26 U.S.C. § 163 : US Code - Section 163: Interest

Search 26 U.S.C. § 163 : US Code - Section 163: Interest

(a) General rule
There shall be allowed as a deduction all interest paid or
accrued within the taxable year on indebtedness.
(b) Installment purchases where interest charge is not separately
stated
(1) General rule
If personal property or educational services are purchased
under a contract -
(A) which provides that payment of part or all of the
purchase price is to be made in installments, and
(B) 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 6 percent of the average unpaid balance under
the contract during the taxable year. For purposes of the
preceding sentence, the average unpaid balance is the sum of the
unpaid balance outstanding on the first day of each month
beginning during the taxable year, divided by 12. For purposes of
this paragraph, the term "educational services" means any service
(including lodging) which is purchased from an educational
organization described in section 170(b)(1)(A)(ii) and which is
provided for a student of such organization.
(2) Limitation
In the case of any contract to which paragraph (1) applies, the
amount treated as interest for any taxable year shall not exceed
the aggregate carrying charges which are properly attributable to
such taxable year.
(c) Redeemable ground rents
For purposes of this subtitle, any annual or periodic rental
under a redeemable ground rent (excluding amounts in redemption
thereof) shall be treated as interest on an indebtedness secured by
a mortgage.
(d) Limitation on investment interest
(1) In general
In the case of a taxpayer other than a corporation, the amount
allowed as a deduction under this chapter for investment interest
for any taxable year shall not exceed the net investment income
of the taxpayer for the taxable year.
(2) Carryforward of disallowed interest
The amount not allowed as a deduction for any taxable year by
reason of paragraph (1) shall be treated as investment interest
paid or accrued by the taxpayer in the succeeding taxable year.
(3) Investment interest
For purposes of this subsection -
(A) In general
The term "investment interest" means any interest allowable
as a deduction under this chapter (determined without regard to
paragraph (1)) which is paid or accrued on indebtedness
properly allocable to property held for investment.
(B) Exceptions
The term "investment interest" shall not include -
(i) any qualified residence interest (as defined in
subsection (h)(3)), or
(ii) any interest which is taken into account under section
469 in computing income or loss from a passive activity of
the taxpayer.
(C) Personal property used in short sale
For purposes of this paragraph, the term "interest" includes
any amount allowable as a deduction in connection with personal
property used in a short sale.
(4) Net investment income
For purposes of this subsection -
(A) In general
The term "net investment income" means the excess of -
(i) investment income, over
(ii) investment expenses.
(B) Investment income
The term "investment income" means the sum of -
(i) gross income from property held for investment (other
than any gain taken into account under clause (ii)(I)),
(ii) the excess (if any) of -
(I) the net gain attributable to the disposition of
property held for investment, over
(II) the net capital gain determined by only taking into
account gains and losses from dispositions of property held
for investment, plus
(iii) so much of the net capital gain referred to in clause
(ii)(II) (or, if lesser, the net gain referred to in clause
(ii)(I)) as the taxpayer elects to take into account under
this clause.
Such term shall include qualified dividend income (as defined
in section 1(h)(11)(B)) only to the extent the taxpayer elects
to treat such income as investment income for purposes of this
subsection.
(C) Investment expenses
The term "investment expenses" means the deductions allowed
under this chapter (other than for interest) which are directly
connected with the production of investment income.
(D) Income and expenses from passive activities
Investment income and investment expenses shall not include
any income or expenses taken into account under section 469 in
computing income or loss from a passive activity.
(E) Reduction in investment income during phase-in of passive
loss rules
Investment income of the taxpayer for any taxable year shall
be reduced by the amount of the passive activity loss to which
section 469(a) does not apply for such taxable year by reason
of section 469(m). The preceding sentence shall not apply to
any portion of such passive activity loss which is attributable
to a rental real estate activity with respect to which the
taxpayer actively participates (within the meaning of section
469(i)(6)) during such taxable year.
(5) Property held for investment
For purposes of this subsection -
(A) In general
The term "property held for investment" shall include -
(i) any property which produces income of a type described
in section 469(e)(1), and
(ii) any interest held by a taxpayer in an activity
involving the conduct of a trade or business -
(I) which is not a passive activity, and
(II) with respect to which the taxpayer does not
materially participate.
