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This document contains final regulations under section 987 of the Code and related provisions under sections 861, 985 through 989, and 1502 of the Code. Section 987 applies to any taxpayer that has a qualified business unit (¡°QBU¡±) with a functional currency other than the dollar. Section 987(1) and (2) provide rules for determining and translating taxable income or loss (¡°section 987 taxable income or loss¡±) with respect to the QBU. In addition, foreign currency gain or loss must be determined under section 987(3) (¡°section 987 gain or loss¡±), which requires proper adjustments (as prescribed by the Secretary) for transfers of property between QBUs of the taxpayer having different functional currencies.

Sections 987 and 989 provide several explicit grants of regulatory authority. Section 987(3) directs the Secretary to prescribe the proper adjustments needed to determine the taxable income of the owner of a section 987 QBU. Those adjustments include (but are not limited to) rules for sourcing section 987 gain or loss recognized under section 987(3)(B). Similarly, section 987(2) provides that the income of a QBU is translated at the ¡°appropriate¡± exchange rate. Section 989(b)(4) provides that the appropriate exchange rate generally is the average rate for the taxable year, ¡°except as provided in regulations.¡±

Section 989(c) directs the Secretary to ¡°prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subpart.¡±¹ The grant of authority in section 989(c) includes regulations limiting the recognition of foreign currency loss on certain remittances from QBUs, providing for the appropriate treatment of related party transactions (including transactions between QBUs of the same taxpayer), and setting forth procedures for determining the average exchange rate for any period. Section 989(c)(2), (5), and (6).

On December 8, 2016, the Department of the Treasury (¡°Treasury Department¡±) and the Internal Revenue Service (¡°IRS¡±) published Treasury Decision 9794, which contained final regulations under sections 861, 985, 987, 988, and 989 (the ¡°2016 final regulations¡±), in the Federal Register (81 FR 88806). The same day, the Treasury Department and the IRS published Treasury Decision 9795, which contained temporary regulations under sections 987 and 988 (the ¡°2016 temporary regulations¡±), in the Federal Register (81 FR 88854) and published a notice of proposed rulemaking (REG-128276-12, 81 FR 88882) (the ¡°2016 proposed regulations¡±) in the Federal Register by cross-reference to the temporary regulations. On May 13, 2019, the Treasury Department and the IRS published Treasury Decision 9857, which contained final regulations under section 987 (the ¡°2019 final regulations¡±), in the Federal Register (84 FR 20790).

On November 14, 2023, the Treasury Department and the IRS published proposed regulations (REG-132422-17) under sections 861, 985, 987, 988, 989, and 1502 of the Code (the ¡°2023 proposed regulations¡±) in the Federal Register (88 FR 78134). The same day, the Treasury Department and the IRS also published a notice in the Federal Register (88 FR 77921) that reopened the comment period for the 2016 proposed regulations.

All written comments received in response to the 2016 proposed regulations and the 2023 proposed regulations are available at https://www.regulations.gov or upon request. A public hearing on the 2023 proposed regulations was not held because there were no requests to speak.

Concurrently with the publication of the final regulations, the Treasury Department and the IRS are publishing in the proposed rule section of this edition of the Federal Register (RIN 1545-BR37) a notice of proposed rulemaking providing additional proposed regulations under section 987 (REG-117213-24) (the ¡°2024 proposed regulations¡±).

IRS Revenue Procedures, Revenue Rulings, Notices, and other guidance cited in this document are published in the Internal Revenue Bulletin or Cumulative Bulletin and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at .

The principal authors of these final regulations are Adam G. Province and Raphael J. Cohen of the Office of Associate Chief Counsel (International); and Matthew N. Palucki and Jeremy Aron-Dine of the Office of Associate Chief Counsel (Corporate). However, other personnel from the Treasury Department and the IRS participated in their development.

Income taxes, Reporting and recordkeeping requirements.

Accordingly, the Treasury Department and the IRS amend 26 CFR part 1 as follows:

Paragraph 1. The authority citation for part 1 is amended by:

a. Removing the entry for ¡ì¡ì1.861-9 and 1.861-9T and ¡ì¡ì1.861-8T through 1.861-14T;

b. Adding entries for ¡ì¡ì1.861-8T, 1.861-9, 1.861-9T through 1.861-14T in numerical order;

c. Removing the entry for ¡ì¡ì1.985-0 through 1.985-5;

d. Adding entries for ¡ì¡ì1.985-0 through 1.985-5 in numerical order;

e. Removing the entry for ¡ì¡ì1.987-1 through 1.987-5;

f. Adding entries for ¡ì¡ì1.987-1 through 1.987-11 in numerical order;

g. Revising the entry for ¡ì1.987-12;

h. Adding entries for ¡ì¡ì1.987-13 through 1.987-15 in numerical order;

i. Removing the entry for ¡ì¡ì1.988-0 through 1.988-5;

j. Adding entries for ¡ì¡ì1.988-0 through 1.988-5 and 1.989(a)-1 in numerical order; and

k. Revising the entry for ¡ì1.1502-13.

The additions and revisions read as follows:

Authority: 26 U.S.C. 7805 * * *

* * * * *

Section 1.861-8T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f).

Section 1.861-9 also issued under 26 U.S.C. 861, 863(a), 864(e), 864(e)(7), 865(i), 987, and 989(c), and 7701(f).

Section 1.861-9T also issued under 26 U.S.C. 861, 863(a), 864(e), 864(e)(7), 865(i), and 7701(f).

* * * * *

Section 1.861-10T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f).

* * * * *

Section 1.861-11T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f).

* * * * *

Section 1.861-12T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f).

* * * * *

Section 1.861-13T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f).

* * * * *

Section 1.861-14T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f).

* * * * *

Section 1.985-0 also issued under 26 U.S.C. 985.

Section 1.985-1 also issued under 26 U.S.C. 985.

Section 1.985-2 also issued under 26 U.S.C. 985.

Section 1.985-3 also issued under 26 U.S.C. 985.

Section 1.985-4 also issued under 26 U.S.C. 985.

Section 1.985-5 also issued under 26 U.S.C. 985, 987, and 989.

* * * * *

Section 1.987-1 also issued under 26 U.S.C. 987, 989, and 1502.

Section 1.987-2 also issued under 26 U.S.C. 987, 989, and 1502.

Section 1.987-3 also issued under 26 U.S.C. 987 and 989.

Section 1.987-4 also issued under 26 U.S.C. 987 and 989.

Section 1.987-5 also issued under 26 U.S.C. 987 and 989.

Section 1.987-6 also issued under 26 U.S.C. 904, 987, and 989.

Section 1.987-7 also issued under 26 U.S.C. 987 and 989.

Section 1.987-8 also issued under 26 U.S.C. 987 and 989.

Section 1.987-9 also issued under 26 U.S.C. 987, 989, and 6001.

Section 1.987-10 also issued under 26 U.S.C. 987, 989, and 6001.

Section 1.987-11 also issued under 26 U.S.C. 987, 989, and 1502.

Section 1.987-12 also issued under 26 U.S.C. 987 and 989.

Section 1.987-13 also issued under 26 U.S.C. 987 and 989.

Section 1.987-14 also issued under 26 U.S.C. 987 and 989.

Section 1.987-15 also issued under 26 U.S.C. 987 and 989.

Section 1.988-0 also issued under 26 U.S.C. 988.

Section 1.988-1 also issued under 26 U.S.C. 988 and 989.

Section 1.988-2 also issued under 26 U.S.C. 988.

Section 1.988-3 also issued under 26 U.S.C. 988.

Section 1.988-4 also issued under 26 U.S.C. 988 and 989.

Section 1.988-5 also issued under 26 U.S.C. 988.

* * * * *

Section 1.989(a)-1 also issued under 26 U.S.C. 989.

* * * * *

Section 1.1502-13 also issued under 26 U.S.C. 250(c), 987, 989, and 1502.

* * * * *

Par. 2. Section 1.861-9 is amended by:

a. Revising paragraphs (g)(2)(ii)(A) introductory text, (g)(2)(ii)(A)(1), and (g)(2)(ii)(B); and

b. Adding paragraph (g)(2)(v).

The revisions and addition read as follows:

* * * * *

(g) * * *

(2) * * *

(ii) * * *

(A) Tax book value method. In the case of taxpayers using the tax book value method of apportionment, the following rules apply to determine the value of the assets of a qualified business unit (QBU) (as defined in section 989(a)) of a domestic corporation with a functional currency other than the dollar.

(1) Section 987 QBU. In the case of a section 987 QBU (as defined in ¡ì1.987-1(b)(3)), the tax book value is determined by applying the rules of paragraph (g)(2)(i) of this section and ¡ì1.861-9T(g)(3) to the beginning-of-year and end-of-year owner functional currency amount of assets. The beginning-of-year owner functional currency amount of assets is determined by reference to the owner functional currency amount of assets computed under ¡ì1.987-4(d)(1)(i)(B) and (e) on the last day of the preceding taxable year. The end-of-year owner functional currency amount of assets is determined by reference to the owner functional currency amount of assets computed under ¡ì1.987-4(d)(1)(i)(A) and (e) on the last day of the current taxable year. The beginning-of-year and end-of-year owner functional currency amount of assets, as so determined within each grouping, are then averaged as provided in paragraph (g)(2)(i) of this section.

* * * * *

(B) Fair market value method. In the case of taxpayers using the fair market value method of apportionment, the beginning-of-year and end-of-year fair market values of branch assets within each grouping are computed in dollars and averaged as provided in this paragraph (g)(2) and ¡ì1.861-9T(g)(2).

* * * * *

(v) Applicability date. Generally, paragraph (g)(2)(ii)(A)(1) of this section applies to taxable years beginning after December 31, 2024. However, if pursuant to ¡ì1.987-15(b), a taxpayer chooses to apply ¡ì¡ì1.987-1 through 1.987-15 to a taxable year before the first taxable year described in ¡ì1.987-15(a)(1), then paragraph (g)(2)(ii)(A)(1) of this section applies to that taxable year and subsequent years.

* * * * *

Par. 3. Section 1.861-9T is amended by removing and reserving paragraph (g)(2)(ii) and removing paragraph (g)(2)(vi).

Par. 4. Section 1.904-4 is amended by revising paragraph (c)(5)(iii)(B) to read as follows:

* * * * *

(c) * * *

(5) * * *

(iii) * * *

(B) Section 987. For special rules relating to the allocation and apportionment of foreign income taxes to section 987 items, see ¡ì1.987-6(²ú)(3).

* * * * *

Par. 5. Add an undesignated center heading before ¡ì 1.985-0 to read as follows:

Foreign Currency Transactions

Par. 6. Section 1.985-1 is amended by:

a. In paragraph (f) designating Examples 1 through 12 as paragraphs (f)(1) through (12), respectively; and

b. Removing and reserving newly redesignated paragraphs (f)(9) through (11).

Par. 7. Section 1.985-5 is amended by:

a. In paragraph (a) removing the language ¡°¡ì1.987-1(b)(2)¡± and adding the language ¡°¡ì1.987-1(b)(3)¡± in its place;

b. In paragraph (d)(1)(i) removing the language ¡°1.987-11¡± and adding the language ¡°1.987-15¡± in its place;

c. Revising the last sentence of paragraph (d)(2);

d. Removing the second sentence of paragraph (e)(1);

e. Revising and republishing paragraphs (e)(4) and (f); and

f. Revising paragraph (g).

The revisions read as follows:

* * * * *

(d) * * *

(2) * * * See ¡ì¡ì1.987-5, 1.987-8, 1.987-12, and 1.987-13 for the effect of a termination of a section 987 QBU that is subject to ¡ì¡ì1.987-1 through 1.987-15.

(e) * * *

(4) Adjustments to a section 987 QBU¡¯s balance sheet and unrecognized section 987 gain or loss when an owner changes functional currency¡ª(¾±) Owner changing to a functional currency other than the section 987 QBU¡¯s functional currency. If an owner of a section 987 QBU, subject to ¡ì¡ì1.987-1 through 1.987-15 pursuant to ¡ì1.987-1(b)(1), changes to a functional currency other than the functional currency of the section 987 QBU, the adjustments described in paragraphs (e)(4)(i)(A) through (C) of this section are taken into account for purposes of section 987.

(A) Determining new historic rates. The historic rate (as defined in ¡ì 1.987-1(c)(3)) for the year of change and subsequent taxable years with respect to a historic item (as defined in ¡ì1.987-1(e)) reflected on the balance sheet of the section 987 QBU immediately before the year of change is equal to the historic rate before the year of change (that is, a rate that translates the section 987 QBU¡¯s functional currency into the owner¡¯s old functional currency) divided by the spot rate for translating an amount denominated in the owner¡¯s new functional currency into the owner¡¯s old functional currency on the last day of the last taxable year ending before the year of change. For example, if a taxpayer that owns a section 987 QBU with a British pound functional currency changes from a U.S. dollar functional currency to a euro functional currency, and the historic rate for translating a specific item of the section 987 QBU from GBP to USD is 1.50 and the spot rate for translating EUR to USD on the last day of the last taxable year before the change is 1.10, then the new historic rate for translating this historic item from GBP to EUR is 1.36 (1.50/1.10).

(B) Determining the owner functional currency net value of the section 987 QBU on the last day of the last taxable year ending before the year of change under ¡ì1.987-4(d)(1)(i)(B). For purposes of determining the change in the owner functional currency net value of the section 987 QBU on the last day of the last taxable year preceding the year of change under ¡ì1.987-4(d)(1)(i)(B) and (e), the section 987 QBU¡¯s marked items are translated into the owner¡¯s new functional currency at the spot rate on the last day of the last taxable year ending before the year of change.

(C) Translation of unrecognized section 987 gain or loss. Any net accumulated unrecognized section 987 gain or loss determined under ¡ì 1.987-4(c), cumulative suspended section 987 loss determined under ¡ì1.987-11(b), or deferred section 987 gain or loss determined under ¡ì1.987-12 is translated from the owner¡¯s old functional currency into the owner¡¯s new functional currency using the spot rate for translating an amount denominated in the owner¡¯s old functional currency into the owner¡¯s new functional currency on the last day of the last taxable year ending before the year of change.

(ii) Taxpayer with the same functional currency as its QBU changing to a different functional currency. If a taxpayer with the same functional currency as its QBU changes to a new functional currency and as a result the taxpayer becomes an owner of a section 987 QBU (see ¡ì1.987-1), the taxpayer and the section 987 QBU become subject to section 987 for the year of change and subsequent taxable years.

(iii) Owner changing to the same functional currency as the section 987 QBU. If an owner changes its functional currency to the functional currency of its section 987 QBU, the section 987 QBU is treated as if it terminated on the last day of the last taxable year ending before the year of change. See ¡ì¡ì1.987-5, 1.987-8, 1.987-12, and 1.987-13 for the consequences of a termination of a section 987 QBU that is subject to ¡ì¡ì1.987-1 through 1.987-15.

(f) Example. The provisions of this section are illustrated by the following example:

(1) Facts. FC, a foreign corporation, is wholly owned by DC, a domestic corporation. The Commissioner granted permission to change FC¡¯s functional currency from the British pound to the euro beginning January 1, year 2. The EUR/GBP exchange rate on December 31, year 1, is €1:?0.50.

(2) Analysis¡ª(¾±) Determining new functional currency basis of property and liabilities. The following table shows how FC must convert the items on its balance sheet from the British pound to the euro on December 31, year 1.

 

(ii) Exchange gain or loss on section 988 transactions. Under paragraph (b) of this section, FC will recognize a ?50,000 loss (?50,000 current value minus ?100,000 historical basis) on the Euro Bond resulting from the change in functional currency because, after the change, the Euro Bond will no longer be an asset denominated in a non-functional currency. The amount of FC¡¯s retained earnings on its December 31, year 1, balance sheet reflects the ?50,000 loss on the Euro Bond.

(g) Applicability date. Generally, this section applies to taxable years beginning after December 31, 2024. However, if pursuant to ¡ì1.987-15(b), a taxpayer chooses to apply ¡ì¡ì1.987-1 through 1.987-15 to a taxable year before the first taxable year described in ¡ì1.987-15(a)(1), then this section applies to that taxable year and subsequent years.

Par. 8. Revise ¡ì¡ì 1.987-0 through 1.987-12 and add ¡ì¡ì 1.987.13 through 1.987-15 to read as follows:

Foreign Currency Transactions

Sec.

1.987-0 Table of contents.

1.987-1 Scope, definitions and special rules.

1.987-2 Attribution of items to eligible QBUs; definition of a transfer and related rules.

1.987-3 Determination of section 987 taxable income or loss of an owner of a section 987 QBU.

1.987-4 Determination of net unrecognized section 987 gain or loss of a section 987 QBU.

1.987-5 Recognition of section 987 gain or loss.

1.987-6 Character and source of section 987 gain or loss.

1.987-7 Application of the section 987 regulations to partnerships and S corporations.

1.987-8 Termination of a section 987 QBU.

1.987-9 Recordkeeping requirements.

1.987-10 Transition rules.

1.987-11 Suspended section 987 loss relating to certain elections; loss-to-the-extent-of-gain rule.

1.987-12 Deferral of section 987 gain or loss.

1.987-13 Suspended section 987 loss upon terminations.

1.987-14 Section 987 hedging transactions.

1.987-15 Applicability date.

This section lists the headings for ¡ì¡ì1.987-1 through 1.987-15.

¡ì1.987-1 Scope, definitions and special rules.

(a) In general.

(b) Scope of section 987 and certain rules relating to QBUs.

(1) Persons subject to section 987.

(i) In general.

(ii) Inapplicability to certain entities.

(2) Application of the section 987 regulations to earnings and profits.

(i) In general.

(ii) Timing.

(3) Definition of a section 987 QBU.

(i) In general.

(ii) Section 987 QBU grouping election.

(4) Definition of an eligible QBU.

(i) In general.

(ii) Qualified business unit.

(5) Definition of an owner.

(i) Direct ownership.

(ii) [Reserved]

(6) [Reserved]

(7) Examples illustrating paragraph (b) of this section.

(i) Example 1: Owner owns an eligible QBU and a DE holding company.

(ii) Example 2: Owner owns eligible QBUs through DEs.

(iii) Example 3: Section 987 grouping election.

(c) Exchange rates.

(1) Spot rate.

(i) In general.

(ii) Election to use a spot rate convention.

(2) Yearly average exchange rate.

(3) Historic rate.

(i) In general.

(ii) Date placed in service for depreciable or amortizable property.

(iii) Changed functional currency.

(d) Marked item.

(1) In general.

(2) Current rate election.

(e) Historic item.

(f) Example: Identification of marked and historic items.

(1) Facts.

(2) Analysis.

(g) Elections.

(1) Persons making the election.

(i) United States persons.

(ii) CFCs.

(iii) Consolidated groups.

(iv) Partnerships.

(2) Consistency rules.

(i) Consolidated groups.

(ii) CFCs and foreign partnerships.

(iii) Section 381(a) transactions.

(3) Manner of making or revoking elections.

(i) Statement must be attached to a return.

(ii) Election requirements.

(iii) Elections made under the 2016 and 2019 section 987 regulations.

(4) No change in method of accounting.

(5) Principles of ¡ì1.964-1(c)(3) applicable to section 987 elections.

(h) Definitions.

¡ì1.987-2 Attribution of items to eligible QBUs; definition of a transfer and related rules.

(a) In general.

(b) Attribution of items to an eligible QBU.

(1) General rules.

(2) Exceptions for non-portfolio stock, interests in partnerships, and certain acquisition indebtedness.

(i) In general.

(ii) Separate account assets.

(3) Adjustments to items reflected on the books and records.

(i) General rule.

(ii) Factors indicating no tax avoidance.

(iii) Factors indicating tax avoidance.

(iv) Section 988 transactions.

(c) Transfers to and from section 987 QBUs.

(1) In general.

(2) Disregarded transactions.

(i) General rule.

(ii) Definition of a disregarded transaction.

(iii) Items derived from disregarded transactions ignored.

(3) through (6) [Reserved]

(7) Application of general tax law principles.

(8) Interaction with ¡ì1.988-1(a)(10).

(9) Certain disregarded transactions not treated as transfers.

(i) Combinations of section 987 QBUs.

(ii) Change in functional currency from a combination.

(iii) Separation of section 987 QBUs.

(iv) Special rules for successor suspended loss QBUs.

(10) Examples.

(i) Example 1: Loan to a section 987 QBU.

(ii) Example 2: Transfer between section 987 QBUs.

(iii) Example 3: Sale of property between two section 987 QBUs.

(iv) through (ix) [Reserved]

(x) Example 10: Contribution of a section 987 QBU¡¯s assets to a corporation.

(xi) Example 11: Circular transfers.

(xii) Example 12: Transfers without substance.

(xiii) Example 13: Offsetting positions in section 987 QBUs

(xiv) Example 14: Offsetting positions with respect to a section 987 QBU and a section 988 transaction.

(xv) Example 15: Offsetting positions with respect to a section 987 QBU and a section 988 transaction.

(xvi) Example 16: Borrowing by section 987 QBU followed by immediate distribution to owner.

(xvii) Example 17: Payment of interest by section 987 QBU on obligation of owner.

(xviii) Example 18: Sale of the interests in a DE.

(d) Translation of items transferred to a section 987 QBU.

(1) Marked items.

(2) Historic items.

(e) Cross-reference.

¡ì1.987-3 Determination of section 987 taxable income or loss of an owner of a section 987 QBU.

(a) In general.

(b) Determination of each item of income, gain, deduction, or loss in the section 987 QBU¡¯s functional currency.

(1) In general.

(2) Translation of items of income, gain, deduction, or loss that are denominated in a nonfunctional currency.

(3) [Reserved]

(4) Section 988 transactions.

(i) In general.

(ii) Section 988 mark-to-market election.

(c) Translation of items of income, gain, deduction, or loss of a section 987 QBU into the owner¡¯s functional currency.

(1) In general.

(2) Exceptions.

(i) Recovery of basis with respect to historic assets.

(ii) through (iii) [Reserved]

(iv) Cost of goods sold computation.

(v) Translation of income to account for certain foreign income tax claimed as a credit.

(3) Adjustments to COGS required under the simplified inventory method.

(i) In general.

(ii) Adjustment for cost recovery deductions included in inventoriable costs.

(iii) Adjustment for beginning inventory for non-LIFO inventory.

(iv) Adjustment for year of LIFO liquidation.

(d) [Reserved]

(e) Examples.

(1) Example 1: Item of income denominated in nonfunctional currency.

(2) Example 2: Asset sold for nonfunctional currency.

(3) Example 3: Historic inventory method.

(i) Facts.

(ii) Analysis.

(4) Example 4: Simplified inventory method.

(i) Facts.

(ii) Analysis.

(5) Example 5: Depreciation expense that is not an inventoriable cost.

(6) Example 6: Translation of depreciation expense that is an inventoriable cost (historic inventory method).

(7) Example 7: Sale of land.

(8) Example 8: Current rate election.

(9) through (12) [Reserved]

(13) Example 13: Section 988 transaction.

(i) Facts.

(ii) Analysis.

(14) Example 14: Payment of foreign income tax.

(i) Facts.

(ii) Analysis.

¡ì1.987-4 Determination of net unrecognized section 987 gain or loss of a section 987 QBU.

(a) In general.

(b) Calculation of net unrecognized section 987 gain or loss.

(c) Net accumulated unrecognized section 987 gain or loss for all prior taxable years.

(1) In general.

(2) Additional adjustments for certain taxable years beginning on or before December 31, 2024.

(d) Calculation of unrecognized section 987 gain or loss for a taxable year.

(1) Step 1: Determine the change in the owner functional currency net value of the section 987 QBU for the taxable year.

(i) In general.

(ii) Year section 987 QBU is terminated.

(iii) First taxable year of a section 987 QBU.

(iv) First year in which an election is in effect or ceases to be in effect.

(2) Step 2: Increase the amount determined in step 1 by the amount of assets transferred from the section 987 QBU to the owner.

(i) In general.

(ii) Assets transferred from the section 987 QBU to the owner during the taxable year.

(3) Step 3: Decrease the amount determined in steps 1 and 2 by the amount of assets transferred from the owner to the section 987 QBU.

(i) In general.

(ii) Assets transferred from the owner to the section 987 QBU during the taxable year.

(4) Step 4: Decrease the amount determined in steps 1 through 3 by the amount of liabilities transferred from the section 987 QBU to the owner.

(i) In general.

(ii) Liabilities transferred from the owner to the section 987 QBU during the taxable year.

(5) Step 5: Increase the amount determined in steps 1 through 4 by the amount of liabilities transferred from the owner to the section 987 QBU.

(6) Step 6: Decrease or increase the amount determined in steps 1 through 5 by the section 987 taxable income or loss, respectively, of the section 987 QBU for the taxable year.

(7) Step 7: Increase the amount determined in steps 1 through 6 by certain expenses or losses that are not deductible in computing the section 987 taxable income or loss of the section 987 QBU for the taxable year.

(8) Step 8: Decrease the amount determined in steps 1 through 7 by the amount of certain income or gain that is not included in taxable income in computing the section 987 taxable income or loss of the section 987 QBU for the taxable year.

(9) Step 9: Increase or decrease the amount determined in steps 1 through 8 by any income or gain, or any deduction or loss, respectively, that does not impact the adjusted balance sheet.

(10) Step 10: Decrease or increase the amount determined in steps 1 through 9 by any increase or decrease, respectively, to the section 987 QBU¡¯s net assets that is not previously taken into account under steps 2 through 9.

(i) In general.

(ii) Determining the residual increase or decrease to net assets.

(iii) Modifications for taxable years to which a current rate election or an annual recognition election applies.

(e) Determination of the owner functional currency net value of a section 987 QBU.

(1) In general.

(i) Marked item.

(ii) Historic item.

(2) Current rate election.

(i) In general.

(ii) QBU net value.

(iii) Alternative calculation of QBU net value.

(f) Combinations and separations.

(1) Combinations.

(2) Separations.

(3) Examples.

(i) Example 1: Combination of two section 987 QBUs that have the same owner.

(ii) Example 2: Separation of two section 987 QBUs that have the same owner.

(g) Examples.

(1) Example 1: Determination of net unrecognized section 987 gain or loss.

(i) Facts.

(ii) Analysis.

(2) Example 2: Determination of net unrecognized section 987 gain or loss if a current rate election in effect.

(i) Facts.

(ii) Analysis.

(iii) Alternative computation of QBU net value.

(3) Example 3: Determination of net unrecognized section 987 gain or loss when a current rate election is revoked.

(i) Facts.

(ii) Analysis.

¡ì1.987-5 Recognition of section 987 gain or loss.

(a) Recognition of section 987 gain or loss by the owner of a section 987 QBU.

(b) Remittance proportion.

(1) In general.

(2) Annual recognition election.

(c) Remittance.

(1) Definition.

(2) Alternative calculation.

(i) Step 1: Determine the change in QBU net value.

(ii) Step 2: Adjust the amount determined in step 1 for income or loss of the section 987 QBU.

(iii) Step 3: Multiply the amount determined in step 2 by negative one.

(3) Day when a remittance is determined.

(4) Termination.

(d) Aggregate of all amounts transferred from the section 987 QBU to the owner for the taxable year.

(e) Aggregate of all amounts transferred from the owner to the section 987 QBU for the taxable year.

(f) Determination of owner¡¯s adjusted basis in transferred assets and amount of transferred liabilities.

(1) In general.

(2) Marked items.

(3) Historic items.

(g) Example¡ªCalculation of section 987 gain or loss recognized.

(1) Facts.

(i) In general.

(ii) Year 1 balance sheet.

(iii) Transfers and income in year 2.

(iv) Year 2 balance sheet.

(2) Analysis.

(i) Computation of amount of remittance.

(ii) Alternative computation of remittance amount.

(iii) Computation of section 987 QBU gross assets plus remittance.

(iv) Computation of remittance proportion.

(v) Computation of section 987 gain or loss.

(3) Annual recognition election.

¡ì1.987-6 Character and source of section 987 gain or loss.

(a) Ordinary income or loss.

(b) Character and source of section 987 gain or loss.

(1) Timing of source and character determination.

(2) Method for determining the character and source section 987 gain or loss.

(i) Initial assignment

(ii) Reassignment of section 987 gain or loss.

(iii) Special rule for the application of the GILTI high-tax exclusion to section 987 gain or loss.

(3) Allocation and apportionment of foreign income tax to section 987 items under section 861.

(i) The foreign gross income is an item of foreign currency gain or loss.

(ii) The same event or events give rise to both the foreign gross income and the section 987 gain or loss.

(c) Examples.

(1) Example 1: Initial assignment and reassignment of section 987 gain or loss.

(i) Facts.

(ii) Analysis.

(2) Example 2: Effect of GILTI high-tax exclusion.

(i) Facts.

(ii) Analysis.

(3) Example 3: Section 987 gain or loss treated as attributable to section 988 transactions.

(i) Facts.

(ii) Analysis.

(4) Example 4: Section 987 gain or loss assigned to passive foreign personal holding company income.

(i) Facts.

(ii) Analysis.

¡ì1.987-7 Application of the section 987 regulations to partnerships and S corporations.

(a) Overview.

(b) Section 987 regulations generally do not apply to partnerships.

(c) Provisions of the section 987 regulations that apply to partnerships.

(1) In general.

(i) Eligible QBU.

(ii) Partnership.

(2) Applicable provisions.

(i) In general.

(ii) Annual recognition election.

(iii) Section 988 mark-to-market election.

(3) Modifications to applicable provisions.

(i) In general.

(ii) Controlled group.

(4) Terminating QBUs.

(d) Suspended section 987 loss.

(1) In general.

(i) Rules of ¡ì1.987-11(c) and (d)(2) do not apply.

(ii) Suspension of section 987 loss.

(2) Exceptions.

(i) Method under which historic items do not give rise to section 987 gain or loss.

(ii) Annual recognition election.

(iii) De minimis rule.

(3) Recognition of suspended section 987 loss.

(i) In general.

(ii) Partnership that is not engaged in a trade or business.

(iii) Application of the loss-to-the-extent-of-gain rule.

(e) Adjustments to the basis of a partner¡¯s interest in the partnership.

(f) S corporations treated as partnerships.

(g) Examples.

(1) Example 1: Aggregate approach to section 987.

(i) Facts.

(ii) Analysis.

(2) Example 2: Entity approach to section 987.

(i) Facts.

(ii) Analysis.

¡ì1.987-8 Termination of a section 987 QBU.

(a) Scope.

(b) In general.

(1) Trade or business ceases.

(2) Substantially all assets transferred.

(3) Owner no longer a CFC.

(4) Owner ceases to exist.

(5) Section 987 QBU ceases to be an eligible QBU with a functional currency different from its owner.

(6) Change in form of ownership.

(c) Transactions described in section 381(a).

(1) Liquidations.

(2) Reorganizations.

(d) [Reserved]

(e) Effect of terminations.

(f) Examples.

(1) Example 1: Cessation of operations.

(i) Facts.

(ii) Analysis.

(2) Example 2: Transfer of a section 987 QBU to a member of a consolidated group.

(i) Facts.

(ii) Analysis.

(3) Example 3: Cessation of controlled foreign corporation status.

(i) Facts.

(ii) Analysis.

(4) Example 4: Section 332 liquidation.

(i) Facts.

(ii) Analysis.

(5) [Reserved]

(6) Example 6: Deemed transfers to a CFC upon a check-the-box election.

(i) Facts.

(ii) Analysis.

(7) Example 7: Sale of a section 987 QBU to a member of a consolidated group.

(i) Facts.

(ii) Analysis.

¡ì1.987-9 Recordkeeping requirements.

(a) In general.

(b) Supplemental information.

(c) Retention of records.

(d) Information on a dedicated section 987 form.

¡ì1.987-10 Transition rules.

(a) Overview.

(1) In general.

(2) Terms defined under prior ¡ì1.987-12.

(b) Scope.

(1) Owner of a section 987 QBU.

(2) Deferral QBU owner and owner of outbound loss QBU.

(c) Transition date.

(1) In general.

(2) Terminating QBU.

(i) In general.

(ii) Ordering rule.

(d) Application of the section 987 regulations after the transition date.

(1) Owner functional currency net value on the last day of the preceding taxable year.

(2) Determination of historic rate.

(3) Transition exchange rate.

(i) In general.

(ii) Earnings only method.

(e) Pretransition gain or loss.

(1) In general.

(2) Amount of pretransition gain or loss for an owner that applied an eligible pretransition method.

(i) Owner of a section 987 QBU

(ii) Deferral QBU owner.

(iii) Owner of an outbound loss QBU.

(3) Amount of pretransition gain or loss for an owner that did not apply an eligible pretransition method.

(i) In general.

(ii) Computation of pretransition gain or loss.

(iii) Annual unrecognized section 987 gain or loss.

(iv) Deferral QBU owner.

(v) Owner of an outbound loss QBU.

(4) Eligible pretransition method.

(i) Earnings and capital method.

(ii) Other reasonable methods.

(iii) Other earnings only methods.

(iv) Error in the application of a section 987 method.

(v) Certain consistent practices not treated as errors.

(vi) Deferral of section 987 gain or loss until termination is not reasonable.

(vii) Anti-abuse rule.

(5) Recognition of pretransition gain or loss.

(i) In general.

(ii) Election to recognize pretransition section 987 gain or loss ratably over the transition period.

(6) Predecessor of an owner.

(i) In general.

(ii) Predecessor.

(7) Small business election.

(i) Scope.

(ii) Owner threshold.

(iii) QBU threshold.

(iv) Small business election.

(f) QBUs to which the fresh start transition method was applied.

(1) In general.

(2) Application of the section 987 regulations after the transition date.

(i) Owner functional currency net value on the last day of the preceding taxable year.

(ii) Determination of historic rate.

(iii) Unrecognized section 987 gain or loss.

(3) Taxpayers that are required to transition using the fresh start transition method.

(g) [Reserved]

(h) Determination of source and character.

(1) In general.

(2) Deferral QBU or outbound loss QBU.

(i) [Reserved]

(j) Adjustments to avoid double counting or omissions.

(k) Reporting.

(1) In general.

(2) QBUs for which reporting is required.

(i) In general.

(ii) QBUs to which the fresh start transition method was applied.

(3) Attachments not required where information is reported on a form.

(4) No change in method of accounting.

(l) Examples.

(1) Example 1: Earnings and capital method.

(i) Facts.

(ii) Analysis.

(2) Example 2: Earnings only method described in paragraph (e)(4)(ii) of this section.

(i) Facts.

(ii) Analysis.

(3) Example 3: Earnings only method described in paragraph (e)(4)(iii) of this section.

(i) Facts.

(ii) Analysis.

(4) Example 4: Owner did not apply section 987(3).

(i) Facts.

(ii) Analysis.

(5) Example 5: Error in application of method.

(i) Facts.

(ii) Analysis.

(6) Example 6: Consistent practice not treated as an error.

(i) Facts.

(ii) Analysis.

¡ì1.987-11 Suspended section 987 loss relating to certain elections; loss to the extent of gain rule.

(a) In general.

(b) Cumulative suspended section 987 loss in a recognition grouping.

(1) In general.

(2) Combined QBU.

(3) Separated QBU.

(c) Suspension of section 987 loss for taxable years in which a current rate election is in effect and an annual recognition election is not in effect.

(1) In general.

(2) De minimis rule.

(3) Taxable year of controlled group members.

(i) In general.

(ii) Owner is a CFC.

(d) Suspension of net unrecognized section 987 loss upon making or revoking certain elections.

(1) Making an annual recognition election.

(2) Revoking a current rate election.

(e) Loss-to-the-extent of gain rule.

(1) In general.

(2) Separate determination for each recognition grouping.

(3) Amount of suspended section 987 loss recognized.

(i) Current year gain amount.

(ii) Lookback gain amount.

(iii) Suspended section 987 loss not taken into account.

(iv) Lookback period.

(v) Anti-abuse rule.

(4) Suspended section 987 loss recognized with respect to each section 987 QBU and suspended section 987 loss QBU.

(5) Section 381(a) transactions.

(i) In general.

(ii) Limitation for inbound section 381(a) transactions.

(6) Consolidated group members.

(i) In general.

(ii) Suspended section 987 losses arising in separate return limitation years.

(f) Recognition groupings.

(1) Sourcing and section 904 category.

(2) Statutory and residual groupings for CFC owners.

(g) Examples.

(1) Example 1: Suspension of section 987 loss and recognition of suspended section 987 loss.

(i) Facts.

(ii) Analysis.

(2) Example 2: Recognition of suspended section 987 loss by reason of gain recognized during the lookback period.

(i) Facts.

(ii) Analysis.

(iii) Alternative facts.

(iv) Analysis of alternative facts.

(3) Example 3: Suspension of section 987 loss when a current rate election is revoked. (i) Facts.

(ii) Analysis.

¡ì1.987-12 Deferral of section 987 gain or loss.

(a) Overview.

(1) Scope.

(2) Exceptions.

(i) Annual recognition election.

(ii) De minimis rule.

(b) Treatment of section 987 gain and loss in connection with a deferral event.

(1) Gain or loss recognized (or suspended) in the taxable year of a deferral event.

(2) Deferred section 987 gain or loss.

(i) In general.

(ii) Deferred section 987 gain or loss attributable to a successor deferral QBU.

(c) Recognition (or suspension) of deferred section 987 gain or loss following a deferral event.

(1) Recognition upon a subsequent remittance.

(i) In general.

(ii) Amount.

(iii) Deemed remittance by a successor deferral QBU.

(2) Deferral events and outbound loss events with respect to a successor deferral QBU.

(d) Successor deferral QBU becomes a successor suspended loss QBU.

(e) Anti-abuse rule.

(f) Combinations and separations of successor deferral QBUs.

(1) Combined QBU.

(2) Separated QBU.

(g) Definitions.

(1) Deferral event.

(i) Events.

(ii) Assets on books of successor deferral QBU.

(2) Successor deferral QBU.

(3) Original deferral QBU owner.

(4) Qualified successor.

(h) Examples.

(1) Example 1: Contribution of a section 987 QBU with net unrecognized section 987 gain to a member of the controlled group.

(i) Facts.

(ii) Analysis.

(2) Example 2: Contribution of a section 987 QBU with net unrecognized section 987 loss to a member of the controlled group when a current rate election is in effect.

(i) Facts.

(ii) Analysis.

(3) Example 3: Election to be classified as a corporation.

(i) Facts.

(ii) Analysis.

(4) Example 4: Partial recognition of deferred gain or loss.

(i) Facts.

(ii) Analysis.

¡ì1.987-13 Suspended section 987 loss upon terminations.

(a) Overview.

(1) In general.

(2) Ordering rule.

(b) Termination of a section 987 QBU with suspended loss.

(1) Suspended section 987 loss becomes suspended section 987 loss with respect to a successor suspended loss QBU.

(i) Successor suspended loss QBU.

(ii) Attribution of suspended section 987 loss to successor suspended loss QBU.

(2) Recognition of suspended section 987 loss.

(c) Termination of a successor suspended loss QBU.

(1) Successor to the successor suspended loss QBU.

(i) Successor suspended loss QBU.

(ii) Attribution of suspended section 987 loss to successor suspended loss QBU.

(2) Recognition of suspended section 987 loss.

(d) Transfer of successor suspended loss QBU owner.

(e) Transfer of original suspended loss QBU owner.

(f) Owner ceases to exist.

(g) Inbound nonrecognition transactions¨Cno carryover of suspended section 987 loss.

(h) Outbound transactions¨Crecognition or suspension of net unrecognized section 987 loss.

(1) In general.

(2) Outbound loss event.

(3) Loss recognition upon an outbound loss event

(4) Loss suspension upon outbound loss event.

(i) [Reserved]

(j) Termination of a successor suspended loss QBU.

(k) Anti-abuse.

(l) Definitions.

(1) Original suspended loss QBU owner.

(i) In general.

(ii) Successors.

(2) Successor suspended loss QBU.

(3) Successor suspended loss QBU owner.

(4) Ownership interests.

(5) Significant portion.

(m) Examples.

(1) Example 1: Trade or business of a section 987 QBU ceases.

(i) Facts.

(ii) Analysis.

(2) Example 2: Trade or business of a section 987 QBU is sold to a third party.

(i) Facts.

(ii) Analysis.

(3) Example 3: Outbound loss event.

(i) Facts.

(ii) Analysis.

¡ì1.987-14 Section 987 hedging transactions.

(a) Overview.

(b) Section 987 hedging transaction.

(1) In general.

(2) Requirements.

(i) Identification.

(ii) Current rate election.

(iii) Mark-to-market method of accounting.

(iv) Treatment under U.S. generally accepted accounting principles.

(v) Hedge entered into by owner of the hedged QBU.

(3) Anti-abuse rule.

(4) Partial termination of a section 987 hedging transaction.

(c) Identification requirements.

(1) In general.

(2) Inadvertent error.

(d) Taxation of section 987 hedging transactions.

(1) Hedging gain or loss with respect to a hedged QBU.

(2) Adjustment to unrecognized section 987 gain or loss for the taxable year.

(i) Hedging loss.

(ii) Hedging gain.

(3) Termination of a hedged QBU.

(e) Examples.

(1) Example 1: Section 987 hedging transaction.

(i) Facts.

(ii) Analysis.

(2) Example 2: Excess hedging gain from a section 987 hedging transaction.

(i) Facts.

(ii) Analysis.

¡ì1.987-15 Applicability date.

(a) Applicability date of section 987 regulations.

(1) In general.

(2) Applicability date for a terminating QBU.

(b) Application of the section 987 regulations to taxable years beginning on or before December 31, 2024, and ending after November 9, 2023.

(c) Application of the 2016 and 2019 section 987 regulations.

(1) In general.

(2) Application to section 987 QBUs not owned on the transition date.

(3) Modifications of defined terms for purposes of this paragraph (c).

(i) Application of ¡ì1.987-10 in lieu of prior ¡ì1.987-10.

(ii) Partnerships not included in section 987 electing group.

(iii) Transition date.

(d) Prior ¡ì1.987-12.

(a) In general. Sections 1.987-1 through 1.987-15 (the section 987 regulations) provide rules for determining the taxable income or loss and earnings and profits of a taxpayer with respect to a qualified business unit (QBU) that is subject to section 987. Further, the section 987 regulations provide rules for determining the timing, amount, character, and source of section 987 gain or loss recognized with respect to a section 987 QBU. This section addresses the scope of the section 987 regulations and provides certain definitions, special rules, and procedures for making elections. Section 1.987-2 provides rules for attributing assets and liabilities and items of income, gain, deduction, and loss to an eligible QBU. It also provides rules regarding the translation of items transferred to a section 987 QBU. Section 1.987-3 provides rules for determining and translating the taxable income or loss of a taxpayer with respect to a section 987 QBU. Section 1.987-4 provides rules for determining net unrecognized section 987 gain or loss. Section 1.987-5 provides rules regarding the recognition of section 987 gain or loss. It also provides rules regarding the translation of items transferred from a section 987 QBU to its owner. Section 1.987-6 provides rules regarding the character and source of section 987 gain or loss. Section 1.987-7 provides rules relating to the application of the section 987 regulations with respect to a partnership or S corporation. Section 1.987-8 provides rules regarding the termination of a section 987 QBU. Section 1.987-9 provides rules regarding the recordkeeping required under section 987. Section 1.987-10 provides transition rules. Section 1.987-11 provides rules relating to suspended losses in connection with certain elections and the loss-to-the-extent-of-gain rule. Section 1.987-12 provides rules regarding when section 987 gain or loss is deferred, as well as when such deferred amounts are recognized. Section 1.987-13 provides rules relating to suspended section 987 loss of an owner with respect to a section 987 QBU that terminates. Section 1.987-14 provides rules relating to section 987 hedging transactions. Section 1.987-15 provides the applicability date of the section 987 regulations.

(b) Scope of section 987 and certain rules relating to QBUs¡ª(1) Persons subject to section 987¡ª(¾±) In general. Except as provided in paragraphs (b)(1)(ii) and (b)(6) of this section, any individual or corporation is subject to the section 987 regulations. See ¡ì1.987-7 for rules relating to the application of the section 987 regulations in the case of a partnership or S corporation.

(ii) Inapplicability to certain entities. Section 987(3) and the section 987 regulations do not apply to individuals who are not United States persons and foreign corporations that either are not controlled foreign corporations or that are controlled foreign corporations in which no United States shareholders own (within the meaning of section 958(a)) stock.

(2) Application of the section 987 regulations to earnings and profits¡ª(¾±) In general. The rules and principles of the section 987 regulations also apply to the determination of earnings and profits, and any elections that apply pursuant to the section 987 regulations also apply for purposes of determining earnings and profits.

(ii) Timing. Earnings and profits are increased when section 987 gain is recognized and decreased when section 987 loss is recognized. As a result, converting net unrecognized section 987 gain or loss to deferred section 987 gain or loss or suspended section 987 loss does not affect earnings and profits because the amounts have not yet been recognized.

(3) Definition of a section 987 QBU¡ª(¾±) In general. For purposes of section 987, a section 987 QBU is an eligible QBU that has a functional currency different from its owner. A section 987 QBU will continue to be treated as a section 987 QBU of the owner until a sale or other termination of the section 987 QBU as described in ¡ì1.987-8(b) and (c). See ¡ì1.985-1 for rules determining the functional currency of an eligible QBU.

(ii) Section 987 QBU grouping election¡ª(´¡) In general. Solely for purposes of section 987, an owner may elect to treat all section 987 QBUs with the same functional currency as a single section 987 QBU except to the extent provided in paragraph (b)(3)(ii)(B) of this section. However, a QBU described in ¡ì1.987-7(c)(1) may not be treated as part of the same QBU as a section 987 QBU that is not described in ¡ì1.987-7(c)(1).

(B) [Reserved]

(4) Definition of an eligible QBU¡ª(¾±) In general. For purposes of section 987, an eligible QBU means a qualified business unit that is not subject to the United States dollar approximate separate transactions method rules of ¡ì1.985-3.

(ii) Qualified business unit. For purposes of this paragraph (b)(4), a qualified business unit is defined in ¡ì1.989(a)-1(b), except that a corporation, partnership, trust, estate, or disregarded entity is not itself a qualified business unit, but the activities of such entity may be a qualified business unit if they meet the requirements of ¡ì1.989(a)-1(b)(1) and (b)(2)(ii). For example, if a corporation is solely engaged in activities that constitute a trade or business, and the corporation maintains only one set of books and records, the activities (but not the corporation) are a qualified business unit.

(5) Definition of an owner. For purposes of section 987, an owner is any person having direct ownership in an eligible QBU (including ownership through DEs). The term owner does not include an eligible QBU. For example, a section 987 QBU (QBU1) is not an owner of another section 987 QBU (QBU2) even if QBU1 wholly owns the DE that owns QBU2. A person that is not subject to the section 987 regulations under paragraph (b)(1)(ii) of this section can meet the definition of an owner under this paragraph (b)(5) for purposes of applying the section 987 regulations to other persons.

(i) Direct ownership. A person is a direct owner of an eligible QBU if the person is the owner for Federal income tax purposes of the assets and liabilities of the eligible QBU.

(ii) [Reserved]

(6) [Reserved]

(7) Examples illustrating paragraph (b) of this section. The following examples illustrate the principles of this paragraph (b). The following facts are assumed for purposes of the examples. U.S. Corp is a domestic corporation, has the U.S. dollar as its functional currency, and uses the calendar year as its taxable year. Except as otherwise provided: Business A and Business B are eligible QBUs and have the euro and the Japanese yen, respectively, as their functional currencies; and DE1 and DE2 are DEs, have no assets or liabilities, and conduct no activities.

(i) Example 1: Owner owns an eligible QBU and a DE holding company¡ª(´¡) Facts. U.S. Corp owns Business A and all of the interests in DE1. DE1 maintains a separate set of books and records that are kept in British pounds. DE1 owns pounds and all of the stock of a foreign corporation, FC. DE1 is liable to a lender on a pound-denominated obligation that was incurred to acquire the stock of FC. The FC stock, the pounds, and the liability incurred to acquire the FC stock are recorded on DE1¡¯s separate books and records. DE1 has no other assets or liabilities and conducts no activities (other than holding the FC stock and pounds and servicing its liability).

(B) Analysis¡ª(1) Pursuant to paragraph (b)(5) of this section, U.S. Corp is the owner of Business A because it has direct ownership of Business A, an eligible QBU. Because Business A is an eligible QBU with a functional currency that is different from the functional currency of its owner, U.S. Corp, Business A is a section 987 QBU under paragraph (b)(3)(i) of this section. As a result, U.S. Corp and its section 987 QBU, Business A, are subject to section 987.

(2) Holding the stock of FC and pounds and servicing a liability does not constitute a trade or business within the meaning of ¡ì1.989(a)-1(c). Because the activities of DE1 do not constitute a trade or business within the meaning of ¡ì1.989(a)-1(c), such activities are not an eligible QBU. In addition, pursuant to paragraph (b)(4)(ii) of this section, DE1 itself is not an eligible QBU. As a result, neither DE1 nor its activities qualify as a section 987 QBU of U.S. Corp. Therefore, neither the activities of DE1 nor DE1 itself is subject to section 987. For the foreign currency treatment of payments on DE1¡¯s pound-denominated liability, see ¡ì1.988-2(²ú).

(ii) Example 2: Owner owns eligible QBUs through DEs¡ª(´¡) Facts. U.S. Corp owns all of the interests in DE1. DE1 owns Business A and all of the interests in DE2. The only activities of DE1 are Business A activities and holding the interests in DE2. DE2 owns Business B and Business C. For purposes of this example, Business B does not maintain books and records that are separate from DE2. Instead, the activities of Business B are reflected on the books and records of DE2, which are maintained in Japanese yen. In addition, Business C has the U.S. dollar as its functional currency, maintains books and records that are separate from the books and records of DE2, and is an eligible QBU.

(B) Analysis¡ª(1) Pursuant to paragraph (b)(4)(ii) of this section, DE1 and DE2 are not eligible QBUs. Moreover, pursuant to paragraph (b)(5) of this section, DE1 is not the owner of the Business A, Business B, or Business C eligible QBUs, and neither Business A nor DE2 is the owner of the Business B or Business C eligible QBUs. Instead, pursuant to paragraph (b)(5) of this section, U.S. Corp is the owner of the Business A, Business B, and Business C eligible QBUs.

(2) Because Business A and Business B are eligible QBUs with functional currencies that are different than the functional currency of U.S. Corp, Business A and Business B are section 987 QBUs under paragraph (b)(3)(i) of this section.

(3) The Business C eligible QBU has the same functional currency as U.S. Corp, the U.S. dollar. Therefore, the Business C eligible QBU is not a section 987 QBU under paragraph (b)(3)(i) of this section.

(iii) Example 3: Section 987 grouping election¡ª(´¡) Facts. U.S. Corp owns all of the interests in DE1. DE1 owns Business A and Business B. For purposes of this example, assume Business B has the euro as its functional currency.

(B) Analysis¡ª(1) Pursuant to paragraph (b)(4)(ii) of this section, DE1 is not an eligible QBU. Moreover, pursuant to paragraph (b)(5) of this section, DE1 is not the owner of the Business A or Business B eligible QBUs. Instead, pursuant to paragraph (b)(5) of this section, U.S. Corp is the owner of the Business A and Business B eligible QBUs.

(2) Business A and Business B constitute two separate eligible QBUs, each with the euro as its functional currency. Accordingly, Business A and Business B are section 987 QBUs of U.S. Corp under paragraph (b)(3)(i) of this section. U.S. Corp may elect to treat Business A and Business B as a single section 987 QBU pursuant to paragraph (b)(3)(ii) of this section. If such election is made, pursuant to paragraph (b)(5) of this section, U.S. Corp would be the owner of the Business AB section 987 QBU that would include the activities of both the Business A section 987 QBU and the Business B section 987 QBU. In addition, pursuant to paragraph (b)(5) of this section, DE1 would not be treated as the owner of the Business AB section 987 QBU.

(c) Exchange rates. Solely for purposes of section 987, the spot rate, the yearly average exchange rate, and the historic rate are determined as provided in paragraphs (c)(1) through (3) of this section.

(1) Spot rate¡ª(¾±) In general. Except as otherwise provided in this section, the spot rate means the rate determined under the rules of ¡ì1.988-1(d)(1), (2), and (4) on the relevant date.

