Internal Revenue Service
Revenue Ruling
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smRev. Rul. 70-37
1970-1 C.B. 3
Sec. 46
Sec. 266
IRS Headnote
A cash basis taxpayer electing to capitalize carrying charges on an installment purchase of "section 38 property" must determine the interest under section 163(b) of the Code and may capitalize only the interest paid prior to placing the property in service.
Full Text
Rev. Rul. 70-37
Advice has been requested as to the basis of "section 38 property" for purposes of computing the investment credit under the circumstances described below.
During calendar year 1968 a taxpayer, who uses the cash receipts and disbursements method of accounting, traded in his old tractor, with a trade-in value of 600x dollars and an adjustment basis of 800x dollars, for a new tractor costing 2,600x dollars that qualified as "new section 38 property." The total contract price, which is to be paid over a 48-month period, is 2,400x dollars consisting of the purchase price of the new tractor (2,600x dollars) less the trade-in allowance for the old tractor (600x dollars) plus separately stated carrying charges in the amount of 400x dollars. The actual interest charge included in the carrying charges cannot be determined. However, 150x dollars was determined to be interest under section 163(b) of the Internal Revenue Code of 1954 and the Income Tax Regulations thereunder. The taxpayer elected to capitalize the balance of the carrying charges (250x dollars) in accordance with section 266 of the Code and regulations thereunder. The loss on the exchange of 200x dollars (the difference between the adjusted basis of the old tractor, 800x dollars, and its trade-in value of 600x dollars) was not recognized as provided in section 1031 of the Code. 5x dollars of the interest charge was paid by the taxpayer prior to the time the tractor was placed in service by him.
Section 1.46-3(c)(1) of the regulations provides that 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 as determined under section 1012 of the Code. The regulations further provide that if new section 38 property is acquired in exchange for cash and other property in a transaction described in section 1031 (concerning a voluntary exchange of property) in which no gain or loss is recognized, the basis of the newly acquired property is equal to the adjusted basis of the property traded in plus the cash paid.
Section 1.266-1(b)(iii) of the regulations permits a taxpayer to capitalize taxes and interest paid or incurred up to the date of installation of tangible property or the date when such property is first put into use by the taxpayer, whichever date is later.
Section 163(b) of the Code provides that if personal property is purchased under a contract that provides that payment of part or all of the purchase price is to be made in installments, and in which carrying charges are separately stated but the interest charge cannot be ascertained, then the payments made during the taxable year under the contract shall be treated for purposes of this section as if they included interest equal to six percent of the average unpaid balance under the contract during the taxable year.
Basis or cost determined pursuant to section 1.46-3(c) of the regulations does not include interest charges expensed by a taxpayer when paid or accrued. To the extent, however, that section 266 of the Code is applicable, a taxpayer that elects to capitalize interest charges may properly include such amounts in the basis of "new section 38 property." Section 1.266-1(b)(iii) of the regulations only permits a taxpayer to capitalize interest paid or incurred up to the date of installation.
Pursuant to section 163(b) of the Code, 150x dollars of the 400x dollars carrying charge is determined to be interest charges. The balance of 250x dollars is a carrying charge that is considered part of the basis under section 1012 of the Code. Only 5x dollars of the interest was paid prior to the time the tractor was placed in service and, since the taxpayer uses the cash method, that is the only portion of the carrying charges that may be capitalized pursuant to the election made in accordance with section 266 of the Code. The interest that had not been paid prior to placing the tractor in service is deductible under section 163(a) of the Code when paid.
Accordingly, in the instant case, the basis of the new tractor for investment credit purposes is 3,055x dollars computed as follows:
Dollars
Purchase price ................................... 2,600x
Carrying charge ................................. 250x
Interest paid prior to placement in service ..... 2,855x
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Less trade-in allowance ......................... 600x
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2,255x
Plus adjusted basis of old tractor ............... 800x
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Basis of new tractor ............................. 3,055x
It should be noted that if an investment credit was allowed with respect to the old tractor and if it was disposed of in the exchange before the end of the useful life taken into account in computing the investment credit so allowed, section 47 of the Code requires the "recapture" of such investment credit to the extent provided for therein.