(B) Investment expenses
In the case of property described in subparagraph (A)(i),
expenses shall be allocated to such property in the same manner
as under section 469.
(C) Terms
For purposes of this paragraph, the terms "activity",
"passive activity", and "materially participate" have the
meanings given such terms by section 469.
(6) Phase-in of disallowance
In the case of any taxable year beginning in calendar years
1987 through 1990 -
(A) In general
The amount of interest paid or accrued during any such
taxable year which is disallowed under this subsection shall
not exceed the sum of -
(i) the amount which would be disallowed under this
subsection if -
(I) paragraph (1) were applied by substituting "the sum
of the ceiling amount and the net investment income" for
"the net investment income", and
(II) paragraphs (4)(E) and (5)(A)(ii) did not apply, and
(ii) the applicable percentage of the excess of -
(I) the amount which (without regard to this paragraph)
is not allowable as a deduction under this subsection for
the taxable year, over
(II) the amount described in clause (i).
The preceding sentence shall not apply to any interest treated
as paid or accrued during the taxable year under paragraph (2).
(B) Applicable percentage
For purposes of this paragraph, the applicable percentage
shall be determined in accordance with the following table:
In the case of taxable 2The applicable
years beginning in:
percentage is:
--------------------------------------------------------------------
1987 35
1988 60
1989 80
1990 90.
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(C) Ceiling amount
For purposes of this paragraph, the term "ceiling amount"
means -
(i) $10,000 in the case of a taxpayer not described in
clause (ii) or (iii),
(ii) $5,000 in the case of a married individual filing a
separate return, and
(iii) zero in the case of a trust.
(e) Original issue discount
(1) In general
In the case of any debt instrument issued after July 1, 1982,
the portion of the original issue discount with respect to such
debt instrument which is allowable as a deduction to the issuer
for any taxable year shall be equal to the aggregate daily
portions of the original issue discount for days during such
taxable year.
(2) Definitions and special rules
For purposes of this subsection -
(A) Debt instrument
The term "debt instrument" has the meaning given such term by
section 1275(a)(1).
(B) Daily portions
The daily portion of the original issue discount for any day
shall be determined under section 1272(a) (without regard to
paragraph (7) thereof and without regard to section
1273(a)(3)).
(C) Short-term obligations
In the case of an obligor of a short-term obligation (as
defined in section 1283(a)(1)(A)) who uses the cash receipts
and disbursements method of accounting, the original issue
discount (and any other interest payable) on such obligation
shall be deductible only when paid.
(3) Special rule for original issue discount on obligation held
by related foreign person
(A) In general
If any debt instrument having original issue discount is held
by a related foreign person, any portion of such original issue
discount shall not be allowable as a deduction to the issuer
until paid. The preceding sentence shall not apply to the
extent that the original issue discount is effectively
connected with the conduct by such foreign related person of a
trade or business within the United States unless such original
issue discount is exempt from taxation (or is subject to a
reduced rate of tax) pursuant to a treaty obligation of the
United States.
(B) Special rule for certain foreign entities
(i) In general
In the case of any debt instrument having original issue
discount which is held by a related foreign person which is a
controlled foreign corporation (as defined in section 957) or
a passive foreign investment company (as defined in section
1297), a deduction shall be allowable to the issuer with
respect to such original issue discount for any taxable year
before the taxable year in which paid only to the extent such
original issue discount is includible (determined without
regard to properly allocable deductions and qualified
deficits under section 952(c)(1)(B)) during such prior
taxable year in the gross income of a United States person
who owns (within the meaning of section 958(a)) stock in such
corporation.
(ii) Secretarial authority
The Secretary may by regulation exempt transactions from
the application of clause (i), including any transaction
which is entered into by a payor in the ordinary course of a
trade or business in which the payor is predominantly
engaged.
(C) Related foreign person
For purposes of subparagraph (A), the term "related foreign
person" means any person -
(i) who is not a United States person, and
(ii) who is related (within the meaning of section 267(b))
to the issuer.
(4) Exceptions
This subsection shall not apply to any debt instrument
described in -
(A) subparagraph (D) of section 1272(a)(2) (relating to
obligations issued by natural persons before March 2, 1984),
and
(B) subparagraph (E) of section 1272(a)(2) (relating to loans
between natural persons).
