--- kind: "range" citation: "26 C.F.R. §§ 1.446-1–1.446-7" title: "26" from: "1.446-1" to: "1.446-7" count: 8 url: "https://uscodex.org/cfr/26/1.446-1..1.446-7" --- # §1.446-1. General rule for methods of accounting. - (a) **General rule.** - (1) [Section 446(a)](/cfr/26/446.md?p=a) provides that taxable income shall be computed under the method of accounting on the basis of which a taxpayer regularly computes his income in keeping his books. The term “method of accounting” includes not only the overall method of accounting of the taxpayer but also the accounting treatment of any item. Examples of such over-all methods are the cash receipts and disbursements method, an accrual method, combinations of such methods, and combinations of the foregoing with various methods provided for the accounting treatment of special items. These methods of accounting for special items include the accounting treatment prescribed for research and experimental expenditures, soil and water conservation expenditures, depreciation, net operating losses, etc. Except for deviations permitted or required by such special accounting treatment, taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. For requirement respecting the adoption or change of accounting method, see [section 446(e)](/cfr/26/446.md?p=e) and [paragraph (e)](#e) of this section. - (2) **It is recognized that no uniform method of accounting can be prescribed for all taxpayers.** Each taxpayer shall adopt such forms and systems as are, in his judgment, best suited to his needs. However, no method of accounting is acceptable unless, in the opinion of the Commissioner, it clearly reflects income. A method of accounting which reflects the consistent application of generally accepted accounting principles in a particular trade or business in accordance with accepted conditions or practices in that trade or business will ordinarily be regarded as clearly reflecting income, provided all items of gross income and expense are treated consistently from year to year. - (3) Items of gross income and expenditures which are elements in the computation of taxable income need not be in the form of cash. It is sufficient that such items can be valued in terms of money. For general rules relating to the taxable year for inclusion of income and for taking deductions, see sections [451](/cfr/26/451.md) and [461](/cfr/26/461.md), and the regulations thereunder. - (4) Each taxpayer is required to make a return of his taxable income for each taxable year and must maintain such accounting records as will enable him to file a correct return. See [section 6001](/cfr/26/6001.md) and the regulations thereunder. Accounting records include the taxpayer's regular books of account and such other records and data as may be necessary to support the entries on his books of account and on his return, as for example, a reconciliation of any differences between such books and his return. The following are among the essential features that must be considered in maintaining such records: - (i) Except in the case of a taxpayer qualifying as a small business taxpayer for the taxable year under [section 471(c)](/cfr/26/471.md?p=c), in all cases in which the production, purchase or sale of merchandise of any kind is an income-producing factor, merchandise on hand (including finished goods, work in progress, raw materials, and supplies) at the beginning and end of the year shall be taken into account in computing the taxable income of the year. (For rules relating to computation of inventories, see section [263A](/cfr/26/263A.md), [471](/cfr/26/471.md), and [472](/cfr/26/472.md) and the regulations thereunder.) - (ii) Expenditures made during the year shall be properly classified as between capital and expense. For example, expenditures for such items as plant and equipment, which have a useful life extending substantially beyond the taxable year, shall be charged to a capital account and not to an expense account. - (iii) In any case in which there is allowable with respect to an asset a deduction for depreciation, amortization, or depletion, any expenditures (other than ordinary repairs) made to restore the asset or prolong its useful life shall be added to the asset account or charged against the appropriate reserve. - (b) **Exceptions.** - (1) If the taxpayer does not regularly employ a method of accounting which clearly reflects his income, the computation of taxable income shall be made in a manner which, in the opinion of the Commissioner, does clearly reflect income. - (2) A taxpayer whose sole source of income is wages need not keep formal books in order to have an accounting method. Tax returns, copies thereof, or other records may be sufficient to establish the use of the method of accounting used in the preparation of the taxpayer's income tax returns. - (c) **Permissible methods—** - (1) **In general.** Subject to the provisions of paragraphs [(a)](#a) and [(b)](#b) of this section, a taxpayer may compute his taxable income under any of the following methods of accounting: - (i) **Cash receipts and disbursements method.** Generally, under the cash receipts and disbursements method in the computation of taxable income, all items which constitute gross income (whether in the form of cash, property, or services) are to be included for the taxable year in which actually or constructively received. Expenditures are to be deducted for the taxable year in which actually made. For rules relating to constructive receipt, see [§ 1.451-2](/cfr/26/1.451-2.md). For treatment of an expenditure attributable to more than one taxable year, see [section 461(a)](/cfr/26/461.md?p=a) and [paragraph (a)(1)](/cfr/26/1.461-1.md?p=a-1) of § 1.461-1. - (ii) **Accrual method.** - (A) Generally, under an accrual method, income is to be included for the taxable year when all the events have occurred that fix the right to receive the income and the amount of the income can be determined with reasonable accuracy. (See [§ 1.451-1](/cfr/26/1.451-1.md) for rules relating to the taxable year of inclusion.) Under such a method, a liability is incurred, and generally is taken into account for Federal income tax purposes, in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability. (See [paragraph (a)(2)(iii)(A)](/cfr/26/1.461-1.md?p=a-2-iii-A) of § 1.461-1 for examples of liabilities that may not be taken into account until after the taxable year incurred, and see [§§ 1.461-4 through 1.461-6](/cfr/26/1.461-4..1.461-6.md) for rules relating to economic performance.) Applicable provisions of the Code, the Income Tax Regulations, and other guidance published by the Secretary prescribe the manner in which a liability that has been incurred is taken into account. For example, [section 162](/cfr/26/162.md) provides that a deductible liability generally is taken into account in the taxable year incurred through a deduction from gross income. As a further example, under section [263](/cfr/26/263.md) or [263A](/cfr/26/263A.md), a liability that relates to the creation of an asset having a useful life extending substantially beyond the close of the taxable year is taken into account in the taxable year incurred through capitalization (within the meaning of [§ 1.263A-1(c)(3)](/cfr/26/1.263A-1.md?p=c-3)) and may later affect the computation of taxable income through depreciation or otherwise over a period including subsequent taxable years, in accordance with applicable Internal Revenue Code sections and related guidance. - (B) The term “liability” includes any item allowable as a deduction, cost, or expense for Federal income tax purposes. In addition to allowable deductions, the term includes any amount otherwise allowable as a capitalized cost, as a cost taken into account in computing cost of goods sold, as a cost allocable to a long-term contract, or as any other cost or expense. Thus, for example, an amount that a taxpayer expends or will expend for capital improvements to property must be incurred before the taxpayer may take the amount into account in computing its basis in the property. The term “liability” is not limited to items for which a legal obligation to pay exists at the time of payment. Thus, for example, amounts prepaid for goods or services and amounts paid without a legal obligation to do so may not be taken into account by an accrual basis taxpayer any earlier than the taxable year in which those amounts are incurred. - (C) No method of accounting is acceptable unless, in the opinion of the Commissioner, it clearly reflects income. The method used by the taxpayer in determining when income is to be accounted for will generally be acceptable if it accords with generally accepted accounting principles, is consistently used by the taxpayer from year to year, and is consistent with the Income Tax Regulations. For example, a taxpayer engaged in a manufacturing business may account for sales of the taxpayer's product when the goods are shipped, when the product is delivered or accepted, or when title to the goods passes to the customers, whether or not billed, depending on the method regularly employed in keeping the taxpayer's books. - (iii) **Other permissible methods.** Special methods of accounting are described elsewhere in chapter 1 of the Code and the regulations thereunder. For example, see the following sections and the regulations thereunder: Sections [61](/cfr/26/61.md) and [162](/cfr/26/162.md), relating to the crop method of accounting; [section 453](/cfr/26/453.md), relating to the installment method; [section 460](/cfr/26/460.md), relating to the long-term contract methods. In addition, special methods of accounting for particular items of income and expense are provided under other sections of chapter 1. For example, see [section 174](/cfr/26/174.md), relating to research and experimental expenditures, and [section 175](/cfr/26/175.md), relating to soil and water conservation expenditures. - (iv) **Combinations of the foregoing methods.** (a) In accordance with the following rules, any combination of the foregoing methods of accounting will be permitted in connection with a trade or business if such combination clearly reflects income and is consistently used. Where a combination of methods of accounting includes any special methods, such as those referred to in subdivision (iii) of this subparagraph, the taxpayer must comply with the requirements relating to such special methods. A taxpayer using an accrual method of accounting with respect to purchases and sales may use the cash method in computing all other items of income and expense. However, a taxpayer who uses the cash method of accounting in computing gross income from his trade or business shall use the cash method in computing expenses of such trade or business. Similarly, a taxpayer who uses an accrual method of accounting in computing business expenses shall use an accrual method in computing items affecting gross income from his trade or business. (b) A taxpayer using one method of accounting in computing items of income and deductions of his trade or business may compute other items of income and deductions not connected with his trade or business under a different method of accounting. - (2) **Special rules.** - (i) In any case in which it is necessary to use an inventory, the accrual method of accounting must be used with regard to purchases and sales unless: - (A) The taxpayer qualifies as a small business taxpayer for the taxable year under [section 471(c)](/cfr/26/471.md?p=c), or - (B) **Otherwise authorized under paragraph (c)(2)(ii) of this section.** - (ii) No method of accounting will be regarded as clearly reflecting income unless all items of gross profit and deductions are treated with consistency from year to year. The Commissioner may authorize a taxpayer to adopt or change to a method of accounting permitted by this chapter although the method is not specifically described in the regulations in this part if, in the opinion of the Commissioner, income is clearly reflected by the use of such method. Further, the Commissioner may authorize a taxpayer to continue the use of a method of accounting consistently used by the taxpayer, even though not specifically authorized by the regulations in this part, if, in the opinion of the Commissioner, income is clearly reflected by the use of such method. See [section 446(a)](/cfr/26/446.md?p=a) and [paragraph (a)](#a) of this section, which require that taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books, and [section 446(e)](/cfr/26/446.md?p=e) and [paragraph (e)](#e) of this section, which require the prior approval of the Commissioner in the case of changes in accounting method. - (iii) The timing rules of [§ 1.1502-13](/cfr/26/1.1502-13.md) are a method of accounting for intercompany transactions (as defined in [§ 1.1502-13(b)(1)(i)](/cfr/26/1.1502-13.md?p=b-1-i)), to be applied by each member of a consolidated group in addition to the member's other methods of accounting. See [§ 1.1502-13(a)(3)(i)](/cfr/26/1.1502-13.md?p=a-3-i). This [paragraph (c)(2)(iii)](#c-2-iii) is applicable to consolidated return years beginning on or after November 7, 2001. - (3) **Applicability date.** The first sentence of [paragraph (a)(4)(i)](#a-4-i) of this section and [paragraph (c)(2)(i)](#c-2-i) of this section apply to taxable years beginning on or after January 5, 2021. However, for a taxable year beginning after December 31, 2017, and before January 5, 2021, a taxpayer may apply the rules provided in the first sentence of this [paragraph (c)(3)](#c-3), provided that the taxpayer follows all the applicable rules contained in the regulations under [section 446](/cfr/26/446.md) for such taxable year and all subsequent taxable years. - (d) **Taxpayer engaged in more than one business.** - (1) Where a taxpayer has two or more separate and distinct trades or businesses, a different method of accounting may be used for each trade or business, provided the method used for each trade or business clearly reflects the income of that particular trade or business. For example, a taxpayer may account for the operations of a personal service business on the cash receipts and disbursements method and of a manufacturing business on an accrual method, provided such businesses are separate and distinct and the methods used for each clearly reflect income. The method first used in accounting for business income and deductions in connection with each trade or business, as evidenced in the taxpayer's income tax return in which such income or deductions are first reported, must be consistently followed thereafter. - (2) No trade or business will be considered separate and distinct for purposes of this paragraph unless a complete and separable set of books and records is kept for such trade or business. - (3) If, by reason of maintaining different methods of accounting, there is a creation or shifting of profits or losses between the trades or businesses of the taxpayer (for example, through inventory adjustments, sales, purchases, or expenses) so that income of the taxpayer is not clearly reflected, the trades or businesses of the taxpayer will not be considered to be separate and distinct. - (e) **Requirement respecting the adoption or change of accounting method.** - (1) A taxpayer filing his first return may adopt any permissible method of accounting in computing taxable income for the taxable year covered by such return. See [section 446(c)](/cfr/26/446.md?p=c) and [paragraph (c)](#c) of this section for permissible methods. Moreover, a taxpayer may adopt any permissible method of accounting in connection with each separate and distinct trade or business, the income from which is reported for the first time. See [section 446(d)](/cfr/26/446.md?p=d) and [paragraph (d)](#d) of this section. See also [section 446(a)](/cfr/26/446.md?p=a) and [paragraph (a)](#a) of this section. - (2) - (i) Except as otherwise expressly provided in chapter 1 of the Code and the regulations thereunder, a taxpayer who changes the method of accounting employed in keeping his books shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner. Consent must be secured whether or not such method is proper or is permitted under the Internal Revenue Code or the regulations thereunder. - (ii) (a) A change in the method of accounting includes a change in the overall plan of accounting for gross income or deductions or a change in the treatment of any material item used in such overall plan. Although a method of accounting may exist under this definition without the necessity of a pattern of consistent treatment of an item, in most instances a method of accounting is not established for an item without such consistent treatment. A material item is any item that involves the proper time for the inclusion of the item in income or the taking of a deduction. Changes in method of accounting include a change from the cash receipts and disbursement method to an accrual method, or vice versa, a change involving the method or basis used in the valuation of inventories (see sections [471](/cfr/26/471.md) and [472](/cfr/26/472.md) and the regulations under sections [471](/cfr/26/471.md) and [472](/cfr/26/472.md)), a change from the cash or accrual method to a long-term contract method, or vice versa (see [§ 1.460-4](/cfr/26/1.460-4.md)), certain changes in computing depreciation or amortization (see paragraph (e)(2)(ii)(d) of this section), a change involving the adoption, use or discontinuance of any other specialized method of computing taxable income, such as the crop method, and a change where the Internal Revenue Code and regulations under the Internal Revenue Code specifically require that the consent of the Commissioner must be obtained before adopting such a change. (b) A change in method of accounting does not include correction of mathematical or posting errors, or errors in the computation of tax liability (such as errors in computation of the foreign tax credit, net operating loss, percentage depletion, or investment credit). Also, a change in method of accounting does not include adjustment of any item of income or deduction that does not involve the proper time for the inclusion of the item of income or the taking of a deduction. For example, corrections of items that are deducted as interest or salary, but that are in fact payments of dividends, and of items that are deducted as business expenses, but that are in fact personal expenses, are not changes in method of accounting. In addition, a change in the method of accounting does not include an adjustment with respect to the addition to a reserve for bad debts. Although such adjustment may involve the question of the proper time for the taking of a deduction, such items are traditionally corrected by adjustment in the current and future years. For the treatment of the adjustment of the addition to a bad debt reserve (for example, for banks under section 585 of the Internal Revenue Code), see the regulations under [section 166](/cfr/26/166.md) of the Internal Revenue Code. A change in the method of accounting also does not include a change in treatment resulting from a change in underlying facts. For further guidance on changes involving depreciable or amortizable assets, see paragraph (e)(2)(ii)(d) of this section and [§ 1.1016-3(h)](/cfr/26/1.1016-3.md?p=h). (c) A change in an overall plan or system of identifying or valuing items in inventory is a change in method of accounting. Also a change in the treatment of any material item used in the overall plan for identifying or valuing items in inventory is a change in method of accounting. (d) Changes involving depreciable or amortizable assets—(1) Scope. This paragraph (e)(2)(ii)(d) applies to property subject to section [167](/cfr/26/167.md), [168](/cfr/26/168.md), [197](/cfr/26/197.md), [1400I](/cfr/26/1400I.md), [1400L(c)](/cfr/26/1400L.md?p=c), to [section 168](/cfr/26/168.md) prior to its amendment by the Tax Reform Act of 1986 (100 Stat. 2121) (former [section 168](/cfr/26/168.md)), or to an additional first year depreciation deduction provision of the Internal Revenue Code (for example, section [168(k)](/cfr/26/168.md?p=k), [1400L(b)](/cfr/26/1400L.md?p=b), or [1400N(d)](/cfr/26/1400N.md?p=d)). (2) Changes in depreciation or amortization that are a change in method of accounting. Except as provided in paragraph (e)(2)(ii)(d)(3) of this section, a change in the treatment of an asset from nondepreciable or nonamortizable to depreciable or amortizable, or vice versa, is a change in method of accounting. Additionally, a correction to require depreciation or amortization in lieu of a deduction for the cost of depreciable or amortizable assets that had been consistently treated as an expense in the year of purchase, or vice versa, is a change in method of accounting. Further, except as provided in paragraph (e)(2)(ii)(d)(3) of this section, the following changes in computing depreciation or amortization are a change in method of accounting: (i) A change in the depreciation or amortization method, period of recovery, or convention of a depreciable or amortizable asset. (ii) A change from not claiming to claiming the additional first year depreciation deduction provided by, for example, section [168(k)](/cfr/26/168.md?p=k), [1400L(b)](/cfr/26/1400L.md?p=b), or [1400N(d)](/cfr/26/1400N.md?p=d), for, and the resulting change to the amount otherwise allowable as a depreciation deduction for the remaining adjusted depreciable basis (or similar basis) of, depreciable property that qualifies for the additional first year depreciation deduction (for example, qualified property, 50-percent bonus depreciation property, qualified New York Liberty Zone property, or qualified Gulf Opportunity Zone property), provided the taxpayer did not make the election out of the additional first year depreciation deduction (or did not make a deemed election out of the additional first year depreciation deduction; for further guidance, for example, see Rev. Proc. 2002-33 (2002-1 C.B. 963), Rev. Proc. 2003-50 (2003-2 C.B. 119), Notice 2006-77 (2006-40 I.R.B. 590), and [§ 601.601(d)(2)(ii)(b)](/cfr/26/601.601.md?p=d-2-ii-b) of this chapter) for the class of property in which the depreciable property that qualifies for the additional first year depreciation deduction (for example, qualified property, 50-percent bonus depreciation property, qualified New York Liberty Zone property, or qualified Gulf Opportunity Zone property) is included. (iii) A change from claiming the 30-percent additional first year depreciation deduction to claiming the 50-percent additional first year depreciation deduction for depreciable property that qualifies for the 50-percent additional first year depreciation deduction, provided the property is not included in any class of property for which the taxpayer elected the 30-percent, instead of the 50-percent, additional first year depreciation deduction (for example, 50-percent bonus depreciation property or qualified Gulf Opportunity Zone property), or a change from claiming the 50-percent additional first year depreciation deduction to claiming the 30-percent additional first year depreciation deduction for depreciable property that qualifies for the 30-percent additional first year depreciation deduction, including property that is included in a class of property for which the taxpayer elected the 30-percent, instead of the 50-percent, additional first year depreciation deduction (for example, qualified property or qualified New York Liberty Zone property), and the resulting change to the amount otherwise allowable as a depreciation deduction for the property's remaining adjusted depreciable basis (or similar basis). This paragraph (e)(2)(ii)(d)(2)(iii) does not apply if a taxpayer is making a late election or revoking a timely valid election under the applicable additional first year depreciation deduction provision of the Internal Revenue Code (for example, section [168(k)](/cfr/26/168.md?p=k), [1400L(b)](/cfr/26/1400L.md?p=b), or [1400N(d)](/cfr/26/1400N.md?p=d)) (see paragraph (e)(2)(ii)(d)(3)(iii) of this section). (iv) A change from claiming to not claiming the additional first year depreciation deduction for an asset that does not qualify for the additional first year depreciation deduction, including an asset that is included in a class of property for which the taxpayer elected not to claim any additional first year depreciation deduction (for example, an asset that is not qualified property, 50-percent bonus depreciation property, qualified New York Liberty Zone property, or qualified Gulf Opportunity Zone property), and the resulting change to the amount otherwise allowable as a depreciation deduction for the property's depreciable basis. (v) A change in salvage value to zero for a depreciable or amortizable asset for which the salvage value is expressly treated as zero by the Internal Revenue Code (for example, [section 168(b)(4)](/cfr/26/168.md?p=b-4)), the regulations under the Internal Revenue Code (for example, [§ 1.197-2(f)(1)(ii)](/cfr/26/1.197-2.md?p=f-1-ii)), or other guidance published in the Internal Revenue Bulletin. (vi) A change in the accounting for depreciable or amortizable assets from a single asset account to a multiple asset account (pooling), or vice versa, or from one type of multiple asset account (pooling) to a different type of multiple asset account (pooling). (vii) For depreciable or amortizable assets that are mass assets accounted for in multiple asset accounts or pools, a change in the method of identifying which assets have been disposed. For purposes of this paragraph (e)(2)(ii)(d)(2)(vii), the term mass assets means a mass or group of individual items of depreciable or amortizable assets that are not necessarily homogeneous, each of which is minor in value relative to the total value of the mass or group, numerous in quantity, usually accounted for only on a total dollar or quantity basis, with respect to which separate identification is impracticable, and placed in service in the same taxable year. (viii) Any other change in depreciation or amortization as the Secretary may designate by publication in the Federal Register or in the Internal Revenue Bulletin (see [§ 601.601(d)(2)](/cfr/26/601.601.md?p=d-2) of this chapter). (3) Changes in depreciation or amortization that are not a change in method of accounting. [Section 1.446-1(e)(2)(ii)(b)](#e-2-ii-b) applies to determine whether a change in depreciation or amortization is not a change in method of accounting. Further, the following changes in depreciation or amortization are not a change in method of accounting: (i) Useful life. An adjustment in the useful life of a depreciable or amortizable asset for which depreciation is determined under [section 167](/cfr/26/167.md) (other than under [section 168](/cfr/26/168.md), [section 1400I](/cfr/26/1400I.md), [section 1400L(c)](/cfr/26/1400L.md?p=c), former [section 168](/cfr/26/168.md), or an additional first year depreciation deduction provision of the Internal Revenue Code (for example, section [168(k)](/cfr/26/168.md?p=k), [1400L(b)](/cfr/26/1400L.md?p=b), or [1400N(d)](/cfr/26/1400N.md?p=d))) is not a change in method of accounting. This paragraph (e)(2)(ii)(d)(3)(i) does not apply if a taxpayer is changing to or from a useful life (or recovery period or amortization period) that is specifically assigned by the Internal Revenue Code (for example, [section 167(f)(1)](/cfr/26/167.md?p=f-1), [section 168(c)](/cfr/26/168.md?p=c), section [168(g)(2)](/cfr/26/168.md?p=g-2) or [(3)](/cfr/26/168.md?p=g-3), [section 197](/cfr/26/197.md)), the regulations under the Internal Revenue Code, or other guidance published in the Internal Revenue Bulletin and, therefore, such change is a change in method of accounting (unless paragraph (e)(2)(ii)(d)(3)(v) of this section applies). See paragraph (e)(2)(ii)(d)(5)(iv) of this section for determining the taxable year in which to correct an adjustment in useful life that is not a change in method of accounting. (ii) Change in use. A change in computing depreciation or amortization allowances in the taxable year in which the use of an asset changes in the hands of the same taxpayer is not a change in method of accounting. (iii) Elections. Generally, the making of a late depreciation or amortization election or the revocation of a timely valid depreciation or amortization election is not a change in method of accounting, except as otherwise expressly provided by the Internal Revenue Code, the regulations under the Internal Revenue Code, or other guidance published in the Internal Revenue Bulletin. This paragraph (e)(2)(ii)(d)(3)(iii) also applies to making a late election or revoking a timely valid election made under section 13261(g)(2) or (3) of the Revenue Reconciliation Act of 1993 (107 Stat. 312, 540) (relating to amortizable [section 197](/cfr/26/197.md) intangibles). A taxpayer may request consent to make a late election or revoke a timely valid election by submitting a request for a private letter ruling. For making or revoking an election under section 179 of the Internal Revenue Code, see [section 179(c)](/cfr/26/179.md?p=c) and [§ 1.179-5](/cfr/26/1.179-5.md). (iv) Salvage value. Except as provided under paragraph (e)(2)(ii)(d)(2)(v) of this section, a change in salvage value of a depreciable or amortizable asset is not treated as a change in method of accounting. (v) Placed-in-service date. Except as otherwise expressly provided by the Internal Revenue Code, the regulations under the Internal Revenue Code, or other guidance published in the Internal Revenue Bulletin, any change in the placed-in-service date of a depreciable or amortizable asset is not treated as a change in method of accounting. For example, if a taxpayer changes the placed-in-service date of a depreciable or amortizable asset because the taxpayer incorrectly determined the date on which the asset was placed in service, such a change is a change in the placed-in-service date of the asset and, therefore, is not a change in method of accounting. However, if a taxpayer incorrectly determines that a depreciable or amortizable asset is nondepreciable property and later changes the treatment of the asset to depreciable property, such a change is not a change in the placed-in-service date of the asset and, therefore, is a change in method of accounting under paragraph (e)(2)(ii)(d)(2) of this section. Further, a change in the convention of a depreciable or amortizable asset is not a change in the placed-in-service date of the asset and, therefore, is a change in method of accounting under paragraph (e)(2)(ii)(d)(2)(i) of this section. See paragraph (e)(2)(ii)(d)(5)(v) of this section for determining the taxable year in which to make a change in the placed-in-service date of a depreciable or amortizable asset that is not a change in method of accounting. (vi) Any other change in depreciation or amortization as the Secretary may designate by publication in the Federal Register or in the Internal Revenue Bulletin (see [§ 601.601(d)(2)](/cfr/26/601.601.md?p=d-2) of this chapter). (4) Item being changed. For purposes of a change in depreciation or amortization to which this paragraph (e)(2)(ii)(d) applies, the item being changed generally is the depreciation treatment of each individual depreciable or amortizable asset. However, the item is the depreciation treatment of each vintage account with respect to a depreciable asset for which depreciation is determined under [§ 1.167(a)-11](/cfr/26/1.167..11.md) (class life asset depreciation range (CLADR) property). Similarly, the item is the depreciable treatment of each general asset account with respect to a depreciable asset for which general asset account treatment has been elected under [section 168(i)(4)](/cfr/26/168.md?p=i-4) or the item is the depreciation treatment of each mass asset account with respect to a depreciable asset for which mass asset account treatment has been elected under former [section 168(d)(2)(A)](/cfr/26/168.md?p=d-2-A). Further, a change in computing depreciation or amortization under [section 167](/cfr/26/167.md) (other than under [section 168](/cfr/26/168.md), [section 1400I](/cfr/26/1400I.md), [section 1400L(c)](/cfr/26/1400L.md?p=c), former [section 168](/cfr/26/168.md), or an additional first year depreciation deduction provision of the Internal Revenue Code (for example, section [168(k)](/cfr/26/168.md?p=k), [1400L(b)](/cfr/26/1400L.md?p=b), or [1400N(d)](/cfr/26/1400N.md?p=d))) is permitted only with respect to all assets in a particular account (as defined in [§ 1.167(a)-7](/cfr/26/1.167..7.md)) or vintage account. (5) Special rules. For purposes of a change in depreciation or amortization to which this paragraph (e)(2)(ii)(d) applies— (i) Declining balance method to the straight line method for MACRS property. For tangible, depreciable property subject to [section 168](/cfr/26/168.md) (MACRS property) that is depreciated using the 200-percent or 150-percent declining balance method of depreciation under section [168(b)(1)](/cfr/26/168.md?p=b-1) or [(2)](/cfr/26/168.md?p=b-2), a taxpayer may change without the consent of the Commissioner from the declining balance method of depreciation to the straight line method of depreciation in the first taxable year in which the use of the straight line method with respect to the adjusted depreciable basis of the MACRS property as of the beginning of that year will yield a depreciation allowance that is greater than the depreciation allowance yielded by the use of the declining balance method. When the change is made, the adjusted depreciable basis of the MACRS property as of the beginning of the taxable year is recovered through annual depreciation allowances over the remaining recovery period (for further guidance, see [section 6.06](/cfr/26/6.06.md) of Rev. Proc. 87-57 (1987-2 C.B. 687) and [§ 601.601(d)(2)(ii)(b)](/cfr/26/601.601.md?p=d-2-ii-b) of this chapter). (ii) Depreciation method changes for [section 167](/cfr/26/167.md) property. For a depreciable or amortizable asset for which depreciation is determined under [section 167](/cfr/26/167.md) (other than under [section 168](/cfr/26/168.md), [section 1400I](/cfr/26/1400I.md), [section 1400L(c)](/cfr/26/1400L.md?p=c), former [section 168](/cfr/26/168.md), or an additional first year depreciation deduction provision of the Internal Revenue Code (for example, section [168(k)](/cfr/26/168.md?p=k), [1400L(b)](/cfr/26/1400L.md?p=b), or [1400N(d)](/cfr/26/1400N.md?p=d))), see § [1.167(e)-1(b)](/cfr/26/1.167..1.md), [(c)](/cfr/26/1.167.md?p=c), and [(d)](/cfr/26/1.167.md?p=d) for the changes in depreciation method that are permitted to be made without the consent of the Commissioner. For CLADR property, see [§ 1.167(a)-11(c)(1)(iii)](/cfr/26/1.167..11.md) for the changes in depreciation method for CLADR property that are permitted to be made without the consent of the Commissioner. Further, see [§ 1.167(a)-11(b)(4)(iii)(c)](/cfr/26/1.167..11.md) for how to correct an incorrect classification or characterization of CLADR property. (iii) [Section 481](/cfr/26/481.md) adjustment. Except as otherwise expressly provided by the Internal Revenue Code, the regulations under the Internal Revenue Code, or other guidance published in the Internal Revenue Bulletin, no [section 481](/cfr/26/481.md) adjustment is required or permitted for a change from one permissible method of computing depreciation or amortization to another permissible method of computing depreciation or amortization for an asset because this change is implemented by either a cut-off method (for further guidance, for example, see [section 2.06](/cfr/26/2.06.md) of Rev. Proc. 97-27 (1997-1 C.B. 680), [section 2.06](/cfr/26/2.06.md) of Rev. Proc. 2002-9 (2002-1 C.B. 327), and [§ 601.601(d)(2)(ii)(b)](/cfr/26/601.601.md?p=d-2-ii-b) of this chapter) or a modified cut-off method (under which the adjusted depreciable basis of the asset as of the beginning of the year of change is recovered using the new permissible method of accounting), as appropriate. However, a change from an impermissible method of computing depreciation or amortization to a permissible method of computing depreciation or amortization for an asset results in a [section 481](/cfr/26/481.md) adjustment. Similarly, a change in the treatment of an asset from nondepreciable or nonamortizable to depreciable or amortizable (or vice versa) or a change in the treatment of an asset from expensing to depreciating (or vice versa) results in a [section 481](/cfr/26/481.md) adjustment. (iv) Change in useful life. This paragraph (e)(2)(ii)(d)(5)(iv) applies to an adjustment in the useful life of a depreciable or amortizable asset for which depreciation is determined under [section 167](/cfr/26/167.md) (other than under [section 168](/cfr/26/168.md), [section 1400I](/cfr/26/1400I.md), [section 1400L(c)](/cfr/26/1400L.md?p=c), former [section 168](/cfr/26/168.md), or an additional first year depreciation deduction provision of the Internal Revenue Code (for example, section [168(k)](/cfr/26/168.md?p=k), [1400L(b)](/cfr/26/1400L.md?p=b), or [1400N(d)](/cfr/26/1400N.md?p=d))) and that is not a change in method of accounting under paragraph (e)(2)(ii)(d) of this section. For this adjustment in useful life, no [section 481](/cfr/26/481.md) adjustment is required or permitted. The adjustment in useful life, whether initiated by the Internal Revenue Service (IRS) or a taxpayer, is corrected by adjustments in the taxable year in which the conditions known to exist at the end of that taxable year changed thereby resulting in a redetermination of the useful life under [§ 1.167(a)-1(b)](/cfr/26/1.167..1.md) (or if the period of limitation for assessment under [section 6501(a)](/cfr/26/6501.md?p=a) has expired for that taxable year, in the first succeeding taxable year open under the period of limitation for assessment), and in subsequent taxable years. In other situations (for example, the useful life is incorrectly determined in the placed-in-service year), the adjustment in the useful life, whether initiated by the IRS or a taxpayer, may be corrected by adjustments in the earliest taxable year open under the period of limitation for assessment under [section 6501(a)](/cfr/26/6501.md?p=a) or the earliest taxable year under examination by the IRS but in no event earlier than the placed-in-service year of the asset, and in subsequent taxable years. However, if a taxpayer initiates the correction in useful life, in lieu of filing amended Federal tax returns (for example, because the conditions known to exist at the end of a prior taxable year changed thereby resulting in a redetermination of the useful life under [§ 1.167(a)-1(b)](/cfr/26/1.167..1.md)), the taxpayer may correct the adjustment in useful life by adjustments in the current and subsequent taxable years. (v) Change in placed-in-service date. This paragraph (e)(2)(ii)(d)(5)(v) applies to a change in the placed-in-service date of a depreciable or amortizable asset that is not a change in method of accounting under paragraph (e)(2)(ii)(d) of this section. For this change in placed-in-service date, no [section 481](/cfr/26/481.md) adjustment is required or permitted. The change in placed-in-service date, whether initiated by the IRS or a taxpayer, may be corrected by adjustments in the earliest taxable year open under the period of limitation for assessment under [section 6501(a)](/cfr/26/6501.md?p=a) or the earliest taxable year under examination by the IRS but in no event earlier than the placed-in-service year of the asset, and in subsequent taxable years. However, if a taxpayer initiates the change in placed-in-service date, in lieu of filing amended Federal tax returns, the taxpayer may correct the placed-in-service date by adjustments in the current and subsequent taxable years. - (iii) **Examples.** The rules of this [paragraph (e)](#e) are illustrated by the following examples: - (3) - (i) Except as otherwise provided under the authority of [paragraph (e)(3)(ii)](#e-3-ii) of this section, to secure the Commissioner's consent to a taxpayer's change in method of accounting the taxpayer generally must file an application on Form 3115, “Application for Change in Accounting Method,” with the Commissioner during the taxable year in which the taxpayer desires to make the change in method of accounting. See §§ [1.381(c)(4)-1(d)(2)](/cfr/26/1.381..1.md) and [1.381(c)(5)-1(d)(2)](/cfr/26/1.381..1.md) for rules allowing additional time, in some circumstances, for the filing of an application on Form 3115 with respect to a transaction to which [section 381(a)](/cfr/26/381.md?p=a) applies. To the extent applicable, the taxpayer must furnish all information requested on the Form 3115. This information includes all classes of items that will be treated differently under the new method of accounting, any amounts that will be duplicated or omitted as a result of the proposed change, and the taxpayer's computation of any adjustments necessary to prevent such duplications or omissions. The Commissioner may require such other information as may be necessary to determine whether the proposed change will be permitted. Permission to change a taxpayer's method of accounting will not be granted unless the taxpayer agrees to the Commissioner's prescribed terms and conditions for effecting the change, including the taxable year or years in which any adjustment necessary to prevent amounts from being duplicated or omitted is to be taken into account. See [section 481](/cfr/26/481.md) and the regulations thereunder, relating to certain adjustments resulting from accounting method changes, and [section 472](/cfr/26/472.md) and the regulations thereunder, relating to adjustments for changes to and from the last-in, first-out inventory method. For any Form 3115 filed on or after May 15, 1997, see [§ 1.446-1T(e)(3)(i)(B)](/cfr/26/1.446-1T.md?p=e-3-i-B). - (ii) Notwithstanding the provisions of [paragraph (e)(3)(i)](#e-3-i) of this section, the Commissioner may prescribe administrative procedures under which taxpayers will be permitted to change their method of accounting. The administrative procedures shall prescribe those terms and conditions necessary to obtain the Commissioner's consent to effect the change and to prevent amounts from being duplicated or omitted. The terms and conditions that may be prescribed by the Commissioner may include terms and conditions that require the change in method of accounting to be effected on a cut-off basis or by an adjustment under [section 481(a)](/cfr/26/481.md?p=a) to be taken into account in the taxable year or years prescribed by the Commissioner. - (iii) This [paragraph (e)(3)](#e-3) applies to Forms 3115 filed on or after December 31, 1997. For other Forms 3115, see [§ 1.446-1(e)(3)](#e-3) in effect prior to December 31, 1997 ([§ 1.446-1(e)(3)](#e-3) as contained in the [26 CFR part 1](/cfr/26/part1.md) edition revised as of April 1, 1997). - (4) **Effective date—** - (i) **In general.** Except as provided in paragraphs [(e)(3)(iii)](#e-3-iii), [(e)(4)(ii)](#e-4-ii), and [(e)(4)(iii)](#e-4-iii) of this section, [paragraph (e)](#e) of this section applies on or after December 30, 2003. For the applicability of regulations before December 30, 2003, see [§ 1.446-1(e)](#e) in effect prior to December 30, 2003 ([§ 1.446-1(e)](#e) as contained in [26 CFR part 1](/cfr/26/part1.md) edition revised as of April 1, 2003). - (ii) **Changes involving depreciable or amortizable assets.** With respect to paragraph (e)(2)(ii)(d) of this section, [paragraph (e)(2)(iii)](#e-2-iii) Examples 9 through 19 of this section, and the language “certain changes in computing depreciation or amortization (see paragraph (e)(2)(ii)(d) of this section)” in the last sentence of paragraph (e)(2)(ii)(a) of this section— - (A) For any change in depreciation or amortization that is a change in method of accounting, this section applies to such a change in method of accounting made by a taxpayer for a depreciable or amortizable asset placed in service by the taxpayer in a taxable year ending on or after December 30, 2003; and - (B) For any change in depreciation or amortization that is not a change in method of accounting, this section applies to such a change made by a taxpayer for a depreciable or amortizable asset placed in service by the taxpayer in a taxable year ending on or after December 30, 2003. - (iii) **Effective/applicability date for paragraph (e)(3)(i).** The rules of [paragraph (e)(3)(i)](#e-3-i) of this section apply to corporate reorganizations and tax-free liquidations described in [section 381(a)](/cfr/26/381.md?p=a) that occur on or after August 31, 2011. # §1.446-2. Method of accounting for interest. - (a) **Applicability—** - (1) **In general.** This section provides rules for determining the amount of interest that accrues during an accrual period (other than interest described in [paragraph (a)(2)](#a-2) of this section) and for determining the portion of a payment that consists of accrued interest. For purposes of this section, interest includes original issue discount and amounts treated as interest (whether stated or unstated) in any lending or deferred payment transaction. Accrued interest determined under this section is taken into account by a taxpayer under the taxpayer's regular method of accounting (e.g., an accrual method or the cash receipts and disbursements method). Application of an exception described in [paragraph (a)(2)](#a-2) of this section to one party to a transaction does not affect the application of this section to any other party to the transaction. - (2) **Exceptions—** - (i) **Interest included or deducted under certain other provisions.** This section does not apply to interest that is taken into account under— - (A) Sections [1272(a)](/cfr/26/1272.md?p=a), [1275](/cfr/26/1275.md), and [163(e)](/cfr/26/163.md?p=e) (income and deductions relating to original issue discount); - (B) [Section 467(a)(2)](/cfr/26/467.md?p=a-2) (certain payments for the use of property or services); - (C) [Sections 1276 through 1278](/cfr/26/1276..1278.md) (market discount); - (D) [Sections 1281 through 1283](/cfr/26/1281..1283.md) (discount on certain short-term obligations); - (E) [Section 7872(a)](/cfr/26/7872.md?p=a) (certain loans with below-market interest rates); - (F) [Section 1.1272-3](/cfr/26/1.1272-3.md) (an election by a holder to treat all interest on a debt instrument as original issue discount); or - (G) [Section 1.451-3(j)](/cfr/26/1.451-3.md?p=j) (special ordering rule for specified fees). - (ii) **De minimis original issue discount.** This section does not apply to de minimis original issue discount (other than de minimis original issue discount treated as qualified stated interest) as determined under [§ 1.1273-1(d)](/cfr/26/1.1273-1.md?p=d). See [§ 1.163-7](/cfr/26/1.163-7.md) for the treatment of de minimis original issue discount by the issuer and §§ [1.1273-1(d)](/cfr/26/1.1273-1.md?p=d) and [1.1272-3](/cfr/26/1.1272-3.md) for the treatment of de minimis original issue discount by the holder. - (b) **Accrual of qualified stated interest.** Qualified stated interest (as defined in [§ 1.1273-1(c)](/cfr/26/1.1273-1.md?p=c)) accrues ratably over the accrual period (or periods) to which it is attributable and accrues at the stated rate for the period (or periods). - (c) **Accrual of interest other than qualified stated interest.** Subject to the modifications in [paragraph (d)](#d) of this section, the amount of interest (other than qualified stated interest) that accrues for any accrual period is determined under rules similar to those in the regulations under sections [1272](/cfr/26/1272.md) and [1275](/cfr/26/1275.md) for the accrual of original issue discount. The preceding sentence applies regardless of any contrary formula agreed to by the parties. - (d) **Modifications—** - (1) **Issue price.** The issue price of the loan or contract is equal to— - (i) In the case of a contract for the sale or exchange of property to which [section 483](/cfr/26/483.md) applies, the amount described in § [1.483-2(a)(1)(i)](/cfr/26/1.483-2.md?p=a-1-i) or [(ii)](/cfr/26/1.483-2.md?p=a-1-ii), whichever is applicable; - (ii) In the case of a contract for the sale or exchange of property to which [section 483](/cfr/26/483.md) does not apply, the stated principal amount; or - (iii) **In any other case, the amount loaned.** - (2) **Principal payments that are not deferred payments.** In the case of a contract to which [section 483](/cfr/26/483.md) applies, principal payments that are not deferred payments are ignored for purposes of determining yield and adjusted issue price. - (e) **Allocation of interest to payments—** - (1) **In general.** Except as provided in paragraphs [(e)(2)](#e-2), [(e)(3)](#e-3), and [(e)(4)](#e-4) of this section, each payment under a loan (other than payments of additional interest or similar charges provided with respect to amounts that are not paid when due) is treated as a payment of interest to the extent of the accrued and unpaid interest determined under paragraphs [(b)](#b) and [(c)](#c) of this section as of the date the payment becomes due. - (2) **Special rule for points deductible under section 461(g)(2).** If a payment of points is deductible by the borrower under [section 461(g)(2)](/cfr/26/461.md?p=g-2), the payment is treated by the borrower as a payment of interest. - (3) **Allocation respected in certain small transactions.** [Reserved] - (4) **Pro rata prepayments.** Accrued but unpaid interest is allocated to a pro rata prepayment under rules similar to those for allocating accrued but unpaid original issue discount to a pro rata prepayment under [§ 1.1275-2(f)](/cfr/26/1.1275-2.md?p=f). For purposes of the preceding sentence, a pro rata prepayment is a payment that is made prior to maturity that— - (i) Is not made pursuant to the contract's payment schedule; and - (ii) **Results in a substantially pro rata reduction of each payment remaining to be paid on the contract.** - (f) **Aggregation rule.** For purposes of this section, all contracts calling for deferred payments arising from the same transaction (or a series of related transactions) are treated as a single contract. This rule, however, generally only applies to contracts involving a single borrower and a single lender. - (g) **Debt instruments denominated in a currency other than the U.S. dollar.** This section applies to a debt instrument that provides for all payments denominated in, or determined by reference to, the functional currency of the taxpayer or qualified business unit of the taxpayer (even if that currency is other than the U.S. dollar). See [§ 1.988-2(b)](/cfr/26/1.988-2.md?p=b) to determine interest income or expense for debt instruments that provide for payments denominated in, or determined by reference to, a nonfunctional currency. - (h) **Example.