Section 1035; certain exchanges of insurance policies. A taxpayer’s receipt of a check issued by an insurance company under a non-qualified annuity contract is treated as a taxable distribution, even if the check is endorsed to a second insurance company for the purchase of a second annuity. The transaction is not characterized as a tax-free exchange under section 1035(a)(3) of the Code unless there is a direct exchange or assignment of the original contract.

Income attributable to domestic production activities; qualifying in-kind partnerships. This ruling provides that a partnership engaged in the extraction and processing of minerals within the United States is a qualifying in-kind partnership for purposes of section 199 of the Code. Each partner of a qualifying in-kind partnership is treated as having manufactured, produced, grown, or extracted (MPGE) property MPGE by the partnership that is distributed to that partner.

Contributions to the capital of a corporation; nonshareholder contributions. This ruling provides that payments received by a corporation under the federal universal service support mechanisms do not represent a nonshareholder contribution to capital under section 118(a) of the Code. The federal universal service support mechanisms are funded by contributions from telecommunications carriers. Telecommunications carriers receive support payments to provide discounted telecommunications services or telecommunication services in high cost areas.

Accrual of interest. This ruling requires an accrual method bank with a reasonable expectancy of receiving future payments on a loan to include accrued interest (determined under regulations section 1.446-2(a)(2)) in gross income for the taxable year in which the right to receive the interest becomes fixed, notwithstanding bank regulatory rules that prevent accrual of the interest for regulatory purposes. The ruling also provides guidance as to the period in which a bank that has elected the conformity method of accounting under regulations section 1.166-2(d)(3) can treat uncollected interest as worthless. Rev. Rul. 81-18 distinguished.

Real estate investment trust (REIT) foreign currency. This ruling provides that section 988 gain that is recognized by a REIT will be qualifying income under section 856(c)(2) or (3) of the Code to the extent that the underlying income so qualifies.

Renewable electricity production, refined coal production, and Indian coal production; calendar year 2007 inflation adjustment factors and reference prices. This notice announces the calendar year 2007 inflation adjustment factors and reference prices for the renewable electricity production credit, refined coal production credit, and Indian coal production credit under section 45 of the Code.

The Department of Treasury and the Service invite public comments on recommendations for items that should be included on the 2007-2008 Guidance Priority List. Taxpayers may submit recommendations for guidance at any time during the year. Recommendations submitted by May 31, 2007, will be reviewed for possible inclusion on the original 2007-2008 Guidance Priority List. Recommendations received after May 31, 2007, will be reviewed for inclusion in the next periodic update.

This notice provides guidance to real estate investment trusts (REITs) concerning the circumstances under which section 856(c)(2) or (3) of the Code characterizes section 987 gain as qualifying income for REIT qualification.

This document provides the exclusive procedures under which a bank may change its method of accounting for uncollected interest to an elective safe harbor method based on the bank’s collection experience. Rev. Proc. 2002-9 modified and amplified.

Weighted average interest rate update; corporate bond indices; 30-year Treasury securities. The weighted average interest rate for May 2007 and the resulting permissible range of interest rates used to calculate current liability and to determine the required contribution are set forth.

The Department of Treasury and the Service invite public comments on recommendations for items that should be included on the 2007-2008 Guidance Priority List. Taxpayers may submit recommendations for guidance at any time during the year. Recommendations submitted by May 31, 2007, will be reviewed for possible inclusion on the original 2007-2008 Guidance Priority List. Recommendations received after May 31, 2007, will be reviewed for inclusion in the next periodic update.

The Department of Treasury and the Service invite public comments on recommendations for items that should be included on the 2007-2008 Guidance Priority List. Taxpayers may submit recommendations for guidance at any time during the year. Recommendations submitted by May 31, 2007, will be reviewed for possible inclusion on the original 2007-2008 Guidance Priority List. Recommendations received after May 31, 2007, will be reviewed for inclusion in the next periodic update.

Proposed regulations under section 2053 of the Code provide guidance to determine the amount deductible from a decedent’s gross estate for claims against the estate under section 2053(a)(3). Under these regulations, the amount deductible is generally the amount actually paid in satisfaction of a legitimate claim. The regulations provide special rules for potential claims, contested claims, claims against multiple parties, claims by family members and related entities, unenforceable claims, and recurring payments. A public hearing is scheduled for August 6, 2007.

The Department of Treasury and the Service invite public comments on recommendations for items that should be included on the 2007-2008 Guidance Priority List. Taxpayers may submit recommendations for guidance at any time during the year. Recommendations submitted by May 31, 2007, will be reviewed for possible inclusion on the original 2007-2008 Guidance Priority List. Recommendations received after May 31, 2007, will be reviewed for inclusion in the next periodic update.

The Department of Treasury and the Service invite public comments on recommendations for items that should be included on the 2007-2008 Guidance Priority List. Taxpayers may submit recommendations for guidance at any time during the year. Recommendations submitted by May 31, 2007, will be reviewed for possible inclusion on the original 2007-2008 Guidance Priority List. Recommendations received after May 31, 2007, will be reviewed for inclusion in the next periodic update.

The Department of Treasury and the Service invite public comments on recommendations for items that should be included on the 2007-2008 Guidance Priority List. Taxpayers may submit recommendations for guidance at any time during the year. Recommendations submitted by May 31, 2007, will be reviewed for possible inclusion on the original 2007-2008 Guidance Priority List. Recommendations received after May 31, 2007, will be reviewed for inclusion in the next periodic update.

The Department of Treasury and the Service invite public comments on recommendations for items that should be included on the 2007-2008 Guidance Priority List. Taxpayers may submit recommendations for guidance at any time during the year. Recommendations submitted by May 31, 2007, will be reviewed for possible inclusion on the original 2007-2008 Guidance Priority List. Recommendations received after May 31, 2007, will be reviewed for inclusion in the next periodic update.

The Department of Treasury and the Service invite public comments on recommendations for items that should be included on the 2007-2008 Guidance Priority List. Taxpayers may submit recommendations for guidance at any time during the year. Recommendations submitted by May 31, 2007, will be reviewed for possible inclusion on the original 2007-2008 Guidance Priority List. Recommendations received after May 31, 2007, will be reviewed for inclusion in the next periodic update.

This document contains corrections to final regulations (T.D. 9315, 2007-15 I.R.B. 891) that address various dual consolidated loss issues, including exceptions to the general prohibition against using a dual consolidated loss to reduce the taxable income of any other member of the affiliated group.

Is universal service support received by a corporation under the universal service support mechanisms a nonshareholder contribution to capital under section 118(a) of the Internal Revenue Code?

The federal universal service support mechanisms are required by 47 U.S.C. § 254. The Federal Communication Commission (Commission) is required to establish periodically the services to be supported by federal universal service support mechanisms. 47 U.S.C. § 254(c)(1). The Commission has established that the following services be supported by federal universal service support mechanisms: (1) voice grade access to the public switched network; (2) local usage; (3) dual tone multi-frequency signaling or its functional equivalent; (4) single-party service or its functional equivalent; (5) access to emergency services; (6) access to operator services; (7) access to interexchange service; (8) access to directory assistance; and (9) toll limitations for qualifying low-income consumers. 47 C.F.R. § 54.101(a). An eligible telecommunications carrier must offer each of the services in order to receive federal universal service support. 47 C.F.R. § 54.101(b).

The Universal Service Administrative Company (Administrator) administers the federal universal service support mechanisms. 47 C.F.R. § 54.701. The Administrator is responsible for administering the following federal universal support mechanisms: (1) the high cost support mechanisms described in 47 C.F.R. part 54, subpart D; (2) the low income support mechanisms described in 47 C.F.R. part 54, subpart E; (3) the schools and libraries support mechanism described in 47 C.F.R. part 54, subpart F; (4) the rural health care support mechanism described in 47 C.F.R. part 54, subpart G; (5) the interstate access universal support mechanism described in 47 C.F.R. part 54, subpart J; and (6) the interstate common line support mechanism described in 47 C.F.R. part 54, subpart K. 47 C.F.R. § 54.702(a). The Administrator is responsible for billing contributors, collecting contributions to the universal service support mechanisms, and disbursing universal service support funds. 47 C.F.R. § 54.702(b).

The federal universal service support mechanisms are funded by contributions from telecommunications carriers. Every telecommunications carrier that provides interstate telecommunications services must contribute, on an equitable and nondiscriminatory basis, to the specific, predictable, and sufficient mechanisms established by the Commission to preserve and advance universal service. 47 U.S.C. § 254(d). Entities that provide interstate telecommunications services to the public, or to such classes of users as to be effectively available to the public, for a fee will be considered telecommunications carriers providing interstate telecommunications services and must contribute to the universal service support mechanisms. 47 C.F.R. § 54.706(a). Federal universal service contribution costs may be recovered through interstate telecommunications-related charges to end users. 47 C.F.R. § 54.712(a).

In order to receive support, an eligible telecommunications carrier first must provide the supported services. The universal service support provided pursuant to 47 C.F.R. part 54, subparts D, J, and K (identified above) ensures that consumers in all regions of the nation have access to and pay rates for telecommunication services that are reasonably comparable to those in urban areas. The universal service support provided by 47 C.F.R. part 54, subparts E, F, and G (identified above) allows carriers to provide discounted, or reduced, rates to low income consumers, schools and libraries, and rural health care providers. The amount of federal universal service support received depends on either the discount offered to the targeted customers or the cost of providing service (the carrier’s revenue requirement) in high cost areas. For financial accounting purposes, the Commission requires all carriers to record their federal universal service support receipts as revenue.

All carriers that receive universal service support must use that support only for the provision, maintenance, and upgrading of facilities and services for which the universal service support is intended. 47 U.S.C. § 254(e) and 47 C.F.R. § 54.7. This includes, for example, the ability to use the funds to reduce intrastate rates, to cover operating expenses (billing and marketing expenses) associated with the supported services, and to upgrade the facilities for the supported services. Annual certifications are required to be filed with the Administrator and the Commission with respect to universal service support from certain universal service support mechanisms stating that all universal service support received from such mechanisms will be used only for the provision, maintenance, and upgrading of facilities and services for which the support is intended.

Section 118(a) of the Code provides that in the case of a corporation, gross income does not include any contribution to the capital of the taxpayer. The committee reports accompanying the enactment of what is now section 118(a) indicate that the provision was intended to codify the existing law that had developed through administrative and court decisions on the subject. H.R. Rep. No. 1337, 83d Cong., 2d Sess. 17 (1954); S. Rep. No. 1622, 83d Cong., 2d Sess. 18 (1954).

Section 1.118-1 of the Income Tax Regulations includes within the meaning of a contribution to capital, a contribution by a nonshareholder and cites as examples of nonshareholder contributions to capital: the value of land and other property contributed to a corporation by a governmental unit or by a civic group for the purpose of inducing the corporation to locate its business in a particular community, or for the purpose of enabling the corporation to expand its operating facilities. However, the exclusion from gross income does not apply to any money or property transferred to the corporation in consideration for goods or services rendered.

In Detroit Edison Co. v. Commissioner, 319 U.S. 98 (1943), 1943 C.B. 1019, the Supreme Court held that payments by prospective customers to an electric power company that were used by the company to construct the facilities necessary to deliver electricity to the customers were not nonshareholder contributions to capital. The Court found that the motivation for the prospective customers’ contributions was to obtain electric services from the power company and, therefore, the contributions were payment for services. 319 U.S. at 102, 1943 C.B. at 1021.

In contrast, Brown Shoe Co. v. Commissioner, 339 U.S. 583 (1950), 1950-1 C.B. 38, held that money and property contributions by community groups to induce a shoe company to locate or expand its factory operations in the contributing communities were nonshareholder contributions to capital. The Court reasoned that when the motivation of the contributors is to benefit the community at large and the contributors do not anticipate any direct benefit from their contributions, the contributions are nonshareholder contributions to capital. 339 U.S. at 591, 1950-1 C.B. at 41.

The Court again considered this issue in United States v. Chicago, Burlington & Quincy R.R., 412 U.S. 401 (1973), 1973-2 C.B. 428. In that case, the Court set forth the following five characteristics of a nonshareholder contribution to capital: (1) the contribution must become a permanent part of transferee’s working capital structure; (2) the contribution may not be compensation, such as a direct payment for a specific, quantifiable service provided for the transferor by the transferee; (3) the contribution must be bargained for; (4) the asset transferred foreseeably must result in benefit to the transferee in an amount commensurate with its value; and (5) the asset ordinarily, if not always, will be employed in or contribute to the production of additional income and its value assured in that respect. 412 U.S. at 413, 1973-2 C.B. at 432.

In reaching its conclusion that the improvements at issue did not qualify as contributions to capital, the Court reasoned:

412 U.S. at 413-14, 1973-2 C.B. at 432.

In Texas & Pacific Railway Co. v. United States, 286 U.S. 285 (1932), XI-1 C.B. 263, the Court held that payments received by a railroad company from the federal government did not constitute a contribution to capital and thus were includible in income. The Court noted the Transportation Act of 1920 provided for payments representing a guarantee of minimum operating income to compensate the railroad during the transition from federal control to private ownership. The Court reasoned that the payments did not represent capital contributions:

286 U.S. at 290, XI-1 C.B. at 265.

In Deason v. Commissioner, 590 F.2d 1377 (5th Cir. 1979), the Fifth Circuit held that payments received from the Department of Labor for job training for unemployed individuals were not a contribution to capital under section 118. The court affirmed the opinion of the Tax Court, which concluded that irrespective of the public benefit of reduced unemployment that occurred as a result of the payments, the payments constituted direct compensation for training services and thus could not be considered a contribution to capital.

As provided in section 1.118-1 and stated by the Supreme Court in Detroit Edison and Chicago, Burlington & Quincy R.R., compensation in exchange for a specific quantifiable service constitutes taxable income, not a capital contribution. Indeed, the Court in Brown Shoe premised its decision that inducement payments by community groups to a private corporation for relocating and building a factory constituted a capital contribution, based on the specific absence of customers and payment for services. Conversely, these are precisely the factors that are present in the universal service support. There is a clear nexus between the universal service support and the provision of universal telecommunications services by the carriers. The motivation underlying the universal service support is to compensate the carriers for the shortfall in operating income for providing services at a discount to certain customers and/or providing services to customers in high cost areas at below cost rates. The universal service support is predicated on the carriers providing the mandated universal service and is an integral part of the government’s mandate to insure that universal service is provided.

In addition, the universal service support does not satisfy the five characteristics of a nonshareholder contribution to capital set forth in Chicago, Burlington & Quincy R.R., because the universal service support: (1) does not necessarily become a permanent part of the carrier’s working capital structure because the support is not limited to the acquisition of capital assets and can be used to pay current expenses; (2) is made for specific, quantifiable telecommunication services to telecommunication customers of the carrier; (3) is not bargained for because the universal service support mechanisms are a unilateral government program and the method of participation by carriers is mandated (despite any certification requirements); (4) does not benefit the carrier commensurate with the value of the support because the support payments merely maintain the carrier’s viability; and (5) does not necessarily generate additional income for the carrier because the support is not limited to the acquisition of capital assets that will generate additional income for the carrier, but can be used to pay current expenses or to replace capital assets.

The holdings in Texas Pacific and Deason also are illustrative in this context. In Texas Pacific, the federal government provided payments to fulfill a statutory public purpose and yet because of the inherent nature of the transaction as reimbursement for deficiencies in operating income, the payments did not warrant capital contribution treatment. In Deason, the federal government made payments that served the public goal of reducing unemployment. Despite the existence of a public benefit derived from the payment, the court concluded that the payments were compensation for services and therefore ineligible as a capital contribution. Similarly, although a public purpose is served by payment of the universal service support, and the payor is not the consumer of the universal telecommunications services, the universal service support is nonetheless compensation to the carriers for the provision of universal telecommunications services.

Universal service support received by a corporation under the universal service support mechanisms is not a nonshareholder contribution to capital under section 118(a) of the Code.

The principal author of this revenue ruling is David McDonnell of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. McDonnell at (202) 622-3040 (not a toll-free call).

This revenue ruling designates the extraction and processing of minerals (as defined in § 1.611-1(d)(5) of the Income Tax Regulations) as an activity within § 1.199-9(i)(2)(iii) and § 1.199-3T(i)(7)(ii)(C) of the temporary Income Tax Regulations. A partnership engaged solely in an activity or industry designated by the Secretary will be a qualifying in-kind partnership under §§ 1.199-9(i)(2) and 1.199-3T(i)(7)(ii).

Pursuant to §§ 1.199-9(i)(1) and 1.199-3T(i)(7)(i), each partner of a qualifying in-kind partnership is treated as having manufactured, produced, grown, or extracted (MPGE) property MPGE by the partnership that is distributed to that partner.

Sections 1.199-9(i)(2) and 1.199-3T(i)(7)(ii) provide that a qualifying in-kind partnership includes a partnership engaged solely in the extraction, refining, or processing of oil, natural gas, petrochemicals, or products derived from oil, natural gas, or petrochemicals in whole or in significant part within the United States; or the production or generation of electricity in the United States. Under §§ 1.199-9(i)(2)(iii) and 1.199-3T(i)(7)(ii)(C), a qualifying in-kind partnership may include a partnership engaged solely in an activity or industry designated by the Secretary by publication in the Internal Revenue Bulletin.

By this revenue ruling, the Internal Revenue Service designates the extraction and processing of minerals (as defined in § 1.611-1(d)(5)) as an activity within §§ 1.199-9(i)(2)(iii) and 1.199-3T(i)(7)(ii)(C). Accordingly, a partnership engaged solely in the extraction and processing of minerals within the United States will be a qualifying in-kind partnership under §§ 1.199-9(i)(2) and 1.199-3T(i)(7)(ii).

This revenue ruling is effective for taxable years beginning after December 31, 2004, the effective date of § 199. However, for taxable years beginning before June 1, 2006, a taxpayer may apply this revenue ruling only if the taxpayer applies §§ 1.199-1 through 1.199-8 to that taxable year.

The principal author of this revenue ruling is David McDonnell of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. McDonnell at (202) 622-3040 (not a toll-free call).

1. If federal banking rules require a bank to suspend the recognition of certain uncollected “accrued interest” as defined in § 1.446-2 of the Income Tax Regulations as income for regulatory financial statement purposes should the bank also cease recognizing uncollected accrued interest into income for federal income tax purposes?

2. If a bank uses a conformity method of accounting as provided for in § 1.166-2(d) but does not recognize uncollected accrued interest as income for regulatory financial statement purposes, when should the bank recognize a worthless debt with respect to uncollected accrued interest for federal income tax purposes?

3. If a bank receives payments on a loan where the bank for federal income tax purposes either (i) previously recognized the uncollected accrued interest as income and subsequently deducted the accrued interest receivable as a worthless debt under section 166 or (ii) did not recognized the uncollected accrued interest on the loan as income, how should the payments be characterized for federal income tax purposes?

X corporation is a bank as defined in § 1.166-2(d)(4)(i). X determines its taxable income using an accrual method of accounting and files its federal income tax returns on a calendar year basis. Loans made by X are subject to § 1.446-2, which determines the amount of “accrued interest” related to each loan for federal income tax purposes.

X is subject to regulatory supervision by federal banking authorities (“supervisory authorities”) and is required to prepare regulatory financial statements that comply with federal banking rules. For regulatory financial statement purposes, unless a loan is both well secured and in the process of collection, federal banking rules generally require that X suspend the recognition into income of uncollected accrued interest on a loan and reverse any previously recognized uncollected interest income if:

(i) the loan is maintained on a cash basis because of deterioration in the borrower’s financial condition;

(ii) payment in full of principal or interest is not expected; or

(iii) payment of principal or interest has been in default for a period of 90 days or more.

Under federal banking rules, a loan may be considered a bankable asset (i.e., not written off for regulatory financial statement purposes) even if accrued interest on the loan is no longer being recognized as income (or was previously recognized and subsequently charged off) for regulatory financial statement purposes. In this revenue ruling, the loan is referred to as a “non-accrual loan receivable.”

In general, federal banking rules require a bank such as X to apply any payment received on a non-accrual loan receivable to reduce its recorded investment in the loan (i.e., treat all monies that come in on the loan as a collection of loan principal) to the extent necessary to eliminate doubt as to collectibility. Therefore, for regulatory financial statement purposes, X characterizes any payment received on a non-accrual loan receivable as a payment of principal rather than a payment of the outstanding accrued interest on the loan until the remaining principal on the non-accrual loan receivable is considered to be fully collectible.

On January 16, 2007, X classifies Loan A as a non-accrual loan receivable for regulatory financial statement purposes because an amount of principal or interest has become 90 days past due. Nonetheless, X reasonably expects the borrower to continue making some but not all payments on the loan.

On January 16, 2007, the uncollected accrued interest on Loan A is $9,000 ($8,000 attributable to the calendar year ending December 31, 2006, and $1,000 attributable to the period January 1, 2007 through January 16, 2007). Prior to January 17, 2007, X recognized the $9,000 as income for regulatory financial statement purposes. During the period January 17, 2007 through December 31, 2007, an additional $23,000 of accrued interest becomes due on Loan A.

Pursuant to federal banking rules, on January 16, 2007, X reverses the $9,000 of uncollected accrued interest that had previously been recognized by making adjustments to appropriate income statement and balance sheet accounts for regulatory financial statement purposes. In addition, federal banking rules do not permit X to recognize as income any of the $23,000 accrued interest attributable to the period January 17, 2007 through December 31, 2007.

On January 1, 2008, X receives a $31,000 payment on Loan A. For regulatory financial statement purposes, X characterizes the $31,000 payment as a recovery of principal rather than a recovery of accrued interest. Therefore, X does not recognize any of the $31,000 payment as interest income for regulatory financial statement purposes.

X’s supervisory authorities, in connection with the most recent examination of X’s regulatory financial statements and lending practices, have determined that X maintains and applies standards that are consistent with federal banking rules.

1. X is required to recognize in gross income the uncollected accrued interest on Loan A for federal income tax purposes notwithstanding that federal banking rules required X to suspend the recognition of accrued interest on Loan A into income for regulatory financial statement purposes. For the taxable year ending December 31, 2006, X must recognize in gross income the $8,000 of uncollected accrued interest on Loan A that was generated during 2006. For the taxable year ending December 31, 2007, X must recognize in gross income the $24,000 of uncollected accrued interest on Loan A that was generated during 2007. X must recognize the uncollected accrued interest as gross income in 2006 and 2007 regardless of whether X has elected a conformity method of accounting under § 1.166-2(d)(3) to determine when a debt becomes worthless.

2. As X uses a conformity method of accounting under § 1.166-2(d), X’s $32,000 accrued interest receivable related to Loan A ($8,000 of uncollected accrued interest in 2006 and $24,000 of uncollected accrued interest in 2007) is considered worthless for purposes of section 166 in the year the amount is charged off for regulatory financial statement purposes. Therefore, for federal income tax purposes, X is allowed a worthless debt deduction for the $32,000 of uncollected accrued interest written off for regulatory financial statement purposes in the tax year ending December 31, 2007.

3. X is required to characterize the $31,000 payment received on Loan A in 2008 as a payment of interest for federal income tax purposes. The result would be the same whether (i) X had not yet recognized the $32,000 of uncollected accrued interest on Loan A as gross income under its method of accounting for federal income tax purposes, (ii) X had recognized the $32,000 of uncollected accrued interest on Loan A as gross income for federal tax purposes but subsequently deducted the receivable as a bad debt under section 166, or (iii) X used a conformity method of accounting under § 1.166-2(d). If X had previously deducted the $32,000 of uncollected accrued interest as a bad debt for federal income tax purposes then the subsequent $31,000 payment on the loan will be characterized as a partial recovery of that bad debt.

Rev. Rul. 81-18 is distinguished with regard to when interest accrues for federal income tax purposes.

The principal author of this revenue ruling is Timothy Sebastian of the Office of the Associate Chief Counsel (Financial Institutions and Products). For further information regarding this revenue ruling, contact Mr. Sebastian (202) 622-7417.

If a real estate investment trust (REIT) recognizes foreign currency gain in a section 988 transaction, to what extent is that gain qualifying income for purposes of the REIT income tests under § 856(c) of the Internal Revenue Code?

R, a corporation with the U.S. dollar as its functional currency, has elected, and qualifies, to be treated as a REIT under subchapter M of Chapter 1 of the Code. R invests both in real property from which R derives rental income and in debt instruments that are partially or fully secured by mortgages on real property.

Some of the leases of the real estate that R owns provide for rents to be paid in euros. For some of these leases, R recognizes rental income for federal income tax purposes before receiving the corresponding rent payments. R’s rental income from these euro-denominated leases is described in § 856(c)(2)(C) and in § 856(c)(3)(A).

Some of the mortgage loans that R acquires are denominated in euros, and both principal and interest under these loans are payable in euros. R’s interest income from these euro-denominated loans is described in § 856(c)(2)(B) and in § 856(c)(3)(B).

R’s activities of investing in rent-producing real estate and in mortgage loans are not subject to § 987. Therefore, if the euro changes in value against the dollar, payments of rent under the leases of the real estate and periodic payments made under the mortgage loans may generate foreign currency gain or loss under § 988. See § 1.988-2(b).

During its taxable year, R recognized rental income on the euro-denominated leases, interest income on the euro-denominated mortgage loans, and section 988 gain on payments received under the leases and the mortgage loans.

To qualify as a REIT for a taxable year, at least 95 percent of an entity’s gross income must be “derived from” the types of income listed in § 856(c)(2), and at least 75 percent of its gross income must be “derived from” the types of income listed in § 856(c)(3). Gains from foreign currency are not specifically enumerated in § 856(c)(2) or (c)(3).

Section 988(c)(1) defines a “section 988 transaction” as any transaction described in § 988(c)(1)(B) if the amount which the taxpayer is entitled to receive (or is required to pay) by reason of such transaction is denominated in terms of a nonfunctional currency or is determined by reference to the value of one or more nonfunctional currencies. Under § 988(c)(1)(B)(i), a section 988 transaction includes the acquisition of a debt instrument or becoming the obligor under a debt instrument. Under § 988(c)(1)(B)(ii), a section 988 transaction also includes accruing (or otherwise taking into account) any item of gross income or receipts which is received after the date on which so accrued or taken into account.

Section 988(b)(1) provides that the term “foreign currency gain” means any gain from a section 988 transaction to the extent that such gain does not exceed gain realized by reason of changes in exchange rates on or after the booking date (as defined in § 988(c)(2)) and before the payment date (as defined in § 988(c)(3)).

Rev. Rul. 74-191, 1974-1 C.B. 170, holds that otherwise-qualifying assets do not fail to satisfy § 856(c)(4) merely because the assets are foreign:

1974-1 C.B. at 170. It follows from this holding both that rents on foreign real property qualify under § 856(c)(2)-(3) to the same extent that they would qualify if the property were located in the United States and that interest on foreign mortgage loans qualifies under § 856(c)(2)-(3) to the same extent that it would qualify if the loans were governed by United States law and the property were located in the United States. Thus, foreign situs of a REIT’s assets does not necessarily prevent the REIT from satisfying the income and asset tests of § 856(c), which must be met in order to qualify as a REIT. Rev. Rul. 74-191, however, does not address the treatment of foreign currency gain that may result from investing in real property or other assets that produce income denominated in a currency other than the taxpayer’s functional currency.

The legislative history describing the tax treatment of REITs indicates that the central concern behind the gross income restrictions in § 856(c) is that a REIT’s gross income should largely be composed of passive income. For example, H.R. Rep. No. 2020, 86th Cong., 2d Sess. 4 (1960) at 6, 1960-2 C.B. 819, 822-23 states, “One of the principal purposes of your committee in imposing restrictions on types of income of a qualifying real estate investment trust is to be sure the bulk of its income is from passive income sources and not from the active conduct of a trade or business.”

Although § 856(c) describes the sources of REIT qualifying income, neither the statute nor its legislative history describes what it means for income to be “derived from” those sources. Because of the close nexus, however, between section 988 gain on payments received by a REIT and the income from which that payment is derived, the section 988 gain qualifies under § 856(c)(2) or (3) to the extent that the underlying income does. Thus, for example, if interest income recognized by R qualifies under § 856(c)(2) or (3), then so does the 988 gain from that interest income. Similarly, if an item of income qualifies as rents from real property for purposes of § 856(c)(3)(C), then, for purposes of § 856(c)(3), section 988 gain with respect to that income is derived from a type of income listed in § 856(c)(3)(A)-(H). Cf. Rev. Rul. 92-56, 1992-2 C.B. 153 (concluding that a regulated investment company’s (RIC’s) receipt of a reimbursement of an investment advisory fee was “derived from” the RIC’s business of investing in stock, securities, or foreign currencies and was therefore qualifying income under the “other income” provision of § 851(b)(2)).

If section 988 gain is recognized with respect to income recognized by a REIT, the gain qualifies under § 856(c)(2) or (3) to the extent that the underlying income so qualifies.

The principal author of this revenue ruling is Jonathan D. Silver of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this revenue ruling, contact Jonathan D. Silver at (202) 622-3930 (not a toll-free call).

If a Taxpayer receives a check from a life insurance company under a non-qualified annuity contract, does the endorsement of the check to a second company as consideration for a second annuity contract qualify as a tax-free exchange under § 1035(a)(3) of the Internal Revenue Code?

A, an individual, owned a non-qualified annuity contract issued by IC1, a life insurance company. In 2007, A requested that IC1 issue directly to IC2, another life insurance company, a check as consideration for a new annuity contract to be issued by IC2. A intended the transaction to be treated as a tax-free exchange under § 1035. IC1 refused to do so and, instead, issued a check to A. A did not deposit the check, but instead endorsed it to IC2 as consideration for a new annuity contract.

Section 72(a) provides that, except as otherwise provided in Chapter 1 of the Internal Revenue Code, gross income includes any amount received as an annuity under an annuity contract. Under § 72(e), amounts received under an annuity contract, but not as an annuity, generally are included in gross income to the extent allocable to income on the contract. That is, they are taxed on an income-first basis. Section 72(e)(5)(E) provides that this rule applies to any amounts received on the complete surrender, redemption, or maturity of an annuity contract.

Section 1035(a)(3) provides that no gain or loss is recognized on the exchange of an annuity contract for another annuity contract. The legislative history of § 1035 explains that § 1035 provides non-recognition treatment for taxpayers who have “merely exchanged an [annuity contract] for another better suited to their needs and who have not actually realized gain.” H. Rep. 1337, 83d Cong., 2d Sess. 81 (1954). Under § 1.1035-1, the contracts exchanged must relate to the same insured, and the obligee or obligees under the contract received in the exchange must be the same as those under the original contract.

In Rev. Rul. 72-358, 1972-2 C.B. 473, a taxpayer who owned a life insurance contract issued by one insurance company assigned the contract, prior to its maturity, to a second insurance company in exchange for a variable annuity contract issued by the second company. The ruling concludes that, pursuant to § 1035, no gain or loss is recognized on the exchange. Similarly, Rev. Rul. 2002-75, 2002-2 C.B. 812, concludes that an individual’s assignment of an annuity contract issued by one insurance company to a second insurance company, which then deposits the cash surrender value of the assigned contract into a pre-existing annuity contract owned by the same taxpayer, qualifies as a tax-free exchange under § 1035.

In the present case, there was no actual exchange of annuity contracts; nor did A assign the IC1 contract to IC2; nor was there a direct transfer from IC1 to IC2 of the cash value of the old contract in exchange for the new contract. Instead, IC1 disbursed a check to A, which A, in turn, endorsed to IC2 as consideration for a new contract. Neither § 1035 nor the regulations make any special provision for the purchase of an annuity contract with amounts distributed to the policyholder under another contract. Because the annuity contract was a non-qualified contract, no rollover provision, such as § 403(a)(4), applied to the amount received from IC1. Accordingly, the amount that A received from IC1 under the first annuity contract is taxable in 2007 to the extent set forth in § 72(e).

If a Taxpayer receives a check from a life insurance company under a non-qualified annuity contract, the endorsement of the check to a second company as consideration for a second annuity contract does not qualify as a tax-free exchange under § 1035(a)(3). Instead, the amount received is taxable to the extent set forth in § 72(e).

The principal author of this revenue ruling is Josephine H. Firehock of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this revenue ruling, contact Josephine H. Firehock at (202) 622-3970 (not a toll-free call).

This notice provides guidance as to the corporate bond weighted average interest rate and the permissible range of interest rates specified under § 412(b)(5)(B)(ii)(II) of the Internal Revenue Code. In addition, it provides guidance as to the interest rate on 30-year Treasury securities under § 417(e)(3)(A)(ii)(II).

Sections 412(b)(5)(B)(ii) and 412(l)(7)(C)(i), as amended by the Pension Funding Equity Act of 2004 and by the Pension Protection Act of 2006, provide that the interest rates used to calculate current liability and to determine the required contribution under § 412(l) for plan years beginning in 2004 through 2007 must be within a permissible range based on the weighted average of the rates of interest on amounts invested conservatively in long term investment grade corporate bonds during the 4-year period ending on the last day before the beginning of the plan year.

Notice 2004-34, 2004-1 C.B. 848, provides guidelines for determining the corporate bond weighted average interest rate and the resulting permissible range of interest rates used to calculate current liability. That notice establishes that the corporate bond weighted average is based on the monthly composite corporate bond rate derived from designated corporate bond indices. The methodology for determining the monthly composite corporate bond rate as set forth in Notice 2004-34 continues to apply in determining that rate. See Notice 2006-75, 2006-36 I.R.B. 366.

The composite corporate bond rate for April 2007 is 5.98 percent. Pursuant to Notice 2004-34, the Service has determined this rate as the average of the monthly yields for the included corporate bond indices for that month.

The following corporate bond weighted average interest rate was determined for plan years beginning in the month shown below.

Section 417(e)(3)(A)(ii)(II) defines the applicable interest rate, which must be used for purposes of determining the minimum present value of a participant’s benefit under § 417(e)(1) and (2), as the annual rate of interest on 30-year Treasury securities for the month before the date of distribution or such other time as the Secretary may by regulations prescribe. Section 1.417(e)-1(d)(3) of the Income Tax Regulations provides that the applicable interest rate for a month is the annual interest rate on 30-year Treasury securities as specified by the Commissioner for that month in revenue rulings, notices or other guidance published in the Internal Revenue Bulletin.

The rate of interest on 30-year Treasury securities for April 2007 is 4.87 percent. The Service has determined this rate as the monthly average of the daily determination of yield on the 30-year Treasury bond maturing in February 2037.

The principal authors of this notice are Paul Stern and Tony Montanaro of the Employee Plans, Tax Exempt and Government Entities Division. For further information regarding this notice, please contact the Employee Plans’ taxpayer assistance telephone service at 877-829-5500 (a toll-free number), between the hours of 8:30 a.m. and 4:30 p.m. Eastern time, Monday through Friday. Mr. Stern may be reached at 202-283-9703. Mr. Montanaro may be reached at 202-283-9714. The telephone numbers in the preceding sentences are not toll-free.

This notice publishes the inflation adjustment factors and reference prices for calendar year 2007 for the renewable electricity production credit, the refined coal production credit, and the Indian coal production credit under § 45 of the Internal Revenue Code. The 2007 inflation adjustment factors and reference prices are used in determining the availability of the credits. The 2007 inflation adjustment factors and reference prices apply to calendar year 2007 sales of kilowatt-hours of electricity produced in the United States or a possession thereof from qualified energy resources and to calendar year 2007 sales of refined coal and Indian coal produced in the United States or a possession thereof.

Section 45(a) provides that the renewable electricity production credit for any tax year is an amount equal to the product of 1.5 cents multiplied by the kilowatt hours of specified electricity produced by the taxpayer and sold to an unrelated person during the tax year. This electricity must be produced from qualified energy resources and at a qualified facility during the 10-year period beginning on the date the facility was originally placed in service.

Section 45(b)(1) provides that the amount of the credit determined under § 45(a) is reduced by an amount which bears the same ratio to the amount of the credit as (A) the amount by which the reference price for the calendar year in which the sale occurs exceeds 8 cents, bears to (B) 3 cents. Under § 45(b)(2), the 1.5 cent amount in § 45(a), the 8 cent amount in § 45(b)(1), the $4.375 amount in § 45(e)(8)(A), and in § 45(e)(8)(B)(i) the reference price of fuel used as feedstock (within the meaning of § 45(c)(7)(A)) in 2002 are each adjusted by multiplying the amount by the inflation adjustment factor for the calendar year in which the sale occurs. If any amount as increased under the preceding sentence is not a multiple of 0.1 cent, the amount is rounded to the nearest multiple of 0.1 cent.

Section 45(c)(1) defines qualified energy resources as wind, closed-loop biomass, open-loop biomass, geothermal energy, solar energy, small irrigation power, municipal solid waste, and qualified hydropower production.

Section 45(d)(1) defines a qualified facility using wind to produce electricity as any facility owned by the taxpayer that is originally placed in service after December 31, 1993, and before January 1, 2009. See § 45(e)(7) for rules relating to the inapplicability of the credit to electricity sold to utilities under certain contracts.

Section 45(d)(2)(A) defines a qualified facility using closed-loop biomass to produce electricity as any facility (i) owned by the taxpayer that is originally placed in service after December 31, 1992, and before January 1, 2009, or (ii) owned by the taxpayer which before January 1, 2009, is originally placed in service and modified to use closed-loop biomass to co-fire with coal, with other biomass, or with both, but only if the modification is approved under the Biomass Power for Rural Development Programs or is part of a pilot project of the Commodity Credit Corporation as described in 65 Fed. Reg. 63052. Section 45(d)(2)(B) provides that in the case of a qualified facility described in § 45(d)(2)(A)(ii), (i) the 10-year period referred to in § 45(a) is treated as beginning no earlier than the date of enactment of § 45(d)(2)(B)(i); (ii) the amount of the credit determined under § 45(a) with respect to the facility is an amount equal to the amount determined without regard to § 45(d)(2)(B)(ii) multiplied by the ratio of the thermal content of the closed-loop biomass used in the facility to the thermal content of all fuels used in the facility; and (iii) if the owner of the facility is not the producer of the electricity, the person eligible for the credit allowable under § 45(a) is the lessee or the operator of the facility.

Section 45(d)(3)(A) defines a qualified facility using open-loop biomass to produce electricity as any facility owned by the taxpayer which (i) in the case of a facility using agricultural livestock waste nutrients, (I) is originally placed in service after the date of enactment of § 45(d)(3)(A)(i)(I) and before January 1, 2009, and (II) the nameplate capacity rating of which is not less than 150 kilowatts; and (ii) in the case of any other facility, is originally placed in service before January 1, 2009. In the case of any facility described in § 45(d)(3)(A), if the owner of the facility is not the producer of the electricity, § 45(d)(3)(B) provides that the person eligible for the credit allowable under § 45(a) is the lessee or the operator of the facility.

Section 45(d)(4) defines a qualified facility using geothermal or solar energy to produce electricity as any facility owned by the taxpayer which is originally placed in service after the date of enactment of § 45(d)(4) and before January 1, 2009 (January 1, 2006, in the case of a facility using solar energy). A qualified facility using geothermal or solar energy does not include any property described in § 48(a)(3) the basis of which is taken into account by the taxpayer for purposes of determining the energy credit under § 48.

Section 45(d)(5) defines a qualified facility using small irrigation power to produce electricity as any facility owned by the taxpayer which is originally placed in service after the date of enactment of § 45(d)(5) and before January 1, 2009.

Section 45(d)(6) defines a qualified facility using gas derived from the biodegradation of municipal solid waste to produce electricity as any facility owned by the taxpayer which is originally placed in service after the date of enactment of § 45(d)(6) and before January 1, 2009.

Section 45(d)(7) defines a qualified facility that burns municipal solid waste to produce electricity as any facility owned by the taxpayer which is originally placed in service after the date of enactment of § 45(d)(7) and before January 1, 2009. A qualified facility burning municipal solid waste includes a new unit placed in service in connection with a facility placed in service on or before the date of enactment of § 45(d)(7), but only to the extent of the increased amount of electricity produced at the facility by reason of such new unit.

Section 45(d)(8) provides in the case of a facility that produces refined coal, the term “refined coal production facility” means a facility which is placed in service after the date of enactment of § 45(d)(8) and before January 1, 2009.

Section 45(d)(9) defines a qualified facility producing qualified hydroelectric production described in § 45(c)(8) as (A) any facility producing incremental hydropower production, but only to the extent of its incremental hydropower production attributable to efficiency improvements or additions to capacity described in § 45(c)(8)(B) placed in service after the date of enactment of § 45(d)(9) and before January 1, 2009, and (B) any other facility placed in service after the date of enactment of § 45(d)(9) and before January 1, 2009. Section 45(d)(9)(C) provides that in the case of a qualified facility described in § 45(d)(9)(A), the 10-year period referred to in § 45(a) is treated as beginning on the date the efficiency improvements or additions to capacity are placed in service.

Section 45(d)(10) provides in the case of a facility that produces Indian coal, the term “Indian coal production facility” means a facility which is placed in service before January 1, 2009.

Section 45(e)(8)(A) provides that the refined coal production credit is an amount equal to $4.375 per ton of qualified refined coal (i) produced by the taxpayer at a refined coal production facility during the 10-year period beginning on the date the facility was originally placed in service, and (ii) sold by the taxpayer (I) to an unrelated person and (II) during the 10-year period and the tax year. Section 45(e)(8)(B) provides that the amount of credit determined under § 45(e)(8)(A) is reduced by an amount which bears the same ratio to the amount of the increase as (i) the amount by which the reference price of fuel used as feedstock (within the meaning of § 45(c)(7)(A)) for the calendar year in which the sale occurs exceeds an amount equal to 1.7 multiplied by the reference price for such fuel in 2002, bears to (ii) $8.75.

Section 45(e)(10)(A) provides in the case of a producer of Indian coal, the credit determined under section 45 for any taxable year shall be increased by an amount equal to the applicable dollar amount per ton of Indian coal (i) produced by the taxpayer at an Indian coal production facility during the 7-year period beginning on January 1, 2006, and (ii) sold by the taxpayer (I) to an unrelated person, and (II) during such 7-year period and such taxable year.

Section 45(e)(10)(B)(i) defines “applicable dollar amount” for any taxable year as (I) $1.50 in the case of calendar years 2006 through 2009, and (II) $2.00 in the case of calendar years beginning after 2009.

Section 45(e)(2)(A) requires the Secretary to determine and publish in the Federal Register each calendar year the inflation adjustment factor and the reference price for the calendar year. The inflation adjustment factors and the reference prices for the 2007 calendar year were published in the Federal Register on March 29, 2007 (72 Fed. Reg. 14862).

Section 45(e)(2)(B) defines the inflation adjustment factor for a calendar year as the fraction the numerator of which is the GDP implicit price deflator for the preceding calendar year and the denominator of which is the GDP implicit price deflator for the calendar year 1992. The term “GDP implicit price deflator” means the most recent revision of the implicit price deflator for the gross domestic product as computed and published by the Department of Commerce before March 15 of the calendar year.

Section 45(e)(2)(C) provides that the reference price is the Secretary’s determination of the annual average contract price per kilowatt hour of electricity generated from the same qualified energy resource and sold in the previous year in the United States. Only contracts entered into after December 31, 1989, are taken into account.

Under § 45(e)(8)(C), the determination of the reference price for fuel used as feedstock within the meaning of § 45(c)(7)(A) is made according to rules similar to the rules under § 45(e)(2)(C).

Under section 45(e)(10)(B)(ii), in the case of any calendar year after 2006, each of the dollar amounts under section 45(e)(10)(B)(i) shall be equal to the product of such dollar amount and the inflation adjustment factor determined under section 45(e)(2)(B) for the calendar year, except that section 45(e)(2)(B) shall be applied by substituting 2005 for 1992.

The inflation adjustment factor for calendar year 2007 for qualified energy resources and refined coal is 1.3433. The inflation adjustment factor for Indian coal is 1.0293. The reference price for calendar year 2007 for facilities producing electricity from wind (based upon information provided by the Department of Energy) is 3.29 cents per kilowatt hour. The reference prices for fuel used as feedstock within the meaning of § 45(c)(7)(A), relating to refined coal production (based upon information provided by the Department of Energy) are $31.90 per ton for calendar year 2002 and $48.35 per ton for calendar year 2007. The reference prices for facilities producing electricity from closed-loop biomass, open-loop biomass, geothermal energy, solar energy, small irrigation power, municipal solid waste, and qualified hydropower production have not been determined for calendar year 2007. The IRS is exploring methods of determining those reference prices for calendar year 2008.

Because the 2007 reference price for electricity produced from wind does not exceed 8 cents multiplied by the inflation adjustment factor, the phaseout of the credit provided in § 45(b)(1) does not apply to such electricity sold during calendar year 2007. Because the 2007 reference price of fuel used as feedstock for refined coal does not exceed the $31.90 reference price of such fuel in 2002 multiplied by the inflation adjustment factor and 1.7, the phaseout of credit provided in § 45(e)(8)(B) does not apply to refined coal sold during calendar year 2007. Further, for electricity produced from closed-loop biomass, open-loop biomass, geothermal energy, solar energy, small irrigation power, municipal solid waste, and qualified hydropower production, the phaseout of credit provided in § 45(b)(1) does not apply to such electricity sold during calendar year 2007.

As required by § 45(b)(2), the 1.5 cent amount in § 45(a)(1), the 8 cent amount in § 45(b)(1), and the $4.375 amount in § 45(e)(8)(A) are each adjusted by multiplying such amount by the inflation adjustment factor for the calendar year in which the sale occurs. If any amount as increased under the preceding sentence is not a multiple of 0.1 cent, such amount is rounded to the nearest multiple of 0.1 cent. In the case of electricity produced in open-loop biomass facilities, small irrigation power facilities, landfill gas facilities, trash combustion facilities, and qualified hydropower facilities, § 45(b)(4)(A) requires the amount in effect under § 45(a)(1) (before rounding to the nearest 0.1 cent) to be reduced by one-half. Under the calculation required by § 45(b)(2), the credit for renewable electricity production for calendar year 2007 under § 45(a) is 2.0 cents per kilowatt hour on the sale of electricity produced from the qualified energy resources of wind, closed-loop biomass, geothermal energy, and solar energy, and 1.0 cent per kilowatt hour on the sale of electricity produced in open-loop biomass facilities, small irrigation power facilities, landfill gas facilities, trash combustion facilities, and qualified hydropower facilities. Under the calculation required by § 45(b)(2), the credit for refined coal production for calendar year 2007 under section 45(e)(8)(A) is $5.877 per ton on the sale of qualified refined coal. The credit for Indian coal production for calendar year 2007 under § 45(e)(10)(B) is $1.544 per ton on the sale of Indian coal.

The principal author of this notice is David A. Selig of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this notice, contact Mr. Selig at (202) 622-3040 (not a toll-free call).

The Department of Treasury and Internal Revenue Service invite public comment on recommendations for items that should be included on the 2007-2008 Guidance Priority List.

Treasury’s Office of Tax Policy and the Service use the Guidance Priority List each year to identify and prioritize the tax issues that should be addressed through regulations, revenue rulings, revenue procedures, notices, and other published administrative guidance. The 2007-2008 Guidance Priority List will establish the guidance that the Treasury Department and the Service intend to issue from July 1, 2007, through June 30, 2008. The Treasury Department and the Service recognize the importance of public input to formulate a Guidance Priority List that focuses resources on guidance items that are most important to taxpayers and tax administration. Published guidance plays an important role in increasing voluntary compliance by helping to clarify ambiguous areas of the tax law.

As is the case whenever significant legislation is enacted, the Treasury Department and the Service have continued to dedicate substantial resources during the current plan year to published guidance projects necessary to implement the provisions of the American Jobs Creation Act of 2004, Pub. L. No. 108-357, 118 Stat. 1418, which was enacted on October 22, 2004; the Energy Policy Act of 2005, Pub. L. No. 109-58, 119 Stat. 594, which was enacted on August 8, 2005; the Gulf Opportunity Zone Act of 2005, Pub. L. No. 109-135, 119 Stat. 2577, which was enacted on December 21, 2005; and the Tax Increase Prevention and Reconciliation Act of 2005, Pub. L. No. 109-222, 120 Stat. 345, which was enacted on May 17, 2006. Similarly, the Treasury Department and the Service have devoted substantial resources to published guidance projects necessary to implement the provisions of additional tax legislation that was enacted during the current plan year, such as the Pension Protection Act of 2006, Pub. L. No. 109-280, 120 Stat. 780, which was enacted on August 17, 2006; and the Tax Relief and Health Care Act of 2006, Pub. L. No. 109-432, 120 Stat. 2922, which was enacted on December 20, 2006. The Treasury Department and the Service will continue to evaluate the priority of each guidance project in light of the above-mentioned tax legislation and other developments occurring during the 2007-2008 plan year.

In reviewing recommendations and selecting projects for inclusion on the 2007-2008 Guidance Priority List, the Treasury Department and the Service will consider the following:

Taxpayers may submit recommendations for guidance at any time during the year. Please submit recommendations by May 31, 2007, for possible inclusion on the original 2007-2008 Guidance Priority List. The Service plans to update the 2007-2008 Guidance Priority List periodically to reflect additional guidance that the Treasury Department and the Service intend to publish during the plan year. The periodic updates allow the Treasury Department and the Service to respond to the need for additional guidance that may arise during the plan year. Recommendations for guidance received after May 31, 2007, will be reviewed for inclusion in the next periodic update.

Taxpayers are not required to submit recommendations for guidance in any particular format. Taxpayers should, however, briefly describe the recommended guidance and explain the need for the guidance. In addition, taxpayers may include an analysis of how the issue should be resolved. It would be helpful if taxpayers suggesting more than one guidance project would prioritize the projects by order of importance. If a large number of projects are being suggested, it also would be helpful if the projects were grouped in terms of high, medium or low priority.

Taxpayers should send written comments to:

or hand deliver comments Monday through Friday between the hours of 8 a.m. and 4 p.m. to:

Alternatively, taxpayers may submit comments electronically via e-mail to the following address: Notice.Comments@irscounsel.treas.gov. Taxpayers should include “Notice 2007-41” in the subject line. All comments will be available for public inspection and copying in their entirety.

For further information regarding this notice, contact Henry Schneiderman of the Office of Associate Chief Counsel (Procedure and Administration) at (202) 622-3400 (not a toll-free call).

This notice provides guidance with respect to the circumstances under which § 856(c)(2) or § 856(c)(3) characterizes § 987 gain as qualifying income for purposes of REIT qualification.

Under paragraph (3) of § 856(c), at least 75 percent of a REIT’s annual gross income must be derived from the types of income listed in that paragraph, often characterized as income from real estate sources. Under paragraph (2) of § 856(c), at least 95 percent of a REIT’s annual gross income must be derived from the types of income listed in that paragraph, often characterized as income from “passive” sources, including interest and dividends.

The Service is aware that some REITs have invested in real estate assets outside the United States through entities or partnerships that qualify as QBUs, as defined in § 989(a). The Service has explicitly ruled that otherwise-qualifying assets do not fail to satisfy § 856(c)(4) merely because the assets are foreign:

Rev. Rul. 74-191, 1974-1 C.B. 170, 170. It follows from this holding both that rents on foreign real property qualify under § 856(c)(2)-(3) to the same extent that they would qualify if the property were located in the United States, and that interest on foreign mortgage loans qualifies under § 856(c)(2)-(3) to the same extent that it would qualify if the loans were governed by United States law and the property were located in the United States. Thus, foreign situs of a REIT’s assets does not necessarily prevent the REIT from satisfying the income and asset tests of § 856(c), which must be met in order to qualify as a REIT. Rev. Rul. 74-191, however, does not address the treatment of foreign currency gain that may result from investing in real property or other assets through a QBU with a functional currency other than the dollar.

In general, § 985 provides that all determinations for federal income tax purposes are to be made in the taxpayer’s functional currency. Section 985(a). Section 1.985-1(b)(1)(iii) of the Income Tax Regulations provides that, except as otherwise provided by ruling or administrative pronouncement, the U.S. dollar is the functional currency of a QBU that has the United States as its residence, as defined in § 988(a)(3)(B). Section 1.989(a)-1(b)(2)(i) provides that a corporation is a QBU. Section 988(a)(3)(B)(i)(II) provides that the United States is the residence of a corporation that is a United States person. Section 7701(a)(30) provides, in part, that the term “United States person” includes a domestic corporation. Section 7701(a)(4) provides that the term “domestic,” as applied to a corporation, means created or organized in the United States or under the law of the United States or any State. Thus, absent a ruling to the contrary, a REIT has the dollar as its functional currency because § 856(a)(3) requires it to be taxable as a domestic corporation.

A REIT may have a QBU that is subject to § 987 and that has a functional currency other than the dollar. See § 1.985-1(c). In such a case, a REIT may recognize currency gain under § 987 when the QBU remits property to the REIT. Section 987(3).

Proposed regulations (REG-208270-86, 2006-42 I.R.B. 698 [71 FR 52,876]) under § 987 were issued September 7, 2006. Section 1.987-6(b) of the proposed regulations generally provides that the owner of a § 987 QBU must determine the character of § 987 gain or loss in the year of remittance using the asset method provided in § 1.861-9T(g), as modified by the proposed regulations. The modified gross income method described in § 1.861-9T(j) cannot be used. If finalized as currently proposed, however, the regulations will not apply to REITs. See Prop. Treas. Reg. § 1.987-1(b)(1)(iii). Some REITs have requested guidance concerning the status under § 856(c)(2)-(3) of any foreign currency gain that is recognized under § 987 when a QBU remits property to a REIT.

Because the currency gain from remittances is determined under § 987, the Service believes that it is appropriate for issues that arise in connection with that gain to be addressed under methods similar to those provided in § 987 and the regulations thereunder. The Treasury Department and the Service therefore intend to amend the proposed regulations under § 987 to include guidance concerning the characterization for purposes of § 856(c)(2) and (3) of § 987 gain recognized by a REIT on a remittance from a QBU of the REIT.

Until further guidance is published, if a REIT recognizes § 987 gain, the REIT may apply the principles of the proposed regulations under § 987 issued September 7, 2006 to determine whether that § 987 gain is derived from income that is described in § 856(c)(2)(A) - (H) or § 856(c)(3)(A) - (I).

The principal author of this notice is Jonathan D. Silver of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this notice, contact Jonathan D. Silver at (202) 622-3930 (not a toll-free call).

This revenue procedure provides the exclusive procedure by which a taxpayer described in SECTION 3 may obtain the Commissioner’s consent to change its method of accounting for uncollected interest (other than interest described in § 1.446-2(a)(2) of the Income Tax Regulations) to the safe harbor method provided in SECTION 4 of this revenue procedure.

.01 For certain types of interest, § 1.446-2 provides rules for determining the amount of interest that accrues during an accrual period and the portion of a payment that consists of accrued interest. For descriptions of the types of interest (e.g., original issue discount) to which the § 1.446-2 accrual rules do not apply, see 1.446-2(a)(2).

.02 Section 1.446-2(b) provides that “qualified stated interest” accrues ratably over an accrual period (or periods) to which it is attributable and accrues at the stated rate for the period (or periods). In general, “qualified stated interest” is stated interest that is unconditionally payable in cash or in property (other than debt instruments of the issuer) at least annually at a single fixed rate that appropriately takes into account the length of the interval between payments. See 1.1273-1(c).

.03 In the case of interest other than “qualified stated interest,” § 1.446-2(c) provides that the amount of interest that accrues for any accrual period is determined under rules similar to those in the regulations under sections 1272 and 1275 of the Internal Revenue Code for the accrual of original issue discount (subject to the modifications set forth in § 1.446-2(d)).

.04 Section 1.446-2(e) provides that each payment on a loan (other than payments of additional interest or similar charges with regard to amounts not paid when due) is treated as a payment of interest to the extent of the accrued but unpaid interest (determined under § 1.446-2(b) and § 1.446-2(c)) as of the date the payment becomes due.

.05 Section 1.446-2(a)(1) provides that a taxpayer determines the taxable year in which to include an amount of accrued interest (determined under § 1.446-2(b) or § 1.446-2(c)) in gross income under the taxpayer’s regular method of accounting.

.06 Rev. Rul. 2007-32, page of this Bulletin, requires an accrual method bank with a reasonable expectancy of receiving future payments on a loan to accrue interest in the taxable year in which the right to receive the interest becomes fixed, notwithstanding bank regulatory rules that prevent accrual of the interest for regulatory purposes. The ruling also provides guidance as to the period in which a taxpayer that has elected the conformity method of accounting under 1.166-2(d)(3) can treat uncollected interest as worthless.

.07 APPENDIX 5A of Rev. Proc. 2002-9, 2002-1 C.B. 327, modified and clarified by Announcement 2002-17, 2002-1 C.B. 561, modified and amplified by Rev. Proc. 2002-19, 2002-1 C.B. 696, amplified, clarified, and modified by Rev. Proc. 2002-54, 2002-2 C.B. 432, states that “for interest to be determined uncollectible, the taxpayer must substantiate, taking into account all the facts and circumstances, that it has no reasonable expectation of payment of the interest.” APPENDIX 5A of Rev. Proc. 2002-9 also states that the “substantiation requirement is applied on a loan by loan basis.”

.08 Substantiation of uncollectible interest using a loan-by-loan facts and circumstances methodology can be administratively burdensome and impractical, particularly for smaller unsecured loans. For example, a bank may have a significant number of consumer loans. For these loans, the bank’s loan files often may not contain updated information regarding the debtors’ financial condition or the value of the collateral, if any, securing the loans.

This revenue procedure applies to a “bank” as defined in 1.166-2(d)(4)(i) that—

(1) uses an accrual method of accounting to determine its taxable income for federal income tax purposes,

(2) is subject to supervision by Federal authorities, or by state authorities maintaining substantially equivalent standards, and

(3) has uncollected interest other than interest described in 1.446-2(a)(2).

.01 Safe Harbor Method. Under the safe harbor method of accounting provided by this SECTION 4, a bank determines for each taxable year the amount of uncollected interest (other than interest described in 1.446-2(a)(2)) for which it is considered to have a reasonable expectancy of payment by multiplying: (1) the total accrued (determined under § 1.446-2) but uncollected interest for the year by, (2) the bank’s “recovery percentage” (determined under paragraph .02 of this SECTION 4) for that year. Solely for purposes of this safe harbor, the bank is not considered to have a reasonable expectancy of payment for the excess, if any, of the accrued but uncollected interest over the expected collection amount determined using the bank’s recovery percentage. The bank includes in gross income the portion of accrued but uncollected interest for which it has a reasonable expectancy of payment. The bank excludes from income the portion of accrued but uncollected interest for which it has no reasonable expectancy of payment.

.02 Recovery Percentage. (1) Subject to the limitations and conditions in subparagraphs (2) - (4) of this SECTION 4.02, a bank determines its recovery percentage for each taxable year by dividing—

(a) total payments that the bank received on loans (including principal and interest) during the 5 taxable years immediately preceding the taxable year (or, with the approval of the Commissioner, a shorter period if the bank has less than 6 years of collection experience, i.e., the taxable year and the 5 immediately preceding taxable years), by

(b) total amounts that were due and payable to the bank on loans during the same 5 (or fewer) taxable years.

(2) The recovery percentage cannot exceed 100 percent.

(3) The recovery percentage must be calculated to at least four decimal places.

(4) The data used in the recovery percentage must take into account acquisitions and dispositions as follows:

(a) If a bank acquires the major portion of a trade or business of another person (predecessor) or the major portion of a separate unit of a trade or business of a predecessor, then in applying this revenue procedure for any taxable year ending on or after the acquisition, the data from preceding taxable years of the predecessor attributable to the portion of the trade or business acquired, if available, must be used in determining the bank’s recovery percentage.

(b) If a bank disposes of a major portion of a trade or business or the major portion of a separate unit of a trade or business, and the bank furnished the acquiring person the information necessary for the computations required by this revenue procedure, then in applying this revenue procedure for any taxable year ending on or after the disposition, the data from preceding taxable years attributable to the disposed portion of the trade or business may not be used in determining the bank’s recovery percentage.

.01 Facts. Bank X is a calendar year taxpayer that determines its taxable income using an accrual method of accounting. For 2007, Bank X’s accrued but uncollected interest (determined under § 1.446-2) is $51,600. Bank X uses the safe harbor method of accounting described in SECTION 4 of this revenue procedure to determine the amount of uncollected interest for which the Bank has a reasonable expectancy of payment. During the 5 immediately preceding taxable years, Bank X received $73,048,313 of payments on all of its loans. During the same 5-year period, $74,900,705 was due and payable on the loans.

.02 Analysis. (1) To determine the portion of the accrued but uncollected interest for which there is a reasonable expectancy of payment, Bank X first calculates its recovery percentage for 2007. Bank X determines its recovery percentage by dividing the $73,048,313 of payments received during the 2002-2006 period by the $74,900,705 that was due and payable during the same period. Bank X’s 2007 recovery percentage is 97.5269% [$73,048,313 ÷ $74,900,705 = 97.5269%]. Bank X determines the portion of the uncollected 2007 interest for which it is considered to have a reasonable expectancy of payment by multiplying the $51,600 of accrued but uncollected interest for that year by the 97.5269 recovery percentage. Bank X has a reasonable expectancy of payment for $50,323.88 of the uncollected 2007 interest [$51,600 × 97.5269% = $50,323.88]. Bank X includes the $50,323.88 of uncollected 2007 interest in gross income for 2007.

(2) Bank X is considered not to have a reasonable expectancy of payment for $1,276.12 of the uncollected 2007 interest ($51,600 - $50,323.88 = $1,276.12). Bank X excludes $1,276.12 of the uncollected 2007 interest from its 2007 gross income.

.01 Any change to the safe harbor method provided in SECTION 4 of this revenue procedure is a change in method of accounting to which the provisions of section 446 and section 481, and the regulations thereunder, apply. Under § 1.446-1(e)(2)(i), a taxpayer generally must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the terms and conditions necessary to obtain consent to change a method of accounting.

.02 If a bank with less than 6 years of collection experience wants to change its method of accounting for uncollected interest to the safe harbor method provided in SECTION 4 of this revenue procedure, the bank is required to follow the provisions of Rev. Proc. 97-27, 1997-1 C.B. 680 (or its successor), as modified and amplified by Rev. Proc. 2002-19, as amplified and clarified by Rev. Proc. 2002-54, except that the scope limitations in section 4.02(2) through (6) of Rev. Proc. 97-27 do not apply to a bank that makes the change for either its first or second taxable year ending on or after December 31, 2006.

.03 If a bank with 6 or more years of collection experience wants to change its method of accounting for uncollected interest to the safe harbor method provided in SECTION 4 of this revenue procedure, the bank is required to follow the automatic change in method of accounting provisions of Rev. Proc. 2002-9 (or its successor), with the following modifications:

(1) the scope limitations in section 4.02 of Rev. Proc. 2002-9 do not apply to a bank that makes the change for either its first or second taxable year ending on or after December 31, 2006; and

(2) the designated automatic accounting change number for changes in method of accounting made pursuant to the revenue procedure is 108.

The Internal Revenue Service requests comments on this revenue procedure. In particular, comments are requested regarding the appropriate treatment of payments received in future years. For example, comments are requested regarding how to determine the portion, if any, of a payment attributable to amounts that the bank excluded from gross income. All comments should be submitted by August 20, 2007, to:

Alternatively, comments may be submitted electronically directly to the Service via the following e-mail address: Notice.comments@irscounsel.treas.gov. Please include “Rev. Proc. 2007-33” in the subject line of any electronic communication. All materials submitted will be available for public inspection and copying.

This revenue procedure is effective for tax years ending on or after its publication.

Rev. Proc. 2002-9 is modified and amplified to include the accounting method change provided by this revenue procedure.

The principal author of this revenue procedure is Timothy Sebastian of the Office of the Associate Chief Counsel (Financial Institutions and Products). For further information regarding this revenue procedure, contact Mr. Sebastian (202) 622-7417 (not a toll-free call).

Internal Revenue Service (IRS), Treasury.

Notice of proposed rulemaking and notice of public hearing.

This document contains proposed amendments to the regulations relating to the amount deductible from a decedent’s gross estate for claims against the estate under section 2053(a)(3) of the Internal Revenue Code (Code). In addition, the proposed regulations update the provisions relating to the deduction for certain state death taxes to reflect the statutory amendments made in 2001 under sections 2053(d) and 2058. The proposed regulations will affect estates of decedents against whom there are claims outstanding at the time of the decedent’s death. This document also provides notice of a public hearing on these proposed regulations.

Written or electronic comments must be received by July 23, 2007. Outlines of topics to be discussed at the public hearing scheduled for August 6, 2007, at 10 a.m., must be received by July 30, 2007.

Send submissions to: CC:PA:LPD:PR (REG-143316-03), Room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-143316-03), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC; or sent electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS REG-143316-03). The public hearing will be held in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

Concerning the proposed regulations, DeAnn K. Malone, at (202) 622-3112; concerning submissions of comments, the hearing, and/or to be placed on the building access list to attend the hearing, Richard Hurst, at (202) 622-2949 (TDD telephone) (not toll-free numbers) or e-mail at Richard.A.Hurst@irscounsel.treas.gov.

Accordingly, 26 CFR part 20 is proposed to be amended as follows:

The principal author of these proposed regulations is DeAnn K. Malone, Office of the Chief Counsel, IRS.

* * * * *

Internal Revenue Service (IRS), Treasury.

Correcting amendments.

This document contains corrections to final regulations (T.D. 9315, 2007-15 I.R.B. 891) that were published in the Federal Register on Monday, March 19, 2007 (72 FR 12902) regarding dual consolidated losses. Section 1503(d) generally provides that a dual consolidated loss of a dual resident corporation cannot reduce the taxable income of any other member of the affiliated group unless, to the extent provided in regulations, the loss does not offset the income of any foreign corporation.

These correcting amendments are effective April 25, 2007.

Jeffrey P. Cowan, (202) 622-3860 (not a toll-free number).