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The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.
the amount of the depreciation adjustment to 2. The depreciation deduction, if allowable, Thus, Y sustained an NOL of $2,500
use in determining average adjusted basis. is computed only by use of the ($10,000 of income less $12,500 of deduc-
straight-line method. tions), which may be carried back or carried
Basis for debt-financed property ac- over to other tax years without further applica-
quired in corporate liquidation. If an exempt To be directly connected with debt-financed tion of the debt/basis percentage.
organization acquires debt-financed property in property or with the income from it, a deductible
a complete or partial liquidation of a corporation item must have proximate and primary relation-
in exchange for its stock, the organization's ba- ship to the property or income. Expenses, de- Allocation Rules
sis in the property is the same as it would be in preciation, and similar items attributable solely
the hands of the transferor corporation. This ba- to the property qualify for deduction, to the ex- When only part of the property is debt-financed
sis is increased by the gain recognized to the tent they meet the requirements of an allowable property, proper allocation of the basis, debt, in-
transferor corporation upon the distribution and deduction. come, and deductions with respect to the prop-
by the amount of any gain that, because of the erty must be made to determine how much in-
distribution, is includible in the organization's For example, if the straight-line depreciation come or gain derived from the property to treat
gross income as unrelated debt-financed in- allowance for an office building is $10,000 a as unrelated debt-financed income.
come. year, an organization can deduct depreciation
of $10,000 if the entire building is debt-financed Example. X, an exempt college, owns a
Computation of debt/basis percentage. The property. However, if only half of the building is four-story office building that it bought with bor-
following example shows how to compute the debt-financed property, the depreciation al- rowed funds (assumed to be acquisition indebt-
debt/basis percentage by first determining the lowed as a deduction is $5,000. edness). During the year, the lower two stories
average acquisition indebtedness and average of the building were used to house computers
adjusted basis. Capital losses. If a sale or exchange of that X uses for administrative purposes. The
debt-financed property results in a capital loss, two upper stories were rented to the public and
Example. On July 7, an exempt organiza- the loss taken into account in the tax year in used for nonexempt purposes.
tion buys an office building for $510,000 using which the loss arises is computed as provided The gross income X derived from the build-
$300,000 of borrowed funds. The organization earlier. See Gain or loss from sale or other dis- ing was $6,000, all of which was attributable to
files its return on a calendar year basis. During position of property under Computation of the rents paid by tenants. The expenses were
the year the only adjustment to basis is $20,000 Debt-Financed Income, earlier. $2,000 and were equally allocable to each use
for depreciation. Starting July 28, the organiza- If any part of the allowable capital loss isn’t of the building. The average adjusted basis of
tion pays $20,000 each month on the mortgage taken into account in the current tax year, it may the building for the year was $100,000 and the
principal plus interest. The debt/basis percent- be carried back or carried over to another tax average acquisition indebtedness for the year
age for the year is calculated as follows: year without application of the debt/basis per- was $60,000.
centage for that year. Since the two lower stories were used for
Debt on first day exempt purposes, only the upper half of the
of each month
Month property is held Example. X, an exempt educational organ- building is debt-financed property. Conse-
ization, owned debt-financed securities that quently, only the rental income and the deduc-
July 300,000 were capital assets. Last year, X sold the secur- tions directly connected with this income are
August 280,000 ities at a loss of $20,000. The debt/basis per- taken into account in computing UBTI. The part
September 260,000 centage for computing the loss from the sale of taken into account is determined by multiplying
October 240,000 the securities is 40%. Thus, X sustained a capi- the $6,000 of rental income and $1,000 of de-
November 220,000 ductions directly connected with the rental in-
December 200,000 tal loss of $8,000 (40% of $20,000) on the sale
Total $1,500,000 of the securities. Last year and the preceding 3 come by the debt/basis percentage.
tax years, X had no other capital transactions. The debt/basis percentage is the ratio of the
Average acquisition Under these circumstances, the $8,000 of capi- allocable part of the average acquisition indebt-
indebtedness: tal loss may be carried over to succeeding edness to the allocable part of the property's
$1,500,000 ÷ 6 months $ 250,000 years without further application of the debt/ average adjusted basis: that is, in this case, the
basis percentage. ratio of $30,000 (one-half of $60,000) to
Basis $50,000 (one-half of $100,000). Thus, the debt/
As of July 7 510,000 NOL. If, after applying the debt/basis percent- basis percentage for the year is 60% (the ratio
As of December 31 490,000 age to the income from debt-financed property of $30,000 to $50,000).
Total $1,000,000 and the deductions directly connected with this Under these circumstances, X must include
Average adjusted basis: income, the deductions exceed the income, an net rental income of $3,000 in its UBTI for the
$1,000,000 ÷ 2 $ 500,000 organization has an NOL for the tax year. This year, computed as follows:
amount may be carried over to other tax years
Debt/basis percentage in the same manner as any other NOL of an or- Rental income treated as gross income
$250,000 ÷ $500,000 = 50% ganization with UBTI. (For a discussion of the from an unrelated trade or business (60% of
$6,000) $3,600
NOL deduction, see Modifications under De-
ductions, earlier in this chapter.) However, the Less the allowable portion of
Deductions for debt/basis percentage is not applied in those deductions directly connected with that income
other tax years to determine the deductions that (60% of $1,000) 600
Debt-Financed Property may be taken in those years. Net rental income included by X in
computing its UBTI from debt-financed
The deductions allowed for each debt-financed Example. Last year, Y, an exempt organi- property. $3,000
property are determined by applying the debt/ zation, received $20,000 of rent from a debt-fi-
basis percentage to the sum of allowable de- nanced building that it owns. Y had no other
ductions. UBTI for the year. The deductions directly con-
The allowable deductions are those directly nected with this building were property taxes of
connected with the debt-financed property or $5,000, interest of $5,000 on the acquisition in-
with the income from it (including the divi- debtedness, and salary of $15,000 to the build-
dends-received deduction), except that: ing manager. The debt/basis percentage with
respect to the building was 50%. Under these
1. The allowable deductions are subject to circumstances, Y must take into account, in
the modifications for computation of the computing its UBTI, $10,000 (50% of $20,000)
UBTI (discussed earlier in this chapter), of income and $12,500 (50% of $25,000) of the
and deductions directly connected with that income.
Page 20 Chapter 4 Unrelated Business Taxable Income
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