . . . . . . . 540.3 551.3 2.0
9. Women’s Outerwear and Girls’ Wear . . . . . . . . . . . . . . . . . . . . . . . 356.4 362.7 1.8
10. Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550.6 535.1 -2.8
11. Men’s Furnishings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 584.7 583.4 -0.2
12. Boys’ Clothing and Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 446.2 429.0 -3.9
13. Jewelry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 855.4 848.0 -0.9
14. Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 793.2 799.6 0.8
15. Toilet Articles and Drugs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 967.5 976.5 0.9
16. Furniture and Bedding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 623.8 612.9 -1.7
17. Floor Coverings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 596.3 595.1 -0.2
18. Housewares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 734.4 710.6 -3.2
19. Major Appliances. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219.4 206.8 -5.7
20. Radio and Television. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47.3 43.8 -7.4
21. Recreation and Education ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84.3 81.5 -3.3
22. Home Improvements ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125.8 125.4 -0.3
23. Automotive Accessories ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111.3 112.1 0.7

Groups 1–15: Soft Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 560.7 555.8 -0.9 Groups 16–20: Durable Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 402.4 386.8 -3.9 Groups 21–23: Misc. Goods ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95.2 93.5 -1.8

Store Total ³ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503.0 495.1 -1.6

1Absence of a minus sign before the percentage change in this column signifies a price increase. 2Indexes on a January 1986 = 100 base. 3The store total index covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco and contract departments.

Section 807.—Rules for Certain Reserves

Insurance companies; interest rate tables. Prevailing state assumed interest

DRAFTING INFORMATION

The principal author of this revenue ruling is Michael Burkom of the Office of Associate Chief Counsel (Income Tax

and Accounting). For further information regarding this revenue ruling, contact Mr. Burkom at (202) 622–7924 (not a toll-free call).

2004-8 I.R.B. 511 February 23, 2004

Earlier supplements were published in Rev. Rul. 93–58, 1993–2 C.B. 241 (interest rates for insurance products issued in 1992 and 1993); Rev. Rul. 94–11, 1994–1 C.B. 196 (1993 and 1994); Rev. Rul. 95–4, 1995–1 C.B. 141 (1994 and 1995); Rev. Rul. 96–2, 1996–1 C.B. 141 (1995 and 1996); Rev. Rul. 97–2, 1997–1 C.B. 134 (1996 and 1997); Rev. Rul. 98–2, 1998–1 C.B. 259 (1997 and 1998); Rev. Rul. 99–10, 1999–1 C.B. 671 (1998 and 1999); Rev. Rul. 2000–17, 2000–1 C.B. 842 (1999 and 2000); Rev. Rul. 2001–11, 2001–1 C.B. 780 (2000 and 2001); Rev. Rul. 2002–12, 2002–1 C.B. 624 (2001 and 2002); and Rev. Rul. 2003–24, 2003–1 C.B. 557 (2002 and 2003).

rates are provided for the determination of reserves under section 807 of the Code for contracts issued in 2003 and 2004. Rev. Rul. 92–19 supplemented in part.

Rev. Rul. 2004–14

For purposes of § 807(d)(4) of the Internal Revenue Code, for taxable years beginning after December 31, 2002, this ruling supplements the schedules of prevailing state assumed interest rates set forth in Rev. Rul. 92–19, 1992–1 C.B. 227. This information is to be used by insurance companies in computing their reserves for (1) life insurance and supplementary total and permanent disability benefits, (2) individual annuities and pure endowments, and (3) group annuities and pure endow

ments. As § 807(d)(2)(B) requires that the interest rate used to compute these reserves be the greater of (1) the applicable federal interest rate, or (2) the prevailing state assumed interest rate, the table of applicable federal interest rates in Rev. Rul. 92–19 is also supplemented.

Following are supplements to schedules A, B, C, and D to Part III of Rev. Rul. 92–19, providing prevailing state assumed interest rates for insurance products with different features issued in 2003 and 2004, and a supplement to the table in Part IV of Rev. Rul. 92–19, providing the applicable federal interest rates under § 807(d) for 2003 and 2004. This ruling does not supplement Parts I and II of Rev. Rul. 92–19.

This is the twelfth supplement to the interest rates provided in Rev. Rul. 92–19.