# Prop. Treas. Reg. § 1.172(h)-3: Limitation on allocable interest deductions. Proposed regulation, not in force. REG-140668-07, 77 FR 57452, published 2012-09-17 . Interprets 26 U.S.C. § 172. Par. 2. Sections 1.172(h)-0 through 1.172(h)-5 are added to read as follows: (a) General rule. (b) Three-year average for a short loss limitation year. (1) General rule. (2) Example. (c) Computation of interest paid or accrued by corporation with incomplete lookback period. (1) Lookback period for corporation not in existence. (2) Interest history of corporation not in existence. (3) Example. (d) Computation of a CERIL if single year constitutes loss limitation year with regard to multiple CERTs. (1) Single CERIL computation. (2) Limitation on allocable interest deductions. (3) Computation of three-year average if CERTs have different lookback periods. (i) In general. (ii) Cumulative three-year average. (4) Allocation of a CERIL among CERTs. (5) Examples. (e) Effective/applicability date. (a) General rule. The amount of allocable interest deductions (determined under § 1.172(h)-2(b)) for any loss limitation year is limited to the excess (if any) of the amount allowable as a deduction for interest paid or accrued by the taxpayer during the loss limitation year, over the average of interest paid or accrued by the taxpayer (the three-year average) for the three taxable years preceding the taxable year in which the corporate equity reduction transaction (CERT) occurred (the lookback period). This section provides additional rules for computing the three-year average relevant to any loss limitation year for purposes of applying section 172(b)(1)(E) and (h), §§ 1.172(h)-1 through 1.172(h)-5, and § 1.1502-72 (the CERT rules ). (b) Three-year average for a short loss limitation year —(1) General rule. For purposes of computing the three-year average if the relevant loss limitation year is less than a full 12-month year, the interest paid or accrued with regard to any year of the taxpayer during a lookback period (lookback period year) equals the amount of interest treated as paid or accrued multiplied by a fraction, the numerator of which equals the number of days in the short loss limitation year, and the denominator of which equals the number of days in the lookback period year. The value of the fraction may not exceed 100 percent. Zero interest is deemed paid or accrued (in excess of amounts actually paid or accrued) in a lookback period year that is shorter than the loss limitation year. (2) Example. The following example illustrates the short loss limitation year rule of this paragraph (b): Example. (i) Facts. T, a domestic C corporation, was organized on July 1, Year 1. T's first taxable year is a short taxable year, which includes July 1 through December 31, Year 1 (184 days). T's next two taxable years are full calendar years: Calendar Year 2 and Calendar Year 3. T's Year 4 ends on September 30 as a result of a change in accounting period. T engages in a CERT during its taxable Year 4, which includes January 1, Year 4, through September 30, Year 4 (273 days). T's next two taxable periods are full 12-month fiscal years ending on September 30, Year 5, and September 30, Year 6. (ii) Year 4 analysis. T's taxable Year 4 is a short loss limitation year. Therefore, in computing its three-year average applicable to loss limitation Year 4, T multiplies its interest treated as paid or accrued during each of the three years of the lookback period by the fraction specified in paragraph (b)(1) of this section. The pertinent fraction with regard to Year 1 of the lookback period is 273/184 (number of days in short loss limitation year divided by the number of days in the lookback period year). However, under paragraph (b)(1) of this section, the value of the fraction cannot exceed 100 percent. As a result, T includes in the computation of its three-year average its actual interest paid or accrued in Year 1. As to Years 2 and 3, T includes in the computation of its three-year average its actual interest paid or accrued in each of those years, multiplied by a fraction equal to 273/365. (iii) Year 5 and 6 analysis. Because T's taxable Years 5 and 6 are full 12-month loss limitation years, T includes in the computation of its three-year average applicable to those loss limitation years its actual interest paid or accrued in each year of the lookback period, without adjustment. (c) Computation of interest paid or accrued by corporation with incomplete lookback period —(1) Lookback period for corporation not in existence. If an applicable corporation was not in existence for three taxable years preceding the taxable year in which the CERT occurred (the lookback period), for purposes of determining