(5) Special rules for original issue discount on certain high
yield obligations
(A) In general
In the case of an applicable high yield discount obligation
issued by a corporation -
(i) no deduction shall be allowed under this chapter for
the disqualified portion of the original issue discount on
such obligation, and
(ii) the remainder of such original issue discount shall
not be allowable as a deduction until paid.
For purposes of this paragraph, rules similar to the rules of
subsection (i)(3)(B) shall apply in determining the amount of
the original issue discount and when the original issue
discount is paid.
(B) Disqualified portion treated as stock distribution for
purposes of dividend received deduction
(i) In general
Solely for purposes of sections 243, 245, 246, and 246A,
the dividend equivalent portion of any amount includible in
gross income of a corporation under section 1272(a) in
respect of an applicable high yield discount obligation shall
be treated as a dividend received by such corporation from
the corporation issuing such obligation.
(ii) Dividend equivalent portion
For purposes of clause (i), the dividend equivalent portion
of any amount includible in gross income under section
1272(a) in respect of an applicable high yield discount
obligation is the portion of the amount so includible -
(I) which is attributable to the disqualified portion of
the original issue discount on such obligation, and
(II) which would have been treated as a dividend if it
had been a distribution made by the issuing corporation
with respect to stock in such corporation.
(C) Disqualified portion
(i) In general
For purposes of this paragraph, the disqualified portion of
the original issue discount on any applicable high yield
discount obligation is the lesser of -
(I) the amount of such original issue discount, or
(II) the portion of the total return on such obligation
which bears the same ratio to such total return as the
disqualified yield on such obligation bears to the yield to
maturity on such obligation.
(ii) Definitions
For purposes of clause (i), the term "disqualified yield"
means the excess of the yield to maturity on the obligation
over the sum referred to (!1) subsection (i)(1)(B) plus 1
percentage point, and the term "total return" is the amount
which would have been the original issue discount on the
obligation if interest described in the parenthetical in
section 1273(a)(2) were included in the stated redemption
price at maturity.
(D) Exception for S corporations
This paragraph shall not apply to any obligation issued by
any corporation for any period for which such corporation is an
S corporation.
(E) Effect on earnings and profits
This paragraph shall not apply for purposes of determining
earnings and profits; except that, for purposes of determining
the dividend equivalent portion of any amount includible in
gross income under section 1272(a) in respect of an applicable
high yield discount obligation, no reduction shall be made for
any amount attributable to the disqualified portion of any
original issue discount on such obligation.
(F) Cross reference
For definition of applicable high yield discount obligation,
see subsection (i).
(6) Cross references
For provision relating to deduction of original issue
discount on tax-exempt obligation, see section 1288.
For special rules in the case of the borrower under certain
loans for personal use, see section 1275(b).
(f) Denial of deduction for interest on certain obligations not in
registered form
(1) In general
Nothing in subsection (a) or in any other provision of law
shall be construed to provide a deduction for interest on any
registration-required obligation unless such obligation is in
registered form.
(2) Registration-required obligation
For purposes of this section -
(A) In general
The term "registration-required obligation" means any
obligation (including any obligation issued by a governmental
entity) other than an obligation which -
(i) is issued by a natural person,
(ii) is not of a type offered to the public,
(iii) has a maturity (at issue) of not more than 1 year, or
(iv) is described in subparagraph (B).
(B) Certain obligations not included
An obligation is described in this subparagraph if -
(i) there are arrangements reasonably designed to ensure
that such obligation will be sold (or resold in connection
with the original issue) only to a person who is not a United
States person, and
(ii) in the case of an obligation not in registered form -
(I) interest on such obligation is payable only outside
the United States and its possessions, and
(II) on the face of such obligation there is a statement
that any United States person who holds such obligation
will be subject to limitations under the United States
income tax laws.
(C) Authority to include other obligations
Clauses (ii) and (iii) of subparagraph (A), and subparagraph
(B), shall not apply to any obligation if -
(i) in the case of -
(I) subparagraph (A), such obligation is of a type which
the Secretary has determined by regulations to be used
frequently in avoiding Federal taxes, or
(II) subparagraph (B), such obligation is of a type
specified by the Secretary in regulations, and
(ii) such obligation is issued after the date on which the
regulations referred to in clause (i) take effect.
(3) Book entries permitted, etc.
For purposes of this subsection, rules similar to the rules of
section 149(a)(3) shall apply.
(g) Reduction of deduction where section 25 credit taken
The amount of the deduction under this section for interest paid
or accrued during any taxable year on indebtedness with respect to
which a mortgage credit certificate has been issued under section
25 shall be reduced by the amount of the credit allowable with
respect to such interest under section 25 (determined without
regard to section 26).
(h) Disallowance of deduction for personal interest
(1) In general
In the case of a taxpayer other than a corporation, no
deduction shall be allowed under this chapter for personal
interest paid or accrued during the taxable year.
(2) Personal interest
For purposes of this subsection, the term "personal interest"
means any interest allowable as a deduction under this chapter
other than -
(A) interest paid or accrued on indebtedness properly
allocable to a trade or business (other than the trade or
business of performing services as an employee),
(B) any investment interest (within the meaning of subsection
(d)),
(C) any interest which is taken into account under section
469 in computing income or loss from a passive activity of the
taxpayer,
(D) any qualified residence interest (within the meaning of
paragraph (3)),
(E) any interest payable under section 6601 on any unpaid
portion of the tax imposed by section 2001 for the period
during which an extension of time for payment of such tax is in
effect under section 6163, and
(F) any interest allowable as a deduction under section 221
(relating to interest on educational loans).
(3) Qualified residence interest
For purposes of this subsection -
(A) In general
The term "qualified residence interest" means any interest
which is paid or accrued during the taxable year on -
(i) acquisition indebtedness with respect to any qualified
residence of the taxpayer, or
(ii) home equity indebtedness with respect to any qualified
residence of the taxpayer.
For purposes of the preceding sentence, the determination of
whether any property is a qualified residence of the taxpayer
shall be made as of the time the interest is accrued.
(B) Acquisition indebtedness
(i) In general
The term "acquisition indebtedness" means any indebtedness
which -
(I) is incurred in acquiring, constructing, or
substantially improving any qualified residence of the
taxpayer, and
(II) is secured by such residence.
Such term also includes any indebtedness secured by such
residence resulting from the refinancing of indebtedness
meeting the requirements of the preceding sentence (or this
sentence); but only to the extent the amount of the
indebtedness resulting from such refinancing does not exceed
the amount of the refinanced indebtedness.
(ii) $1,000,000 limitation
The aggregate amount treated as acquisition indebtedness
for any period shall not exceed $1,000,000 ($500,000 in the
case of a married individual filing a separate return).
(C) Home equity indebtedness
(i) In general
The term "home equity indebtedness" means any indebtedness
(other than acquisition indebtedness) secured by a qualified
residence to the extent the aggregate amount of such
indebtedness does not exceed -
(I) the fair market value of such qualified residence,
reduced by
(II) the amount of acquisition indebtedness with respect
to such residence.
(ii) Limitation
The aggregate amount treated as home equity indebtedness
for any period shall not exceed $100,000 ($50,000 in the case
of a separate return by a married individual).
(D) Treatment of indebtedness incurred on or before October 13,
1987
(i) In general
In the case of any pre-October 13, 1987, indebtedness -
(I) such indebtedness shall be treated as acquisition
indebtedness, and
(II) the limitation of subparagraph (B)(ii) shall not
apply.
(ii) Reduction in $1,000,000 limitation
The limitation of subparagraph (B)(ii) shall be reduced
(but not below zero) by the aggregate amount of outstanding
pre-October 13, 1987, indebtedness.
(iii) Pre-October 13, 1987, indebtedness
The term "pre-October 13, 1987, indebtedness" means -
(I) any indebtedness which was incurred on or before
October 13, 1987, and which was secured by a qualified
residence on October 13, 1987, and at all times thereafter
before the interest is paid or accrued, or
(II) any indebtedness which is secured by the qualified
residence and was incurred after October 13, 1987, to
refinance indebtedness described in subclause (I) (or
refinanced indebtedness meeting the requirements of this
subclause) to the extent (immediately after the
refinancing) the principal amount of the indebtedness
resulting from the refinancing does not exceed the
principal amount of the refinanced indebtedness
(immediately before the refinancing).
(iv) Limitation on period of refinancing
Subclause (II) of clause (iii) shall not apply to any
indebtedness after -
(I) the expiration of the term of the indebtedness
described in clause (iii)(I), or
(II) if the principal of the indebtedness described in
clause (iii)(I) is not amortized over its term, the
expiration of the term of the 1st refinancing of such
indebtedness (or if earlier, the date which is 30 years
after the date of such 1st refinancing).
(4) Other definitions and special rules
For purposes of this subsection -
(A) Qualified residence
(i) In general
The term "qualified residence" means -
(I) the principal residence (within the meaning of
section 121) of the taxpayer, and
(II) 1 other residence of the taxpayer which is selected
by the taxpayer for purposes of this subsection for the
taxable year and which is used by the taxpayer as a
residence (within the meaning of section 280A(d)(1)).
(ii) Married individuals filing separate returns
If a married couple does not file a joint return for the
taxable year -
(I) such couple shall be treated as 1 taxpayer for
purposes of clause (i), and
(II) each individual shall be entitled to take into
account 1 residence unless both individuals consent in
writing to 1 individual taking into account the principal
residence and 1 other residence.
(iii) Residence not rented
For purposes of clause (i)(II), notwithstanding section
280A(d)(1), if the taxpayer does not rent a dwelling unit at
any time during a taxable year, such unit may be treated as a
residence for such taxable year.
(B) Special rule for cooperative housing corporations
Any indebtedness secured by stock held by the taxpayer as a
tenant-stockholder (as defined in section 216) in a cooperative
housing corporation (as so defined) shall be treated as secured
by the house or apartment which the taxpayer is entitled to
occupy as such a tenant-stockholder. If stock described in the
preceding sentence may not be used to secure indebtedness,
indebtedness shall be treated as so secured if the taxpayer
establishes to the satisfaction of the Secretary that such
indebtedness was incurred to acquire such stock.
(C) Unenforceable security interests
Indebtedness shall not fail to be treated as secured by any
property solely because, under any applicable State or local
homestead or other debtor protection law in effect on August
16, 1986, the security interest is ineffective or the
enforceability of the security interest is restricted.
(D) Special rules for estates and trusts
For purposes of determining whether any interest paid or
accrued by an estate or trust is qualified residence interest,
any residence held by such estate or trust shall be treated as
a qualified residence of such estate or trust if such estate or
trust establishes that such residence is a qualified residence
of a beneficiary who has a present interest in such estate or
trust or an interest in the residuary of such estate or trust.
(5) Phase-in of limitation
In the case of any taxable year beginning in calendar years
1987 through 1990, the amount of interest with respect to which a
deduction is disallowed under this subsection shall be equal to
the applicable percentage (within the meaning of subsection
(d)(6)(B)) of the amount which (but for this paragraph) would
have been so disallowed.
(i) Applicable high yield discount obligation
(1) In general
For purposes of this section, the term "applicable high yield
discount obligation" means any debt instrument if -
(A) the maturity date of such instrument is more than 5 years
from the date of issue,
(B) the yield to maturity on such instrument equals or
exceeds the sum of -
(i) the applicable Federal rate in effect under section
1274(d) for the calendar month in which the obligation is
issued, plus
(ii) 5 percentage points, and
(C) such instrument has significant original issue discount.
For purposes of subparagraph (B)(i), the Secretary may by
regulation permit a rate to be used with respect to any debt
instrument which is higher than the applicable Federal rate if
the taxpayer establishes to the satisfaction of the Secretary
that such higher rate is based on the same principles as the
applicable Federal rate and is appropriate for the term of the
instrument.
(2) Significant original issue discount
For purposes of paragraph (1)(C), a debt instrument shall be
treated as having significant original issue discount if -
(A) the aggregate amount which would be includible in gross
income with respect to such instrument for periods before the
close of any accrual period (as defined in section 1272(a)(5))
ending after the date 5 years after the date of issue, exceeds -

(B) the sum of -
(i) the aggregate amount of interest to be paid under the
instrument before the close of such accrual period, and
(ii) the product of the issue price of such instrument (as
defined in sections 1273(b) and 1274(a)) and its yield to
maturity.
(3) Special rules
For purposes of determining whether a debt instrument is an
applicable high yield discount obligation -
(A) any payment under the instrument shall be assumed to be
made on the last day permitted under the instrument, and
(B) any payment to be made in the form of another obligation
of the issuer (or a related person within the meaning of
section 453(f)(1)) shall be assumed to be made when such
obligation is required to be paid in cash or in property other
than such obligation.
Except for purposes of paragraph (1)(B), any reference to an
obligation in subparagraph (B) of this paragraph shall be treated
as including a reference to stock.
(4) Debt instrument
For purposes of this subsection, the term "debt instrument"
means any instrument which is a debt instrument as defined in
section 1275(a).
(5) Regulations
The Secretary shall prescribe such regulations as may be
appropriate to carry out the purposes of this subsection and
subsection (e)(5), including -
(A) regulations providing for modifications to the provisions
of this subsection and subsection (e)(5) in the case of varying
rates of interest, put or call options, indefinite maturities,
contingent payments, assumptions of debt instruments,
conversion rights, or other circumstances where such
modifications are appropriate to carry out the purposes of this
subsection and subsection (e)(5), and
(B) regulations to prevent avoidance of the purposes of this
subsection and subsection (e)(5) through the use of issuers
other than C corporations, agreements to borrow amounts due
under the debt instrument, or other arrangements.
(j) Limitation on deduction for interest on certain indebtedness
(1) Limitation
(A) In general
If this subsection applies to any corporation for any taxable
year, no deduction shall be allowed under this chapter for
disqualified interest paid or accrued by such corporation
during such taxable year. The amount disallowed under the
preceding sentence shall not exceed the corporation's excess
interest expense for the taxable year.
(B) Disallowed amount carried to succeeding taxable year
Any amount disallowed under subparagraph (A) for any taxable
year shall be treated as disqualified interest paid or accrued
in the succeeding taxable year (and clause (ii) of paragraph
(2)(A) shall not apply for purposes of applying this subsection
to the amount so treated).
(2) Corporations to which subsection applies
(A) In general
This subsection shall apply to any corporation for any
taxable year if -
(i) such corporation has excess interest expense for such
taxable year, and
(ii) the ratio of debt to equity of such corporation as of
the close of such taxable year (or on any other day during
the taxable year as the Secretary may by regulations
prescribe) exceeds 1.5 to 1.
(B) Excess interest expense
(i) In general
For purposes of this subsection, the term "excess interest
expense" means the excess (if any) of -
(I) the corporation's net interest expense, over
(II) the sum of 50 percent of the adjusted taxable income
of the corporation plus any excess limitation carryforward
under clause (ii).
(ii) Excess limitation carryforward
If a corporation has an excess limitation for any taxable
year, the amount of such excess limitation shall be an excess
limitation carryforward to the 1st succeeding taxable year
and to the 2nd and 3rd succeeding taxable years to the extent
not previously taken into account under this clause. The
amount of such a carryforward taken into account for any such
succeeding taxable year shall not exceed the excess interest
expense for such succeeding taxable year (determined without
regard to the carryforward from the taxable year of such
excess limitation).
(iii) Excess limitation
For purposes of clause (ii), the term "excess limitation"
means the excess (if any) of -
(I) 50 percent of the adjusted taxable income of the
corporation, over
(II) the corporation's net interest expense.
(C) Ratio of debt to equity
For purposes of this paragraph, the term "ratio of debt to
equity" means the ratio which the total indebtedness of the
corporation bears to the sum of its money and all other assets
reduced (but not below zero) by such total indebtedness. For
purposes of the preceding sentence -
(i) the amount taken into account with respect to any asset
shall be the adjusted basis thereof for purposes of
determining gain,
(ii) the amount taken into account with respect to any
indebtedness with original issue discount shall be its issue
price plus the portion of the original issue discount
previously accrued as determined under the rules of section
1272 (determined without regard to subsection (a)(7) or
(b)(4) thereof), and
(iii) there shall be such other adjustments as the
Secretary may by regulations prescribe.
(3) Disqualified interest
For purposes of this subsection, the term "disqualified
interest" means -
(A) any interest paid or accrued by the taxpayer (directly or
indirectly) to a related person if no tax is imposed by this
subtitle with respect to such interest,
(B) any interest paid or accrued by the taxpayer with respect
to any indebtedness to a person who is not a related person if -

(i) there is a disqualified guarantee of such indebtedness,
and
(ii) no gross basis tax is imposed by this subtitle with
respect to such interest, and
(C) any interest paid or accrued (directly or indirectly) by
a taxable REIT subsidiary (as defined in section 856(l)) of a
real estate investment trust to such trust.