(ii) Election to use a spot rate convention. An owner may elect to use a spot rate convention that reasonably approximates the spot rate determined in paragraph (c)(1)(i) of this section. A spot rate convention may be based on the spot rate at the beginning of a reasonable period, the spot rate at the end of a reasonable period, the average of spot rates for a reasonable period, or spot and forward rates for a reasonable period. For this purpose, a reasonable period may not exceed three months. For example, in lieu of the spot rate determined in paragraph (c)(1)(i) of this section, the spot rate for all transactions during a monthly period may be determined pursuant to one of the following conventions: the spot rate at the beginning of the current month or at the end of the preceding month; the monthly average of daily spot rates for the current or preceding month; or an average of the beginning and ending spot rates for the current or preceding month. Similarly, in lieu of the spot rate determined in paragraph (c)(1)(i) of this section, the spot rate may be determined pursuant to an average of the spot rate and the 30-day forward rate on a day of the preceding month. Use of a spot rate convention that is consistent with the convention used for financial accounting purposes is generally presumed to reasonably approximate the rate in paragraph (c)(1)(i) of this section. However, the Commissioner may prescribe the spot rate as determined in paragraph (c)(1)(i) of this section or an appropriate spot rate pursuant to this paragraph (c)(1)(ii) if the Commissioner determines that the use of the convention would not clearly reflect income based on the facts and circumstances available at the time of the election. The election or revocation of a spot rate convention does not change the spot rate with respect to any day of a taxable year before the election or revocation becomes effective. See paragraph (g) of this section for rules relating to section 987 elections.

(2) Yearly average exchange rate. For purposes of section 987, the yearly average exchange rate is a rate that represents an average exchange rate for the taxable year (or, if the section 987 QBU existed for less than the full taxable year, the portion of the year during which the section 987 QBU existed) computed under any reasonable method. For example, an owner may determine the yearly average exchange rate based on a daily, monthly, or quarterly averaging convention, whether weighted or unweighted, and may take into account forward rates for a period not to exceed three months. Use of an averaging convention that is consistent with the convention used for financial accounting purposes is generally presumed to be a reasonable method. However, the Commissioner may prescribe an appropriate yearly average exchange rate if the Commissioner determines that the use of the convention would not have been expected to clearly reflect income based on the facts and circumstances available at the time of the election.

(3) Historic rate¡ª(¾±) In general. Except as otherwise provided in the section 987 regulations, the historic rate is determined as described in paragraphs (c)(3)(i)(A) through (E) of this section.

(A) Assets generally. In the case of an asset other than inventory that is acquired by a section 987 QBU (or otherwise becomes attributable to a section 987 QBU, including through a transfer), the historic rate is the yearly average exchange rate applicable to the year of acquisition (or the year in which the asset otherwise becomes attributable to the section 987 QBU).

(B) Inventory under the simplified inventory method. If a taxpayer has not elected under ¡ì1.987-3(c)(2)(iv)(B) to use the historic inventory method, the historic rate for inventory is determined under this paragraph (c)(3)(i)(B).

(1) LIFO inventory. The historic rate for LIFO inventory is the yearly average exchange rate applicable to the year in which the inventory¡¯s LIFO layer arose.

(2) Non-LIFO inventory. The historic rate for non-LIFO inventory is the yearly average exchange rate for the relevant taxable year. For example, in determining the owner functional currency net value of a section 987 QBU on the last day of the current taxable year under ¡ì1.987-4(d)(1)(i)(A), the historic rate for non-LIFO inventory is the yearly average exchange rate for the current taxable year. In determining the owner functional currency net value of a section 987 QBU on the last day of the preceding taxable year under ¡ì1.987-4(d)(1)(i)(B), the historic rate for non-LIFO inventory is the yearly average exchange rate for the preceding taxable year.

(C) Inventory under the historic inventory method. If a taxpayer has elected under ¡ì1.987-3(c)(2)(iv)(B) to use the historic inventory method, each inventoriable cost with respect to a section 987 QBU¡¯s inventory may have a different historic rate. The historic rate for each inventoriable cost is the exchange rate at which the cost would be translated under ¡ì1.987-3 if it were not an inventoriable cost.

(D) Liabilities generally. In the case of a liability that is incurred or assumed by a section 987 QBU, the historic rate is the yearly average exchange rate applicable to the year the liability is incurred or assumed.

(E) Determination of historic rates after revocation of current rate election. If a current rate election is revoked or otherwise ceases to be in effect, the historic rate of all historic items (other than non-LIFO inventory subject to the simplified inventory method) that were attributable to a section 987 QBU on the last day of the last taxable year in which the current rate election was in effect is the spot rate applicable to that day. Similarly, except as provided in paragraph (c)(3)(i)(B)(2) of this section, if a marked item becomes a historic item (such as when an asset of an insurance company ceases to be a separate account asset), the historic rate for the historic item is equal to the spot rate applicable to the last day of the last taxable year in which it was treated as a marked item.

(ii) Date placed in service for depreciable or amortizable property. In the case of depreciable or amortizable property, an owner may determine the historic rate by reference to the date such property is placed in service by the section 987 QBU rather than the date the property was acquired, provided that this convention is consistently applied for all such property attributable to that section 987 QBU.

(iii) Changed functional currency. In the case of a section 987 QBU or an owner of a section 987 QBU that previously changed its functional currency, ¡ì1.985-5(d)(1)(ii)(A) and (e)(4)(i)(A), respectively, are taken into account in determining the historic rate for an item reflected on the balance sheet of the section 987 QBU immediately before the year of change.

(d) Marked item¡ª(1) In general. Except as provided in paragraph (d)(2) of this section, a marked item is an asset (marked asset) or liability (marked liability) that is attributable to a section 987 QBU under ¡ì1.987-2(b) and that¡ª

(i) Is denominated in, or determined by reference to, the functional currency of the section 987 QBU and would be a section 988 transaction if such item were held or entered into directly by the owner of the section 987 QBU;

(ii) Is a prepaid expense or a liability for an advance payment of unearned income, in either case having an original term of one year or less on the date the prepaid expense or liability for an advance payment of unearned income arises;

(iii) Is a section 988 transaction of the section 987 QBU;

(iv) Is an insurance reserve; or

(v) Is a separate account asset.

(2) Current rate election. A taxpayer may elect to treat all assets and liabilities that are attributable to a section 987 QBU under ¡ì1.987-2(b) as marked items (a current rate election). See ¡ì1.987-11(c) for rules suspending section 987 loss if a current rate election is in effect.

(e) Historic item. A historic item is an asset (historic asset) or liability (historic liability) that is attributable to a section 987 QBU under ¡ì1.987-2(b) and that is not a marked item.

(f) Example: Identification of marked and historic items. The following example illustrates the application of paragraphs (d) and (e) of this section.

(1) Facts. U.S. Corp is a domestic corporation with the U.S. dollar as its functional currency and is the owner of Business A, a section 987 QBU that has the pound as its functional currency. Items reflected on Business A¡¯s balance sheet include ?10,000, $1,000, a building with a basis of ?100,000, a light general purpose truck with a basis of ?30,000, a computer with a basis of ?1,000, a 60-day receivable for ?15,000, an account payable of ?5,000, and a foreign currency contract within the meaning of section 1256(g)(2) that requires Business A to exchange ?100 for $125 in 90 days.

(2) Analysis. Under paragraph (d) of this section, the ?10,000, the $1,000, the ?15,000 receivable, the ?5,000 account payable, and the ?/$ section 1256 foreign currency contract are marked items. The other items are historic items under paragraph (e) of this section.

(g) Elections. This paragraph (g) provides rules for making and revoking elections under the section 987 regulations (the section 987 elections). A section 987 election is made for the owner and for a taxable year and applies to every section 987 QBU owned by the owner while the election is in effect. Once made, a section 987 election remains in effect until revoked.

(1) Persons making the election. A section 987 election is made or revoked by the authorized person. The authorized person is described in paragraph (g)(1)(i), (ii), (iii), or (iv) of this section. If there are multiple controlling domestic shareholders, references to ¡°the authorized person¡± refer to all authorized persons acting in concert.

(i) United States persons. Except as provided in paragraph (g)(1)(iii) or (iv) of this section, if the owner of a section 987 QBU is a United States person, the owner is the authorized person.

(ii) CFCs. If the owner of a section 987 QBU is a controlled foreign corporation, the controlling domestic shareholders (determined under ¡ì1.964-1(c)(5)(i)) of the controlled foreign corporation are treated as the authorized person.

(iii) Consolidated groups. If the owner is a member of a consolidated group, see ¡ì1.1502-77.

(iv) Partnerships. If the owner of a section 987 QBU is a partnership, the election is made or revoked by the partnership. For a partnership that is not otherwise required to file a partnership return, see ¡ì1.6031(a)-1(b)(5) for elections that can only be made by a partnership under section 703.

(2) Consistency rules¡ª(¾±) Consolidated groups. A section 987 election is made or revoked by a consolidated group and applies to all members of the group. Therefore, the same section 987 elections will be in effect for all members of a consolidated group at all times. If a corporation becomes a member of a consolidated group, it is deemed to make or revoke any section 987 election as necessary to be consistent with the consolidated group. If a corporation ceases to be a member of a consolidated group and does not join another group, its section 987 elections are unaffected by its departure from the group. All members of a consolidated group are treated as a single United States person for purposes of applying paragraph (g)(2)(ii) of this section.

(ii) CFCs and foreign partnerships. If the authorized person makes or revokes an election on behalf of any person (including the authorized person) described in paragraphs (g)(2)(ii)(A) through (C) of this section (the section 987 electing group), then the election must be made or revoked on behalf of all members of the section 987 electing group for the first taxable year of each entity that ends with or within the taxable year of the United States person described in paragraph (g)(2)(ii)(A) of this section in which the election or revocation became effective. If an entity that was not previously a member of the section 987 electing group becomes a member (for example, upon formation or acquisition), it is deemed to make or revoke any section 987 election as necessary to be consistent with the other members (without regard to the requirements of paragraph (g)(3)(ii) of this section). The following persons are described in this paragraph (g)(2)(ii):

(A) A United States person (the relevant United States person).

(B) Each controlled foreign corporation in which the relevant United States person owns (within the meaning of section 958(a)) more than fifty percent of the stock (by vote or value).

(C) In the case of an election that can be made by or for a partnership, each foreign partnership in which the relevant United States person owns (directly or indirectly) more than fifty percent of the capital and profits interest.

(iii) Section 381(a) transactions. If a corporation (acquiring corporation) acquires the assets of another corporation in a transaction described in section 381(a), the acquiring corporation¡¯s election status applies to all section 987 QBUs owned by the acquiring corporation after the transaction.

(3) Manner of making or revoking elections. The section 987 elections must be made in accordance with this paragraph (g)(3), except as provided in forms and instructions or other guidance as provided by the Secretary.

(i) Statement must be attached to a return. An authorized person that makes or revokes a section 987 election in accordance with this paragraph (g) must attach to its return the statement described in this paragraph (g)(3)(i) (or must provide the information described in this paragraph (g)(3)(i) in the manner prescribed in forms or instructions or other guidance). Each statement must include an identification of the election that is made or revoked (including the section and paragraph of the regulations under which the election is made); the name, address, and functional currency of each owner (or if the owner is a member of a consolidated group, the common parent of the consolidated group) for which the election is made or revoked; and the name, address, functional currency, and owner of each section 987 QBU to which the election applies. The elections provided in ¡ì1.987-10 are made by reporting the election on the statement described in ¡ì1.987-10(k). An election to use a spot rate convention under paragraph (c)(1)(ii) of this section must describe the convention.

(ii) Election requirements¡ª(´¡) Consent required. Except as provided in paragraph (g)(3)(ii)(B) or (C) of this section, a section 987 election may not be made or revoked without the consent of the Commissioner. A copy of the consent must be attached to the statement described in paragraph (g)(3)(i) of this section. For purposes of this paragraph (g)(3)(ii), the Commissioner¡¯s consent may be obtained only with a ruling or administrative pronouncement. See Revenue Procedure 2024-1, I.R.B. 2024-1 (or superseding guidance).

(B) Current rate election, annual recognition election, and section 988 mark-to-market election. Except as provided in paragraph (g)(3)(ii)(C) of this section, the authorized person may make a current rate election, an annual recognition election, or a section 988 mark-to-market election without the Commissioner¡¯s consent by filing the statement prescribed in paragraph (g)(3)(i) of this section with the Internal Revenue Service in accordance with the prescribed form or its instructions (or other guidance) on or before the first day of the taxable year to which the election applies, and attaching a copy of the statement to its return. Once made, a current rate election, annual recognition election, or section 988 mark-to-market election may not be revoked without the Commissioner¡¯s consent for any taxable year beginning within 60 months of the first day of the taxable year for which it was made. Once revoked, a new current rate election, annual recognition election, or section 988 mark-to-market election may not be made without the Commissioner¡¯s consent for any taxable year beginning within 60 months of the first day of the taxable year for which it was revoked.

(C) First year to which the section 987 regulations apply. The authorized person may make a section 987 election without the consent of the Commissioner on its original, timely filed (including extensions) return for the first taxable year of an owner in which both¡ª

(1) The section 987 regulations apply (other than by applying solely to one or more terminating QBUs pursuant to ¡ì1.987-15(a)(2)); and

(2) Either the owner or any member of its consolidated group or section 987 electing group is the owner of a section 987 QBU.

(iii) Elections made under the 2016 and 2019 section 987 regulations. Each section 987 election must be made by the authorized person under the rules of this section without regard to whether the election was in effect under the 2016 and 2019 final regulations or under prior ¡ì1.987-8T. In the first taxable year in which the section 987 regulations apply, any elections made under the 2016 and 2019 final regulations cease to be effective.

(4) No change in method of accounting. An election under section 987 is not treated as a change in method of accounting for purposes of sections 446 and 481.

(5) Principles of ¡ì1.964-1(c)(3) applicable to section 987 elections. Except as otherwise provided in this paragraph (g), if the authorized person makes or revokes a section 987 election on behalf of a controlled foreign corporation, the authorized person must make or revoke the section 987 election in accordance with the rules and principles of ¡ì1.964-1(c)(3).

(h) Definitions. The definitions in this paragraph (h) apply for purposes of the section 987 regulations.

1991 proposed regulations. 1991 proposed regulations means proposed ¡ì¡ì 1.987-1 through 1.987-3 as contained in 56 FR 48457-01 (September 25, 1991).

2006 proposed regulations. 2006 proposed regulations means: proposed ¡ì¡ì 1.861-9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 1.985-5; 1.987-1 through 1.987-11; 1.988-1(a)(3) and (4), (a)(10)(ii), and (i); 1.988-4(b)(2); and 1.989(a)-1(b)(2)(i), and (b)(4) as contained in 71 FR 52876-01 (September 7, 2006).

2016 and 2019 section 987 regulations. 2016 and 2019 section 987 regulations means the following regulations:

(i) Sections 1.861-9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 1.985-5; 1.987-1 through 1.987-10; 1.988-1(a)(4), (a)(10)(ii), and (i); 1.988-4(b)(2); and 1.989(a)-1(b)(2)(i), (b)(4), (d)(3) and (4), as contained in 26 CFR in part 1 in effect on April 1, 2017.

(ii) Sections 1.987-2T(c)(9), 1.987-4T(c)(2) and (f), and 1.987-7T, as contained in 26 CFR in part 1 in effect on April 1, 2017 (until they were revoked on May 13, 2019).

(iii) Sections 1.987-2(c)(9) and 1.987-4(c)(2) and (f), as contained in 26 CFR in part 1 in effect on April 1, 2020 (beginning on May 13, 2019).

(iv) Sections 1.987-1T (other than ¡ì¡ì1.987-1T(g)(2)(i)(B) and (g)(3)(i)(H)), 1.987-3T, 1.987-6T, 1.988-1T, and 1.988-2T(i), as contained in 26 CFR in part 1 in effect on April 1, 2017 (until they expired on December 6, 2019).

Adjusted balance sheet. Adjusted balance sheet means a tax basis balance sheet in the functional currency of the eligible QBU, determined by¡ª

(i) Preparing a balance sheet for the relevant date from the section 987 QBU¡¯s books and records (within the meaning of ¡ì1.989(a)-1(d)) recorded in the section 987 QBU¡¯s functional currency and showing all assets and liabilities attributable to the section 987 QBU under ¡ì1.987-2(b) (the preliminary balance sheet); and

(ii) Making adjustments necessary to conform the items reflected on the preliminary balance sheet to United States tax accounting principles (including adjustments to reflect items that were not reflected on the preliminary balance sheet but should be reflected under United States tax accounting principles, and adjustments to eliminate items that are reflected on the preliminary balance sheet but should not be reflected under United States tax accounting principles).

Annual recognition election. Annual recognition election has the meaning provided in ¡ì1.987-5(b)(2).

Authorized person. Authorized person has the meaning provided in paragraph (g)(1) of this section.

Combination. Combination has the meaning provided in ¡ì1.987-2(c)(9)(i).

Combined QBU. Combined QBU has the meaning provided in ¡ì1.987-2(c)(9)(i).

Combining QBU. Combining QBU has the meaning provided in ¡ì1.987-2(c)(9)(i).

Consolidated group. Consolidated group has the meaning provided in ¡ì1.1502-1(h).

Controlled foreign corporation. Controlled foreign corporation (or CFC) has the meaning provided in section 957 (or, if applicable, section 953(c)(1)(B)).

Controlled group. A controlled group means all persons with the relationships to each other specified in section 267(b) or section 707(b).

Cumulative suspended section 987 loss. Cumulative suspended section 987 loss has the meaning provided in ¡ì1.987-11(b).

Current rate election. Current rate election has the meaning provided in paragraph (d)(2) of this section.

Current year gain amount. Current year gain amount has the meaning provided in ¡ì1.987-11(e)(3)(i).

Deferral event. Deferral event has the meaning provided in ¡ì1.987-12(g)(1).

Deferred section 987 gain or loss. Deferred section 987 gain or loss has the meaning provided in ¡ì1.987-12(b)(2). Deferred section 987 gain or loss does not include net unrecognized section 987 gain or loss or suspended section 987 loss.

Disregarded entity. Disregarded entity (or DE) means an entity disregarded as an entity separate from its owner for Federal income tax purposes, including an entity described in ¡ì301.7701-2(c)(2) of this chapter, a qualified subchapter S subsidiary under section 1361(b)(3), a qualified REIT subsidiary within the meaning of section 856(i)(2), and a trust all of which is treated (under subpart E of part I of subchapter J of Chapter 1 of the Code) as owned by the grantor or another person.

Disregarded transactions. Disregarded transactions has the meaning provided in ¡ì1.987-2(c)(2)(ii).

Earnings only method. Earnings only method means a method of applying section 987 before the transition date under which gain or loss under section 987(3) is determined only with respect to the earnings of a section 987 QBU.

ECI. ECI means income that is effectively connected with the conduct of a trade or business within the United States.

Eligible pretransition method. Eligible pretransition method has the meaning provided in ¡ì1.987-10(e)(4).

Eligible QBU. Eligible QBU has the meaning provided in paragraph (b)(4) of this section.

Financial instrument. Financial instrument has the meaning provided in ¡ì1.1275-6(b)(3). It includes a financial instrument entered into between related parties or unrelated parties.

Foreign source income. Foreign source income means income from sources without the United States.

Generally accepted accounting principles. Generally accepted accounting principles means United States generally accepted accounting principles described in standards established and made effective by the Financial Accounting Standards Board.

Hedge. Hedge has the meaning provided in ¡ì1.987-14(b)(1).

Hedged QBU. Hedged QBU has the meaning provided in ¡ì1.987-14(b)(1).

Hedging gain or loss. Hedging gain or loss has the meaning provided in ¡ì1.987-14(d)(1).

Historic asset. Historic asset has the meaning provided in paragraph (e) of this section.

Historic item. Historic item has the meaning provided in paragraph (e) of this section.

Historic liability. Historic liability has the meaning provided in paragraph (e) of this section.

Historic rate. Historic rate has the meaning provided in paragraph (c)(3) of this section.

Insurance reserve. Insurance reserve means an item that is a reserve under section 807(c) or section 953(b) (as applicable).

LIFO. LIFO means the last-in, first-out inventory method (as described in section 472).

LIFO inventory. LIFO inventory means inventory accounted for under the LIFO inventory method.

Liability. Liability means the amount of a liability on the adjusted balance sheet (or the amount that would be on the adjusted balance sheet if an adjusted balance sheet were prepared for that day).

Lookback gain amount. Lookback gain amount has the meaning provided in ¡ì1.987-11(e)(3)(ii).

Lookback period. Lookback period has the meaning provided in ¡ì1.987-11(e)(3)(iv).

Loss-to-the-extent-of-gain rule. Loss-to-the-extent-of-gain rule has the meaning provided in ¡ì1.987-11(e)(1).

Marked asset. Marked asset has the meaning provided in paragraph (d) of this section.

Marked item. Marked item has the meaning provided in paragraph (d) of this section.

Marked liability. Marked liability has the meaning provided in paragraph (d) of this section.

Net accumulated unrecognized section 987 gain or loss. Net accumulated unrecognized section 987 gain or loss has the meaning provided in ¡ì1.987-4(c).

Net unrecognized section 987 gain or loss. Net unrecognized section 987 gain or loss has the meaning provided in ¡ì1.987-4(b). Net unrecognized section 987 gain or loss does not include deferred section 987 gain or loss or suspended section 987 loss.

Non-LIFO inventory. Non-LIFO inventory means inventory that is not accounted for under the LIFO inventory method.

Original deferral QBU. Original deferral QBU has the meaning provided in ¡ì1.987-12(b).

Original deferral QBU owner. Original deferral QBU owner has the meaning provided in ¡ì1.987-12(g)(3).

Original suspended loss QBU owner. Original suspended loss QBU owner has the meaning provided in ¡ì1.987-13(l)(1).

Outbound loss event. Outbound loss event has the meaning provided in ¡ì1.987-13(h)(2).

Outbound loss QBU. Outbound loss QBU has the meaning provided in ¡ì1.987-13(h)(1).

Outbound section 987 loss. Outbound section 987 loss has the meaning provided in ¡ì1.987-13(h)(4).

Owner. Owner has the meaning provided in paragraph (b)(5) of this section.

Prior ¡ì1.987-1. Prior ¡ì1.987-1 means ¡ì1.987-1, as contained in 26 CFR in part 1 in effect on April 1, 2017.

Prior ¡ì1.987-4. Prior ¡ì1.987-4 means ¡ì1.987-4, as contained in 26 CFR in part 1 in effect on April 1, 2017.

Prior ¡ì1.987-5. Prior ¡ì1.987-5 means ¡ì1.987-5, as contained in 26 CFR in part 1 in effect on April 1, 2017.

Prior ¡ì1.987-8T. Prior ¡ì1.987-8T means ¡ì1.987-8T, as contained in 26 CFR in part 1 in effect on April 1, 2017.

Prior ¡ì1.987-10. Prior ¡ì1.987-10 means ¡ì1.987-10, as contained in 26 CFR in part 1 in effect on April 1, 2017.

Prior ¡ì1.987-12. Prior ¡ì1.987-12 means ¡ì1.987-12, as contained in 26 CFR in part 1 in effect on April 1, 2020.

Prior ¡ì1.987-12T. Prior ¡ì1.987-12T means ¡ì1.987-12T, as contained in 26 CFR in part 1 in effect on April 1, 2017.

QBU net value. QBU net value has the meaning provided in ¡ì1.987-4(e)(2)(ii).

Recognition grouping. Recognition grouping has the meaning provided in ¡ì1.987-11(f).

Remittance. Remittance has the meaning provided in ¡ì1.987-5(c).

S corporation. S corporation has the meaning provided in section 1361(a)(1).

Section 904 category. Section 904 category means a separate category of income described in ¡ì1.904-5(a)(4)(v).

Section 987 electing group. Section 987 electing group has the meaning provided in paragraph (g)(2)(ii) of this section.

Section 987 elections. Section 987 elections has the meaning provided in paragraph (g) of this section.

Section 987 gain or loss. Section 987 gain or loss means gain or loss that is recognized under ¡ì1.987-5, deferred section 987 gain or loss, suspended section 987 loss, and pretransition gain or loss that is recognized under ¡ì1.987-10(e)(5)(ii).

Section 987 hedging transaction. Section 987 hedging transaction has the meaning provided in ¡ì1.987-14(b).

Section 987 QBU. Section 987 QBU has the meaning provided in paragraph (b)(3) of this section.

Section 987 regulations. Section 987 regulations has the meaning provided in paragraph (a) of this section.

Section 987 taxable income or loss. Section 987 taxable income or loss has the meaning provided in ¡ì1.987-3(a).

Section 988 mark-to-market election. Section 988 mark-to-market election has the meaning provided in ¡ì1.987-3(b)(4)(ii).

Separate account. Separate account means a separate set of financial records maintained with respect to an insurance contract or group of contracts to report assets and liabilities for specific products that are separated from the insurer¡¯s general account, provided the following requirements are met¡ª

(i) Any liability of the separate account is the liability only of that account and not the liability of any other separate account or the general account;

(ii) The separate account is not part of the company¡¯s general account and is protected from the general creditors of the company; and

(iii) The value of each contract supported by the separate account is supported proportionately by each of the assets in such account.

Separate account asset. Separate account asset means an asset that is reflected on the books and records of an eligible QBU and held in a separate account with respect to a separate account insurance contract. A separate account asset does not include an asset held in the general account.

Separate account insurance contract. Separate account insurance contract means a contract that would be treated as an insurance contract for Federal income tax purposes (except to the extent provided in this definition with respect to the requirements in section 72(s), 101(f), 817(h), or 7702) for which some or all of the assets supporting the insurance reserves are required to be held in a separate account under the insurance regulatory rules of the jurisdiction in which the contract is issued, and either¡ª

(i) The contract qualifies as a variable contract under section 817(d) (treating foreign law as a State law or regulation); or

(ii) The contract would qualify as a variable contract under section 817(d) (treating foreign law as a State law or regulation) but for its failure to meet one or more of the requirements in section 72(s), 101(f), 817(h), or 7702, provided that the following requirements are met¡ª

(A) The contract is regulated as a life insurance or annuity contract in the foreign jurisdiction in which it is issued;

(B) The contract reserves are computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest. For this purpose, the reflection of the investment return and the market value of assets in the separate account is considered an assumed rate of interest; and

(C) No policyholder, annuitant, insured, or beneficiary under the contract is a United States person.

Separated QBU. Separated QBU has the meaning provided in ¡ì1.987-2(c)(9)(iii).

Separating QBU. Separating QBU has the meaning provided in ¡ì1.987-2(c)(9)(iii).

Separation. Separation has the meaning provided in ¡ì1.987-2(c)(9)(iii).

Separation fraction. In the case of a separated QBU, separation fraction means a fraction, the numerator of which is the aggregate adjusted basis of the gross assets attributable to the separated QBU immediately after the separation, and the denominator of which is the aggregate adjusted basis of the gross assets attributable to all separated QBUs immediately after the separation.

Spot rate. Spot rate has the meaning provided in paragraph (c)(1) of this section.

SRLY section 987 losses. SRLY section 987 losses has the meaning provided in ¡ì1.987-11(e)(6)(ii).

Successor deferral QBU. Successor deferral QBU has the meaning provided in ¡ì1.987-12(g)(2).

Successor deferral QBU owner. Successor deferral QBU owner has the meaning provided in ¡ì1.987-12(c)(1).

Successor suspended loss QBU. Successor suspended loss QBU has the meaning provided in ¡ì1.987-13(l)(2).

Successor suspended loss QBU owner. Successor suspended loss QBU owner has the meaning provided in ¡ì1.987-13(l)(3).

Suspended section 987 loss. Suspended section 987 loss means section 987 loss that is subject to the limitations on recognition described in ¡ì1.987-11(e). See ¡ì¡ì1.987-10(e)(5), 1.987-11(c) and (d), 1.987-12(c), and 1.987-13(h) for rules regarding when net unrecognized section 987 loss or deferred section 987 loss becomes suspended section 987 loss. Suspended section 987 loss does not include net unrecognized section 987 loss or deferred section 987 loss.

Tentative tested income group. Tentative tested income group has the meaning provided in ¡ì1.987-6(b)(2)(i)(D)(1).

Terminating QBU. Terminating QBU means a section 987 QBU, if both¡ª

(i) The section 987 QBU terminates on any date on or after November 9, 2023, or the section 987 QBU terminates as a result of an entity classification election made under ¡ì301.7701-3 of this chapter that is filed on or after November 9, 2023, and that is effective before November 9, 2023; and

(ii) When the section 987 QBU terminates, neither the section 987 regulations nor the 2016 and 2019 section 987 regulations would apply with respect to the section 987 QBU but for ¡ì1.987-15(a)(2).

Termination. With respect to a section 987 QBU, termination has the meaning provided in ¡ì1.987-8(b) and (c). With respect to a successor suspended loss QBU, the term termination has the meaning provided in ¡ì1.987-13(j).

Trade or business. Trade or business has the meaning provided in ¡ì1.989(a)-1(c).

Transfer. Transfer has the meaning provided in ¡ì1.987-2(c).

Transition date. Transition date has the meaning provided in ¡ì1.987-10(c).

United States person. United States person (or U.S. person) has the meaning provided in section 7701(a)(30).

United States shareholder. United States shareholder (or U.S. shareholder) has the meaning provided in section 951(b) (or, if applicable, section 953(c)(1)(A)).

U.S. source income. U.S. source income means income from sources within the United States.

Yearly average exchange rate. Yearly average exchange rate has the meaning provided in paragraph (c)(2) of this section.

(a) In general. This section provides rules regarding when items are attributed to eligible QBUs and when they are treated as transferred to or from section 987 QBUs. Paragraph (b) of this section provides rules for attributing assets and liabilities, and items of income, gain, deduction, and loss, to an eligible QBU. Paragraph (c) of this section defines a transfer to or from a section 987 QBU. Paragraph (d) of this section provides translation rules for transfers to a section 987 QBU. Paragraph (e) of this section provides a cross-reference relating to the treatment of section 987 QBUs owned by consolidated groups.

(b) Attribution of items to an eligible QBU¡ª(1) General rules. Except as provided in paragraphs (b)(2) and (3) of this section, items are attributable to an eligible QBU to the extent they are reflected on the separate set of books and records, as defined in ¡ì1.989(a)-1(d)(1) and (2), of the eligible QBU. For purposes of this section, the term item refers to any asset or liability, and any item of income, gain, deduction, or loss. Items that are attributed to an eligible QBU pursuant to this section must be adjusted to conform to Federal income tax principles. An item that is not taken into account for financial accounting purposes, and therefore is not reflected on the separate set of books and records of an eligible QBU, is treated as reflected on the separate set of books and records of an eligible QBU to the extent it would have been so reflected if the item were taken into account for financial accounting purposes. Except as provided in ¡ì1.989(a)-1(d)(3), these attribution rules apply solely for purposes of section 987. For example, the allocation and apportionment of interest expense under section 864(e) is independent of these rules.

(2) Exceptions for non-portfolio stock, interests in partnerships, and certain acquisition indebtedness. (i) In general. Except as provided in paragraph (b)(2)(ii) of this section, the following items are not considered to be on the books and records of an eligible QBU:

(A) Stock of a corporation (whether domestic or foreign), other than stock of a corporation if the owner of the eligible QBU owns less than 10 percent of the total combined voting power of all classes of stock entitled to vote and less than 10 percent of the total value of all classes of stock of such corporation. For this purpose, section 958 (other than section 958(b)(1)) applies in determining ownership of a controlled foreign corporation and section 318(a) applies in determining ownership of other corporations, except that in applying section 318(a)(2)(C), the phrase ¡°10 percent¡± is used instead of the phrase ¡°50 percent.¡±

(B) An interest in a partnership (whether domestic or foreign).

(C) A liability that was incurred to acquire stock described in paragraph (b)(2)(i)(A) of this section or that was incurred to acquire a partnership interest described in paragraph (b)(2)(i)(B) of this section.

(D) Income, gain, deduction, or loss arising from the items described in paragraphs (b)(2)(i)(A) through (C) of this section. For example, if a dividend is received with respect to stock of a corporation described in paragraph (b)(2)(i)(A) of this section, the dividend is excluded from the income of the eligible QBU. See also paragraph (c)(2)(ii) of this section, treating the payment as received by the owner and contributed to the eligible QBU.

(ii) Separate account assets. Paragraph (b)(2)(i) of this section does not apply to separate account assets, liabilities related to separate account assets, or income, gain, deduction, or loss arising from those assets and liabilities.

(3) Adjustments to items reflected on the books and records¡ª(¾±) General rule. If a principal purpose of recording (or not recording) an item on the books and records of an eligible QBU is the avoidance of Federal income tax under, or through the use of, section 987, the item must be allocated between or among the eligible QBU, the owner of such eligible QBU, and any other persons, entities (including DEs), or other QBUs within the meaning of ¡ì1.989(a)-1(b) (including eligible QBUs) in a manner that reflects the substance of the transaction. For purposes of this paragraph (b)(3)(i), relevant factors for determining whether such Federal income tax avoidance is a principal purpose of recording (or not recording) an item on the books and records of an eligible QBU include the factors set forth in paragraphs (b)(3)(ii) and (iii) of this section. The presence or absence of any factor or factors is not determinative. The weight given to any factor (whether or not set forth in paragraphs (b)(3)(ii) and (iii) of this section) depends on the facts and circumstances.

(ii) Factors indicating no tax avoidance. For purposes of paragraph (b)(3)(i) of this section, factors that may indicate that recording (or not recording) an item on the books and records of an eligible QBU did not have as a principal purpose the avoidance of Federal income tax under, or through the use of, section 987 include the recording (or not recording) of an item:

(A) For a significant and bona fide business purpose;

(B) In a manner that is consistent with the economics of the underlying transaction;

(C) In accordance with generally accepted accounting principles (or a similar comprehensive accounting standard);

(D) In a manner that is consistent with the treatment of similar items from year to year;

(E) In accordance with accepted conditions or practices in the particular trade or business of the eligible QBU;

(F) In a manner that is consistent with an explanation of existing internal accounting policies that is evidenced by documentation contemporaneous with the timely filing of a return for the taxable year; and

(G) As a result of a transaction between legal entities (for example, the transfer of an asset or the assumption of a liability), even if such transaction is not regarded for Federal income tax purposes (for example, a transaction between a DE and its owner).

(iii) Factors indicating tax avoidance. For purposes of paragraph (b)(3)(i) of this section, factors that may indicate that a principal purpose of recording (or not recording) an item on the books and records of an eligible QBU is the avoidance of Federal income tax under, or through the use of, section 987 include:

(A) The presence or absence of an item on the books and records that is the result of one or more transactions that are transitory, for example, due to a circular flow of cash or other property;

(B) The presence or absence of an item on the books and records that is the result of one or more transactions that do not have substance; and

(C) The presence or absence of an item on the books and records that results in the taxpayer (or a person related to the taxpayer within the meaning of section 267(b) or section 707(b)) having offsetting positions with respect to the functional currency of a section 987 QBU.

(iv) Section 988 transactions. A section 988 transaction that is reflected on the books and records of an eligible QBU is not attributable to an eligible QBU if the transaction was entered into or was reflected on the eligible QBU¡¯s books and records with a principal purpose of generating fully or partially offsetting amounts of section 988 gain or loss and section 987 gain or loss (or if the taxpayer chose to denominate the section 988 transaction in a nonfunctional currency with such a principal purpose).

(c) Transfers to and from section 987 QBUs¡ª(1) In general. The following rules apply for purposes of determining whether there is a transfer of an asset or a liability from an owner to a section 987 QBU, or from a section 987 QBU to an owner. These rules apply solely for purposes of section 987.

(2) Disregarded transactions¡ª(¾±) General rule. An asset or liability is treated as transferred to a section 987 QBU from its owner if, as a result of a disregarded transaction, such asset or liability is reflected on the books and records of (or otherwise becomes attributable to) the section 987 QBU within the meaning of paragraph (b) of this section. Similarly, an asset or liability is treated as transferred from a section 987 QBU to its owner if, as a result of a disregarded transaction, such asset or liability is no longer reflected on the books and records of (or otherwise ceases to be attributable to) the section 987 QBU within the meaning of paragraph (b) of this section.

(ii) Definition of a disregarded transaction. For purposes of this section, a disregarded transaction means a transaction that is not regarded for Federal income tax purposes (for example, any transaction between separate section 987 QBUs of the same owner). For purposes of this paragraph (c), a disregarded transaction is treated as including events described in paragraphs (c)(2)(ii)(A) through (F) of this section.

(A) If the recording (or not recording) of an asset or liability on the books and records of a section 987 QBU of an owner is the result of such asset or liability being removed from (or included on) the books and records of the owner or another eligible QBU of the owner, the asset or liability is treated as transferred to (or from) the section 987 QBU in a disregarded transaction.

(B) If an asset or liability that was previously attributable to a section 987 QBU of an owner begins to be attributable to the owner (or another eligible QBU of the owner) as a result of the application of paragraph (b)(2) or (3) of this section, the asset or liability is treated as having been transferred by the section 987 QBU in a disregarded transaction. If an asset or liability that was previously attributable to the owner (or another eligible QBU of the owner) begins to be attributable to the section 987 QBU as a result of the application of paragraph (b)(2) or (3) of this section, the asset or liability is treated as transferred to the section 987 QBU in a disregarded transaction.

(C) If an asset or liability that is attributable to a section 987 QBU is sold or exchanged (including in a nonrecognition transaction, such as an exchange under section 351) for an asset or liability that is not attributable to the section 987 QBU immediately after the sale or exchange, the sold or exchanged asset or liability that was attributable to the section 987 QBU immediately before the transaction is treated as transferred from the section 987 QBU to its owner in a disregarded transaction immediately before the sale or exchange for purposes of section 987 (including for purposes of recognizing section 987 gain or loss under ¡ì1.987-5) and subsequently sold or exchanged by the owner.

(D) If an asset or liability of an owner of a section 987 QBU that is not attributable to a section 987 QBU is sold or exchanged (including in a nonrecognition transaction, such as an exchange under section 351) for an asset or liability that is attributable to the section 987 QBU immediately after the sale or exchange, the asset or liability that is attributable to the section 987 QBU immediately after the transaction is treated as received or assumed by the owner and transferred from the owner to the section 987 QBU in a disregarded transaction immediately after the sale or exchange for purposes of section 987 (including for purposes of recognizing section 987 gain or loss under ¡ì1.987-5).

(E) If an asset or liability that is attributable to a section 987 QBU was received, transferred, assumed, or accrued in a regarded transaction (including the making or receiving of a payment) in which the related item of income, gain, deduction, or loss is not attributable to the section 987 QBU, the asset or liability is treated as though it was received, transferred, assumed, or accrued by the owner or another eligible QBU and transferred to or from the section 987 QBU in a disregarded transaction. Similarly, if an asset or liability that is not attributable to a section 987 QBU was received, transferred, assumed, or accrued in a regarded transaction (including the making or receiving of a payment) in which the related item of income, gain, deduction, or loss is attributable to the section 987 QBU, the asset or liability is treated as though it was received, transferred, assumed, or accrued by the section 987 QBU and transferred to or from the section 987 QBU in a disregarded transaction. For example, if a section 987 QBU receives a dividend on an interest in stock that would be attributable to the section 987 QBU but for paragraph (b)(2)(i)(A) of this section, the owner is treated as receiving the dividend and transferring to the section 987 QBU the amount of the dividend in a disregarded transaction. Similarly, if a section 987 QBU pays interest on a liability that would be attributable to the section 987 QBU but for paragraph (b)(2)(i)(C) of this section, the section 987 QBU is treated as transferring to the owner the amount of the interest expense and the owner is treated as paying the interest expense in a disregarded transaction. See also paragraph (c)(7) of this section (application of general tax law principles).

(F) In the first taxable year in which an eligible QBU is treated as a section 987 QBU, all assets and liabilities attributable to the eligible QBU are treated as transferred from the owner to the section 987 QBU in a disregarded transaction on the first day on which the eligible QBU is treated as a section 987 QBU.

(iii) Items derived from disregarded transactions ignored. For purposes of section 987, disregarded transactions do not give rise to items of income, gain, deduction, or loss that are taken into account in determining section 987 taxable income or loss under ¡ì1.987-3.

(3) through (6) [Reserved]

(7) Application of general tax law principles. General tax law principles, including the circular cash flow, step-transaction, economic substance, and substance-over-form doctrines, apply for purposes of determining whether there is a transfer of an asset or liability under this paragraph (c), including a transfer of an asset or liability pursuant to a disregarded transaction.

(8) Interaction with ¡ì1.988-1(a)(10). See ¡ì1.988-1(a)(10) for rules regarding the treatment of an intra-taxpayer transfer of a section 988 transaction.

(9) Certain disregarded transactions not treated as transfers¡ª(¾±) Combinations of section 987 QBUs. The combination (a combination) of two or more separate section 987 QBUs (combining QBUs) that are directly owned by the same owner into one section 987 QBU (combined QBU) does not give rise to a transfer of any combining QBU¡¯s assets or liabilities to the owner under this paragraph (c). In addition, transactions between the combining QBUs occurring in the taxable year of the combination do not result in a transfer of the combining QBUs¡¯ assets or liabilities to the owner under this paragraph (c). For this purpose, a combination occurs when the assets and liabilities that were attributable to two or more combining QBUs begin to be attributable to a combined QBU and the separate existence of the combining QBUs ceases. A combination may result from any transaction or series of transactions in which the combining QBUs become a combined QBU. A combination may also result when an owner of two or more section 987 QBUs with the same functional currency becomes subject to a grouping election under ¡ì1.987-1(b)(3)(ii) or when a section 987 QBU of an owner subject to a grouping election changes its functional currency to that of another section 987 QBU of the same owner. For purposes of determining net unrecognized section 987 gain or loss, deferred section 987 gain or loss, and cumulative suspended section 987 loss of a combined QBU, the combining QBUs are treated as having combined immediately before the beginning of the taxable year of combination. See ¡ì¡ì1.987-4(f)(1), 1.987-11(b)(2), and 1.987-12(f)(1).

(ii) Change in functional currency from a combination. If, following a combination of section 987 QBUs described in paragraph (c)(9)(i) of this section, the combined section 987 QBU has a different functional currency than one or more of the combining section 987 QBUs, any such combining section 987 QBU is treated as changing its functional currency, and the owner of the combined section 987 QBU must comply with the regulations under section 985 regarding the change in functional currency. See ¡ì¡ì1.985-1(c)(6) and 1.985-5.

(iii) Separation of section 987 QBUs. The separation (a separation) of a section 987 QBU (separating QBU) into two or more section 987 QBUs (separated QBUs) that, after the separation, are directly owned by the same owner does not result in a transfer of the separating QBU¡¯s assets or liabilities to the owner under this paragraph (c). Additionally, transactions that occurred between the separating QBUs in the taxable year of the separation before the completion of the separation do not result in transfers for purposes of section 987. For this purpose, a separation occurs when the assets and liabilities that were attributable to a separating QBU begin to be attributable to two or more separated QBUs and each of the separated QBUs continues to perform a significant portion of the separating QBU¡¯s activities immediately after the separation. A separation may result from any transaction or series of transactions in which a separating QBU becomes two or more separated QBUs described in the preceding sentence. A separation may also result when a section 987 QBU that is subject to a grouping election under ¡ì1.987-1(b)(3)(ii) changes its functional currency or when the grouping election is revoked. For purposes of determining net unrecognized section 987 gain or loss, deferred section 987 gain or loss, or cumulative suspended section 987 loss of a separated QBU, the separating QBU is treated as having separated immediately before the beginning of the taxable year of separation. See ¡ì¡ì1.987-4(f)(2), 1.987-11(b)(3), and 1.987-12(f)(2).

(iv) Special rules for successor suspended loss QBUs. For purposes of determining whether a combination or separation has occurred with respect to a successor suspended loss QBU, the rules of paragraphs (c)(9)(i) and (iii) of this section are applied without regard to whether any of the combining QBUs, the combined QBU, the separating QBU, or the separated QBUs are section 987 QBUs. A combined QBU is a successor suspended loss QBU if either combining QBU was a successor suspended loss QBU, and a separated QBU is a successor suspended loss QBU if the separating QBU was a successor suspended loss QBU.

(10) Examples. The following examples illustrate the principles of this paragraph (c). For purposes of the examples, X and Y are domestic corporations, have the U.S. dollar as their functional currencies, and use the calendar year as their taxable years. Furthermore, except as otherwise provided, Business A and Business B are eligible QBUs that have the euro and the Japanese yen, respectively, as their functional currencies, and DE1 and DE2 are DEs. For purposes of determining whether any of the transfers in these examples result in remittances, see ¡ì1.987-5.

(i) Example 1: Loan to a section 987 QBU¡ª(´¡) Facts. X owns all of the interests in DE1. DE1 owns Business A, which is a section 987 QBU of X. X owns €100 that are not reflected on the books and records of Business A. Business A is in need of additional capital and, as a result, X lends the €100 to DE1 for use in Business A in exchange for a note.

(B) Analysis¡ª(1) The loan from X to DE1 is not regarded for Federal income tax purposes (because it is an interbranch transaction) and therefore is a disregarded transaction (as defined in paragraph (c)(2)(ii) of this section). Because DE1 is a DE, the DE1 note held by X and the liability of DE1 under the note are not taken into account under this section.

(2) As a result of the disregarded transaction, the €100 is reflected on the books and records of Business A and is attributable to Business A under paragraph (b) of this section. Therefore, X is treated as transferring €100 to its Business A section 987 QBU for purposes of section 987. This transfer is taken into account in determining the amount of any remittance for the taxable year under ¡ì1.987-5(c). See ¡ì1.988-1(a)(10)(ii) for the application of section 988 to X as a result of the transfer of nonfunctional currency to its section 987 QBU.

(ii) Example 2: Transfer between section 987 QBUs¡ª(´¡) Facts. X owns Business A and Business B, both of which are section 987 QBUs of X. X owns equipment that is used in Business A and is reflected on the books and records of Business A. Because Business A has excess manufacturing capacity and X intends to expand the manufacturing capacity of Business B, the equipment formerly used in Business A is transferred to Business B for use by Business B. As a result of the transfer, the equipment is removed from the books and records of Business A and is recorded on the books and records of Business B.

(B) Analysis. The transfer of the equipment from the books and records of Business A to the books and records of Business B is not regarded for Federal income tax purposes (because it is an interbranch transaction) and therefore is a disregarded transaction (as defined in paragraph (c)(2)(ii) of this section). Therefore, for purposes of section 987, the Business A section 987 QBU is treated as transferring the equipment to X, and X is subsequently treated as transferring the equipment to the Business B section 987 QBU. These transfers are taken into account in determining the amount of any remittance for the taxable year under ¡ì1.987-5(c).

(iii) Example 3: Sale of property between two section 987 QBUs¡ª(´¡) Facts. X owns all of the interests in DE1 and DE2. DE1 and DE2 own Business A and Business B, respectively, both of which are section 987 QBUs of X. DE1 owns equipment that is used in Business A and is reflected on the books and records of Business A. For business reasons, DE1 sells a portion of the equipment used in Business A to DE2 in exchange for a fair market value amount of Japanese yen. The yen used by DE2 to acquire the equipment was generated by Business B and was reflected on Business B¡¯s books and records. Following the sale, the yen and the equipment will be used in Business A and Business B, respectively. As a result of such sale, the equipment is removed from the books and records of Business A and is recorded on the books and records of Business B. Similarly, as a result of the sale, the yen is removed from the books and records of Business B and is recorded on the books and records of Business A.

(B) Analysis¡ª(1) The sale of equipment between DE1 and DE2 is a transaction that is not regarded for Federal income tax purposes (because it is an interbranch transaction) and therefore the transaction is a disregarded transaction (as defined in paragraph (c)(2)(ii) of this section). Pursuant to paragraph (c)(2)(iii) of this section, the sale does not give rise to an item of income, gain, deduction, or loss for purposes of determining section 987 taxable income or loss under ¡ì1.987-3. However, the yen and equipment exchanged by DE1 and DE2 in connection with the sale must be taken into account as a transfer under paragraph (c)(2)(i) of this section.

(2) As a result of the disregarded transaction, the equipment ceases to be reflected on the books and records of Business A and becomes reflected on the books and records of Business B. Therefore, the Business A section 987 QBU is treated as transferring the equipment to X, and X is subsequently treated as transferring the equipment to the Business B section 987 QBU.

(3) Additionally, as a result of the disregarded transaction, the yen currency ceases to be reflected on the books and records of Business B and becomes reflected on the books and records of Business A. Therefore, the Business B section 987 QBU is treated as transferring the yen to X, and X is subsequently treated as transferring the yen from X to the Business A section 987 QBU. The transfers among Business A, Business B and X are taken into account in determining the amount of any remittance for the taxable year under ¡ì1.987-5(c).

(iv) through (ix) [Reserved]

(x) Example 10: Contribution of a section 987 QBU¡¯s assets to a corporation¡ª(´¡) Facts. X owns Business A. X forms Z, a domestic corporation, contributing 50 percent of its Business A assets and liabilities to Z in exchange for all of the stock of Z. X and Z do not file a consolidated tax return.

(B) Analysis. Pursuant to paragraph (b)(2) of this section, the Z stock received in exchange for 50 percent of Business A¡¯s assets and liabilities is not reflected on the books and records of, and therefore is not attributable to, Business A for purposes of section 987 immediately after the exchange. As a result, pursuant to paragraphs (c)(2)(i) and (ii) of this section, 50 percent of the assets and liabilities of Business A are treated as transferred from Business A to X in a disregarded transaction immediately before the exchange. See ¡ì1.1502-13(j)(9) if X and Z file a consolidated return.

(xi) Example 11: Circular transfers¡ª(´¡) Facts. X owns Business A. On December 30, year 1, Business A purports to transfer €100 to X. On January 2, year 2, X purports to transfer €50 to Business A. On January 4, year 2, X purports to transfer another €50 to Business A. As of the end of year 1, X has net unrecognized section 987 loss with respect to Business A, such that a remittance, if respected, would result in recognition of a foreign currency loss under section 987.

(B) Analysis. Because the transfer by Business A to X is offset by the transfers from X to Business A that occurred in close temporal proximity, the purported transfers to and from Business A may be disregarded for purposes of section 987 pursuant to general tax principles under paragraph (c)(7) of this section.

(xii) Example 12: Transfers without substance¡ª(´¡) Facts. X owns Business A and Business B. On January 1, year 1, Business A purports to transfer €100 to X. On January 4, year 1, X purports to transfer €100 to Business B. The account in which Business B deposited the €100 is used to pay the operating expenses and other costs of Business A. As of the end of year 1, X has net unrecognized section 987 loss with respect to Business A, such that a remittance, if respected, would result in recognition of a foreign currency loss under section 987.

(B) Analysis. Because Business A continues to have use of the transferred property, the €100 purported transfer from Business A to X may be disregarded for purposes of section 987 pursuant to general tax principles under paragraph (c)(7) of this section.

(xiii) Example 13: Offsetting positions in section 987 QBUs¡ª(´¡) Facts. X owns Business A and Business B. Business A and Business B each have the euro as their functional currency. X has not made a grouping election under ¡ì1.987-1(b)(3)(ii). On January 1, year 1, X borrows €1,000 from a third-party lender, records the liability with respect to the borrowing on the books and records of Business A, and records the borrowed €1,000 on the books and records of Business B. On December 31, year 2, when Business A has $100 of net unrecognized section 987 loss and Business B has $100 of net unrecognized section 987 gain resulting from the change in exchange rates with respect to the liability and the €1,000, X terminates the Business A section 987 QBU.

(B) Analysis. Under paragraph (b)(3) of this section, the fact that Business A and Business B have offsetting positions in the euro is a factor indicating that a principal purpose of recording the euro-denominated liability on the books and records of Business A and the borrowed euros on the books and records of Business B was the avoidance of tax under section 987. If such a principal purpose is present, the items must be reallocated (that is, the euros and the euro-denominated liability) between Business A, Business B, and X under paragraph (b)(3) of this section to reflect the substance of the transaction.

