payer, places in service during 1968 property described in section 48(a) (2) (B) (vii); that X's unused credit for 1968 is $10,000; and that, but for the application of section 48 (a) (2) (B) (vii), X's unused credit for 1968 would have been $7,000. X's investment credit carryback from 1968 to 1965 is limited to $7,000, and X's 1968 carryback to 1966 is $3,000 plus any portion of the $7,000 carried back to 1965 which was not allowed as a credit for such year.

(b) Limitation on allowance of unused credit. The amount of the unused credit from any particular unused credit year which may be added to the amount allowable as a credit under section 38 for any of the 3 preceding or 7 succeeding taxable years to which such credit may be carried shall not exceed the amount by which the limitation based on amount of tax for such preceding or succeeding taxable year exceeds the sum of (1) the credit earned for such preceding or succeeding year, and (2) other unused credits carried to such preceding or succeeding year which are attributable to unused credit years prior to the particular unused credit year. Thus, in determining the amount, if any, of an unused credit from a particular unused credit year which shall be added to the amount allowable as a credit for any preceding or succeeding taxable year, the credit earned for such preceding or succeeding taxable year, plus any unused credits originating in taxable years prior to a particular unused credit year, shall first be applied against the limitation based on amount of tax for such preceding or succeeding taxable year. To the extent the limitation based on amount of tax for the preceding or succeeding year exceeds the sum of the credit earned for such year and other unused credits attributable to years prior to the particular unused credit year, the unused credit from the particular unused credit year shall be added to the amount allowable as a credit under section 38 for such preceding or succeeding year. To the extent that an unused credit cannot be added for a particular preceding or succeeding taxable year because of the limitation contained in this paragraph, such unused credit shall be available as a carryback or carryover to the next succeeding taxable year to which it may be carried.

(c) Effect of net operating loss carryback from a taxable year ending on or before July 31, 1967. If the effect of a net

operating loss carryback from a taxable year ending on or before July 31, 1967, is to create an unused credit (as defined in paragraph (a) (1) of this section), such unused credit shall not be treated as an investment credit carryback. However, the full amount of the unused credit so arising shall be available for use as an investment credit carryover for the 7 taxable years (5 taxable years in a case in which paragraph (a) (3) of this section applies) following the unused credit year. Thus, assume that a calendar-year taxpayer has a credit earned for 1965 of $25,000 and a liability for tax of the same amount. If in 1966 such taxpayer has a net operating loss which he carries back to 1965 thereby fully eliminating his taxable income and liability for tax for 1965, then the $25,000 credit earned (no longer allowable for 1965) becomes an unused credit which, although it may not be treated as an investment credit carryback, shall be carried forward to each of the subsequent years to which it may be carried. On the other hand, if his net operating loss arose in 1967 rather than in 1966, then the $25,000 unused credit for 1965 would be an investment credit carryback to each of the 3 taxable years preceding 1965 and an investment credit carryover to each of the subsequent years to which it may be carried.

(d) Taxable years beginning before January 1, 1962, and ending after December 31, 1961. Section 46(b) (4) provides a transition rule relating to the amount of an investment credit carryback which may be added to the amount allowable as a credit under section 38 for a taxable year beginning before January 1, 1962, and ending after December 31, 1961. For purposes of determining the amount of unused credits which may be carried back to such a taxable year and added to the amount allowable as a credit for such year, the limitation based on amount of tax for such year (determined without regard to this paragraph) shall be reduced to an amount which bears the same ratio to such limitation as the number of days in such taxable year after December 31, 1961, bears to the total number of days in such year.

(e) Corporate acquisitions. For the carryover of unused credits in the case of certain corporate acquisitions, see section 381(c) (23).

(f) Periods of less than 12 months. A fractional part of a year which is considered as a taxable year under sections 441(b) and 7701(a) (23) shall be treated

as a preceding or a succeeding taxable year for the purpose of determining under section 46(b) the taxable years to which an unused credit may be carried.

(g) Examples. The provisions of paragraphs (a) through (f) of this section may be illustrated by the following examples:

Example (1). Corporation X files its income tax return on the basis of the calendar year. X's credit earned and its limitation based on amount of tax for each of its taxable years 1962 through 1968 are as follows:

(1) Corporation X's credit earned for 1962, $175,000, is allowable in full as a credit under section 38 for 1962 since such amount is less than the limitation based on amount of tax for such year, $200,000. Since the limitation based on amount of tax for 1963 is $160,000, only $160,000 of the $250,000 credit earned for such year is allowable under section 38 as a credit for 1963. The unused credit for 1963 of $90,000 ($250,000 less $160,000) is an investment credit carryback to 1962 and an investment credit carryover to 1964 and subsequent years. The portions of the $90,000 unused credit which shall be added to the amount allowable as a credit under section 38 for 1962 and for 1964 and subsequent years are computed as follows:

(a) 1962. The portion of the unused credit for 1963 ($90,000) which is allowable as a credit for 1962 is $25,000. This amount shall be added to the amount allowable

as

a credit for 1962. The balance of the unused credit for 1963 to be carried to 1964 is $65,000. These amounts are computed as follows:

35,000

Balance of 1963 unused credit to be
carried to 1966.

(d) 1966. The entire balance of the unused credit for 1963 ($35,000) is allowable as a credit for 1966, since the limitation based on amount of tax for 1966 exceeds the sum of the credit earned for 1966 and unused credits attributable to years prior to 1963 by an amount in excess of $35,000. Since the balance of the unused credit for 1963 has been fully allowed, no portion thereof remains to be carried to 1967 or 1968. This is illustrated as follows:

(b) 1964. The portion of the balance of the unused credit for 1963 ($65,000) allowable as a credit for 1964 is $10,000. This amount shall be added to the amount allowable as a credit for 1964. The balance of the

25,000

1967 (unused credit

from 1963)..

10,000

210,000

Balance of 1967 unused credit to be carried to 1969.. Example (2). Corporation Y files its income tax return on the basis of a fiscal year ending June 30. For its taxable year beginning July 1, 1961, and ending June 30, 1962, Y's credit earned is $65,000, and its limitation based on amount of tax is $200,000. The full credit earned ($65,000) is allowable for Y's taxable year ending June 30, 1962, as a credit against tax since such amount is less than the limitation (8 ($200,000). For purposes of determining the amount of an investment credit carryback from any subsequent taxable year which may be added to the amount allowable as a credit for the taxable year ending June 30, 1962, the limitation based on amount of tax for such year shall be reduced from $200,000 to $99,178 200,000 X 181

365

Therefore, the total in

vestment credit carrybacks to the taxable year ending June 30, 1962, may not exceed $34,178 ($99,178 less $65,000).

(h) Electing small business corporation. An unused credit of a corporation which arises in an unused credit year for which the corporation is not an electing small business corporation (as defined in section 1371(b)) and which is a carryback or carryover to a taxable year for which the corporation is an electing small business corporation shall not be added to the amount allowable as a credit under section 38 to the shareholders of such corporation for any taxable year. However, a taxable year for which the corporation is an electing small business corporation shall be counted as a taxable year for purposes of determining the taxable years to which such unused credit may be carried.

[T.D. 6731, 29 F.R. 6066, May 8, 1964, as amended by T.D. 6958, 33 F.R. 9170, June 21, 1968]

§ 1.46-3 Qualified investment.

(a) In general. (1) With respect to any taxable year, the qualified investment of the taxpayer is the aggregate (expressed in dollars) of (i) the applicable percentage of the basis of each new

section 38 property placed in service by the taxpayer during such taxable year, plus (ii) the applicable percentage of the cost of each used section 38 property placed in service by the taxpayer during such taxable year. With respect to any section 38 property, qualified investment means the applicable percentage of the basis (or cost) of such property. Section 38 property placed in service by the taxpayer during the taxable year includes the taxpayer's share of the basis (or cost) of section 38 property placed in service by a partnership in the taxable year of such partnership ending with or within the taxpayer's taxable year. In the case of a shareholder of an electing small business corporation (as defined in section 1371(b)), or a beneficiary of an estate or trust, see §§ 1.48-5 and 1.48–6, respectively, for apportionment of the basis (or cost) of section 38 property placed in service by such corporation, estate, or trust. For the definitions of new section 38 property and used section 38 property, see §§ 1.48-2 and 1.48-3, respectively.

(2) The basis (or cost) of section 38 property placed in service during a taxable year shall not be taken into account in determining qualified investment for such year if such property is disposed of or otherwise ceases to be section 38 property during such year, except where §1.47-3 applies. Thus, if individual A places in service during a taxable year section 38 property and later in the same year sells such property, the basis (or cost) of such property shall not be taken into account in determining A's qualified investment. On the other hand, if A places in service section 38 property during a taxable year and dies later in the same year, the basis (or cost) of such property would be taken into account in computing qualified investment. Similarly, if section 38 property is destroyed by fire in the same year in which it is placed in service and paragraph (h) of this section applies to reduce the basis (or cost) of replacement property, the basis (or cost) of the destroyed property would be taken into account in computing qualified investment. In order to determine whether section 38 property is disposed of or otherwise ceases to be section 38 property see § 1.47–2.

(3) Qualified investment is reduced in the case of property which is "public utility property" (see paragraph (h) of this section), and in the case of property

of organizations to which section 593 applies, regulated investment companies or real estate investment trusts subject to taxation under subchapter M, chapter 1 of the Code, and cooperative organizations described in section 1381(a) (see § 1.46-4).

(b) Applicable percentage. The applicable percentage to be applied to the basis (or cost) of property is 33% percent if the estimated useful life of the property is 4 years or more but less than 6 years; 663 percent if the estimated useful life is 6 years or more but less than 8 years; or 100 percent if the estimated useful life is 8 years or more. The provisions of this paragraph may be illustrated by the following example:

Example. Corporation Y acquires and places in service during 1963 the following new and used section 38 properties:

(c) Basis or cost. (1) The basis of any new section 38 property shall be determined in accordance with the general rules for determining the basis of property. Thus, the basis of property would generally be its cost (see section 1012), unreduced by the adjustment to basis provided by section 48 (g) (1) with respect to property placed in service before January 1, 1964, and any other adjustment to basis, such as that for depreciation, and would include all items properly included by the taxpayer in the depreciable basis of the property, such as installation and freight costs. However, for purposes of determining qualified investment, the basis of new section property constructed, reconstructed, or erected by the taxpayer shall not include any depreciation sustained with respect

38

to any other property used in the construction, reconstruction, or erection of such new section 38 property. (See paragraph (b) (4) of § 1.48-1.) If new section 38 property is acquired in exchange for cash and other property in a transaction described in section 1031 in which no gain or loss is recognized, the basis of the newly acquired property for purposes of determining qualified investment would be equal to the adjusted basis of the other property plus the cash paid. See § 1.48-4 for the basis of property to a lessee where the lessor has elected to treat such lessee as a purchaser.

(2) The cost of any used section 38 property shall be determined in accordance with paragraph (b) of § 1.48-3. However, the aggregate cost of used section 38 property which may be taken into account in any taxable year in computing qualified investment cannot exceed $50,000 (see paragraph (c) of § 1.48-3).

(3) For reduction in the basis (or cost) of certain property which replaces other property which was destroyed or damaged by fire, storm, shipwreck, or other casualty, or which was stolen, see paragraph (h) of this section.

(d) Placed in service. (1) For purposes of the credit allowed by section 38, property shall be considered placed in service in the earlier of the following taxable years:

(i) The taxable year in which, under the taxpayer's depreciation practice, the period for depreciation with respect to such property begins; or

(ii) The taxable year in which the property is placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, in a tax-exempt activity, or in a personal activity.

Thus, if property meets the conditions of subdivision (ii) of this subparagraph in a taxable year, it shall be considered placed in service in such year notwithstanding that the period for depreciation with respect to such property begins in a succeeding taxable year because, for example, under the taxpayer's depreciation practice such property is accounted for in a multiple asset account and depreciation is computed under an "averaging convention" (see § 1.167 (a)-10), or depreciation with respect to such property is computed under the com

pleted contract method, the unit of production method, or the retirement

method.

(2) In the case of property acquired by a taxpayer for use in his trade or business (or in the production of income), the following are examples of cases where property shall be considered in a condition or state of readiness and availability for a specifically assigned function:

(i) Parts are acquired and set aside during the taxable year for use as replacements for a particular machine (or machines) in order to avoid operational time loss.

(ii) Operational farm equipment is acquired during the taxable year and it is not practicable to use such equipment for its specifically assigned function in the taxpayer's business of farming until the following year.

(iii) Equipment is acquired for a specifically assigned function and is operational but is undergoing testing to eliminate any defects.

However, fruit-bearing trees and vines shall not be considered in a condition or state of readiness and availability for a specifically assigned function until they have reached an income-producing stage. Moreover, materials and parts acquired to be used in the construction of an item of equipment shall not be considered in a condition or state of readiness and availability for a specifically assigned function.

(3) Notwithstanding subparagraph (1) of this paragraph, property with respect to which an election is made under § 1.48-4 to treat the lessee as having purchased such property shall be considered placed in service by the lessor in the taxable year in which possession is transferred to such lessee.

(4) (i) The credit allowed by section 38 with respect to any property shall be allowed only for the first taxable year in which such property is placed in service by the taxpayer. The determination of whether property is section 38 property in the hands of the taxpayer shall be made with respect to such first taxable year. Thus, if a taxpayer places property in service in a taxable year and such property does not qualify as section 38 property (or only a portion of such property qualifies as section 38 property) in such year, no credit (or a credit only as to the portion which qualifies in such year) shall be allowed to the taxpayer