the limitation on allocable interest deductions under section 172(h)(2)(C) and paragraph (a) of this section, the applicable corporation's lookback period is deemed to have additional 12-month periods that end on the calendar date that is one day prior to the date of the corporation's organization. See § 1.172(h)-4(c)(2)(i)(B) (regarding determination of lookback period for successor applicable corporations not in existence on date of CERT) and § 1.1502-72(d)(4)(ii) (regarding consolidated groups not in existence during the entire lookback period). (2) Interest history of corporation not in existence. If an applicable corporation was not in existence for the entire lookback period, it is treated as having paid or accrued zero interest during periods deemed to exist under paragraph (c)(1) of this section in computing any three-year average. However, if the applicable corporation is a successor corporation pursuant to § 1.172(h)-1(b)(2), the computation of any three-year average for the successor includes interest paid or accrued by any predecessor during the lookback period. See § 1.172(h)-4(c)(2)(ii)(A). (3) Example. The following example illustrates the rules of this paragraph (c): Example. Corporation not in existence for entire lookback period. C is a domestic C corporation that does not join in the filing of a consolidated return and maintains a calendar taxable year. C is formed on October 1, Year 3, and engages in a CERT during Year 5. For purposes of computing any CERIL related to the CERT, paragraph (a) of this section requires that C must measure its interest deductions for the lookback period. However, C was not in existence for three taxable years preceding the year in which the CERT occurred. Rather, C was in existence for one full calendar taxable year (Year 4) and one short taxable year (October 1 through December 31, Year 3). Pursuant to paragraph (c)(1) of this section, C's lookback period is deemed to include an additional taxable period (October 1, Year 2, through September 30, Year 3). Further, in computing any three-year average, C is treated as having paid or accrued zero interest during the deemed additional period. See paragraph (c)(2) of this section. (d) Computation of a CERIL if single year constitutes loss limitation year with regard to multiple CERTs —(1) Single CERIL computation. This paragraph (d) applies if a taxable year constitutes a loss limitation year of the taxpayer with regard to more than one CERT. In that case, a single corporate equity reduction interest loss (CERIL) is computed under section 172(h)(1) and § 1.172(h)-2(a)(2) for that year. This computation takes into account accumulated CERT costs for every CERT, determined under § 1.172(h)-2(b)(4)(iv) for the loss limitation year. (2) Limitation on allocable interest deductions. In computing the single CERIL under this paragraph (d), section 172(h)(2)(C) and paragraph (a) of this section are applied a single time to limit the cumulative amount of interest allocable to all of the CERTs to the excess (if any) of the amount allowable as a deduction for interest paid or accrued by the taxpayer during the loss limitation year over the three-year average for the lookback period. The limitation is not applied separately with respect to interest allocable to a particular CERT. (3) Computation of three-year average if CERTs have different lookback periods —(i) In general. If the lookback periods (as defined in paragraph (a) of this section or in § 1.1502-72(d)(4)) relevant to all of the CERTs pertinent to a loss limitation year are not identical, a cumulative three-year average is computed by applying the rules of paragraph (d)(3)(ii) of this section. The cumulative three-year average is treated as the three-year average relevant to the loss limitation year, and is applied to determine the limitation on the amount of interest allocable to all of the CERTs under section 172(h)(2)(C) and paragraph (a) of this section. (ii) Cumulative three-year average. The cumulative three-year average applicable to any loss limitation year is computed under this paragraph (d)(3)(ii). With regard to each lookback period relevant to a loss limitation year, a modified three-year average is computed. The modified three-year average is the three-year average relevant to a particular lookback period (determined under section 172(h)(2)(C) and this section) multiplied by a fraction, the numerator of which equals the accumulated CERT costs as of the close of the loss limitation year that are attributable to the particular CERT or CERTs to which the three-year average corresponds, and the denominator of which equals the total accumulated CERT costs as of the close of the loss limitation year that are attributable to all CERTs relevant to the loss limitation year. See § 1.172(h)-2(b)(4) defining accumulated CERT costs. The sum of all modified three-year averages is the cumulative three-year average for that year. (4) Allocation of a CERIL among CERTS. After the computation of the single CERIL for a loss limitation year that is attributable to all CERTs, the total CERIL is allocated to particular CERTs, if CERILs attributable to different CERTs are subject to different limitations on carryback. See section 172(b)(1)(E)(i) and § 1.172(h)-5(b) (regarding prohibition on carrybacks). For purposes of this allocation, the CERT costs attributable to each particular CERT are identified. The total CERIL is then attributed to each CERT by multiplying the total CERIL by a fraction, the numerator of which equals the accumulated CERT costs as of the close of the loss limitation year that are attributable to a particular CERT, and the denominator of which equals the total accumulated CERT costs as of the close of the loss limitation year that are attributable to all CERTs relevant to the loss limitation year. See § 1.172(h)-2(b)(4) defining accumulated CERT costs. (5) Examples. The following examples illustrate the rules of this paragraph (d). Unless otherwise provided, assume that all entities are domestic C corporations that do not join in the filing of consolidated returns and that maintain calendar taxable years. Assume that all applicable corporations have substantial net operating losses in their loss limitation years: Example 1. Multiple CERTs with identical lookback period. (i) Facts. Corporation A maintains a calendar taxable year. A engages in two separate CERTs during its taxable Year 4. The lookback period for both CERTs is January 1, Year 1, through December 31, Year 3. The total amount of interest deductions allocable to CERT 1 and CERT 2 (before application of section 172(h)(2)(C) and paragraph (a) of this section) is $50. A's total interest expense during Year 4 was $150, and its three-year average interest for the lookback period was $120. (ii) Analysis. Year 4 constitutes a loss limitation year with regard to both CERT 1 and CERT 2. A single CERIL is computed with regard to Year 4, and the limitation on allocable interest under section 172(h)(2)(C) and paragraph (a) of this section is applied a single time. See paragraphs (d)(1) and (2) of this section. The limitation under section 172(h)(2)(C) and paragraph (a) of this section is applied to the cumulative amount of interest allocable to the two CERTs ($50). See paragraph (d)(2) of this section. The limitation under section 172(h)(2)(C) and paragraph (a) of this section equals the excess of the amount of interest allowable in Year 4 ($150) over the three-year average ($120), or $30. Therefore, the CERIL is limited to $30. Example 2. Multiple CERTs with different lookback periods. (i) Facts. Corporation A maintains a calendar taxable year. A engages in CERT 1 during its taxable Year 4. The lookback period relevant to CERT 1 is January 1, Year 1, through December 31, Year 3. A also engages in CERT 2 during its taxable Year 5. The lookback period relevant to CERT 2 is January 1, Year 2, through December 31, Year 4. The total amount of interest deductions allocable to CERT 1 and CERT 2 (before application of section 172(h)(2)(C) and paragraph (a) of this section) during taxable Year 5 is $50. A's total interest expense during Year 5 is $126. A's three-year average interest that is relevant to loss limitation Year 5 for the CERT 1 lookback period is $100, and its three-year average interest that is relevant to loss limitation Year 5 for the CERT 2 lookback period is $110. A's accumulated CERT costs attributable to CERT 1 are $400. A's accumulated CERT costs attributable to CERT 2 are $600. (ii) Cumulative three-year average. Year 5 is a loss limitation year with regard to both CERT 1 and CERT 2. A single CERIL is computed with regard to Year 5, and the limitation on allocable interest under section 172(h)(2)(C) and paragraph (a) of this section is applied a single time. See paragraph (d)(1) and (2) of this section. The limitation under section 172(h)(2)(C) and paragraph (a) of this section is applied to the cumulative amount of interest allocable to the two CERTs ($50). See paragraph (d)(2) of this section. Because Year 5 constitutes a loss limitation year with regard to CERTs with different lookback periods, the relevant three-year average applied under section 172(h)(2)(C) and paragraph (a) of this section is the cumulative three-year average, which is the sum of all modified three-year averages. See paragraph (d)(3)(ii) of this section. The modified three-year average with regard to CERT 1 is the three-year average for CERT 1 multiplied by $400/$1,000 (accumulated CERT costs attributable to CERT 1 divided by the total accumulated CERT costs attributable to CERTs 1 and 2), or 2/5 . Therefore, the modified three-year average with regard to CERT 1 is $40 (100 × 2/5 ). The modified three-year average with regard to CERT 2 is the three-year average for CERT 2 multiplied by $600/$1,000 (accumulated CERT costs attributable to CERT 2 divided by the total accumulated CERT costs attributable to CERTs 1 and 2), or 3/5 . Therefore, the modified three-year average with regard to CERT 2 is $66 (110 × 3/5 ). Thus, the cumulative three-year average interest for Year 5 is $106 ($40 + $66). See paragraph (d)(3) of this section. The limitation under section 172(h)(2)(C) and paragraph (a) of this section equals the excess of the amount of interest allowable in Year 5 ($126) over the cumulative three-year average interest ($106), or $20. Therefore, the CERIL for Year 5 is limited to $20. (iii) Allocation of a CERIL to different CERTs. Because Year 5 constitutes a loss limitation year with regard to more than one CERT, and a CERIL associated with each CERT is subject to different limitations on carryback, the total CERIL must be allocated between CERT 1 and CERT 2. See paragraph (d)(4) of this section. The portion of the total CERIL allocated to CERT 1 is the total CERIL multiplied by $400/$1,000 (accumulated CERT costs attributable to CERT 1 divided by the total accumulated CERT costs attributable to CERTs 1 and 2), or 2/5 . Therefore, the portion of the total CERIL allocated to CERT 1 is $8 ($20 × 2/5 ). The portion of the total CERIL allocated to CERT 2 is the total CERIL multiplied by $600/$1,000 (accumulated CERT costs attributable to CERT 2 divided by the total accumulated CERT costs attributable to CERTs 1 and 2), or 3/5 . Therefore, the portion of the total CERIL allocated to CERT 2 is $12 ($20 × 3/5 ). See paragraph (d)(4) of this section. See also section 172(b)(1)(E)(i) and § 1.172(h)-5(b)(1) for rules regarding the prohibition on carryback of a CERIL. Example 3. CERTs of multiple corporations with identical lookback period. (i) Facts. Corporation T maintains a taxable year ending on June 30. On August 31, Year 5, T engages in CERT 1. Unrelated P is the parent of a group that maintains a calendar taxable year. On October 31, Year 5, P acquires all the stock of T in an MSA (CERT 2). T is first included in the P group on November 1, Year 5. For its calendar Year 5, the P group is treated as an applicable corporation with respect to CERT 1 and CERT 2. See § 1.1502-72(a)(2)(iv)(A). The P group's lookback period for both CERTs is January 1, Year 2, through December 31, Year 4. The total CERIL of the group in Year 5 is $80. The P group's accumulated CERT costs attributable to CERT 1 are $500. The P group's accumulated CERT costs attributable to CERT 2 are $1,500. The P group has a consolidated net operating loss (CNOL) in Year 5, a portion of which is allocable to T under § 1.1502-21(b)(2)(iv)(B). (ii) Allocation of a CERIL to different CERTs. Year 5 constitutes a loss limitation year with regard to two CERTs that share a common lookback period. However, the CERIL associated with the different CERTs is subject to different limitations on carryback under § 1.172(h)-5(b)(1) (some CNOL will be carried back to the group's consolidated return years and some will be carried back to T's separate return years). Therefore, the total CERIL must be allocated between CERT 1 and CERT 2. The portion of the total CERIL allocated to CERT 1 is the total CERIL multiplied by $500/$2,000 (accumulated CERT costs attributable to CERT 1 divided by the total accumulated CERT costs attributable to CERTs 1 and 2), or 1/4 . See paragraph (d)(4) of this section. Therefore, the portion of the total CERIL allocated to CERT 1 is $20 ($80 × 1/4 ). The portion of the total CERIL allocated to CERT 2 is the total CERIL multiplied by $1,500/$2,000 (accumulated CERT costs attributable to CERT 2 divided by the total accumulated CERT costs attributable to CERTs 1 and 2), or 3/4 . Therefore, the portion of the total CERIL allocated to CERT 2 is $60 ($80 × 3/4 ). (e) Effective/applicability date. This section is applicable to CERTs occurring on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register . This section is also applicable to the deconsolidation of a member from, or the acquisition of a corporation by, a consolidated group that occurs on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register . However, in each case, this section does not apply to any CERT, deconsolidation, or acquisition occurring pursuant to a written agreement that is binding before the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register .