REVENUE RULE 91-7

1991-1 C.B. 110, 1991-4 I.R.B. 5.

Internal Revenue Service
Revenue Ruling

DENIAL OF CAPITALIZATION OF EXPENSES

Published: January 28, 1991

Section 871. Tax On Nonresident Alien Individuals, 26 CFR 1.871-10: Election to treat real property income as effectively connected with conduct of a U.S. business.

(See Also Sections 266, 873, 881, 882.)

Denial of capitalization of expenses. Foreign persons who purchase real estate that produces no gross income may not capitalize interest, taxes, and other carrying charges that are otherwise not deductible.

ISSUES

(1) May a nonresident alien or a foreign corporation make an election under section 871(d) or 882(d) of the Internal Revenue Code for a taxable year in which the taxpayer does not derive income from U.S. real property.

(2) May a nonresident alien or a foreign corporation make an election under section 266 of the Code to capitalize real estate taxes, mortgage interest, and other carrying charges attributable to unimproved and unproductive real property for a taxable year in which it may not deduct such expenses under section 873(a) or 882(c).

FACTS

A, a nonresident alien individual, and FC, a foreign corporation, co-own parcel P, unimproved real estate located in the United States. Parcel P is held for investment purposes. During the 1990 taxable year, A and FC do not derive any income from parcel P. A and FC annually pay real estate taxes, mortgage interest, and other carrying charges connected with parcel P. Neither A nor FC has made an election under section 871(d) or section 882(d) of the Code with respect to parcel P in any previous taxable year.

LAW AND ANALYSIS

Nonresident alien individuals had foreign corporations are subject to taxation at a rate of 30 percent on certain types of U.S. source gross income (including rent) which is not effectively connected with the conduct of a trade or business within the United States (ECI). See sections 871(a) and 881(a) of the Code.

Nonresident alien individuals or foreign corporations that are engaged in a U.S. trade or business during the taxable year are subject to taxation under sections 871(b) and 882(a) of the Code on their taxable income which is ECI. Sections 873(a) and 882(c) allow deductions to nonresident alien individuals and foreign corporations only if and to the extent that the deductions are connected with the ECI of such persons.

Nonresident alien individuals and foreign corporations that, during a taxable year, derive from U.S. real property gross income which is not ECI may elect for such taxable year to treat such income as if it were ECI. See sections 871(d) and 882(d) of the Code. Income subject to the election is taxable as ECI under section 871(b) or section 882(a), and is not taxable under section 871(a) or section 881(a).

Because A and FC do not derive any income from parcel P during the 1990 taxable year, neither taxpayer can make an election for such year under section 871(d) or section 882(d) of the Code. Sections 1.871-10(a) and 1.882-2(a) of the Income Tax Regulations. Under sections 873(a) and 882(c), A and FC are not allowed any deductions in the 1990 taxable year for the real estate taxes, mortgage interest, or other carrying charges paid during such taxable year, because such amounts are not connected with ECI.

Section 1.1016-(c) of the regulations provides that adjustments to basis shall be made for taxes and other carrying charges which the taxpayer elects, under section 266 of the Code, to treat as chargeable to capital account, rather than as an allowable deduction. Under section 1.266-1(b)-(1)(i) of the regulations, annual taxes, interest on a mortgage, and other carrying charges on unimproved and unproductive real property, which are otherwise expressly deductible under Subtitle A of the Code, may be capitalized at the election of the taxpayer. An item not otherwise deductible may not be capitalized under section 266. See section 1.266-1(b)(2).

Because the real estate taxes and mortgage interest incurred during the 1990 taxable year on parcel P are not allowable deductions for A and FC for such taxable year, those expenses cannot be capitalized under section 266 of the Code by adding the amount of the expenses to the basis of parcel P.

HOLDINGS

(1) A nonresident alien individual or foreign corporation may not make an election under section 871(d) or 882(d) of the Code for a taxable year in which the foreign taxpayer does not derive income from U.S. real property.

(2) A nonresident alien individual or foreign corporation may not make an election under section 266 of the Code to capitalize real estate taxes, mortgage interest, and other carrying charges attributable to unimproved and unproductive U.S. real property if, during the taxable year in which such expenses are incurred, such expenses are not allowable deductions under section 873(a) or 882(c).

DRAFTING INFORMATION

The principal author of this revenue ruling is James H. W. Insley of the Office of the Associate Chief Counsel (International). For further information regarding this revenue ruling, contact Mr. Insley on (202) 287-4851 (not a toll-free call).

Rev. Rul. 91-7, 1991-1 C.B. 110, 1991-4 I.R.B. 5.