** The following example illustrates the rules of this section. - (i) [Reserved] - (j) **Effective date.** This section applies to debt instruments issued on or after April 4, 1994, and to lending transactions, sales, and exchanges that occur on or after April 4, 1994. Taxpayers, however, may rely on this section for debt instruments issued after December 21, 1992, and before April 4, 1994, and for lending transactions, sales, and exchanges that occur after December 21, 1992, and before April 4, 1994. # §1.446-3. Notional principal contracts. - (a) **Table of contents.** This [paragraph (a)](#a) lists captioned paragraphs contained in § 1.446-3. - (b) **Purpose.** The purpose of this section is to enable the clear reflection of the income and deductions from notional principal contracts by prescribing accounting methods that reflect the economic substance of such contracts. - (c) **Definitions and scope—** - (1) **Notional principal contract—** - (i) **In general.** A notional principal contract is a financial instrument that provides for the payment of amounts by one party to another at specified intervals calculated by reference to a specified index upon a notional principal amount in exchange for specified consideration or a promise to pay similar amounts. An agreement between a taxpayer and a qualified business unit (as defined in [section 989(a)](/cfr/26/989.md?p=a)) of the taxpayer, or among qualified business units of the same taxpayer, is not a notional principal contract because a taxpayer cannot enter into a contract with itself. Notional principal contracts governed by this section include interest rate swaps, currency swaps, basis swaps, interest rate caps, interest rate floors, commodity swaps, equity swaps, equity index swaps, and similar agreements. A collar is not itself a notional principal contract, but certain caps and floors that comprise a collar may be treated as a single notional principal contract under [paragraph (f)(2)(v)(C)](#f-2-v-C) of this section. A contract may be a notional principal contract governed by this section even though the term of the contract is subject to termination or extension. Each confirmation under a master agreement to enter into agreements governed by this section is treated as a separate notional principal contract. - (ii) **Excluded contracts.** A contract described in [section 1256(b)](/cfr/26/1256.md?p=b), a futures contract, a forward contract, and an option are not notional principal contracts. An instrument or contract that constitutes indebtedness under general principles of Federal income tax law is not a notional principal contract. An option or forward contract that entitles or obligates a person to enter into a notional principal contract is not a notional principal contract, but payments made under such an option or forward contract may be governed by [paragraph (g)(3)](#g-3) of this section. - (iii) **Transactions within section 475.** To the extent that the rules provided in paragraphs [(e)](#e) and [(f)](#f) of this section are inconsistent with the rules that apply to any notional principal contract that is governed by [section 475](/cfr/26/475.md) and regulations thereunder, the rules of [section 475](/cfr/26/475.md) and the regulations thereunder govern. - (iv) **Transactions within section 988.** To the extent that the rules provided in this section are inconsistent with the rules that apply to any notional principal contract that is also a [section 988](/cfr/26/988.md) transaction or that is integrated with other property or debt pursuant to [section 988(d)](/cfr/26/988.md?p=d), the rules of [section 988](/cfr/26/988.md) and the regulations thereunder govern. - (2) **Specified index.** A specified index is— - (i) A fixed rate, price, or amount; - (ii) A fixed rate, price, or amount applicable in one or more specified periods followed by one or more different fixed rates, prices, or amounts applicable in other periods; - (iii) An index that is based on objective financial information (as defined in [paragraph (c)(4)(ii)](#c-4-ii) of this section); and - (iv) An interest rate index that is regularly used in normal lending transactions between a party to the contract and unrelated persons. - (3) **Notional principal amount.** For purposes of this section, a notional principal amount is any specified amount of money or property that, when multiplied by a specified index, measures a party's rights and obligations under the contract, but is not borrowed or loaned between the parties as part of the contract. The notional principal amount may vary over the term of the contract, provided that it is set in advance or varies based on objective financial information (as defined in [paragraph (c)(4)(ii)](#c-4-ii) of this section). - (4) **Special definitions—** - (i) **Related person and party to the contract.** A related person is a person related (within the meaning of section [267(b)](/cfr/26/267.md?p=b) or [707(b)(1)](/cfr/26/707.md?p=b-1)) to one of the parties to the notional principal contract or a member of the same consolidated group (as defined in [§ 1.1502-1(h)](/cfr/26/1.1502-1.md?p=h)) as one of the parties to the contract. For purposes of this [paragraph (c)](#c), a related person is considered to be a party to the contract. - (ii) **Objective financial information.** For purposes of this [paragraph (c)](#c), objective financial information is any current, objectively determinable financial or economic information that is not within the control of any of the parties to the contract and is not unique to one of the parties' circumstances (such as one party's dividends, profits, or the value of its stock). Thus, for example, a notional principal amount may be based on a broadly-based equity index or the outstanding balance of a pool of mortgages, but not on the value of a party's stock. - (iii) **Dealer in notional principal contracts.** A dealer in notional principal contracts is a person who regularly offers to enter into, assume, offset, assign, or otherwise terminate positions in notional principal contracts with customers in the ordinary course of a trade or business. - (d) **Taxable year of inclusion and deduction.** For all purposes of the Code, the net income or net deduction from a notional principal contract for a taxable year is included in or deducted from gross income for that taxable year. The net income or net deduction from a notional principal contract for a taxable year equals the total of all of the periodic payments that are recognized from that contract for the taxable year under [paragraph (e)](#e) of this section and all of the nonperiodic payments that are recognized from that contract for the taxable year under [paragraph (f)](#f) of this section. - (e) **Periodic payments—** - (1) **Definition.** Periodic payments are payments made or received pursuant to a notional principal contract that are payable at intervals of one year or less during the entire term of the contract (including any extension periods provided for in the contract), that are based on a specified index described in paragraph [(c)(2)(i)](#c-2-i), [(iii)](#c-2-iii), or [(iv)](#c-2-iv) of this section (appropriately adjusted for the length of the interval), and that are based on either a single notional principal amount or a notional principal amount that varies over the term of the contract in the same proportion as the notional principal amount that measures the other party's payments. Payments to purchase or sell a cap or a floor, however, are not periodic payments. - (2) **Recognition rules—** - (i) **In general.** All taxpayers, regardless of their method of accounting, must recognize the ratable daily portion of a periodic payment for the taxable year to which that portion relates. - (ii) **Rate set in arrears.** If the amount of a periodic payment is not determinable at the end of a taxable year because the value of the specified index is not fixed until a date that occurs after the end of the taxable year, the ratable daily portion of a periodic payment that relates to that taxable year is generally based on the specified index that would have applied if the specified index were fixed as of the last day of the taxable year. If a taxpayer determines that the value of the specified index as of the last day of the taxable year does not provide a reasonable estimate of the specified index that will apply when the payment is fixed, the taxpayer may use a reasonable estimate of the specified index each year, provided that the taxpayer (and any related person that is a party to the contract) uses the same method to make the estimate consistently from year to year and uses the same estimate for purposes of all financial reports to equity holders and creditors. The taxpayer's treatment of notional principal contracts with substantially similar specified indices will be considered in determining whether the taxpayer's estimate of the specified index is reasonable. Any difference between the amount that is recognized under this [paragraph (e)(2)(ii)](#e-2-ii) and the corresponding portion of the actual payment that becomes fixed under the contract is taken into account as an adjustment to the net income or net deduction from the notional principal contract for the taxable year during which the payment becomes fixed. - (iii) **Notional principal amount set in arrears.** Rules similar to the rules of [paragraph (e)(2)(ii)](#e-2-ii) of this section apply if the amount of a periodic payment is not determinable at the end of a taxable year because the notional principal amount is not fixed until a date that occurs after the end of the taxable year. - (3) **Examples.** The following examples illustrate the application of [paragraph (e)](#e) of this section. - (f) **Nonperiodic payments—** - (1) **Definition.** A nonperiodic payment is any payment made or received with respect to a notional principal contract that is not a periodic payment (as defined in [paragraph (e)(1)](#e-1) of this section) or a termination payment (as defined in [paragraph (h)](#h) of this section). Examples of nonperiodic payments are the premium for a cap or floor agreement (even if it is paid in installments), the payment for an off-market swap agreement, the prepayment of part or all of one leg of a swap, and the premium for an option to enter into a swap if and when the option is exercised. - (2) **Recognition rules—** - (i) **In general.** All taxpayers, regardless of their method of accounting, must recognize the ratable daily portion of a nonperiodic payment for the taxable year to which that portion relates. Generally, a nonperiodic payment must be recognized over the term of a notional principal contract in a manner that reflects the economic substance of the contract. - (ii) **General rule for swaps.** A nonperiodic payment that relates to a swap must be recognized over the term of the contract by allocating it in accordance with the forward rates (or, in the case of a commodity, the forward prices) of a series of cash-settled forward contracts that reflect the specified index and the notional principal amount. For purposes of this allocation, the forward rates or prices used to determine the amount of the nonperiodic payment will be respected, if reasonable. See [paragraph (f)(4)](#f-4) Example 7 of this section. - (iii) **Alternative methods for swaps.** Solely for purposes of determining the timing of income and deductions, a nonperiodic payment made or received with respect to a swap may be allocated to each period of the swap contract using one of the methods described in this [paragraph (f)(2)(iii)](#f-2-iii). The alternative methods may not be used by a dealer in notional principal contracts (as defined in [paragraph (c)(4)(iii)](#c-4-iii) of this section) for swaps entered into or acquired in its capacity as a dealer. - (A) **Prepaid swaps.** An upfront payment on a swap may be amortized by assuming that the nonperiodic payment represents the present value of a series of equal payments made throughout the term of the swap contract (the level payment method), adjusted as appropriate to take account of increases or decreases in the notional principal amount. The discount rate used in this calculation must be the rate (or rates) used by the parties to determine the amount of the nonperiodic payment. If that rate is not readily ascertainable, the discount rate used must be a rate that is reasonable under the circumstances. Under this method, an upfront payment is allocated by dividing each equal payment into its principal recovery and time value components. The principal recovery components of the equal payments are treated as periodic payments that are deemed to be made on each of the dates that the swap contract provides for periodic payments by the payor of the nonperiodic payment or, if none, on each of the dates that the swap contract provides for periodic payments by the recipient of the nonperiodic payment. The time value component is needed to compute the amortization of the nonperiodic payment, but is otherwise disregarded. See [paragraph (f)(4)](#f-4) Example 5 of this section. - (B) **Other nonperiodic swap payments.