(xiv) Example 14: Offsetting positions with respect to a section 987 QBU and a section 988 transaction¡ª(´¡) Facts. X owns all of the interests in DE1, and DE1 owns Business A. On January 1, year 1, X borrows €1,000 from a third-party lender and records the liability with respect to the borrowing on its books and records. X contributes the €1,000 loan proceeds to DE1 and the €1,000 are reflected on the books and records of Business A. On December 31, year 2, when Business A has $100 of net unrecognized section 987 loss resulting from the change in exchange rates with respect to the €1,000 received from the borrowing, and when the euro-denominated borrowing, if repaid, would result in $100 of gain under section 988, X terminates the Business A section 987 QBU.

(B) Analysis. Under paragraph (b)(3) of this section, the fact that X and Business A have offsetting positions in the euro is a factor indicating that a principal purpose of recording the borrowed euros on the books and records of Business A, or not recording the corresponding euro-denominated liability on the books and records of Business A, was the avoidance of tax under section 987. If such a principal purpose is present, the items (that is, the euros and the euro-denominated liability) must be reallocated between Business A and X under paragraph (b)(3) of this section to reflect the substance of the transaction.

(xv) Example 15: Offsetting positions with respect to a section 987 QBU and a section 988 transaction¡ª(´¡) Facts. X owns all of the stock of Y and all of the interests in DE1. DE1 owns Business A. X and Y do not file a consolidated return. On January 1, year 1, DE1 lends €1,000 to Y. X records the receivable with respect to the loan on Business A¡¯s books and records. On December 31, year 2, when Business A has $100 of net unrecognized section 987 gain resulting from the loan, Y repays the €1,000 liability. The repayment of the euro-denominated borrowing results in $100 of loss to Y under section 988. Business A does not make any remittances to X in year 2, so the offsetting gain with respect to the loan receivable has not been recognized by X.

(B) Analysis. Under paragraph (b)(3) of this section, the fact that Y (a related party to X) and Business A have offsetting positions in the euro is a factor indicating that a principal purpose of recording the euro-denominated receivable on the books and records of Business A, rather than on the books and records of X, was to avoid Federal income tax under, or through the use of, section 987. If such a principal purpose is present, the euro-denominated receivable must be reallocated between Business A and X under paragraph (b)(3) of this section to reflect the substance of the transaction. Other provisions (for example, section 267) may also apply to defer or disallow the loss. See ¡ì1.1502-13(j)(9) if X and Y file a consolidated return.

(xvi) Example 16: Borrowing by section 987 QBU followed by immediate distribution to owner¡ª(´¡) Facts. X owns all of the interests in DE1. DE1 owns Business A. On January 1, year 1, Business A borrows €1,000 from a bank. On January 2, year 1, Business A distributes the €1,000 it received from the bank to X. There are no other transfers between X and Business A during the year. At the end of the year, X has net unrecognized section 987 loss with respect to Business A such that a remittance would result in the recognition of foreign currency loss under section 987.

(B) Analysis. Under paragraph (b)(3) of this section, if a principal purpose of recording of the loan on the books and records of Business A, rather than on the books and records of X, was to avoid Federal income tax under, or through the use of, section 987, the items must be reallocated to reflect the substance of the transaction (for example, by moving the loan onto the books of X, resulting in the transfer not being taken into account for purposes of section 987).

(xvii) Example 17: Payment of interest by section 987 QBU on obligation of owner¡ª(´¡) Facts. X owns all of the interests in DE1. DE1 owns Business A. On January 1, X borrows €1,000 from a bank. On July 1, DE1 pays €20 in interest on X¡¯s €1,000 obligation to the bank, which is treated as a payment by Business A.

(B) Analysis. Under general tax law principles as provided in paragraph (c)(7) of this section, on July 1, year 1, Business A is treated for purposes of section 987 as making a transfer of €20 to X, and X is treated as making a €20 interest payment to the bank. See also paragraph (c)(2)(ii)(E) of this section for interest payments on loans that are not attributable to a section 987 QBU pursuant to paragraph (b)(2) or (3) of this section.

(xviii) Example 18: Sale of the interests in a DE¡ª(´¡) Facts. X owns all of the interests in DE1, a disregarded entity. DE1 owns Business A, which is a section 987 QBU of X. X has made a current rate election under ¡ì1.987-1(d)(2) but not an annual recognition election under ¡ì1.987-5(b)(2). On December 31, year 1, X sells all of the interests in DE1 to FC, an unrelated foreign corporation, for $150,000, when the exchange rate is €1=$1.2. The sale proceeds are reflected on X¡¯s books and records after the sale. At the time of the sale, all of DE1¡¯s assets are used in Business A and are reflected on the books and records of Business A. The assets have a basis of €100,000 and Business A has no liabilities. In year 1, X has net unrecognized section 987 gain with respect to Business A of $20,000.

(B) Analysis¡ª(1) Under paragraph (c)(2)(ii)(C) of this section, if an asset that is attributable to a section 987 QBU is sold or exchanged for an asset that is not attributable to the section 987 QBU immediately after the sale or exchange, the sold or exchanged asset is treated as transferred from the section 987 QBU to its owner in a disregarded transaction immediately before the sale or exchange and subsequently sold or exchanged by the owner. The sale of DE1 is treated as a sale of the assets of Business A in exchange for cash that is not reflected on the books and records of the Business A section 987 QBU. Therefore, the assets of Business A are treated as transferred from the Business A section 987 QBU to X, and X is treated as selling the assets to FC.

(2) The deemed transfer of all of Business A¡¯s assets to X results in a termination of the Business A section 987 QBU under ¡ì1.987-8(b)(2) (substantially all assets transferred). Under ¡ì1.987-5(c)(4) and ¡ì1.987-8(e), a termination of a section 987 QBU is treated as a remittance of all the gross assets of the section 987 QBU to the owner on the date of the termination. Therefore, the owner¡¯s remittance proportion is one, and X recognizes all of its net unrecognized section 987 gain with respect to Business A, or $20,000.

(3) Because a current rate election was in effect, all of the assets of Business A are marked items. Therefore, under ¡ì1.987-5(f)(2), X¡¯s basis in the assets transferred from Business A is determined by translating Business A¡¯s functional currency basis in the assets into X¡¯s functional currency at the spot rate applicable to the date of the transfer, €1=$1.2. Consequently, immediately before the sale of the interests in DE1, X¡¯s functional currency basis in Business A¡¯s assets (which Business A held with a basis of €100,000) is $120,000. X recognizes $30,000 of gain under section 1001(a) on the sale of DE1.

(d) Translation of items transferred to a section 987 QBU¡ª(1) Marked items. The adjusted basis of a marked asset, or the amount of a marked liability, transferred to a section 987 QBU is translated into the section 987 QBU¡¯s functional currency at the spot rate applicable to the date of transfer. If, and to the extent that, exchange gain or loss is recognized on the asset or liability transferred under ¡ì1.988-1(a)(10)(ii), the adjusted basis of the marked asset, or the amount of the marked liability, is adjusted to take into account the exchange gain or loss recognized.

(2) Historic items. The adjusted basis of a historic asset, or the amount of a historic liability, transferred to a section 987 QBU is translated into the section 987 QBU¡¯s functional currency at the rate provided in ¡ì1.987-1(c)(3).

(e) Cross-reference. See also ¡ì1.1502-13(j)(9) regarding the treatment of intercompany transactions involving section 987 QBUs owned by a member of a consolidated group.

(a) In general. This section provides rules for determining the taxable income or loss of an owner of a section 987 QBU (section 987 taxable income or loss). Paragraph (b) of this section provides rules for determining items of income, gain, deduction, and loss in the section 987 QBU¡¯s functional currency. Paragraph (c) of this section provides rules for translating each item determined under paragraph (b) of this section into the functional currency of the owner of the section 987 QBU. Paragraph (d) of this section is reserved. Paragraph (e) of this section provides examples illustrating the application of the rules of this section.

(b) Determination of each item of income, gain, deduction, or loss in the section 987 QBU¡¯s functional currency¡ª(1) In general. The owner of a section 987 QBU must determine each item of income, gain, deduction, or loss attributable to the section 987 QBU in the section 987 QBU¡¯s functional currency under Federal income tax principles.

(2) Translation of items of income, gain, deduction, or loss that are denominated in a nonfunctional currency. Except as otherwise provided in paragraph (b)(4) of this section, an item of income, gain, deduction, or loss (or the item¡¯s components and related items, such as gross receipts and amount realized) that is denominated in (or determined by reference to) a nonfunctional currency (including the functional currency of the owner) is translated into the section 987 QBU¡¯s functional currency at the spot rate on the date such item is properly taken into account. Paragraphs (e)(1) and (2) of this section (Examples 1 and 2) illustrate the application of this paragraph (b)(2).

(3) [Reserved]

(4) Section 988 transactions¡ª(¾±) In general. Section 988 and the regulations under section 988 apply to section 988 transactions of a section 987 QBU. The determination of whether an asset or liability of a section 987 QBU is a section 988 transaction is determined by reference to the functional currency of the section 987 QBU. Section 988 gain or loss is determined in, and by reference to, the functional currency of the section 987 QBU. The amount of section 988 gain or loss determined under this paragraph (b)(4)(i) is translated into the owner¡¯s functional currency under paragraph (c) of this section.

(ii) Section 988 mark-to-market election¡ª(´¡) In general. A taxpayer may elect to apply the section 988 mark-to-market method of accounting described in this paragraph (b)(4)(ii) with respect to all section 988 transactions that are properly attributable to a section 987 QBU and that are not otherwise accounted for under a mark-to-market method of accounting under section 475 or section 1256 (other than a section 988 transaction described in paragraph (b)(4)(ii)(B) of this section). Under the section 988 mark-to-market method of accounting, the timing of section 988 gain or loss on section 988 transactions described in the preceding sentence is determined under the principles of section 1256. Only section 988 gain or loss is taken into account under the foreign currency mark-to-market method of accounting. Appropriate adjustments must be made to prevent the section 988 gain or loss from being taken into account again after it is recognized under this paragraph (b)(4)(ii). A section 988 transaction subject to the foreign currency mark-to-market method of accounting is not subject to the netting rule of section 988(b) and ¡ì1.988¨C2(b)(8) (under which exchange gain or loss is limited to overall gain or loss realized in a transaction) in taxable years before the taxable year in which section 988 gain or loss would be recognized with respect to the section 988 transaction but for this election.

(B) Built-in loss transactions contributed to a section 987 QBU. Paragraph (b)(4)(ii)(A) of this section does not apply to a section 988 transaction if¡ª

(1) The transaction was transferred to the section 987 QBU from its owner (or from another eligible QBU of the owner);

(2) Immediately before the transfer, the transaction was a section 988 transaction in the hands of the owner (or other eligible QBU of the owner) and was not subject to a mark-to-market method of accounting;

(3) If the owner (or other eligible QBU) had disposed of the section 988 transaction immediately before the transfer (and ¡ì1.988-2(b)(8) did not apply), the owner would have recognized section 988 loss; and

(4) Section 988 loss was not recognized in connection with the transfer under ¡ì1.988-1(a)(10).

(c) Translation of items of income, gain, deduction, or loss of a section 987 QBU into the owner¡¯s functional currency¡ª(1) In general. Except as otherwise provided in this section, the exchange rate to be used by an owner in translating an item of income, gain, deduction, or loss attributable to a section 987 QBU (or the item¡¯s components and related items, such as gross receipts, amount realized, basis, and cost of goods sold) into the owner¡¯s functional currency, if necessary, is the yearly average exchange rate for the taxable year.

(2) Exceptions. Except as otherwise provided in paragraph (c)(2)(v) of this section, this paragraph (c)(2) applies only to taxable years for which neither the annual recognition election nor the current rate election is in effect.

(i) Recovery of basis with respect to historic assets. Except as otherwise provided in this paragraph (c)(2), the exchange rate to be used by the owner in translating any recovery of basis (whether through a sale or exchange; deemed sale or exchange; cost recovery deduction such as depreciation, depletion or amortization; or otherwise) with respect to a historic asset is the historic rate for the property to which such recovery of basis is attributable.

(ii) through (iii) [Reserved]

(iv) Cost of goods sold computation¡ª(´¡) General rule¡ªsimplified inventory method. Except as otherwise provided in paragraph (c)(2)(iv)(B) of this section, cost of goods sold (COGS) for a taxable year is translated into the functional currency of the owner at the yearly average exchange rate for the taxable year in which the sale of inventory occurs (or the COGS is otherwise taken into account in computing taxable income) and adjusted as provided in paragraph (c)(3) of this section.

(B) Election to use the historic inventory method. In lieu of using the simplified inventory method described in paragraph (c)(2)(iv)(A) of this section, the owner of a section 987 QBU may elect under this paragraph (c)(2)(iv)(B) to translate inventoriable costs (including current-year inventoriable costs and costs that were capitalized into inventory in prior years) that are included in COGS at the historic rate for each such cost.

(v) Translation of income to account for certain foreign income tax claimed as a credit. The owner of a section 987 QBU claiming a credit under section 901 for foreign income taxes, other than foreign income taxes deemed paid under section 960, that are properly reflected on the books and records of the section 987 QBU (the creditable tax amount) must determine section 987 taxable income or loss attributable to the section 987 QBU by reducing the amount of section 987 taxable income or loss that otherwise would be determined under this section by an amount equal to the creditable tax amount, translated into U.S. dollars using the yearly average exchange rate for the taxable year in which the creditable tax is accrued, and by increasing the resulting amount by an amount equal to the creditable tax amount, translated using the same exchange rate that is used to translate the creditable taxes into U.S. dollars under section 986(a). This paragraph (c)(2)(v) applies whether or not a current rate election or an annual recognition election is in effect. See paragraph (e)(14) of this section (Example 14) for an illustration of this rule.

(3) Adjustments to COGS required under the simplified inventory method. This paragraph (c)(3) applies only to taxable years for which neither the annual recognition election nor the current rate election is in effect.

(i) In general. An owner of a section 987 QBU that uses the simplified inventory method described in paragraph (c)(2)(iv)(A) of this section must make the adjustment described in paragraph (c)(3)(ii) of this section. In addition, the owner must make the adjustment described in paragraph (c)(3)(iii) of this section with respect to any inventory for which the section 987 QBU does not use the LIFO inventory method and must make the adjustment described in paragraph (c)(3)(iv) of this section with respect to any inventory for which the section 987 QBU uses the LIFO inventory method. An owner of a section 987 QBU that uses the simplified inventory method must make all of the applicable adjustments described in paragraphs (c)(3)(ii) through (iv) of this section with respect to the section 987 QBU even in taxable years in which the amount of COGS is zero.

(ii) Adjustment for cost recovery deductions included in inventoriable costs¡ª(´¡) In general. The translated COGS amount computed under paragraph (c)(2)(iv)(A) of this section is increased or decreased (as appropriate) by the amount described in paragraph (c)(3)(ii)(B) of this section. The adjustment is included as an adjustment to translated COGS computed under paragraph (c)(2)(iv)(A) of this section in full in the year to which the adjustment relates and is not allocated between COGS and ending inventory.

(B) Amount of adjustment. With respect to each cost recovery deduction attributable to a historic asset that is included in inventoriable costs for a taxable year, the adjustment is equal to¡ª

(1) The amount of the cost recovery deduction included in inventoriable costs, translated at the historic rate for the property to which the deduction is attributable; less

(2) The amount of the cost recovery deduction included in inventoriable costs, translated at the yearly average exchange rate for the current taxable year.

(iii) Adjustment for beginning inventory for non-LIFO inventory¡ª(´¡) In general. In the case of non-LIFO inventory, the translated COGS amount computed under paragraph (c)(2)(iv)(A) of this section is increased or decreased (as appropriate) by the amount described in paragraph (c)(3)(iii)(B) of this section.

(B) Amount of adjustment. The adjustment is equal to¡ª

(1) The ending non-LIFO inventory included on the closing balance sheet for the preceding taxable year, translated at the exchange rate described in paragraph (c)(3)(iii)(C) of this section (which is generally the yearly average exchange rate for the preceding taxable year); less

(2) The ending non-LIFO inventory included on the closing balance sheet for the preceding taxable year, translated at the yearly average exchange rate for the current taxable year.

(C) Exchange rate¡ª(1) In general. Except as provided in paragraph (c)(3)(iii)(C)(2) of this section, the exchange rate used to translate non-LIFO inventory under paragraph (c)(3)(iii)(B)(1) of this section is the yearly average exchange rate for the preceding taxable year.

(2) Revocation of current rate election or taxable year beginning on the transition date. In the first taxable year in which a current rate election is revoked or otherwise ceases to be in effect (or in the taxable year beginning on the transition date), the exchange rate used to translate non-LIFO inventory under paragraph (c)(3)(iii)(B)(1) of this section is the spot rate applicable to the last day of the preceding taxable year.

(iv) Adjustment for year of LIFO liquidation¡ª(´¡) In general. In the case of inventory with respect to which a section 987 QBU uses the LIFO inventory method, the translated COGS amount computed under paragraph (c)(2)(iv)(A) of this section is increased or decreased (as appropriate) by the amount described in paragraph (c)(3)(iv)(B) of this section.

(B) Amount of adjustment. With respect to each LIFO layer liquidated in whole or in part during the taxable year, the adjustment is equal to:

(1) The amount of the LIFO layer liquidated during the taxable year, translated at the historic rate that is used for translating the LIFO layer (which is generally the yearly average exchange rate for the year the LIFO layer arose); less

(2) The amount of the LIFO layer liquidated during the taxable year, translated at the yearly average exchange rate for the taxable year.

(d) [Reserved]

(e) Examples. The following examples illustrate the application of this section. For purposes of the examples, U.S. Corp is a domestic corporation that uses the calendar year as its taxable year and has the U.S. dollar as its functional currency. Except as otherwise indicated, U.S. Corp is the owner of Business A, a section 987 QBU with the euro as its functional currency, and U.S. Corp elects under paragraph (c)(2)(iv)(B) of this section to use the historic inventory method with respect to Business A but does not make any other elections.

(1) Example 1: Item of income denominated in nonfunctional currency. Business A accrues ?100 of income from the provision of services. Under paragraph (b)(2) of this section, the ?100 is translated into €90 at the spot rate on the date of accrual, without the use of a spot rate convention. In determining U.S. Corp¡¯s taxable income, the €90 of income is translated into dollars at the yearly average exchange rate under paragraph (c)(1) of this section.

(2) Example 2: Asset sold for nonfunctional currency. Business A sells a historic asset consisting of non-inventory property for ?100. Under paragraph (b)(2) of this section, the ?100 amount realized is translated into €85 at the spot rate on the sale date without the use of a spot rate convention. In determining U.S. Corp¡¯s taxable income, the €85 is translated into dollars at the yearly average exchange rate under paragraph (c)(1) of this section. The euro basis of the property is translated into dollars at the historic rate under paragraph (c)(2)(i) of this section.

(3) Example 3: Historic inventory method¡ª(¾±) Facts. Business A uses a first-in, first-out (FIFO) method of accounting for inventory. Business A sells 1,200 units of inventory in year 2 for €3 per unit. The yearly average exchange rate is €1 = $1.02 for year 1 and €1 = $1.05 for year 2.

(ii) Analysis¡ª(´¡) Gross sales. Business A¡¯s gross sales are translated under paragraph (c)(1) of this section at the yearly average exchange rate for the year of the sale. Business A¡¯s dollar gross sales will be computed as follows:

 

(B) Translated basis of inventory. The purchase price for each inventory unit was €1.50. Under ¡ì1.987-1(c)(3)(i) and paragraph (c)(2)(iv)(B) of this section, the basis of each item of inventory is translated into dollars at the yearly average exchange rate for the year the inventory was acquired.

 

(C) COGS. Because Business A uses a FIFO method for inventory, Business A is considered to have sold in year 2 the 100 units of opening inventory purchased in year 1 ($153.00), the 300 units purchased in January year 2 ($472.50), the 300 units purchased in April year 2 ($472.50), the 300 units purchased in July year 2 ($472.50), and 200 of the 300 units purchased in November year 2 ($315.00). Accordingly, Business A¡¯s translated dollar COGS for year 2 is $1,885.50. Business A¡¯s opening inventory for year 3 is 100 units of inventory with a translated dollar basis of $157.50.

(D) Gross sales income. Accordingly, for purposes of section 987, Business A has gross income in dollars of $1,894.50 ($3,780.00 - $1,885.50) from the sale of inventory in year 2.

(4) Example 4: Simplified inventory method¡ª(¾±) Facts. The facts are the same as in paragraph (e)(3) of this section (Example 3), except that U.S. Corp does not elect to use the historic inventory method with respect to Business A.

(ii) Analysis. Because U.S. Corp does not elect to use the historic inventory method, the simplified inventory method under paragraph (c)(2)(iv)(A) of this section applies.

(A) Gross sales. Business A¡¯s dollar gross sales will be computed as described in paragraph (e)(3)(ii)(A) of this section (Example 3). Therefore, Business A has gross sales of $3,780.

(B) COGS. Business A sold 1,200 units of inventory in year 2, and the purchase price for each unit was €1.50. The total purchase price for the inventory sold in year 2 was €1,800. Under the simplified inventory method provided in paragraph (c)(2)(iv)(A) of this section, COGS for a taxable year is translated into the functional currency of the owner at the yearly average exchange rate for the taxable year in which the sale of inventory occurs. Therefore, before making the adjustments required under paragraph (c)(3) of this section, Business A¡¯s dollar COGS for year 2 is equal to $1,890 (the purchase price for the inventory sold in year 2 (€1,800), translated at the yearly average exchange rate of €1 = $1.05).

(C) Adjustments required. Because the simplified inventory method applies, Business A¡¯s COGS must be adjusted under paragraph (c)(3) of this section. No adjustment is required under paragraph (c)(3)(ii) of this section because no cost recovery deduction attributable to a historic asset is included in inventoriable costs for year 2. However, an adjustment for beginning inventory is required under paragraph (c)(3)(iii)(A) of this section because Business A uses a FIFO method of accounting for inventory.

(D) Adjustment for beginning inventory. The adjustment required under paragraph (c)(3)(iii)(A) of this section is equal to: the ending non-LIFO inventory included on Business A¡¯s closing balance sheet for the preceding taxable year (€150), translated at the yearly average exchange rate for year 1 (€1 = $1.02), which is $153; less the ending non-LIFO inventory included on Business A¡¯s closing balance sheet for the preceding taxable year (€150), translated at the yearly average exchange rate for year 2 (€1 = $1.05), which is $157.50. Therefore, there is a negative adjustment to COGS of $4.50. Business A¡¯s COGS for year 2 is reduced from $1,890 to $1,885.50.

(E) Gross sales income. Accordingly, for purposes of section 987, Business A has gross income in dollars of $1,894.50 ($3,780.00 - $1,885.50) from the sale of inventory in year 2.

(5) Example 5: Depreciation expense that is not an inventoriable cost. The facts are the same as in paragraph (e)(3) of this section (Example 3) except that during year 2, Business A incurred €100 of depreciation expense with respect to a truck. No portion of the depreciation expense is an inventoriable cost. The truck was purchased on January 15, year 1. The yearly average exchange rate for year 1 was €1 = $1.02. Under paragraph (c)(2)(i) of this section, the €100 of depreciation is translated into dollars at the historic rate. The historic rate is the yearly average exchange rate for year 1. Accordingly, U.S. Corp takes into account depreciation of $102 with respect to Business A in year 2.

(6) Example 6: Translation of depreciation expense that is an inventoriable cost (historic inventory method). The facts are the same as in paragraph (e)(5) of this section (Example 5) except that the €100 of depreciation expense incurred during year 2 with respect to the truck is an inventoriable cost. As a result, the depreciation expense is capitalized into the 1,200 units of inventory purchased by Business A in year 2. Of those 1,200 units, 1,100 units are sold during the year, and 100 units become ending inventory. The portion of depreciation expense capitalized into inventory that is sold during year 2 is reflected in Business A¡¯s euro COGS and is translated at the €1 = $1.02 yearly average exchange rate for year 1, the year in which the truck was purchased. The portion of the depreciation expense capitalized into the 100 units of ending inventory is not taken into account in year 2 but rather, will be taken into account in the year the ending inventory is sold, translated at the €1 = $1.02 yearly average exchange rate for year 1.

(7) Example 7: Sale of land. Business A purchased raw land on October 16, year 1, for €8,000 and sold the land on November 1, year 2, for €10,000. The yearly average exchange rate was €1 = $1.02 for year 1 and €1 = $1.05 for year 2. Under paragraph (c)(1) of this section, the amount realized is translated into dollars at the yearly average exchange rate for year 2 (€10,000 x $1.05 = $10,500). Under paragraph (c)(2)(i) of this section, the basis is translated at the historic rate for year 1, which is the yearly average exchange rate under section ¡ì1.987-1(c)(3)(i) (€8,000 x $1.02 = $8,160). Accordingly, the amount of gain reported by U.S. Corp on the sale of the land is $2,340 ($10,500 - $8,160).

(8) Example 8: Current rate election. The facts are the same as in paragraph (e)(7) of this section (Example 7), except that U.S. Corp makes a current rate election under ¡ì1.987-1(d)(2). Under paragraph (c)(2) of this section, the exceptions to paragraph (c)(1) of this section generally do not apply in a taxable year for which an annual recognition election or a current rate election is in effect. As a result, all items of income, gain, deduction, and loss with respect to Business A are translated into U.S Corp¡¯s functional currency at the yearly average exchange rate under paragraph (c)(1) of this section. Business A¡¯s gain on the sale of the land is determined in its functional currency and is equal to €2,000 (amount realized of €10,000 less basis of €8,000). This gain is translated at the yearly average exchange rate for year 2 of €1 = $1.05, and the amount of gain reported by U.S. Corp on the sale of the land is $2,100. The result would be the same if U.S. Corp made an annual recognition election under ¡ì1.987-5(b)(2) (and did not make a current rate election).

(9) through (12) [Reserved]

(13) Example 13: Section 988 transaction¡ª(¾±) Facts. Business A receives and accrues $100 of income from the provision of services on January 1, 2021. Business A continues to hold the $100 as a U.S. dollar-denominated demand deposit at a bank on December 31, 2021. U.S. Corp has made a section 988 mark-to-market election under paragraph (b)(4)(ii) of this section. The euro-dollar spot rate without the use of a spot rate convention is €1 = $1 on January 1, 2021, and €1 = $2 on December 31, 2021, and the yearly average exchange rate for 2021 is €1 = $1.50.

(ii) Analysis¡ª(´¡) Under paragraph (b)(2) of this section, the $100 earned by Business A is translated into €100 at the spot rate on January 1, 2021, as defined in ¡ì1.987-1(c)(1) without the use of a spot rate convention. In determining U.S. Corp¡¯s taxable income, the €100 of services income is translated into $150 at the yearly average exchange rate for 2021, as provided in paragraph (c)(1) of this section.

(B) Under paragraph (b)(4)(i) of this section, section 988 gain or loss for Business A¡¯s section 988 transactions is determined in, and by reference to, the euro, the functional currency of Business A. Accordingly, section 988 gain or loss must be determined on Business A¡¯s holding of the $100 demand deposit in, and by reference to, the euro. Under ¡ì1.988-2(a)(2), Business A is treated as having an amount realized of €50 when the $100 is marked to market at the end of 2021 under paragraph (b)(4)(ii) of this section. Marking the dollars to market gives rise to a section 988 loss of €50 (€50 amount realized, less Business A¡¯s €100 basis in the $100). In determining U.S. Corp¡¯s taxable income, that €50 loss is translated into a $75 loss at the yearly average exchange rate for 2021, as provided in paragraph (c)(1) of this section.

(14) Example 14: Payment of foreign income tax¡ª(¾±) Facts. Business A earns €100 of revenue from the provision of services and incurs €30 of general expenses and €10 of depreciation expense during 2021. Except as otherwise provided, U.S. Corp uses the yearly average exchange rate described in ¡ì1.987-1(c)(2) to translate items of income, gain, deduction, and loss of Business A. Business A is subject to income tax in Country X at a 25 percent rate. U.S. Corp claims a credit with respect to Business A¡¯s foreign income taxes and elects under section 986(a)(1)(D) to translate the foreign income taxes at the spot rate on the date the taxes were paid. The yearly average exchange rate for 2021 is €1 = $1.50. The historic rate used to translate the depreciation expense is €1 = $1.00. The spot rate on the date that Business A paid its foreign income taxes was €1 = $1.60.

(ii) Analysis. Because U.S. Corp has elected to translate foreign income taxes at the spot rate on the date such taxes were paid rather than at the yearly average exchange rate, U.S. Corp must make the adjustments described in paragraph (c)(2)(v) of this section. Accordingly, U.S. Corp determines its section 987 taxable income or loss by reducing the section 987 taxable income or loss that otherwise would be determined under this section by €15, translated into U.S. dollars at the yearly average exchange rate (€1 = $1.50), and increasing the resulting amount by €15, translated using the same exchange rate that is used to translate the creditable taxes into U.S. dollars under section 986(a) (€1 = $1.60). Following these adjustments, Business A¡¯s section 987 taxable income for 2021 is $96.50, computed as follows:

(a) In general. The net unrecognized section 987 gain or loss of a section 987 QBU is determined by the owner annually as provided in paragraph (b) of this section in the owner¡¯s functional currency. Only assets and liabilities attributable to the section 987 QBU are taken into account.

(b) Calculation of net unrecognized section 987 gain or loss. Net unrecognized section 987 gain or loss of a section 987 QBU for a taxable year equals the sum of:

(1) The section 987 QBU¡¯s net accumulated unrecognized section 987 gain or loss for all prior taxable years as determined in paragraph (c) of this section; and

(2) The section 987 QBU¡¯s unrecognized section 987 gain or loss for the current taxable year as determined in paragraph (d) of this section and ¡ì1.987-14.

(c) Net accumulated unrecognized section 987 gain or loss for all prior taxable years¡ª(1) In general. A section 987 QBU¡¯s net accumulated unrecognized section 987 gain or loss for all prior taxable years is the aggregate of the amounts determined under paragraph (d) of this section for all prior taxable years to which this section applies, reduced by amounts recognized under ¡ì1.987-5(a), amounts treated as deferred section 987 gain or loss, and amounts treated as suspended section 987 loss for all prior taxable years to which this section applies. Accordingly, net accumulated unrecognized section 987 gain or loss is not reduced under this paragraph (c)(1) when deferred section 987 gain or loss is recognized (or suspended) under ¡ì1.987-12 or when suspended section 987 loss is recognized under ¡ì1.987-11 or ¡ì1.987-13.

(2) Additional adjustments for certain taxable years beginning on or before December 31, 2024. For any section 987 QBU in existence before the transition date, see ¡ì1.987-10(e)(5) and (f)(2) for additional adjustments to the section 987 QBU¡¯s net accumulated unrecognized section 987 gain or loss.

(d) Calculation of unrecognized section 987 gain or loss for a taxable year. The unrecognized section 987 gain or loss of a section 987 QBU for a taxable year is generally determined under paragraphs (d)(1) through (10) of this section. However, for taxable years in which a current rate election or an annual recognition election is in effect, the unrecognized section 987 gain or loss of a section 987 QBU for a taxable year is determined by applying only paragraphs (d)(1) through (5) and (10) of this section. See ¡ì1.987-14 for additional adjustments that must be made to the unrecognized section 987 gain or loss of a section 987 QBU for a taxable year in connection with a section 987 hedging transaction.

(1) Step 1: Determine the change in the owner functional currency net value of the section 987 QBU for the taxable year¡ª(¾±) In general. The change in the owner functional currency net value of the section 987 QBU for the taxable year equals¡ª

(A) The owner functional currency net value of the section 987 QBU, determined in the functional currency of the owner under paragraph (e) of this section, on the last day of the taxable year; less

(B) The owner functional currency net value of the section 987 QBU, determined in the functional currency of the owner under paragraph (e) of this section, on the last day of the preceding taxable year.

(ii) Year section 987 QBU is terminated. If a section 987 QBU is terminated within the meaning of ¡ì1.987-8 during an owner¡¯s taxable year, the termination date is treated as the last day of the taxable year for purposes of this section.

(iii) First taxable year of a section 987 QBU. If the owner¡¯s taxable year is the first taxable year of a section 987 QBU, the owner functional currency net value of the section 987 QBU described in paragraph (d)(1)(i)(B) of this section is zero.

(iv) First year in which an election is in effect or ceases to be in effect. Except as otherwise provided, the owner functional currency net value of the section 987 QBU described in paragraph (d)(1)(i)(B) of this section is determined based on the elections that were (or were not) in effect on the last day of the preceding taxable year.

(2) Step 2: Increase the amount determined in step 1 by the amount of assets transferred from the section 987 QBU to the owner¡ª(¾±) In general. The amount determined in paragraph (d)(1) of this section is increased by the total amount of assets transferred from the section 987 QBU to the owner during the taxable year translated into the functional currency of the owner as provided in paragraph (d)(2)(ii) of this section.

(ii) Assets transferred from the section 987 QBU to the owner during the taxable year. The total amount of assets transferred from the section 987 QBU to the owner for the taxable year translated into the functional currency of the owner equals the sum of:

(A) The amount of the functional currency of the section 987 QBU and the aggregate adjusted basis of all other marked assets, after taking into account ¡ì1.988-1(a)(10), transferred to the owner during the taxable year determined in the functional currency of the section 987 QBU and translated into the functional currency of the owner at the spot rate applicable to the date of transfer; and

(B) The aggregate adjusted basis of all historic assets transferred to the owner during the taxable year determined in the functional currency of the section 987 QBU and translated into the functional currency of the owner at the historic rate for each such asset.

(3) Step 3: Decrease the amount determined in steps 1 and 2 by the amount of assets transferred from the owner to the section 987 QBU¡ª(¾±) In general. The aggregate amount determined in paragraphs (d)(1) and (2) of this section is decreased by the total amount of assets transferred from the owner to the section 987 QBU during the taxable year determined in the functional currency of the owner as provided in paragraph (d)(3)(ii) of this section.

(ii) Assets transferred from the owner to the section 987 QBU during the taxable year. The total amount of assets transferred from the owner to the section 987 QBU for the taxable year equals the sum of:

(A) The amount of functional currency of the owner transferred to the section 987 QBU during the taxable year; and

(B) The aggregate adjusted basis of all other assets, after taking into account ¡ì1.988-1(a)(10), transferred to the section 987 QBU during the taxable year determined in the functional currency of the owner immediately before the transfer.

(4) Step 4: Decrease the amount determined in steps 1 through 3 by the amount of liabilities transferred from the section 987 QBU to the owner¡ª(¾±) In general. The aggregate amount determined in paragraphs (d)(1) through (3) of this section is decreased by the total amount of liabilities transferred from the section 987 QBU to the owner during the taxable year translated into the functional currency of the owner as provided in paragraph (d)(4)(ii) of this section.

(ii) Liabilities transferred from the section 987 QBU to the owner during the taxable year. The total amount of liabilities transferred from the section 987 QBU to the owner for the taxable year equals the sum of:

(A) The amount of marked liabilities, after taking into account ¡ì1.988-1(a)(10), transferred to the owner during the taxable year determined in the functional currency of the section 987 QBU and translated into the functional currency of the owner at the spot rate applicable to the date of transfer; and

(B) The amount of historic liabilities transferred to the owner during the taxable year determined in the functional currency of the section 987 QBU and translated into the functional currency of the owner at the historic rate for each such liability.

(5) Step 5: Increase the amount determined in steps 1 through 4 by the amount of liabilities transferred from the owner to the section 987 QBU. The aggregate amount determined in paragraphs (d)(1) through (4) of this section is increased by the total amount of liabilities, after taking into account ¡ì1.988-1(a)(10), transferred from the owner to the section 987 QBU during the taxable year determined in the functional currency of the owner immediately before the transfer.

(6) Step 6: Decrease or increase the amount determined in steps 1 through 5 by the section 987 taxable income or loss, respectively, of the section 987 QBU for the taxable year. The aggregate amount determined in paragraphs (d)(1) through (5) of this section is decreased or increased by the section 987 taxable income or loss, respectively, computed under ¡ì1.987-3 for the taxable year.

(7) Step 7: Increase the amount determined in steps 1 through 6 by certain expenses or losses that are not deductible in computing the section 987 taxable income or loss of the section 987 QBU for the taxable year. The aggregate amount determined under paragraphs (d)(1) through (6) of this section is increased by the amount of any expense or loss that reduces the basis of assets or increases the amount of liabilities attributable to the section 987 QBU for the taxable year but is not deductible in computing the section 987 QBU¡¯s taxable income or loss for the taxable year (such as business interest expense that is not deductible under section 163(j)). Items of expense or loss described in the preceding sentence are translated into the functional currency of the owner using the exchange rate that would apply under ¡ì1.987-3(c) if they were deductible in computing the section 987 QBU¡¯s taxable income or loss for the taxable year. However, any foreign income taxes incurred by the section 987 QBU with respect to which the owner claims a credit are translated at the same rate at which such taxes were translated under section 986(a).

(8) Step 8: Decrease the amount determined in steps 1 through 7 by the amount of certain income or gain that is not included in taxable income in computing the section 987 taxable income or loss of the section 987 QBU for the taxable year. The aggregate amount determined under paragraphs (d)(1) through (7) of this section is decreased by the amount of any income or gain that increases the basis of assets or reduces the amount of liabilities attributable to the section 987 QBU for the taxable year but is not included in taxable income in computing the section 987 QBU¡¯s taxable income or loss for the taxable year. Items of income or gain described in the preceding sentence are translated into the functional currency of the owner using the exchange rate that would apply under ¡ì1.987-3(c) if they were included in taxable income in computing the section 987 QBU¡¯s taxable income or loss for the taxable year.

(9) Step 9: Increase or decrease the amount determined in steps 1 through 8 by any income or gain, or any deduction or loss, respectively, that does not impact the adjusted balance sheet. The aggregate amount determined under paragraphs (d)(1) through (8) of this section is increased by any items of income or gain taken into account in paragraph (d)(6) of this section (step 6) that do not increase the basis of assets or reduce the amount of liabilities attributable to the section 987 QBU for the taxable year, and decreased by any items of deduction or loss taken into account in paragraph (d)(6) of this section (step 6) that do not reduce the basis of assets or increase the amount of liabilities attributable to the section 987 QBU for the taxable year. Items of income, gain, deduction, or loss described in the preceding sentence are translated into the functional currency of the owner using the exchange rate that applied under ¡ì1.987-3(c) in computing the section 987 QBU¡¯s taxable income or loss for the taxable year.

(10) Step 10: Decrease or increase the amount determined in steps 1 through 9 by any increase or decrease, respectively, to the section 987 QBU¡¯s net assets that is not previously taken into account under steps 2 through 9¡ª(¾±) In general. Except as provided in paragraph (d)(10)(iii) of this section, the aggregate amount determined under paragraphs (d)(1) through (9) of this section is¡ª

(A) Decreased by the residual increase to net assets (as defined in paragraph (d)(10)(ii) of this section), translated into the owner¡¯s functional currency at the yearly average exchange rate for the taxable year; or

(B) Increased by the residual decrease to net assets (as defined in paragraph (d)(10)(ii) of this section), translated into the owner¡¯s functional currency at the yearly average exchange rate for the taxable year.

(ii) Determining the residual increase or decrease to net assets¡ª(´¡) In general. The residual increase to net assets is the positive amount, if any, that would be determined under paragraphs (d)(1) through (9) of this section in the functional currency of the section 987 QBU if such amounts were determined in the functional currency of the section 987 QBU. The residual decrease to net assets is the negative amount, if any, that would be determined under paragraphs (d)(1) through (9) of this section in the functional currency of the section 987 QBU if such amounts were determined in the functional currency of the section 987 QBU.

(B) Application of step 1 in the functional currency of the section 987 QBU if a current rate election is in effect. In a taxable year in which a current rate election is in effect, for purposes of applying step 1 (paragraph (d)(1) of this section) in the functional currency of the section 987 QBU, the change in the net value of the section 987 QBU is determined by reference to the QBU net value described in paragraph (e)(2)(ii) of this section.

(C) Application of steps 3 and 5 in the functional currency of the section 987 QBU. For purposes of applying steps 3 and 5 (paragraphs (d)(3) and (5) of this section) in the functional currency of the section 987 QBU, the amount of assets and liabilities transferred from an owner to a section 987 QBU is determined by translating the basis of the assets and the amount of the liabilities under ¡ì1.987-2(d).

(iii) Modifications for taxable years to which a current rate election or an annual recognition election applies. For any taxable year to which a current rate election or an annual recognition election applies, paragraphs (d)(10)(i) and (ii) of this section are applied by replacing ¡°paragraphs (d)(1) through (9) of this section¡± with ¡°paragraphs (d)(1) through (5) of this section.¡±

(e) Determination of the owner functional currency net value of a section 987 QBU¡ª(1) In general. Except as provided in paragraph (e)(2) of this section, the owner functional currency net value of a section 987 QBU on the last day of a taxable year is equal to the aggregate amount of functional currency and the adjusted basis of each other asset on the section 987 QBU¡¯s adjusted balance sheet on that day, less the aggregate amount of each liability on the section 987 QBU¡¯s adjusted balance sheet on that day, in each case translated into the owner¡¯s functional currency as provided in paragraphs (e)(1)(i) and (ii) of this section.

(i) Marked item. A marked item is translated into the owner¡¯s functional currency at the spot rate applicable to the last day of the relevant taxable year.

(ii) Historic item. A historic item is translated into the owner¡¯s functional currency at the historic rate.

(2) Current rate election¡ª(¾±) In general. If a current rate election is in effect, the owner functional currency net value of a section 987 QBU on the last day of a taxable year is equal to the QBU net value described in paragraph (e)(2)(ii) of this section, translated into the owner¡¯s functional currency at the spot rate applicable to that day.

(ii) QBU net value. The QBU net value of a section 987 QBU on the last day of a taxable year is determined in the functional currency of the section 987 QBU and is equal to the aggregate amount of functional currency and the adjusted basis of each other asset that is attributable to the section 987 QBU on that day, less the aggregate amount of each liability that is attributable to the section 987 QBU on that day. The QBU net value of a section 987 QBU on the last day of a taxable year may be determined either by preparing an adjusted balance sheet or by following the steps described in paragraph (e)(2)(iii) of this section (provided that the calculation is made consistently for all years in which a current rate election is in effect). However, in the first taxable year in which a current rate election ceases to be in effect, the owner functional currency net value of the section 987 QBU for the preceding taxable year must be determined by preparing an adjusted balance sheet.

(iii) Alternative calculation of QBU net value. The QBU net value of a section 987 QBU on the last day of a taxable year can be computed using the following steps (each applied in the functional currency of the section 987 QBU). See paragraph (g)(2)(iii) of this section (Example 2) for an example illustrating this rule.

(A) Step 1: Determine the QBU net value on the last day of the preceding taxable year. Determine the QBU net value on the last day of the preceding taxable year under this paragraph (e)(2). If the owner¡¯s taxable year is the first taxable year of a section 987 QBU, the QBU net value on the last day of the preceding taxable year is zero. In the first taxable year in which a current rate election is in effect (other than the taxable year beginning on the transition date or the first taxable year of a section 987 QBU), the QBU net value on the last day of the preceding taxable year is determined by preparing an adjusted balance sheet. In the taxable year beginning on the transition date (other than the first taxable year of a section 987 QBU), the QBU net value on the last day of the preceding taxable year may be determined either by preparing an adjusted balance sheet or by applying the steps described in this paragraph (e)(2)(iii) for each taxable year beginning with the first taxable year of the section 987 QBU.

(B) Step 2: Adjust for transfers between the section 987 QBU and its owner. The amount determined in paragraph (e)(2)(iii)(A) of this section is increased by the amount of each transfer described in paragraph (d)(3) or (4) of this section and decreased by the amount of each transfer described in paragraph (d)(2) or (5) of this section (in each case, after adjustment for gain or loss recognized under ¡ì1.988-1(a)(10)). For this purpose, the amount of assets and liabilities transferred from an owner to a section 987 QBU is determined by translating the basis of the assets and the amount of the liabilities under ¡ì1.987-2(d)(1).

(C) Step 3: Adjust for income or loss of the section 987 QBU. The amount determined in paragraph (e)(2)(iii)(B) of this section is increased by items of income and gain attributable to the section 987 QBU (including tax-exempt income described in paragraph (d)(8) of this section) for the taxable year and reduced by items of deduction and loss attributable to the section 987 QBU (including non-deductible expenses described in paragraph (d)(7) of this section) for the taxable year. However, no adjustment is made under the preceding sentence for any item of income, gain, deduction, or loss described in paragraph (d)(9) of this section.

(f) Combinations and separations¡ª(1) Combinations. The net accumulated unrecognized section 987 gain or loss of a combined QBU for a taxable year is equal to the sum of the combining QBUs¡¯ net accumulated unrecognized section 987 gain or loss. See paragraph (f)(3)(i) of this section (Example 1) for an illustration of this rule.

(2) Separations. The net accumulated unrecognized section 987 gain or loss of a separated QBU for a taxable year is equal to the separating QBU¡¯s net accumulated unrecognized section 987 gain or loss multiplied by the separation fraction. For purposes of determining the owner functional currency net value and QBU net value of the separated QBUs on the last day of the taxable year preceding the taxable year of separation under paragraphs (d)(1)(i)(B) and (e) of this section, the assets and liabilities attributable to the separating QBU on that day are deemed to be attributable to the separated QBUs on that day, and are apportioned between the separated QBUs in a reasonable manner that takes into account the assets and liabilities attributable to the separated QBUs immediately after the separation. See paragraph (f)(3)(ii) of this section (Example 2) for an illustration of this rule.

(3) Examples. The following examples illustrate the rules of paragraphs (f)(1) and (2) of this section. For purposes of these examples, assume that no section 987 elections are in effect.

(i) Example 1: Combination of two section 987 QBUs that have the same owner¡ª(´¡) Facts. DC1, a domestic corporation, owns Entity A, a DE. Entity A conducts a manufacturing business that constitutes a section 987 QBU (Manufacturing QBU) that has the euro as its functional currency. Manufacturing QBU has a net accumulated unrecognized section 987 loss of $100. DC1 also owns Entity B, a DE. Entity B conducts a sales business that constitutes a section 987 QBU (Sales QBU) that has the euro as its functional currency. Sales QBU has a net accumulated unrecognized section 987 gain of $110. During the taxable year, Entity A merges into Entity B under local law pursuant to which Entity A ceases to exist, Entity B survives, and Entity B acquires all the assets and liabilities of Entity A. As a result, the books and records of Manufacturing QBU and Sales QBU are combined into a new single set of books and records. The combined entity has the euro as its functional currency.

(B) Analysis. Pursuant to ¡ì1.987-2(c)(9)(i), Manufacturing QBU and Sales QBU are combining QBUs, and their combination does not give rise to a transfer that is taken into account in determining the amount of a remittance (as defined in ¡ì1.987-5(c)). For purposes of computing net unrecognized section 987 gain or loss under this section for the year of the combination, the combination is deemed to have occurred on the last day of the owner¡¯s prior taxable year, such that the owner functional currency net value of the combined section 987 QBU at the end of that taxable year described under paragraph (d)(1)(i)(B) of this section takes into account items attributable to both Manufacturing QBU and Sales QBU at that time. Additionally, any transactions between Manufacturing QBU and Sales QBU occurring during the year of the merger will not result in transfers to or from a section 987 QBU. Pursuant to paragraph (f)(1) of this section, the combined QBU will have a net accumulated unrecognized section 987 gain of $10 (the $100 loss from Manufacturing QBU plus the $110 gain from Sales QBU).

(ii) Example 2: Separation of two section 987 QBUs that have the same owner¡ª(´¡) Facts. DC1, a domestic corporation, owns Entity A, a DE. Entity A conducts a business in the Netherlands that constitutes a section 987 QBU (Dutch QBU) that has the euro as its functional currency. The business of Dutch QBU consists of manufacturing and selling bicycles and scooters and is recorded on a single set of books and records. On the last day of year 1, the adjusted basis of the gross assets of Dutch QBU is €1,000. In year 2, the net accumulated unrecognized section 987 loss of Dutch QBU from all prior taxable years is $200. During year 2, Entity A separates the bicycle and scooter business such that each business begins to have its own books and records and to meet the definition of a section 987 QBU under ¡ì1.987-1(b)(3) (hereafter, ¡°bicycle QBU¡± and ¡°scooter QBU¡±). There are no transfers between DC1 and Dutch QBU before the separation. After the separation, the aggregate adjusted basis of bicycle QBU¡¯s assets is €600 and the aggregate adjusted basis of scooter QBU¡¯s assets is €400. Each section 987 QBU continues to have the euro as its functional currency.

(B) Analysis. Pursuant to ¡ì1.987-2(c)(9)(iii), bicycle QBU and scooter QBU are separated QBUs, and the separation of Dutch QBU, a separating QBU, does not give rise to a transfer taken into account in determining the amount of a remittance. For purposes of computing net unrecognized section 987 gain or loss under this section for year 2, the separation will be deemed to have occurred on the last day of the owner¡¯s prior taxable year, year 1. Pursuant to paragraph (f)(2) of this section and ¡ì1.987-1(h), bicycle QBU will have a separation fraction of €600/€1,000 and net accumulated unrecognized section 987 loss of $120 (€600/€1,000 x $200), and scooter QBU will have a separation fraction of €400/€1,000 and net accumulated unrecognized section 987 loss of $80 (€400/€1,000 x $200).

(g) Examples. The following examples illustrate the provisions of this section. For purposes of the examples, U.S. Corp is a domestic corporation that uses the calendar year as its taxable year and has the dollar as its functional currency. Except as otherwise indicated, no section 987 elections are in effect. The examples are not intended to demonstrate when activities constitute a trade or business within the meaning of ¡ì1.989(a)-1(b)(2)(ii)(A) and (c) and therefore whether a section 987 QBU is considered to exist.

(1) Example 1: Determination of net unrecognized section 987 gain or loss¡ª(i) Facts. On July 1, year 1, U.S. Corp establishes Japan Branch, a section 987 QBU that has the yen as its functional currency, and U.S. Corp transfers to Japan Branch ?100,000 with a basis of $1,000 and raw land with a basis of $500. On the same day, Japan Branch borrows ?10,000 from a bank. In year 1, Japan Branch earns ?12,000 for providing services and incurs ?2,000 of related expenses. Japan Branch thus earns ?10,000 of net income in year 1. The spot rate on July 1, year 1, is $1 = ?100; the spot rate on December 31, year 1, is $1 = ?120; and the average rate for the period of July 1, year 1, to December 31, year 1, is $1 = ?110. Thus, the ?12,000 of services revenue when translated under ¡ì1.987-3(c)(1) at the yearly average exchange rate equals $109.09 (?12,000 x ($1 / ?110)) = $109.09). The ?2,000 of expenses translated at the same yearly average exchange rate equals $18.18 (?2,000 x ($1 / ?110) = $18.18). Thus, Japan Branch¡¯s net income translated into dollars equals $90.91 ($109.09 - $18.18 = $90.91).

(ii) Analysis. Under paragraph (a) of this section, U.S. Corp must compute the net unrecognized section 987 gain or loss of Japan Branch for year 1. Because this is Japan Branch¡¯s first taxable year, the net unrecognized section 987 gain or loss (as defined under paragraph (b) of this section) is equal to the branch¡¯s unrecognized section 987 gain or loss for year 1 as determined in paragraph (d) of this section. The calculations under paragraph (d) of this section are made as follows:

(A) Step 1. Under paragraph (d)(1) of this section (step 1), U.S. Corp must determine the change in the owner functional currency net value (OFCNV) of Japan Branch for year 1 in dollars. The change in the OFCNV of Japan Branch for year 1 is equal to the OFCNV of Japan Branch determined in dollars on the last day of year 1, less the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year.

(1) The OFCNV of Japan Branch on December 31, year 1 is determined under paragraph (e) of this section as the sum of the basis of each asset on Japan Branch¡¯s adjusted balance sheet on December 31, year 1, less the sum of each liability on Japan Branch¡¯s adjusted balance sheet on that date, translated into dollars as provided in paragraphs (e)(1)(i) and (ii) of this section.