(4) Related person
For purposes of this subsection -
(A) In general
Except as provided in subparagraph (B), the term "related
person" means any person who is related (within the meaning of
section 267(b) or 707(b)(1)) to the taxpayer.
(B) Special rule for certain partnerships
(i) In general
Any interest paid or accrued to a partnership which
(without regard to this subparagraph) is a related person
shall not be treated as paid or accrued to a related person
if less than 10 percent of the profits and capital interests
in such partnership are held by persons with respect to whom
no tax is imposed by this subtitle on such interest. The
preceding sentence shall not apply to any interest allocable
to any partner in such partnership who is a related person to
the taxpayer.
(ii) Special rule where treaty reduction
If any treaty between the United States and any foreign
country reduces the rate of tax imposed by this subtitle on a
partner's share of any interest paid or accrued to a
partnership, such partner's interests in such partnership
shall, for purposes of clause (i), be treated as held in part
by a tax-exempt person and in part by a taxable person under
rules similar to the rules of paragraph (5)(B).
(5) Special rules for determining whether interest is subject to
tax
(A) Treatment of pass-thru entities
In the case of any interest paid or accrued to a partnership,
the determination of whether any tax is imposed by this
subtitle on such interest shall be made at the partner level.
Rules similar to the rules of the preceding sentence shall
apply in the case of any pass-thru entity other than a
partnership and in the case of tiered partnerships and other
entities.
(B) Interest treated as tax-exempt to extent of treaty
reduction
If any treaty between the United States and any foreign
country reduces the rate of tax imposed by this subtitle on any
interest paid or accrued by the taxpayer, such interest shall
be treated as interest on which no tax is imposed by this
subtitle to the extent of the same proportion of such interest
as -
(i) the rate of tax imposed without regard to such treaty,
reduced by the rate of tax imposed under the treaty, bears to
(ii) the rate of tax imposed without regard to the treaty.
(6) Other definitions and special rules
For purposes of this subsection -
(A) Adjusted taxable income
The term "adjusted taxable income" means the taxable income
of the taxpayer -
(i) computed without regard to -
(I) any deduction allowable under this chapter for the
net interest expense,
(II) the amount of any net operating loss deduction under
section 172,
(III) any deduction allowable under section 199, and
(IV) any deduction allowable for depreciation,
amortization, or depletion, and
(ii) computed with such other adjustments as the Secretary
may by regulations prescribe.
(B) Net interest expense
The term "net interest expense" means the excess (if any) of -

(i) the interest paid or accrued by the taxpayer during the
taxable year, over
(ii) the amount of interest includible in the gross income
of such taxpayer for such taxable year.
The Secretary may by regulations provide for adjustments in
determining the amount of net interest expense.
(C) Treatment of affiliated group
All members of the same affiliated group (within the meaning
of section 1504(a)) shall be treated as 1 taxpayer.
(D) Disqualified guarantee
(i) In general
Except as provided in clause (ii), the term "disqualified
guarantee" means any guarantee by a related person which is -

(I) an organization exempt from taxation under this
subtitle, or
(II) a foreign person.
(ii) Exceptions
The term "disqualified guarantee" shall not include a
guarantee -
(I) in any circumstances identified by the Secretary by
regulation, where the interest on the indebtedness would
have been subject to a net basis tax if the interest had
been paid to the guarantor, or
(II) if the taxpayer owns a controlling interest in the
guarantor.
For purposes of subclause (II), except as provided in
regulations, the term "a controlling interest" means direct
or indirect ownership of at least 80 percent of the total
voting power and value of all classes of stock of a
corporation, or 80 percent of the profit and capital
interests in any other entity. For purposes of the preceding
sentence, the rules of paragraphs (1) and (5) of section
267(c) shall apply; except that such rules shall also apply
to interest in entities other than corporations.
(iii) Guarantee
Except as provided in regulations, the term "guarantee"
includes any arrangement under which a person (directly or
indirectly through an entity or otherwise) assures, on a
conditional or unconditional basis, the payment of another
person's obligation under any indebtedness.
(E) Gross basis and net basis taxation
(i) Gross basis tax
The term "gross basis tax" means any tax imposed by this
subtitle which is determined by reference to the gross amount
of any item of income without any reduction for any deduction
allowed by this subtitle.
(ii) Net basis tax
The term "net basis tax" means any tax imposed by this
subtitle which is not a gross basis tax.
(7) Coordination with passive loss rules, etc.
This subsection shall be applied before sections 465 and 469.
(8) Regulations
The Secretary shall prescribe such regulations as may be
appropriate to carry out the purposes of this subsection,
including -
(A) such regulations as may be appropriate to prevent the
avoidance of the purposes of this subsection,
(B) regulations providing such adjustments in the case of
corporations which are members of an affiliated group as may be
appropriate to carry out the purposes of this subsection, and
(C) regulations for the coordination of this subsection with
section 884.
(k) Section 6166 interest
No deduction shall be allowed under this section for any interest
payable under section 6601 on any unpaid portion of the tax imposed
by section 2001 for the period during which an extension of time
for payment of such tax is in effect under section 6166.
(l) Disallowance of deduction on certain debt instruments of
corporations
(1) In general
No deduction shall be allowed under this chapter for any
interest paid or accrued on a disqualified debt instrument.
(2) Disqualified debt instrument
For purposes of this subsection, the term "disqualified debt
instrument" means any indebtedness of a corporation which is
payable in equity of the issuer or a related party or equity held
by the issuer (or any related party) in any other person.
(3) Special rules for amounts payable in equity
For purposes of paragraph (2), indebtedness shall be treated as
payable in equity of the issuer or any other person only if -
(A) a substantial amount of the principal or interest is
required to be paid or converted, or at the option of the
issuer or a related party is payable in, or convertible into,
such equity,
(B) a substantial amount of the principal or interest is
required to be determined, or at the option of the issuer or a
related party is determined, by reference to the value of such
equity, or
(C) the indebtedness is part of an arrangement which is
reasonably expected to result in a transaction described in
subparagraph (A) or (B).
For purposes of this paragraph, principal or interest shall be
treated as required to be so paid, converted, or determined if it
may be required at the option of the holder or a related party
and there is a substantial certainty the option will be
exercised.
(4) Capitalization allowed with respect to equity of persons
other than issuer and related parties
If the disqualified debt instrument of a corporation is payable
in equity held by the issuer (or any related party) in any other
person (other than a related party), the basis of such equity
shall be increased by the amount not allowed as a deduction by
reason of paragraph (1) with respect to the instrument.
(5) Exception for certain instruments issued by dealers in
securities
For purposes of this subsection, the term "disqualified debt
instrument" does not include indebtedness issued by a dealer in
securities (or a related party) which is payable in, or by
reference to, equity (other than equity of the issuer or a
related party) held by such dealer in its capacity as a dealer in
securities. For purposes of this paragraph, the term "dealer in
securities" has the meaning given such term by section 475.
(6) Related party
For purposes of this subsection, a person is a related party
with respect to another person if such person bears a
relationship to such other person described in section 267(b) or
707(b).
(7) Regulations
The Secretary shall prescribe such regulations as may be
necessary or appropriate to carry out the purposes of this
subsection, including regulations preventing avoidance of this
subsection through the use of an issuer other than a corporation.
(m) Interest on unpaid taxes attributable to nondisclosed
reportable transactions
No deduction shall be allowed under this chapter for any interest
paid or accrued under section 6601 on any underpayment of tax which
is attributable to the portion of any reportable transaction
understatement (as defined in section 6662A(b)) with respect to
which the requirement of section 6664(d)(2)(A) is not met.
(n) Cross references
(1) For disallowance of certain amounts paid in connection
with insurance, endowment, or annuity contracts, see section
264.
(2) For disallowance of deduction for interest relating to
tax-exempt income, see section 265(a)(2).
(3) For disallowance of deduction for carrying charges
chargeable to capital account, see section 266.
(4) For disallowance of interest with respect to transactions
between related taxpayers, see section 267.
(5) For treatment of redeemable ground rents and real
property held subject to liabilities under redeemable ground
rents, see section 1055.