# Prop. Treas. Reg. § 1.56A-15: AFSI adjustments for section 168 property. Proposed regulation, not in force. REG-112129-23, 89 FR 75062, published 2024-09-13 . Interprets 26 U.S.C. § 56A. Par. 9. Sections 1.56A-0 through 1.56A-27 are added to read as follows: (a) Overview. This section provides rules under section 56A(c)(13) of the Code for determining AFSI adjustments with respect to section 168 property. Paragraph (b) of this section provides definitions that apply for purposes of this section. Paragraph (c) of this section provides rules for determining the extent to which property (or an expenditure with respect to property) is section 168 property. Paragraph (d) of this section provides rules for adjusting AFSI for depreciation and other amounts with respect to section 168 property. Paragraph (e) of this section provides rules for adjusting AFSI upon the disposition of section 168 property. Paragraph (f) of this section provides the applicability date of this section. (b) Definitions. For purposes of this section: (1) Covered book inventoriable depreciation. The term covered book inventoriable depreciation means any of the following items that are included in inventoriable cost (or capitalized as part of the cost of non-inventory property held for sale) in a CAMT entity's AFS with respect to section 168 property— (i) Depreciation expense; (ii) Other recovery of AFS basis (including from an impairment loss) that occurs prior to the taxable year in which the disposition of section 168 property occurs for regular tax purposes; or (iii) Impairment loss reversal. (2) Covered book COGS depreciation. The term covered book COGS depreciation means any of the following items that are taken into account as part of cost of goods sold (or as part of the computation of gain or loss from the sale or exchange of property held for sale) in FSI with respect to section 168 property— (i) Depreciation expense; (ii) Other recovery of AFS basis (including from an impairment loss) that occurs prior to the taxable year in which the disposition of section 168 property occurs for regular tax purposes; or (iii) Impairment loss reversal. (3) Covered book depreciation expense. The term covered book depreciation expense means any of the following items other than covered book COGS depreciation that are taken into account in FSI with respect to section 168 property— (i) Depreciation expense; (ii) Other recovery of AFS basis (including from an impairment loss) that occurs prior to the taxable year in which the disposition of section 168 property occurs for regular tax purposes; or (iii) Impairment loss reversal. (4) Covered book expense. The term covered book expense means an amount, other than covered book COGS depreciation and covered book depreciation expense, that— (i) Reduces FSI; and (ii) Is reflected in the unadjusted depreciable basis, as defined in § 1.168(b)-1(a)(3), of section 168 property for regular tax purposes. (5) Deductible tax depreciation. The term deductible tax depreciation means tax depreciation, as defined in paragraph (b)(8) of this section, that is allowed as a deduction in computing taxable income, including tax depreciation that is capitalized and subsequently recovered as a deduction in computing taxable income (even if the deduction is allowed under a provision of the Code other than section 167 of the Code). (6) Section 168 property. The term section 168 property means property to which section 168 of the Code applies, as described in paragraph (c) of this section. (7) Tax COGS depreciation. The term tax COGS depreciation means— (i) Tax depreciation that is capitalized to inventory under section 263A of the Code and is recovered as part of cost of goods sold in computing gross income; and (ii) Tax depreciation that is capitalized under section 263A to the basis of property described in section 1221(a)(1) of the Code that is not inventory and is recovered as part of the computation of gain or loss from the sale or exchange of such property in computing taxable income. (8) Tax depreciation. The term tax depreciation means depreciation deductions allowed under section 167 with respect to section 168 property. (9) Tax depreciation section 481(a) adjustment. The term tax depreciation section 481(a) adjustment means the net amount of the adjustments required under section 481(a) of the Code for a change in method of accounting for depreciation for any item of section 168 property. The term also includes an adjustment (or portion thereof) required under section 481(a) for any other change in method of accounting (other than a change in method of accounting described in paragraph (b)(10) of this section) that impacts the timing of taking into account depreciation with respect to section 168 property in computing taxable income (for example, a change in method of accounting involving a change from deducting depreciation with respect to section 168 property to capitalizing such depreciation under section 263A or another capitalization provision, or vice versa). (10) Tax capitalization method change. The term tax capitalization method change means a change in method of accounting for regular tax purposes involving a change from capitalizing and depreciating costs as section 168 property (including costs that were capitalized to such property under section 263A or another capitalization provision) to deducting the costs (or vice versa). (11) Tax capitalization method change AFSI adjustment. The term tax capitalization method change AFSI adjustment means an adjustment to AFSI that is required under paragraph (d)(1) of this section if a CAMT entity makes a tax capitalization method change. The tax capitalization method change AFSI adjustment is computed separately for each tax capitalization method change and equals the difference between the following amounts computed as of the beginning of the tax year of change— (i) The cumulative amount of adjustments to AFSI under paragraph (d)(1) of this section with respect to the cost(s) subject to the tax capitalization method change that were made with respect to taxable years beginning after December 31, 2019, and before the tax year of change; and (ii) The cumulative amount of adjustments to AFSI under paragraph (d)(1) of this section with respect to the cost(s) subject to the tax capitalization method change that would have been made with respect to taxable years beginning after December 31, 2019, and before the tax year of change, if the new method of accounting for the cost(s) had been applied for regular tax purposes in those taxable years. (c) Property to which section 168 applies —(1) In general. For purposes of section 56A(c)(13) and this section, property to which section 168 applies consists of the following (but only to the extent provided in this paragraph (c))— (i) MACRS property, as defined in § 1.168(b)-1(a)(2), that is depreciable under section 168; (ii) Computer software that is qualified property as defined in § 1.168(k)-1(b)(1) or 1.168(k)-2(b)(1), as applicable, and depreciable under section 168; and (iii) Other property depreciable under section 168 that is— (A) Qualified property as defined in § 1.168(k)-2(b)(1); and (B) Described in § 1.168(k)-2(b)(2)(i)(E), (F), or (G). (2) Property to which section 168 applies includes only the portion of property for which a depreciation deduction is allowable under section 167. If a CAMT entity deducts or otherwise recovers the cost of property described in paragraph (c)(1) of this section (or a portion thereof) under sections 179, 179C, or 181 of the Code, or any similar provision, property to which section 168 applies is limited to the unadjusted depreciable basis, as defined in § 1.168(b)-1(a)(3), of such property. (3) Deductible expenditures are not property to which section 168 applies. Property to which section 168 applies does not include any expenditure (or portion thereof) that is deducted for regular tax purposes, even if the expenditure is made with respect to property to which section 168 applies. For example, an expenditure to repair property to which section 168 applies that is deducted for regular tax purposes but capitalized and depreciated as an improvement for FSI purposes is not property to which section 168 applies. (4) Property to which section 168 applies does not include property that is not depreciable under section 168 for regular tax purposes. Except as provided in paragraph (c)(5) of this section, property to which section 168 applies does not include property that is not depreciable under section 168 for regular tax purposes. For example, if a foreign corporation other than a controlled foreign corporation is not subject to U.S. taxation, then property owned by the foreign corporation is not treated as property to which section 168 applies. (5) Effect of election out of additional first year depreciation. Property to which section 168 applies includes property described in paragraph (c)(1) of this section regardless of whether the CAMT entity makes an election out of the additional first year depreciation deduction under section 168(k) with respect to such property. (6) Property placed in service in taxable years beginning before the CAMT effective date. Notwithstanding § 1.56A-1(d)(3), property to which section 168 applies includes property placed in service by the CAMT entity in any taxable year, including taxable years ending on or before December 31, 2019. (d) AFSI adjustments for depreciation and other amounts with respect to section 168 property —(1) In general. The AFSI of a CAMT entity for a taxable year is— (i) Reduced by tax COGS depreciation with respect to section 168 property, but only to the extent of the amount recovered— (A) As part of cost of goods sold in computing gross income for the taxable year; or (B) As part of the computation of gain or loss from the sale or exchange of non-inventory property described in section 1221(a)(1) that is included in taxable income, or deducted in computing taxable income, respectively, for the taxable year; (ii) Reduced by deductible tax depreciation with respect to section 168 property, but only to the extent of the amount allowed as a deduction in computing taxable income for the taxable year; (iii) Adjusted to disregard covered book COGS depreciation, covered book depreciation expense, covered book expense, and amounts described in paragraph (e)(6) of this section with respect to section 168 property, including section 168 property placed in service for regular tax purposes in a taxable year subsequent to the taxable year the property is treated as placed in service for AFS purposes; (iv) Reduced by any tax depreciation section 481(a) adjustment with respect to section 168 property that is negative, but only to the extent of the amount of the adjustment that is taken into account in computing taxable income for the taxable year; (v) Increased by any tax depreciation section 481(a) adjustment with respect to section 168 property that is positive, but only to the extent of the amount of the adjustment that is taken into account in computing taxable income for the taxable year; (vi) Increased or decreased, as appropriate, by any tax capitalization method change AFSI adjustment in accordance with paragraph (d)(4) of this section; and (vii) Adjusted for other items as provided in IRB guidance the IRS may publish. (2) Special rules for section 168 property held by a partnership —(i) In general. If section 168 property is held by a partnership, see § 1.56A-5(e) for the manner in which the adjustments provided in paragraph (d)(1) of this section are taken into account by the partnership and its CAMT entity partners under the applicable method described in § 1.56A-5(c). (ii) Basis adjustment under section 743(b) of the Code. If section 168 property is held by a partnership, the adjustments provided in paragraphs (d)(1)(i), (ii), and (iv) through (vii) of this section do not include amounts resulting from any basis adjustment under section 743(b) of the Code attributable to the section 168 property that are treated as increases or decreases to tax depreciation or a tax depreciation section 481(a) adjustment for regular tax purposes. See § 1.743-1(j)(4). Instead, such amounts resulting from any basis adjustment under section 743(b) attributable to the section 168 property that would have been included in the adjustments provided in paragraphs (d)(1)(i), (ii), and (iv) through (vii) of this section are separately stated to the CAMT entity partners under § 1.56A-5(e)(4)(i) and are taken into account by the CAMT entity partners in the manner provided in § 1.56A-5(e)(4)(ii)(A). (iii) Basis adjustment under section 734(b) of the Code. If section 168 property is held by a partnership, the adjustments provided in paragraphs (d)(1)(i), (ii), and (iv) through (vii) of this section include amounts resulting from any basis adjustment under section 734(b) of the Code attributable to the section 168 property that are treated as increases or decreases to tax depreciation or a tax depreciation section 481(a) adjustment for regular tax purposes. See § 1.734-1(e). (iv) Basis adjustment under § 1.1017-1(g)(2). If section 168 property is held by a partnership, the adjustments provided in paragraphs (d)(1)(i), (ii), and (iv) through (vii) of this section do not include any decreases in tax depreciation or income amounts for regular tax purposes, as applicable, resulting from any basis adjustment under § 1.1017-1(g)(2) attributable to section 168 property (as calculated under § 1.743-1(j)(4)(ii)). Instead, such decreases in tax depreciation or income amounts, as applicable, resulting from any basis adjustment under § 1.1017-1(g)(2) attributable to section 168 property that would have been included in the adjustments provided in paragraphs (d)(1)(i), (ii), and (iv) through (vii) of this section are separately stated to the CAMT entity partners under § 1.56A-5(e)(4)(i) and are taken into account by the CAMT entity partners in the manner provided in § 1.56A-5(e)(4)(ii)(A). (3) Special rules for determining tax COGS depreciation and covered book COGS depreciation adjustments —(i) In general. Except as provided in paragraph (d)(3)(ii) of this section, a CAMT entity is required— (A) To apply the method(s) of accounting under section 263A that the CAMT entity uses for regular tax purposes (and, in the case of inventory property, the method(s) of accounting that the CAMT entity uses to identify and value inventories under sections 471 and 472 of the Code) to determine the tax COGS depreciation adjustments under paragraph (d)(1)(i) of this section; and (B) To apply the method(s) of accounting the CAMT entity uses for FSI purposes to determine the covered book COGS depreciation adjustments under paragraph (d)(1)(iii) of this section. (ii) Simplifying methods. A CAMT entity is permitted to use the simplifying methods of determining depreciation in ending inventory provided in this paragraph (d)(3)(ii) to determine the tax COGS depreciation and covered book COGS depreciation adjustments under paragraphs (d)(1)(i) and (iii) of this section, respectively. (A) Tax depreciation in inventory for FIFO method taxpayers. For a CAMT entity that uses the First-In-First-Out (FIFO) method to identify inventories for regular tax purposes, the tax depreciation in additional section 263A costs in ending inventory may be computed by multiplying the section 471 costs in ending inventory by the ratio of the tax depreciation in additional section 263A costs incurred during the taxable year to the section 471 costs incurred during the taxable year (tax depreciation absorption ratio). See § 1.263A-1(d)(2) and (3), respectively, for the definitions of section 471 costs and additional section 263A costs. (B) Tax depreciation in inventory for LIFO method taxpayers. For a CAMT entity that uses the LIFO method to identify inventories for regular tax purposes, the tax depreciation in section 471 costs in a LIFO increment may be computed by multiplying the tax depreciation in section 471 costs incurred during the taxable year by the ratio of the section 471 costs in the increment to the section 471 costs incurred during the taxable year (tax increment to current-year cost ratio). The tax depreciation in additional section 263A costs in a LIFO increment may be computed by multiplying the tax depreciation in additional section 263A costs incurred during the taxable year by the tax increment to current-year cost ratio. The total tax depreciation that remains in a LIFO increment after a decrement is determined by multiplying the tax depreciation in the section 471 costs and the tax depreciation in additional section 263A costs in the LIFO increment before the decrement by the ratio of the section 471 costs in the increment after the decrement to the section 471 costs in the LIFO increment before the decrement. See § 1.263A-1(d)(2) and (3), respectively, for the definitions of section 471 costs and additional section 263A costs. (C) Covered book inventoriable depreciation in inventory for LIFO method taxpayers. For a CAMT entity that uses the LIFO method to identify inventories for AFS and FSI purposes, the covered book inventoriable depreciation in a LIFO increment may be computed by multiplying the covered book inventoriable depreciation incurred during the taxable year by the ratio of inventoriable costs in the increment in the CAMT entity's AFS to the inventoriable costs incurred during the taxable year in the CAMT entity's AFS (book increment to current-year cost ratio). The covered book inventoriable depreciation that remains in a LIFO increment after a decrement is determined by multiplying the covered book inventoriable depreciation in the LIFO increment before the decrement by the ratio of the inventoriable costs in the increment after the decrement to the inventoriable costs in the LIFO increment before the decrement. (4) Adjustment period for tax capitalization method change AFSI adjustments. A tax capitalization method change AFSI adjustment that is negative reduces AFSI under paragraph (d)(1)(vi) of this section in the tax year of change by the full amount of the adjustment. A tax capitalization method change AFSI adjustment that is positive increases AFSI under paragraph (d)(1)(vi) of this section ratably over four taxable years beginning with the tax year of change. For purposes of this paragraph (d)(4), if any taxable year during the four-year spread period for a tax capitalization method change AFSI adjustment that is positive is a short taxable year, the CAMT entity takes the adjustment into account as if that short taxable were a full 12-month taxable year. If, in any taxable year, a CAMT entity ceases to engage in the trade or business to which the tax capitalization method change AFSI adjustment relates, the CAMT entity includes in AFSI for such taxable year any portion of the adjustment not included in AFSI for a previous taxable year. (5) Examples. The following examples illustrate the application of the rules in this paragraph (d). For purposes of paragraphs (d)(5)(i) through (viii) of this section (Examples 1 through 8), each of X and Y is a corporation that uses the calendar year as its taxable year and has a calendar-year financial accounting period. Unless otherwise stated, each of X and Y has elected out of additional first year depreciation under section 168(k), and the tax depreciation with respect to any section 168 property is not required to be capitalized under any capitalization provision in the Code. (i) Example 1: Tax COGS depreciation and covered book COGS depreciation adjustments under FIFO method —(A) General facts. X is a manufacturer that uses the FIFO method to identify inventories and values inventories at the lower of cost or market for regular tax and FSI purposes. X uses the simplified service cost method to determine capitalizable mixed service costs under § 1.263A-1(h) and the modified simplified production method to allocate additional section 263A costs to ending inventory under § 1.263A-2(c)(3). X determines both the type and amount of section 471 costs by reference to its financial statements in accordance with § 1.263A-1(d)(2)(iii)(A). All depreciation for regular tax and FSI purposes is attributable to section 168 property. There were no write downs of inventory for regular tax purposes and no disposition or book impairment losses for FSI purposes in 2024. X uses the same method(s) of allocating section 471 costs to ending inventory for regular tax purposes that it uses to allocate inventoriable costs to ending inventory for AFS purposes, so the tax depreciation in section 471 costs in ending inventory and the covered book inventoriable depreciation in ending inventory are equal. (B) Facts: Beginning inventory for 2024. X's beginning inventory for 2024 is $2,500,000x, consisting of $2,000,000x of section 471 costs and $500,000x of additional section 263A costs. The section 471 costs in beginning inventory include $100,000x of book depreciation based on X's financial statement method of accounting. The additional section 263A costs in beginning inventory include $10,000x of tax depreciation computed under the simplifying method in paragraph (d)(3)(ii) of this section for the preceding year. (C) Facts: Current-year costs for 2024. During 2024, X incurs $11,000,000x of inventoriable costs, consisting of $10,000,000x of section 471 costs and $1,000,000x of additional section 263A costs. The section 471 costs include $500,000x of book depreciation based on X's financial statement method of accounting and the additional section 263A costs include $40,000x of tax depreciation, which is comprised of book depreciation in capitalizable mixed service costs determined under the simplified service cost method, as well as the excess of tax depreciation over book depreciation under § 1.263A-1(d)(2)(iii)(B) related to the book depreciation in section 471 costs and capitalizable mixed service costs. (D) Facts: Ending inventory for 2024. X's ending inventory for 2024 is $3,300,000x, consisting of $3,000,000x of section 471 costs and $300,000x of additional section 263A costs computed under the modified simplified production method. The section 471 costs include $150,000x of book depreciation based on X's financial statement method of accounting. (E) Facts: Cost of goods sold for 2024. X's cost of goods sold for 2024 is $10,200,000x ($2,500,000x beginning inventory + $11,000,000x inventoriable costs incurred during the year − $3,300,000x ending inventory). (F) Analysis: Ending inventory for 2024. X determines the tax depreciation in additional section 263A costs in ending inventory for 2024 using the simplifying method in paragraph (d)(3)(ii)(A) of this section as follows: X's tax depreciation absorption ratio is 0.4% ($40,000x tax depreciation in additional section 263A costs incurred during the year/$10,000,000x section 471 costs incurred during the year) and its tax depreciation in additional section 263A costs in ending inventory is $12,000x (tax depreciation absorption ratio of 0.4% x $3,000,000x of section 471 costs remaining in ending inventory). (G) A nalysis: Taxable year 2024: Tax COGS depreciation. X's tax COGS depreciation for 2024 is $488,000x ($100,000x tax depreciation in section 471 costs in beginning inventory + $10,000x tax depreciation in additional section 263A costs in beginning inventory + $500,000x tax depreciation in section 471 costs incurred during the year + $40,000x tax depreciation in additional section 263A costs incurred during the year − $150,000x tax depreciation in section 471 costs in ending inventory − $12,000x of tax depreciation in additional section 263A costs in ending inventory). Pursuant to paragraph (d)(1)(i)(A) of this section, X reduces AFSI by $488,000x, the tax COGS depreciation for taxable year 2024. (H) Analysis: Taxable year 2024: Covered book COGS depreciation. X's covered book COGS depreciation for 2024 is $450,000x ($100,000x covered book inventoriable depreciation in beginning inventory + $500,000x covered book inventoriable depreciation incurred during the year − $150,000x covered book inventoriable depreciation in ending inventory). Pursuant to paragraph (d)(1)(iii) of this section, X adjusts AFSI to disregard the covered book COGS depreciation by increasing AFSI by $450,000x for 2024. (ii) Example 2: Tax COGS depreciation and covered book COGS depreciation adjustments under LIFO method— (A) General facts. The facts are the same as in paragraph (d)(5)(i) of this section ( Example 1 ), except that X uses the same dollar-value LIFO method to identify inventory for regular tax and AFS purposes. X uses the simplifying method in paragraph (d)(3)(ii)(B) of this section to determine the tax depreciation in section 471 costs and the tax depreciation in additional section 263A costs in its LIFO increments for purposes of computing tax COGS depreciation. X also uses the simplifying method in paragraph (d)(3)(ii)(C) of this section to determine the covered book inventoriable depreciation in its LIFO increments for purposes of computing covered book COGS depreciation. Based on X's methods of accounting for determining and allocating section 471 costs for regular tax purposes described in paragraph (d)(5)(i) of this section ( Example 1 ), X's section 471 costs (including tax depreciation) incurred for the taxable year and X's inventoriable costs (including covered book inventoriable depreciation) incurred for the taxable year in X's AFS are equal, and X's section 471 costs (including tax depreciation) in any LIFO increment and the inventoriable costs (including covered book inventoriable depreciation) in such increment in X's AFS are equal. (B) Facts: Beginning inventory for 2024. X's beginning inventory for 2024 is $2,500,000x, consisting of a base layer of $2,000,000x and a 2023 increment of $500,000x. The base layer consists of $1,800,000x of section 471 costs and $200,000x of additional section 263A costs and the 2023 increment consists of $450,000x of section 471 costs and $50,000x of additional section 263A costs. The base layer includes $100,000x of tax depreciation ($90,000x of tax depreciation in section 471 costs + $10,000x of tax depreciation in additional section 263A costs) and the 2023 increment includes $25,000x of tax depreciation ($22,500x of tax depreciation in section 471 costs + $2,500x of tax depreciation in additional section 263A costs), computed under the simplifying method in paragraph (d)(3)(ii)(B) of this section for the preceding year. The covered book inventoriable depreciation in X's beginning inventory for 2024 computed under the simplifying method in paragraph (d)(3)(ii)(C) of this section equals the tax depreciation in section 471 costs in X's beginning inventory for 2024 computed under the simplifying method in paragraph (d)(3)(ii)(B) of this section (that is, the covered book inventoriable depreciation in the base layer equals $90,000x and covered book inventoriable depreciation in the 2023 increment equals $22,500x). (C) Facts: Current-year costs for 2024. During 2024, X incurs $11,000,000x of inventoriable costs, consisting of $10,000,000x of section 471 costs and $1,000,000x of additional section 263A costs. The section 471 costs include $500,000x of book depreciation based on X's financial statement method of accounting and the additional section 263A costs include $40,000x of tax depreciation, which includes book depreciation in capitalizable mixed service costs determined under the simplified service cost method, as well as for the excess of tax depreciation over book depreciation under § 1.263A-1(d)(2)(iii)(B) related to the book depreciation in section 471 costs and capitalizable mixed service costs. (D) Facts: Ending inventory for 2024. X's ending inventory for 2024 is $2,750,000x, consisting of the base layer of $2,000,000x, the 2023 increment of $500,000x, and a 2024 increment of $250,000x. The 2024 increment consists of $225,000x of section 471 costs and $25,000x of additional section 263A costs. (E) Facts: Cost of goods sold for 2024. X's cost of goods sold for 2024 is $10,750,000x ($2,500,000x beginning inventory + $11,000,000x inventoriable costs incurred during the year − $2,750,000x ending inventory). (F) Analysis: Ending inventory for 2024. X determines the tax depreciation in section 471 costs and the tax depreciation in additional section 263A costs in the 2024 increment under the simplifying method in paragraph (d)(3)(ii)(B) of this section as follows: X computes a tax increment to current-year cost ratio of 2.25% by dividing the section 471 costs in the increment, or $225,000x, by the section 471 costs incurred during the year, or $10,000,000x. X determines the tax depreciation in section 471 costs for the 2024 increment of $11,250x by multiplying the tax increment to current-year cost ratio, or 2.25%, by the tax depreciation in section 471 costs incurred during the year, or $500,000x. X determines the tax depreciation in additional section 263A costs for the 2024 increment of $900x by multiplying the tax increment to current-year cost ratio, or 2.25%, by the tax depreciation in additional section 263A costs incurred during the year, or $40,000x. X determines the covered book inventoriable depreciation in the 2024 increment under the simplifying method in paragraph (d)(3)(ii)(C) of this section as follows: X computes a book increment to current-year cost ratio of 2.25% by dividing the inventoriable costs in the increment in X's AFS, or $225,000x, by the inventoriable costs incurred during the taxable year in X's AFS, or $10,000,000x. X determines the covered book inventoriable depreciation for the 2024 increment of $11,250x by multiplying the book increment to current-year cost ratio, or 2.25%, by covered book inventoriable depreciation incurred for the year, or $500,000x. (G) Analysis: Taxable year 2024: Tax COGS depreciation. X's tax COGS depreciation for 2024 of $527,850x is equal to the tax depreciation in section 471 costs in beginning inventory of $112,500x ($90,000x from the base layer + $22,500x from the 2023 increment), plus the tax depreciation in additional section 263A costs in beginning inventory of $12,500x ($10,000x from the base layer + $2,500x from the 2023 increment), plus the $500,000x of tax depreciation in section 471 costs incurred during the year, plus the $40,000x of tax depreciation in additional section 263A costs incurred during the year, less the tax depreciation in section 471 costs in ending inventory of $123,750x ($90,000x from the base layer + $22,500x from the 2023 increment + $11,250x from the 2024 increment), less the tax depreciation in additional section 263A costs in ending inventory of $13,400x ($10,000x from the base layer + $2,500x from the 2023 increment + $900x from the 2024 increment). Pursuant to paragraph (d)(1)(i)(A) of this section, X reduces AFSI by $527,850x, the tax COGS depreciation for taxable year 2024. (H) Analysis: Taxable year 2024: Covered book COGS depreciation. X's covered book COGS depreciation for 2024 of $488,750x is equal to the covered book inventoriable depreciation in beginning inventory of $112,500x ($90,000x from the base layer + $22,500x from the 2023 increment), plus the $500,000x of covered book inventoriable depreciation incurred during the year, less the $123,750x of covered book inventoriable depreciation in ending inventory ($90,000x from the base layer + $22,500x from the 2023 increment + $11,250x from the 2024 increment). Pursuant to paragraph (d)(1)(iii) of this section, X adjusts AFSI to disregard the covered book COGS depreciation by increasing AFSI by $488,750x for 2024. (iii) Example 3: Tax COGS depreciation and covered book COGS depreciation adjustments under LIFO method— (A) General facts. The facts are the same as in paragraph (d)(5)(ii) of this section ( Example 2 ), except that X continues to use the dollar-value LIFO method for regular tax and AFS purposes for 2025. (B) Facts: Current-year costs for 2025. During 2025, X incurs $13,250,000x of inventoriable costs, consisting of $12,000,000x of section 471 costs and $1,250,000x of additional section 263A costs. The section 471 costs include $750,000x of book depreciation based on X's financial statement method of accounting and the additional section 263A costs include $100,000x of tax depreciation which is comprised of book depreciation in capitalizable mixed service costs determined under the simplified service cost method and a positive book-to-tax adjustment for the excess of tax depreciation over book depreciation under § 1.263A-1(d)(2)(iii)(B) related to the book depreciation in section 471 costs and capitalizable mixed service costs. (C) Facts: Ending inventory for 2025. X incurs a LIFO decrement in 2025 that eliminates the entire 2024 increment and a portion of the 2023 increment. X's ending inventory is $2,250,000x, consisting of the base layer of $2,000,000x and a remaining 2023 increment of $250,000x. The base layer consists of $1,800,000x of section 471 costs and $200,000x of additional section 263A costs. The remaining portion of the 2023 increment consists of $225,000x of section 471 costs and $25,000x of additional section 263A costs. (D) Facts: Cost of goods sold for 2025. X's cost of goods sold for 2025 is $13,750,000x ($2,750,000x beginning inventory + $13,250,000x inventoriable costs incurred during the year − $2,250,000x ending inventory). (E) Analysis: Ending inventory for 2025. X determines the tax depreciation in section 471 costs and the tax depreciation in additional section 263A costs that remain in the 2023 increment under the simplifying method in paragraph (d)(3)(ii)(B) of this section as follows: After taking into account the 2025 decrement, 50% of the 2023 increment remains ($225,000x of section 471 costs in the increment after the decrement/$450,000x of section 471 costs in the increment before the decrement). The tax depreciation in section 471 costs that remains in the 2023 increment is $11,250x (50% surviving proportion of the increment x $22,500x tax depreciation in section 471 costs in the 2023 increment before the decrement). X's tax depreciation in additional section 263A costs that remains in the 2023 increment is $1,250x (50% surviving proportion of the increment x $2,500x tax depreciation in additional section 263A costs in the 2023 increment before the decrement, or $2,500x). X determines the covered book inventoriable depreciation that remains in the 2023 increment under the simplifying method in paragraph (d)(3)(ii)(C) of this section as follows: After taking into account the 2025 decrement, 50% of the 2023 increment remains ($225,000x of inventoriable costs in the increment in X's AFS after the decrement/$450,000x of inventoriable costs in the increment before the decrement). The covered book inventoriable depreciation that remains in the 2023 increment is $11,250x (50% surviving proportion of the increment x $22,500x of covered book inventoriable depreciation in the 2023 increment before the decrement). (F) Analysis: Taxable year 2025: Tax COGS depreciation. X's tax COGS depreciation for 2025 of $874,650x is equal to the tax depreciation in section 471 costs in beginning inventory of $123,750 ($90,000x from the base layer + $22,500x from the 2023 increment + $11,250x from the 2024 increment), plus the tax depreciation in additional section 263A costs in beginning inventory of $13,400x ($10,000x from the base layer + $2,500x from the 2023 increment + $900x from the 2024 increment), plus $750,000x of tax depreciation in section 471 costs incurred during the year, plus $100,000x of tax depreciation in additional section 263A costs incurred during the year, less the tax depreciation in section 471 costs in ending inventory of $101,250x ($90,000x from the base layer + $11,250x from the 2023 increment), less the tax depreciation in additional section 263A costs in ending inventory of $11,250x ($10,000x from the base layer + $1,250x from the 2023 increment). Pursuant to paragraph (d)(1)(i)(A) of this section, B reduces AFSI by $874,650x, the tax COGS depreciation for taxable year 2025. (G) Analysis: Taxable year 2025: Covered book COGS depreciation. X's covered book COGS depreciation for 2025 of $772,500x is equal to the covered book inventoriable depreciation in beginning inventory of $123,750x ($90,000x from the base layer + $22,500x from the 2023 increment + $11,250x from the 2024 increment), plus the $750,000x of covered book inventoriable depreciation incurred during the year, less $101,250x of covered book inventoriable depreciation in ending inventory ($90,000x from the base layer + $11,250x from the 2023 increment). Pursuant to paragraph (d)(1)(iii) of this section, X adjusts AFSI to disregard the covered book COGS depreciation by increasing AFSI by $772,500x for 2025. (iv) Example 4: Net positive tax depreciation section 481(a) adjustment —(A) Facts. Y timely files a Form 3115, Application for Change in Accounting Method, under Rev. Proc. 2015-13 (2015-5 I.R.B. 419) for the calendar year ending December 31, 2024, to change its method of accounting for depreciation for an item of section 168 property, and the Commissioner consents to the change. The adjustment required under section 481(a) to implement the change is positive because the total amount of depreciation taken by Y with respect to the section 168 property under its present method was $1,000x greater than the total amount of depreciation allowable under the new method of accounting. Y takes the $1,000x net positive section 481(a) adjustment into account in computing taxable income ratably over the section 481(a) adjustment period of 4 taxable years, beginning with the year of change (2024 through 2027). (B) Analysis: Taxable years 2024 through 2027. Pursuant to paragraph (d)(1)(v) of this section, Y takes the $1,000x net positive tax depreciation section 481(a) adjustment into account in determining AFSI under section 56A(c)(13) for taxable years 2024 through 2027. Because the adjustment is positive, A increases AFSI by $250x each year. (v) Example 5: Change in method of accounting to treat the replacement of a portion of section 168 property as a deductible repair— (A) Facts: Taxable years 2024 through 2026. On January 1, 2024, Y replaces a component of section 168 property (replacement property), at a cost of $10,000x. For regular tax purposes, Y capitalized the cost of the replacement property and depreciates it under the general depreciation system by using the 200 percent declining balance method, the half-year convention, and a 5-year recovery period. For regular tax purposes, Y claims $2,000x ($10,000x cost × 20%) of deductible tax depreciation in 2024, $3,200x ($10,000x × 32%) of deductible tax depreciation in 2025, and $1,920x ($10,000x × 19.2%) of deductible tax depreciation in 2026. For AFS purposes, Y depreciates the replacement property over 10 years using the straight-line method and the half-year convention. Y takes into account $500x ($10,000x cost/10 years/2) of covered book depreciation expense in 2024, and $1,000x ($10,000x cost/10 years) of covered book depreciation expense in each of 2025 and 2026. (B) Facts: Taxable year 2027. Y timely files a Form 3115, Application for Change in Accounting Method, under Rev. Proc. 2015-13 for the calendar year ending December 31, 2027, to change its method of accounting from capitalizing and depreciating the cost of the replacement property to deducting those costs as a repair under section 162, and the Commissioner consents to the change. The section 481(a) adjustment to implement the method change is negative $2,880x (the difference between the total amount of tax depreciation Y claimed under its present method of $7,120x ($2,000x + $3,200x + $1,920x) and the $10,000x repair expense deductible under Y's new method of accounting). Y takes the $2,880x negative section 481(a) adjustment into account in computing taxable income for regular tax purposes in 2027, the year of change. (C) Analysis: Adjustment to AFSI under paragraph (d)(1) of this section. Because repair expenditures deductible under section 162 are not property to which section 168 applies, the replacement property is no longer section 168 property. Accordingly, the negative section 481(a) adjustment of $2,880x does not reduce AFSI for 2027 under paragraph (d)(1)(ii) or (iv) of this section because the negative section 481(a) adjustment is neither tax depreciation nor a tax depreciation section 481 adjustment (that is, it is not attributable to change in method of accounting for depreciation with respect to section 168 property). Further, except as provided in the analysis in paragraph (d)(5)(v)(D) of this section, beginning in 2027, Y will not make any other AFSI adjustments under paragraph (d)(1) of this section with respect to the replacement property because, following the accounting method change, the replacement property is not section 168 property. (D) Analysis: Tax capitalization method change AFSI adjustment. The change in method of accounting implemented by Y for its taxable year ending December 31, 2027, is a tax capitalization method change. Accordingly, Y must compute and take into account the corresponding tax capitalization method change AFSI adjustment under paragraph (d)(1)(vi) of this section. The tax capitalization method change AFSI adjustment is $4,620x, and is computed as the difference between the amount determined under paragraph (b)(11)(i) of this section of $4,620x (the cumulative amount of deductible tax depreciation taken into account under paragraph (d)(1)(ii) of this section with respect to taxable years ending on or after December 31, 2019, and before the tax year of change, of $7,120x ($2,000x + $3,200x + $1,920x), less the cumulative amount of covered book depreciation expense that was disregarded under paragraph (d)(1)(iii) of this section with respect to taxable years ending on or after December 31, 2019, and before the tax year of change, of $2,500x ($500x + $1,000x + $1,000x)), and the amount determined under paragraph (b)(11)(ii) of this section of $0x (following the tax capitalization method change, the replacement property is not section 168 property and, therefore, no adjustments under paragraph (d)(1) of this section would have been required with respect to taxable years ending on or after December 31, 2019, and before the tax year of change under the new method of accounting). Under paragraphs (d)(1)(vi) and (d)(4) of this section, Y takes the $4,620x positive tax capitalization method change AFSI adjustment into account as an increase to AFSI ratably over four taxable years beginning in 2027. (vi) Example 6: Change in method of accounting to capitalize costs to section 168 property as required under section 263A— (A) Facts: Taxable years 2024 through 2026. During 2024, Y produces and places in service section 168 property with a cost of $20,000x. For regular tax purposes, Y depreciates the section 168 property under the general depreciation system by using the 200 percent declining balance method, the half-year convention, and a 5-year recovery period. For regular tax purposes, Y claims $4,000x ($20,000x cost × 20%) of deductible tax depreciation in 2024, $6,400 ($20,000x × 32%) of deductible tax depreciation in 2025, and $3,840 ($20,000x × 19.2%) of deductible tax depreciation in 2026. For AFS purposes, Y depreciates the section 168 property over 10 years using the straight-line method and the half-year convention. Y takes into account in its FSI $1,000x ($20,000x cost/10 years/2) of covered book depreciation expense for 2024 and $2,000x ($20,000x cost/10 years) of covered book depreciation expense for each of 2025 and 2026. Further, Y deducts $10,000x of general and administrative costs in computing taxable income for 2024 consistent with its established method of accounting for regular tax purposes with respect to those costs. Y also takes into account the $10,000x of general and administrative costs as an expense in its FSI for 2024. (B) Facts: Taxable year 2027. During 2027, Y determines that the $10,000x of general and administrative costs deducted in computing taxable income for 2024 were incurred by reason of the production of the section 168 property Y produced and placed in service in 2024, and therefore Y should have capitalized the $10,000x of general and administrative costs to the basis of the section 168 property under section 263A and depreciated those costs under sections 167 and 168. Accordingly, Y timely files a Form 3115, Application for Change in Accounting Method, under Rev. Proc. 2015-13 for its taxable year ending December 31, 2027, to change its method of accounting to capitalize and depreciate the $10,000x of general and administrative costs as part of the basis of the corresponding section 168 property. The Commissioner consents to the change. The section 481(a) adjustment required to implement the method change is positive $2,880x (the difference between the amount of the general and administrative costs Y deducted under its present method of accounting prior to the tax year of change of $10,000x, and the amount that would be have been deducted under Y's proposed method of accounting prior to the tax year of change of $7,120x (this amount equals the deductible tax depreciation that would have been claimed prior to the tax year of change ($2,000x for 2024 + $3,200x for 2025 + $1,920x for 2026)). Y takes one fourth of the $2,880x positive section 481(a) adjustment into account in computing taxable income for regular tax purposes for 2027, the tax year of change. (C) Analysis: Tax capitalization method change AFSI adjustment. The change in method of accounting for regular tax purposes implemented by Y for its taxable year ending December 31, 2027, is a tax capitalization method change as defined in paragraph (b)(10) of this section. Accordingly, Y must compute and take into account in AFSI a tax capitalization method change AFSI adjustment pursuant to paragraphs (b)(11) and (d)(1)(vi) of this section. The tax capitalization method change AFSI adjustment equals positive $2,880x, computed as the difference between the amount determined under paragraph (b)(11)(i) of this section of $0x (under Y's prior method of accounting, the $10,000x of general and administrative costs did not constitute section 168 property as those costs were deducted, and therefore no adjustments under paragraph (d)(1) of this section were made with respect to taxable years ending on or after December 31, 2019, and before the tax year of change) and the amount determined under paragraph (b)(11)(ii) of this section of $2,880x (the cumulative amount of deductible tax depreciation that would have reduced AFSI under paragraph (d)(1)(ii) of this section with respect to taxable years ending on or after December 31, 2019, and before the tax year of change of $7,120x ($2,000x + $3,200x + $1,920x), plus the cumulative amount of covered book expense that would have been disregarded under paragraph (d)(1)(iii) of this section with respect to taxable years ending on or after December 31, 2019, and before the tax year of change of $10,000x). Y takes the $2,880x positive tax capitalization method change AFSI adjustment into account in computing AFSI ratably over four taxable years beginning in 2027 under paragraph (d)(4) of this section. (D) Analysis: Adjustments to AFSI under paragraph (d)(1) of this section for 2027 and subsequent taxable years. Following the tax capitalization method change, the $10,000x of general and administrative costs constitute section 168 property as those costs become part of the unadjusted basis of the underlying section 168 property produced and placed in service in 2024, resulting in total unadjusted basis of the section 168 property of $30,000x. Therefore, in addition to taking into account the tax capitalization method change AFSI adjustment described in paragraph (d)(5)(vi)(C) of this section, Y is required to begin making adjustments to AFSI under paragraph (d)(1) of this section with respect to the general and administrative costs. Accordingly, Y reduces AFSI for 2027 and subsequent taxable years by the deductible tax depreciation it claims for the particular taxable year with respect to the section 168 property (including the $10,000x of general and administrative costs) under paragraph (d)(1)(ii) of this section (that is, $3,456x for 2027 ($30,000x × 11.52%)). Y increases AFSI for 2027 and subsequent taxable years by the covered book depreciation expense with respect to the section 168 property under paragraph (d)(1)(iii) of this section (that is, $2,000x for 2027). As the covered book expense attributable to the $10,000x of general and administrative costs was taken into account in Y's FSI for 2024, there is no covered book expense for Y to disregard under paragraph (d)(1)(iii) of this section when computing AFSI for 2027 and subsequent taxable years with respect to those costs. (vii) Example 7: Deductible tax depreciation under section 174 —(A) Facts. Y is engaged in the business of developing chemical products. On January 1, 2024, Y begins a research project in the United States to develop a new product. Y pays or incurs costs for the research project that are considered specified research or experimental expenditures under section 174 of the Code. Y owns a facility that is used exclusively for research. Tax depreciation on the facility is $200,000x in 2024. Y treats the $200,000x of 2024 tax depreciation as a specified research or experimental expenditure under section 174. Accordingly, Y capitalizes and amortizes the $200,000x of 2024 tax depreciation ratably over a 5-year period under section 174(a)(2), beginning at the midpoint of 2024. Thus, $20,000x of the capitalized amount ($200,000x depreciation/5 years × 6/12 months) results in a deduction (through section 174 amortization) in computing taxable income in 2024. (B) Analysis. Pursuant to paragraph (d)(1)(ii) of this section, Y reduces AFSI for 2024 by deductible tax depreciation of $20,000x, which is the portion of the 2024 tax depreciation that reduced Y's taxable income for 2024. (viii) Example 8: Section 168 property treated as leased property for AFS purposes —(A) Facts. On January 1, 2024, Y enters into an agreement to obtain the right to use equipment in its trade or business for seven years. Under the agreement, Y will make seven annual payments of $10,000x at the end of each year. At the end of the agreement, Y will take ownership of the equipment at no additional cost. For regular tax purposes, Y treats the agreement as a financed purchase of equipment and capitalizes the cost of the equipment of $57,750x (equal to the present value of the annual payments based on a 5% rate stated in the agreement) and depreciates the equipment under the general depreciation system using the 200 percent declining balance method, the half-year convention, and a 5-year recovery period. For regular tax purposes, Y claims $11,550x ($57,750x cost × 20%) of deductible tax depreciation in 2024 and $18,480x ($57,750x cost × 32%) of deductible tax depreciation in 2025. For regular tax purposes, Y also incurs interest expense on the remaining liability as of the end of the year equal to $2,900x for 2024 and $2,550x for 2025, based on the 5% interest rate stated in the agreement. Y prepares its AFS on the basis of GAAP and accounts for the agreement as a finance lease under ASC 842. Accordingly, Y capitalizes a right of use asset of $57,750x (equal to the present value of the annual lease payments) and recognizes right of use asset amortization each year of $8,250x ($57,750x right of use asset/7 years). For AFS purposes, Y also recognizes interest expense each year equal to the amounts incurred for regular tax purposes. (B) Analysis: Taxable year 2024. The right of use asset amortization of $8,250x is a covered book depreciation expense under paragraph (b)(3) of this section. Pursuant to paragraph (d)(1)(iii) of this section, Y makes an adjustment to AFSI to disregard the covered book depreciation expense of $8,250x for 2024 (equal to the right of use asset amortization of $8,250x). Pursuant to paragraph (d)(1)(ii) of this section, AFSI is also reduced by the deductible tax depreciation of $11,550x for 2024. The interest expense of $2,900x incurred for regular tax and AFS purposes is not a covered book expense as such amount is not reflected in the unadjusted depreciable basis, as defined in § 1.168(b)-1(a)(3), of the equipment for regular tax purposes and, accordingly, does not give rise to an AFSI adjustment under this paragraph (d). (C) Analysis: Taxable year 2025. Pursuant to paragraph (d)(1)(iii) of this section, Y makes an adjustment to AFSI to disregard the covered book depreciation expense of $8,250x for 2025 (equal to the right of use asset amortization for 2025 of $8,250x). Pursuant to paragraph (d)(1)(ii) of this section, AFSI is also reduced by the deductible tax depreciation of $18,480x for 2025. The interest expense of $2,550x incurred for regular tax and AFS purposes is not a covered book expense as such amount is not reflected in the unadjusted depreciable basis, as defined in § 1.168(b)-1(a)(3), of the equipment for regular tax purposes and, accordingly, does not give rise to an AFSI adjustment under this paragraph (d). (D) Analysis: Taxable years 2026 through 2029. Pursuant to paragraph (d)(1)(iii) of this section, Y continues to make an annual adjustment to AFSI to disregard the covered book depreciation expense of $8,250x for each year (equal to the right of use asset amortization of $8,250x). Pursuant to paragraph (d)(1)(ii) of this section, Y continues to reduce AFSI by the deductible tax depreciation for each taxable year. As of the end of 2029, the equipment is fully depreciated for regular tax purposes. Interest expense incurred for regular tax and AFS purposes for each year is not a covered book expense as such amount is not reflected in the unadjusted depreciable basis, as defined in § 1.168(b)-1(a)(3), of the equipment for regular tax purposes and, accordingly, does not give rise to an AFSI adjustment under this paragraph (d). (E) Analysis: Taxable year 2030. Although the equipment is fully depreciated for regular tax purposes, the right of use asset amortization of $8,250x for 2030 continues to be treated as a covered book depreciation expense under paragraph (b)(3) of this section. Pursuant to paragraph (d)(1)(iii) of this section, Y makes an adjustment to AFSI to disregard the covered book depreciation expense of $8,250x for 2030 (equal to the right of use asset amortization for 2030 of $8,250x). As the equipment was fully depreciated as of the end of 2029, there is no reduction to AFSI needed under paragraph (d)(1)(ii) of this section, as the deductible tax depreciation for the equipment for 2030 is zero. Interest expense incurred for regular tax and AFS purposes for 2030 is not a covered book expense as such amount is not reflected in the unadjusted depreciable basis, as defined in § 1.168(b)-1(a)(3), of the equipment for regular tax purposes and, accordingly, does not give rise to an AFSI adjustment under this paragraph (d). (ix) Example 9: Basis adjustment under section 743(b) to section 168 property —(A) Facts. PRS1, a partnership for Federal tax and AFS purposes, is owned by X, a C corporation, and A, an individual. PRS1 was formed in 2022, uses the calendar year as its taxable year, and has a calendar-year financial accounting period. For 2024, PRS1 has $100x of FSI, which includes $20x of covered book depreciation expense. For regular tax purposes, PRS1's deductible tax depreciation with respect to its section 168 property is $30x. X has a basis adjustment under section 743(b) with respect to its investment in PRS1 that relates to section 168 property owned by PRS1. As result of the basis adjustment, X is allocated an additional $5x of tax depreciation that relates to PRS1's section 168 property. X does not have a corresponding equity interest method basis adjustment for AFS purposes. (B) Analysis: PRS1's modified FSI adjustment. In computing its modified FSI for the 2024 taxable year, pursuant to § 1.56A-5(e)(3) and paragraph (d)(2)(i) of this section, PRS1 adjusts the $100x FSI to disregard the covered book depreciation expense of $20x, and reduces modified FSI by the deductible tax depreciation of $30x, which under paragraph (d)(2)(ii) of this section does not include X's $5x tax depreciation resulting from the basis adjustment under section 743(b). Accordingly, PRS1's modified FSI is $90x ($100x FSI + $20x covered book depreciation expense − $30x deductible tax depreciation). (C) Analysis: X's adjustments to its share of PRS1's modified FSI. Pursuant to § 1.56A-5(e)(1)(iv) and (e)(4)(ii)(A) and paragraph (d)(2)(ii) of this section, X adjusts its share of PRS1's modified FSI by deductible tax depreciation resulting from the basis adjustment under section 743(b) attributable to section 168 property under paragraph (d)(2)(ii) of this section. Accordingly, X reduces its share of modified FSI by deductible tax depreciation of $5x. (x) Example 10: Basis adjustment under section 734(b) to section 168 property —(A) Facts. The facts are the same as in paragraph (d)(5)(ix) of this section ( Example 9), except that on December 31, 2023, PRS1 distributed property, that is not section 168 property, to A. The distribution of property to A required PRS1 to increase its basis in its remaining partnership property under section 734(b), including its section 168 property. For 2024, as a result of the positive basis adjustment under section 734(b), PRS1 has additional tax depreciation with respect to section 168 property of $10x, increasing the deductible tax depreciation with respect to section 168 property from $30x to $40x. Consistent with paragraph (d)(5)(ix) of this section ( Example 9 ), X has a basis adjustment under section 743(b) with respect to its investment in PRS1 that relates to section 168 property owned by PRS1. As result of the basis adjustment, X is allocated an additional $5x of tax depreciation that relates to PRS1's section 168 property for 2024. (B) Analysis: PRS1's modified FSI adjustment. In computing its modified FSI for the 2024 taxable year, pursuant to § 1.56A-5(e)(3) and paragraph (d)(2)(i) of this section, PRS1 adjusts the $100x FSI to disregard the covered book depreciation expense of $20x, and reduces modified FSI by the deductible tax depreciation of $40x, which under paragraph (d)(2)(iii) of this section includes the deductible tax depreciation resulting from the basis adjustment under section 734(b). Accordingly, PRS1's modified FSI is $80x ($100x FSI + $20x covered book depreciation expense − $40x deductible tax depreciation). (C) Analysis: X's adjustments to its share of PRS1's modified FSI. Pursuant to § 1.56A-5(e)(1)(iv) and (e)(4)(ii)(A) and paragraph (d)(2)(ii) of this section, X adjusts its share of PRS1's modified FSI by deductible tax depreciation resulting from the basis adjustment under section 743(b) attributable to section 168 property under paragraph (d)(2)(ii) of this section. Accordingly, X reduces its share of modified FSI by deductible tax depreciation of $5x. (e) AFSI adjustments upon disposition of section 168 property —(1) In general. Except as otherwise provided in paragraph (e)(7) of this section, if a CAMT entity disposes of section 168 property for regular tax purposes, the CAMT entity adjusts AFSI for the taxable year in which the disposition occurs to redetermine any gain or loss taken into account in the CAMT entity's FSI with respect to the disposition for the taxable year (including a gain or loss of zero) by reference to the CAMT basis (in lieu of the AFS basis) of the section 168 property as of the date of the disposition (disposition date), as determined under paragraph (e)(2)(i) of this section. To the extent the CAMT basis of the section 168 property is negative (for example, because of differences between regular tax basis and AFS basis), this negative amount is required to be recognized as AFSI gain upon disposition of the section 168 property. (2) Adjustments to the AFS basis of section 168 property —(i) In general. For purposes of applying paragraph (e)(1) of this section, and subject to paragraphs (e)(2)(ii) and (e)(3) of this section, the CAMT basis of the section 168 property as of the disposition date is the AFS basis of the section 168 property as of that date— (A) Decreased by the full amount of tax depreciation with respect to such property as of the disposition date (regardless of whether any amount of tax depreciation was capitalized for regular tax purposes and not yet taken into account as a reduction to AFSI through an adjustment described in paragraph (d)(1)(i) or (ii) of this section as of the disposition date); (B) Increased by the amount of any covered book expense with respect to such property; (C) Increased by the amount of any covered book COGS depreciation and covered book depreciation expense that reduced the AFS basis of such property as of the disposition date, including covered book COGS depreciation and covered book depreciation expense with respect to AFS basis increases that are otherwise disregarded for AFSI and CAMT basis purposes (for example, AFS basis increases that are disregarded for AFSI and CAMT basis purposes under §§ 1.56A-18 and 1.56A-19); (D) Decreased by any reductions to the CAMT basis of such property under § 1.56A-21(c)(4) and (5); (E) Decreased by any amount allowed as a credit against tax imposed by subtitle A with respect to such property, but only to the extent of the amount that reduces the basis of such property for regular tax purposes; and (F) Increased or decreased, as appropriate, by the amount of any adjustments to AFS basis that are disregarded for AFSI and CAMT basis purposes under other sections of the section 56A regulations with respect to such property (for example, AFS basis decreases that are disregarded for AFSI and CAMT basis purposes under § 1.56A-8 and AFS basis adjustments that are disregarded for AFSI and CAMT basis purposes under § 1.56A-18 or § 1.56A-19). (ii) Special rules regarding adjustments to the AFS basis of section 168 property —(A) Property placed in service prior to the effective date of CAMT. In the case of section 168 property placed in service by a CAMT entity in a taxable year that begins before January 1, 2023, the amounts described in paragraph (e)(2)(i) of this section include amounts attributable to all taxable years beginning before January 1, 2023 (including taxable years beginning on or before December 31, 2019). (B) Property acquired in certain transactions to which section 168(i)(7) applies. In the case of section 168 property that was acquired by a CAMT entity in a transaction that is a covered recognition transaction, as defined in § 1.56A-18(b)(10), with respect to at least one party to the transaction, or in a transaction described in § 1.56A-20, the amounts described in paragraph (e)(2)(i) of this section include only amounts attributable to the period following the transaction, regardless of whether section 168(i)(7) applies to any portion of the transaction for regular tax purposes. (C) Coordination with section 56A(c)(5). The adjustment described in paragraph (e)(2)(i)(E) of this section applies regardless of the treatment of the tax credit for AFS purposes. See § 1.56A-8(b) and paragraph (e)(2)(i)(F) of this section. (D) Determination of CAMT basis of section 168 property following a change in method of accounting for depreciation or a tax capitalization method change. In the case of section 168 property for which the CAMT entity made a change in method of accounting for depreciation for regular tax purposes or a tax capitalization method change, the amounts described in paragraph (e)(2)(i) of this section are determined as though the CAMT entity used the method of accounting to which it changed under the corresponding method change when making the adjustments under paragraph (d)(1) of this section in all taxable years prior to the taxable year in which the disposition of the section 168 property occurs. The immediately preceding sentence applies regardless of whether the full amount of a corresponding tax depreciation section 481(a) adjustment or a tax capitalization method change AFSI adjustment has been taken into account in AFSI under paragraph (d)(1) of this section as of the end of the taxable year in which the disposition of the section 168 property occurs. (E) Adjustments to the AFS basis of section 168 property include only the covered book amounts actually disregarded in determining AFSI. The adjustments described in paragraphs (e)(2)(i)(B) and (C) of this section include only the amounts that were actually disregarded by the CAMT entity under paragraph (d)(1)(iii) of this section in computing its AFSI, modified FSI, or adjusted net income or loss for the relevant taxable years. Accordingly, for a taxable year ending after December 31, 2019, only the amounts disregarded under paragraph (d)(1)(iii) of this section in computing the AFSI, modified FSI, or adjusted net income or loss reported by the CAMT entity as required by the section 56A regulations or other sections of the Code (for example, on its annual return on Form 4626 (or any successor), on its Form 5471, or in accordance with the reporting requirements in § 1.56A-5(h)) for such taxable year with respect to the section 168 property are taken into account in computing the adjustments described in paragraphs (e)(2)(i)(B) and (C) of this section. For a taxable year ending on or before December 31, 2019, or for a taxable year in which the CAMT entity satisfies the simplified method under § 1.59-2(g) (including a taxable year included in the relevant three-taxable-year period), the CAMT entity is deemed to have disregarded the appropriate amounts under paragraph (d)(1)(iii) with respect to the section 168 property for such taxable year. (3) Special rules for section 168 property disposed of by a partnership. If a partnership disposes of section 168 property— (i) The adjustment under paragraph (e)(1) of this section with respect to the section 168 property is taken into account in determining the partnership's modified FSI under § 1.56A-5(e)(3); and (ii) For purposes of determining the adjustment under paragraph (e)(1) of this section with respect to the section 168 property, the adjustment to the partnership's AFS basis in the section 168 property under paragraph (e)(2)(i)(A) of this section— (A) Includes any tax depreciation (including any reduction in tax depreciation) with respect to a section 734(b) basis adjustment; (B) Excludes any tax depreciation (including any reduction in tax depreciation) with respect to a section 743(b) basis adjustment; and (C) Excludes any tax depreciation (including any reduction in tax depreciation) with respect to a basis adjustment under § 1.1017-1(g)(2). (iii) For purposes of determining the adjustment under paragraph (e)(1) of this section with respect to the section 168 property, the adjustment to the partnership's AFS basis in the section 168 property under paragraph (e)(2)(i)(D) of this section excludes any basis adjustment under § 1.1017-1(g)(2), regardless of whether any partner in the partnership is subject to the attribute reduction rules under § 1.56A-21(c)(5) and (6). However, if a partner in the partnership is subject to the attribute reduction rules under § 1.56A-21(c)(5) and (6), the partner increases its distributive share amount (under § 1.56A-5(e)(4)(ii)(B)) for the taxable year of the disposition of the section 168 property by the amount of any basis adjustment under § 1.1017-1(g)(2) with respect to the section 168 property that has not yet been taken into account for regular tax purposes. See § 1.1017-1(g)(2)(v). (iv) If a partner has a basis adjustment under section 743(b) with respect to section 168 property held by a partnership that is disposed of by the partnership for regular tax purposes, the partner— (A) Increases its distributive share amount (under § 1.56A-5(e)(4)(ii)(B)) for the taxable year of the disposition of the section 168 property by an amount equal to the total amount of any tax depreciation or tax depreciation section 481(a) adjustment(s) with respect to a section 743(b) basis adjustment that decreased the partner's distributive share amount under § 1.56A-5(e)(1)(iv) and (e)(4)(ii)(A) for taxable years prior to the disposition; and (B) Decreases its distributive share amount (under § 1.56A-5(e)(4)(ii)(B)) for the taxable year of the disposition of the section 168 property by an amount equal to the total amount of any tax depreciation or tax depreciation section 481(a) adjustment(s) with respect to a section 743(b) basis adjustment that increased the partner's distributive share amount under § 1.56A-5(e)(1)(iv) and (e)(4)(ii)(A) for taxable years prior to the disposition. (4) Treatment of amounts recognized in FSI upon the disposition of section 168 property. Except as provided in other sections of the section 56A regulations, if a CAMT entity disposes of section 168 property for regular tax purposes and recognizes gain or loss from the disposition in its FSI, the gain or loss (as redetermined under paragraph (e)(1) of this section) is recognized for AFSI purposes in the taxable year of the disposition, regardless of whether any gain or loss with respect to the disposition is realized, recognized, deferred, or otherwise taken into account for regular tax purposes. (5) Determining the appropriate asset. For purposes of determining the appropriate asset to ascertain whether section 168 property has been disposed of, the unit of property determination under § 1.263(a)-3(e) does not apply. Instead, section 168 and the regulations under section 168 apply. See § 1.168(i)-8(c)(4). (6) Subsequent AFS dispositions. If section 168 property is disposed of for regular tax purposes before it is treated as disposed of for AFS purposes, any AFS basis recovery with respect to such property that is reflected in FSI following the date such property is disposed of for regular tax purposes is disregarded in determining AFSI. (7) Intercompany transactions. If a member of a tax consolidated group disposes of section 168 property for regular tax purposes in an intercompany transaction, as defined in § 1.1502-13(b)(1)(i), for which the AFS consolidation entries are taken into account under § 1.1502-56A(c)(3)(i) in determining AFSI of the tax consolidated group for the taxable year that includes the intercompany transaction, the tax consolidated group member's AFSI adjustment under paragraph (e)(1) of this section is determined as of the date of the intercompany transaction. However, such AFSI adjustment is deferred, and the tax consolidated group does not adjust AFSI under this paragraph (e), until the taxable year in which the AFS consolidation entries related to the disposition become disregarded under § 1.1502-56A(c)(3)(ii). See § 1.1502-56A(e)(3). (8) Examples. The following examples illustrate the application of the rules in this paragraph (e). For purposes of paragraphs (e)(8)(i) through (ix) of this section (Examples 1 through 9), each of X and Y is a corporation that uses the calendar year as its taxable year and has a calendar-year financial accounting period. Unless otherwise stated, Y has elected out of additional first year depreciation under section 168(k), and the tax depreciation with respect to any section 168 property is not required to be capitalized under any capitalization provision in the Code. (i) Example 1: Disposition of section 168 property —(A) Facts. X is an applicable corporation for the calendar year ending December 31, 2024. On January 1, 2019, X purchased and placed in service Property 1, which is section 168 property, at a cost of $1,000x. Property 1 qualified for, and X claimed, the 100-percent additional first year depreciation deduction allowable under section 168(k) for its taxable year ending December 31, 2019. For AFS purposes, X depreciates Property 1 over 40 years on a straight-line method and recognizes $25x ($1,000x cost/40 years) of covered book depreciation expense in 2019 and each year thereafter until X sells Property 1 (a disposition for regular tax and AFS purposes) on January 1, 2025, for $900x. For 2025, X takes into account $50x of net gain from the sale of Property 1 in its FSI ($900x consideration−$850x of AFS basis ($1,000x cost−$150x accumulated covered book depreciation expense as of January 1, 2025)). (B) Analysis: Taxable year 2024. In determining AFSI for the taxable year ending December 31, 2024, X does not have any tax COGS depreciation or deductible tax depreciation in computing taxable income with respect to Property 1, and thus, the adjustments under paragraphs (d)(1)(i) and (ii) of this section are zero. In addition, X adjusts AFSI under paragraph (d)(1)(iii) of this section to disregard the $25x of covered book depreciation expense with respect to Property 1. (C) Analysis: Taxable year 2025. To determine the AFSI adjustment for the gain or loss from the sale of Property 1 under paragraph (e)(1) of this section, X determines the CAMT basis of Property 1 by adjusting the AFS basis of Property 1 by the amounts described in paragraph (e)(2)(i) of this section with respect to Property 1, including those amounts attributable to taxable years beginning before January 1, 2023 (as required by paragraph (e)(2)(ii)(A) of this section). Accordingly, the CAMT basis of Property 1 for AFSI purposes is zero ($850x AFS basis + $150x accumulated covered book depreciation expense−$1,000x accumulated tax depreciation). Thus, the redetermined gain on the sale of Property 1 for AFSI purposes is $900x ($900x consideration−$0x CAMT basis), and X's AFSI adjustment under paragraph (e)(1) of this section required to reflect the redetermined gain is a positive adjustment of $850x ($900x redetermined gain−$50x net gain in FSI). (ii) Example 2: Property acquired in a covered nonrecognition transaction —(A) Facts: Property 1. The facts are the same as in paragraph (e)(8)(i)(A) of this section ( Example 1 ), except that X does not sell Property 1. (B) Facts: Merger. On January 1, 2024, X merges with and into Y, a corporation, in a transaction that qualifies as a reorganization under section 368(a)(1)(A) of the Code (Merger). The sole consideration received by X's shareholders in the Merger is Y voting stock. On X's AFS and Y's AFS for the 2024 taxable year, the Merger results in $165x net gain included in FSI and a corresponding $165x increase in the AFS basis of the assets exchanged in the transaction. As a result, Y's AFS basis of Property 1 as of January 1, 2024, is $1,040x ($1,000x AFS basis on January 1, 2019−$125x accumulated covered book depreciation expense + $165x net gain in FSI from the Merger). For AFS purposes, Y depreciates Property 1 over 40 years on a straight-line method and recognizes $26x ($1,040x AFS basis following the Merger/40 years) of covered book depreciation expense in the 2024 taxable year. (C) Facts: Disposition of Property 1. On January 1, 2025, Y sells Property 1 for $900x. For 2025, Y takes into account $114x of net loss from the sale of Property 1 in its FSI ($900x consideration−$1,014x AFS basis ($1,040x AFS basis following the Merger−$26x of covered book depreciation expense for the 2024 taxable year)). (D) Analysis: Merger in 2024. The Merger is a covered nonrecognition transaction, as defined in § 1.56A-18(b)(9). Under § 1.56A-19(c)(1)(i)(A), in computing AFSI resulting from the Merger, X disregards any gain or loss reflected in its FSI resulting from the exchange of X's assets for the Y stock in the Merger. As a result, X's AFSI does not include the $165x net gain that was taken into account on its AFS as a result of the transfer of its assets to Y in the Merger. Under § 1.56A-19(c)(3)(i)(A), Y disregards any gain or loss reflected in its FSI resulting from the exchange of its stock for X's assets in the Merger. Under § 1.56A-19(c)(3)(ii), Y takes Property 1 (acquired from X in the Merger) with a CAMT basis of $0x, equal to X's CAMT basis in Property 1 prior to the Merger ($875x AFS basis + $125x accumulated covered book depreciation expense−$1,000x accumulated tax depreciation). Under § 1.56A-19(c)(4)(i), X's shareholders' AFSI is adjusted to disregard the $165x net gain in FSI and, thus, includes no gain or loss in AFSI resulting from the exchange of X stock for Y stock in the Merger. (E) Analysis: Property 1 in taxable year 2024. For regular tax purposes, Y is treated as X for purposes of computing tax depreciation with respect to Property 1 under section 168(i)(7). Because Property 1 was already fully depreciated by X prior to the Merger, Y's tax depreciation with respect to Property 1 is zero. As a result, Y does not have any tax COGS depreciation or deductible tax depreciation with respect to Property 1 for 2024, and thus, the adjustments under paragraphs (d)(1)(i) and (ii) of this section are zero. In addition, Y adjusts AFSI under paragraph (d)(1)(iii) of this section to disregard the $26x of covered book depreciation expense with respect to Property 1. (F) Analysis: Taxable year 2025. To determine the AFSI adjustment for gain or loss resulting from the sale of Property 1 under paragraph (e)(1) of this section, Y determines the CAMT basis of Property 1 by adjusting the AFS basis by the amounts described in paragraph (e)(2)(i) of this section with respect to Property 1, including those amounts attributable to taxable years beginning before January 1, 2024 (as required by paragraph (e)(2)(ii)(A) of this section). Because the Merger in 2024 is a covered nonrecognition transaction, paragraph (e)(2)(ii)(B) of this section does not apply and, thus, depreciation with respect to years prior to the Merger is accounted for in determining the CAMT basis of Property 1. Accordingly, the CAMT basis of Property 1 for AFSI purposes is zero ($1,014x AFS basis + $125x accumulated covered book depreciation expense from years prior to the Merger + $26x accumulated covered book depreciation expense from years after the Merger−$1,000x of accumulated tax depreciation−$165x increase in AFS basis from the Merger that is disregarded for CAMT purposes under § 1.56A-19(c)(3)(ii)). Thus, the redetermined gain on the sale of Property 1 for AFSI purposes is $900x ($900x consideration−$0x CAMT basis) and Y's AFSI adjustment under paragraph (e)(1) of this section to reflect the redetermined gain is a positive adjustment of $1,014x ($900x redetermined gain−$114x net loss in FSI). (iii) Example 3: Property acquired in a covered recognition transaction —(A) Facts: Property 1 before the transaction. The facts are the same as in paragraph (e)(8)(i)(A) of this section ( Example 1 ), except that X does not sell Property 1, and Property 1 has a fair market value of $900x on January 1, 2024. (B) Facts: Section 351 transfer with boot. On January 1, 2024, X transfers Property 1 to Y, an unrelated applicable corporation, in exchange for 100 shares of Y stock with a fair market value of $700x and $200x cash in a transaction that qualifies under section 351(b) of the Code (Exchange). The Exchange is made pursuant to an integrated transaction in which unrelated Z transfers non-depreciable Property 2 to Y. Following the Exchange, X and Y are not members of the same controlled group of corporations, as defined in § 1.59-2(e), and do not report their FSI on a consolidated financial statement. On X's AFS for the 2024 taxable year, the Exchange results in $25x net gain in FSI ($900x consideration−$875x AFS basis ($1,000x cost−$125x accumulated book depreciation)). On Y's AFS for the 2024 taxable year, Y has a corresponding $25x increase in the AFS basis of Property 1. As a result, Y's AFS basis of Property 1 is $900x ($1,000x AFS basis on January 1, 2019−$125x X's accumulated covered book depreciation expense + $25x net gain in X's FSI from the Exchange). For AFS purposes, Y depreciates Property 1 over 40 years using the straight line method and recognizes $22.5x ($900x AFS basis following the Exchange)/40 years) of covered book depreciation expense in the 2024 taxable year. (C) Facts: Tax depreciation for Property 1 in taxable year 2024. Y is treated as acquiring Property 1 on January 1, 2024. For regular tax purposes, under section 168(i)(7), Y is treated as X for purposes of computing depreciation deductions with respect to so much of the basis of Property 1 in the hands of Y as does not exceed the adjusted basis of Property 1 in the hands of X. Because X fully depreciated Property 1 prior to the Exchange, the adjusted basis of Property 1 in the hands of X prior to the Exchange is zero and, thus, the amount of Y's tax depreciation for Property 1 that is determined under section 168(i)(7) is also zero. However, under section 362(a) of the Code, the $200x cash X received from Y in the Exchange increases Y's adjusted basis of Property 1. Y depreciates the $200x adjusted basis of Property 1 under the general depreciation system by using the 200 percent declining balance method, 5-year recovery period, and half-year convention. For regular tax purposes, Y recognizes $40x ($200x x 20%) of deductible tax depreciation in 2024 with respect to Property 1. (D) Facts: Disposition of Property 1. On January 1, 2025, Y sells Property 1 for $800x. For 2025, Y takes into account $77.5x of net loss for the sale of Property 1 in its FSI ($800x consideration−$877.5x AFS basis ($900x AFS basis following the Exchange−$22.5x of covered book depreciation expense for the 2024 taxable year)). (E) Analysis: Exchange in 2024. Because Y transferred cash to X in addition to Y stock, under § 1.56A-19(g)(4)(i), the Exchange is a covered recognition transaction, as defined in § 1.56A-18(b)(10). Under § 1.56A-19(g)(3)(i), to determine AFSI resulting from the Exchange, X redetermines the gain or loss reflected in FSI by reference to CAMT basis. Thus, X's redetermined gain from the Exchange is $900x ($900x consideration−$0x CAMT basis in Property 1 ($875x AFS basis + $125x accumulated covered book depreciation expense−$1,000x accumulated tax depreciation)) and X's AFSI adjustment to reflect the redetermined gain is a positive adjustment of $875x ($900x redetermined gain−$25x net gain in FSI). Under § 1.56A-19(g)(5)(ii), Y's CAMT basis in Property 1 is equal to its AFS basis of $900x. (F) Analysis: Property 1 in taxable year 2024. In determining AFSI for the taxable year ending December 31, 2024, Y does not have any tax COGS depreciation in computing taxable income with respect to Property 1, and thus, the adjustment under paragraph (d)(1)(i) of this section is zero. In addition, Y reduces AFSI under paragraph (d)(1)(ii) of this section by deductible tax depreciation of $40x, and Y adjusts AFSI under paragraph (d)(1)(iii) of this section to disregard the $22.5x of covered book depreciation expense with respect to Property 1. (G) Analysis: Taxable year 2025. To determine the AFSI adjustment for the gain or loss from the sale of Property 1 under paragraph (e)(1) of this section, Y determines the CAMT basis of Property 1 by adjusting the AFS basis of Property 1 by the amounts described in paragraph (e)(2)(i) of this section, which generally include amounts attributable to taxable years beginning before January 1, 2024 (as required by paragraph (e)(2)(ii)(A) of this section). However, because the Exchange is a covered recognition transaction, under paragraph (e)(2)(ii)(B) of this section, the amounts described in paragraph (e)(2)(i) of this section taken into account to determine Y's CAMT basis of Property 1 include only amounts attributable to the period following the date Property 1 was acquired in the Exchange, or January 1, 2024. Accordingly, the CAMT basis of Property 1 is $860x ($877.5x AFS basis ($900x AFS basis following the Exchange−$22.5x of covered book depreciation expense for the 2024 taxable year) + $22.5x accumulated covered book depreciation expense following the Exchange−$40x of tax depreciation following the Exchange). Thus, the redetermined loss on the sale of Property 1 for AFSI purposes is $60x ($800x consideration−$860x CAMT basis) and Y's AFSI adjustment under paragraph (e)(1) of this section to reflect the redetermined loss is a positive adjustment of $17.5x ($60x redetermined loss−$77.5x net loss in FSI). (iv) Example 4: Property for which a tax credit was claimed —(A) Facts. X is a domestic corporation that uses the calendar year as its taxable year and has a calendar-year financial accounting period. On January 1, 2018, X purchased and placed in service Property A, which is section 168 property, at a cost of $1,000x. Property A qualified for, and X claimed, a $200x investment tax credit for its taxable year ending December 31, 2018. X reduced its regular tax basis in Property A under section 50(c)(1) of the Code and its AFS basis in Property A under the accounting standards used to prepare its AFS to $800x ($1,000x cost basis−$200x basis reduction for the credit received). For regular tax purposes, Property A qualified for, and X claimed, the 100-percent additional first year depreciation deduction allowable under section 168(k) for its taxable year ending December 31, 2018, for the remaining $800x of regular tax basis. For AFS purposes, X depreciates Property A over 40 years on a straight-line method and recognizes $20x ($800x AFS basis/40 years) of depreciation expense in its FSI in 2018 and each year thereafter until it sells Property A (a disposition for regular tax and AFS purposes) on January 1, 2024, for $900x. For 2024, X recognizes $220x of net gain for the sale of Property A in its FSI ($900x consideration−$680x AFS basis ($1,000x cost−$200x investment tax credit−$120x accumulated depreciation expense as of January 1, 2024)). Under § 1.56A-8(b), X disregards the $200x investment tax credit claimed with respect to Property A in determining its AFSI. Had X determined its depreciation expense for AFS purposes without regard to the $200x investment tax credit, X would have instead recognized $25x ($1000x AFS basis/40 years) of depreciation expense each year and $50 of net gain in 2024 from the sale from the sale of Property A ($900x consideration−$850 AFS basis ($1000x cost−$150x accumulated depreciation expense). (B) Analysis for taxable year 2023. In determining AFSI for the taxable year ending December 31, 2023, X does not have any tax COGS depreciation or deductible tax depreciation in computing taxable income with respect to Property A, and thus, the adjustments to AFSI under paragraphs (d)(1)(i) and (ii) of this section are zero. In addition, X is required to adjust AFSI under paragraph (d)(1)(iii) of this section to disregard covered book depreciation expense with respect to Property A. Notwithstanding that the depreciation expense reflected in X's FSI is reduced as a result of the AFS treatment of the investment tax credit, and that the investment tax credit is disregarded under § 1.56A-8(b), covered book depreciation expense for 2023 is $20x (as opposed to $25x), which is the amount of depreciation expense that X actually reflects in its FSI for 2023. That is, the adjustment to AFSI under paragraph (d)(1)(iii) of this section encompasses the adjustment required under § 1.56A-8(b). (C) Analysis for taxable year 2024. To determine the AFSI adjustment for the gain or loss from the sale of Property A under paragraph (e)(1) of this section, X determines the CAMT basis of such property by adjusting the AFS basis of such property as of the disposition date by the amounts described in paragraph (e)(2)(i) of this section, including those amounts attributable to taxable years beginning before January 1, 2023 (as required by paragraph (e)(2)(ii)(A) of this section). The AFS basis of Property A as of the disposition date is $680x. Such amount is decreased by the $800x of tax depreciation with respect to Property A under paragraph (e)(2)(i)(A) of this section, increased by the $120x of covered book depreciation expense under paragraph (e)(2)(i)(C) of this section (which is the amount of covered book depreciation expense that reduced the AFS basis of Property A as of the disposition date), decreased by the $200x investment tax credit under paragraph (e)(2)(i)(E) of this section (which equals the amount by which X reduced its basis in Property A for regular tax purposes), and increased, under paragraph (e)(2)(i)(F) of this section, by the $200x reduction to AFS basis that is disregarded under § 1.56A-8(b). Accordingly, the CAMT basis of Property A is $0, and the redetermined gain on the sale of Property A for AFSI purposes is $900x ($900x consideration−$0x CAMT basis). Thus, X's AFSI adjustment under paragraph (e)(1) of this section is an increase to AFSI of $680x ($900x redetermined gain−$220x FSI gain). (v) Example 5: Disposition of property that was subject to a tax capitalization method change and is not section 168 property at time of disposition— (A) General facts. The facts are the same as in paragraph (d)(5)(v) of this section ( Example 5), except Y transfers the replacement property to a scrap account on January 1, 2030, and sells it on the same day for $5,000x. Y's AFS basis in the replacement property as of January 1, 2030, is $4,000x ($10,000x cost−$6,000x of cumulative book depreciation expense as of January 1, 2030 ($500x for 2024, $1,000x for each year in the period 2025 through 2029, and $500x for 2030)). Accordingly, Y takes into account $1,000x of net gain for the sale of the replacement property in its FSI for 2030 ($5,000x consideration−$4,000x of AFS basis). (B) Analysis: Taxable years 2027 through 2029. As discussed in the analysis in paragraph (d)(5)(v)(C) of this section, the replacement property is no longer section 168 property beginning in 2027. Therefore, except as provided in the analysis in paragraph (d)(5)(v)(D) of this section (regarding the tax capitalization method change AFSI adjustment), Y does not make any AFSI adjustments under paragraph (d)(1) of this section with respect to the replacement property for taxable years 2027 through 2029. Accordingly, Y's AFSI for taxable years 2027 through 2029 includes the book depreciation expense taken into account in Y's FSI for those years ($1,000x for each of 2027, 2028, and 2029) and the portion of the tax capitalization method change AFSI adjustment pursuant to paragraph (d)(4) of this section. (C) Analysis: Taxable year 2030. If a CAMT entity disposes of section 168 property, this paragraph (e) requires the CAMT entity to adjust AFSI for the taxable year of the disposition to redetermine any gain or loss taken into account in the CAMT entity's FSI by reference to the CAMT basis of the section 168 property, as determined under paragraph (e)(2)(i) of this section. However, as discussed in the analysis in paragraph (d)(5)(v)(C) of this section, the replacement property is no longer section 168 property under the method of accounting Y changed to under the tax capitalization method change, and therefore the replacement property is not section 168 property at the time of disposition. Accordingly, this paragraph (e) does not apply for purposes of determining the CAMT basis and any corresponding amount of any gain or loss Y takes into account in computing AFSI for 2030 with respect to the disposition of the replacement property. Therefore, the net gain from the sale of the replacement property that Y takes into account in its AFSI for 2030 is the same as the amount taken into account in Y's FSI for 2030 ($1,000x). (vi) Example 6: Disposition of property that was subject to a tax capitalization method change and is section 168 property at time of disposition— (A) General facts. The facts are the same as in paragraph (d)(5)(vi) of this section ( Example 6), except Y sells the section 168 property on December 31, 2029, for $5,000x. (B) Facts: Basis of the section 168 property for regular tax and AFS purposes at disposition. As provided in the analysis in paragraph (d)(5)(vi)(D) of this section, Y's unadjusted basis in the section 168 property is $30,000x following the tax capitalization method change. Based on Y's depreciation methods of accounting with respect to the section 168 property for regular tax purposes (described in paragraph (d)(5)(vi)(A) of this section), the section 168 property is fully depreciated for regular tax purposes as of December 31, 2029 (that is, cumulative deductible tax depreciation as of December 31, 2029 equals $30,000x), resulting in adjusted basis for regular tax purposes at disposition of zero. For AFS purposes, Y's cumulative covered book depreciation expense taken into account in Y's FSI as of December 31, 2029 with respect to the section 168 property is $10,000x ($1,000x in 2024, $2,000x in each year for the period 2025 through 2028, and $1,000x in 2029), resulting in AFS basis at the time of disposition with respect to the section 168 property of $10,000x ($20,000x original cost less $10,000x of cumulative covered book depreciation expense). (C) Facts: AFS gain or loss for taxable year 2029. For its taxable year 2029, Y takes into account a net loss equal to $5,000x in its FSI with respect to the disposition of the section 168 property ($5,000x consideration less $10,000x AFS basis). (D) Analysis: AFSI gain or loss for taxable year 2029. If a CAMT entity disposes of section 168 property, this paragraph (e) requires the CAMT entity to adjust AFSI for the taxable year of the disposition to redetermine any gain or loss taken into account in the CAMT entity's FSI by reference to the CAMT basis of the section 168 property, as determined under paragraph (e)(2)(i) of this section. In addition, pursuant to the special rule in paragraph (e)(2)(ii)(E) of this section, if a CAMT entity made a tax capitalization method change with respect to the section 168 property disposed of, the amounts described in paragraph (e)(2)(i) of this section are determined as though the CAMT entity used the method of accounting it changed to under the corresponding method change. As provided in the analysis in paragraph (d)(5)(vi)(D) of this section, the $10,000x of general and administrative costs taken into account in computing taxable income for 2024 constitute section 168 property beginning in 2027. Accordingly, the CAMT basis of the section 168 property for purposes of determining any gain or loss to take into account in AFSI upon the sale of the property on December 31, 2029 is zero ($10,000x AFS basis + $10,000x accumulated covered book depreciation expense + $10,000x of covered book expense (the general and administrative costs taken into account in FSI for 2024)−$30,000x of accumulated tax depreciation). Pursuant to the special rule in paragraph (e)(2)(ii)(E) of this section, CAMT basis is zero notwithstanding that Y has not yet taken into account in AFSI the full amount of the tax capitalization method change AFSI adjustment that resulted from the tax capitalization method change (as of December 31, 2029, Y has included 75% of the tax capitalization method change AFSI adjustment in AFSI ($720x for each of 2027, 2028, and 2029)). Thus, the redetermined gain on the sale of the section 168 property for AFSI purposes is $5,000x ($5,000x consideration−$0x CAMT basis), and Y's AFSI adjustment under paragraph (e)(1) of this section required to reflect the redetermined gain is a positive adjustment of $10,000x ($5,000x redetermined gain less $5,000x of net loss in FSI). (vii) Example 7: Installment sale under section 453 —(A) Facts. X is a CAMT entity that uses the calendar year as its taxable year and has a calendar-year financial accounting period. On January 1, 2018, X purchased for $550x and placed in service residential rental property (Real Property 1), which is section 168 property. For regular tax purposes, X depreciates Real Property 1 under the general depreciation system by using the straight-line method, a 27.5-year recovery period, and the mid-month convention. X depreciates Real Property 1 for AFS purposes using the same recovery period, depreciation method, and convention that is used for regular tax purposes. X becomes an applicable corporation for the calendar year ending December 31, 2024. On January 1, 2024, X sells Real Property 1 to Y, an unrelated taxpayer, for $1,000x with the following payment structure: $100x payable at closing and the remainder payable in equal annual installments over the next 9 years, together with adequate stated interest. As of the date of the installment sale, X's adjusted basis for regular tax purposes, AFS basis, and CAMT basis for AFSI purposes (as determined under paragraph (e)(1) of this section) for Real Property 1 is $430x. X does not elect out of the installment method under section 453 of the Code. The gross profit to be realized on the sale is $570x ($1,000x selling price−$430x adjusted regular tax/AFS/CAMT basis). The gross profit percentage is 57% ($570x gross profit/$1,000x contract price). No provision in section 56A or the section 56A regulations provides for an adjustment to AFSI to apply the installment method under section 453. (B) Analysis. For taxable year 2024, X realizes $570x ($1,000x selling price−$430x basis) of gain for both regular tax and FSI purposes from the disposition of Real Property 1 in the installment sale. X recognizes $570x of the gain in FSI, but for regular tax purposes, X recognizes only $57x (57% of the $100x payment received in 2024) of the gain, and the remaining $513x of gain is deferred and recognized as subsequent payments are received under the installment method. Pursuant to paragraph (e)(4) of this section, the installment method in section 453 does not apply for purposes of determining the AFSI gain or loss on the disposition of Real Property 1. Accordingly, X recognizes the entire $570x FSI gain in AFSI, notwithstanding that $513x was deferred under section 453 for regular tax purposes. (viii) Example 8: Like-kind exchange under section 1031 —(A) Facts. The facts are the same as paragraph (e)(8)(vii)(A) of this section ( Example 7 ), except that, on January 1, 2024, instead of an installment sale, X transfers Real Property 1 to Y in exchange for Real Property 2 with a fair market value of $440x and $20x cash. The exchange qualifies as an exchange of real property held for productive use or investment under section 1031 of the Code. As of the date of the exchange, X's adjusted basis for regular tax purposes, AFS basis, and CAMT basis for AFSI purposes (as determined under paragraph (e)(1) of this section) for Real Property 1 is $430x. No provision in section 56A or the section 56A regulations provides for an adjustment to AFSI to apply the nonrecognition rules under section 1031. (B) Analysis. For taxable year 2024, X realizes $30x of gain under section 1001(a) of the Code ($460x amount realized ($440x fair market value of replacement Real Property B + $20x cash)−$430x adjusted regular tax basis of relinquished property). Of the $30x realized gain, only $20x is recognized by X under section 1031(b) for regular tax purposes, as this is the amount of non-like-kind consideration received in the exchange ($20x cash). For AFS purposes, X recognizes $30x of gain in its FSI ($460x amount realized ($440x fair market value of Real Property 2 + $20x cash)−$430x AFS basis of Real Property 1). Pursuant to paragraph (e)(4) of this section, the nonrecognition rules in section 1031 do not apply for purposes of determining the AFSI gain or loss on the disposition of Real Property 1. Accordingly, for AFSI purposes, X recognizes the entire redetermined gain of $30x ($460x amount realized−$430x of CAMT basis under paragraph (e)(1) of this section) for purposes of computing AFSI, notwithstanding that X recognized only $20x of the $30x gain realized for regular tax purposes. (ix) Example 9: Replacement property received in a like-kind exchange —(A) Facts. The facts are the same as in paragraph (e)(8)(viii)(A) of this section ( Example 8 ). In addition, for regular tax purposes, X's regular tax basis in the replacement Real Property 2 as of the date of the exchange is $430x ($430x adjusted regular tax basis in relinquished Real Property 1−$20x cash + $20x gain recognized). X's AFS basis in Real Property 2 as of the date of the exchange is $440x, which is the fair market value of Real Property 2 as of the date of the exchange. Under § 1.168(i)-6(c)(3)(ii) and paragraph (c)(4) of this section, X depreciates the $430x regular tax basis of Real Property 2 over the remaining recovery period of, and using the same depreciation method and convention as that of, Real Property 1. For AFS purposes, X depreciates the $440x AFS basis of Real Property 2 using the straight-line method and a 27.5-year recovery period and recognizes $16x ($440x/27.5 years) of covered book depreciation expense each year. On January 1, 2032, X sells Real Property 2 with a regular tax basis of $270x ($430x exchange basis−$160x accumulated tax depreciation) and a AFS basis of $312x ($440x AFS basis−$128x accumulated book depreciation) to Z for $500x cash. (B) Analysis. For regular tax purposes, X recognizes a gain on the sale of Real Property 2 of $230x ($500x amount realized−$270x regular tax basis). For AFS purposes, X recognizes a gain of $188x in its FSI ($500x amount realized−$312x AFS basis). Pursuant to paragraph (e)(1) of this section, X adjusts AFSI for taxable year 2032 to redetermine the gain or loss taken to account in FSI with respect to the disposition of Real Property 2 by reference to the CAMT basis of Real Property 2, as determined under paragraph (e)(2)(i) of this section. Accordingly, the CAMT basis of Real Property 2 for AFSI purposes is $280x ($312x AFS basis + $128x accumulated covered book depreciation expense−$160x of accumulated tax depreciation). Thus, the redetermined gain on the sale of Real Property 2 for AFSI purposes is $220x ($500x consideration−$280x CAMT basis), and Y's AFSI adjustment under paragraph (e)(1) of this section required to reflect the redetermined gain is a positive adjustment of $32x ($220x redetermined gain−$188x of net gain in FSI). (x) Example 10: Section 168 property disposed of by a partnership— (A) Facts. PRS1, a partnership for Federal tax and AFS purposes, is owned by X, a C corporation, and A, an individual. PRS1 was formed in 2022, uses the calendar year as its taxable year, and has a calendar-year financial accounting period. PRS1 purchased and placed in service section 168 property on January 1, 2023, at a cost of $210x. For AFS purposes, PRS1 depreciates the section 168 property over 10 years on a straight-line method, recognizing $21x ($210x cost basis/10 years) of covered book depreciation expense in 2023 and each year thereafter. For regular tax purposes, the applicable recovery period of the section 168 property is 7 years and PRS1 makes an election under section 168(b)(5) to depreciate the section 168 property on a straight-line basis using the half-year convention. Accordingly, the deductible tax depreciation with respect to the section 168 property is $15x for 2023 and $30x for each of 2024 and 2025. In addition, the deductible tax depreciation with respect to the section 168 property is increased in 2024 and subsequent years by $10x each year as a result of a positive basis adjustment under section 734(b) on December 31, 2023, so that the deductible tax depreciation with respect to the section 168 property is $40x in each of 2024 and 2025. On January 1, 2026, PRS1 sells the section 168 property for $100x (a disposition for regular tax and AFS purposes). For 2026, PRS1 takes into account $47x of net loss from the sale of the section 168 property in its FSI ($100x consideration−$147x AFS basis ($210x cost−$63x accumulated covered book depreciation expense as of January 1, 2026)). (B) Analysis: Taxable years 2023 through 2025. In determining modified FSI for the 2023, 2024 and 2025 taxable years, PRS1 adjusts its modified FSI under § 1.56A-5(e)(3) and paragraph (d)(2)(i) of this section to disregard the $21x of covered book depreciation expense each year with respect to the section 168 property and reduces modified FSI by deductible tax depreciation of $15x for 2023 and $40x for each of 2024 and 2025, which under paragraph (d)(2)(iii) of this section includes the deductible tax depreciation with respect to the basis adjustment under section 734(b). (C) Analysis: Taxable year 2026. Under paragraphs (e)(1) and (e)(3)(i) of this section, PRS1 adjusts its modified FSI for 2026 to redetermine any gain or loss taken into account in its FSI with respect to the disposition of the section 168 property by reference to the CAMT basis of the section 168 property, taking into account the adjustments under paragraphs (e)(2)(i) and (e)(3)(ii) of this section. Under paragraphs (e)(2)(i)(A) and (e)(3)(ii)(A) of this section, PRS1 adjusts the AFS basis, decreasing it by the full amount of tax depreciation with respect to the property as of the disposition date. Accordingly, the CAMT basis of the section 168 property is $115x ($147x AFS basis + $63x accumulated covered book depreciation expense−$95x accumulated tax depreciation). Thus, the redetermined loss on the sale of the section 168 property is $15x ($100x consideration−$115x CAMT basis) and PRS1's adjustment to modified FSI under paragraph (e)(1) of this section to reflect the redetermined loss is a positive adjustment of $32x ($15x redetermined loss−$47x net loss in FSI). (xi) Example 11: Section 168 property disposed of by a partnership with a section 743(b) basis adjustment in place— (A) Facts. The facts are the same as in paragraph (e)(8)(x)(A) of this section ( Example 10 ). In addition, on January 1, 2024, X purchased additional interests in PRS1 that resulted in a $50x basis adjustment under section 743(b) with respect to its investment in PRS1 that relates to section 168 property owned by PRS1. As result of the basis adjustment, X is allocated an additional $5x of tax depreciation that relates to PRS1's section 168 property for each of 2024 and 2025. X does not have a corresponding equity interest method basis adjustment for AFS purposes. (B) Analysis: Taxable years 2024 and 2025. Pursuant to § 1.56A-5(e)(1)(iv) and (e)(4)(ii)(A) and paragraph (d)(2)(i) of this section, X adjusts its share of PRS1's modified FSI by deductible tax depreciation resulting from the basis adjustment under section 743(b) attributable to section 168 property under paragraph (d)(2)(ii) of this section. Accordingly, X reduces its share of modified FSI by deductible tax depreciation of $5x for each of 2024 and 2025. (C) Analysis: Taxable year 2026. Pursuant to § 1.56A-5(e)(1)(iv) and (e)(4)(ii)(B) and paragraph (e)(3)(iv) of this section, X increases its distributive share amount for 2026 by an amount equal to the total amount of tax depreciation with respect to its section 743(b) basis adjustment that decreased its distributive share amount under §§ 1.56A-5(e)(1)(iv) and (e)(4)(ii)(A), that is, an increase of $10x. (f) Applicability date. This section applies to taxable years ending after [DATE OF PUBLICATION OF FINAL RULE IN THE Federal Register ].