(2) For this purpose, Japan Branch will show the following assets and liabilities on its adjusted balance sheet for December 31, year 1: cash of ?120,000; raw land with a basis of ?55,000 ($500 translated under ¡ì1.987-2(d)(2) at the historic rate of $1 = ?110); and liabilities of ?10,000.

(3) Under paragraphs (e)(1)(i) and (ii) of this section, U.S. Corp will translate these items as follows. The ?120,000 is a marked asset and the ?10,000 liability is a marked liability. These items are translated into dollars on December 31, year 1, using the spot rate on December 31, year 1, of $1 = ?120. The raw land is a historic asset and is translated into dollars under paragraph (e)(1)(ii) of this section at the historic rate, which under ¡ì1.987-1(c)(3)(i)(A) is the yearly average exchange rate of $1 = ?110 applicable to the year the land was transferred to the QBU.

(4) The OFCNV of Japan Branch on December 31, year 1, in dollars is $1,416.67. The determination of the OFCNV of Japan Branch on December 31, year 1, is shown below in dollars together with the corresponding amounts in yen.

 

(5) Under paragraph (d)(1) of this section, the change in OFCNV of Japan Branch for year 1 is equal to the OFCNV of the branch determined in dollars on December 31, year 1, (which is $1,416.67) less the OFCNV of the branch determined in dollars on the last day of the preceding taxable year. Because this is the first taxable year of Japan Branch, the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year is zero under paragraph (d)(1)(iii) of this section. Accordingly, the change in OFCNV of Japan Branch for year 1 is $1,416.67.

(B) Step 2 (no adjustment). No adjustment is made under paragraph (d)(2) of this section (step 2) because no assets were transferred by Japan Branch to U.S. Corp during the taxable year.

(C) Step 3. On July 1, year 1, U.S. Corp transferred to Japan Branch ?100,000 with a basis of $1,000.00 and raw land with a basis of $500.00 (equal to ?55,000, translated under ¡ì1.987-2(d)(2) at the historic rate of $1 = ?110). The total amount of assets transferred from U.S. Corp to Japan Branch in dollars is $1,500, and the total amount of the transfer in yen is ?155,000. Therefore, under paragraph (d)(3) of this section (step 3), the amount determined in previous steps is reduced by $1,500.00, from $1,416.67 to negative $83.33.

(D) Steps 4 and 5 (no adjustment). No adjustment is made under paragraphs (d)(4) and (5) of this section (steps 4 and 5) because no liabilities were transferred by U.S. Corp to Japan Branch or by Japan Branch to U.S. Corp during the taxable year.

(E) Step 6. Under paragraph (d)(6) of this section (step 6), the amount determined in previous steps is decreased by the section 987 taxable income of Japan Branch of $90.91, from negative $83.33 to negative $174.24.

(F) Steps 7 through 9 (no adjustment). No adjustment is made under paragraphs (d)(7) through (9) of this section (steps 7 through 9) because all of Japan Branch¡¯s items of income or deduction for the taxable year impact the basis of Japan Branch¡¯s assets or the amount of its liabilities and are taken into account in computing taxable income.

(G) Step 10 (no adjustment)¡ª(1) Calculation of residual increase or decrease to net assets. Under paragraph (d)(10)(ii) of this section, the residual increase (or decrease) to net assets is the positive (or negative) amount, if any, that would be determined under paragraphs (d)(1) through (9) of this section (steps 1 through 9) in the functional currency of the section 987 QBU if such amounts were determined in the functional currency of the section 987 QBU. In year 1, the relevant steps that must be applied in the functional currency of Japan Branch (the yen) are paragraphs (d)(1), (3), and (6) of this section (steps 1, 3, and 6). For purposes of applying paragraph (d)(1) of this section (step 1) in yen, the change in the net value of Japan Branch is ?165,000. See paragraph (g)(1)(ii)(A)(4) of this section. For purposes of applying paragraph (d)(3) of this section (step 3) in yen, the amount of assets transferred from U.S. Corp to Japan Branch is ?155,000. See paragraph (g)(1)(ii)(C) of this section. For purposes of applying paragraph (d)(6) of this section (step 6) in yen, Japan Branch earned ?10,000 of net income in year 1. The application of these steps results in no residual increase or decrease to the adjusted balance sheet, as shown below:

 

(2) No residual increase or decrease to the adjusted balance sheet. As explained in paragraph (g)(1)(ii)(G)(1) of this section, there is no residual increase or decrease to the adjusted balance sheet of Japan Branch in year 1. Therefore, no adjustment is made under paragraph (d)(10) of this section (step 10). Accordingly, the unrecognized section 987 loss of Japan Branch for year 1 is $174.24.

(2) Example 2: Determination of net unrecognized section 987 gain or loss if a current rate election is in effect¡ª(¾±) Facts. The facts are the same as in paragraph (g)(1) of this section (Example 1), except that U.S. Corp makes a current rate election under ¡ì1.987-1(d)(2) for year 1.

(ii) Analysis. Because a current rate election is in effect for year 1, the unrecognized section 987 gain or loss for year 1 is determined by applying only paragraphs (d)(1) through (5) and (10) of this section (steps 1 through 5 and step 10). The calculations under paragraph (d) of this section are made as follows:

(A) Step 1. The change in the OFCNV of Japan Branch for year 1 is equal to the OFCNV of Japan Branch determined in dollars on the last day of year 1, less the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year.

(1) For this purpose, Japan Branch will show the same assets and liabilities on its adjusted balance sheet for December 31, year 1 as are described in paragraph (g)(1)(ii)(A)(2) of this section (Example 1), but the land is treated as a marked asset as a result of the current rate election. The adjusted balance sheet reflects cash of ?120,000, raw land with a basis of ?50,000 ($500 translated under ¡ì1.987-2(d)(1) at the July 1, year 1 spot rate of $1 = ?100), and liabilities of ?10,000.

(2) Under paragraph (e)(2)(ii) of this section, because a current rate election is in effect, the OFCNV of Japan Branch at the end of year 1 is equal to the QBU net value, translated into U.S. dollars at the applicable spot rate on the last day of the taxable year. The QBU net value of Japan Branch at the end of year 1 is ?160,000, as shown below. The OFCNV of Japan Branch is $1,333.33, which is equal to the QBU net value of ?160,000, translated at the applicable spot rate on December 31, year 1 of $1 = ?120.

 

(3) Under paragraph (d)(1) of this section, the change in OFCNV of Japan Branch for year 1 is equal to the OFCNV of the branch determined in dollars on December 31, year 1, (which is $1,333.33) less the OFCNV of the branch determined in dollars on the last day of the preceding taxable year. Because this is the first taxable year of Japan Branch, the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year is zero under paragraph (d)(1)(iii) of this section. Accordingly, the change in OFCNV of Japan Branch for year 1 is $1,333.33.

(B) Step 2 (no adjustment). No adjustment is made under paragraph (d)(2) of this section (step 2) because no assets were transferred by Japan Branch to U.S. Corp during the taxable year.

(C) Step 3. On July 1, year 1, U.S. Corp transferred to Japan Branch ?100,000 with a basis of $1,000.00 and raw land with a basis of $500.00 (equal to ?50,000, translated under ¡ì1.987-2(d)(1) at the spot rate on July 31, year 1 of $1 = ?100). The total amount of assets transferred in dollars is $1,500.00, and the amount of assets transferred in yen is ?150,000. Therefore, under paragraph (d)(3) of this section (step 3), the amount determined in previous steps is reduced by $1,500, from $1,333.33 to negative $166.67.

(D) Steps 4 and 5 (no adjustment). No adjustment is made under paragraphs (d)(4) and (5) of this section (steps 4 and 5) because no liabilities were transferred by U.S. Corp to Japan Branch or by Japan Branch to U.S. Corp during the taxable year.

(E) Steps 6 through 9 do not apply. Under paragraph (d) of this section, paragraphs (d)(6) through (9) of this section (steps 6 through 9) do not apply because a current rate election is in effect.

(F) Step 10¡ª(1) Application of relevant steps in Japan Branch¡¯s functional currency. Under paragraph (d)(10)(iii) of this section, because a current rate election is in effect, the residual increase or decrease to net assets is determined by applying paragraphs (d)(1) through (5) of this section (steps 1 through 5) in the functional currency of the section 987 QBU. The relevant steps that must be applied under paragraph (d)(10) of this section in the functional currency of Japan Branch are paragraphs (d)(1) and (3) of this section (steps 1 and 3). Under paragraph (d)(10)(ii)(B) of this section, step 1 is applied by reference to Japan Branch¡¯s QBU net value. See paragraphs (g)(2)(ii)(A) and (C) of this section for amounts determined in yen. The residual increase to net assets is determined as follows:

 

(2) Residual increase or decrease to net assets. As explained in paragraph (g)(2)(ii)(F)(1) of this section, the residual increase to Japan Branch¡¯s net assets in year 1 is ?10,000. This amount, translated at the yearly average exchange rate of $1 = ?110, equals $90.91. Therefore, the amount determined in previous steps is reduced by $90.91, from negative $166.67 to negative $257.58. Accordingly, the unrecognized section 987 loss of Japan Branch for year 1 is $257.58.

(iii) Alternative computation of QBU net value. Alternatively, for purposes of applying steps 1 and 10 (paragraphs (d)(1) and (10) of this section), U.S. Corp can determine QBU net value using the following steps under paragraph (e)(2)(iii) of this section.

(A) Step 1: Determine QBU net value at the end of the preceding taxable year. Because year 1 is the first taxable year in which Japan Branch exists, the QBU net value at the end of the preceding taxable year is zero.

(B) Step 2: Adjust for transfers between the section 987 QBU and its owner. During year 1, U.S. Corp transferred assets to Japan Branch with an aggregate basis of ?150,000, as described in paragraph (g)(2)(ii)(C) of this section. Therefore, the amount determined in step 1 is increased from zero to ?150,000.

(C) Step 3: Adjust for income or loss of the section 987 QBU. During year 1, Japan Branch earned ?10,000 of net income. Therefore, the amount determined in step 2 is increased from ?150,000 to ?160,000.

(D) QBU net value. Japan Branch¡¯s QBU net value at the end of the preceding taxable year is zero. This amount is increased by the transfer from U.S. Corp of ?150,000 and by Japan Branch¡¯s taxable income of ?10,000. Japan Branch did not have any tax-exempt income or non-deductible expenses in year 1. Accordingly, Japan Branch¡¯s QBU net value at the end of year 1 is ?160,000.

(3) Example 3: Determination of net unrecognized section 987 gain or loss when a current rate election is revoked¡ª(¾±) Facts¡ª(´¡) Background. The facts in year 1 are the same as in paragraph (g)(2) of this section (Example 2). In year 9, a current rate election remains in effect, U.S. Corp has net unrecognized section 987 loss of $1,000 with respect to Japan Branch, and Japan Branch does not make a remittance. On December 31, year 9, the adjusted balance sheet of Japan Branch shows the following assets and liabilities: cash of ?120,000; raw land with a basis of ?50,000; and liabilities of ?10,000. Effective for year 10, U.S. Corp revokes the current rate election.

(B) Operations in year 10. In year 10, Japan Branch earns ?12,000 for providing services and incurs ?2,000 of related expenses. Japan Branch thus earns ?10,000 of net income in year 10. On December 31, year 10, the adjusted balance sheet of Japan Branch shows the following assets and liabilities: cash of ?130,000; raw land with a basis of ?50,000; and liabilities of ?10,000. Assume that the spot rate on December 31, year 9, is $1 = ?120; the spot rate on December 31, year 10, is $1 = ?130; and the yearly average exchange rate for year 10 is $1 = ?125. Thus, the ?12,000 of services revenue when properly translated under ¡ì1.987-3(c)(1) at the yearly average exchange rate equals $96.00 (?12,000 ¡Á ($1/?125)) = $96.00). The ?2,000 of expenses translated at the same yearly average exchange rate equals $16.00 (?2,000 ¡Á ($1/?125) = $16.00). Thus, Japan Branch¡¯s net income translated into dollars equals $80. There are no transfers of assets or liabilities between U.S. Corp and Japan Branch in year 10.

(ii) Analysis¡ª(´¡) Determination of OFCNV for year 9. Under paragraph (d)(1)(iv) of this section, the OFCNV of a section 987 QBU on the last day of the preceding taxable year is determined based on the elections that were (or were not) in effect on the last day of that taxable year. In year 9, a current rate election was in effect. Therefore, in determining the OFCNV of Japan Branch for year 9, all assets and liabilities of Japan Branch (including the land) are treated as marked items. Under paragraph (e)(2)(ii) of this section, because a current rate election was in effect for year 9, the OFCNV of Japan Branch at the end of year 9 is equal to the QBU net value, translated into U.S. dollars at the applicable spot rate on the last day of the taxable year. The QBU net value of Japan Branch at the end of year 9 is ?160,000, as shown below. The OFCNV of Japan Branch is $1,333.33, which is equal to the QBU net value of ?160,000, translated at the applicable spot rate on December 31, year 9 of $1 = ?120.

 

(B) Determination of OFCNV for year 10. In year 10, a current rate election is not in effect. Therefore, in determining the OFCNV of Japan Branch for year 10, the land owned by Japan Branch is treated as a historic item. Under ¡ì1.987-1(c)(3)(i)(E), the historic rate applicable to historic items that were attributable to Japan Branch on the last day of the last taxable year in which a current rate election was in effect (December 31, year 9) generally is equal to the spot rate applicable to that day. Therefore, the historic rate applicable to the land is the spot rate on December 31, year 9. The OFCNV of Japan Branch for year 10 is $1,339.74, determined under paragraph (e) of this section as follows (together with the corresponding amounts in yen):

 

(C) Determination of unrecognized section 987 gain or loss for year 10. The unrecognized section 987 gain or loss of Japan Branch for year 10 is determined under paragraph (d) of this section as follows:

(1) Step 1. The change in the OFCNV of Japan Branch for year 10 is equal to the OFCNV of Japan Branch determined in dollars on the last day of year 10, less the OFCNV of Japan Branch determined in dollars on the last day of year 9. Therefore, the change in OFCNV is equal to $6.41 ($1,339.74 - $1,333.33).

(2) Steps 2 through 5 (no adjustment). No adjustment is made under paragraphs (d)(2) through (5) of this section (steps 2 through 5) because no assets or liabilities were transferred by U.S. Corp to Japan Branch or by Japan Branch to U.S. Corp during the taxable year.

(3) Step 6. Under paragraph (d)(6) of this section (step 6), the amount determined in previous steps is decreased by the section 987 taxable income of Japan Branch of $80.00, from $6.41 to negative $73.59.

(4) Steps 7 through 10 (no adjustment). No adjustment is made under paragraphs (d)(7) through (10) of this section (steps 7 through 10) because all of Japan Branch¡¯s items of income or deduction for the taxable year impact the basis of Japan Branch¡¯s assets or the amount of its liabilities and are taken into account in computing taxable income. In addition, Japan Branch does not have a residual increase or decrease to net assets (because the change in net value of ?10,000 is equal to the amount of Japan Branch¡¯s net income in year 10). Accordingly, the unrecognized section 987 loss of Japan Branch for year 10 is negative $73.59.

(D) Determination of net unrecognized section 987 gain or loss. In year 10, Japan Branch has net accumulated section 987 loss of $1,000. Because U.S. Corp revoked the current rate election for year 10, the net accumulated section 987 loss of $1,000 becomes suspended section 987 loss under ¡ì1.987-11(d)(2) and Japan Branch¡¯s net accumulated section 987 loss is reduced to zero. Therefore, in year 10, Japan Branch¡¯s net unrecognized section 987 loss is equal to $73.59, its unrecognized section 987 loss for year 10.

(a) Recognition of section 987 gain or loss by the owner of a section 987 QBU. The taxable income of an owner of a section 987 QBU includes the owner¡¯s section 987 gain or loss recognized with respect to the section 987 QBU for the taxable year. Except as otherwise provided in the section 987 regulations (including ¡ì1.987-11(c), ¡ì1.987-12(b) or (e), or ¡ì1.987-13(h) or (k)), for any taxable year the owner¡¯s section 987 gain or loss recognized with respect to a section 987 QBU is equal to:

(1) The owner¡¯s net unrecognized section 987 gain or loss with respect to the section 987 QBU determined under ¡ì1.987-4 on the last day of such taxable year (or, if earlier, on the day the section 987 QBU is terminated under ¡ì1.987-8); multiplied by

(2) The owner¡¯s remittance proportion for the taxable year, as determined under paragraph (b) of this section.

(b) Remittance proportion¡ª(1) In general. Except as provided in paragraph (b)(2) of this section, the owner¡¯s remittance proportion with respect to a section 987 QBU for a taxable year is equal to:

(i) The amount of the remittance, as determined under paragraph (c) of this section, to the owner from the section 987 QBU for such taxable year; divided by

(ii) The sum of:

(A) The aggregate adjusted basis of the gross assets that are attributable to the section 987 QBU as of the end of the taxable year, determined in the functional currency of the section 987 QBU; and

(B) The amount of the remittance, as determined under paragraph (c) of this section.

(2) Annual recognition election. A taxpayer may elect to recognize its net unrecognized section 987 gain or loss with respect to the section 987 QBU on an annual basis (annual recognition election). For any taxable year in which the annual recognition election is in effect, the owner¡¯s remittance proportion with respect to a section 987 QBU is one. See paragraph (g) of this section for an example illustrating this rule. Additionally, for any taxable year of an original deferral QBU owner in which an annual recognition election is in effect, the remittance proportion with respect to any successor deferral QBU is one.

(c) Remittance¡ª(1) Definition. A remittance is determined in the section 987 QBU¡¯s functional currency and equals the excess, if any, of:

(i) The aggregate of all amounts transferred from the section 987 QBU to the owner during the taxable year, as determined in paragraph (d) of this section; over

(ii) The aggregate of all amounts transferred from the owner to the section 987 QBU during the taxable year, as determined in paragraph (e) of this section.

(2) Alternative calculation. The amount of a remittance described in paragraph (c)(1) of this section may alternatively be determined under the following steps (each applied in the functional currency of the section 987 QBU). If the amount determined under this paragraph (c)(2) is negative, the amount of the remittance is zero.

(i) Step 1: Determine the change in QBU net value. The change in QBU net value is equal to the QBU net value on the date provided in paragraph (c)(3) of this section, less the QBU net value on the last day of the preceding taxable year. In the first taxable year in which the section 987 QBU exists, the QBU net value on the last day of the preceding taxable year is zero.

(ii) Step 2: Adjust the amount determined in step 1 for income or loss of the section 987 QBU. The amount determined in paragraph (c)(2)(i) of this section is reduced (including below zero) by items of income and gain attributable to the section 987 QBU (including tax-exempt income described in ¡ì1.987-4(d)(8)) for the taxable year and increased by items of deduction and loss attributable to the section 987 QBU (including non-deductible expenses described in ¡ì1.987-4(d)(7)) for the taxable year. However, no adjustment is made under the preceding sentence for any item of income, gain, deduction, or loss described in ¡ì1.987-4(d)(9) (items that do not impact the adjusted balance sheet).

(iii) Step 3: Multiply the amount determined in step 2 by negative one. The amount of a remittance is equal to the amount determined in paragraph (c)(2)(ii) of this section multiplied by negative one.

(3) Day when a remittance is determined. An owner¡¯s remittance from a section 987 QBU for a taxable year is determined on the last day of the taxable year (or, if earlier, on the day of the taxable year when the section 987 QBU is terminated under ¡ì1.987-8).

(4) Termination. A termination of a section 987 QBU as determined under ¡ì1.987-8 is treated as a remittance of all the gross assets of the section 987 QBU to the owner on the date of such termination. See ¡ì1.987-8(e). Accordingly, for purposes of paragraph (b) of this section, the remittance proportion in the case of a termination is one.

(d) Aggregate of all amounts transferred from the section 987 QBU to the owner for the taxable year. For purposes of paragraph (c)(1)(i) of this section, the aggregate of all amounts transferred from the section 987 QBU to the owner for the taxable year is the aggregate amount of functional currency and the aggregate adjusted basis of the other assets transferred (after taking into account ¡ì1.988-1(a)(10)), determined in the section 987 QBU¡¯s functional currency. Solely for this purpose, the amount of liabilities transferred from the owner to the section 987 QBU (determined in the section 987 QBU¡¯s functional currency under ¡ì1.987-2(d) after taking into account ¡ì1.988-1(a)(10)) is treated as a transfer of assets from the section 987 QBU to the owner with an adjusted basis equal to the amount of such liabilities.

(e) Aggregate of all amounts transferred from the owner to the section 987 QBU for the taxable year. For purposes of paragraph (c)(1)(ii) of this section, the aggregate of all amounts transferred from the owner to the section 987 QBU for the taxable year is the aggregate amount of functional currency and the aggregate adjusted basis of the assets transferred (determined in the section 987 QBU¡¯s functional currency under ¡ì1.987-2(d) after taking into account ¡ì1.988-1(a)(10)). Solely for this purpose, the amount of liabilities transferred from the section 987 QBU to the owner (determined in the section 987 QBU¡¯s functional currency after taking into account ¡ì1.988-1(a)(10)) is treated as a transfer of assets from the owner to the section 987 QBU with an adjusted basis equal to the amount of such liabilities.

(f) Determination of owner¡¯s adjusted basis in transferred assets and amount of transferred liabilities¡ª(1) In general. The owner¡¯s adjusted basis in an asset or the amount of a liability received in a transfer from a section 987 QBU (whether or not such transfer is made in connection with a remittance) is determined in the owner¡¯s functional currency under the rules prescribed in paragraphs (f)(2) and (3) of this section.

(2) Marked items. The basis of a marked asset or amount of a marked liability is the amount determined by translating the section 987 QBU¡¯s functional currency basis of the asset or amount of the liability, after taking into account ¡ì1.988-1(a)(10), into the owner¡¯s functional currency at the spot rate applicable to the date of transfer.

(3) Historic items. The basis of a historic asset or amount of a historic liability is the amount determined by translating the section 987 QBU¡¯s functional currency basis of the asset or amount of the liability into the owner¡¯s functional currency at the historic rate for the asset or liability.

(g) Example¡ªCalculation of section 987 gain or loss recognized. The following example illustrates the calculation of section 987 gain or loss under this section. For purposes of this example, except as otherwise indicated, assume that no section 987 elections are in effect. Depreciation is ignored for purposes of this example.

(1) Facts¡ª(¾±) In general. U.S. Corp, a domestic corporation with the dollar as its functional currency, operates in the United Kingdom through Business A, a section 987 QBU with the pound as its functional currency. The net unrecognized section 987 gain for Business A as determined under ¡ì1.987-4 as of the last day of year 2 is $80.

(ii) Year 1 balance sheet. At the end of year 1, the following assets are attributable to Business A: cash of ?3,350; a computer with an adjusted basis of ?500; and a machine with an adjusted basis of ?500. Thus, the aggregate basis of Business A¡¯s assets is ?4,350. Business A has no liabilities.

(iii) Transfers and income in year 2. During year 2, Business A earned income of ?1,500. In addition, the following transfers took place between U.S. Corp and Business A in year 2. On January 5, year 2, U.S. Corp transferred to Business A ?300 (acquired by U.S. Corp immediately before the transfer). On March 5, year 2, Business A transferred a machine (with an adjusted basis of ?500) to U.S. Corp. On November 1, year 2, Business A transferred ?2,300 to U.S. Corp. On December 7, year 2, U.S. Corp transferred a truck to Business A. The adjusted basis of the truck, when properly translated into pounds under ¡ì1.987-2(d), is ?2,000.

(iv) Year 2 balance sheet. At the end of year 2, the following assets are attributable to Business A: cash of ?2,850, a computer with a pound adjusted basis of ?500, and a truck with a pound adjusted basis of ?2,000. Thus, the aggregate basis of Business A¡¯s assets is ?5,350. Business A has no liabilities.

(2) Analysis. U.S. Corp¡¯s section 987 gain with respect to Business A is determined as follows:

(i) Computation of amount of remittance. Under paragraphs (c)(1) and (2) of this section, U.S. Corp must determine the amount of the remittance for year 2 in the QBU¡¯s functional currency (pounds) on the last day of year 2. The amount of the remittance for year 2 is ?500, determined as follows:

 

(ii) Alternative computation of remittance amount. Under paragraph (c)(2) of this section, U.S. Corp can compute the amount of the remittance for year 2 using the following steps.

(A) Step 1: Change in QBU net value. The change in Business A¡¯s QBU net value is equal to ?1,000 (?5,350 - ?4,350).

(B) Step 2: Adjustment for income or loss. The amount determined in step 1 (?1,000) is reduced by Business A¡¯s income for year 2 of ?1,500, to negative ?500.

(C) Step 3: Multiply by negative one. The amount determined in step 2 (negative ?500) is multiplied by negative one. The remittance for year 2 is equal to ?500.

(iii) Computation of section 987 QBU gross assets plus remittance. Under paragraph (b)(1)(ii) of this section, Business A must determine the aggregate basis of its gross assets and must increase this amount by the amount of the remittance.

 

(iv) Computation of remittance proportion. Under paragraph (b) of this section, Business A must compute the remittance proportion by dividing the ?500 remittance amount by the ?5,850 sum of the aggregate basis of Business A¡¯s gross assets and the amount of the remittance. The resulting remittance proportion is 0.085.

(v) Computation of section 987 gain or loss. The amount of U.S. Corp¡¯s section 987 gain or loss that is recognized with respect to Business A is determined under paragraph (a) of this section by multiplying the 0.085 remittance proportion by the $80 of net unrecognized section 987 gain. U.S. Corp¡¯s resulting recognized section 987 gain for year 2 is $6.80.

(3) Annual recognition election. If an annual recognition election under paragraph (b)(2) of this section were in effect for year 2, U.S. Corp¡¯s remittance proportion would be one. Accordingly, U.S. Corp would recognize all $80 of the net unrecognized section 987 gain with respect to Business A.

(a) Ordinary income or loss. Section 987 gain or loss is ordinary income or loss for Federal income tax purposes.

(b) Character and source of section 987 gain or loss. With respect to each section 987 QBU, the character and source of section 987 gain or loss is determined under this paragraph (b) for all purposes of the Internal Revenue Code, including sections 904(d), 907, and 954.

(1) Timing of character and source determination. The character and source of section 987 gain or loss is determined based on the initial assignment pursuant to paragraph (b)(2)(i) of this section and may be reassigned in the year in which the section 987 gain or loss is recognized pursuant to paragraph (b)(2)(ii) of this section. The initial assignment is made in the earliest of the taxable years described in paragraphs (b)(1)(i) through (iv) of this section.

(i) The taxable year in which net unrecognized section 987 gain or loss is recognized.

(ii) The taxable year in which net unrecognized section 987 loss or pretransition loss becomes suspended section 987 loss.

(iii) The taxable year in which net unrecognized section 987 gain or loss becomes deferred section 987 gain or loss.

(iv) In the case of pretransition gain or loss that is recognized ratably over the transition period pursuant to the election under ¡ì1.987-10(e)(5)(ii), the taxable year that includes the transition date.

(2) Method for determining the character and source of section 987 gain or loss¡ª(¾±) Initial assignment¡ª(´¡) In general. In the taxable year of the initial assignment, determined under paragraph (b)(1) of this section, the owner assigns gross section 987 gain or loss to the statutory and residual groupings in the same proportions as the proportions in which the tax book value of the assets of the section 987 QBU are assigned to the groupings under the asset method in ¡ì¡ì1.861-9(g) and 1.861-9T(g), as modified by this paragraph (b)(2)(i). For purposes of applying the asset method, the owner takes into account only the assets that are attributable to the section 987 QBU under ¡ì1.987-2(b). See ¡ì1.987-11(e) and (f) (grouping of section 987 gain and loss and applying the loss-to-the-extent-of-gain rule on basis of the initial assignment of section 987 gain and loss under this paragraph (b)(2)(i)).

(B) Special rules for applying the asset method to assign section 987 gain or loss. For purposes of assigning gross section 987 gain or loss to the statutory and residual groupings under paragraph (b)(2)(i)(A) of this section, the proportions in which the tax book value of the assets of the section 987 QBU are assigned to the groupings described in paragraph (b)(2)(i)(A) of this section are determined without regard to section 987 gain or loss. Further, the section 987 gain or loss is assigned after any reattribution of gross income required under ¡ì1.904-4(f)(2)(vi) or ¡ì1.951A-2(c)(7)(ii)(B)(2) (or the principles thereof, as applicable), but before the allocation and apportionment of expenses or the application of provisions that are based on a net income computation, such as the high-tax exception to passive category income in ¡ì1.904-4(c), the high-tax exception to foreign base company income in ¡ì1.954-1(d), and the high-tax exclusion from tested income in ¡ì1.951A-2(c)(7).

(C) Election to treat section 987 gain or loss that is assigned to subpart F income groups relating to foreign personal holding company income as attributable to section 988 transactions¡ª(1) In general. If an election is made under this paragraph (b)(2)(i)(C)(1), section 987 gain or loss assigned under paragraphs (b)(2)(i)(A) and (B) of this section to any grouping of passive foreign personal holding company income, as described in ¡ì1.960-1(d)(2)(ii)(B)(2)(i), is treated as foreign currency gain of the owner attributable to section 988 transactions not directly related to the business needs of the controlled foreign corporation, or as loss allocated and apportioned to such foreign currency gain. See ¡ì1.987-1(g) for rules that apply to section 987 elections.

(2) Coordination with ¡ì1.954-2(g). The rules of ¡ì1.954-2(g)(2), (3) and (4) apply without regard to any section 987 gain treated as gain from section 988 transactions, or loss allocated and apportioned to such gain, by reason of an election under paragraph (b)(2)(i)(C)(1) of this section.

(D) Section 987 gain or loss assigned to tentative tested income rather than tested income¡ª(1) In general. In the case of a controlled foreign corporation, section 987 gain or loss is initially assigned to tentative tested income within a section 904 category (a tentative tested income group) under paragraphs (b)(2)(i)(A) and (B) of this section as though the election described in ¡ì1.951A-2(c)(7)(viii) is in effect for the taxable year. As a result, section 987 gain or loss that would have initially been characterized as tested income if no election under ¡ì1.951A-2(c)(7)(viii) was in effect is initially characterized as tentative tested income.

(2) For purposes of the GILTI high-tax exclusion, section 987 gain or loss is not attributable to any tested unit. In the case of a controlled foreign corporation, the initial assignment of section 987 gain or loss is made as though the section 987 gain or loss was not attributable to any tested unit for purposes of applying ¡ì1.951A-2(c)(7) (GILTI high-tax exclusion). See paragraph (b)(2)(iii) of this section (applying the GILTI high-tax exclusion by treating all section 987 gain or loss in the same tentative tested income group as composing a single tentative tested income item).

(ii) Reassignment of section 987 gain or loss. In the taxable year in which section 987 gain or loss is recognized (determined by taking into account ¡ì¡ì1.987-5, 1.987-11(e), 1.987-12(c), and 1.987-13(b) through (d), if applicable), the section 987 gain or loss is sourced and characterized based on the initial assignment in paragraph (b)(2)(i) of this section, but with appropriate changes to account for the application of provisions that apply to the section 987 gain or loss based on a net income computation such as the high-tax exception to passive category income in ¡ì1.904-4(c), the high-tax exception to foreign base company income in ¡ì1.954-1(d), and the high-tax exclusion to tested income in ¡ì1.951A-2(c)(7). Thus, for example, if an election under ¡ì1.951A-2(c)(7)(viii) is in effect for the taxable year, section 987 gain or loss initially assigned to a tentative tested income group will be reassigned to a tested income group (as defined in ¡ì1.960-1(d)(2)(ii)(C)) or to the residual income group (as defined in ¡ì1.960-1(d)(2)(ii)(D)), as applicable, depending on whether the item of income (as described in paragraph (b)(2)(iii) of this section) is subject to a high rate of tax (as determined under ¡ì1.951A-2(c)(7)(vi)). If no election is made under ¡ì1.951A-2(c)(7)(viii) for a taxable year, all of the section 987 gain or loss that is recognized in the taxable year that was initially assigned to tentative tested income under paragraph (b)(2)(i) of this section, is reassigned to the appropriate tested income group (as defined in ¡ì1.960¨C1(d)(2)(ii)(C)).

(iii) Special rule for the application of the GILTI high-tax exclusion to section 987 gain or loss. Section 987 gain in a tentative tested income group that is recognized by a controlled foreign corporation in a taxable year comprises a single tentative gross tested income item (as if it were allocable to its own tested unit) within the meaning of ¡ì1.951A-2(c)(7)(ii), and section 987 loss in a tentative tested income group that is recognized by a controlled foreign corporation in the taxable year is allocated and apportioned to the corresponding tentative gross tested income item for purposes of calculating the tentative tested income item within the meaning of ¡ì1.951A-2(c)(7)(iii). Thus, for purposes of applying the high-tax exclusion in ¡ì1.951A-2(c)(7), all of the section 987 gain and loss in a tentative tested income group that is recognized by the controlled foreign corporation in a taxable year is a single tentative tested income item.

(3) Allocation and apportionment of foreign income tax to section 987 items under section 861. For purposes of applying the definition of a corresponding U.S. item in ¡ì1.861-20(b), an item of foreign gross income and an item of section 987 gain or loss are treated as arising from the same transaction or other realization event only if the requirements in both paragraphs (b)(3)(i) and (ii) of this section are satisfied.

(i) The foreign gross income is an item of foreign currency gain or loss. The owner of the section 987 QBU, original deferral QBU owner, or original suspended loss QBU owner includes the foreign gross income under the laws of the foreign country in which it is a tax resident because under that foreign law it is required to recognize foreign currency gain or loss with respect to its interest in the section 987 QBU or with respect to a successor deferral QBU or successor suspended loss QBU.

(ii) The same event or events give rise to both the foreign gross income and the section 987 gain or loss. The remittance under ¡ì1.987-5(c) that gave rise to the item of section 987 gain or loss comprises one or more of the events that gave rise to the item of foreign gross income described in paragraph (b)(3)(i) of this section.

(c) Examples. The following examples illustrate the application of this section. For purposes of the examples, except as otherwise indicated, assume that no section 987 elections are in effect.

(1) Example 1: Initial assignment and reassignment of section 987 gain or loss¡ª(¾±) Facts. CFC is a controlled foreign corporation with the Swiss franc (Sf) as its functional currency. CFC is the owner of Business A, a section 987 QBU that has the euro as its functional currency. For year 1, CFC does not have an election described in ¡ì1.951A-2(c)(7)(viii) in effect but is subject to an election under paragraph (b)(2)(i)(C) of this section. CFC recognizes section 987 gain of Sf10,000 under ¡ì1.987-5. Business A has average total assets of Sf1,000,000 in year 1, which generate income (other than section 987 gain) as follows: Sf750,000 of assets that produce gross income in the statutory grouping for foreign source general category tested income under sections 904(d)(1)(A) and 951A; and Sf250,000 of assets that produce foreign source passive gross income in one of the groupings described in ¡ì¡ì1.960-1(d)(2)(ii)(B)(2)(i) and 1.954-1(c)(1)(iii)(B) (subpart F income groups relating to passive foreign personal holding company income).

(ii) Analysis. Under paragraphs (b)(2)(i)(A), (B), and (D) of this section, Sf7,500 (Sf750,000/Sf1,000,000 x Sf10,000) of the section 987 gain is initially assigned to the statutory grouping of foreign source general category tentative tested income. Because an election under ¡ì1.951A-2(c)(7)(viii) is not in effect for the taxable year in which the section 987 gain is recognized, the section 987 gain is reassigned under paragraph (b)(2)(ii) of this section to foreign source general category tested income. The remaining Sf2,500 (Sf250,000/Sf1,000,000 x Sf10,000) is characterized under paragraphs (b)(2)(i)(A) and (B) of this section by reference to assets that give rise to foreign source passive gross income in one of the groupings described in ¡ì1.960-1(d)(2)(ii)(B)(2)(i) (subpart F income groups relating to passive foreign personal holding company income) and is therefore generally treated under the election in paragraph (b)(2)(i)(C) of this section as foreign source foreign currency gain of CFC attributable to section 988 transactions not directly related to the business needs of the controlled foreign corporation. All of the section 987 gain is treated as ordinary income under paragraph (a) of this section.

(2) Example 2: Effect of GILTI high-tax exclusion¡ª(¾±) Facts. The facts are the same as in paragraph (c)(1) of this section (Example 1) except that CFC does have an election described in ¡ì1.951A-2(c)(7)(viii) in effect. Without regard to the section 987 gain or loss, CFC has two tentative gross tested income items: Sf100,000 of gross tentative tested income attributable to a CFC tested unit (the CFC item) and Sf5,000,000 of gross tentative tested income attributable to a Business A tested unit (the Business A item). CFC accrues Sf1,010,000 of current year taxes and has no other current year deductions. CFC is not required by its country of tax residence to include in foreign gross income foreign currency gain or loss with respect to its interest in a foreign QBU. For purposes of ¡ì 1.951A-2(c)(7)(iii)(A), Sf1,000,000 of current year tax is allocated and apportioned to the Business A item and Sf10,000 is allocated and apportioned to the CFC item. At all relevant times Sf1 = $1.

(ii) Analysis. As in paragraph (c)(1)(ii) of this section (Example 1), Sf7,500 of section 987 gain is initially assigned to the statutory grouping of foreign source general category tentative tested income. Under paragraph (b)(2)(iii) of this section, the section 987 gain comprises a single tentative gross tested income item of the CFC (the section 987 item). Therefore, the CFC has three tentative gross tested income items: the section 987 item, the CFC item, and the Business A item. No tax is allocated and apportioned to the section 987 item. See paragraph (b)(3) of this section. Applying ¡ì1.951A-2(c)(7)(vi), the effective tax rate of the section 987 item is 0% ($0/$7,500), the effective tax rate of the CFC item is 10% ($10,000/$100,000), and the effective tax rate of the Business A item is 20% ($1,000,000/$5,000,000). An election under ¡ì1.951A-2(c)(7)(viii) is in effect; therefore, the section 987 gain is reassigned based on the application of ¡ì1.951A-2(c)(7). Because the section 987 item was not subject to an effective tax rate of greater than 90 percent of the maximum rate of tax specified in section 11, it is reassigned under paragraph (b)(2) of this section to foreign source general category tested income. The remaining Sf2,500 of section 987 gain is foreign source foreign currency gain of CFC attributable to section 988 transactions not directly related to the business needs of the controlled foreign corporation for the reasons stated in paragraph (c)(1)(ii) of this section (Example 1).

(3) Example 3: Section 987 gain or loss treated as attributable to section 988 transactions¡ª(¾±) Facts. The facts are the same as in paragraph (c)(1) of this section (Example 1) except that CFC recognizes section 987 loss of Sf40,000, Sf5,000 of which is characterized under paragraphs (b)(2)(i)(A) and (B) of this section by reference to assets that give rise to foreign source passive gross income in a separate subpart F income group for non-related party interest income of Business A and Sf5,000 of which is characterized by reference to assets that give rise to foreign source passive gross income in a separate subpart F income group for gains from certain property transactions of Business A not derived from the active conduct of a trade or business. CFC otherwise has Sf12,000 of net foreign currency gain determined under ¡ì1.954-2(g) that is taken into account in determining the excess of foreign currency gain over foreign currency losses characterized as foreign personal holding company income under section 954(c)(1)(D).

(ii) Analysis. Under paragraph (b)(2)(i)(C) of this section, the Sf10,000 total section 987 loss characterized by reference to assets that give rise to foreign source passive gross income in one of the groupings described in ¡ì¡ì1.960-1(d)(2)(ii)(B)(2)(i) and 1.954-1(c)(1)(iii)(B) (subpart F income groups relating to passive foreign personal holding company income) is treated as foreign source foreign currency loss of CFC attributable to section 988 transactions. Accordingly, CFC will aggregate the Sf10,000 section 987 loss with the Sf12,000 net foreign currency gain and will have Sf2,000 of net foreign currency gain characterized as passive foreign personal holding company income under section 954(c)(1)(D).

(4) Example 4: Section 987 gain or loss assigned to passive foreign personal holding company income¡ª(¾±) Facts. The facts are the same as in paragraph (c)(3) of this section (Example 3) except that CFC is not subject to an election under paragraph (b)(2)(i)(C) of this section.

(ii) Analysis. As the CFC is not subject to an election under paragraph (b)(2)(i)(C) of this section, Sf5,000 of section 987 loss is initially assigned to the statutory grouping for foreign source passive gross income in a separate subpart F income group for non-related party interest income of Business A, and Sf5,000 is initially assigned to the statutory grouping for foreign source passive gross income in a separate subpart F income group for gains from certain property transactions of Business A not derived from the active conduct of a trade or business. The Sf12,000 net foreign currency gain is foreign source passive gross income in a separate subpart F income group for foreign currency gain of CFC attributable to section 988 transactions of CFC. As a result, if the net income in a subpart F income group to which either section 987 loss is assigned is less than zero, that loss will not reduce any other category of subpart F income, including CFC¡¯s foreign currency gain from section 988 transactions, except by reason of the earnings and profit limitation in section 952(c)(1). See ¡ì1.954-1(³¦)(1)(¾±¾±).

(a) Overview. This section provides rules relating to the application of the section 987 regulations to partnerships and S corporations. Paragraph (b) of this section provides the general rule that the section 987 regulations do not apply to partnerships. Paragraph (c) of this section identifies certain provisions of the section 987 regulations that are applicable to partnerships, subject to certain modifications. Paragraph (d) of this section provides special rules relating to suspended section 987 loss. Paragraph (e) of this section provides rules for adjusting a partner¡¯s basis in its partnership interest. Paragraph (f) of this section provides that S corporations are treated in the same manner as partnerships for purposes of the section 987 regulations. Paragraph (g) of this section provides examples that illustrate the rules of this section.

(b) Section 987 regulations generally do not apply to partnerships. Except as otherwise provided in this section, the section 987 regulations do not apply to a partnership, and the section 987 regulations do not apply to an eligible QBU if a partnership is the owner for Federal income tax purposes of the eligible QBU¡¯s assets and liabilities. However, a taxpayer must apply sections 987 and 989(a) to partnerships and eligible QBUs of partnerships in a reasonable manner using a method that is applied consistently from year to year with respect to a particular partnership or eligible QBU. In addition, all members of the same controlled group must apply the same method consistently with respect to a particular partnership or eligible QBU.

(c) Provisions of the section 987 regulations that apply to partnerships¡ª(1) In general¡ª(¾±) Eligible QBU. The rules described in paragraph (c)(2) of this section apply to an eligible QBU if a partnership is the owner for Federal income tax purposes of the eligible QBU¡¯s assets and liabilities and either¡ª

(A) The partnership (or a partner) treats the eligible QBU as a qualified business unit of the partnership that is subject to section 987 (for example, under an entity approach); or

(B) A partner in the partnership treats all or a portion of the eligible QBU as a qualified business unit of the partner that is subject to section 987 (for example, under an aggregate approach).

(ii) Partnership. The rules described in paragraph (c)(2) of this section apply to a partnership if a partner in the partnership treats the partnership itself (or an interest in the partnership) as a qualified business unit that is subject to section 987 (for example, under an entity approach).

(2) Applicable provisions¡ª(¾±) In general. Sections 1.987-6 (character and source of section 987 gain or loss), 1.987-9(d) (information on a dedicated section 987 form), ¡ì¡ì1.987-11 through 1.987-13 (suspended section 987 loss, deferral of section 987 gain or loss, and suspended section 987 loss upon terminations, respectively), and ¡ì1.987-15 (applicability dates) apply to a QBU described in paragraph (c)(1) of this section, subject to the modifications described in this paragraph (c) and in paragraph (d) of this section.

(ii) Annual recognition election. An annual recognition election under ¡ì1.987-5(b)(2) applies to a QBU described in paragraph (c)(1) of this section, subject to the modifications described in this paragraph (c). In each taxable year of the owner of a QBU described in paragraph (c)(1) of this section in which an annual recognition election is in effect, the owner recognizes any unrecognized gain or loss with respect to the QBU under section 987(3) (other than suspended section 987 loss) as though the QBU terminated on the last day of the taxable year. Appropriate adjustments must be made to prevent the gain or loss from being taken into account again after it is recognized under this paragraph (c)(2)(ii) (for example, in the case of a taxpayer applying the 1991 proposed regulations, by adjusting the equity and basis pools to reflect the gain or loss recognized). The rules of ¡ì1.987-1(g) apply with respect to an annual recognition election that is made by or for an owner of a QBU described in paragraph (c)(1) of this section.

(iii) Section 988 mark-to-market election. A section 988 mark-to-market election under ¡ì1.987-3(b)(4)(ii) applies to a QBU described in paragraph (c)(1) of this section. The rules of ¡ì1.987-1(g) apply with respect to a section 988 mark-to-market election that is made by or for an owner of a QBU described in paragraph (c)(1) of this section.

(3) Modifications to applicable provisions¡ª(¾±) In general. An owner of a QBU described in paragraph (c)(1) of this section must adapt the rules described in paragraph (c)(2) of this section as necessary to recognize section 987 gain or loss in a manner that is consistent with the principles of those rules. For purposes of applying this section and the rules described in paragraph (c)(2) of this section to a QBU described in paragraph (c)(1) of this section, the definitions provided in the section 987 regulations apply with appropriate modifications. For example, in the case of a QBU described in paragraph (c)(1) of this section, the term section 987 gain or loss means gain or loss recognized under section 987(3), the term owner means the person that recognizes gain or loss under section 987(3), and the term section 987 QBU means any qualified business unit subject to section 987 (including a QBU described in paragraph (c)(1) of this section). In addition, references to other rules of the section 987 regulations must be adapted as necessary to apply section 987 in a manner that is consistent with the principles of this section and the rules described in paragraphs (c)(2) of this section. For example, references to the recognition of section 987 gain or loss under ¡ì1.987-5 encompass any recognition of gain or loss under section 987(3).

(ii) Controlled group. For purposes of applying ¡ì¡ì1.987-12 and 1.987-13, if a partner in a partnership is treated as the owner of an eligible QBU described in paragraph (c)(1)(i) of this section (for example, under an aggregate approach) before the QBU terminates, each member of the partnership¡¯s controlled group is treated as a member of the partner¡¯s controlled group at any time that the partner (or any member of the partner¡¯s controlled group, determined without regard to this paragraph (c)(3)(ii)) continues to be a direct or indirect partner in the partnership. This paragraph (c)(3)(ii) does not apply for purposes of the de minimis rule in ¡ì1.987-11(c)(2).

(4) Terminating QBUs. In the case of a terminating QBU described in paragraph (c)(1) of this section, the rules of this section and the rules described in paragraph (c)(2) of this section apply immediately before the termination, but ¡ì1.987-10 does not apply because ¡ì1.987-10 is not applicable to a QBU described in paragraph (c)(1) of this section.

(d) Suspended section 987 loss¡ª(1) In general¡ª(¾±) Rules of ¡ì1.987-11(c) and (d)(2) do not apply. The rules of ¡ì1.987-11(c) and (d)(2) do not apply to a QBU described in paragraph (c)(1) of this section.

(ii) Suspension of section 987 loss. Except as provided in paragraph (d)(2) of this section, any loss that would otherwise be recognized under section 987(3) (after applying ¡ì1.987-12) with respect to a QBU described in paragraph (d)(1)(ii)(A) or (B) of this section is not recognized and becomes suspended section 987 loss.

(A) Eligible QBU. This paragraph (d)(1)(ii) applies to an eligible QBU described in paragraph (c)(1)(i) of this section.

(B) Partnership. This paragraph (d)(1)(ii) applies to a partnership (or a partnership interest) described in paragraph (c)(1)(ii) of this section if at least 95 percent of the interests in partnership capital and profits are owned, directly or indirectly, by persons related to each other within the meaning of section 267(b) or section 707(b). For this purpose, ownership of an interest in partnership capital or profits is determined in accordance with the rules for constructive ownership provided in section 267(c), other than section 267(c)(3).

(2) Exceptions¡ª(¾±) Method under which historic items do not give rise to section 987 gain or loss. Paragraph (d)(1)(ii) of this section does not apply to an eligible QBU described in paragraph (d)(1)(ii)(A) of this section if section 987 is consistently applied to the QBU using a method under which historic items of the QBU do not give rise to section 987 gain or loss (for example, a method that follows the principles of ¡ì¡ì1.987-3 through 1.987-5).

(ii) Annual recognition election. Paragraph (d)(1)(ii) of this section does not apply in a taxable year in which an annual recognition election is in effect.

(iii) De minimis rule. Paragraph (d)(1)(ii) of this section does not apply in a taxable year described in ¡ì1.987-11(c)(2).

(3) Recognition of suspended section 987 loss¡ª(¾±) In general. Except as provided in paragraph (d)(3)(ii) of this section, suspended section 987 loss with respect to a QBU described in paragraph (d)(1)(ii)(A) or (B) of this section is recognized under the rules of ¡ì¡ì1.987-11(e) and 1.987-13.

(ii) Partnership that is not engaged in a trade or business. In the case of a partnership described in paragraph (d)(1)(ii)(B) of this section that is not engaged in a trade or business, suspended section 987 loss cannot be recognized under ¡ì1.987-13(b) through (d) (and thus can only be recognized under ¡ì1.987-11(e)).

(iii) Application of the loss-to-the-extent-of-gain rule. If a partner in a partnership is the owner of a section 987 QBU described in paragraph (c)(1) of this section and also owns one or more section 987 QBUs that are not described in paragraph (c)(1) of this section, the loss-to-the-extent-of-gain rule of ¡ì1.987-11(e) is applied by taking into account all of the owner¡¯s section 987 gain and suspended section 987 loss in each recognition grouping with respect to all of its section 987 QBUs (whether or not they are described in paragraph (c)(1) of this section).

(e) Adjustments to the basis of a partner¡¯s interest in the partnership. When, and to the extent that, a partner recognizes section 987 gain or loss, defers section 987 gain or loss, or suspends section 987 loss at the partner level with respect to a partnership described in paragraph (c)(1)(ii) of this section or an eligible QBU of the partnership described in paragraph (c)(1)(i) of this section, the principles of sections 704(d) and 705 apply as though the item of income or loss was part of the partner¡¯s distributive share of partnership items. Thus, proper adjustments must be made to the partner¡¯s adjusted basis in the partnership under the principles of section 705, taking into account the principles of section 704(d).

(f) S corporations treated as partnerships. For purposes of the section 987 regulations, S corporations are treated in the same manner as partnerships and shareholders of S corporations are treated in the same manner as partners of partnerships.

(g) Examples. The following examples illustrate the principles of this section. For purposes of these examples, DC1 and DC2 are domestic corporations, and P is a foreign partnership. P is also the owner for Federal income tax purposes of the assets and liabilities of Business A, an eligible QBU that has the pound as its functional currency. DC1 and DC2 each own 50% of the capital and profits interests in P. If P is treated as a qualified business unit under section 989(a), P would have the euro as its functional currency due to activities unrelated to Business A.

(1) Example 1: Aggregate approach to section 987¡ª(¾±) Facts. DC1 and DC2 each apply section 987 using an aggregate approach, under which each partner¡¯s indirect interest in Business A is treated as a section 987 QBU of the partner. DC1 and DC2 each use the earnings and capital method described in the 1991 proposed regulations to apply section 987 with respect to Business A. Neither DC1 nor DC2 has made an annual recognition election. Under the earnings and capital method, but for the application of paragraph (d)(1)(ii) of this section, DC1 and DC2 each would recognize section 987 loss of $10 million in year 1 with respect to Business A.

(ii) Analysis¡ª(´¡) Application of loss suspension rule to Business A. Business A is an eligible QBU described in paragraph (c)(1)(i) of this section because a partnership (P) is the owner of Business A¡¯s assets and liabilities for federal income tax purposes and P¡¯s partners treat Business A as a section 987 QBU. Therefore, under paragraph (d)(1)(ii) of this section, the section 987 loss of DC1 and DC2 that would otherwise be recognized in year 1 becomes suspended section 987 loss, which DC1 and DC2 may recognize in year 1 or in future taxable years under ¡ì¡ì1.987-11(e) and 1.987-13(b) through (d).

(B) Annual recognition election. If DC1 and DC2 were subject to an annual recognition election in year 1, they would recognize section 987 gain or loss with respect to Business A as though Business A terminated at the end of year 1, and the loss suspension rule of paragraph (d)(1)(ii) of this section would not apply.

(C) FEEP method. If DC1 and DC2 applied section 987 to Business A under the principles of ¡ì¡ì1.987-3 through 1.987-5, such that historic items of Business A did not give rise to section 987 gain or loss, the loss suspension rule of paragraph (d)(1)(ii) of this section would not apply.

(2) Example 2: Entity approach to section 987¡ª(¾±) Facts. P applies section 987 to Business A using an entity approach, under which Business A is treated as a section 987 QBU of P. P is treated as a qualified business unit under section 989(a) and uses the euro as its functional currency. P uses the earnings and capital method described in the 1991 proposed regulations to apply section 987 with respect to Business A. Under the earnings and capital method, but for the application of paragraph (d)(1)(ii) of this section, P would recognize section 987 loss of $10 million in year 1 with respect to Business A. In addition, DC1 and DC2 apply section 987 to P using an entity approach, treating each partner¡¯s interest in P as a section 987 QBU. DC1 and DC2 each use the earnings and capital method described in the 1991 proposed regulations to apply section 987 with respect to P. Under the earnings and capital method, but for the application of paragraph (d)(1)(ii) of this section, DC1 and DC2 each would recognize section 987 loss of $10 million in year 1 with respect to P. Neither DC1 nor DC2 has made an annual recognition election.

(ii) Analysis¡ª(´¡) Business A treated as a QBU subject to section 987. Business A is an eligible QBU described in paragraph (c)(1)(i) of this section because a partnership (P) is the owner of Business A¡¯s assets and liabilities for Federal income tax purposes, and P treats Business A as a QBU subject to section 987. Therefore, the loss suspension rule in paragraph (d)(1)(ii) of this section applies to suspend P¡¯s recognition of section 987 loss with respect to Business A.

(B) Treatment of P as a section 987 QBU. P is a partnership described in paragraph (c)(1)(ii) of this section because DC1 and DC2 each treat their interest in P as a section 987 QBU. Under paragraph (d)(1)(ii)(B) of this section, if DC1 and DC2 are related within the meaning of section 267(b) or section 707(b), the loss suspension rule in paragraph (d)(1)(ii) of this section applies to suspend DC1¡¯s and DC2¡¯s recognition of section 987 loss with respect to their interest in P. However, if DC1 and DC2 are unrelated, the loss suspension rule in paragraph (d)(1)(ii) of this section does not apply.

(a) Scope. This section provides rules regarding the termination of a section 987 QBU. Paragraph (b) of this section provides general rules for determining when a termination occurs. Paragraph (c) of this section provides exceptions to the general termination rules for certain transactions described in section 381(a). Paragraph (d) of this section is reserved. Paragraph (e) of this section describes certain effects of terminations. Paragraph (f) of this section contains examples that illustrate the principles of this section.

(b) In general. Except as provided in paragraph (c) of this section, a section 987 QBU terminates if the conditions described in any one of paragraphs (b)(1) through (6) of this section are satisfied.

(1) Trade or business ceases. A section 987 QBU ceases its trade or business. When a section 987 QBU ceases its trade or business is determined based on all the facts and circumstances, provided that an owner may continue to treat a section 987 QBU as a section 987 QBU for a reasonable period during the winding up of such trade or business, which period may in no event exceed two years from the date on which such QBU ceases its activities carried on for profit. See paragraph (f)(1) of this section (Example 1).

(2) Substantially all assets transferred. The section 987 QBU transfers substantially all (within the meaning of section 368(a)(1)(C)) of its assets to its owner. For purposes of this paragraph (b)(2), the amount of assets transferred from the section 987 QBU to its owner as a result of a transaction is reduced by the amount of assets transferred from the owner to the section 987 QBU pursuant to the same transaction. See paragraphs (f)(2), (6), and (7) of this section (Examples 2, 6, and 7).

(3) Owner no longer a CFC. A foreign corporation that is a controlled foreign corporation that is the owner of a section 987 QBU ceases to be a controlled foreign corporation as a result of a transaction or series of transactions after which persons that were related to the corporation within the meaning of section 267(b) immediately before the transaction or series of transactions collectively own sufficient interests in the corporation such that the corporation would continue to be considered a controlled foreign corporation if such persons were United States shareholders within the meaning of section 951(b). See paragraph (f)(3) of this section (Example 3).

(4) Owner ceases to exist. The owner of the section 987 QBU ceases to exist (including in connection with a transaction described in section 381(a)). See paragraph (f)(4) of this section (Example 4).

(5) Section 987 QBU ceases to be an eligible QBU with a functional currency different from its owner. The section 987 QBU ceases to be an eligible QBU that has a functional currency different from its owner. See ¡ì1.985-5(d)(2) and (e)(4)(iii) (providing that a termination resulting from a change in functional currency occurs on the last day of the last taxable year ending before the year of change).

(6) Change in form of ownership. An individual or corporation that was the direct owner of a section 987 QBU ceases to be the direct owner of the section 987 QBU (for example, because the assets of the section 987 QBU are transferred to a partnership).

(c) Transactions described in section 381(a)¡ª(1) Liquidations. Notwithstanding paragraph (b) of this section, a termination does not occur when the owner (distributor) of a section 987 QBU ceases to exist in a liquidation described in section 332 pursuant to which it transfers the section 987 QBU to another corporation (distributee), except in the following cases:

(i) The distributor is a domestic corporation and the distributee is a foreign corporation.

(ii) The distributor is a foreign corporation and the distributee is a domestic corporation.

(iii) The distributor and the distributee are both foreign corporations and the functional currency of the distributee is the same as the functional currency of the distributor¡¯s section 987 QBU.

(2) Reorganizations. Notwithstanding paragraph (b) of this section, a termination does not occur when the owner (transferor) of the section 987 QBU ceases to exist in a reorganization described in section 381(a)(2) pursuant to which it transfers the section 987 QBU to another corporation (acquiring corporation), except in the following cases:

(i) The transferor is a domestic corporation and the acquiring corporation is a foreign corporation.

(ii) The transferor is a foreign corporation and the acquiring corporation is a domestic corporation.

(iii) The transferor is a controlled foreign corporation immediately before the transfer, the acquiring corporation is a foreign corporation that is not a controlled foreign corporation immediately after the transfer, and the acquiring corporation was related to the transferor within the meaning of section 267(b) immediately before the transfer.

(iv) The transferor and the acquiring corporation are foreign corporations and the functional currency of the acquiring corporation is the same as the functional currency of the transferor¡¯s section 987 QBU.

(d) [Reserved]

(e) Effect of terminations. A termination of a section 987 QBU as determined in this section is treated as a remittance of all the gross assets of the section 987 QBU to its owner immediately before the section 987 QBU terminates. Thus, except as otherwise provided in the section 987 regulations, a termination generally results in the recognition of any net unrecognized section 987 gain or loss of the section 987 QBU (unless it is treated as deferred section 987 gain or loss or suspended section 987 loss). See ¡ì1.987-5(c)(3) (generally recognizing section 987 gain or loss on a termination) and ¡ì¡ì1.987-11 through 1.987-13 (suspending section 987 gain or loss and deferring section 987 loss in certain instances).

(f) Examples. The following examples illustrate the principles of this section. Except as otherwise provided, U.S. Corp is a domestic corporation that has the U.S. dollar as its functional currency, and Business A is a section 987 QBU.

(1) Example 1: Cessation of operations¡ª(¾±) Facts. U.S. Corp is the owner of Business A, a sales office of U.S. Corp in Country X. Business A ceases sales activities on December 31, year 1. During year 2, Business A sells all of the assets used in its sales activities and winds up its business, settling outstanding accounts.

(ii) Analysis. Business A¡¯s trade or business ceases on December 31, year 1. The cessation of Business A¡¯s trade or business causes a termination of the Business A section 987 QBU under paragraph (b)(1) of this section on December 31, year 1, unless U.S. Corp chooses to continue to treat Business A as a section 987 QBU until completion of the wind-up activities in year 2. If U.S. Corp chooses to continue to treat Business A as a section 987 QBU during the wind-up of Business A, the Business A section 987 QBU would terminate under paragraph (b)(1) of this section upon completion of the wind-up in year 2.

(2) Example 2: Transfer of a section 987 QBU to a member of a consolidated group¡ª(i) Facts. U.S. Corp, the owner of Business A, transfers all the assets and liabilities of Business A to DS, a domestic corporation all of the stock of which is owned by U.S. Corp, in a transaction qualifying under section 351. U.S. Corp and DS are members of the same consolidated group.

(ii) Analysis. Pursuant to ¡ì1.987-2(c)(2)(i) and (ii), as a result of the deemed exchange of the assets and liabilities of Business A for DS stock in a section 351 transaction, Business A is treated as transferring its assets and liabilities to U.S. Corp immediately before the transfer by U.S. Corp of the assets and liabilities to DS. Because a section 351 transaction is not a transaction described in section 381(a)(2), the transfer of all of the assets of Business A to U.S. Corp causes a termination of the Business A section 987 QBU under paragraph (b)(2) of this section.

(3) Example 3: Cessation of controlled foreign corporation status¡ª(¾±) Facts. Foreign parent (FP) is a foreign corporation that owns all the stock of U.S. Corp, a domestic corporation. U.S. Corp owns all of the stock of FC, a controlled foreign corporation as defined in section 957. FC is the owner of Business A. U.S. Corp liquidates into FP. FC no longer constitutes a controlled foreign corporation after the liquidation.

(ii) Analysis. Because FC ceases to qualify as a controlled foreign corporation as a result of a transaction after which persons that were related to FC within the meaning of section 267(b) immediately before the transaction collectively own sufficient interests in FC such that FC would continue to be considered a controlled foreign corporation if such persons were United States shareholders within the meaning of section 951(b), the Business A section 987 QBU terminates pursuant to paragraph (b)(3) of this section.

(4) Example 4: Section 332 liquidation¡ª(i) Facts. U.S. Corp owns all of the stock of FC, a foreign corporation. FC is the owner of Business A. Pursuant to a liquidation described in section 332, FC distributes all of its assets and liabilities to U.S. Corp.

(ii) Analysis. FC¡¯s liquidation causes a termination of the Business A section 987 QBU as provided in paragraph (b)(4) of this section because FC ceases to exist as a result of the liquidation. The exception for certain section 332 liquidations provided under paragraph (c)(1) of this section does not apply because U.S. Corp is a domestic corporation and FC is a foreign corporation. See paragraph (c)(1)(ii) of this section.

(5) [Reserved]

(6) Example 6: Deemed transfers to a CFC upon a check-the-box election¡ª(¾±) Facts. In year 1, U.S. Corp forms an entity in a foreign country, Entity A. Entity A owns Business A, which has the pound as its functional currency. Entity A forms Entity B in another foreign country. Entity B owns Business B, a section 987 QBU that has the euro as its functional currency. At the time of formation, Entity A and Entity B elect to be DEs. In year 6, Entity A files an election on Form 8832 to be classified as a corporation under ¡ì301.7701-3(g)(1)(iv) of this chapter and becomes a CFC (FC) owned directly by U.S. Corp. FC has the pound as its functional currency.

(ii) Analysis¡ª(´¡) Under ¡ì1.987-1(b)(5), U.S. Corp is the owner of Business A and Business B. In year 6, when Entity A elects to be classified as a corporation, U.S. Corp is deemed to contribute the assets and liabilities of Business A and Business B to FC under section 351 in exchange for FC stock. Pursuant to ¡ì1.987-2(c)(2)(i) and (ii), as a result of the deemed exchange of the assets and liabilities of Business A and Business B for FC stock in a section 351 transaction, Business A and Business B are each treated as transferring their assets and liabilities to U.S. Corp immediately before U.S. Corp¡¯s transfer of such assets and liabilities to FC. The transfer of assets from Business A and Business B to U.S. Corp causes terminations of those section 987 QBUs under paragraph (b)(2) of this section. The assets and liabilities of Business A and Business B are now owned by FC, but because FC and Business A have the same functional currency, only Business B qualifies as a section 987 QBU to which section 987 applies.

(B) Terminations also would have occurred in year 6 if U.S. Corp had contributed Entity A and Entity B to an existing foreign corporation owned by U.S. Corp or to a newly created foreign corporation owned by U.S. Corp pursuant to a section 351 exchange because the transfer of all of the assets of Business A and Business B would cause terminations of those section 987 QBUs under paragraph (b)(2) of this section.

(7) Example 7: Sale of a section 987 QBU to a member of a consolidated group¡ª(¾±) Facts. U.S. Corp, the owner of Business A, sells all of the assets and liabilities of Business A to DS, a domestic corporation, in exchange for cash. U.S. Corp and DS are members of the same consolidated group. The cash received on the sale is recorded on the books of U.S. Corp.

(ii) Analysis. Pursuant to ¡ì1.987-2(c)(2)(i) and (ii), Business A is treated as transferring all of its assets and liabilities to U.S. Corp immediately before the sale by U.S. Corp to DS. As a result of this deemed transfer from Business A to U.S. Corp, the Business A section 987 QBU terminates under paragraph (b)(2) of this section.

(a) In general. An owner (or the authorized person on behalf of an owner) must keep a copy of the statement described in ¡ì1.987-1(g)(3)(i) for each section 987 election made by or on behalf of the owner (if not required to be made on a form published by the Commissioner) and reasonable records sufficient to establish section 987 taxable income or loss and section 987 gain or loss with respect to each section 987 QBU, successor deferral QBU, and successor suspended loss QBU, as applicable, for each taxable year.

(b) Supplemental information. A person¡¯s obligation to maintain records under section 6001 and paragraph (a) of this section is not satisfied unless the following information is maintained in those records with respect to each section 987 QBU, successor deferral QBU, and successor suspended loss QBU for each taxable year:

(1) The amount of the items of income, gain, deduction, or loss attributed to the section 987 QBU in the functional currency of the section 987 QBU and its owner.

(2) The adjusted balance sheet of the section 987 QBU in the functional currency of the section 987 QBU and its owner. If a current rate election is in effect and the owner computes QBU net value under ¡ì1.987-4(e)(2)(iii) without preparing an adjusted balance sheet, the information needed to apply ¡ì1.987-4(e)(2)(iii) must be maintained in lieu of an adjusted balance sheet.

(3) The exchange rates used to translate items of income, gain, deduction, or loss of the section 987 QBU into the owner¡¯s functional currency and, if a spot rate convention is used, the manner in which the convention is determined.

(4) The exchange rates used to translate the assets and liabilities of the section 987 QBU into the owner¡¯s functional currency and, if a spot rate convention is used, the manner in which the convention is determined.

(5) The amount of assets and liabilities transferred by the owner to the section 987 QBU determined in the functional currency of the owner and the section 987 QBU.

(6) The amount of assets and liabilities transferred by the section 987 QBU to the owner determined in the functional currency of the owner and the section 987 QBU.

(7) The amount of the unrecognized section 987 gain or loss for the taxable year determined under ¡ì1.987-4(d).

(8) The amount of the net accumulated unrecognized section 987 gain or loss for the taxable year determined under ¡ì1.987-4(c).

(9) The amount of the remittance and the remittance proportion for the taxable year.

(10) The computations required under ¡ì¡ì1.861-9(g) and 1.861-9T(g) for purposes of sourcing and characterizing section 987 gain or loss, deferred section 987 gain or loss, suspended section 987 loss, or pretransition gain or loss under ¡ì1.987-6.

(11) The cumulative suspended section 987 loss in each recognition grouping.

(12) The outstanding deferred section 987 gain or loss in each recognition grouping.

(13) The transition information required to be determined under ¡ì1.987-10(k).

(14) The identification required under ¡ì1.987-14(c) with respect to a section 987 hedging transaction.

(c) Retention of records. The records required by this section, or records that support the information required on a form published by the Commissioner regarding section 987, must be maintained and kept available for inspection by the Internal Revenue Service for so long as the contents thereof may become relevant in the administration of the Internal Revenue Code.

(d) Information on a dedicated section 987 form. Information necessary to determine section 987 gain or loss and section 987 taxable income or loss must be reported on a form prescribed for that purpose (or, until that form is published, on Form 8858 or its successor) in accordance with the applicable forms and instructions. A taxpayer satisfies its obligation described in paragraphs (a) and (b) of this section to the extent that the taxpayer provides the specific information required on Form 8858 (or its successor) or other form prescribed for this purpose (including the information required by the instructions accompanying those forms).

(a) Overview¡ª(1) In general. This section provides transition rules for the first taxable year in which the section 987 regulations apply. Paragraph (b) of this section describes the scope of this section¡¯s application. Paragraph (c) of this section provides rules for determining the transition date. Paragraph (d) of this section provides rules relating to the application of the section 987 regulations after the transition date. Paragraph (e) of this section provides rules relating to the determination and recognition of pretransition gain or loss. Paragraph (f) of this section provides special rules for section 987 QBUs to which the fresh start transition method was applied. Paragraph (g) of this section is reserved. Paragraph (h) of this section provides rules relating to the source and character of pretransition gain or loss. Paragraph (i) of this section is reserved. Paragraph (j) of this section provides adjustments to avoid double counting or omissions. Paragraph (k) of this section provides reporting requirements that apply in the taxable year beginning on the transition date. Paragraph (l) of this section provides examples illustrating the rules of this section.

(2) Terms defined under prior ¡ì1.987-12. For purposes of this section, the terms deferral QBU, deferral QBU owner, successor QBU, outbound loss QBU, outbound section 987 loss, and qualified successor have the meaning provided in prior ¡ì1.987-12.

(b) Scope¡ª(1) Owner of a section 987 QBU. Except as provided in paragraph (f) of this section, any person that is an owner of a section 987 QBU on the applicable transition date and any person that is the owner of a terminating QBU on the termination date must apply the rules of this section with respect to the section 987 QBU.

(2) Deferral QBU owner and owner of outbound loss QBU. Except as provided in paragraph (f) of this section, a deferral QBU owner or the owner of an outbound loss QBU must apply the rules of this section with respect to the deferral QBU or outbound loss QBU if the deferral event or outbound loss event occurred before the applicable transition date. This paragraph (b)(2) does not apply to the owner of a terminating QBU.

(c) Transition date¡ª(1) In general. Except as provided in paragraph (c)(2) of this section, the transition date for a section 987 QBU, deferral QBU, or outbound loss QBU is the first day of the first taxable year described in ¡ì1.987-15(a)(1), (b), or (c) to which this section applies.

(2) Terminating QBU¡ª(¾±) In general. With respect to a terminating QBU, the transition date is the day after the termination date. Until the transition date described in paragraph (c)(1) of this section, the owner of the terminating QBU must apply the section 987 regulations with respect to the terminating QBU, and any section 987 gain or loss attributable thereto, without regard to any section 987 elections (other than the election described in ¡ì1.987-6(b)(2)(i)(C)).

(ii) Ordering rule. In the case of a terminating QBU, the transition rules of this section are applied immediately before the termination, and the consequences of the termination are determined under the section 987 regulations after applying this section.

(d) Application of the section 987 regulations after the transition date¡ª(1) Owner functional currency net value on the last day of the preceding taxable year. Except as provided in paragraph (f) of this section, for purposes of applying ¡ì1.987-4 in the taxable year beginning on the transition date, the owner functional currency net value of a section 987 QBU on the last day of the preceding taxable year under ¡ì1.987-4(d)(1)(i)(B) is determined by translating the assets and liabilities that are attributable to the section 987 QBU on the day before the transition date into the owner¡¯s functional currency at the transition exchange rate described in paragraph (d)(3) of this section.

(2) Determination of historic rate. If a current rate election is not in effect for the taxable year beginning on the transition date, the historic rate for historic items that are attributable to a section 987 QBU on the day before the transition date (other than non-LIFO inventory subject to the simplified inventory method under ¡ì1.987-3(c)(2)(iv)(A)) is the transition exchange rate described in paragraph (d)(3) of this section.

(3) Transition exchange rate¡ª(¾±) In general. Except as provided in paragraph (d)(3)(ii) of this section, the transition exchange rate is the spot rate applicable to the day before the transition date.

(ii) Earnings only method. If an earnings only method described in paragraph (e)(4)(ii) of this section was applied with respect to a section 987 QBU before the transition date, and a current rate election is not in effect in the taxable year beginning on the transition date, the transition exchange rate for each historic item (other than inventory subject to the simplified inventory method under ¡ì1.987-3(c)(2)(iv)(A)) is the pretransition translation rate described in paragraph (e)(2)(i)(C) of this section. This paragraph (d)(3)(ii) does not apply with respect to a terminating QBU.

(e) Pretransition gain or loss¡ª(1) In general. Except as provided in paragraph (f) of this section, pretransition gain or loss is determined and recognized under this paragraph (e).

(2) Amount of pretransition gain or loss for an owner that applied an eligible pretransition method¡ª(¾±) Owner of a section 987 QBU. If an owner of a section 987 QBU described in paragraph (b)(1) of this section applied an eligible pretransition method with respect to the section 987 QBU, the amount of pretransition gain or loss with respect to the section 987 QBU is equal to the sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. See paragraphs (l)(1) through (3) of this section (Examples 1 through 3) for an illustration of this rule.

(A) Deemed termination amount. The deemed termination amount is the amount of section 987 gain or loss that would have been recognized by the owner under the eligible pretransition method if the section 987 QBU terminated and transferred all of its assets and liabilities to the owner on the day before the transition date and ¡ì¡ì1.987-12 and 1.987-13 and prior ¡ì1.987-12 did not apply.

(B) Owner functional currency net value adjustment. The owner functional currency net value adjustment may be either positive or negative and is equal to the amount described in paragraph (e)(2)(i)(B)(1) of this section reduced by the amount described in paragraph (e)(2)(i)(B)(2) of this section.

(1) The basis of the assets, reduced by the amount of liabilities, that are attributable to the section 987 QBU on the day before the transition date, translated into the owner¡¯s functional currency at the transition exchange rate.

(2) The basis of the assets, reduced by the amount of liabilities, that are attributable to the section 987 QBU on the day before the transition date, translated into the owner¡¯s functional currency at the pretransition translation rate.

(C) Pretransition translation rate. The pretransition translation rate is the rate that would be used under the eligible pretransition method to determine the basis of an asset or the amount of a liability in the hands of the owner of a section 987 QBU if the section 987 QBU transferred all of its assets and liabilities to the owner on the day before the transition date.

(ii) Deferral QBU owner. If a deferral QBU owner described in paragraph (b)(2) of this section applied an eligible pretransition method with respect to the deferral QBU, the amount of pretransition gain or loss with respect to the deferral QBU is equal to the deferred section 987 gain or loss (determined under prior ¡ì1.987-12) that was not recognized before the transition date with respect to the deferral QBU.

(iii) Owner of an outbound loss QBU. If the owner of an outbound loss QBU described in paragraph (b)(2) of this section applied an eligible pretransition method with respect to the outbound loss QBU, the pretransition loss with respect to the outbound loss QBU is equal to the outbound section 987 loss that was not added to the basis of stock or recognized under prior ¡ì1.987-12 before the transition date with respect to the outbound loss QBU.

(3) Amount of pretransition gain or loss for an owner that did not apply an eligible pretransition method¡ª(¾±) In general. If the owner of a section 987 QBU described in paragraph (b)(1) of this section did not apply an eligible pretransition method with respect to the section 987 QBU, the amount of pretransition gain or loss with respect to the section 987 QBU is determined under paragraph (e)(3)(ii) of this section. See paragraph (l)(4) of this section (Example 4) for an illustration of this rule.

(ii) Computation of pretransition gain or loss. With respect to a section 987 QBU described in paragraph (e)(3)(i) of this section, pretransition gain or loss is equal to the amount described in paragraph (e)(3)(ii)(A) of this section reduced by the amount described in paragraph (e)(3)(ii)(B) of this section.

(A) The sum of the owner¡¯s annual unrecognized section 987 gain or loss determined under paragraph (e)(3)(iii) of this section with respect to the section 987 QBU for all taxable years ending before the transition date and beginning after September 7, 2006, in which it was the owner of the section 987 QBU.

(B) The total net amount of section 987 gain or loss recognized by the owner with respect to the section 987 QBU in all taxable years ending before the transition date and beginning after September 7, 2006.

(iii) Annual unrecognized section 987 gain or loss. An owner of a section 987 QBU described in paragraph (e)(3)(i) of this section determines annual unrecognized section 987 gain or loss with respect to a section 987 QBU under the rules of ¡ì1.987-4(d), applied as though a current rate election was in effect for all relevant taxable years, and subject to the following modifications¡ª

(A) Only ¡ì1.987-4(d)(1) and (10) (steps 1 and 10) are applied; and

(B) Section 1.987-4(d)(10) is applied by replacing ¡°paragraphs (d)(1) through (9) of this section¡± with ¡°paragraph (d)(1) of this section.¡±

(iv) Deferral QBU owner. If a deferral QBU owner described in paragraph (b)(2) of this section did not apply an eligible pretransition method with respect to the deferral QBU, the pretransition gain or loss with respect to the deferral QBU is equal to the amount that would be determined under paragraph (e)(3)(ii) of this section with respect to the deferral QBU if the transition date was the day of the deferral event, reduced by the amount of deferred section 987 gain or loss (determined under prior ¡ì1.987-12) recognized before the actual transition date.

(v) Owner of an outbound loss QBU. If the owner of an outbound loss QBU described in paragraph (b)(2) of this section did not apply an eligible pretransition method with respect to the outbound loss QBU, the pretransition loss with respect to the outbound loss QBU is equal to the amount that would be determined under paragraph (e)(3)(ii) of this section with respect to the outbound loss QBU if the transition date was the day of the outbound loss event, reduced by any outbound section 987 loss recognized or added to the basis of stock under prior ¡ì1.987-12 before the actual transition date.

(4) Eligible pretransition method. An eligible pretransition method means a method of applying section 987 before the transition date that is described in paragraphs (e)(4)(i) through (iii) of this section. An owner is treated as applying an eligible pretransition method with respect to a section 987 QBU only if it applied an eligible pretransition method with respect to the QBU on a return filed before November 9, 2023.

(i) Earnings and capital method. An earnings and capital method is an eligible pretransition method if it is applied in a reasonable manner. For purposes of this paragraph (e)(4)(i), an earnings and capital method means a method of applying section 987 that requires section 987 gain or loss to be determined and recognized with respect to both the earnings of the section 987 QBU and capital contributed to the section 987 QBU (for example, the method prescribed in the 1991 proposed regulations under section 987). See paragraph (l)(1) of this section (Example 1) for an illustration of this rule.

(ii) Other reasonable methods. Any reasonable method of applying section 987 is an eligible pretransition method if it produces the same total amount of income over the life of the owner of a section 987 QBU as the method described in paragraph (e)(4)(i) of this section (taking into account the aggregate of section 987 gain or loss, section 987 taxable income or loss, and income or loss recognized by the owner of the section 987 QBU with respect to property transferred between the section 987 QBU and the owner or any QBU of the owner). See paragraph (l)(2) of this section (Example 2) for an illustration of this rule.

(iii) Other earnings only methods. An earnings only method that does not meet the requirements of paragraph (e)(4)(ii) of this section is an eligible pretransition method, provided that¡ª

(A) The earnings only method was first applied by the owner on a return filed before November 9, 2023;

(B) The earnings only method was applied consistently to all section 987 QBUs of the owner since the first taxable year in which the owner applied an eligible pretransition method; and

(C) The owner of the section 987 QBU otherwise applied section 987 in a reasonable manner. See paragraph (l)(3) of this section (Example 3) for an illustration of this rule.

(iv) Error in the application of a section 987 method. If an owner generally applied section 987 with respect to a section 987 QBU before the transition date under a method described in paragraph (e)(4)(i), (ii), or (iii) of this section but made errors in the application of the method or failed to apply the method to every taxable year since the QBU¡¯s inception, the owner is considered to have applied an eligible pretransition method with respect to the QBU. However, pretransition gain or loss must be determined under paragraph (e)(2) of this section as though the eligible pretransition method was applied without error since the section 987 QBU¡¯s inception. See paragraph (l)(5) of this section (Example 5) for an illustration of this rule.

(v) Certain consistent practices not treated as errors¡ª(´¡) In general. If an owner generally applied section 987 with respect to a section 987 QBU before the transition date under a method described in paragraph (e)(4)(i), (ii), or (iii) of this section and used a consistent practice described in paragraph (e)(4)(v)(B) of this section for purposes of applying that method, the owner is considered to have applied an eligible pretransition method with respect to the QBU. In addition, the consistent practice is not treated as an error under paragraph (e)(4)(iv) of this section. Therefore, the owner must take the consistent practice into account in determining pretransition gain or loss under paragraph (e)(2) of this section. See paragraph (l)(6) of this section (Example 6) for an illustration of this rule.

(B) Practices not treated as errors¡ª(1) Reasonable conventions. The use of a reasonable convention (for example, the use of a yearly average exchange rate rather than the applicable spot rate to translate frequently recurring transfers) is a practice described in this paragraph (e)(4)(v)(B).

(2) Disregarded transactions. If, in determining the amount of a remittance that requires the recognition of gain or loss under section 987(3), an owner of a QBU consistently disregarded certain transfers to or from the QBU (other than transfers from the QBU to the owner that would be treated as distributions if the QBU were treated as a separate corporation), the owner is considered to have applied a practice described in this paragraph (e)(4)(v)(B) with respect to the QBU, provided that the owner otherwise accounts for the disregarded transfers in a reasonable manner (for example, under the method described in the 1991 proposed regulations, by taking the disregarded transfers into account in computing equity and basis pools so as to properly reflect the owner¡¯s net equity in the QBU and its functional currency basis in the QBU).

(vi) Deferral of section 987 gain or loss until termination is not reasonable. For purposes of this paragraph (e)(4), a method under which the owner of a section 987 QBU defers the recognition of section 987 gain or loss until the section 987 QBU is terminated, sold, or liquidated is not a reasonable method.

(vii) Anti-abuse rule. If an owner changes its pretransition method of applying section 987 with a principal purpose of reducing its pretransition gain or increasing its pretransition loss, the Commissioner may redetermine pretransition gain or loss based on the owner¡¯s original method of applying section 987 or by treating the owner as not applying an eligible pretransition method.

(5) Recognition of pretransition gain or loss¡ª(¾±) In general. Except as provided in paragraph (e)(5)(ii) of this section, pretransition gain is recognized under paragraph (e)(5)(i)(A) of this section and pretransition loss is recognized under paragraph (e)(5)(i)(B) of this section.

(A) Pretransition gain. Pretransition gain with respect to a section 987 QBU is treated as net accumulated unrecognized section 987 gain (within the meaning of ¡ì1.987-4(c)). Pretransition gain with respect to a deferral QBU is treated as deferred section 987 gain and is attributed to one or more successor deferral QBUs under the principles of ¡ì1.987-12(b)(2) and (c)(2).

(B) Pretransition loss¡ª(1) In general. Except as provided in paragraph (e)(5)(i)(B)(2) of this section, pretransition loss with respect to a section 987 QBU, a deferral QBU, or an outbound loss QBU is treated as suspended section 987 loss with respect to the section 987 QBU, the deferral QBU, or the outbound loss QBU. In the case of a deferral QBU or outbound loss QBU, suspended section 987 loss is attributed to one or more successor suspended loss QBUs under the principles of ¡ì1.987-13(b)(1) and (c)(1).

(2) Current rate election. If a current rate election is in effect (and an annual recognition election is not in effect) in the taxable year beginning on the transition date, pretransition loss with respect to a section 987 QBU (other than a terminating QBU) is treated as net accumulated unrecognized section 987 loss (within the meaning of ¡ì1.987-4(c)), and pretransition loss with respect to a deferral QBU is treated as deferred section 987 loss and is attributed to one or more successor deferral QBUs under the principles of ¡ì1.987-12(b)(2) and (c)(2).

(ii) Election to recognize pretransition section 987 gain or loss ratably over the transition period¡ª(´¡) In general. A taxpayer may elect to recognize pretransition gain or loss ratably over the transition period. If an election is made to recognize pretransition gain or loss ratably over the transition period, then paragraph (e)(5)(i) of this section does not apply, and each owner to which the election applies recognizes one tenth of its pretransition gain or loss with respect to each section 987 QBU, original deferral QBU, and outbound loss QBU in each taxable year for ten taxable years beginning with the taxable year that begins on the transition date described in paragraph (c)(1) of this section. See ¡ì1.987-1(g) for rules relating to section 987 elections (including consistency rules).

(B) Special rules for certain transactions¡ª(1) Scope. This paragraph (e)(5)(ii)(B) applies if a corporation (acquiring corporation) acquires the assets of an owner that is subject to an election under paragraph (e)(5)(ii)(A) of this section in a transaction described in section 381(a), and either the owner is a foreign corporation and the acquiring corporation is a domestic corporation or the owner is a domestic corporation and the acquiring corporation is a foreign corporation. This paragraph (e)(5)(ii)(B) also applies to any transaction entered into with a principal purpose of avoiding the recognition of pretransition gain under paragraph (e)(5)(ii)(A) of this section.

(2) Recognition of pretransition gain or loss. In the case of a transaction described in paragraph (e)(5)(ii)(B)(1) of this section, pretransition gain or loss that has not been recognized under paragraph (e)(5)(ii)(A) of this section ceases to be subject to the election to be recognized ratably over the transition period. Any unrecognized pretransition gain is recognized immediately before the transaction, and any unrecognized pretransition loss becomes suspended section 987 loss immediately before the transaction. As a result, the suspended section 987 loss may be recognized to the extent of section 987 gain recognized in the same recognition grouping pursuant to ¡ì1.987-11(e). See also ¡ì1.987-13(g) (providing that any remaining suspended section 987 loss does not carry over to the acquiring corporation upon an inbound transaction to which section 381(a) applies).

(C) Terminating QBU. This paragraph (e)(5)(ii)(C) applies with respect to a terminating QBU if, in the taxable year beginning on the transition date described in paragraph (c)(1) of this section, the owner of the terminating QBU elects to recognize pretransition gain or loss ratably over the transition period. Any deferred section 987 gain or loss or suspended section 987 loss with respect to the terminating QBU that was not recognized before the transition date described in paragraph (c)(1) of this section is treated as pretransition gain or loss for purposes of this paragraph (e)(5)(ii) (and ceases to be treated as deferred section 987 gain or loss or suspended section 987 loss). The pretransition gain or loss is recognized ratably over ten taxable years beginning with the taxable year that begins on the transition date described in paragraph (c)(1) of this section.

(6) Predecessor of an owner¡ª(¾±) In general. For purposes of this paragraph (e), references to an owner of a section 987 QBU, a deferral QBU owner, and the owner of an outbound loss QBU include a predecessor described in paragraph (e)(6)(ii) of this section.

(ii) Predecessor. If a corporation (acquiring corporation) becomes the owner of a section 987 QBU in a transaction described in section 381(a) in which the section 987 QBU does not terminate, the corporation that was the owner of the section 987 QBU immediately before the transaction is a predecessor of the acquiring corporation. If a corporation (acquiring corporation) becomes a qualified successor of a deferral QBU owner or the owner of an outbound loss QBU (each, a transferor corporation), the transferor corporation is a predecessor of the acquiring corporation. A predecessor of a corporation includes the predecessor of a predecessor of the corporation.

(7) Small business election¡ª(¾±) Scope. This paragraph (e)(7) applies if the owner of a QBU meets the threshold described in paragraph (e)(7)(ii) of this section and the QBU meets the threshold described in paragraph (e)(7)(iii) of this section. This paragraph (e)(7) does not apply with respect to a terminating QBU.

(ii) Owner threshold. An owner of a QBU meets the requirements of this paragraph (e)(7)(ii) if the owner would qualify for the small business exemption provided in section 163(j)(3) for the taxable year beginning on the transition date described in paragraph (c)(1) of this section.

(iii) QBU threshold. A QBU meets the requirements of this paragraph (e)(7)(iii) if the assets attributable to the QBU have an adjusted basis (translated at the spot rate applicable to the last day of each taxable year) of $10 million or less at the end of each of the three taxable years of the owner ending before the transition date described in paragraph (c)(1) of this section (or, if the QBU was not in existence for three taxable years, each taxable year ending before the transition date in which the QBU existed). For this purpose, all QBUs owned by members of the same controlled group that have the same country of residence (as defined in section 988(a)(3)(B)) are treated as a single QBU. Solely for purposes of applying this paragraph (e)(7)(iii) in the case of a deferral QBU or outbound loss QBU described in paragraph (b)(2) of this section, the termination date is treated as the transition date.

(iv) Small business election. If the owner of a QBU meets the requirements of paragraph (e)(7)(ii) of this section, the owner may elect to treat all QBUs that meet the requirements of paragraph (e)(7)(iii) of this section as having no pretransition gain or loss.

(f) QBUs to which the fresh start transition method was applied¡ª(1) In general. Paragraphs (d) and (e) of this section do not apply with respect to any section 987 QBU, deferral QBU, or outbound loss QBU with respect to which the taxpayer applied the rules of prior ¡ì1.987-10 (or applied ¡ì1.987-10 of the 2006 proposed regulations in a reasonable manner) on a return filed before November 9, 2023 or pursuant to paragraph (f)(3) of this section.

(2) Application of the section 987 regulations after the transition date¡ª(¾±) Owner functional currency net value on the last day of the preceding taxable year. For purposes of applying ¡ì1.987-4 with respect to a section 987 QBU described in paragraph (f)(1) of this section for the taxable year beginning on the transition date, the owner functional currency net value of the section 987 QBU on the last day of the preceding taxable year under ¡ì1.987-4(d)(1)(i)(B) is the amount that was determined for the preceding taxable year under prior ¡ì1.987-4(d)(1)(A) or ¡ì1.987-4(d)(1)(A) of the 2006 proposed section 987 regulations, as applicable.

(ii) Determination of historic rate. For purposes of applying the section 987 regulations with respect to historic items (other than inventory subject to the simplified inventory method under ¡ì1.987-3(c)(2)(iv)(A)) that are attributable to the section 987 QBU on the day before the transition date, a taxpayer must use the same historic rates as were used under the taxpayer¡¯s application of the 2016 and 2019 section 987 regulations or the 2006 proposed section 987 regulations, as applicable, in place of the historic rates that otherwise would be determined under ¡ì1.987-1(c)(3).

(iii) Unrecognized section 987 gain or loss¡ª(´¡) Net accumulated unrecognized section 987 gain or loss of a section 987 QBU. In taxable years beginning on or after the transition date, for purposes of calculating the net accumulated unrecognized section 987 gain or loss of a section 987 QBU described in paragraph (f)(1) of this section under ¡ì1.987-4(c)¡ª

(1) Amounts determined under prior ¡ì1.987-4(d) or under ¡ì1.987-4(d) or ¡ì1.987-10 of the 2006 proposed section 987 regulations, as applicable, are included in amounts determined under ¡ì1.987-4(d) for all prior taxable years; and

(2) Amounts taken into account under prior ¡ì1.987-5(a) or under ¡ì1.987-5(a) of the 2006 proposed section 987 regulations, as applicable, are included in amounts recognized under ¡ì1.987-5(a) for all prior taxable years. For this purpose, amounts taken into account under prior ¡ì1.987-5(a) or under ¡ì1.987-5(a) of the 2006 proposed section 987 regulations, as applicable, are determined without regard to prior ¡ì1.987-12 or prior ¡ì1.987-12T.

(B) Deferred section 987 gain or loss attributable to a successor deferral QBU. In the taxable year beginning on the transition date, the outstanding deferred section 987 gain or loss (as determined under prior ¡ì1.987-12) of a deferral QBU described in paragraph (f)(1) of this section becomes deferred section 987 gain or loss (within the meaning of ¡ì1.987-12). The deferred section 987 gain or loss is attributed to one or more successor deferral QBUs under the principles of ¡ì1.987-12(b)(2) and (c)(2).

(C) Outbound section 987 loss attributable to a successor suspended loss QBU. In the taxable year beginning on the transition date, outbound section 987 loss of an outbound loss QBU described in paragraph (f)(1) of this section that has not been recognized or added to the basis of stock under prior ¡ì1.987-12 becomes suspended section 987 loss. The suspended section 987 loss is attributed to one or more successor suspended loss QBUs under the principles of ¡ì1.987-13(b)(1) and (c)(1).

(3) Taxpayers that are required to transition using the fresh start transition method. If a taxpayer is subject to a consent agreement under which it is required to apply the fresh start transition method with respect to a section 987 QBU, then the taxpayer must apply the transition rules of prior ¡ì1.987-10 to that section 987 QBU for the taxable year beginning on the transition date and immediately before the taxpayer applies this section. In applying this section, the taxpayer is treated as having applied prior ¡ì1.987-10 to the section 987 QBU.

(g) [Reserved]

(h) Determination of source and character¡ª(1) In general. Except as provided in paragraph (h)(2) of this section, the source and character of pretransition gain or loss is determined under the rules of ¡ì1.987-6. See ¡ì1.987-6(b)(1) (timing of source and character determination).

(2) Deferral QBU or outbound loss QBU. Notwithstanding paragraph (h)(1) of this section and ¡ì1.987-6, the source and character of pretransition gain or loss with respect to a deferral QBU or an outbound loss QBU described in paragraph (b)(2) of this section is the same as the source and character of the outstanding deferred section 987 gain or loss (determined under prior ¡ì1.987-12) of the deferral QBU or the outbound section 987 loss of the outbound loss QBU (determined under prior ¡ì1.987-12(e)).

(i) [Reserved]

(j) Adjustments to avoid double counting or omissions. If a difference between the treatment of any item under the section 987 regulations and the treatment of the item under the taxpayer¡¯s prior section 987 method would result in income, gain, deduction, or loss (including section 988 gain or loss) being taken into account more than once or not being taken into account, then pretransition gain or loss, as determined under paragraphs (e)(2) and (3) of this section, is adjusted to account for the difference. In case of a QBU described in paragraph (f)(1) of this section, appropriate adjustments must be made under the principles of paragraph (e)(5) of this section. In the case of a terminating QBU, the determination as to whether an adjustment is required under this paragraph (j) is made after taking into account section 988 gain or loss recognized in connection with the termination.

(k) Reporting¡ª(1) In general. Except as otherwise provided in this paragraph (k), a statement titled ¡°Section 987 Transition Information¡± must be attached to an owner¡¯s timely filed (including extensions) return for the taxable year beginning on the transition date providing the following information for each QBU described in paragraph (k)(2) of this section:

(i) A description of each QBU, the QBU¡¯s principal place of business, and a description of the prior method used by the taxpayer to determine its section 987 gain or loss, deferred section 987 gain or loss, or outbound section 987 loss with respect to the QBU, including an explanation as to whether such method was an eligible pretransition method.

(ii) The pretransition gain or loss with respect to each QBU and the computations used to determine pretransition gain or loss.

(iii) Whether the authorized person has elected to recognize pretransition gain or loss ratably over the transition period pursuant to paragraph (e)(5)(ii) of this section.

(iv) Whether the authorized person has made a small business election under paragraph (e)(7) of this section and the computations used to determine eligibility for the election.

(v) With respect to each QBU for which any adjustment is made under paragraph (j) of this section, a description of each adjustment and the basis for computing the adjustment.

(vi) A list of the QBUs described in paragraph (f)(1) of this section, or a statement that no QBUs are described in paragraph (f)(1) of this section.

(2) QBUs for which reporting is required¡ª(¾±) In general. Except as provided in paragraph (k)(2)(ii) of this section, the information described in paragraph (k)(1) of this section must be provided with respect to¡ª

(A) Each section 987 QBU described in paragraph (b)(1) of this section;

(B) Each deferral QBU described in paragraph (b)(2) of this section and each of its successor deferral QBUs; and

(C) Each outbound loss QBU described in paragraph (b)(2) of this section and each of its successor suspended loss QBUs.

(ii) QBUs to which the fresh start transition method was applied. A taxpayer is not required to provide the information described in paragraphs (k)(1)(i) through (iv) of this section with respect to a QBU described in paragraph (f)(1) of this section.

(3) Attachments not required where information is reported on a form. This paragraph (k) does not apply to the extent provided on a form or instructions published by the Commissioner.

(4) No change in method of accounting. The application of this section is not treated as a change in method of accounting for purposes of sections 446 and 481.

(l) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC is a domestic corporation with the U.S. dollar as its functional currency and Branch is a section 987 QBU with the euro as its functional currency. DC has a taxable year ending December 31, and the transition date is January 1, year 4. For purposes of the examples, except as otherwise indicated, assume that no section 987 elections are in effect.

(1) Example 1: Earnings and capital method¡ª(¾±) Facts¡ª(´¡) Formation of Branch and Branch¡¯s operations. DC formed Branch on November 30, year 1, with a contribution of €150. In year 1, Branch purchased a parcel of unimproved land for €100. In year 2, Branch earned €25. In year 3, Branch again earned €25. On June 30, year 3, Branch distributed €100 cash to DC, and DC immediately exchanged the €100 for $135.

(B) Exchange rates. The relevant exchange rates are shown below.

 

(C) Pretransition method. DC used the method prescribed in the 1991 proposed regulations under section 987 with respect to Branch before the transition date. Under this method, DC maintains an equity pool in euros (Branch¡¯s functional currency) and a basis pool in U.S. dollars (DC¡¯s functional currency). When Branch makes a remittance (whether out of earnings or capital), DC recognizes section 987 gain or loss equal to the difference between the amount of the remittance (translated into U.S. dollars at the spot rate on the date of the remittance) and the portion of the basis pool attributable to the remittance. DC¡¯s basis in assets distributed from Branch is equal to Branch¡¯s basis in the assets, translated into U.S. dollars at the spot rate on the date of the remittance. Branch¡¯s earnings are translated into U.S. dollars at the average exchange rate for the taxable year. DC otherwise applies section 987 in a reasonable manner.

(D) Application of the pretransition method before the transition date. For purposes of determining section 987 gain or loss recognized as a result of the June 30, year 3, remittance, DC was required to determine the amount in Branch¡¯s equity and basis pools. Branch¡¯s equity pool was equal to €200, and its basis pool was equal to $210, as shown in the table below. Because the remittance was equal to 50% of the equity pool (€100), 50% of the basis pool, or $105, was attributable to the remittance. The amount of the remittance was $135 (€100 translated at the spot rate on June 30, year 3, of €1 = $1.35). Therefore, in year 3, DC recognized section 987 gain of $30, equal to the difference between the amount of the remittance ($135) and the portion of the basis pool attributable to the remittance ($105). As a result of the remittance, the equity pool was reduced by the amount distributed (€100), and the basis pool was reduced by the portion of the basis pool attributable to the remittance ($105). Therefore, after the remittance, the equity pool was equal to €100, and the basis pool was equal to $105. In the hands of DC, the euros distributed had a basis of $135 (equal to the €100 distribution translated at the spot rate on June 30, year 3, of €1 = $1.35). DC did not recognize section 988 gain or loss when it exchanged the euros for $135.

 

(ii) Analysis¡ª(´¡) DC¡¯s method is an eligible pretransition method. Before the transition date, DC followed the method prescribed in the 1991 proposed regulations under section 987 with respect to Branch. This method is an eligible pretransition method under paragraph (e)(4)(i) of this section. Therefore, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section.

(B) Pretransition gain or loss. Under paragraph (e)(2) of this section, DC¡¯s pretransition gain or loss with respect to Branch is equal to the sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. As explained in paragraphs (l)(1)(ii)(B)(1) and (2) of this section (Example 1), DC¡¯s deemed termination amount is $35 and its owner functional currency net value adjustment is zero. Therefore, DC has $35 of pretransition gain with respect to Branch. Under paragraph (e)(5)(i)(A) of this section, the pretransition gain is treated as Branch¡¯s net accumulated unrecognized section 987 gain. However, if DC elects to recognize its pretransition gain ratably over the transition period under paragraph (e)(5)(ii) of this section, the pretransition gain is not treated as net accumulated unrecognized section 987 gain. Instead, DC recognizes $3.50 (one tenth of its pretransition gain) for each of the ten taxable years from year 4 through year 13.

(1) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this section, the deemed termination amount is the amount of section 987 gain or loss that would have been recognized by DC under the eligible pretransition method if Branch terminated and transferred all its assets and liabilities to DC (the land with a basis of €100) on December 31, year 3. Under DC¡¯s eligible pretransition method, DC would have recognized section 987 gain of $35, determined by subtracting the remaining basis pool of $105 from the amount of the remittance of $140 (€100 translated at the spot rate on December 31, year 3, of €1 = $1.40). Therefore, the deemed termination amount is $35.

(2) Owner functional currency net value adjustment. On December 31, year 3, Branch had no liabilities and only one asset: land with a basis of €100. Under paragraph (e)(2)(i)(B) of this section, the owner functional currency net value adjustment is equal to the basis of the land, translated into U.S. dollars at the transition exchange rate, reduced by the basis of the land, translated into U.S. dollars at the pretransition translation rate. Under paragraph (d)(3)(i) of this section, the transition exchange rate is the spot rate applicable to December 31, year 3. Under paragraph (e)(2)(i)(C) of this section, the pretransition translation rate is the rate that would be used under DC¡¯s eligible pretransition method to determine the basis of the land in the hands of DC if Branch transferred the land to DC on December 31, year 3. Under DC¡¯s eligible pretransition method, if Branch transferred the land to DC, DC¡¯s basis in the land would be equal to Branch¡¯s basis (€100) translated at the spot rate on the date of the remittance. Therefore, the pretransition translation rate on December 31, year 3, is equal to the spot rate on December 31, year 3. Consequently, the owner functional currency net value adjustment is zero.

(C) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under ¡ì1.987-4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the €100 basis of the land at the transition exchange rate, which is the spot rate on December 31, year 3 (€1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140.

(2) Example 2: Earnings only method described in paragraph (e)(4)(ii) of this section¡ª(¾±) Facts¡ª(´¡) In general. The facts and exchange rates are the same as in paragraph (l)(1) of this section (Example 1), except that DC uses an earnings only method with respect to Branch before the transition date, as described in paragraph (l)(2)(i)(B) of this section. In addition, a current rate election is in effect for Year 4.

(B) Pretransition method. Under the earnings only method, DC maintains an equity pool in euros (Branch¡¯s functional currency) and a basis pool in U.S. dollars (DC¡¯s functional currency) with respect to Branch¡¯s earnings. DC also maintains separate equity and basis pools with respect to Branch¡¯s capital. Distributions are treated as being made first out of earnings and then out of capital. When Branch makes a remittance out of earnings, DC recognizes section 987 gain or loss equal to the difference between the amount of the remittance (translated into U.S. dollars at the spot rate on the date of the remittance) and the portion of the earnings basis pool attributable to the remittance. No section 987 gain or loss is recognized on a distribution out of capital. DC¡¯s basis in assets distributed out of Branch¡¯s earnings is equal to Branch¡¯s basis in the assets translated at the spot rate on the date of the remittance. DC¡¯s basis in assets distributed out of Branch¡¯s capital is equal to the portion of the capital basis pool attributable to the distribution. Branch¡¯s earnings are translated into U.S. dollars at the average exchange rate for the taxable year. DC otherwise applies section 987 in a reasonable manner.

(C) Application of the pretransition method before the transition date. On June 30, year 3, Branch distributed €100 cash to DC. Of this amount, €50 represented a remittance out of earnings, and €50 represented a distribution out of capital.

(1) Remittance out of earnings. For purposes of determining section 987 gain or loss recognized on the remittance, Branch¡¯s earnings equity pool was equal to €50, and its earnings basis pool was equal to $60, as shown in the table below. Because Branch remitted 100% of the earnings equity pool (€50), the entire earnings basis pool, or $60, was attributable to the remittance. The value of the remittance was $67.50 (€50 translated at the spot rate on June 30, year 3, of €1 = $1.35). Therefore, in year 3, DC recognized section 987 gain of $7.50, equal to the difference between the value of the remittance ($67.50) and the portion of the basis pool attributable to the remittance ($60). As a result of the remittance, the earnings equity pool and the earnings basis pool were each reduced to zero. In the hands of DC, the €50 distributed out of earnings had a basis of $67.50 (€50 translated at the spot rate on June 30, year 3, of €1 = $1.35).

