§ 1.545-3. Special adjustment to taxable income.

(a) The adjusted basis of the property disposed of (determined under section 1011 and the regulations thereunder) immediately before such disposition; over

(b) The amount of qualified indebtedness which ceased to be qualified indebtedness with respect to the taxpayer by reason of the assumption of indebtedness by the transferee of the property disposed of (whether or not such indebtedness was incurred by the taxpayer in connection with the property disposed of).

For purposes of (b) of this subdivision, the transferee will be treated as having assumed qualified indebtedness if such transferee acquires real estate of which the taxpayer is the legal or equitable owner immediately before the transfer and which is subject to indebtedness that, with respect to the taxpayer, is qualified indebtedness immediately before the transfer, provided the taxpayer shows to the satisfaction of the Commissioner that under all the facts and circumstances it no longer bears the burden of discharging such indebtedness.

M Corporation, a calendar year taxpayer has $600,000 of indebtedness outstanding on December 31, 1963 (which was incurred after 1933), represented by three demand notes. Individuals A and B (who are not shareholders) each hold one of M Corporation's notes in the amount of $150,000 and N Corporation (which is not a shareholder) holds M Corporation's note in the amount of $300,000. The note held by N Corporation is secured by a mortgage on certain depreciable real estate owned by M Corporation which has an adjusted basis to it on July 1, 1964, of $500,000. On July 1, 1964, M Corporation sells the depreciable real estate to O Corporation in consideration for $200,000 in cash and the assumption by O Corporation of the indebtedness on the note held by N Corporation. M Corporation borrows $200,000 on September 30, 1964, of which amount $150,000 is simultaneously applied to liquidate the note held by B. M Corporation's qualified indebtedness is reduced on July 1, 1964, by $300,000, the qualified indebtedness which ceased to be outstanding by reason of the transfer. In addition, the reduction (computed under section 545(c)(6) and subparagraph (4) of this paragraph) of M Corporation's qualified indebtedness by reason of the disposition of depreciable property on July 1, 1964, is as follows:

The pro-rata share of the reduction with respect to each debt is computed as follows:

Of the $150,000 paid by M Corporation on September 30, 1964, to retire the note held by B only $50,000 qualified as a use of an amount to pay or retire qualified indebtedness and, thus, only $50,000 is allowable as a deduction for purposes of computing undistributed personal holding company income for 1964.

The facts are the same as in example 1 except that M Corporation elects in accordance with paragraph (e) of this section not to deduct $25,000 of the $50,000 amount otherwise deductible. Then $25,000 of the $200,000 of new indebtedness incurred by M Corporation is qualified indebtedness. If the payment on the note held by B had not been made until January 1, 1965, then the new indebtedness would not be qualified indebtedness since the payment was not made in the taxable year in which the new indebtedness was incurred. If M Corporation pays $40,000 on April 1 and July 1, 1965, on the indebtedness incurred September 30, 1964, then (unless M indicates otherwise in its return for 1965 in accordance with subparagraph (5) of this paragraph) the payments made on such dates must be allocated between qualified and nonqualified indebtedness in the following manner:

Thus, a total of $10,000 of the two payments would be considered used to pay or retire qualified indebtedness. The results in examples 1 and 2 would be the same if O Corporation purchased the real estate subject to the indebtedness (not assuming the indebtedness) on the note held by N Corporation, provided M Corporation does not bear the burden of discharging such indebtedness after July 1, 1964.

C owns all of the 1000 shares of outstanding capital stock of P Corporation. On December 31, 1963, P Corporation, a calendar year taxpayer, owes $200,000 of outstanding indebtedness to D and$500,000 of outstanding indebtedness to E. These debts were incurred after 1933. On January 15, 1964, P Corporation pays $100,000 in partial liquidation of the $500,000 indebtedness. On March 15, 1964, P Corporation pays $50,000 into a sinking fund with respect to the $200,000 indebtedness owed to D. On April 15, 1964, D purchases one-half of the shares owned by C, constituting 50 percent in value of P Corporation's outstanding stock. P Corporation, on June 15, 1964, pays $50,000 into a sinking fund with respect to the indebtedness owed to D. For purposes of the March 15, 1964, set-aside, the indebtedness owed to D ($200,000) is qualified indebtedness. However, the indebtedness owed to D is not qualified indebtedness for purposes of the June set-aside with respect to such indebtedness since D is a person who after December 31, 1963, and before the June set-aside, owned more than 10 percent in value of P Corporation's outstanding stock. Moreover, any subsequent set-asides made with respect to the indebtedness owed to D will not be made with respect to qualified indebtedness even if the shares owned by D are subsequently sold. Assuming no payments or set-asides are made by P Corporation after June 15, 1964, the P Corporation is entitled to a deduction of $150,000 under section 545(c)(1) for the calendar year 1964 for amounts paid and for amounts irrevocably set aside to pay or retire qualified indebtedness, and the total qualified indebtedness at the end of 1964 is $400,000. No additional deduction is allowed in subsequent taxable years for amounts paid out of the amounts set aside in 1964.

(a) The date on which such indebtedness was incurred;

(b) The amount of such indebtedness;

(c) The person or persons to whom such indebtedness is owed; and

(d) A statement that such person or persons do not own more than 10 percent in value of the taxpayer's outstanding stock.

(a) The deductions allowed for the taxable year and all preceding taxable years beginning after December 31, 1963, for exhaustion, wear and tear, obsolescence, amortization, or depletion (other than such deductions which are disallowed in computing undistributed personal holding company income under the rule of paragraph (h) of § 1.545-2), exceed

(b) Any reduction, by reason of section 545(c)(5)(A) and this subdivision (i), of the deductions otherwise allowed by section 545(c)(1) for such preceding years; and

(a) The deductions allowed under section 545(b)(5) (relating to long-term capital gain deduction) in computing undistributed personal holding company income for the taxable year and all preceding taxable years beginning after December 31, 1963, exceed

(b) Any reduction, by reason of section 545(c)(5)(B) and this subdivision (ii), of the deductions otherwise allowed by section 545(c)(1) for such preceding years.

(i) Q Corporation, a calendar year taxpayer, has qualified indebtedness of $400,000 on January 1, 1964, with respect to which payments of $50,000 are made on April 15, 1964, and 1965, and $300,000 on April 15, 1966. In the years 1964 and 1966, Q Corporation is allowed a deduction under section 545(b)(5) of $50,000 for the excess of its net long-term capital gain over its net short-term capital loss, minus the taxes attributable to such excess. Q Corporation is allowed a depreciation deduction of $50,000 for each of its taxable years 1964 through 1966. Q Corporation is a personal holding company with taxable income of $200,000 in each of the years 1964 and 1966.

(ii) For 1964, in computing undistributed personal holding company income, Q Corporation's taxable income is reduced by $50,000 by reason of the deduction under section 545(b)(5). No part of the depreciation deduction is disallowed under the rule of paragraph (h) of § 1.545-2. Q Corporation's deduction for payment of qualified indebtedness otherwise allowable under section 545(c)(1) and this section is reduced to zero by reason of the depreciation deduction and the capital gains deduction. The reduction by reason of section 545(c)(5)(A) and subparagraph (1)(i) of this paragraph (depreciation) is $25,000 [($50,000 ÷ $100,000) × $50,000], and the reduction by reason of section 545(c)(5)(B) and subparagraph (1) (ii) of this paragraph (capital gain) is $25,000 [($50,000 ÷ $100,000) × $50,000].

(iii) For 1966, Q Corporation is allowed a deduction for payment of qualified indebtedness of $100,000 computed as follows: