Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 70-5

1970-1 C.B. 142

Sec. 593

IRS Headnote

An organization described in section 593(a) of the Code may increase its reserves for losses on qualifying real property loans for a taxable year in which the Revenue Service makes an adjustment with respect to some other item on its income tax return.

Full Text

Rev. Rul. 70-5

Advice has been requested whether an organization of the type described in section 593(a) of the Internal Revenue Code of 1954 may increase its reasonable addition to its reserve for losses on qualifying real property loans for a particular taxable year, under the circumstances described below.

The taxpayer is an organization of the type described in section 593(a) of the Code. In the process of computing an amount that constituted a reasonable addition to its reserve for losses on qualifying real property loans under section 593(b)(1)(B) of the Code, the taxpayer determined that the maximum allowable reserve addition would be afforded by the limitation established by the "percentage of real property loans method" set forth in section 593(b)(3) of the Code rather than by the limitations afforded by the "taxable income" or "experience" methods respectively set forth in sections 593(b)(2) and 593(b)(4) of the Code. The maximum amount allowable as an addition to the reserve for losses on qualifying real property loans under the percentage of real property loans method provided in section 593(b)(3) of the Code was 150x dollars. The taxpayer chose, however, to make an addition to its reserve for losses on qualifying real property loans of only 25x dollars since this amount was sufficient to offset the taxpayer's taxable income for the taxable year computed without regard to the bad debt deduction. Thus, 25x dollars was claimed as a bad debt deduction by the taxpayer on its Federal income tax return.

As the result of an examination of the taxpayer's Federal income tax return an adjustment was made by the Service which disallowed, as a deduction, an item other than the taxpayer's claimed bad debt deduction. Since this adjustment had the effect of increasing taxable income for the taxable year in question, the taxpayer desired to increase its addition to its reserve for losses on qualifying real property loans, within the maximum limitations of section 593(b) of the Code, in an amount sufficient to offset taxable income as redetermined subsequent to the aforementioned adjustment. Subsequent to this adjustment the limitations established by the percentage of real property loans method still afforded the maximum allowable reserve addition. This maximum exceeded the amount by which the taxpayer desired to increase its addition to its reserve for bad debts.

The reserve for losses on qualifying real property loans, set forth in section 593(b)(1)(B) of the Code, is recognized as a bad debt reserve for Federal income tax purposes.

Section 1.593-5(b)(2) of the Income Tax Regulations provides that if an adjustment with respect to the income tax return for a taxable year is made, and if such adjustment (whether initiated by the taxpayer or the Commissioner) has the effect of permitting an increase, or requiring a reduction, in the amount claimed on such return as an addition to the reserve for losses on nonqualifying loans or to the reserve for losses on qualifying real property loans, then the amount initially credited to such reserve for such year may have to be increased or decreased, as the case may be, to the extent necessary to reflect such adjustment.

Section 1.593-6(a) of the regulations provides, in pertinent part, that for each taxable year the taxpayer must include in its income tax return for such year a computation of the reasonable addition to the reserve for losses on qualifying real property loans. That section further provides that for purposes of section 1.593-5 of the regulations the use of a particular method in the return for a taxable year is not a binding election by the taxpayer to apply such method either for such taxable year or for subsequent taxable years. Thus, in the case of a subsequent adjustment described in section 1.593-5(b)(2) of the regulations which has the effect of permitting an increase, or requiring a reduction, in the amount claimed in the return for a taxable year as an addition to the reserve for losses on qualifying real property loans, the amount of such reasonable addition to such reserve may be recomputed under whichever method the taxpayer selects for the purpose of such recomputation, irrespective of the method initially applied for such taxable year. However, a taxpayer may not subsequently reduce the amount claimed in the return for a taxable year for the purpose of obtaining a larger deduction in a later year.

Accordingly, it is held, under the circumstances of the instant case, that the taxpayer, may increase its reasonable addition to its reserve for losses on qualifying real property loans in an amount sufficient to offset taxable income, as redetermined, as a result of the subsequent adjustment by the Service to the taxpayer's Federal income tax return disallowing as a deduction an item other than the taxpayer's bad debt deduction. It is further held that in recomputing its reasonable addition to its reserve for losses on qualifying real property loans the taxpayer may utilize the limitation afforded by any method described in section 593(b) of the Code, pursuant to section 1.593-6(a) of the regulations, subject to the over-all limitations of section 593(b)(1)(B)(i) and (ii) of the Code.