 

(2) Distribution out of capital. The basis of the €50 distributed out of capital was equal to the portion of the capital basis pool attributable to the distribution. For this purpose, the capital equity pool was equal to €150, and the capital basis pool was equal to $150, as shown in the table below. Because Branch distributed 33% of the capital equity pool, or €50, 33% of the capital basis pool, or $50, was attributable to the distribution. In the hands of DC, the €50 distributed out of capital had a basis of $50. As a result of the capital distribution, the capital equity pool was reduced to €100 and the capital basis pool was reduced to $100.

 

(3) Section 988 gain recognized. On June 30, year 3, DC exchanged €100 with an aggregate basis of $117.50 (equal to the sum of the $67.50 basis of the remittance out of earnings and the $50 basis of the distribution out of capital) for $135. Therefore, DC recognized $17.50 of gain under section 988.

(ii) Analysis¡ª(´¡) DC¡¯s method is an eligible pretransition method. Before the transition date, DC followed a reasonable method of applying section 987 that would result in the same total amount of income over the life of DC ($125) as an earnings and capital method, as explained in paragraphs (l)(2)(ii)(A)(1) and (2) of this section (Example 2). Therefore, this method is an eligible pretransition method under paragraph (e)(4)(ii) of this section. Consequently, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section.

(1) DC¡¯s total amount of income under its pretransition method. Under DC¡¯s pretransition method, DC recognized $7.50 of section 987 gain and $17.50 of section 988 gain in year 3. In addition, on December 31, year 3, DC had $40 of embedded gain in its capital equity and basis pools (equal to the difference between its capital equity pool of €100, translated at the spot rate on December 31, year 3, of €1 = $1.40, and its capital basis pool of $100) which will be taken into account in the future (when Branch distributes property out of capital and the property is sold). DC also recognized $60 of earnings with respect to Branch ($28.75 in year 2 and $31.25 in year 3). Thus, DC¡¯s total income (recognized and unrecognized) with respect to Branch is $125.

(2) DC¡¯s total amount of income under an earnings and capital method. If DC had instead applied an earnings and capital method, as described in paragraph (l)(1)(i)(C) of this section (Example 1), DC would have recognized section 987 gain of $30 in year 3 and would not have recognized section 988 gain in year 3, as explained in paragraph (l)(1)(i)(D) of this section. On December 31, year 3, DC would have unrecognized section 987 gain in its equity and basis pools of $35 (see paragraph (l)(1)(ii)(B)(1) of this section (Example 1)). DC would also have recognized $60 of earnings with respect to Branch ($28.75 in year 2 and $31.25 in year 3). Thus, DC¡¯s total income (recognized and unrecognized) with respect to Branch is $125.

(B) Pretransition gain or loss. Under paragraph (e)(2) of this section, DC¡¯s pretransition gain or loss with respect to Branch is equal to sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. As explained in paragraphs (l)(2)(ii)(B)(1) and (2) of this section (Example 2), the deemed termination amount is zero and the owner functional currency net value adjustment is $40. Therefore, DC has $40 of pretransition gain with respect to Branch. Under paragraph (e)(5)(i)(A) of this section, the pretransition gain is treated as Branch¡¯s net accumulated unrecognized section 987 gain. However, if DC elects to recognize its pretransition gain ratably over the transition period under paragraph (e)(5)(ii) of this section, the pretransition gain is not treated as net accumulated unrecognized section 987 gain. Instead, DC recognizes $4 (one tenth of its pretransition gain) for each of the ten taxable years from year 4 through year 13.

(1) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this section, the deemed termination amount is the amount of section 987 gain or loss that would have been recognized by DC under the eligible pretransition method if Branch terminated and transferred all of its assets and liabilities to DC on December 31, year 3. Under DC¡¯s eligible pretransition method, if Branch had transferred all of its assets and liabilities to DC, this would have been treated as a distribution out of capital. Under its eligible pretransition method, DC would not have recognized section 987 gain or loss on a distribution out of capital. Therefore, the deemed termination amount is zero.

(2) Owner functional currency net value adjustment. On December 31, year 3, Branch had no liabilities and only one asset: land with a basis of €100. Under paragraph (e)(2)(i)(B) of this section, the owner functional currency net value adjustment is equal to the basis of Branch¡¯s land, translated into U.S. dollars at the transition exchange rate, reduced by the basis of Branch¡¯s land, translated into U.S. dollars at the pretransition translation rate on December 31, year 3. Under paragraph (e)(2)(i)(C) of this section, the pretransition translation rate is the rate that would be used under the eligible pretransition method to determine the basis of the land in the hands of DC if Branch transferred the land to DC. Under DC¡¯s eligible pretransition method, DC¡¯s basis in assets distributed from Branch is equal to the portion of the capital basis pool attributable to the distribution. If Branch transferred the land with a basis of €100 to DC on December 31, year 3, its remaining capital basis pool of $100 would be attributable to the distribution, and the land would have a basis of $100 in the hands of DC. Because the land had a basis of €100 in the hands of Branch, and would have a basis of $100 in the hands of DC if it were distributed on December 31, year 3, the pretransition translation rate is €1 = $1. Under paragraph (d)(3)(i) of this section, because a current rate election is in effect for year 4, the transition exchange rate is the spot rate applicable to December 31, year 3. The €100 basis of Branch¡¯s land, translated at the spot rate on December 31, year 3 of €1 = $1.40 is equal to $140. The €100 basis of Branch¡¯s land, translated at the pretransition translation rate on December 31, year 3 of €1 = $1 is equal to $100. Therefore, the owner functional currency net value adjustment is equal to $40 ($140 - $100).

(C) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under ¡ì1.987-4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the €100 basis of the land at the transition exchange rate, which is the spot rate on December 31, year 3 (€1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140.

(iii) Alternative facts¡ª(A) No current rate election. Assume the facts are the same as described in paragraph (l)(2)(i) of this section (Example 2), except that a current rate election is not in effect for year 4.

(B) Analysis. As explained in paragraph (l)(2)(ii)(A) of this section (Example 2), DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section. Because a current rate election is not in effect, the transition exchange rate is determined under paragraph (d)(3)(ii) of this section.

(1) Transition exchange rate. DC applied an earnings only method described in paragraph (e)(4)(ii) of this section before the transition date. Under paragraph (d)(3)(ii) of this section, because a current rate election is not in effect for year 4, the transition exchange rate for Branch¡¯s land is equal to the pretransition translation rate. As explained in paragraph (l)(2)(ii)(B)(2) of this section (Example 2), the pretransition translation rate is €1 = $1.

(2) Pretransition gain or loss. Because the transition exchange rate for the land (Branch¡¯s sole asset) is equal to the pretransition translation rate, the owner functional currency net value adjustment is zero. As explained in paragraph (l)(2)(ii)(B)(1) of this section (Example 2), the deemed termination amount is also zero. Therefore, DC has no pretransition gain or loss with respect to Branch.

(3) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under ¡ì1.987-4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the €100 basis of the land at the transition exchange rate, which is the pretransition translation rate of €1 = $1. Therefore, the owner functional currency net value of Branch on the last day of year 3 is $100.

(3) Example 3: Earnings only method described in paragraph (e)(4)(iii) of this section¡ª(¾±) Facts¡ª(´¡) In general. The facts and exchange rates are the same as in paragraph (l)(1) of this section (Example 1), except that DC used an earnings only method with respect to Branch before the transition date, as described in paragraph (l)(3)(i)(B) of this section.

(B) Pretransition method. Under the earnings only method, DC maintains an equity pool in euros (Branch¡¯s functional currency) and a basis pool in U.S. dollars (DC¡¯s functional currency) with respect to Branch¡¯s earnings. However, DC does not maintain separate equity and basis pools with respect to Branch¡¯s capital. Distributions are treated as being made first out of earnings and then out of capital. When Branch makes a remittance out of earnings, DC recognizes section 987 gain or loss equal to the difference between the amount of the remittance (translated into U.S. dollars at the spot rate on the date of the remittance) and the portion of the earnings basis pool attributable to the remittance. No section 987 gain or loss is recognized on a distribution out of capital. Under DC¡¯s pretransition method, DC¡¯s basis in assets distributed by Branch (whether out of earnings or capital) is equal to Branch¡¯s basis in the assets translated at the spot rate on the date of the distribution. Branch¡¯s earnings are translated into U.S. dollars at the average exchange rate for the taxable year. DC first applied its earnings only method on a return filed before November 9, 2023. In addition, DC applied its earnings only method consistently to all of its section 987 QBUs and otherwise applied section 987 in a reasonable manner.

(C) Application of the pretransition method before the transition date. On June 30, year 3, Branch distributed €100 cash to DC. Of this amount, €50 represented a remittance out of earnings, and €50 represented a distribution out of capital.

(1) Remittance out of earnings. For purposes of determining section 987 gain or loss recognized on the remittance, Branch¡¯s earnings equity pool was equal to €50, and its earnings basis pool was equal to $60, as shown in the table below. Because Branch remitted 100% of the earnings equity pool (€50), the entire earnings basis pool, or $60, was attributable to the remittance. The value of the remittance was $67.50 (€50 translated at the spot rate on June 30, year 3, of €1 = $1.35). Therefore, in year 3, DC recognized section 987 gain of $7.50, equal to the difference between the value of the remittance ($67.50) and the portion of the basis pool attributable to the remittance ($60). As a result of the remittance, the earnings equity pool and the earnings basis pool were each reduced to zero.

 

(2) Basis of euros distributed. In the hands of DC, the €100 distributed had a basis of $135 (€100 translated at the spot rate on June 30, year 3, of €1 = $1.35). DC did not recognize gain or loss under section 988 when it exchanged the €100 for $135.

(ii) Analysis¡ª(´¡) DC¡¯s method is an eligible pretransition method. Unlike in paragraph (l)(2) of this section (Example 2), DC¡¯s earnings only method would not result in the same total amount of income over the life of DC as an earnings and capital method described in paragraph (e)(4)(i) of this section because DC does not maintain capital basis and equity pools and DC translates the basis of all property distributed from Branch at the spot rate on the distribution date. However, this method is an eligible pretransition method under paragraph (e)(4)(iii) of this section because DC first applied its earnings only method on a return filed before November 9, 2023, DC applied its earnings only method consistently to all of its section 987 QBUs, and DC otherwise applied section 987 in a reasonable manner. Consequently, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section.

(B) Pretransition gain or loss. Under paragraph (e)(2) of this section, DC¡¯s pretransition gain or loss with respect to Branch is equal to the sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. As explained in paragraphs (l)(3)(ii)(B)(1) and (2) of this section (Example 3), the deemed termination amount is zero and the owner functional currency net value adjustment is zero. Therefore, DC has no pretransition gain or loss with respect to Branch.

(1) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this section, the deemed termination amount is the amount of section 987 gain or loss that would have been recognized by DC under the eligible pretransition method if Branch terminated and transferred all of its assets and liabilities to DC on December 31, year 3. Under DC¡¯s eligible pretransition method, if Branch had transferred all of its assets and liabilities to DC, it would have been treated as a distribution out of capital. Under its eligible pretransition method, DC would not have recognized section 987 gain or loss on a distribution out of capital. Therefore, the deemed termination amount is zero.

(2) Owner functional currency net value adjustment. On December 31, year 3, Branch has no liabilities and only one asset: land with a basis of €100. Under paragraph (e)(2)(i)(B) of this section, the owner functional currency net value adjustment is equal to the basis of the land, translated into U.S. dollars at the transition exchange rate, reduced by the basis of the land, translated into U.S. dollars at the pretransition translation rate. Under paragraph (d)(3)(i) of this section, the transition exchange rate is the spot rate applicable to December 31, year 3. Under paragraph (e)(2)(i)(C) of this section, the pretransition translation rate is the rate that would be used under DC¡¯s eligible pretransition method to determine the basis of the land in the hands of DC if Branch transferred the land to DC on December 31, year 3. Under DC¡¯s eligible pretransition method, if Branch transferred the land to DC, DC¡¯s basis in the land would be equal to Branch¡¯s basis (€100) translated at the spot rate on the date of the distribution. Therefore, the pretransition translation rate on December 31, year 3, is equal to the spot rate on December 31, year 3. Consequently, the owner functional currency net value adjustment is zero.

(C) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under ¡ì1.987-4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the €100 basis of the land at the spot rate on December 31, year 3 (€1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140.

(4) Example 4: Owner did not apply section 987(3)¡ª(¾±) Facts. The facts and exchange rates are the same as in paragraph (l)(1) of this section (Example 1), except that DC did not apply section 987(3) with respect to Branch and did not recognize section 987 gain or loss with respect to Branch before the transition date.

(ii) Analysis¡ª(´¡) DC¡¯s method is not an eligible pretransition method. Because DC did not apply section 987(3) with respect to Branch before the transition date, DC did not apply an eligible pretransition method under paragraph (e)(4) of this section. Therefore, DC determines pretransition gain or loss under paragraph (e)(3) of this section.

(B) Pretransition gain or loss. Under paragraph (e)(3) of this section, DC¡¯s pretransition gain or loss with respect to Branch is equal to the annual unrecognized section 987 gain or loss with respect to Branch for all taxable years ending before the transition date in which DC was the owner of Branch (that is, years 1 through 3), reduced by section 987 gain or loss recognized by DC before the transition date. As explained in paragraphs (l)(4)(ii)(C) through (E) of this section (Example 4), DC¡¯s annual unrecognized section 987 gain for year 1 is $7.50, DC¡¯s annual unrecognized section 987 gain for year 2 is $16.25, and DC¡¯s annual unrecognized section 987 gain for year 3 is $23.75. DC did not recognize any section 987 gain or loss with respect to Branch before the transition date. Therefore, DC has $47.50 of pretransition gain with respect to Branch. Under paragraph (e)(5)(i)(A) of this section, the pretransition gain is treated as Branch¡¯s net accumulated unrecognized section 987 gain. However, if DC elects to recognize its pretransition gain ratably over the transition period under paragraph (e)(5)(ii) of this section, the pretransition gain is not treated as net accumulated unrecognized section 987 gain. Instead, DC recognizes $4.75 (one tenth of its pretransition gain) for each of the ten taxable years from year 4 through year 13.

(C) Annual unrecognized section 987 gain or loss for year 1. Under paragraph (e)(3)(iii) of this section, annual unrecognized section 987 gain or loss with respect to a section 987 QBU is determined under the rules of ¡ì1.987-4(d), applied as though a current rate election was in effect for all relevant taxable years (such that all items are treated as marked items), but modified so that only ¡ì¡ì1.987-4(d)(1) (change in owner functional currency net value) and 1.987-4(d)(10) (adjustment for residual increase or decrease to net assets) are applied. As explained in paragraphs (l)(4)(ii)(C)(1) and (2) of this section (Example 4), in year 1, the change in owner functional currency net value under ¡ì1.987-4(d)(1) is an increase of $165, and there is a negative adjustment of $157.50 under ¡ì1.987-4(d)(10). Therefore, DC¡¯s annual unrecognized section 987 gain for year 1 is $7.50.

(1) Change in owner functional currency net value for year 1. On December 31, year 1, Branch held land with a basis of €100 and €50 cash. Therefore, on the last day of year 1, Branch¡¯s owner functional currency net value is $165 (150 euros translated at the spot rate on December 31, year 1, of €1 = $1.10). Because Branch was formed in year 1, its owner functional currency net value on the last day of the preceding taxable year is zero. See ¡ì1.987-4(d)(1)(iii). Therefore, the change in owner functional currency net value is an increase of $165.

(2) Residual increase to net assets for year 1. Under ¡ì1.987-4(d)(10), unrecognized section 987 gain or loss for a taxable year is decreased by any residual increase to net assets (and increased by any residual decrease to net assets), translated into the owner¡¯s functional currency at the yearly average exchange rate for the taxable year. For this purpose, the residual increase (or decrease) to net assets is equal to the change in net value of the section 987 QBU, determined in the section 987 QBU¡¯s functional currency (that is, the QBU net value). See ¡ì1.987-4(d)(10)(ii)(B) and (e)(2)(ii). On December 31, year 1, Branch held land with a basis of €100 euros and €50 cash. Therefore, on the last day of year 1, Branch has a QBU net value of €150. Because Branch was formed in year 1, its QBU net value on the last day of the preceding taxable year is zero. See ¡ì1.987-4(d)(1)(iii). Therefore, the residual increase to net assets is €150. This results in a negative adjustment to annual unrecognized section 987 gain or loss of $157.50 for year 1 (equal to €150 translated at the yearly average exchange rate for year 1 of €1 = $1.05).

(D) Annual unrecognized section 987 gain or loss for year 2. As explained in paragraphs (l)(4)(ii)(D)(1) and (2) of this section (Example 4), in year 2, the change in owner functional currency net value under ¡ì1.987-4(d)(1) is an increase of $45, and there is a negative adjustment of $28.75 under ¡ì1.987-4(d)(10). Therefore, DC¡¯s annual unrecognized section 987 gain for year 2 is $16.25.

(1) Change in owner functional currency net value for year 2. On December 31, year 2, Branch held land with a basis of €100 and €75 cash. Therefore, on the last day of year 2, Branch¡¯s owner functional currency net value is $210 (175 euros translated at the spot rate on December 31, year 2, of €1 = $1.20). As explained in paragraph (l)(4)(ii)(C)(1) of this section (Example 4), Branch¡¯s owner functional currency net value on the last day of year 1 was $165. Therefore, the change in owner functional currency net value is an increase of $45.

(2) Residual increase to net assets for year 2. On December 31, year 2, Branch held land with a basis of €100 and €75 cash. Therefore, on the last day of year 2, Branch has a QBU net value of €175. As explained in paragraph (l)(4)(ii)(C)(2) of this section (Example 4), Branch had a QBU net value of €150 on December 31, year 1. Therefore, the residual increase to net assets is €25. This results in a negative adjustment to annual unrecognized section 987 gain or loss of $28.75 for year 2 (equal to a reduction of €25, translated at the yearly average exchange rate for year 2 of €1 = $1.15).

(E) Annual unrecognized section 987 gain or loss for year 3. As explained in paragraphs (l)(4)(ii)(E)(1) and (2) of this section (Example 4), in year 3, the change in owner functional currency net value under ¡ì1.987-4(d)(1) is a decrease of $70, and there is a positive adjustment of $93.75 under ¡ì1.987-4(d)(10). Therefore, DC¡¯s annual unrecognized section 987 gain for year 3 is $23.75.

(1) Change in owner functional currency net value for year 3. On December 31, year 3, Branch held land with a basis of €100. Therefore, on the last day of year 3, Branch¡¯s owner functional currency net value is $140 (100 euros translated at the spot rate on December 31, year 3, of €1 = $1.40). As explained in paragraph (l)(4)(ii)(D)(1) of this section (Example 4), Branch¡¯s owner functional currency net value on the last day of year 2 was $210. Therefore, the change in owner functional currency net value is a decrease of $70.

(2) Residual decrease to net assets for year 3. On December 31, year 3, Branch held land with a basis of €100. Therefore, on the last day of year 3, Branch has a QBU net value of €100. As explained in paragraph (l)(4)(ii)(D)(2) of this section (Example 4), Branch had a QBU net value of €175 on December 31, year 2. Therefore, the residual decrease to net assets is €75. This results in a positive adjustment to annual unrecognized section 987 gain or loss of $93.75 for year 3 (equal to €75, translated at the yearly average exchange rate for year 3 of €1 = $1.25).

(F) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under ¡ì1.987-4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the €100 basis of the land at the spot rate on December 31, year 3 (€1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140.

(5) Example 5: Error in application of method¡ª(¾±) Facts. The facts are the same as described in paragraph (l)(1)(i) of this section (Example 1), except that DC inadvertently miscalculated the amount of the June 30, year 3, remittance as being €90 rather than €100. This reduced the amount of section 987 gain recognized by DC in year 3.

(ii) Analysis. DC committed an error in its application of the earnings and capital method to Branch. Under paragraph (e)(4)(iv)(A) of this section, DC is nonetheless treated as having applied an eligible pretransition method. However, under paragraph (e)(4)(iv)(B) of this section, DC must determine its pretransition gain or loss as though the error had not been made. Therefore, DC computes its pretransition gain or loss as described in paragraph (l)(1)(ii)(B) of this section (Example 1). DC has $35 of pretransition gain with respect to Branch.

(6) Example 6: Consistent practice not treated as an error¡ª(¾±) Facts. Before the transition date, DC used the earnings and capital method described in the 1991 proposed regulations under section 987 with respect to Branch, as described in paragraph (l)(1)(i) of this section (Example 1). In years 1, 2, and 3, Branch made recurring purchases of inventory from Owner, which Branch sold to unrelated customers. In connection with the purchase transactions, Branch transferred cash to Owner, and Owner transferred inventory to Branch. Owner did not take these transfers into account in determining the amount of any remittance and, accordingly, did not recognize section 987 gain or loss with respect to these transfers. However, Owner consistently adjusted Branch¡¯s equity and basis pools in a reasonable manner to reflect all transfers between Owner and Branch; for this purpose, the amount of each transfer made in connection with the purchase transactions was translated using the average rate for the relevant taxable year. Owner also adjusted Branch¡¯s equity and basis pools to account for Branch¡¯s income from the sale of inventory.

(ii) Analysis¡ª(´¡) DC¡¯s method is an eligible pretransition method. Before the transition date, DC followed the earnings and capital method described in the 1991 proposed regulations under section 987 with respect to Branch. This method is an eligible pretransition method under paragraph (e)(4)(i) of this section. Therefore, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section.

(B) Effect of consistent practice. Before the transition date, Owner engaged in a consistent practice under which Owner did not account for inventory purchase transactions in determining the amount of a remittance requiring the recognition of gain or loss under section 987(3). However, Owner consistently accounted for the disregarded transfers in a reasonable manner for purposes of computing its equity and basis pools. Under paragraph (e)(4)(v) of this section, this consistent practice is not treated as an error in the application of a pretransition method and does not preclude Owner¡¯s method from being treated as an eligible pretransition method. Therefore, Owner must take this consistent practice into account in determining pretransition gain or loss under paragraph (e)(2) of this section. In particular, Owner must use the equity and basis pools computed under its consistent practice (rather than the equity and basis pools it would have computed if it had historically taken the disregarded transfers into account in determining the amount of remittances) to determine the deemed termination amount under paragraph (e)(2)(i)(A) of this section.

(a) In general. This section provides rules relating to suspended section 987 loss. Paragraph (b) of this section provides rules for computing the cumulative suspended section 987 loss with respect to a section 987 QBU or successor suspended loss QBU. Paragraph (c) of this section provides rules that suspend section 987 loss that would otherwise be recognized when a current rate election is in effect. Paragraph (d) of this section provides rules that treat net unrecognized section 987 loss and deferred section 987 loss as suspended section 987 loss when an annual recognition election is made or a current rate election is revoked. Paragraph (e) of this section describes the extent to which suspended section 987 loss is recognized under a loss-to-the-extent-of-gain rule. Paragraph (f) of this section provides rules for determining recognition groupings based on the source and character of section 987 gain or loss. Paragraph (g) of this section provides examples illustrating the rules of this section.

(b) Cumulative suspended section 987 loss in a recognition grouping¡ª(1) In general. The cumulative suspended section 987 loss in a recognition grouping with respect to a section 987 QBU or a successor suspended loss QBU for the current taxable year is equal to the cumulative suspended section 987 loss in the recognition grouping for the prior taxable year, decreased by the amount of suspended section 987 loss in the recognition grouping that was recognized with respect to the QBU under paragraph (e) of this section or under ¡ì1.987-13(b) through (d) in the prior taxable year, and increased by the amount that becomes suspended section 987 loss in the recognition grouping with respect to the QBU in the current taxable year (including under ¡ì1.987-10(e)(5)(i)(B)(1)). If the taxable year is the first taxable year of the section 987 QBU (or the first taxable year in which the section 987 regulations apply), the cumulative suspended section 987 loss for the prior taxable year is zero. An owner¡¯s (or original suspended loss QBU owner¡¯s) total cumulative suspended section 987 loss in a recognition grouping is equal to the sum of its cumulative suspended section 987 gain or loss with respect to each section 987 QBU and successor suspended loss QBU.

(2) Combined QBU. For purposes of paragraph (b)(1) of this section, in the taxable year of a combination, the cumulative suspended section 987 loss in a recognition grouping with respect to a combined QBU for the prior taxable year is equal to the sum of the cumulative suspended section 987 loss in the recognition grouping with respect to each combining QBU for the prior taxable year; the suspended section 987 loss in a recognition grouping with respect to a combined QBU that was recognized in the prior taxable year is equal to sum of the suspended section 987 loss in the recognition grouping with respect to each combining QBU that was recognized in the prior taxable year.

(3) Separated QBU. For purposes of paragraph (b)(1) of this section, in the taxable year of a separation, the cumulative suspended section 987 loss in a recognition grouping with respect to a separated QBU for the prior taxable year is equal to the cumulative suspended section 987 loss in the recognition grouping with respect to the separating QBU for the prior taxable year multiplied by the separation fraction; the suspended section 987 loss in a recognition grouping with respect to a separated QBU that was recognized in the prior taxable year is equal to the suspended section 987 loss in the recognition grouping with respect to the separating QBU that was recognized in the prior taxable year multiplied by the separation fraction.

(c) Suspension of section 987 loss for taxable years in which a current rate election is in effect and an annual recognition election is not in effect¡ª(1) In general. Except as provided in paragraph (c)(2) of this section, in a taxable year in which a current rate election is in effect and an annual recognition election is not in effect, to the extent that an owner¡¯s net unrecognized section 987 loss with respect to a section 987 QBU would otherwise be recognized under ¡ì1.987-5 (including pursuant to ¡ì1.987-12(b)), or its deferred section 987 loss would otherwise be recognized under ¡ì1.987-12(c), the net unrecognized section 987 loss or deferred section 987 loss is not recognized by the owner and instead becomes suspended section 987 loss. See paragraph (g)(1) of this section (Example 1) for an illustration of this rule.

(2) De minimis rule. Paragraph (c)(1) of this section does not apply in a taxable year of an owner in which the total amount of net unrecognized section 987 loss or deferred section 987 loss of the owner and all members of the owner¡¯s controlled group that would (but for the application of this paragraph (c)(2) and ¡ì1.987-7(d)(2)(iii)) become suspended section 987 loss under paragraph (c)(1) of this section or ¡ì1.987-7(d) does not exceed the lesser of¡ª

(i) $3 million; or

(ii) Two percent of the total amount of gross income of the owner and all members of the owner¡¯s controlled group for the taxable year.

(3) Taxable year of controlled group members¡ª(¾±) In general. Except as provided in paragraph (c)(3)(ii) of this section, for purposes of applying paragraph (c)(2) of this section with respect to an owner, suspended section 987 loss and gross income of a member of the owner¡¯s controlled group is determined by reference to the member¡¯s suspended section 987 loss and gross income for its taxable year ending with or within the owner¡¯s taxable year.

(ii) Owner is a CFC. For purposes of applying paragraph (c)(2) of this section with respect to an owner that is a CFC, suspended section 987 loss and gross income of a member of the owner¡¯s controlled group is determined by reference to the member¡¯s suspended section 987 loss and gross income for its taxable year ending with or within the owner¡¯s required year described in section 898(c)(1), without regard to section 898(c)(2).

(d) Suspension of net unrecognized section 987 loss upon making or revoking certain elections¡ª(1) Making an annual recognition election. At the beginning of the first taxable year for which an annual recognition election is in effect, an owner¡¯s net accumulated unrecognized section 987 loss and deferred section 987 loss are converted into suspended section 987 loss if either¡ª

(i) A current rate election was in effect for the immediately preceding taxable year; or

(ii) A current rate election was not in effect for the immediately preceding taxable year and, as of the beginning of the taxable year, the sum of the owner¡¯s net accumulated unrecognized section 987 loss and deferred section 987 loss exceeds the sum of the owner¡¯s net accumulated unrecognized section 987 gain and deferred section 987 gain by more than $5 million.

(2) Revoking a current rate election. At the beginning of the first taxable year in which a current rate election ceases to be in effect, an owner¡¯s net accumulated unrecognized section 987 loss and deferred section 987 loss are converted into suspended section 987 loss. See paragraph (g)(3) of this section (Example 3) for an illustration of this rule.

(e) Loss-to-the-extent-of-gain rule¡ª(1) In general. An owner of a section 987 QBU (or an original suspended loss QBU owner) only recognizes suspended section 987 loss to the extent described in this paragraph (e) (the loss-to-the-extent-of-gain rule). See ¡ì1.987-13(b) through (d) for rules requiring the recognition of additional suspended section 987 loss (after the application of the loss-to-the-extent-of-gain rule) in connection with certain transactions.

(2) Separate determination for each recognition grouping. The amount of suspended section 987 loss recognized is determined separately for the suspended section 987 loss in each recognition grouping. Because the recognition groupings generally are determined on the basis of the initial assignment of section 987 gain or loss under ¡ì1.987-6(b)(2)(i), the loss-to-the-extent-of-gain rule generally is applied on the basis of the initial assignment of section 987 gain or loss.

(3) Amount of suspended section 987 loss recognized. Except as provided in paragraph (e)(5) or (6) of this section, the amount of suspended section 987 loss in each recognition grouping that an owner recognizes in a taxable year is equal to the sum (if positive) of the current year gain amount described in paragraph (e)(3)(i) of this section and the lookback gain amount described in paragraph (e)(3)(ii) of this section, but may not exceed the owner¡¯s total cumulative suspended section 987 loss in the recognition grouping. If the sum of the current year gain amount and the lookback gain amount is negative, then the amount of suspended section 987 loss recognized under this paragraph (e) is zero. See paragraphs (g)(1) and (2) of this section (Examples 1 and 2) for an illustration of this rule.

(i) Current year gain amount. The current year gain amount described in this paragraph (e)(3)(i) is equal to the section 987 gain in the recognition grouping that is recognized by the owner in the taxable year, reduced (including below zero) by section 987 loss (other than suspended section 987 loss) in the recognition grouping that is recognized by the owner in the taxable year.

(ii) Lookback gain amount. The lookback gain amount described in this paragraph (e)(3)(ii) is equal to the section 987 gain in the recognition grouping that was recognized by the owner in the lookback period, reduced (including below zero) by section 987 loss (other than suspended section 987 loss described in paragraph (e)(3)(iii) of this section) in the recognition grouping that was recognized by the owner in the lookback period. The total amount of suspended section 987 loss recognized by reason of the recognition of an amount of section 987 gain cannot, in any event, exceed the amount of section 987 gain recognized.

(iii) Suspended section 987 loss not taken into account¡ª(´¡) In general. For purposes of applying paragraph (e)(3)(ii) of this section in a taxable year (the current taxable year), suspended section 987 loss recognized during the lookback period is not taken into account if it was recognized under this paragraph (e) by reason of the recognition of section 987 gain that was recognized before the lookback period for the current taxable year.

(B) Ordering rule. For purposes of this paragraph (e)(3)(iii), suspended section 987 loss is treated as recognized by reason of the most recently recognized section 987 gain in the same recognition grouping. See paragraph (g)(2) of this section (Example 2) for an illustration of this rule.

(iv) Lookback period¡ª(´¡) In general. Except as provided in paragraph (e)(3)(iv)(B) of this section, the lookback period with respect to a taxable year of an owner means the three preceding taxable years of the owner (or, if the owner was not in existence for three preceding taxable years, each taxable year in which the owner existed), but it does not include any taxable year beginning before the transition date described in ¡ì1.987-10(c)(1).

(B) Taxable years in which both a current rate election and an annual recognition election are in effect. In a taxable year of an owner in which both a current rate election and an annual recognition election are in effect, the lookback period includes all prior taxable years of the owner in which both a current rate election and an annual recognition election were continuously in effect.

(v) Anti-abuse rule. If an owner recognizes section 987 gain with a principal purpose of reducing the Federal income tax liability of the owner (or its U.S. shareholders or partners, as applicable), including over multiple taxable years, the section 987 gain is disregarded for purposes of this paragraph (e)(3). For example, this paragraph (e)(3)(v) may apply if an owner that is a CFC recognizes section 987 gain that is offset by a tax attribute of one of the CFC¡¯s U.S. shareholders that would not otherwise be used (such as excess foreign tax credits with respect to section 951A category income, or a tested loss). In determining whether a principal purpose described in this paragraph (e)(3)(v) exists, all relevant facts and circumstances are considered, including the extent to which the transaction giving rise to the recognition of section 987 gain resulted in a sustained economic contraction of the section 987 QBU over a period of at least twelve months.

(4) Suspended section 987 loss recognized with respect to each section 987 QBU and suspended section 987 loss QBU. The amount of suspended section 987 loss in a recognition grouping that is recognized by an owner in a taxable year is treated as attributable to each section 987 QBU or successor suspended loss QBU in proportion to the QBU¡¯s suspended section 987 loss in that recognition grouping.

(5) Section 381(a) transactions¡ª(¾±) In general. Except as provided in paragraph (e)(5)(ii) of this section (or to the extent that other limitations apply), if one corporation (acquiring corporation) acquires the assets of another corporation (transferor corporation) in a transaction described in section 381(a), section 987 gain or loss recognized by the transferor corporation during the lookback period is taken into account in determining the lookback gain amount of the acquiring corporation in taxable years ending after the transaction under paragraph (e)(3)(ii) of this section. If the lookback period for a taxable year of the acquiring corporation is determined under paragraph (e)(3)(iv)(A) of this section, the lookback period includes each taxable year of the transferor corporation ending with or within the current taxable year of the acquiring corporation or during the acquiring corporation¡¯s lookback period. If the lookback period for a taxable year of the acquiring corporation is determined under paragraph (e)(3)(iv)(B) of this section, the lookback period includes only taxable years of the transferor corporation in which both an annual recognition election and a current rate election were continuously in effect before the transaction (and only if both elections were continuously in effect from the date of the transaction through the current taxable year).

(ii) Limitation for inbound nonrecognition transactions. If a foreign corporation ceases to exist in a transaction described in ¡ì1.987-8(c)(1)(ii) (inbound section 332 liquidation) or ¡ì1.987-8(c)(2)(ii) (inbound reorganization), section 987 gain recognized by the foreign corporation before the transaction is disregarded for purposes of applying paragraph (e)(3) of this section in taxable years ending after the transaction.

(6) Consolidated group members¡ª(¾±) In general. All members of a consolidated group are treated as a single owner for purposes of applying this paragraph (e).

(ii) Suspended section 987 losses arising in separate return limitation years. This paragraph (e)(6)(ii) applies to suspended section 987 losses arising in a separate return limitation year (SRLY, as defined in ¡ì1.1502-1(f)) or treated as arising in a SRLY under the principles of ¡ì1.1502-21(c) (SRLY section 987 losses). The aggregate of a member¡¯s SRLY section 987 losses that are included in the determination of consolidated taxable income for all consolidated return years of the group may not exceed the aggregate consolidated net income for all consolidated return years of the group determined by reference to only the member¡¯s items of section 987 gain or loss, including the member¡¯s section 987 losses actually absorbed by the group in the taxable year (whether or not absorbed by the member). For purposes of applying this paragraph (e)(6)(ii), the principles of ¡ì1.1502-21(c) (including the SRLY subgroup principles of ¡ì1.1502-21(c)(2)) apply with appropriate adjustments.

(f) Recognition groupings. The term recognition grouping means the section 987 gain or loss (including section 987 gain or loss that is recognized under ¡ì1.987-5, deferred section 987 gain or loss, suspended section 987 loss, or pretransition gain or loss that is recognized under ¡ì1.987-10(e)(5)(ii)) described in paragraph (f)(1) or (2) of this section, as applicable. If an owner has suspended section 987 loss with respect to a terminating QBU in a taxable year ending before the transition date described in ¡ì1.987-10(c)(1), section 987 gain or loss of the owner (other than section 987 gain or loss with respect to the terminating QBU) is assigned to a recognition grouping based on the method that is used to determine the source and character of section 987 gain or loss for that taxable year.

(1) Sourcing and section 904 category. Except as provided in paragraph (f)(2) of this section, a recognition grouping includes only section 987 gain or loss that is initially assigned to one of the following statutory and residual groupings¡ª

(i) U.S. source income; or

(ii) Foreign source income in a single section 904 category.

(2) Statutory and residual groupings for CFC owners. In the case of an owner that is a controlled foreign corporation, a recognition grouping includes only section 987 gain or loss that is initially assigned to one of the statutory and residual groupings described in paragraph (f)(1) of this section and that is also initially assigned to one of the following statutory and residual groupings¡ª

(i) Tentative tested income;

(ii) Each separate subpart F income group (as defined in ¡ì1.960-1(d)(2)(ii)(B));

(iii) Income described in section 952(b) (ECI that is excluded from subpart F income); or

(iv) Income not described in paragraphs (f)(2)(i) through (iii) of this section.

(g) Examples. The following examples illustrate the application of this section.

(1) Example 1: Suspension of section 987 loss and recognition of suspended section 987 loss¡ª(¾±) Facts. CFC is a controlled foreign corporation that has the U.S. dollar as its functional currency. CFC owns three section 987 QBUs, QBU1, QBU2, and QBU3. QBU1 has the euro as its functional currency, QBU2 has the pound as its functional currency, and QBU3 has the yen as its functional currency. CFC is subject to a current rate election but not an annual recognition election. CFC is also subject to an election under ¡ì1.987-6(b)(2)(i)(C) (treating section 987 gain or loss relating to passive foreign personal holding company income as attributable to section 988 transactions). An election has not been made under ¡ì1.951A-2(c)(7)(viii) (GILTI high-tax exclusion) with respect to CFC. In year 1, CFC did not have cumulative suspended section 987 loss with respect to any of its QBUs and did not have outstanding deferred section 987 gain or loss. In the three years before year 2, CFC did not recognize any section 987 gain or loss. In year 2, CFC has net unrecognized section 987 loss of $200 with respect to QBU1, net unrecognized section 987 loss of $1,000 with respect to QBU2, and net unrecognized section 987 gain of $1,000 with respect to QBU3. In year 2, each QBU makes a remittance, and CFC¡¯s remittance proportion (determined under ¡ì1.987-5(b)(1)) is 25% with respect to QBU1, 15% with respect to QBU2, and 10% with respect to QBU3. For purposes of ¡ì1.987-6(b)(2)(i), all of QBU1¡¯s assets generate foreign source passive category income that corresponds to one or more subpart F income groups described in ¡ì1.960-1(d)(2)(ii)(B)(2)(i) through (v), and all of QBU2¡¯s and QBU3¡¯s assets generate foreign source general category tested income. Another member of CFC¡¯s controlled group owns a section 987 QBU with respect to which $10 million of net unrecognized section 987 loss becomes suspended section 987 loss under paragraph (c)(1) of this section in year 2.

(ii) Analysis¡ª(´¡) Application of ¡ì¡ì1.987-5 and 1.987-6 and paragraph (c) of this section. In year 2, CFC recognizes $100 of section 987 gain with respect to QBU3 (10% of $1,000) under ¡ì1.987-5(a). Under ¡ì1.987-6(b)(2)(i)(A), (B), and (D), the section 987 gain is initially characterized as foreign source general category tentative tested income. If a current rate election was not in effect, in year 2 CFC would recognize $50 of section 987 loss with respect to QBU1 (25% of $200) and $150 of section 987 loss with respect to QBU2 (15% of $1,000). However, under paragraph (c) of this section, these amounts instead become suspended section 987 loss. The de minimis rule under paragraph (c)(2) of this section does not apply because a member of CFC¡¯s controlled group has more than $3 million of section 987 loss that is suspended in year 2 under paragraph (c)(1) of this section. Under ¡ì1.987-6(b)(2)(i)(A) and (B), the $50 of suspended section 987 loss with respect to QBU1 is initially characterized as foreign source passive category income assigned to a subpart F income group described in ¡ì1.960-1(d)(2)(ii)(B)(2)(i) through (v), and is treated as foreign currency loss of the CFC attributable to section 988 transactions not directly related to the business needs of the CFC because an election under ¡ì1.987-6(b)(2)(i)(C) is in effect. Under ¡ì1.987-6(b)(2)(i)(A), (B), and (D), the $150 of suspended section 987 loss with respect to QBU2 is initially characterized as foreign source general category tentative tested income.

(B) Cumulative suspended section 987 loss. Under paragraph (b) of this section, in year 2, CFC¡¯s cumulative suspended section 987 loss in the recognition grouping of foreign source passive category income in a separate subpart F income group for foreign currency gains of CFC with respect to QBU1 is $50, the amount that became suspended section 987 loss in the recognition grouping in year 2. In addition, CFC¡¯s total cumulative suspended section 987 loss in that recognition grouping is $50. Similarly, CFC¡¯s cumulative suspended section 987 loss in the recognition grouping of foreign source general category tentative tested income with respect to QBU2 is $150, the amount that became suspended section 987 loss in the recognition grouping in year 2. In addition, CFC¡¯s total cumulative suspended section 987 loss in that recognition grouping is $150.

(C) Current year gain amount and lookback gain amount. Under paragraph (e)(3) of this section, in year 2, CFC recognizes suspended section 987 loss in a recognition grouping to the extent of the sum of the current year gain amount described in paragraph (e)(3)(i) of this section and the lookback gain amount described in paragraph (e)(3)(ii) of this section. In the recognition grouping of foreign source general category tentative tested income, the current year gain amount described in paragraph (e)(3)(i) of this section is equal to the section 987 gain of $100 recognized by CFC in year 2 with respect to QBU3. The current year gain amount for all other recognition groupings is zero. During the lookback period (the three years before year 2), CFC did not recognize any section 987 gain or loss. Therefore, the lookback gain amount described in paragraph (e)(3)(ii) of this section is zero for all recognition groupings.

(D) Recognition of suspended section 987 loss. In year 2, CFC has $50 of total cumulative suspended section 987 loss in the recognition grouping of foreign source passive category income in a separate subpart F income group for foreign currency gains of CFC and $150 of total cumulative suspended section 987 loss in the recognition grouping of foreign source general category tentative tested income. In the recognition grouping of foreign source general category tentative tested income, CFC has a current year gain amount of $100 and a lookback gain amount of zero ($100 in total). Therefore, CFC recognizes $100 of suspended section 987 loss in that recognition grouping. Under paragraph (e)(4) of this section, the cumulative suspended section 987 loss that is recognized by CFC is attributable to QBU2, because QBU2 is CFC¡¯s only QBU with cumulative suspended section 987 loss in the recognition grouping of foreign source general category tentative tested income. Because no election under ¡ì1.951A-2(c)(7) applies in year 2, both the $100 of recognized section 987 gain and the $100 of recognized section 987 loss are allocated to foreign source general category tested income. See ¡ì1.987-6(b)(2)(ii). The amounts of suspended section 987 loss not recognized (that is, $50 of suspended section 987 loss assigned to foreign source passive category income in the subpart F income group for foreign currency gains of CFC with respect to QBU1 and $50 of suspended section 987 loss assigned to foreign source general category tentative tested income with respect to QBU2) remain suspended.

(2) Example 2: Recognition of suspended section 987 loss by reason of gain recognized during the lookback period¡ª(¾±) Facts. CFC is a controlled foreign corporation that has the U.S. dollar as its functional currency. CFC owns QBU1, a section 987 QBU with the euro as its functional currency, and CFC has no other QBUs. Assume that all section 987 gain or loss (including suspended section 987 loss) is assigned to the same recognition grouping. CFC is subject to a current rate election but not an annual recognition election. Before year 1, QBU1 does not have cumulative suspended section 987 loss. In year 1, CFC recognizes section 987 gain of $10 million with respect to QBU1. In year 3, CFC recognizes section 987 gain of $15 million with respect to QBU1. In year 4, QBU1 has net unrecognized section 987 loss, and $10 million of the net unrecognized section 987 loss becomes suspended section 987 loss under paragraph (c) of this section. In year 6, an additional $10 million of net unrecognized section 987 loss with respect to QBU1 becomes suspended section 987 loss under paragraph (c) of this section.

(ii) Analysis¡ª(´¡) Recognition of suspended section 987 loss in year 4. In year 4, CFC¡¯s total cumulative suspended section 987 loss is $10 million (that is, the loss that becomes suspended in year 4). The current year gain amount under paragraph (e)(3)(i) of this section is zero, because CFC does not recognize section 987 gain in year 4. The lookback period under paragraph (e)(3)(iv)(A) of this section is three years (years 1 through 3). The lookback gain amount under paragraph (e)(3)(ii) of this section is $25 million (the sum of the $10 million of section 987 gain recognized in year 1 and the $15 million of section 987 gain recognized in year 3). Therefore, under paragraph (e)(3) of this section, CFC recognizes suspended section 987 loss of $10 million. Under paragraph (e)(3)(iii)(B) of this section, the suspended section 987 loss is considered to be recognized by reason of the section 987 gain recognized in year 3, which is the most recent taxable year in which section 987 gain was recognized.

(B) Recognition of suspended section 987 loss in year 6. In year 6, CFC¡¯s total cumulative suspended section 987 loss is $10 million (that is, the loss that becomes suspended in year 6). The current year gain amount under paragraph (e)(3)(i) of this section is zero, because CFC does not recognize section 987 gain in year 6. The lookback period under paragraph (e)(3)(iv)(A) of this section is three years (years 3 through 5). The lookback gain amount under paragraph (e)(3)(ii) of this section is $5 million (the sum of the section 987 gain of $15 million recognized in year 3 and the suspended section 987 loss of $10 million recognized in year 4 by reason of the section 987 gain recognized in year 3). Therefore, under paragraph (e)(3) of this section, CFC recognizes $5 million of suspended section 987 loss in year 6.

(iii) Alternative facts. Assume the facts are the same as described in paragraph (g)(2)(i) of this section, with the following modifications. In year 1, CFC recognizes section 987 gain of $10 million with respect to QBU1. CFC does not recognize section 987 gain in year 3. In year 4, $10 million of net unrecognized section 987 loss with respect to QBU1 becomes suspended section 987 loss under paragraph (c) of this section. In year 5, CFC recognizes section 987 gain of $15 million with respect to QBU1. In year 6, $10 million of net unrecognized section 987 loss with respect to QBU1 becomes suspended section 987 loss under paragraph (c) of this section.

(iv) Analysis of alternative facts¡ª(´¡) Recognition of suspended section 987 loss in year 4. In year 4, CFC¡¯s total cumulative suspended section 987 loss is $10 million (that is, the loss that becomes suspended in year 4). The current year gain amount under paragraph (e)(3)(i) of this section is zero, because CFC does not recognize section 987 gain in year 4. The lookback period under paragraph (e)(3)(iv)(A) of this section is three years (years 1 through 3). The lookback gain amount under paragraph (e)(3)(ii) of this section is $10 million (equal to the $10 million of section 987 gain recognized in year 1). Therefore, under paragraph (e)(3) of this section, CFC recognizes suspended section 987 loss of $10 million in year 4. Under paragraph (e)(3)(iii)(B) of this section, the suspended section 987 loss is considered to be recognized by reason of the section 987 gain recognized in year 1, which is the most recent taxable year in which section 987 gain was recognized.

(B) Recognition of suspended section 987 loss in year 6. In year 6, CFC¡¯s total cumulative suspended section 987 loss is $10 million (that is, the loss that becomes suspended in year 6). The current year gain amount under paragraph (e)(3)(i) of this section is zero because CFC does not recognize section 987 gain in year 6. The lookback period under paragraph (e)(3)(iv)(A) of this section is three years (years 3 through 5). The lookback gain amount under paragraph (e)(3)(ii) of this section is $15 million (equal to the section 987 gain of $15 million recognized in year 5). Under paragraph (e)(3)(iii)(A) of this section, the suspended section 987 loss recognized in year 4 is not taken into account in determining the lookback gain amount, because it was recognized by reason of the section 987 gain recognized in year 1 (before the beginning of the lookback period for year 6). Therefore, under paragraph (e)(3) of this section, CFC recognizes $10 million of suspended section 987 loss in year 6.

(3) Example 3: Suspension of section 987 loss when a current rate election is revoked¡ª(¾±) Facts. U.S. Corp is a domestic corporation that owns all of the interests in DE1. DE1 owns Business A, which is a section 987 QBU of U.S. Corp. In year 1, U.S. Corp made a current rate election but not an annual recognition election. In year 9, U.S. Corp has net unrecognized section 987 loss of $2 million with respect to Business A, which is not recognized or suspended in year 9. U.S. Corp revokes its current rate election effective for year 10. In year 10, before the application of this section, U.S. Corp has net accumulated unrecognized section 987 loss of $2 million.

(ii) Analysis. Under paragraph (d)(2) of this section, U.S. Corp¡¯s net accumulated unrecognized section 987 loss of $2 million with respect to Business A is converted into suspended section 987 loss at the beginning of year 10, the first taxable year in which the current rate election ceases to be in effect.

(a) Overview¡ª(1) Scope. This section provides rules that defer the recognition of section 987 gain or loss and rules for recognizing (or suspending) deferred section 987 gain or loss. This paragraph (a) provides an overview of this section and certain instances when this section does not apply. Paragraph (b) of this section describes the extent to which net unrecognized section 987 gain or loss is recognized under ¡ì1.987-5 (or in certain cases, suspended) or becomes deferred section 987 gain or loss in connection with a deferral event. Paragraph (c) of this section describes the extent to which deferred section 987 gain or loss is recognized (or in certain cases, suspended) upon the occurrence of subsequent events. Paragraph (d) of this section provides a rule relating to the treatment of a successor deferral QBU when deferred section 987 loss becomes suspended section 987 loss. Paragraph (e) of this section provides an anti-abuse rule. Paragraph (f) of this section provides rules for determining the deferred section 987 gain or loss of combined and separated QBUs. Paragraph (g) of this section provides definitions. Paragraph (h) of this section provides examples illustrating the rules of this section.

(2) Exceptions¡ª(¾±) Annual recognition election. This section does not apply to a termination of a section 987 QBU in a taxable year in which an annual recognition election is in effect.

(ii) De minimis rule. This section does not apply in a taxable year if the aggregate amount of net unrecognized section 987 gain or loss of the owner with respect to all of its section 987 QBUs that would become deferred section 987 gain or loss under this section does not exceed $5 million.

(b) Treatment of section 987 gain and loss in connection with a deferral event. Notwithstanding ¡ì1.987-5 (general rule requiring recognition of section 987 gain or loss in the taxable year of a remittance), the owner of a section 987 QBU with respect to which a deferral event occurs (an original deferral QBU) includes in taxable income section 987 gain or loss in connection with the deferral event only to the extent provided in this paragraph (b).

(1) Gain or loss recognized (or suspended) in the taxable year of a deferral event. In the taxable year of a deferral event with respect to an original deferral QBU, the owner of the original deferral QBU recognizes section 987 gain or loss under ¡ì1.987-5, except that, solely for purposes of applying ¡ì1.987-5, all assets and liabilities of the original deferral QBU that, immediately after the deferral event, are reflected on the books and records of a successor deferral QBU are treated as not having been transferred and therefore as remaining on the books and records of the original deferral QBU notwithstanding the deferral event. Notwithstanding the prior sentence, any section 987 loss that would otherwise be recognized under this paragraph (b)(1) and ¡ì1.987-5 may instead become suspended loss under ¡ì1.987-11(c) if a current rate election is in effect, or under ¡ì1.987-13(h) if the deferral event also constitutes an outbound loss event.

(2) Deferred section 987 gain or loss¡ª(¾±) In general. In the taxable year of a deferral event with respect to an original deferral QBU, any net unrecognized section 987 gain or loss that is not recognized or suspended in the taxable year of the deferral event becomes deferred section 987 gain or loss of the original deferral QBU owner. Suspended section 987 loss does not become deferred section 987 loss under this paragraph (b)(2).

(ii) Deferred section 987 gain or loss attributable to a successor deferral QBU. A portion of the deferred section 987 gain or loss described in paragraph (b)(2)(i) of this section becomes deferred section 987 gain or loss with respect to each successor deferral QBU. Such portion is equal to the deferred section 987 gain or loss multiplied by a fraction, the numerator of which is the aggregate adjusted basis of the gross assets transferred to the successor deferral QBU in connection with the deferral event and the denominator of which is the aggregate adjusted basis of the gross assets transferred to all successor deferral QBUs in connection with the deferral event.

(c) Recognition (or suspension) of deferred section 987 gain or loss following a deferral event. An original deferral QBU owner recognizes deferred section 987 gain or loss with respect to a successor deferral QBU in the taxable year of the deferral event and in subsequent taxable years as provided in this paragraph (c).

(1) Recognition upon a subsequent remittance¡ª(¾±) In general. Except as provided in paragraph (c)(2) of this section, an original deferral QBU owner recognizes deferred section 987 gain or loss in the taxable year of the deferral event, and in subsequent taxable years, upon a remittance from a successor deferral QBU to the owner of the successor deferral QBU (successor deferral QBU owner) in the amount described in paragraph (c)(1)(ii) of this section. Notwithstanding the prior sentence, any deferred section 987 loss that would otherwise be recognized under this paragraph (c)(1) may instead become suspended section 987 loss under ¡ì1.987-11(c) (if a current rate election is in effect with respect to the original deferral QBU owner) or under ¡ì1.987-7(d)(1)(ii) (in the case of a partnership).

(ii) Amount. The amount of deferred section 987 gain or loss that is recognized (or suspended) pursuant to this paragraph (c)(1) in a taxable year of the original deferral QBU owner is the original deferral QBU owner¡¯s outstanding deferred section 987 gain or loss (that is, the amount of deferred section 987 gain or loss not previously recognized or suspended) with respect to the successor deferral QBU multiplied by the remittance proportion of the successor deferral QBU owner with respect to the successor deferral QBU for the taxable year ending with or within the taxable year of the original deferral QBU owner, as determined under ¡ì1.987-5(b) without regard to any annual recognition election of the successor deferral QBU owner. See paragraph (h)(4) of this section (Example 4) for an illustration of this rule.

(iii) Deemed remittance by a successor deferral QBU. For purposes of this paragraph (c)(1), in a taxable year of the original deferral QBU owner in which a successor deferral QBU ceases to be owned by a member of the controlled group that includes the original deferral QBU owner, the successor deferral QBU is treated as having a remittance proportion of one. Accordingly, if a successor deferral QBU ceases to be owned by a member of the controlled group that includes the original deferral QBU owner, the original deferral QBU owner¡¯s outstanding deferred section 987 gain or loss with respect to that successor deferral QBU will be recognized (or suspended). For purposes of this paragraph (c)(1), if the original deferral QBU owner goes out of existence and there is no qualified successor, in the last taxable year of the original deferral QBU owner, each successor deferral QBU is treated as having a remittance proportion of one. This paragraph (c)(1)(iii) does not affect the application of the section 987 regulations to the successor deferral QBU owner with respect to its ownership of the successor deferral QBU.

(2) Deferral events and outbound loss events with respect to a successor deferral QBU. Notwithstanding paragraph (c)(1) of this section, if assets of the successor deferral QBU (transferred assets) are transferred (or deemed transferred) in a transaction that would constitute a deferral event or an outbound loss event if the original deferral QBU owner owned the successor deferral QBU directly and the original deferral QBU owner had net unrecognized section 987 gain or loss with respect to the successor deferral QBU equal to its outstanding deferred section 987 gain or loss with respect to the successor deferral QBU (the deemed transaction), then, in accordance with the rules of this section and ¡ì1.987-13(h)¡ª

(i) The original deferral QBU owner recognizes its outstanding deferred section 987 gain or loss, or suspends its outstanding deferred section 987 loss, to the extent it would have recognized or suspended net unrecognized section 987 gain or loss as a result of the deemed transaction; and

(ii) Each section 987 QBU is a successor deferral QBU to the extent it would have been after the deemed transaction and the original deferral QBU owner has deferred section 987 gain or loss with respect to the successor deferral QBU to the extent it would have after the deemed transaction;

(iii) Each eligible QBU is a successor suspended loss QBU to the extent it would have been after the deemed transaction and the original deferral QBU owner has suspended section 987 loss with respect to the suspended loss QBU to the extent it would have after the deemed transaction.

(d) Successor deferral QBU becomes a successor suspended loss QBU. A successor deferral QBU becomes a successor suspended loss QBU, and an original deferral QBU owner becomes an original suspended loss QBU owner, if any of the original deferral QBU owner¡¯s deferred section 987 loss with respect to the successor deferral QBU becomes suspended section 987 loss. An eligible QBU may be both a successor deferral QBU and a successor suspended loss QBU and the original deferral QBU owner may also be an original suspended loss QBU owner.

(e) Anti-abuse rule. No section 987 loss is recognized under this section, ¡ì1.987-5 or ¡ì1.987-13 in connection with a transaction or series of transactions that are undertaken with a principal purpose of avoiding the purposes of this section.

(f) Combinations and separations of successor deferral QBUs. A combined QBU is a successor deferral QBU if either combining QBU was a successor deferral QBU. A separated QBU is a successor deferral QBU if the separating QBU was a successor deferral QBU.

(1) Combined QBU. The outstanding deferred section 987 gain or loss of a combined QBU in each recognition grouping for a taxable year is equal to the sum of the combining QBUs¡¯ outstanding deferred section 987 gain or loss in that recognition grouping.

(2) Separated QBU. The outstanding deferred section 987 gain or loss of a separated QBU in each recognition grouping for a taxable year is equal to the separating QBU¡¯s outstanding deferred section 987 gain or loss in each recognition grouping multiplied by the separation fraction.

(g) Definitions. The following definitions apply for purposes of this section.

(1) Deferral event. A deferral event with respect to a section 987 QBU means any transaction or series of transactions that satisfy the conditions described in both paragraphs (g)(1)(i) and (ii) of this section.

(i) Events. The transaction or series of transactions constitutes:

(A) A termination of the section 987 QBU under ¡ì1.987-8(b)(2) (substantially all the assets transferred to the owner), ¡ì1.987-8(b)(5) (section 987 QBU ceases to be a section 987 QBU), or ¡ì1.987-8(b)(6) (individual or corporation ceases to be a direct owner of a section 987 QBU); or

(B) [Reserved]

(ii) Assets on books of successor deferral QBU. Immediately after the transaction or series of transactions, assets of the section 987 QBU are reflected on the books and records of a successor deferral QBU.

(2) Successor deferral QBU. A section 987 QBU (potential successor deferral QBU) is a successor deferral QBU with respect to a section 987 QBU referred to in paragraph (g)(1)(i) of this section if, immediately after the transaction or series of transactions described in that paragraph, the potential successor deferral QBU satisfies all of the conditions described in paragraphs (g)(2)(i) through (iii) of this section.

(i) The books and records of the potential successor deferral QBU reflect assets that, immediately before the transaction or series of transactions described in paragraph (g)(1)(i) of this section, were reflected on the books and records of the section 987 QBU referred to in paragraph (g)(1)(i) of this section.

(ii) The owner of the potential successor deferral QBU and the owner of the section 987 QBU referred to in paragraph (g)(1)(i) of this section immediately before the transaction or series of transactions described in paragraph (g)(1)(i) of this section are members of the same controlled group.

(iii) If the owner of the section 987 QBU referred to in paragraph (g)(1)(i) of this section immediately before the transaction or series of transactions described in paragraph (g)(1)(i) of this section was a U.S. person, the potential successor deferral QBU is owned by a U.S. person.

(3) Original deferral QBU owner. An original deferral QBU owner means, with respect to an original deferral QBU, the owner of the original deferral QBU immediately before the deferral event, or the owner¡¯s qualified successor.

(4) Qualified successor. A qualified successor with respect to a corporation (transferor corporation) means another corporation that acquires the assets of the transferor corporation in a transaction described in section 381(a) (acquiring corporation), provided that the acquiring corporation is a domestic corporation and the transferor corporation was a domestic corporation, or the acquiring corporation is a controlled foreign corporation and the transferor corporation was a controlled foreign corporation. A qualified successor of a person includes the qualified successor of a qualified successor.

(h) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC1 is a domestic corporation that owns all of the stock of DC2, which is also a domestic corporation, and CFC1, a controlled foreign corporation. In addition, DC1, DC2, and CFC1 are members of a controlled group, and the de minimis rule of paragraph (a)(2)(ii) of this section is not applicable. Finally, except as otherwise provided, Business A is a section 987 QBU with the euro as its functional currency, there are no transfers between Business A and its owner, and Business A¡¯s assets are not depreciable or amortizable.

(1) Example 1: Contribution of a section 987 QBU with net unrecognized section 987 gain to a member of the controlled group¡ª(¾±) Facts. DC1 owns Business A. The adjusted balance sheet of Business A reflects assets with an aggregate adjusted basis of €1,000x and no liabilities. DC1 contributes €900x of Business A¡¯s assets to DC2 in exchange for DC2 stock in a transaction to which section 351 applies. Immediately after the contribution, the remaining €100x of Business A¡¯s assets are no longer reflected on the books and records of a section 987 QBU (but are instead reflected on the books and records of DC1¡¯s home office). DC2, which has the U.S. dollar as its functional currency, uses the Business A assets in a business (Business B) that constitutes a section 987 QBU. At the time of the contribution, Business A has net unrecognized section 987 gain of $100x.

(ii) Analysis¡ª(´¡) Under ¡ì1.987-2(c)(2)(ii), DC1¡¯s contribution of €900x of Business A¡¯s assets to DC2 is treated as a transfer of all of the assets of Business A to DC1, immediately followed by DC1¡¯s contribution of €900x of Business A¡¯s assets to DC2. The contribution of Business A¡¯s assets is a deferral event within the meaning of paragraph (g)(1) of this section because:

(1) The transfer from Business A to DC1 is a transfer of substantially all of Business A¡¯s assets to DC1, resulting in a termination of the Business A QBU under ¡ì1.987-8(b)(2); and

(2) Immediately after the transaction, assets of Business A are reflected on the books and records of Business B, a section 987 QBU owned by a member of DC1¡¯s controlled group and a successor deferral QBU within the meaning of paragraph (g)(2) of this section. Accordingly, Business A is an original deferral QBU within the meaning of paragraph (b) of this section, and DC1 is an original deferral QBU owner of Business A within the meaning of paragraph (g)(3) of this section.

(B) Under paragraph (b)(1) of this section, DC1¡¯s taxable income in the taxable year of the deferral event includes DC1¡¯s section 987 gain or loss determined with respect to Business A under ¡ì1.987-5, except that, for purposes of applying ¡ì1.987-5, all assets of Business A that are reflected on the books and records of Business B immediately after Business A¡¯s termination are treated as not having been transferred and therefore as though they remained on Business A¡¯s books and records (notwithstanding the deemed transfer of those assets under ¡ì1.987-8(e)). Accordingly, in the taxable year of the deferral event, Business A is treated as making a remittance of €100x, corresponding to the assets of Business A that are no longer reflected on the books and records of a section 987 QBU, and is treated as having a remittance proportion with respect to Business A of 0.1, determined by dividing the €100x remittance by the sum of the remittance and the €900x aggregate adjusted basis of the gross assets deemed to remain on Business A¡¯s books and records at the end of the taxable year. Thus, DC1 recognizes $10x of section 987 gain in the taxable year of the deferral event. DC1¡¯s deferred section 987 gain equals $90x, which is the amount of its net unrecognized section 987 gain (which is $100x) less the amount of section 987 gain recognized by DC1 under ¡ì1.987-5 and this section (which is $10x).

(2) Example 2: Contribution of a section 987 QBU with net unrecognized section 987 loss to a member of the controlled group when a current rate election is in effect¡ª(¾±) Facts. The facts are the same as in paragraph (h)(1) of this section (Example 1) except that a current rate election is in effect for the taxable year (and an annual recognition election is not in effect) and, at the time of the contribution, Business A has net unrecognized section 987 loss of $100x. Business A is engaged in the business of manufacturing Product X before the contribution, and Business B is engaged in the same business after the contribution. After the contribution, the €100x of assets that are reflected on the books and records of DC1¡¯s home office are not used in the business of manufacturing Product X.

(ii) Analysis¡ª(´¡) For the reasons described in paragraph (h)(1) of this section (Example 1), the contribution results in a termination of the Business A QBU and a deferral event with respect to the Business A QBU, an original deferral QBU; DC1 is an original deferral QBU owner within the meaning of paragraph (g)(3) of this section; Business B is a successor deferral QBU with respect to Business A; and DC2 is a successor deferral QBU owner.

(B) Under paragraph (b)(1) of this section, for purposes of applying ¡ì1.987-5, all the assets of Business A that are reflected on the books and records of Business B immediately after Business A¡¯s termination are treated as not having been transferred and therefore as though they remained on Business A¡¯s books and records (notwithstanding the deemed transfer of those assets under ¡ì1.987-8(e)). Accordingly, in the taxable year of the deferral event, Business A is treated as making a remittance of €100x, corresponding to the assets of Business A that are no longer reflected on the books and records of a section 987 QBU, and DC1 is treated as having a remittance proportion with respect to Business A of 0.1, determined by dividing the €100x remittance by the sum of the remittance and the €900x aggregate adjusted basis of the gross assets deemed to remain on Business A¡¯s books and records at the end of the taxable year. Thus, but for the application of ¡ì1.987-11(c), DC1 would recognize $10x of section 987 loss in the taxable year of the deferral event. Under ¡ì1.987-11(c), because a current rate election is in effect (and an annual recognition election is not in effect), the loss is instead treated as suspended section 987 loss. DC1¡¯s deferred section 987 loss equals $90x, which is the amount of its net unrecognized section 987 loss less the amount of section 987 loss suspended under ¡ì1.987-11(c) (which is $10x).

(C) Under ¡ì1.987-13(b)(1)(i), Business B is a successor suspended loss QBU because, immediately after the termination of the Business A section 987 QBU, a significant portion of the assets of Business A was reflected on the books and records of Business B (an eligible QBU), Business B continued to carry on the trade or business of Business A, and Business B was owned by DC2, a member of the same controlled group as DC1 (which is the original suspended loss QBU owner under ¡ì1.987-13(l)(1)). Therefore, under ¡ì1.987-13(b)(1)(ii), all of Business A¡¯s cumulative suspended section 987 loss (including the suspended section 987 loss resulting from the termination of Business A) becomes suspended section 987 loss with respect to Business B. After the transaction, DC1 may recognize its suspended section 987 loss with respect to Business B under ¡ì1.987-11(e) or ¡ì1.987-13(b) through (d), as applicable.

(3) Example 3: Election to be classified as a corporation¡ª(¾±) Facts. DC1 owns all of the interests in Entity A, a DE. Entity A conducts Business A, which has net unrecognized section 987 gain of $500x. Entity A elects to be classified as a corporation under ¡ì301.7701-3(c) of this chapter. As a result of the election and pursuant to ¡ì301.7701-3(g)(1)(iv) of this chapter, DC1 is treated as contributing all of the assets and liabilities of Business A to newly-formed CFC1, which has the euro as its functional currency. Immediately after the contribution, the assets and liabilities of Business A are reflected on CFC1¡¯s books and records.

(ii) Analysis. Under ¡ì1.987-2(c)(2)(ii), DC1¡¯s deemed contribution of all of the assets and liabilities of Business A to CFC1 is treated as a transfer of all of the assets and liabilities of Business A to DC1, followed immediately by DC1¡¯s contribution of those assets and liabilities to CFC1. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A¡¯s assets to DC1, the Business A QBU terminates under ¡ì1.987-8(b)(2). The contribution of Business A¡¯s assets is not a deferral event within the meaning of paragraph (b) of this section because, immediately after the transaction, no assets of Business A are reflected on the books and records of a successor deferral QBU within the meaning of paragraph (g)(2) of this section due to the fact that the assets of Business A are not reflected on the books and records of a section 987 QBU immediately after the termination. In addition, the requirement of paragraph (g)(2)(iii) of this section is not met because Business A was owned by a U.S. person and the potential successor deferral QBU, which is owned by CFC1, is not owned by a U.S. person. Accordingly, DC1 recognizes section 987 gain of $500x with respect to Business A under ¡ì1.987-5 without regard to this section. Because the requirement of paragraph (g)(2)(iii) of this section is not met, the result would be the same even if the assets of Business A were transferred in a section 351 exchange to an existing foreign corporation that had a different functional currency than Business A.

(4) Example 4: Partial recognition of deferred gain or loss¡ª(¾±) Facts. DC1 owns all of the interests in Entity A, a DE that conducts Business A in Country X. During year 1, DC1 contributes all of its interests in Entity A to DC2 in an exchange to which section 351 applies. At the time of the contribution, Business A has net unrecognized section 987 gain of $100x and cumulative suspended section 987 loss of $50x. After the contribution, Entity A continues to conduct the same trade or business in Country X (Business B). In year 3, as a result of a net transfer of property from Business B to DC2, DC2¡¯s remittance proportion with respect to Business B, as determined under ¡ì1.987-5, is 0.25.

(ii) Analysis¡ª(´¡) For the reasons described in paragraph (h)(1) of this section (Example 1), the contribution of all the interests in Entity A by DC1 to DC2 results in a termination of the Business A QBU and a deferral event with respect to the Business A QBU, an original deferral QBU; DC1 is an original deferral QBU owner within the meaning of paragraph (g)(3) of this section; Business B is a successor deferral QBU with respect to Business A; DC2 is a successor deferral QBU owner; and the $100x of net unrecognized section 987 gain with respect to Business A becomes deferred section 987 gain as a result of the deferral event.

(B) Under ¡ì1.987-13(b)(1)(i), Business B is a successor suspended loss QBU because, immediately after the termination of the Business A section 987 QBU, a significant portion of the assets of Business A was reflected on the books and records of Business B (an eligible QBU), Business B continued to carry on the trade or business of Business A, and Business B was owned by DC2, a member of the same controlled group as DC1 (which is the original suspended loss QBU owner under ¡ì1.987-13(l)(1)). Therefore, under ¡ì1.987-13(b)(1)(ii), all of DC1¡¯s cumulative suspended section 987 loss with respect to Business A becomes suspended section 987 loss of DC1 with respect to Business B.

(C) Under paragraph (c)(1)(i) of this section, DC1 recognizes deferred section 987 gain in year 3 as a result of the remittance from Business B to DC2. Under paragraph (c)(1)(ii) of this section, the amount of deferred section 987 gain that DC1 recognizes is $25x, which is DC1¡¯s outstanding deferred section 987 gain of $100x with respect to Business A multiplied by the remittance proportion of 0.25 of DC2 with respect to Business B for the taxable year as determined under ¡ì1.987-5(b). In addition, under ¡ì1.987-11(e), DC1 recognizes its cumulative suspended section 987 loss to the extent of the deferred section 987 gain recognized in the same recognition grouping.

(a) Overview¡ª(1) In general. This section provides rules relating to suspended section 987 loss of an owner with respect to a section 987 QBU or successor suspended loss QBU that terminates. Paragraph (b) of this section provides rules treating suspended section 987 loss as recognized or attributable to a successor when a section 987 QBU terminates. Paragraph (c) of this section provides rules treating suspended section 987 loss as recognized or attributable to a subsequent successor when a successor suspended loss QBU terminates. Paragraph (d) of this section provides rules regarding the recognition of suspended section 987 loss when interests in a successor suspended loss QBU owner are transferred. Paragraph (e) of this section provides rules that apply when interests in an original suspended loss QBU owner are transferred. Paragraph (f) of this section provides rules that apply when an original suspended loss QBU owner ceases to exist. Paragraph (g) of this section provides rules preventing the carryover of suspended section 987 loss in connection with certain inbound transactions. Paragraph (h) of this section provides rules that suspend section 987 loss in connection with certain outbound transactions. Paragraph (i) of this section is reserved. Paragraph (j) of this section provides rules relating to the termination of a successor suspended loss QBU. Paragraph (k) of this section provides an anti-abuse rule. Paragraph (l) of this section provides definitions that apply for purposes of this section. Paragraph (m) of this section provides examples illustrating the rules of this section.

(2) Ordering rule. Paragraphs (b) through (d) of this section are applied after the application of ¡ì1.987-11(e) (loss-to-the-extent-of-gain rule).

(b) Termination of a section 987 QBU with suspended loss. If a section 987 QBU terminates, and at the time of termination, the owner has suspended section 987 loss with respect to the section 987 QBU (including because the termination was an outbound loss event or because net unrecognized section 987 loss became suspended section 987 loss upon termination as a result of a current rate election), then either paragraph (b)(1) or (2) of this section applies. However, this paragraph (b) does not apply to a termination that occurs in connection with a transaction described in paragraph (f) or (g) of this section.

(1) Suspended section 987 loss becomes suspended section 987 loss with respect to a successor suspended loss QBU¡ª(¾±) Successor suspended loss QBU. If, immediately after the termination, a significant portion of the assets of the terminating section 987 QBU are reflected on the books and records of an eligible QBU that carries on a trade or business of the section 987 QBU and is owned by the owner of the section 987 QBU or a member of its controlled group (determined immediately after the transaction), then the eligible QBU is a successor suspended loss QBU and the rules provided in paragraph (b)(1)(ii) of this section apply.

(ii) Attribution of suspended section 987 loss to successor suspended loss QBU. A portion of the cumulative suspended section 987 loss with respect to the terminating section 987 QBU that is not recognized in the taxable year of the termination under ¡ì1.987-11(e) becomes suspended section 987 loss with respect to each successor suspended loss QBU. Such portion is equal to the suspended section 987 loss described in the preceding sentence, multiplied by a fraction, the numerator of which is the aggregate adjusted basis of the gross assets transferred to the successor suspended loss QBU in connection with the termination, and the denominator of which is the aggregate adjusted basis of the gross assets transferred to all successor suspended loss QBUs in connection with the termination.

(2) Recognition of suspended section 987 loss. If, immediately after the termination of the section 987 QBU, there is no successor suspended loss QBU under paragraph (b)(1) of this section, then the owner recognizes the cumulative suspended section 987 loss with respect to the section 987 QBU that is not recognized in the taxable year of the termination under ¡ì1.987-11(e).

(c) Termination of a successor suspended loss QBU. If a successor suspended loss QBU terminates (as described in paragraph (j) of this section), then either paragraph (c)(1) or (2) of this section applies. However, this paragraph (c) does not apply to a termination that occurs in connection with a transaction described in paragraph (e), (f), or (g) of this section.

(1) Successor to the successor suspended loss QBU¡ª(¾±) Successor suspended loss QBU. If, immediately after the termination, a significant portion of the assets of the terminating successor suspended loss QBU (initial successor) are reflected on the books and records of an eligible QBU (subsequent successor) that carries on a trade or business of the initial successor and is owned by the original suspended loss QBU owner or a member of its controlled group (determined immediately after the transaction), then the subsequent successor is a successor suspended loss QBU and the rules provided in paragraph (c)(1)(ii) of this section apply.

(ii) Attribution of suspended section 987 loss to successor suspended loss QBU. A portion of the cumulative suspended section 987 loss with respect to the initial successor that is not recognized in the taxable year of the termination under ¡ì1.987-11(e) becomes suspended section 987 loss with respect to each subsequent successor. Such portion is equal to the suspended section 987 loss described in the preceding sentence, multiplied by a fraction, the numerator of which is the aggregate adjusted basis of the gross assets transferred to the subsequent successor in connection with the termination, and the denominator of which is the aggregate adjusted basis of the gross assets transferred to all subsequent successors in connection with the termination.

(2) Recognition of suspended section 987 loss. If, immediately after the termination of the initial successor, there is no subsequent successor that is a successor suspended loss QBU under paragraph (c)(1) of this section, then the original suspended loss QBU owner recognizes the cumulative suspended section 987 loss with respect to the initial successor that is not recognized in the taxable year of the termination under ¡ì1.987-11(e).

(d) Transfer of successor suspended loss QBU owner. If a successor suspended loss QBU ceases to be owned by a member of the original suspended loss QBU owner¡¯s controlled group as a result of a direct or indirect transfer, or an issuance or redemption, of an ownership interest in the successor suspended loss QBU owner, then the original suspended loss QBU owner recognizes the cumulative suspended section 987 loss with respect to the successor suspended loss QBU that is not recognized in the taxable year under ¡ì1.987-11(e).

(e) Transfer of original suspended loss QBU owner. If an original suspended loss QBU owner ceases to be a member of the successor suspended loss QBU owner¡¯s controlled group as a result of a direct or indirect transfer, or an issuance or redemption, of an ownership interest in the original suspended loss QBU owner, the original suspended loss QBU owner¡¯s suspended section 987 loss ceases to be attributable to any successor suspended loss QBU (but it continues to be suspended section 987 loss of the original suspended loss QBU owner). As a result, the suspended section 987 loss can be recognized by the original suspended loss QBU owner under ¡ì1.987-11(e) but cannot be recognized under paragraph (b)(2), (c)(2), or (d) of this section.

(f) Owner ceases to exist. If the owner of a section 987 QBU with suspended section 987 loss or an original suspended loss QBU owner ceases to exist and there is no successor under paragraph (l)(1)(ii) of this section (for example, as a result of a section 331 liquidation), then any suspended section 987 loss of the owner that is not recognized after application of the loss-to-the-extent-of-gain rule in ¡ì1.987-11(e) is eliminated and cannot be recognized.

(g) Inbound nonrecognition transactions¡ªno carryover of suspended section 987 loss. If an owner of a section 987 QBU with suspended section 987 loss, or an original suspended loss QBU owner, ceases to exist in a transaction described in ¡ì1.987-8(c)(1)(ii) (inbound section 332 liquidation) or ¡ì1.987-8(c)(2)(ii) (inbound reorganization), then any suspended section 987 loss of the owner or original suspended loss QBU owner that is not recognized after application of the loss-to-the-extent-of-gain rule in ¡ì1.987-11(e) is eliminated and cannot be recognized. As a result, the distributee or acquiring corporation does not succeed to or take into account any suspended section 987 loss of the owner or original suspended loss QBU owner under section 381.

(h) Outbound transactions¡ªrecognition or suspension of net unrecognized section 987 loss. This paragraph (h) applies to taxable years in which neither a current rate election nor an annual recognition election is in effect.

(1) In general. Notwithstanding ¡ì1.987-5, if an outbound loss event occurs with respect to a section 987 QBU (an outbound loss QBU), the original owner of the section 987 QBU includes in taxable income in the taxable year of the outbound loss event section 987 loss with respect to the outbound loss QBU only to the extent provided in paragraph (h)(3) of this section.

(2) Outbound loss event. An outbound loss event means, with respect to a section 987 QBU:

(i) Any termination of the section 987 QBU as a result of a transfer by a U.S. person of assets of the section 987 QBU to a foreign person that is a member of the same controlled group as the U.S. person immediately before the transaction or, if the transferee did not exist immediately before the transaction, immediately after the transaction (related foreign person), provided that the termination would result in the recognition of section 987 loss with respect to the section 987 QBU under ¡ì1.987-5 but for this paragraph (h); or

(ii) [Reserved]

(3) Loss recognition upon an outbound loss event. In the taxable year of an outbound loss event with respect to an outbound loss QBU, the owner of the outbound loss QBU recognizes section 987 loss as determined under ¡ì¡ì1.987-5 and 1.987-12(b), except that, solely for purposes of applying ¡ì1.987-5, assets and liabilities of the outbound loss QBU that, immediately after the outbound loss event, are reflected on the books and records of an eligible QBU owned by the related foreign person described in paragraph (h)(2) of this section are treated as not having been transferred and therefore as remaining on the books and records of the outbound loss QBU notwithstanding the outbound loss event.

(4) Loss suspension upon outbound loss event. Net unrecognized section 987 loss or deferred section 987 loss that, as a result of this paragraph (h), is not recognized in the taxable year of the outbound loss event (outbound section 987 loss) under ¡ì1.987-5 becomes suspended section 987 loss.

(i) [Reserved]

(j) Termination of a successor suspended loss QBU. For purposes of applying paragraph (c) of this section, a successor suspended loss QBU terminates if it ceases to be an eligible QBU of its owner.

(k) Anti-abuse. No section 987 loss is recognized under this section, ¡ì1.987-5, or ¡ì1.987-12 in connection with a transaction or series of transactions that are undertaken with a principal purpose of avoiding the purposes of this section.

(l) Definitions. The following definitions apply for purposes of this section.

(1) Original suspended loss QBU owner¡ª(¾±) In general. An original suspended loss QBU owner is the person that was the owner of a section 987 QBU before its termination in a transaction to which paragraph (b)(1) of this section applies.

(ii) Successors. If an original suspended loss QBU owner is a corporation (transferor corporation) and another corporation acquires the assets of the transferor corporation in a transaction described in section 381(a), then the acquiring corporation becomes the original suspended loss QBU owner.

(2) Successor suspended loss QBU. See paragraphs (b)(1) and (c)(1) of this section and ¡ì1.987-12(d) for rules regarding when an eligible QBU is a successor suspended loss QBU.

(3) Successor suspended loss QBU owner. A successor suspended loss QBU owner is the owner of the assets and liabilities of a successor suspended loss QBU.

(4) Ownership interests. The term ownership interests means stock in a corporation and partnership interests in a partnership.

(5) Significant portion. With respect to the assets of an eligible QBU, the term significant portion means a significant portion of the operating assets, determined based on all the facts and circumstances, provided that more than 30 percent of the operating assets will constitute a significant portion in all cases and less than 10 percent of the operating assets will not constitute a significant portion in all cases.

(m) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC1 is a domestic corporation that owns all of the interests in Entity A, a DE. Entity A conducts Business A, a section 987 QBU that is engaged in the business of selling Product X. Business A has the euro as its functional currency.

(1) Example 1: Trade or business of a section 987 QBU ceases¡ª(¾±) Facts. Entity A¡¯s trade or business of selling Product X ceases, resulting in a termination of the Business A section 987 QBU under ¡ì1.987-8(b)(1). After the trade or business is wound up, the remaining assets are transferred to DC1 and are not used in the trade or business of selling Product X immediately following the termination. Business A has cumulative suspended section 987 loss under ¡ì1.987-11(b) of $500x.

(ii) Analysis. Immediately after the termination of the Business A section 987 QBU, a significant portion of Business A¡¯s assets is not reflected on the books and records of an eligible QBU that carries on a trade or business of Business A and is owned by DC1 or a member of its controlled group. Therefore, Business A has no successor suspended loss QBU under paragraph (b)(1) of this section. Consequently, DC1 recognizes the cumulative suspended section 987 loss with respect to the Business A section 987 QBU under paragraph (b)(2) of this section.

(2) Example 2: Trade or business of a section 987 QBU is sold to a third party¡ª(¾±) Facts. DC1 sells all the interests in Entity A to a third party for cash. Business A has cumulative suspended section 987 loss under ¡ì1.987-11(b) of $500x.

(ii) Analysis. Under ¡ì1.987-2(c)(2)(ii), the sale of the Business A assets and liabilities for cash that is reflected on the books of DC1 is treated as a transfer of all of the assets and liabilities of Business A to DC1, followed immediately by DC1¡¯s sale of those assets and liabilities. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A¡¯s assets to DC1, the Business A section 987 QBU terminates under ¡ì1.987-8(b)(2). Immediately after the termination of the Business A section 987 QBU, a significant portion of Business A¡¯s assets is not reflected on the books and records of an eligible QBU that carries on a trade or business of Business A and is owned by DC1 or a member of its controlled group. Therefore, Business A has no successor suspended loss QBU under paragraph (b)(1) of this section. Consequently, DC1 recognizes the cumulative suspended section 987 loss with respect to the Business A section 987 QBU under paragraph (b)(2) of this section.

(3) Example 3: Outbound loss event¡ª(¾±) Facts. Entity A elects to be classified as a corporation under ¡ì301.7701-3(c) of this chapter. As a result of the election and pursuant to ¡ì301.7701-3(g)(1)(iv) of this chapter, DC1 is treated as contributing all of the assets and liabilities of Business A to newly formed CFC1, which has the euro as its functional currency. Immediately after the contribution, the assets and liabilities of Business A are reflected on CFC1¡¯s books and records (which are the only books and records maintained by CFC1). CFC1 continues to use those assets in the same trade or business after the contribution (Business B). Neither a current rate election nor an annual recognition election is in effect. Business A has net unrecognized section 987 loss of $500x.

(ii) Analysis¡ª(´¡) Under ¡ì1.987-2(c)(2)(ii), DC1¡¯s contribution of all of the assets and liabilities of Business A to CFC1 is treated as a transfer of all of the assets and liabilities of Business A to DC1, followed immediately by DC1¡¯s contribution of those assets and liabilities to CFC1. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A¡¯s assets to DC1, the Business A section 987 QBU terminates under ¡ì1.987-8(b)(2). The contribution of Business A¡¯s assets to CFC1 is not a deferral event within the meaning of ¡ì1.987-12(g)(1) because, immediately after the transaction, no assets of Business A are reflected on the books and records of a successor deferral QBU within the meaning of ¡ì1.987-12(g)(2) due to the fact that the assets of Business A are not reflected on the books and records of a section 987 QBU immediately after the termination, as well as the fact that the requirement of ¡ì1.987-12(g)(2)(iii) is not met because Business A was owned by a U.S. person and the potential successor deferral QBU (Business B) is not owned by a U.S. person. The termination of the Business A section 987 QBU as a result of the transfer of the assets of Business A by a U.S. person (DC1) to a foreign person (CFC1) that is a member of DC1¡¯s controlled group is an outbound loss event described in paragraph (h)(2) of this section.

(B) Under paragraphs (h)(1) and (3) of this section, in the taxable year of the outbound loss event, DC1 includes in taxable income section 987 loss recognized with respect to Business A as determined under ¡ì1.987-5, except that, for purposes of applying ¡ì1.987-5, all assets and liabilities of Business A that are reflected on the books and records of CFC1, a related foreign person described in paragraph (h)(2) of this section, are treated as not having been transferred. Accordingly, DC1¡¯s remittance proportion with respect to Business A is 0, and DC1 recognizes no section 987 loss with respect to Business A. DC1¡¯s outbound section 987 loss is $500x, which is the amount of section 987 loss that DC1 would have recognized under ¡ì1.987-5 without regard to paragraph (h) of this section ($500x), less the amount of section 987 loss recognized by DC1 under paragraph (h)(3) of this section ($0). Under paragraph (h)(4) of this section, the $500x of outbound section 987 loss becomes suspended section 987 loss.

(C) Under paragraph (b)(1)(i) of this section, Business B is a successor suspended loss QBU because, immediately after the termination of the Business A section 987 QBU, the Business A assets are reflected on the books and records of Business B (which is the only set of books and records maintained by CFC1), Business B was an eligible QBU that continued to carry on the same trade or business as Business A did before the contribution, and Business B was owned by CFC1, a member of the same controlled group as DC (which is the original suspended loss QBU owner under paragraph (l)(1) of this section). See ¡ì1.987-1(b)(4)(ii) (providing that, if a corporation is solely engaged in activities that constitute a trade or business, and the corporation maintains only one set of books and records, the activities (but not the corporation) are a qualified business unit). Therefore, under paragraph (b)(1)(ii) of this section, all of Business A¡¯s suspended section 987 loss (including the suspended section 987 loss resulting from the termination of Business A) is treated as suspended section 987 loss of DC1 with respect to Business B.

(a) Overview. This section provides rules relating to section 987 hedging transactions. Paragraph (b) of this section provides the definition of a section 987 hedging transaction. Paragraph (c) of this section provides identification requirements for section 987 hedging transactions. Paragraph (d) of this section provides rules relating to the taxation of section 987 hedging transactions. Paragraph (e) of this section provides examples illustrating the rules of this section.

(b) Section 987 hedging transaction¡ª(1) In general. A section 987 hedging transaction is a financial instrument or a combination or series of financial instruments (a hedge), that is entered into by the owner of a section 987 QBU as part of the normal course of the owner¡¯s trade or business for the purpose of managing exchange rate risk with respect to all or part of the owner¡¯s net investment in the section 987 QBU (the hedged QBU), provided that the requirements of paragraph (b)(2) of this section are met. If only part of a financial instrument (or combination or series of financial instruments) is described in the preceding sentence, that part is treated as a section 987 hedging transaction for purposes of this section.

(2) Requirements. A transaction is a section 987 hedging transaction described in paragraph (b)(1) of this section for a taxable year only if the following requirements are met.

(i) Identification. The hedge must be identified as a section 987 hedging transaction with respect to the hedged QBU under paragraph (c) of this section. The financial instrument or instruments that comprise the hedge must not be identified as a section 987 hedging transaction with respect to any other section 987 QBU. If only part of a financial instrument (or combination or series of financial instruments) is a section 987 hedging transaction, that part must be clearly identified.

(ii) Current rate election. A current rate election must be in effect for the taxable year.

(iii) Mark-to-market method of accounting. Section 988 gain or loss of the owner with respect to the hedge must be accounted for under a mark-to-market method of accounting (for example, under section 1256). In addition, if a member of the owner¡¯s controlled group is a party to the hedge, any section 988 gain or loss of the controlled group member with respect to the hedge must be accounted for under a mark-to-market method of accounting.

(iv) Treatment under U.S. generally accepted accounting principles. Foreign currency gain or loss on the hedge must be properly accounted for under generally accepted accounting principles as a cumulative foreign currency translation adjustment to shareholders¡¯ equity.

(v) Hedge entered into by owner of the hedged QBU. The hedge must be entered into by the owner of the hedged QBU (and not by a section 987 QBU of the owner). In the case of a hedged QBU that is owned by a member of a consolidated group, the hedge must be entered into by the member that owns the hedged QBU.

(3) Anti-abuse rule. If a taxpayer enters into a hedge or a related transaction with a principal purpose of effectively converting section 987 gain or loss into section 988 gain or loss (or another type of income or loss) of the owner or a related party, the hedge is not treated as a section 987 hedging transaction.

(4) Partial termination of a section 987 hedging transaction. If only part of a financial instrument is a section 987 hedging transaction, and a part of the financial instrument is terminated or disposed of, a proportionate part of the section 987 hedging transaction is treated as terminated or disposed of.

(c) Identification requirements¡ª(1) In general. The owner of a hedged QBU must clearly identify the hedge as a section 987 hedging transaction with respect to the hedged QBU in its books and records on or before the close of the day on which the owner entered into the hedge. The identification must meet the requirements of ¡ì1.1221-2(f)(4) and must include the following information¡ª

(i) The date on which the hedge is entered into by the owner of the hedged QBU and the date on which the hedge is identified as a section 987 hedging transaction;

(ii) A description of the hedge; and

(iii) Identification of the hedged QBU.

(2) Inadvertent error. If a hedge is not identified under paragraph (c)(1) of this section, but the hedge would otherwise qualify as a section 987 hedging transaction with respect to a hedged QBU within the meaning of paragraph (b) of this section and the taxpayer can demonstrate to the satisfaction of the Commissioner that its failure to identify the hedge was due to inadvertent error, the taxpayer may treat the hedge as a section 987 hedging transaction if all of the owner¡¯s hedges described in paragraph (b) of this section in all open years are being treated on either original or, if necessary, amended returns as section 987 hedging transactions subject to the rules of paragraph (d) of this section.

(d) Taxation of section 987 hedging transactions¡ª(1) Hedging gain or loss with respect to a hedged QBU. If the owner of a section 987 QBU has entered into a section 987 hedging transaction with respect to the section 987 QBU, the owner¡¯s hedging gain or loss with respect to the hedged QBU for a taxable year is equal to the gain or loss that the owner would (but for the application of this paragraph (d)) recognize under section 988 with respect to the section 987 hedging transaction in the taxable year under the mark-to-market method of accounting described in paragraph (b)(2)(iii) of this section (including gain or loss that would be recognized in connection with a complete or partial disposition or termination of the section 987 hedging transaction). If only part of a financial instrument is a section 987 hedging transaction, a proportionate part of the gain or loss that would (but for the application of this paragraph (d)) be recognized under section 988 with respect to the financial instrument in the taxable year is treated as hedging gain or loss with respect to the hedged QBU. See paragraph (d)(3) of this section for rules relating to the determination of hedging gain or loss in the taxable year in which the hedged QBU terminates.

(2) Adjustment to unrecognized section 987 gain or loss for the taxable year¡ª(i) Hedging loss. In a taxable year in which an owner has hedging loss with respect to a hedged QBU and has unrecognized section 987 gain for the taxable year with respect to the hedged QBU (as determined under ¡ì1.987-4(d), without regard to this paragraph (d)), the unrecognized section 987 gain for the taxable year is reduced (but not below zero) by the amount of the hedging loss. The amount of hedging loss that reduces unrecognized section 987 gain under this paragraph (d)(2)(i) is not recognized under section 988. Any hedging loss that does not reduce unrecognized section 987 gain under this paragraph (d)(2)(i) is recognized under section 988.

(ii) Hedging gain. In a taxable year in which an owner has hedging gain with respect to a hedged QBU and has unrecognized section 987 loss for the taxable year with respect to the hedged QBU (as determined under ¡ì1.987-4(d), without regard to this paragraph (d)), the unrecognized section 987 loss for the taxable year is reduced (but not below zero) by the amount of the hedging gain. The amount of hedging gain that reduces unrecognized section 987 loss under this paragraph (d)(2)(ii) is not recognized under section 988. Any hedging gain that does not reduce unrecognized section 987 loss under this paragraph (d)(2)(ii) is recognized under section 988.

(3) Termination of a hedged QBU. If the owner of a section 987 QBU has entered into a section 987 hedging transaction with respect to the section 987 QBU and the hedged QBU terminates, the owner¡¯s hedging gain or loss with respect to the hedged QBU for the taxable year is equal to the hedging gain or loss that the owner would (but for the application of this paragraph (d)) recognize with respect to the section 987 hedging transaction under the mark-to-market method of accounting described in paragraph (b)(2)(iii) of this section if the taxable year ended on the termination date. Appropriate adjustments must be made to prevent the section 988 gain or loss from being taken into account again after it is applied to reduce unrecognized section 987 gain or loss under this paragraph (d).

(e) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC1 is a domestic corporation that owns Business A, a section 987 QBU that has the euro as its functional currency. A current rate election is in effect for years 1 and 2, but no other elections are in effect. In year 1, DC1 had net unrecognized section 987 loss (determined under ¡ì1.987-4(b)) of $1,000x with respect to Business A, and Business A did not make a remittance in year 1. As a result, in year 2, DC1¡¯s net accumulated unrecognized section 987 loss from prior taxable years (determined under ¡ì1.987-4(c)) was $1,000x. In year 2, DC1 had unrecognized section 987 loss for the taxable year (determined under ¡ì1.987-4(d) before the application of paragraph (d) of this section) of $500x.

(1) Example 1: Section 987 hedging transaction¡ª(¾±) Facts. In year 2, DC1 entered into a six-month foreign currency forward contract with an unrelated bank in the normal course of DC1¡¯s trade or business for the purpose of managing exchange rate risk with respect to DC1¡¯s net investment in Business A. On the same day, DC1 identified the forward contract as a section 987 hedging transaction with respect to Business A under paragraph (c) of this section. Under generally accepted accounting principles, currency gain or loss from the forward contract is accounted for as a cumulative translation adjustment to shareholder¡¯s equity. For Federal income tax purposes, DC1 accounts for section 988 gain or loss with respect to the forward contract under a mark-to-market method of accounting. But for the application of paragraph (d) of this section, DC1 would recognize $400x of section 988 gain with respect to the forward contract.

(ii) Analysis¡ª(´¡) Qualification of the hedge as a section 987 hedging transaction. The forward contract qualifies as a section 987 hedging transaction under paragraph (b) of this section because it is a financial instrument that manages DC1¡¯s exchange rate risk with respect to Business A (the hedged QBU) as part of the normal course of DC1¡¯s trade or business, and the hedge meets the requirements of paragraph (b)(2) of this section.

(B) Treatment of the section 987 hedging transaction. But for the application of paragraph (d) of this section, DC1 would recognize $400x of section 988 gain with respect to the forward contract in year 2. Therefore, DC1 has $400x of hedging gain in year 2. In year 2, DC1 had unrecognized section 987 loss of $500x for the taxable year (determined under ¡ì1.987-4(d) before the application of paragraph (d) of this section). Therefore, under paragraph (d)(2)(ii) of this section, DC1¡¯s unrecognized section 987 loss for the taxable year of $500x is reduced by the $400x of hedging gain. Accordingly, DC1 has unrecognized section 987 loss of $100x for the taxable year with respect to Business A. Under ¡ì1.987-4(b), DC1 has $1,100x of net unrecognized section 987 loss in year 2 (equal to the sum of its net accumulated section 987 loss of $1,000x from prior taxable years and its unrecognized section 987 loss for the taxable year of $100x). DC1 does not recognize its hedging gain under section 988 because all of the hedging gain reduces unrecognized section 987 loss for the taxable year.

(2) Example 2: Excess hedging gain from a section 987 hedging transaction¡ª(¾±) Facts. The facts are the same as in paragraph (e)(1) of this section (Example 1) except that, but for the application of paragraph (d) of this section, DC1 would recognize $600x of section 988 gain with respect to the forward contract.

(ii) Analysis. Under paragraph (d)(2)(ii) of this section, DC1¡¯s unrecognized section 987 loss for the taxable year of $500x is reduced by the hedging gain, but not below zero. Accordingly, $500x of the hedging gain is applied to reduce DC1¡¯s unrecognized section 987 loss for the taxable year to zero. DC1 has $1,000x of net unrecognized section 987 loss in year 2 under ¡ì1.987-4(b) (equal to its net accumulated section 987 loss of $1,000x from prior taxable years). The $500x hedging gain that reduces unrecognized section 987 loss for the taxable year is not recognized under section 988. The excess amount of hedging gain ($100x) is recognized by DC1 under section 988.

(a) Applicability date of the section 987 regulations¡ª(1) In general. Except as provided in this section, the section 987 regulations apply to taxable years beginning after December 31, 2024.

(2) Applicability date for a terminating QBU. The section 987 regulations apply to the owner of a terminating QBU immediately before the section 987 QBU terminates, but only with respect to the section 987 QBU, any successor deferral QBUs or successor suspended loss QBUs (in their capacity as such), and any net unrecognized section 987 gain or loss, deferred section 987 gain or loss, or suspended section 987 loss with respect thereto. See ¡ì1.987-1(h) for the definition of a terminating QBU.

(b) Application of the section 987 regulations to taxable years beginning on or before December 31, 2024, and ending after November 9, 2023. A taxpayer (including a taxpayer that has applied the 2016 and 2019 section 987 regulations to a prior taxable year under paragraph (c) of this section) may choose to apply the section 987 regulations to a taxable year beginning on or before December 31, 2024, and ending after November 9, 2023, provided the taxpayer and each member of its consolidated group and section 987 electing group:

(1) Consistently apply the section 987 regulations in their entirety to the taxable year and all subsequent taxable years beginning on or before December 31, 2024; and

(2) Apply the section 987 regulations on their original timely filed (including extensions) returns for the first taxable year to which the taxpayer chooses to apply the section 987 regulations.

(c) Application of the 2016 and 2019 section 987 regulations¡ª(1) In general. A taxpayer may choose to apply the 2016 and 2019 section 987 regulations to a taxable year beginning after December 7, 2016, and beginning on or before December 31, 2024, provided the taxpayer and each member of its consolidated group and section 987 electing group:

(i) First apply the 2016 and 2019 section 987 regulations to a taxable year ending before November 9, 2023;

(ii) Consistently apply the 2016 and 2019 section 987 regulations in their entirety to all section 987 QBUs (within the meaning of prior ¡ì1.987-1(b)(2)) directly or indirectly owned (within the meaning of prior ¡ì1.987-1(b)(4)) by the taxpayer and each member of its consolidated group and section 987 electing group on the transition date for that taxable year and all subsequent taxable years before the taxable year in which the taxpayer and each member of its consolidated group and section 987 electing group apply the section 987 regulations pursuant to paragraph (a) or (b) of this section; and

(iii) Either¡ª

(A) First applied the 2016 and 2019 section 987 regulations on their returns filed before November 9, 2023; or

(B) First apply the 2016 and 2019 section 987 regulations on their returns filed on or after November 9, 2023 and apply ¡ì1.987-10 in lieu of prior ¡ì1.987-10.

(2) Application to section 987 QBUs not owned on the transition date. For any taxable year in which a taxpayer applies the 2016 and 2019 section 987 regulations pursuant to paragraph (c)(1) of this section, the taxpayer may choose to apply the 2016 and 2019 section 987 regulations to any section 987 QBU (within the meaning of prior ¡ì1.987-1(b)(2)) that the taxpayer did not directly or indirectly own (within the meaning of prior ¡ì1.987-1(b)(4)) on the transition date, provided the taxpayer applies the 2016 and 2019 section 987 regulations consistently to that QBU for that taxable year and all subsequent taxable years before the taxable year in which the taxpayer applies the section 987 regulations pursuant to paragraph (a) or (b) of this section and the taxpayer either¡ª

(i) First applied the 2016 and 2019 section 987 regulations to the section 987 QBU on its return filed before November 9, 2023; or

(ii) First applies the 2016 and 2019 section 987 regulations to the section 987 QBU on its return filed on or after November 9, 2023, and applies ¡ì1.987-10 in lieu of prior ¡ì1.987-10.

(3) Modifications of defined terms for purposes of this paragraph (c). Solely for purposes of this paragraph (c)¡ª

(i) Application of ¡ì1.987-10 in lieu of prior ¡ì1.987-10. For any taxpayer to which paragraph (c)(1)(iii)(B) or (c)(2)(ii) of this section applies, the term 2016 and 2019 section 987 regulations includes ¡ì1.987-10 and not prior ¡ì1.987-10.

(ii) Partnerships not included in section 987 electing group. The term section 987 electing group does not include foreign partnerships.

(iii) Transition date. The term transition date has the meaning provided in prior ¡ì1.987-10.

(d) Prior ¡ì1.987-12. For the applicability dates of prior ¡ì1.987-12, see prior ¡ì1.987-12(j). Prior ¡ì1.987-12 applies through the end of the taxable year immediately preceding the first taxable year in which a taxpayer applies ¡ì1.987-12 pursuant to paragraph (a) or (b) of this section.

Par. 9. Section 1.988-1 is amended by:

a. Removing and reserving paragraph (a)(4);

b. Revising paragraph (a)(10)(i);

c. Removing the language ¡°1988¡± in the fourth sentence of paragraph (a)(1)(iii) and adding the language ¡°2025¡± in its place; and

d. Revising paragraph (i).

The revisions read as follows:

(a) * * *

(10) * * *

(i) In general. Except as provided in paragraph (a)(10)(ii) of this section, disregarded transactions between or among the taxpayer and/or qualified business units of that taxpayer (¡°intra-taxpayer transactions¡±) are not section 988 transactions. See section 987 and the regulations thereunder.

* * * * *

(i) Applicability date¡ª(1) In general. Except as otherwise provided in this section, this section applies to taxable years beginning after December 31, 1986. Thus, except as otherwise provided in this section, any payments made or received with respect to a section 988 transaction in taxable years beginning after December 31, 1986, are subject to this section.

(2) Paragraph (a)(10)(ii). Generally, paragraph (a)(10)(ii) of this section applies to taxable years beginning after December 31, 2024. However, if pursuant to ¡ì1.987-15(b), a taxpayer chooses to apply ¡ì¡ì1.987-1 through 1.987-15 to a taxable year before the first taxable year described in ¡ì1.987-15(a)(1), then paragraph (a)(10)(ii) of this section applies to that taxable year. See ¡ì1.988-1(i), as contained in 26 CFR in part 1 in effect on April 1, 2024, for a prior applicability date for paragraph (a)(10)(ii) of this section.

Par. 10. Section 1.988-4 is amended by revising paragraph (b)(2) to read as follows:

* * * * *

(b) * * *

(2) Proper reflection on the books of the taxpayer or qualified business unit¡ª(¾±) In general. For purposes of paragraph (b)(1) of this section, the principles of ¡ì1.987-2(b) apply in determining whether an asset, liability, or item of income, gain, deduction, or loss is reflected on the books and records of a qualified business unit.

(ii) Applicability date. Generally, paragraph (b)(2)(i) of this section applies to taxable years beginning after December 31, 2024. However, if pursuant to ¡ì1.987-15(b), a taxpayer chooses to apply ¡ì¡ì1.987-1 through 1.987-15 to a taxable year before the first taxable year described in ¡ì1.987-15(a)(1), then paragraph (b)(2)(i) of this section applies to that taxable year.

* * * * *

Par. 11. Section 1.989(a)-1 is amended by:

a. Removing and reserving paragraph (b)(2)(i)(C).

b. Revising paragraphs (b)(4), (d)(3) and (4).

The revisions read as follows:

* * * * *

(b) * * *

(4) Applicability date. Generally, paragraph (b)(2)(i) of this section applies to taxable years beginning after December 31, 2024. However, if pursuant to ¡ì1.987-15(b), a taxpayer chooses to apply ¡ì¡ì1.987-1 through 1.987-15 to a taxable year before the first taxable year described in ¡ì1.987-15(a)(1), then paragraph (b)(2)(i) of this section applies to that taxable year. See ¡ì1.989(a)-1(b)(4), as contained in 26 CFR in part 1 in effect on April 1, 2024, for a prior applicability date for paragraph (b)(2)(i) of this section.

* * * * *

(d) * * *

(3) Proper reflection on the books of the taxpayer or qualified business unit. The principles of ¡ì1.987-2(b) apply in determining whether an asset, liability, or item of income, gain, deduction, or loss is reflected on the books of a qualified business unit (and therefore is attributable to such unit).

(4) Applicability date. Generally, paragraph (d)(3) of this section applies to taxable years beginning after December 31, 2024. However, if pursuant to ¡ì1.987-15(b), a taxpayer applies ¡ì¡ì1.987-1 through 1.987-15 to a taxable year before the first taxable year described in ¡ì1.987-15(a)(1), then paragraph (d)(3) of this section applies to that taxable year. See ¡ì1.989(a)-1(d)(4), as contained in 26 CFR in part 1 in effect on April 1, 2024, for a prior applicability date for paragraph (d)(3) of this section.

* * * * *

Par. 12. Section 1.1502¨C13 is amended by revising paragraph (j)(9) and adding paragraphs (j)(10) and (l)(7) to read as follows:

* * * * *

(j) * * *

(9) Section 987 QBUs. No intercompany transaction is attributable to a section 987 QBU (within the meaning of ¡ì1.987-2(b)). That is, in order to produce single entity treatment, an intercompany transaction that otherwise would involve the section 987 QBU(s) of one or more members is treated instead as occurring directly between the members (without the involvement of any section 987 QBUs), and transfers are deemed to take place between each section 987 QBU and its owner (see ¡ì1.987-2(c)(2)(ii)). For example, if a member (M1) lends money to the section 987 QBU of another member (M2), this intercompany transaction is treated as a loan from M1 to M2 and a contribution from M2 to its section 987 QBU.

(10) Examples. The operating rules of this paragraph (j) are illustrated generally throughout this section, and by the following examples.

(i) Example 1. Intercompany sale followed by section 351 transfer to member¡ª (A) Facts. S holds land for investment with a basis of $70. On January 1 of Year 1, S sells the land to M for $100. M also holds the land for investment. On July 1 of Year 3, M transfers the land to B in exchange for all of B¡¯s stock in a transaction to which section 351 applies. Under section 358, M¡¯s basis in the B stock is $100. B holds the land for sale to customers in the ordinary course of business and, under section 362(b), B¡¯s basis in the land is $100. On December 1 of Year 5, M sells 20% of the B stock to X for $22. In an unrelated transaction on July 1 of Year 8, B sells 20% of the land for $22.

(B) Definitions. Under paragraph (b)(1) of this section, S¡¯s sale of the land to M and M¡¯s transfer of the land to B are both intercompany transactions. S is the selling member and M is the buying member in the first intercompany transaction, and M is the selling member and B is the buying member in the second intercompany transaction. M has no intercompany items under paragraph (b)(2) of this section. Because B acquired the land in an intercompany transaction, B¡¯s items from the land are corresponding items to be taken into account under this section. Under the successor asset rule of paragraph (j)(1) of this section, references to the land include references to M¡¯s B stock. Under the successor person rule of paragraph (j)(2) of this section, references to M include references to B with respect to the land.

(C) Timing and attributes resulting from the stock sale. Under paragraph (c)(3) of this section, M is treated as owning and selling B¡¯s stock for purposes of the matching rule even though, as divisions, M could not own and sell stock in B. Under paragraph (j)(3) of this section, both M¡¯s B stock and B¡¯s land can cause S¡¯s intercompany gain to be taken into account under the matching rule. Thus, S takes $6 of its gain into account in Year 5 to reflect the $6 difference between M¡¯s $2 gain taken into account from its sale of B stock and the $8 recomputed gain. Under paragraph (j)(4) of this section, the attributes of this gain are determined by treating S, M, and B as divisions of a single corporation. Under paragraph (c)(1) of this section, S¡¯s $6 gain and M¡¯s $2 gain are treated as long-term capital gain. The gain would be capital on a separate entity basis (assuming that section 341 does not apply), and this treatment is not inconsistent with treating S, M, and B as divisions of a single corporation because the stock sale and subsequent land sale are unrelated transactions and B remains a member following the sale.

(D) Timing and attributes resulting from the land sale. Under paragraph (j)(3) of this section, S takes $6 of its gain into account in Year 8 under the matching rule to reflect the $6 difference between B¡¯s $2 gain taken into account from its sale of an interest in the land and the $8 recomputed gain. Under paragraph (j)(4) of this section, the attributes of this gain are determined by treating S, M, and B as divisions of a single corporation and taking into account the activities of S, M, and B with respect to the land. Thus, both S¡¯s gain and B¡¯s gain might be ordinary income as a result of B¡¯s activities. (If B subsequently sells the balance of the land, S¡¯s gain taken into account is limited to its remaining $18 of intercompany gain.)

(E) Sale of successor stock resulting in deconsolidation. The facts are the same as in paragraph (j)(10)(i)(A) of this section (Example 1), except that M sells 60% of the B stock to X for $66 on December 1 of Year 5 and B becomes a nonmember. Under the matching rule, M¡¯s sale of B stock results in $18 of S¡¯s gain being taken into account (to reflect the difference between M¡¯s $6 gain taken into account and the $24 recomputed gain). Under the acceleration rule, however, the entire $30 gain is taken into account (to reflect B becoming a nonmember, because its basis in the land reflects M¡¯s $100 cost basis from the prior intercompany transaction). Under paragraph (j)(4) of this section, the attributes of S¡¯s gain are determined by treating S, M, and B as divisions of a single corporation. Because M¡¯s cost basis in the land will be reflected by B as a nonmember, all of S¡¯s gain is treated as from the land (rather than a portion being from B¡¯s stock), and B¡¯s activities with respect to the land might therefore result in S¡¯s gain being ordinary income.

(ii) Example 2. Intercompany sale of member stock followed by recapitalization¡ª(´¡) Facts. Before becoming a member of the P group, S owns P stock with a basis of $70. On January 1 of Year 1, P buys all of S¡¯s stock. On July 1 of Year 3, S sells the P stock to M for $100. On December 1 of Year 5, P acquires M¡¯s original P stock in exchange for new P stock in a recapitalization described in section 368(a)(1)(E).

(B) Timing and attributes. Although P¡¯s basis in the stock acquired from M is eliminated under paragraph (f)(4) of this section, the new P stock received by M is exchanged basis property (within the meaning of section 7701(a)(44)) having a basis under section 358 equal to M¡¯s basis in the original P stock. Under the successor asset rule of paragraph (j)(1) of this section, references to M¡¯s original P stock include references to M¡¯s new P stock. Because it is still possible to take S¡¯s intercompany item into account under the matching rule with respect to the successor asset, S¡¯s gain is not taken into account under the acceleration rule as a result of the basis elimination under paragraph (f)(4) of this section. Instead, the gain is taken into account based on subsequent events with respect to M¡¯s new P stock (for example, a subsequent distribution or redemption of the new stock).

(iii) Example 3. Back-to-back intercompany transactions¡ªmatching¡ª(´¡) Facts. S holds land for investment with a basis of $70. On January 1 of Year 1, S sells the land to M for $90. M also holds the land for investment. On July 1 of Year 3, M sells the land for $100 to B, and B holds the land for sale to customers in the ordinary course of business. During Year 5, B sells all of the land to customers for $105.

(B) Timing. Under paragraph (b)(1) of this section, S¡¯s sale of the land to M and M¡¯s sale of the land to B are both intercompany transactions. S is the selling member and M is the buying member in the first intercompany transaction, and M is the selling member and B is the buying member in the second intercompany transaction. Under paragraph (j)(4) of this section, S, M and B are treated as divisions of a single corporation for purposes of determining the timing of their items from the intercompany transactions. See also paragraph (j)(2) of this section (B is treated as a successor to M for purposes of taking S¡¯s intercompany gain into account). Thus, S¡¯s $20 gain and M¡¯s $10 gain are both taken into account in Year 5 to reflect the difference between B¡¯s $5 gain taken into account with respect to the land and the $35 recomputed gain (the gain that B would have taken into account if the intercompany sales had been transfers between divisions of a single corporation, and B succeeded to S¡¯s $70 basis).

(C) Attributes. Under paragraph (j)(4) of this section, the attributes of the intercompany items and corresponding items of S, M, and B are also determined by treating S, M, and B as divisions of a single corporation. For example, the attributes of S¡¯s and M¡¯s intercompany items are determined by taking B¡¯s activities into account.

(iv) Example 4. Back-to-back intercompany transactions¡ªacceleration¡ª(´¡) Facts. During Year 1, S performs services for M in exchange for $10 from M. S incurs $8 of employee expenses. M capitalizes the $10 cost of S¡¯s services under section 263 as part of M¡¯s cost to acquire real property from X. Under its separate entity method of accounting, S would take its income and expenses into account in Year 1. M holds the real property for investment and, on July 1 of Year 5, M sells it to B at a gain. B also holds the real property for investment. On December 1 of Year 8, while B still owns the real property, P sells all of M¡¯s stock to X and M becomes a nonmember.

(B) M¡¯s items. M takes its gain into account immediately before it becomes a nonmember. Because the real property stays in the group, the acceleration rule redetermines the attributes of M¡¯s gain under the principles of the matching rule as if B sold the real property to an affiliated corporation that is not a member of the group for a cash payment equal to B¡¯s adjusted basis in the real property, and S, M, and B were divisions of a single corporation. Thus, M¡¯s gain is capital gain.

(C) S¡¯s items. Under paragraph (b)(2)(ii) of this section, S includes the $8 of expenses in determining its $2 intercompany income. In Year 1, S takes into account $8 of income and $8 of expenses. Under paragraph (j)(4) of this section, appropriate adjustments must be made to treat both S¡¯s performance of services for M and M¡¯s sale to B as occurring between divisions of a single corporation. Thus, S¡¯s $2 of intercompany income is not taken into account as a result of M becoming a nonmember, but instead will be taken into account based on subsequent events (e.g., under the matching rule based on B¡¯s sale of the real property to a nonmember, or under the acceleration rule based on P¡¯s sale of the stock of S or B to a nonmember). See the successor person rules of paragraph (j)(2) of this section (B is treated as a successor to M for purposes of taking S¡¯s intercompany income into account).

(D) Sale of S¡¯s stock. The facts are the same as in paragraph (j)(9)(iv)(A) of this section (Example 4), except that P sells all of S¡¯s stock (rather than M¡¯s stock) and S becomes a nonmember on July 1 of Year 5. S¡¯s remaining $2 of intercompany income is taken into account immediately before S becomes a nonmember. Because S¡¯s intercompany income is not from an intercompany sale, exchange, or distribution of property, the attributes of the intercompany income are determined on a separate entity basis. Thus, S¡¯s $2 of intercompany income is ordinary income. M does not take any of its intercompany gain into account as a result of S becoming a nonmember.

(E) Intercompany income followed by intercompany loss. The facts are the same as in paragraph (j)(9)(iv)(A) of this section (Example 4), except that M sells the real property to B at a $1 loss (rather than a gain). M takes its $1 loss into account under the acceleration rule immediately before M becomes a nonmember. But see ¡ì 1.267(f)-1 (which might further defer M¡¯s loss if M and B remain in a controlled group relationship after M becomes a nonmember). Under paragraph (j)(4) of this section appropriate adjustments must be made to treat the group as if both intercompany transactions occurred between divisions of a single corporation. Accordingly, P¡¯s sale of M stock also results in S taking into account $1 of intercompany income as capital gain to offset M¡¯s $1 of corresponding capital loss. The remaining $1 of S¡¯s intercompany income is taken into account based on subsequent events.

(v) Example 5. Successor group¡ª(´¡) Facts. On January 1 of Year 1, B borrows $100 from S in return for B¡¯s note providing for $10 of interest annually at the end of each year, and repayment of $100 at the end of Year 20. As of January 1 of Year 3, B has paid the interest accruing under the note. On that date, X acquires all of P¡¯s stock and the former P group members become members of the X consolidated group.

(B) Successor. Under paragraph (j)(5) of this section, although B¡¯s note ceases to be an intercompany obligation of the P group, the note is not treated as satisfied and reissued under paragraph (g) of this section as a result of X¡¯s acquisition of P stock. Instead, the X consolidated group succeeds to the treatment of the P group for purposes of paragraph (g) of this section, and B¡¯s note is treated as an intercompany obligation of the X consolidated group.

(vi) Example 6. Liquidation¡ª80% distributee¡ª(´¡) Facts. X has had preferred stock described in section 1504(a)(4) outstanding for several years. On January 1 of Year 1, S buys all of X¡¯s common stock for $60, and B buys all of X¡¯s preferred stock for $40. X¡¯s assets have a $0 basis and $100 value. On July 1 of Year 3, X distributes all of its assets to S and B in a complete liquidation. Under ¡ì 1.1502-34, section 332 applies to both S and B. Under section 337, X has no gain or loss from its liquidating distribution to S. Under sections 336 and 337(c), X has a $40 gain from its liquidating distribution to B. B has a $40 basis under section 334(a) in the assets received from X, and S has a $0 basis under section 334(b) in the assets received from X.

(B) Intercompany items from the liquidation. Under the matching rule, X¡¯s $40 gain from its liquidating distribution to B is not taken into account under this section as a result of the liquidation (and therefore is not yet reflected under ¡ì¡ì 1.1502-32 and 1.1502-33). Under the successor person rule of paragraph (j)(2)(i) of this section, S and B are both successors to X. Under section 337(c), X recognizes gain or loss only with respect to the assets distributed to B. Under paragraph (j)(2)(ii) of this section, to be consistent with the purposes of this section, S succeeds to X¡¯s $40 intercompany gain. The gain will be taken into account by S under the matching and acceleration rules of this section based on subsequent events. (The allocation of the intercompany gain to S does not govern the allocation of any other attributes.)

(vii) Example 7. Liquidation¡ªno 80% distributee¡ª(´¡) Facts. X has only common stock outstanding. On January 1 of Year 1, S buys 60% of X¡¯s stock for $60, and B buys 40% of X¡¯s stock for $40. X¡¯s assets have a $0 basis and $100 value. On July 1 of Year 3, X distributes all of its assets to S and B in a complete liquidation. Under ¡ì 1.1502-34, section 332 applies to both S and B. Under sections 336 and 337(c), X has a $100 gain from its liquidating distributions to S and B. Under section 334(b), S has a $60 basis in the assets received from X and B has a $40 basis in the assets received from X.

(B) Intercompany items from the liquidation. Under the matching rule, X¡¯s $100 intercompany gain from its liquidating distributions to S and B is not taken into account under this section as a result of the liquidation (and therefore is not yet reflected under ¡ì¡ì 1.1502-32 and 1.1502-33). Under the successor person rule of paragraph (j)(2)(i) of this section, S and B are both successors to X. Under paragraph (j)(2)(ii) of this section, to be consistent with the purposes of this section, S succeeds to X¡¯s $40 intercompany gain with respect to the assets distributed to B, and B succeeds to X¡¯s $60 intercompany gain with respect to the assets distributed to S. The gain will be taken into account by S and B under the matching and acceleration rules of this section based on subsequent events. (The allocation of the intercompany gain does not govern the allocation of any other attributes.)

(viii) Example 8: Loan by section 987 QBU¡ª(´¡) Facts. S owns all the interests in DE1, a disregarded entity operating a business that is a section 987 QBU (S QBU) whose functional currency is the euro. S has net unrecognized section 987 gain with respect to S QBU. In year 1, S QBU lends €100 to B with interest due annually. B makes interest payments on the loan to S QBU in years 1 through 3. In year 3, B repays the loan and recognizes section 988 loss of $12 on the loan repayment. All payments are made in euros, and B recognizes no section 988 gain or loss on the euros it uses to pay the interest and principal. B is never insolvent within the meaning of section 108(d)(3). Other than with respect to the loan, there are no transfers between S and S QBU during years 1 through 3, and neither S nor B had any other foreign currency gain or loss. Neither S nor B has made an election under section 988 or the section 988 regulations.

(B) Analysis¡ª(1) Loan. Under paragraph (j)(9) of this section, the loan is treated as a transfer from S QBU to S and a loan directly between S and B. Specifically, S is treated as receiving a transfer of €100 from S QBU in year 1; S is then treated as lending €100 directly to B. For purposes of ¡ì1.987-2, the loan is attributable to S, not to S QBU. As an intercompany loan, S¡¯s loan to B is subject to the rules of this section. Because there is a remittance from S QBU to S in year 1, S recognizes section 987 gain under ¡ì1.987-5.

(2) Interest payments. While the loan is outstanding, each of B¡¯s interest payments to S QBU is treated as an interest payment from B to S, followed by a transfer from S to S QBU. Under the matching rule in paragraph (c) of this section, S¡¯s intercompany interest income offsets B¡¯s corresponding interest expense. See paragraph (g)(7)(ii)(A)(2) of this section (Example 1). Since the functional currency of both S and B is the dollar, if B recognizes any section 988 gain or loss on the interest payments, S will recognize an offsetting amount of section 988 loss or gain. Because the only transfer between S and S QBU in year 2 is from S to S QBU, there is no remittance from S QBU to S and S does not recognize section 987 gain under ¡ì1.987-5.

(3) Repayment. Upon the year 3 repayment of the loan, B is treated as repaying €100 to S, and S is treated as transferring €100 to S QBU. Since the functional currency of both S and B is the dollar, and B recognizes section 988 loss of $12 on the loan repayment, S will recognize an offsetting section 988 gain of $12. Because the only transfers between S and S QBU in year 3 are from S to S QBU, there is no remittance from S QBU to S and S does not recognize section 987 gain under ¡ì1.987-5.

(4) Summary. Overall, the group¡¯s taxable income includes S¡¯s section 987 gain in year 1 (the section 988 inclusions offset). This result is consistent with the treatment of a single corporation that borrows from its section 987 QBU.

(C) Loan sold to non-member. The facts are the same as in paragraph (j)(10)(viii)(A) of this section, except that, in year 3, S QBU sells the loan to unrelated X for €90, reflecting an increase in prevailing market interest rates. Up until the sale, the analysis is the same as in paragraphs (j)(10)(viii)(B)(1) and (2) of this section. Because the loan is attributable to S (see paragraphs (j)(9) and (j)(10)(viii)(B)(1) of this section), the sale is treated as a sale by S. Under paragraph (g)(3) of this section, immediately before the sale, B is deemed to satisfy and reissue the loan for its fair market value of €90. As a result, B takes into account cancellation of indebtedness income, and S takes into account an offsetting amount of ordinary loss. See paragraph (g)(7)(ii) (Example 2) of this section. If there is currency gain or loss, S and B take into account offsetting amounts of gain and loss under section 988 (subject to the limitation of ¡ì1.988-2(b)(8)). Because S has a basis of €90 in the new loan, S recognizes no gain or loss on the sale to X. S is then treated as transferring the €90 to S QBU.

(D) Party becomes a nonmember. The facts are the same as in paragraph (j)(10)(viii)(A) of this section, except that, in year 3, B becomes a nonmember. Up until B leaves the group, the analysis is the same as in paragraphs (j)(10)(viii)(B)(1) and (2) of this section. Immediately before B becomes a nonmember, B is deemed to satisfy and reissue the loan for its fair market value under paragraph (g)(3) of this section, with the same consequences as described in paragraph (j)(10)(viii)(C) of this section. When B becomes a nonmember, the loan (which is no longer an intercompany obligation) ceases to be subject to paragraph (j)(9) of this section. If the loan is attributable to S QBU under ¡ì1.987-2, S is treated as transferring the loan to S QBU.

(ix) Example 9: Sale of property by section 987 QBU¡ª(´¡) Facts. M1 owns all the interests in DE1, a disregarded entity operating a business that is a section 987 QBU (M1 QBU) whose functional currency is the euro. M1 has net unrecognized section 987 gain with respect to M1 QBU. M1 QBU sells property to M2 for €100 in year 1.

(B) Analysis¡ª(1) In general. Under paragraph (j)(9) of this section, the sale of property is treated as a transfer of the property from M1 QBU to M1, followed by an exchange of the property for €100 directly between M1 and M2, and a transfer of the €100 from M1 to M1 QBU.

(2) Distribution. M1 QBU is treated as transferring the property to M1.

(3) Exchange. M1 is then treated as selling the property to M2 for €100. M1 takes into account its intercompany gain or loss on the property under the rules of this section. M2 recognizes intercompany section 988 gain or loss on its exchange of €100 for the property. See paragraph (b)(1)(iii) of this section for property exchanges between members.

(4) Contribution. Finally, M1 is treated as transferring the €100 to M1 QBU. Because M1¡¯s basis in the €100 equals its fair market value, M1 has a corresponding section 988 gain or loss of zero upon the contribution. See ¡ì1.988-1(a)(10). Both the transfer of the property from M1 QBU to M1 and the transfer of the €100 from M1 to M1 QBU are taken into account in determining whether there is a remittance from M1 QBU to M1 in year 1 and whether M1 recognizes section 987 gain under ¡ì1.987-5.

(5) Summary. Overall, in year 1, M1 may take into account section 987 gain if the transfers between M1 and M1 QBU result in a remittance, and M2 takes into account section 988 gain or loss on the €100. This result is consistent with the treatment of a single corporation that purchases property from its section 987 QBU.

(l) * * *

(7) Applicability date. Generally, paragraph (j)(9) of this section applies to taxable years beginning after December 31, 2024, for which the original Federal income tax return is due (without extensions) after December 11, 2024. However, if pursuant to ¡ì1.987-15(b), a taxpayer chooses to apply ¡ì¡ì1.987-1 through 1.987-15 to a taxable year before the first taxable year described in ¡ì1.987-15(a)(1), then paragraph (j)(9) of this section applies to that taxable year and subsequent years.

Douglas W. O¡¯Donnell, Deputy Commissioner.

Approved: November 20, 2024

Aviva R. Aron-Dine, Deputy Assistant Secretary of the Treasury (Tax Policy).

(obÌåÓýd by the Office of the Federal Register December 10, 2024, 8:45 a.m., and published in the issue of the Federal Register for December 11, 2024, 89 FR 100138)

¹ The reference to ¡°this subpart¡± refers to subpart J of part III of subchapter N of chapter 1 of the Code, which includes section 987.

² Taxpayers would still need to track the gross assets of a section 987 QBU for other purposes, including the denominator of the remittance proportion under ¡ì1.987-5.

³ The Treasury Department and the IRS previously published proposed regulations in the Federal Register on December 19, 2017 (82 FR 60135), which contained proposed rules relating to the treatment of a net investment hedge for purposes of the business needs exception to the definition of foreign personal holding company income under section 954(c)(1)(D) and ¡ì1.954-2(g)(2)(ii). Those proposed regulations would apply only for purposes of the business needs exception and do not address the potential for mismatches in other contexts.

⁴ While ¡ì1.954-1(c)(1)(iii)(A)(1) includes categories of foreign personal holding company income, it expressly excludes passive foreign personal holding company income, which is described in ¡ì1.954-1(c)(1)(iii)(B). Therefore, the two elections apply to mutually exclusive income groups.

⁵ While the legislative history relating to the GILTI high-tax exclusion indicates that high-taxed income does not present base erosion concerns, the policy rationale underlying that view does not extend to excluding low-taxed income from GILTI merely because it may be earned by an entity that also earns high-taxed income. See S. Comm. on the Budget, Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. Print. No. 115¨C20, at 371 (2017) (¡®¡®The Committee believes that certain items of income earned by CFCs should be excluded from the GILTI [regime], either because they should be exempt from U.S. tax¡ªas they are generally not the type of income that is the source of the base erosion concerns¡ªor are already taxed currently by the United States. Items of income excluded from GILTI because they are exempt from U.S. tax under the bill include foreign oil and gas extraction income (which is generally immobile) and income subject to high levels of foreign tax.¡¯¡¯).

⁶ Although taxpayers that own section 987 QBUs generally are not small businesses, this rule is intended to limit the compliance burden for small businesses that may be affected.

⁷ In certain instances, a method that does not constitute a reasonable application of section 987 is treated as an eligible pretransition method in order to reduce the compliance burden of transitioning onto the section 987 regulations.

On December 31, 2018, a notice of proposed rulemaking (REG-141739-08) regarding retirement of tax-exempt bonds was published in the Federal Register (83 FR 67701) (proposed regulations). No public hearing was requested or held. Five public comments responding to the proposed regulations were received and are available at https://www.regulations.gov or upon request. After careful consideration of all the written comments, the proposed regulations are adopted as amended by this Treasury decision in response to such comments as described in the Summary of Comments and Explanation of Revisions.

1. Overview

In general, under section 103, interest received by the holders of certain bonds issued by State and local governments is exempt from Federal income tax. To qualify for the tax exemption, a bond issued by a State or local government must satisfy various eligibility requirements under sections 141 through 150 at the time of issuance of the bond. If the issuer and holder agree after issuance to modify the terms of a tax-exempt bond significantly, the original bond may be treated as having been retired and exchanged for a newly issued, modified bond. Similarly, if the issuer or its agent acquires and resells the bond, the bond may be treated as having been extinguished upon acquisition and replaced upon resale with a newly issued bond.

The term ¡°reissuance¡± commonly refers to the effect of a transaction in which a new bond is deemed to be issued in place of an old bond as a result of retirement of the old bond pursuant to such an exchange or extinguishment. In the case of a reissuance, the reissued bond must be retested for qualification under sections 103 and 141 through 150. The reissuance of an issue of tax-exempt bonds may result in various negative consequences to the issuer, such as changes in yield for purposes of the arbitrage investment yield restrictions under section 148(a), acceleration of arbitrage rebate payment obligations under section 148(f), and change-in-law risk.

2. Tender Option Bonds

Tender option bonds and variable rate demand bonds (collectively, tender option bonds) have special features that present reissuance questions. Specifically, tender option bonds have original terms that provide for a tender option interest rate mode, as described in this paragraph. Issuers of tax-exempt bonds often preauthorize several different interest rate modes in the bond documents and retain an option to switch interest rate modes under parameters set forth in the bond documents. During a tender option mode, tender option bonds have short-term interest rates that are reset periodically at various short-term intervals (typically, every seven days) based on the current market rate necessary to remarket the bonds at par. In connection with each resetting of the interest rate, the holder of a tender option bond has a right or requirement to tender the bond back to the issuer or its agent for purchase at par. Tender option bonds generally are structured with these short-term features supported by put options to enable the bonds to be eligible for purchase by tax-exempt money market funds pursuant to 17 CFR 270.2a-7 (Rule 2a-7 under the Investment Company Act of 1940).

Tender option bonds also may have interest rate mode conversion options that permit the issuer or conduit borrower to change the interest rate mode on the bonds from a tender option mode to another short-term interest rate mode or to a fixed interest rate to maturity. At the time of a conversion to another interest rate mode, the holder of a tender option bond typically has the right or requirement to tender the bond for purchase at par.

Tender option bonds generally have third-party liquidity facilities from banks or other liquidity providers to ensure that there is sufficient cash to repurchase the bonds upon a holder¡¯s tender, and they also commonly have credit enhancement from bond insurers or other third-party guarantors. Upon a holder¡¯s exercise of its tender rights in connection with either a resetting of the interest rate during a tender option mode or a conversion to another interest rate mode, a remarketing agent or a liquidity provider typically will acquire the bonds subject to the tender and resell the bonds either to the same bondholders or to others willing to purchase such bonds.

3. Existing Guidance

To address reissuance questions related to tax-exempt bonds, on December 27, 1988, the Department of the Treasury (Treasury Department) and the IRS published Notice 88-130, 1988-2 CB 543, which provides rules for determining when a tax-exempt bond is retired for purposes of sections 103 and 141 through 150. Notice 88-130 provides in part that a tax-exempt bond is retired when there is a change to the terms of the bond that results in a disposition of the bond for purposes of section 1001. In addition, Notice 88-130 provides special rules for retirement of certain tender option bonds that meet a definition of the term ¡°qualified tender bond.¡±

On June 26, 1996, the Treasury Department and the IRS published final regulations under ¡ì1.1001-3 of the Income Tax Regulations (1996 final regulations) in the Federal Register (61 FR 32926). The 1996 final regulations provide rules for determining whether a modification of the terms of a debt instrument, including a tax-exempt bond, results in an exchange for purposes of section 1001. In recognition of a need to coordinate the interaction of the prior guidance in Notice 88-130 with the 1996 final regulations for particular tax-exempt bond purposes, the Treasury Department and the IRS stated their intention to issue regulations under section 150 on this subject in the preamble of the 1996 final regulations. See 61 FR 32930.

On April 14, 2008, the Treasury Department and the IRS published Notice 2008-41, 2008-1 CB 742. Like Notice 88-130, Notice 2008-41 provides rules for determining when a tax-exempt bond is retired for purposes of sections 103 and 141 through 150 and includes special rules for qualified tender bonds. While the retirement standards provided in these two notices are similar, Notice 2008-41 was intended to coordinate the retirement standards for tax-exempt bond purposes with the 1996 final regulations on modifications of debt instruments under ¡ì1.1001-3 and to be more administrable than Notice 88-130. In order to preserve flexibility and to limit potential unintended consequences during the 2008 financial crisis, Notice 2008-41 permitted issuers to apply either notice. Generally, under Notice 2008-41, a tax-exempt bond is retired when a significant modification to the terms of the bond occurs under ¡ì1.1001-3, the bond is acquired by or on behalf of its issuer, or the bond is otherwise redeemed or retired. The notice clarifies that, for purposes of these retirement standards, the purchase of a tax-exempt bond by a third-party guarantor or third-party liquidity facility provider pursuant to the terms of the guarantee or liquidity facility is not treated as a purchase or other acquisition by or on behalf of a governmental issuer. Although these general rules apply to a qualified tender bond, Notice 2008-41 also provides that certain features of qualified tender bonds will not result in a retirement. In Notice 2008-41, the Treasury Department and the IRS reiterated their intention to provide guidance on the retirement of tax-exempt bonds in regulations under section 150.

The proposed regulations provide rules for determining when tax-exempt bonds are treated as retired for purposes of sections 103 and 141 through 150. The proposed regulations also amend ¡ì1.1001-3(a)(2) of the 1996 final regulations to conform that section to the special rules in the proposed regulations for retirement of qualified tender bonds.

After consideration of the public comments, the Treasury Department and the IRS adopt the proposed regulations as amended by this Treasury decision. This section of the preamble discusses the public comments and the revisions made in the final regulations in response to those comments.

1. General Rules for Retirement of a Tax-Exempt Bond

The proposed regulations generally provide standards for determining when a tax-exempt bond is retired for purposes of sections 103 and 141 through 150, including certain special rules for determining when qualified tender bonds are retired.

One comment suggested expanding the scope of the final regulations to cover taxable tax-advantaged bonds, such as direct pay build America bonds and tax credit bonds, because some of those bonds were also issued as tender option bonds that would benefit from the special rules for qualified tender bonds. The authorizations for these taxable tax-advantaged bonds, however, have been very limited in both time and amount, and very few of these bonds have been issued as tender option bonds. Furthermore, section 13404 of Public Law 115-97, 131 Stat. 2054, 2138 (December 22, 2017), commonly referred to as the Tax Cuts and Jobs Act, repealed the existing authority in the Code for taxable tax-advantaged bonds. Because no taxable tax-advantaged bonds currently may be issued and very few historically have been issued as tender option bonds, the Treasury Department and the IRS have determined that expanding the scope of the final regulations to include those bonds lacks sufficient justification. Accordingly, the final regulations do not adopt this comment.

The proposed regulations generally provide that a tax-exempt bond is retired if a significant modification to the terms of the bond occurs under ¡ì1.1001-3, the issuer or an agent acting on its behalf acquires the bond in a manner that liquidates or extinguishes the bondholder¡¯s investment in the bond, or the bond is otherwise redeemed (for example, redeemed at maturity).

The final regulations make one technical change to the second general rule regarding debt extinguishment to remove the reference to the ¡°bondholder¡¯s investment¡± and thus to focus more clearly on the merger of interests and attendant extinguishment that occurs when an issuer acquires its own bond either directly or through an agent.

Two comments recommended allowing an issuer to make an election to treat a tax-exempt bond as retired and reissued under the final regulations. These comments noted that it is sometimes unclear whether a transaction results in the retirement and reissuance of a tax-exempt bond. The comments described several specific situations in which such an election could address this uncertainty. The Treasury Department and the IRS recognize that such an election could reasonably reduce the burden on issuers in certain specific situations. However, the Treasury Department and the IRS have concerns that an unrestricted right to elect retirement and reissuance of tax-exempt bonds could result in unintended consequences. In response to this comment and to provide flexibility to address this issue in appropriate, tailored circumstances, the final regulations authorize the Commissioner to publish guidance in the Internal Revenue Bulletin that allows issuers to elect to treat tax-exempt bonds as retired and reissued in specific circumstances for purposes of sections 103 and 141 through 150.

2. Exceptions to Retirement of a Tax-Exempt Bond

The proposed regulations provide three exceptions to the operation of the general rules that limit retirements of tax-exempt bonds. Two of these exceptions prevent the special features of tender option bonds from resulting in a retirement. A third exception applies to all tax-exempt bonds.

A. Definition of qualified tender bond

The first two exceptions in the proposed regulations apply to qualified tender bonds, which are defined to cover tender option bonds that meet certain requirements. Specifically, a qualified tender bond is subject to certain limitations on interest rate, timing of interest payments, and maturity. A qualified tender bond must also include a qualified tender right. The proposed regulations generally define a qualified tender right as a right or obligation of the holder of a bond to tender the bond for purchase by the issuer, its agent, or another party at a purchase price equal to par plus any accrued interest. Under the proposed regulations, a qualified tender right must also require the issuer or its remarketing agent to redeem the bond or to use reasonable best efforts to resell the bond within the 90 days of the tender at a purchase price equal to par plus any accrued interest.

Four comments urged the Treasury Department and the IRS to amend the definition of a qualified tender right in the final regulations to allow a bond to be resold at a premium or discount price relative to the par amount of the bond (rather than just at a price equal to par as under the proposed regulations) when the qualified tender right is exercised in connection with a conversion of the interest rate mode to a fixed rate for the remaining term of the bond. The comments noted that, when a long-term fixed rate bond is originally issued at par, a sustained upward trend in interest rates can result in the bond having market discount as it is resold in the secondary market. If that market discount exceeds the permitted de minimis amount, the discount will be taxed as ordinary income to the holder. Premium included in the sale price of a long-term fixed rate tax-exempt bond serves as a buffer against market discount as interest rates rise over time. Accordingly, qualified tender bonds resold at a premium upon conversion of the interest rate mode on the bonds to a fixed rate to maturity generally have greater market demand and a lower yield than they would have if resold at par. The comments also noted that, even when an issue of fixed rate tax-exempt bonds is resold at an aggregate net premium price, certain bonds within the issue may be resold at a discount. The comments further noted that Notice 2008-41 permitted qualified tender bonds to be resold at a premium or a discount upon conversion of the interest rate mode to a fixed rate to maturity and treated the premium received by the issuer upon resale of the bonds as additional sale proceeds for purposes of the arbitrage investment restrictions under section 148. The final regulations adopt this comment.

One comment pointed out a technical discrepancy in the proposed regulations under which a bond may be purchased pursuant to a qualified tender right by the issuer, the issuer¡¯s agent, or another party, whereas the bond must be resold under the terms of a qualified tender right by the issuer or a remarketing agent. The comment recommended that the final regulations clarify this technical issue in the definition of a qualified tender right so that the parties that may purchase the tendered bond (that is, the issuer, the issuer¡¯s agent, or another party) are also permitted to resell the bond. The comment advised against use of the term ¡°remarketing agent¡± on the grounds that the party charged with reselling the bond may not be an agent of the issuer and the resale may be a private placement rather than a remarketing. The final regulations adopt this comment.

B. Exceptions to retirement of a qualified tender bond

A qualified tender bond has two features that could result in retirement of the bond under the general rules for retirement in the proposed regulations. First, the existence or exercise of a qualified tender right in connection with an alteration under the terms of the bond could cause the alteration to be a modification under ¡ì1.1001-3 and, if significant, that modification would result in retirement of the qualified tender bond under ¡ì1.150-3(b)(1) of the proposed regulations. For example, when accompanied by a tender right, an exercise of the issuer¡¯s option to change the interest rate or the interest rate mode under the terms of the bond could be a modification under the rule in ¡ì1.1001-3(c)(2)(iii) for alterations that result from the exercise of an option because the holder¡¯s resulting right to put the bond to the issuer or its agent under the qualified tender right upon the interest rate conversion could cause the issuer¡¯s option to fail to qualify as a unilateral option under ¡ì1.1001-3(c)(3)(i). Similarly, an issuer may be uncertain as to whether the periodic change in interest rate that occurs pursuant to the terms of a bond operating in a tender option mode could be a modification under ¡ì1.1001-3 when accompanied by a tender right. To address these circumstances, the proposed regulations provide a special exception that avoids retirement by disregarding a qualified tender right for purposes of applying ¡ì1.1001-3 to determine whether an alteration of a qualified tender bond constitutes a significant modification under ¡ì1.1001-3 that results in retirement of the bond.

One comment requested that the final regulations clarify whether this exception applies to a qualified tender right arising in connection with any alteration of the terms of the bond or only to a qualified tender right arising in connection with a change in interest rate or interest rate mode. The scope of the analogous provisions in Notices 88-130 and 2008-41 was limited to circumstances covering changes in the interest rate or interest rate mode only. The Treasury Department and the IRS intended for this special rule to be similarly limited in scope. In response to the comment, the final regulations clarify that the special rule for disregarding a qualified tender right in applying ¡ì1.1001-3 to a qualified tender bond applies only for the purpose of determining whether an alteration of the interest rate or interest rate mode pursuant to the terms of a qualified tender bond results in a retirement. The determination of whether any other alteration to the terms of a qualified tender bond, such as a change in maturity or collateral, results in a retirement under ¡ì1.150-3(b)(1)(i) is made under the general rules in ¡ì1.1001-3 without the benefit of the special exception in ¡ì1.150-3(c)(1), even if the alteration occurs contemporaneously with a change in interest rate or interest rate mode on the bond.

One comment recommended that the final regulations include several additional exceptions to the general rule under ¡ì1.150-3(b)(1) that a bond is retired for purposes of sections 103 and 141 through 150 when a significant modification occurs under ¡ì1.1001-3. Specifically, this comment requested that the final regulations include a rule from Notice 2008-41 that a modification that changes the collateral or credit enhancement on a nonrecourse tax-exempt bond is significant only if the change results in a change in payment expectations under ¡ì1.1001-3(e)(4)(vi). This special rule involved an accommodation for circumstances in the 2008 financial crisis. This comment also requested that the final regulations retain the exception in Notice 88-130 for qualified corrective changes. This exception from 1988 preceded the significant modification standard under ¡ì1.1001-3, which was finalized in the 1996 final regulations. In most circumstances, these qualified corrective changes would not be significant modifications under ¡ì1.1001-3. Further, a significant purpose of the final regulations is to improve administrability in a complex area of law by integrating the rules for retirement of a tax-exempt bond as closely as possible with the existing rules under ¡ì1.1001-3. Accordingly, the final regulations do not adopt these comments.

The second feature of a qualified tender bond that could result in retirement of the bond under the general rules for retirement in the proposed regulations is the feature under which an issuer or its agent may acquire the bond upon the holder¡¯s exercise of the qualified tender right. The general rules for retirement treat an acquisition of a bond by an issuer or an issuer¡¯s agent in a manner that extinguishes the bond as a retirement of the bond. To address this circumstance, the proposed regulations provide an exception under which the acquisition of a qualified tender bond pursuant to the exercise of a qualified tender right will not result in retirement, provided that neither the issuer nor its agent holds the bond for longer than 90 days. One comment recommended expanding this special rule to cover all tax-exempt bonds rather than just qualified tender bonds. This exception is limited to qualified tender bonds because the rate-setting mechanism on those bonds may require the issuer or its agent to purchase a tendered bond if a buyer for the bond cannot be found when the bond is tendered. The Treasury Department and the IRS have adopted this limited exception for the narrowly defined class of qualified tender bonds because the acquisition of those bonds occurs pursuant to the ordinary operation of the rate-setting mechanism on those bonds. In addition, qualified tender bonds represent a significant structured type of bonds in the tax-exempt bond market tailored to money market fund investors and the Treasury Department and the IRS have supported this structure with accommodating special rules consistently in all of the existing guidance in this area. Other tax-exempt bonds do not rely on this exception for the ordinary operation of their rate-setting mechanism. The Treasury Department and the IRS decline to expand this exception to allow issuers to hold their own bonds more generally because of concerns regarding the implications for the debt extinguishment principle. Accordingly, the final regulations do not adopt this comment.

One comment recommended continuing a special rule from Notice 2008-41 that modified the definition of program investment for purposes of arbitrage investment restrictions under ¡ì1.148-1(b). Ordinarily, this definition prohibits a conduit borrower of tax-exempt bond proceeds from purchasing the bonds that financed the conduit loan in an amount that is related to the conduit loan. Notice 2008-41 modified this rule so that a conduit borrower could purchase any auction rate bonds that financed the conduit loan, provided the conduit borrower purchased the bonds to facilitate liquidity under adverse market conditions. This special rule permitted conduit borrowers to buy those bonds to address extraordinary circumstances in the 2008 financial crisis and to increase liquidity at a time of market crisis involving the collapse of the auction rate bond market and downgrades of bond insurers. The Treasury Department and the IRS decline to extend this special rule beyond the conditions under which the rule was promulgated. Accordingly, the final regulations do not adopt this comment.

C. Additional exceptions for all tax-exempt bonds

The proposed regulations also provide an exception to the general rules of retirement for all tax-exempt bonds. This exception, carried forward from Notice 2008-41, provides that acquisition of a tax-exempt bond by a guarantor or liquidity facility provider acting as the issuer¡¯s agent does not result in retirement of the bond if the acquisition is pursuant to the terms of the guarantee or liquidity facility and the guarantor or liquidity facility provider is not a related party (as defined in ¡ì1.150-1(b)) to the issuer. No public comments were received on this provision. The final regulations adopt this provision without change.

The proposed regulations provide that a tax-exempt bond is retired for purposes of sections 103 and 141 through 150 when a significant modification occurs under ¡ì1.1001-3. Section 1.1001-3(e)(5)(i) generally provides that, subject to the special rule in ¡ì1.1001-3(f)(7), a modification of a debt instrument that results in an instrument or property right that is not debt for Federal income tax purposes is a significant modification. Section 1.1001-3(f)(7)(ii)(A) generally provides that, in determining whether a modification of a debt instrument results in an instrument or property right that is not debt, any deterioration in the financial condition of the obligor between the issue date of the debt instrument and the date of the modification is not taken into account. One comment recommended that, when new bonds are issued and the proceeds are used to currently refund outstanding bonds, issuers be allowed to apply the credit deterioration rule in ¡ì1.1001-3(f)(7) to treat the new bonds as a continuation of the refunded bonds for purposes of sections 103 and 141 through 150. The Treasury Department and the IRS have concluded that there is not sufficient justification to expand the scope of the final regulations to include rules for new issuances of tax-exempt bonds. Accordingly, the final regulations do not adopt this comment.

3. Effect of Retirement of a Tax-Exempt Bond

The proposed regulations prescribe certain consequences for a bond that is retired pursuant to a deemed exchange under ¡ì1.1001-3 or retired following the acquisition of the bond by the issuer or the issuer¡¯s agent. Upon a deemed exchange under ¡ì1.1001-3, the bond is treated as a new bond issued at the time of the significant modification as determined under ¡ì1.1001-3. Upon an issuer¡¯s acquisition of its own bond, absent any special rule, the bond is extinguished and retired. One comment recommended permitting an issuer that purchases its own tax-exempt bond to treat the resale of that bond as a refunding of the bond extinguished by the purchase. The comment suggested that the issuer be permitted to allocate the proceeds from the resale of the bond to the expenditure incurred in the purchase of the bond under rules similar to the rules for using proceeds of tax-exempt bonds to ¡°reimburse¡± previous expenditures under the reimbursement expenditure rules in ¡ì1.150-2. Section 1.150-2(g)(1), however, specifically prohibits using bond proceeds to reimburse expenditures incurred in repayment of tax-exempt bonds. Modification of the reimbursement rules to encompass refundings of extinguished and retired bonds is beyond the scope of the final regulations. The final regulations do not adopt this comment.

4. Applicability Dates

Under the proposed regulations, the final rules would apply to events and actions taken with respect to bonds that occur on or after the date that is 90 days after the date of publication of the final regulations in the Federal Register. The proposed regulations further state that issuers may apply the proposed regulations to events and actions taken with respect to bonds that occur before that date. One comment recommended applying the final regulations only to bonds issued after the applicability date of the final regulations. This comment noted that outstanding bonds are structured to avoid retirement under the existing guidance and potentially might not avoid retirement under the final regulations. The Treasury Department and the IRS are concerned that this approach would continue the application of the disparate existing guidance in this area for a substantial period of time for the entire current outstanding volume of tax-exempt bonds in the municipal bond market. The principal goals of the final regulations are to unify, clarify, and improve the administrability of the existing guidance on retirement of tax-exempt bonds. The Treasury Department and the IRS have determined that publishing the final regulations without also obsoleting Notice 88-130 and Notice 2008-41 would undermine the unifying and streamlining purposes of the final regulations. In addition, the final regulations and Notice 2008-41 are similar and generally should produce similar results in most cases outside of special circumstances involving the 2008 financial crisis. Accordingly, the final regulations do not adopt this comment.

However, to provide a longer transition period for outstanding tax-exempt bonds, the final regulations provide a period of one year from the date the final regulations are published in the Federal Register during which issuers may continue to apply Notice 88-130 or Notice 2008-41. As a result, the final regulations apply to events occurring and actions taken with respect to bonds on or after December 30, 2025, though an issuer may choose to apply the final regulations to events occurring and actions taken with respect to bonds on or after December 30, 2024.

Notice 88-130 and Notice 2008-41 are obsolete as of December 30, 2025.

Any IRS Revenue Procedure, Revenue Ruling, Notice, or other guidance cited in this document is published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at .

The principal author of these regulations is Zoran Stojanovic of the Office of Associate Chief Counsel (Financial Institutions and Products). However, other personnel from the Treasury Department and the IRS participated in their development.

Income taxes, Reporting and recordkeeping requirements.

Accordingly, 26 CFR part 1 is amended as follows:

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

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.150-3 is added to read as follows:

(a) General purpose and scope. This section provides rules to determine when a tax-exempt bond is retired solely for purposes of sections 103 and 141 through 150 of the Internal Revenue Code (Code).

(b) Retirement of a tax-exempt bond¡ª(1) General rules. Except as otherwise provided in paragraph (c) of this section, a tax-exempt bond is retired when:

(i) A significant modification of the bond occurs under ¡ì1.1001-3;

(ii) The issuer or its agent acquires the bond in a manner that extinguishes the bond; or

(iii) The bond is otherwise redeemed (for example, redeemed at maturity).

(2) Elective retirement. In guidance published in the Internal Revenue Bulletin (see ¡ì601.601(»å)(2)(¾±¾±)(a) of this chapter), the Commissioner may set forth specific circumstances under which an issuer may elect to treat a tax-exempt bond as retired for purposes of sections 103 and 141 through 150 of the Code.

(c) Exceptions to general rules for retirement of a tax-exempt bond¡ª(1) Qualified tender right disregarded for certain purposes. In applying ¡ì1.1001-3 to a qualified tender bond for purposes of paragraph (b)(1)(i) of this section, both the existence and exercise of a qualified tender right are disregarded for purposes of determining whether an alteration of the interest rate or interest rate mode that occurs pursuant to the terms of the bond is a modification. Thus, an issuer¡¯s exercise of an option to alter the interest rate or interest rate mode on a qualified tender bond generally is not a modification under ¡ì1.1001-3 because the alteration occurs by operation of the terms of the bond and the holder¡¯s resulting right to put the bond to the issuer or the issuer¡¯s agent pursuant to the disregarded qualified tender right does not prevent the issuer¡¯s option from qualifying as a unilateral option under ¡ì1.1001-3(c)(3) that would not give rise to a modification.

(2) Acquisition pursuant to a qualified tender right. An acquisition of a qualified tender bond by the issuer or its agent does not result in the retirement of the bond under paragraph (b)(1)(ii) of this section if the acquisition is pursuant to the operation of a qualified tender right and neither the issuer nor its agent continues to hold the bond after the close of the 90-day period beginning on the date of the tender.

(3) Acquisition of a tax-exempt bond by a guarantor or liquidity facility provider. An acquisition of a tax-exempt bond by a guarantor or liquidity facility provider acting on the issuer¡¯s behalf does not result in the retirement of the bond under paragraph (b)(1)(ii) of this section if the acquisition is pursuant to the terms of the guarantee or liquidity facility and the guarantor or liquidity facility provider is not a related party (as defined in ¡ì1.150-1(b)) to the issuer.

(d) Effect of retirement. If a bond is retired pursuant to paragraph (b)(1)(i) of this section (that is, in a transaction treated as an exchange of the bond for a bond with modified terms), the bond is treated as a new bond issued at the time of the modification as determined under ¡ì1.1001-3. If the issuer or its agent resells a bond retired pursuant to paragraph (b)(1)(ii) of this section, the bond is treated as a new bond issued on the date of resale. The rules of ¡ì1.150-1(d) apply to determine if the new bond is part of a refunding issue.

(e) Definitions. For purposes of this section, the following definitions apply:

(1) Issuer means the State or local governmental unit (as defined in ¡ì1.103-1) that actually issues the tax-exempt bond and any related party (as defined in ¡ì1.150-1(b)) to the actual issuer (as distinguished, for example, from a conduit borrower that is not a related party to the actual issuer).

(2) Qualified tender bond means a tax-exempt bond that, pursuant to the terms of the bond, has all of the following features:

(i) During each authorized interest rate mode, the bond bears interest at a fixed interest rate, a qualified floating rate under ¡ì1.1275-5(b), or an objective rate for a tax-exempt bond under ¡ì1.1275-5(c)(5);

(ii) Interest on the bond is unconditionally payable (as defined in ¡ì1.1273-1(c)(1)(ii)) at periodic intervals of no more than one year;

(iii) The bond has a stated maturity date that is not later than 40 years after the issue date of the bond; and

(iv) The bond includes a qualified tender right.

(3) Qualified tender right means a right or obligation of a holder of a tax-exempt bond pursuant to the terms of the bond to tender the bond for purchase as described in this paragraph (e)(3). The purchaser under the tender may be the issuer, its agent, or another party. The tender right is available on at least one date before the stated maturity date. For each such tender, the purchase price of the bond is equal to par (plus any accrued interest). Following each such tender, the issuer, its agent, or another party either redeems the bond or uses reasonable best efforts to resell the bond within the 90-day period beginning on the date of the tender. Upon any such resale, the resale price of the bond is equal to the par amount of the bond (plus any accrued interest), except that, if the tender right is exercised in connection with a conversion of the interest rate mode on the bond to a fixed rate for the remaining term of the bond, the bond may be resold at any price, including a premium price above the par amount of the bond or a discount price below the par amount of the bond (plus any accrued interest). Any premium received by the issuer pursuant to such a resale is treated solely for purposes of the arbitrage investment restrictions under section 148 of the Code as additional sale proceeds of the bonds.

(f) Applicability date¡ª(1) General applicability. This section applies to events occurring and actions taken with respect to bonds on or after December 30, 2025.

(2) Permissive applicability. An issuer may choose to apply this section to events occurring and actions taken with respect to bonds on or after December 30, 2024.

Par. 3. Section 1.1001-3 is amended by revising paragraph (a)(2) to read as follows: