Treasury Regulations, Subchapter A, Sec. 1.514(a)-1
From TaxAlmanac
Sec. 1.514(a)-1 Unrelated debt-financed income and deductions
(a) Income includible in gross income:
(1) Percentage of income taken into account—(i) In general. For taxable years beginning after December 31, 1969, there shall be included with respect to each debt-financed property (as defined in section 514 and §1.514(b)–1) as an item of gross income derived from an unrelated trade or business the amount of unrelated debt-financed income (as defined in subdivision (ii) of this subparagraph). See paragraph (a)(5) of §1.514(c)–1 for special rules regarding indebtedness incurred before June 28, 1966, applicable for taxable years beginning before January 1, 1972, and for special rules applicable to churches or conventions or associations of churches.
(ii) Unrelated debt-financed income. The unrelated debt-financed income with respect to each debt-financed property is an amount which is the same percentage (but not in excess of 100 percent) of the total gross income derived during the taxable year from or on account of such property as:
(a) The average acquisition indebtedness (as defined in subparagraph (3) of this paragraph) with respect to the property is of
(b) The average adjusted basis of such property (as defined in subparagraph (2) of this paragraph).
(iii) Debt/basis percentage. The percentage determined under subdivision (ii) of this subparagraph is hereinafter referred to as the debt/basis percentage.
(iv) Example. Subdivisions (i), (ii), and (iii) of this subparagraph are illustrated by the following example. For purposes of this example it is assumed that the property is debt-financed property.
Example. X, an exempt trade association, owns an office building which in 1971 produces $10,000 of gross rental income. The average adjusted basis of the building for 1971 is $100,000, and the average acquisition indebtedness with respect to the building for 1971 is $50,000. Accordingly, the debt/basis percentage for 1971 is 50 percent (the ratio of $50,000 to $100,000). Therefore, the unrelated debt-financed income with respect to the building for 1971 is $5,000 (50 percent of $10,000).
(v) Gain from sale or other disposition. If debt-financed property is sold or otherwise disposed of, there shall be included in computing unrelated business taxable income an amount with respect to such gain (or loss) which is the same percentage (but not in excess of 100 percent) of the total gain (or loss) derived from such sale or other disposition as:
(a) The highest acquisition indebtedness with respect to such property during the 12-month period, preceding the date of disposition, is of
(b) The average adjusted basis of such property.
The tax on the amount of gain (or loss) included in unrelated business taxable income pursuant to the preceding sentence shall be determined in accordance with the rules set forth in subchapter P, chapter 1 of the Code (relating to capital gains and losses). See also section 511(d) and the regulations thereunder (relating to the minimum tax for tax preferences).
(2) Average adjusted basis—(i) In general. The average adjusted basis of debt-financed property is the average amount of the adjusted basis of such property during that portion of the taxable year it is held by the organization. This amount is the average of:
(a) The adjusted basis of such property as of the first day during the taxable year that the organization holds the property, and
(b) The adjusted basis of such property as of the last day during the taxable year that the organization holds the property.
See section 1011 and the regulations thereunder for determination of the adjusted basis of property.
(ii) Adjustments for prior taxable years. For purposes of subdivision (i) of this subparagraph, the determination of the average adjusted basis of debt-financed property is not affected by the fact that the organization was exempt from taxation for prior taxable years. Proper adjustment must be made under section 1011 for the entire period since the acquisition of the property. For example, adjustment must be made for depreciation for all prior taxable years whether or not the organization was exempt from taxation for any such years. Similarly, the fact that only a portion of the depreciation allowance may be taken into account in computing the percentage of deductions allowable under section 514(a)(2) does not affect the amount of the adjustment for depreciation which is used in determining average adjusted basis.
(iii) Cross reference. For the determination of the basis of debt-financed property acquired in a complete or partial liquidation of a corporation in exchange for its stock, see §1.514(d)–1.
(iv) Example. This subparagraph may be illustrated by the following example. For purposes of this example it is assumed that the property is debt-financed property.
Example.
On July 10, 1970, X, an exempt educational organization, purchased an office building for $510,000, using $300,000 of borrowed funds. During 1970 the only adjustment to basis is $20,000 for depreciation. As of December 31, 1970, the adjusted basis of the building is $490,000 and the indebtedness is still $300,000. X files its return on a calendar year basis. Under these circumstances, the debt/basis percentage for 1970 is 60 percent, calculated in the following manner:
<p>Average Adjusted basis:</p>
<MATH SPAN="1" POSITION="NOFLOAT" BORDER="NODRAW" STRIP="YES" DEEP="12" HTYPE="CENTER" ROTATION="P">
<img src=" <p>Average acquisition indebtedness:</p>
<p>$1,500,000÷6 months=$250,000</p>
<p>Debt/basis percentage:</p>
<p>Average acquisition indebtedness ($250,000)/Average adjusted basis ($500,000)=50 percent</p>
<p>Example 2.
Y, an exempt organization, owns stock in a corporation which it does not control. At the beginning of the year, Y has an outstanding principal indebtedness with respect to such stock of $12,000. Such indebtedness is paid off at the rate of $2,000 per month beginning January 30, so that it is retired at the end of 6 months. The average acquisition indebtedness for the taxable year is $3,500, calculated in the following manner:
<p>Average acquisition indebtedness:</p>
<MATH SPAN="1" POSITION="NOFLOAT" BORDER="NODRAW" STRIP="YES" DEEP="13" HTYPE="CENTER" ROTATION="P">
<img src="
Basis
As of July 10, 1970 (acquisition date)..................... $510,000
As of December 31, 1970.................................... 490,000
------------
Total.................................................. 1,000,000
"></MATH>
<p>Debt/basis percentage:</p>
<p>Average acquisition indebtedness ($300,000)/Average adjusted basis ($500,000)=60 percent</p>
<p>For an illustration of the determination of the debt/basis percentage as changes in the acquisition indebtedness occur, see example 1 of subparagraph (3)(iii) of this paragraph.</p>
<p> (3) Average acquisition indebtedness—(i) In general. The average acquisition indebtedness with respect to debt-financed property is the average amount of the outstanding principal indebtedness during that portion of the taxable year the property is held by the organization.</p>
<p> (ii) Computation. The average acquisition indebtedness is computed by determining the amount of the outstanding principal indebtedness on the first day in each calendar month during the taxable year that the organization holds the property, adding these amounts together, and then dividing this sum by the total number of months during the taxable year that the organization held such property. A fractional part of a month shall be treated as a full month in computing average acquisition indebtedness.</p>
<p> (iii) Examples. The application of this subparagraph may be illustrated by the following examples. For purposes of these examples it is assumed that the property is debt-financed property.</p>
<p>Example 1.
Assume the facts as stated in the example in subparagraph (2)(iv) of this paragraph, except that beginning July 20, 1970, the organization makes payments of $21,000 a month ($20,000 of which is attributable to principal and $1,000 to interest). In this situation, the average acquisition indebtedness for 1970 is $250,000. Thus, the debt/basis percentage for 1970 is 50 percent, calculated in the following manner:
Indebtedness
on the first
day in each
calendar month
that the
property is
held
Month:
July.................................................. $300,000
August................................................ 280,000
September............................................. 260,000
October............................................... 240,000
November.............................................. 220,000
December.............................................. 200,000
---------------
Total............................................. 1,500,000
Indebtedness
on the first
day in each
calendar month
that the
property is
held
Month:
January............................................... $12,000
February.............................................. 10,000
March................................................. 8,000
April................................................. 6,000
May................................................... 4,000
June.................................................. 2,000
July thru December.................................... 0
---------------
Total............................................. 42,000
"></MATH>