** Nonperiodic payments on a swap other than an upfront payment may be amortized by treating the contract as if it provided for a single upfront payment (equal to the present value of the nonperiodic payments) and a loan between the parties. The discount rate (or rates) used in determining the deemed upfront payment and the time value component of the deemed loan is the same as the rate (or rates) used in the level payment method. The single upfront payment is then amortized under the level payment method described in [paragraph (f)(2)(iii)(A)](#f-2-iii-A) of this section. The time value component of the loan is not treated as interest, but, together with the amortized amount of the deemed upfront payment, is recognized as a periodic payment. See [paragraph (f)(4)](#f-4) Example 6 of this section. If both parties make nonperiodic payments, this calculation is done separately for the nonperiodic payments made by each party. - (iv) **General rule for caps and floors.** A payment to purchase or sell a cap or floor must be recognized over the term of the agreement by allocating it in accordance with the prices of a series of cash-settled option contracts that reflect the specified index and the notional principal amount. For purposes of this allocation, the option pricing used by the parties to determine the total amount paid for the cap or floor will be respected, if reasonable. Only the portion of the purchase price that is allocable to the option contract or contracts that expire during a particular period is recognized for that period. Thus, under this [paragraph (f)(2)(iv)](#f-2-iv), straight-line or accelerated amortization of a cap premium is generally not permitted. See [paragraph (f)(4)](#f-4) Examples 1 and 2 of this section. - (v) **Alternative methods for caps and floors that hedge debt instruments.** Solely for purposes of determining the timing of income and deductions, if a cap or floor is entered into primarily to reduce risk with respect to a specific debt instrument or group of debt instruments held or issued by the taxpayer, the taxpayer may amortize a payment to purchase or sell the cap or floor using the methods described in this [paragraph (f)(2)(v)](#f-2-v), adjusted as appropriate to take account of increases or decreases in the notional principal amount. The alternative methods may not be used by a dealer in notional principal contracts (as defined in [paragraph (c)(4)(iii)](#c-4-iii) of this section) for caps or floors entered into or acquired in its capacity as a dealer. - (A) **Prepaid caps and floors.** A premium paid upfront for a cap or a floor may be amortized using the “level payment method” described in [paragraph (f)(2)(iii)(A)](#f-2-iii-A) of this section. See [paragraph (f)(4)](#f-4) Example 3 of this section. - (B) **Other caps and floors.** Nonperiodic payments on a cap or floor other than an upfront payment are amortized by treating the contract as if it provided for a single upfront payment (equal to the present value of the nonperiodic payments) and a loan between the parties as described in [paragraph (f)(2)(iii)(B)](#f-2-iii-B) of this section. Under the level payment method, a cap or floor premium paid in level annual installments over the term of the contract is effectively included or deducted from income ratably, in accordance with the level payments. See [paragraph (f)(4)](#f-4) Example 4 of this section. - (C) **Special method for collars.** A taxpayer may also treat a cap and a floor that comprise a collar as a single notional principal contract and may amortize the net nonperiodic payment to enter into the cap and floor over the term of the collar in accordance with the methods prescribed in this [paragraph (f)(2)(v)](#f-2-v). - (vi) **Additional methods.** The Commissioner may, by a revenue ruling or a revenue procedure published in the Internal Revenue Bulletin, provide alternative methods for allocating nonperiodic payments that relate to a notional principal contract to each year of the contract. See [§ 601.601(d)(2)(ii)(b)](/cfr/26/601.601.md?p=d-2-ii-b) of this chapter. - (3) **Term of extendible or terminable contracts.** For purposes of this [paragraph (f)](#f), the term of a notional principal contract that is subject to extension or termination is the reasonably expected term of the contract. - (4) **Examples.** The following examples illustrate the application of [paragraph (f)](#f) of this section. - (g) **Special rules—** - (1) **Disguised notional principal contracts.** The Commissioner may recharacterize all or part of a transaction (or series of transactions) if the effect of the transaction (or series of transactions) is to avoid the application of this section. - (2) **Hedged notional principal contracts.** If a taxpayer, either directly or through a related person (as defined in [paragraph (c)(4)(i)](#c-4-i) of this section), reduces risk with respect to a notional principal contract by purchasing, selling, or otherwise entering into other notional principal contracts, futures, forwards, options, or other financial contracts (other than debt instruments), the taxpayer may not use the alternative methods provided in paragraphs [(f)(2)(iii)](#f-2-iii) and [(v)](#f-2-v) of this section. Moreover, where such positions are entered into to avoid the appropriate timing or character of income from the contracts taken together, the Commissioner may require that amounts paid to or received by the taxpayer under the notional principal contract be treated in a manner that is consistent with the economic substance of the transaction as a whole. - (3) **Options and forwards to enter into notional principal contracts.** An option or forward contract that entitles or obligates a person to enter into a notional principal contract is subject to the general rules of taxation for options or forward contracts. Any payment with respect to the option or forward contract is treated as a nonperiodic payment for the underlying notional principal contract under the rules of paragraphs [(f)](#f) and [(g)(4)](#g-4) or [(g)(5)](#g-5) of this section if and when the underlying notional principal contract is entered into. - (4) **Swaps with significant nonperiodic payments—** - (i) **General rule.** Except as provided in [paragraph (g)(4)(ii)](#g-4-ii) of this section, a swap with significant nonperiodic payments is treated as two separate transactions consisting of an on-market, level payment swap and a loan. The loan must be accounted for by the parties to the contract independently of the swap. The time value component associated with the loan, determined in accordance with [paragraph (f)(2)(iii)(A)](#f-2-iii-A) of this section, is recognized as interest expense to the payor and interest income to the recipient. - (ii) **Exception for cleared swaps and non-cleared swaps subject to margin or collateral requirements.** [Paragraph (g)(4)(i)](#g-4-i) of this section does not apply to a swap if the contract is described in paragraph [(g)(4)(ii)(A)](#g-4-ii-A) or [(B)](#g-4-ii-B) of this section. - (A) The swap is cleared by a derivatives clearing organization, as such term is defined in section 1a of the Commodity Exchange Act ([7 U.S.C. 1a](/usc/7/1a.md)), or by a clearing agency, as such term is defined in section 3 of the Securities Exchange Act of 1934 ([15 U.S.C. 78c](/usc/15/78c.md)), that is registered as a derivatives clearing organization under the Commodity Exchange Act or as a clearing agency under the Securities Exchange Act of 1934, respectively, and the derivatives clearing organization or clearing agency requires the parties to the swap to post and collect margin or collateral. - (B) The swap is a non-cleared swap that requires the parties to meet the margin or collateral requirements of a federal regulator or that provides for margin or collateral requirements that are substantially similar to a cleared swap or a non-cleared swap subject to the margin or collateral requirements of a federal regulator. For purposes of this [paragraph (g)(4)(ii)(B)](#g-4-ii-B), the term federal regulator means the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), or a prudential regulator, as defined in section 1a(39) of the Commodity Exchange Act ([7 U.S.C. 1a](/usc/7/1a.md)), as amended by [section 721](/cfr/26/721.md) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Public Law 111-203, 124 Stat. 1376, Title VII. - (iii) **Coordination with section 163(j).** For the treatment of swaps with significant nonperiodic payments under [section 163(j)](/cfr/26/163.md?p=j), see [§ 1.163(j)-1(b)(22)(ii)](/cfr/26/1.163..1.md). - (5) **Caps and floors that are significantly in-the-money.** [Reserved] - (6) **Examples.** The following examples illustrate the application of [paragraph (g)](#g) of this section. - (h) **Termination payments—** - (1) **Definition.** A payment made or received to extinguish or assign all or a proportionate part of the remaining rights and obligations of any party under a notional principal contract is a termination payment to the party making the termination payment and the party receiving the payment. A termination payment includes a payment made between the original parties to the contract (an extinguishment), a payment made between one party to the contract and a third party (an assignment), and any gain or loss realized on the exchange of one notional principal contract for another. Where one party assigns its remaining rights and obligations to a third party, the original nonassigning counterparty realizes gain or loss if the assignment results in a deemed exchange of contracts and a realization event under [section 1001](/cfr/26/1001.md). - (2) **Taxable year of inclusion and deduction by original parties.** Except as otherwise provided (for example, in [section 453](/cfr/26/453.md), [section 1092](/cfr/26/1092.md), or [§ 1.446-4](/cfr/26/1.446-4.md)), a party to a notional principal contract recognizes a termination payment in the year the contract is extinguished, assigned, or exchanged. When the termination payment is recognized, the party also recognizes any other payments that have been made or received pursuant to the notional principal contract, but that have not been recognized under [paragraph (d)](#d) of this section. If only a proportionate part of a party's rights and obligations is extinguished, assigned, or exchanged, then only that proportion of the unrecognized payments is recognized under the previous sentence. - (3) **Taxable year of inclusion and deduction by assignees.** A termination payment made or received by an assignee pursuant to an assignment of a notional principal contract is recognized by the assignee under the rules of paragraphs [(f)](#f) and [(g)(4)](#g-4) or [(g)(5)](#g-5) of this section as a nonperiodic payment for the notional principal contract that is in effect after the assignment. - (4) **Special rules—** - (i) **Assignment of one leg of a contract.** A payment is not a termination payment if it is made or received by a party in exchange for assigning all or a portion of one leg of a notional principal contract at a time when a substantially proportionate amount of the other leg remains unperformed and unassigned. The payment is either an amount loaned, an amount borrowed, or a nonperiodic payment, depending on the economic substance of the transaction to each party. This [paragraph (h)(4)(i)](#h-4-i) applies whether or not the original notional principal contract is terminated as a result of the assignment. - (ii) **Substance over form.** Any economic benefit that is given or received by a taxpayer in lieu of a termination payment is a termination payment. - (5) **Examples.** The following examples illustrate the application of this [paragraph (h)](#h). The contracts in the examples are not hedging transactions as defined in [§ 1.1221-2(b)](/cfr/26/1.1221-2.md?p=b), and all of the examples assume that no loss-deferral rules apply. - (i) **Anti-abuse rule.** If a taxpayer enters into a transaction with a principal purpose of applying the rules of this section to produce a material distortion of income, the Commissioner may depart from the rules of this section as necessary to reflect the appropriate timing of income and deductions from the transaction. - (j) - (1) **Effective/applicability date.** These regulations are effective for notional principal contracts entered into on or after December 13, 1993. - (2) The rules provided in [paragraph (g)(4)](#g-4) of this section apply to notional principal contracts entered into on or after September 14, 2021. Taxpayers may choose to apply the rules provided in [paragraph (g)(4)](#g-4) of this section to notional principal contracts entered into before September 14, 2021. # §1.446-3T. Notional principal contracts (temporary). - (a) through (g)(3) [Reserved]. For further guidance, see [§ 1.446-3(a) through (g)(3)](/cfr/26/1.446-3.md?p=a..g-3). - (4) **Notional principal contracts with nonperiodic payments—** - (i) **General rule.** Except as provided in paragraph (g)(4)(ii) of this section, a notional principal contract with one or more nonperiodic payments is treated as two separate transactions consisting of an on-market, level payment swap and one or more loans. The loan(s) must be accounted for by the parties to the contract independently of the swap. The time value component associated with the loan(s) is not included in the net income or net deduction from the swap under [§ 1.446-3(d)](/cfr/26/1.446-3.md?p=d), but it is recognized as interest for all purposes of the Internal Revenue Code. See paragraph (g)(6) Example 2 of this section. - (ii) **Exceptions—** - (A) **Notional principal contract with a term of one year or less—** (1) General rule. Except for purposes of sections [514](/cfr/26/514.md) and [956](/cfr/26/956.md), paragraph (g)(4)(i) of this section does not apply to a notional principal contract if the term of the contract is one year or less. For purposes of this paragraph (g)(4)(ii)(A), the term of a notional principal contract is the stated term of the contract, inclusive of any extensions (optional or otherwise) provided for in the terms of the contract, without regard to whether any extension is unilateral, is subject to approval by one or both parties to the contract, or is based on the occurrence or non-occurrence of a specified event. (2) Anti-abuse rule. For purposes of determining the term of a contract under paragraph (g)(4)(ii)(A)(1) of this section, the Commissioner may treat two or more contracts as a single contract if a principal purpose of entering into separate contracts is to qualify for the exception set forth in paragraph (g)(4)(ii)(A)(1) of this section. A purpose may be a principal purpose even though it is outweighed by other purposes (taken together or separately). - (B) **Notional principal contract subject to margin or collateral requirements.** Subject to the requirements in paragraph (g)(4)(ii)(C) of this section, paragraph (g)(4)(i) of this section does not apply to a notional principal contract if the contract is described in paragraph (g)(4)(ii)(B)(1) or (2) of this section. See [§ 1.956-2T(b)(1)(xi)](/cfr/26/1.956-2T.md?p=b-1-xi) for a related exception under [section 956](/cfr/26/956.md). (1) The contract is cleared by a derivatives clearing organization (as such term is defined in section 1a of the Commodity Exchange Act ([7 U.S.C. 1a](/usc/7/1a.md))) or by a clearing agency (as such term in defined in section 3 of the Securities Exchange Act of 1934 ([15 U.S.C. 78c](/usc/15/78c.md))) that is registered as a derivatives clearing organization under the Commodity Exchange Act or as a clearing agency under the Securities Exchange Act of 1934, respectively, and the derivatives clearing organization or clearing agency requires the parties to the contract to post and collect margin or collateral to fully collateralize the mark-to-market exposure on the contract (including the exposure on the nonperiodic payment) on a daily basis for the entire term of the contract. The mark-to-market exposure on a contract will be fully collateralized only if the contract is subject to both initial variation margin in an amount equal to the nonperiodic payment (except for variances permitted by intraday price changes) and daily variation margin in an amount equal to the daily change in the fair market value of the contract. See paragraph (g)(6) Example 3 of this section. (2) The parties to the contract are required, pursuant to the terms of the contract or the requirements of a federal regulator, to post and collect margin or collateral to fully collateralize the mark-to-market exposure on the contract (including the exposure on the nonperiodic payment) on a daily basis for the entire term of the contract. The mark-to-market exposure on a contract will be fully collateralized only if the contract is subject to both initial variation margin or collateral in an amount equal to the nonperiodic payment (except for variances permitted by intraday price changes) and daily variation margin or collateral in an amount equal to the daily change in the fair market value of the contract. For purposes of this paragraph (g)(4)(ii)(B)(2), the term “federal regulator” means the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), or a prudential regulator, as defined in section 1a(39) of the Commodity Exchange Act ([7 U.S.C. 1a](/usc/7/1a.md)), as amended by [section 721](/cfr/26/721.md) of the Dodd-Frank Act. See paragraph (g)(6) Example 4 of this section. - (C) **Limitations and special rules—** (1) Cash requirement. A notional principal contract is described in paragraph (g)(4)(ii)(B) of this section only to the extent the parties post and collect margin or collateral to fully collateralize the mark-to-market exposure on the contract (including the exposure on the nonperiodic payment) by paying and receiving the required margin or collateral in cash. The term “cash” includes U.S. dollars or cash in any currency in which payment obligations under the notional principal contract are denominated. (2) Excess margin or collateral. For purposes of paragraph (g)(4)(ii)(B)(2) of this section, if the amount of cash margin or collateral posted and collected is in excess of the amount necessary to fully collateralize the mark-to-market exposure on the contract (including the exposure on the nonperiodic payment) on a daily basis for the entire term of the contract, any excess is subject to the rule in paragraph (g)(4)(i) of this section. (3) Margin or collateral paid and received in cash and other property. If the parties to the contract post and collect both cash and other property to satisfy margin or collateral requirements to collateralize the mark-to-market exposure on the contract (including the exposure on the nonperiodic payment), any excess of the nonperiodic payment over the cash margin or collateral posted and collected is subject to the rule in paragraph (g)(4)(i) of this section. - (5) [Reserved]. For further guidance, see [§ 1.446-3(g)(5)](/cfr/26/1.446-3.md?p=g-5). - (6) **Examples—** through Example 1. [Reserved]. For further guidance, see [§ 1.446-3(g)(6)](/cfr/26/1.446-3.md?p=g-6), Examples through Example 1. - (h) through (j)(1) [Reserved]. For further guidance, see [§ 1.446-3(h) through (j)(1)](/cfr/26/1.446-3.md?p=h..j-1). - (2) **Application of § 1.446-3T(g)(4).** Paragraph (g)(4)(i) of this section and paragraph (g)(6) Example 2 of this section apply to notional principal contracts entered into on or after the later of January 1, 2017, or 180 days after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register. Paragraph (g)(4)(ii) of this section applies to notional principal contracts entered into on or after May 8, 2015. However, before the later of January 1, 2017, or 180 days after the date of publication of the Treasury decision adopting paragraph (g)(4)(i) of this section as final regulations in the Federal Register, taxpayers may rely on the provision in [§ 1.446-3(g)(4)](/cfr/26/1.446-3.md?p=g-4), as contained in [26 CFR part 1](/cfr/26/part1.md), revised April 1, 2015, which (except for purposes of [section 956](/cfr/26/956.md)) limits the application of the embedded loan rule to nonperiodic payments that are significant, even if the requirements for the exceptions in paragraph (g)(4)(ii) of this section are not met. Taxpayers may apply paragraph (g)(4)(i) of this section, paragraph (g)(4)(ii) of this section, or both to notional principal contracts entered into before the dates set forth in this paragraph (j)(2). - (k) **Expiration date.** The applicability of paragraph (g)(4) of this section and paragraph (g)(6) Examples 2, 3 and 4 of this section expires May 7, 2018. # §1.446-4. Hedging transactions. - (a) **In general.** Except as provided in this [paragraph (a)](#a), a hedging transaction as defined in [§ 1.1221-2(b)](/cfr/26/1.1221-2.md?p=b) (whether or not the character of gain or loss from the transaction is determined under [§ 1.1221-2](/cfr/26/1.1221-2.md)) must be accounted for under the rules of this section. To the extent that provisions of any other regulations governing the timing of income, deductions, gain, or loss are inconsistent with the rules of this section, the rules of this section control. - (1) **Trades or businesses excepted.** A taxpayer is not required to account for hedging transactions under the rules of this section for any trade or business in which the cash receipts and disbursements method of accounting is used or in which [§ 1.471-6](/cfr/26/1.471-6.md) is used for inventory valuations if, for all prior taxable years ending on or after September 30, 1993, the taxpayer met the $5,000,000 gross receipts test of [section 448(c)](/cfr/26/448.md?p=c) (or would have met that test if the taxpayer were a corporation or partnership). A taxpayer not required to use the rules of this section may nonetheless use a method of accounting that is consistent with these rules. - (2) **Coordination with other sections.** This section does not apply to— - (i) Any position to which [section 475(a)](/cfr/26/475.md?p=a) applies; - (ii) An integrated transaction subject to [§ 1.1275-6](/cfr/26/1.1275-6.md); - (iii) Any [section 988](/cfr/26/988.md) hedging transaction if the transaction is integrated under [§ 1.988-5](/cfr/26/1.988-5.md) or if other regulations issued under [section 988(d)](/cfr/26/988.md?p=d) (or an advance ruling described in 1.988-5(e)) govern when gain or loss from the transaction is taken into account; or - (iv) The determination of the issuer's yield on an issue of tax-exempt bonds for purposes of the arbitrage restrictions to which [§ 1.148-4(h)](/cfr/26/1.148-4.md?p=h) applies. - (b) **Clear reflection of income.** The method of accounting used by a taxpayer for a hedging transaction must clearly reflect income. To clearly reflect income, the method used must reasonably match the timing of income, deduction, gain, or loss from the hedging transaction with the timing of income, deduction, gain, or loss from the item or items being hedged. Taking gains and losses into account in the period in which they are realized may clearly reflect income in the case of certain hedging transactions. For example, where a hedge and the item being hedged are disposed of in the same taxable year, taking realized gain or loss into account on both items in that taxable year may clearly reflect income. In the case of many hedging transactions, however, taking gains and losses into account as they are realized does not result in the matching required by this section. - (c) **Choice of method and consistency.** For any given type of hedging transaction, there may be more than one method of accounting that satisfies the clear reflection requirement of [paragraph (b)](#b) of this section. A taxpayer is generally permitted to adopt a method of accounting for a particular type of hedging transaction that clearly reflects the taxpayer's income from that type of transaction. See [paragraph (e)](#e) of this section for requirements and limitations on the taxpayer's choice of method. Different methods of accounting may be used for different types of hedging transactions and for transactions that hedge different types of items. Once a taxpayer adopts a method of accounting, however, that method must be applied consistently and can only be changed with the consent of the Commissioner, as provided by [section 446(e)](/cfr/26/446.md?p=e) and the regulations and procedures thereunder. - (d) **Recordkeeping requirements—** - (1) **In general.** The books and records maintained by a taxpayer must contain a description of the accounting method used for each type of hedging transaction. The description of the method or methods used must be sufficient to show how the clear reflection requirement of [paragraph (b)](#b) of this section is satisfied. - (2) **Additional identification.