The deductions allowed for each debt-financed property are
determined by applying the debt/basis percentage to the sum of
allowable deductions.
The allowable deductions are those directly connected with the
debt-financed property or with the income from it (including the
dividends-received deduction), except that:
- The allowable deductions are subject to the modifications
for computation of the unrelated business taxable income (discussed in
chapter 4),
and
- The depreciation deduction, if allowable, is computed only
by use of the straight-line method.
To be directly connected with debt-financed property or
with the income from it, a deductible item must have proximate and
primary relationship to the property or income. Expenses,
depreciation, and similar items attributable solely to the property
qualify for deduction, to the extent they meet the requirements of an
allowable deduction.
For example, if the straight-line depreciation allowance for an
office building is $10,000 a year, an organization can deduct
depreciation of $10,000 if the entire building is debt-financed
property. However, if only half of the building is debt-financed
property, the depreciation allowed as a deduction is $5,000.
Capital losses.
If a sale or exchange of debt-financed property results in a
capital loss, the loss taken into account in the tax year in which the
loss arises is computed as provided under Gain From Sale or Other
Disposition of Property, earlier in this chapter.
If any part of the allowable capital loss is not taken into account
in the current tax year, it may be carried back or carried over to
another tax year without application of the debt/basis percentage for
that year.
Example.
X, an exempt educational organization, owned debt-financed
securities that were capital assets. Last year, X sold the securities
at a loss of $20,000. The debt/basis percentage for computing the loss
from the sale of the securities is 40%. Thus, X sustained a capital
loss of $8,000 (40% of $20,000) on the sale of the securities. Last
year and the preceding 3 tax years, X had no other capital
transactions. Under these circumstances, the $8,000 of capital loss
may be carried over to succeeding years without further application of
the debt/basis percentage.
Net operating loss.
If, after applying the debt/basis percentage to the income from
debt-financed property and the deductions directly connected with this
income, the deductions exceed the income, an organization has a net
operating loss for the tax year. This amount may be carried back or
carried over to other tax years in the same manner as any other net
operating loss of an organization with unrelated business taxable
income. (For a discussion of the net operating loss deduction, see
Deductions under Modifications in chapter 4.)
However, the debt/basis percentage is not applied in those other tax
years to determine the deductions that may be taken in those years.
Example.
Last year, Y, an exempt organization, received $20,000 of rent from
a debt-financed building that it owns. Y had no other unrelated
business taxable income for the year. The deductions directly
connected with this building were property taxes of $5,000, interest
of $5,000 on the acquisition indebtedness, and salary of $15,000 to
the building manager. The debt/basis percentage with respect to the
building was 50%. Under these circumstances, Y must take into account,
in computing its unrelated business taxable income, $10,000 (50% of
$20,000) of income and $12,500 (50% of $25,000) of the deductions
directly connected with that income.
Thus, Y sustained a net operating loss of $2,500 ($10,000 of income
less $12,500 of deductions), which may be carried back or carried over
to other tax years without further application of the debt/basis
percentage.
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