** In addition to the identification required by [§ 1.1221-2(f)](/cfr/26/1.1221-2.md?p=f), the books and records maintained by a taxpayer must contain whatever more specific identification with respect to a transaction is necessary to verify the application of the method of accounting used by the taxpayer for the transaction. This additional identification may relate to the hedging transaction or to the item, items, or aggregate risk being hedged. The additional identification must be made at the time specified in [§ 1.1221-2(f)(2)](/cfr/26/1.1221-2.md?p=f-2) and must be made on, and retained as part of, the taxpayer's books and records. - (3) **Transactions in which character of gain or loss is not determined under § 1.1221-2.** A [section 988](/cfr/26/988.md) transaction, as defined in [section 988(c)(1)](/cfr/26/988.md?p=c-1), or a qualified fund, as defined in [section 988(c)(1)(E)(iii)](/cfr/26/988.md?p=c-1-E-iii), is subject to the identification and recordkeeping requirements of [§ 1.1221-2(f)](/cfr/26/1.1221-2.md?p=f). See [§ 1.1221-2(a)(4)](/cfr/26/1.1221-2.md?p=a-4). - (e) **Requirements and limitations with respect to hedges of certain assets and liabilities.** In the case of certain hedging transactions, this [paragraph (e)](#e) provides guidance in determining whether a taxpayer's method of accounting satisfies the clear reflection requirement of [paragraph (b)](#b) of this section. Even if these rules are satisfied, however, the taxpayer's method, as actually applied to the taxpayer's hedging transactions, must clearly reflect income by meeting the matching requirement of [paragraph (b)](#b) of this section. - (1) **Hedges of aggregate risk—** - (i) **In general.** The method of accounting used for hedges of aggregate risk must comply with the matching requirements of [paragraph (b)](#b) of this section. Even though a taxpayer may not be able to associate the hedging transaction with any particular item being hedged, the timing of income, deduction, gain, or loss from the hedging transaction must be matched with the timing of the aggregate income, deduction, gain, or loss from the items being hedged. For example, if a notional principal contract hedges a taxpayer's aggregate risk, taking into account income, deduction, gain, or loss under the provisions of [§ 1.446-3](/cfr/26/1.446-3.md) may clearly reflect income. See [paragraph (e)(5)](#e-5) of this section. - (ii) **Mark-and-spread method.** The following method may be appropriate for taking into account income, deduction, gain, or loss from hedges of aggregate risk: - (A) The hedging transactions are marked to market at regular intervals for which the taxpayer has the necessary data, but no less frequently than quarterly; and - (B) The income, deduction, gain, or loss attributable to the realization or periodic marking to market of hedging transactions is taken into account over the period for which the hedging transactions are intended to reduce risk. Although the period over which the hedging transactions are intended to reduce risk may change, the period must be reasonable and consistent with the taxpayer's hedging policies and strategies. - (2) **Hedges of items marked to market.** In the case of a transaction that hedges an item that is marked to market under the taxpayer's method of accounting, marking the hedge to market clearly reflects income. - (3) **Hedges of inventory—** - (i) **In general.** If a hedging transaction hedges purchases of inventory, gain or loss on the hedging transaction may be taken into account in the same period that it would be taken into account if the gain or loss were treated as an element of the cost of inventory. Similarly, if a hedging transaction hedges sales of inventory, gain or loss on the hedging transaction may be taken into account in the same period that it would be taken into account if the gain or loss were treated as an element of sales proceeds. If a hedge is associated with a particular purchase or sales transaction, the gain or loss on the hedge may be taken into account when it would be taken into account if it were an element of cost incurred in, or sales proceeds from, that transaction. As with hedges of aggregate risk, however, a taxpayer may not be able to associate hedges of inventory purchases or sales with particular purchase or sales transactions. In order to match the timing of income, deduction, gain, or loss from the hedge with the timing of aggregate income, deduction, gain, or loss from the hedged purchases or sales, it may be appropriate for a taxpayer to account for its hedging transactions in the manner described in [paragraph (e)(1)(ii)](#e-1-ii) of this section, except that the gain or loss that is spread to each period is taken into account when it would be if it were an element of cost incurred (purchase hedges), or an element of proceeds from sales made (sales hedges), during that period. - (ii) **Alternative methods for certain inventory hedges.** In lieu of the method described in [paragraph (e)(3)(i)](#e-3-i) of this section, other simpler, less precise methods may be used in appropriate cases where the clear reflection requirement of [paragraph (b)](#b) of this section is satisfied. For example: - (A) Taking into account realized gains and losses on both hedges of inventory purchases and hedges of inventory sales when they would be taken into account if the gains and losses were elements of inventory cost in the period realized may clearly reflect income in some situations, but does not clearly reflect income for a taxpayer that uses the last-in, first-out method of accounting for the inventory; and - (B) Marking hedging transactions to market with resulting gain or loss taken into account immediately may clearly reflect income even though the inventory that is being hedged is not marked to market, but only if the inventory is not accounted for under either the last-in, first-out method or the lower-of-cost-or-market method and only if items are held in inventory for short periods of time. - (4) **Hedges of debt instruments.** Gain or loss from a transaction that hedges a debt instrument issued or to be issued by a taxpayer, or a debt instrument held or to be held by a taxpayer, must be accounted for by reference to the terms of the debt instrument and the period or periods to which the hedge relates. A hedge of an instrument that provides for interest to be paid at a fixed rate or a qualified floating rate, for example, generally is accounted for using constant yield principles. Thus, assuming that a fixed rate or qualified floating rate instrument remains outstanding, hedging gain or loss is taken into account in the same periods in which it would be taken into account if it adjusted the yield of the instrument over the term to which the hedge relates. For example, gain or loss realized on a transaction that hedged an anticipated fixed rate borrowing for its entire term is accounted for, solely for purposes of this section, as if it decreased or increased the issue price of the debt instrument. Similarly, gain or loss realized on a transaction that hedges a contingent payment on a debt instrument subject to [§ 1.1275-4(c)](/cfr/26/1.1275-4.md?p=c) (a contingent payment debt instrument issued for nonpublicly traded property) is taken into account when the contingent payment is taken into account under [§ 1.1275-4(c)](/cfr/26/1.1275-4.md?p=c). - (5) **Notional principal contracts.** The rules of [§ 1.446-3](/cfr/26/1.446-3.md) govern the timing of income and deductions with respect to a notional principal contract unless, because the notional principal contract is part of a hedging transaction, the application of those rules would not result in the matching that is needed to satisfy the clear reflection requirement of [paragraph (b)](#b) and, as applicable, (e)(4) of this section. For example, if a notional principal contract hedges a debt instrument, the method of accounting for periodic payments described in [§ 1.446-3(e)](/cfr/26/1.446-3.md?p=e) and the methods of accounting for nonperiodic payments described in § [1.446-3(f)(2)(iii)](/cfr/26/1.446-3.md?p=f-2-iii) and [(v)](/cfr/26/1.446-3.md?p=f-2-v) generally clearly reflect the taxpayer's income. The methods described in § [1.446-3(f)(2)(ii)](/cfr/26/1.446-3.md?p=f-2-ii) and [(iv)](/cfr/26/1.446-3.md?p=f-2-iv), however, generally do not clearly reflect the taxpayer's income in that situation. - (6) **Disposition of hedged asset or liability.** If a taxpayer hedges an item and disposes of, or terminates its interest in, the item but does not dispose of or terminate the hedging transaction, the taxpayer must appropriately match the built-in gain or loss on the hedging transaction to the gain or loss on the disposed item. To meet this requirement, the taxpayer may mark the hedge to market on the date it disposes of the hedged item. If the taxpayer intends to dispose of the hedging transaction within a reasonable period, however, it may be appropriate to match the realized gain or loss on the hedging transaction with the gain or loss on the disposed item. If the taxpayer intends to dispose of the hedging transaction within a reasonable period and the hedging transaction is not actually disposed of within that period, the taxpayer must match the gain or loss on the hedge at the end of the reasonable period with the gain or loss on the disposed item. For purposes of this [paragraph (e)(6)](#e-6), a reasonable period is generally 7 days. - (7) **Recycled hedges.** If a taxpayer enters into a hedging transaction by recycling a hedge of a particular hedged item to serve as a hedge of a different item, as described in [§ 1.1221-2(d)(4)](/cfr/26/1.1221-2.md?p=d-4), the taxpayer must match the built-in gain or loss at the time of the recycling to the gain or loss on the original hedged item, items, or aggregate risk. Income, deduction, gain, or loss attributable to the period after the recycling must be matched to the new hedged item, items, or aggregate risk under the principles of [paragraph (b)](#b) of this section. - (8) **Unfulfilled anticipatory transactions—** - (i) **In general.** If a taxpayer enters into a hedging transaction to reduce risk with respect to an anticipated asset acquisition, debt issuance, or obligation, and the anticipated transaction is not consummated, any income, deduction, gain, or loss from the hedging transaction is taken into account when realized. - (ii) **Consummation of anticipated transaction.** A taxpayer consummates a transaction for purposes of [paragraph (e)(8)(i)](#e-8-i) of this section upon the occurrence (within a reasonable interval around the expected time of the anticipated transaction) of either the anticipated transaction or a different but similar transaction for which the hedge serves to reasonably reduce risk. - (9) **Hedging by members of a consolidated group—** - (i) **General rule: single-entity approach.** In general, a member of a consolidated group must account for its hedging transactions as if all of the members were separate divisions of a single corporation. Thus, the timing of the income, deduction, gain, or loss on a hedging transaction must match the timing of income, deduction, gain, or loss from the item or items being hedged. Because all of the members are treated as if they were divisions of a single corporation, intercompany transactions are neither hedging transactions nor hedged items for these purposes. - (ii) **Separate-entity election.** If a consolidated group makes an election under [§ 1.1221-2(e)(2)](/cfr/26/1.1221-2.md?p=e-2), then [paragraph (e)(9)(i)](#e-9-i) of this section does not apply. Thus, in that case, each member of the consolidated group must account for its hedging transactions in a manner that meets the requirements of [paragraph (b)](#b) of this section. For example, the income, deduction, gain, or loss from intercompany hedging transactions (as defined in [§ 1.1221-2(e)(2)(ii)](/cfr/26/1.1221-2.md?p=e-2-ii)) is taken into account under the timing rules of § 1.446-4 rather than under the timing rules of [§ 1.1502-13](/cfr/26/1.1502-13.md). - (iii) **Definitions.** For definitions of consolidated group, divisions of a single corporation, intercompany transaction, and member, see [section 1502](/cfr/26/1502.md) and the regulations thereunder. - (iv) **Effective date.** This [paragraph (e)(9)](#e-9) applies to transactions entered into on or after March 8, 1996. - (f) **Type or character of income and deduction.** The rules of this section govern the timing of income, deduction, gain, or loss on hedging transactions but do not affect the type or character of income, deduction, gain, or loss produced by the transaction. Thus, for example, the rules of [paragraph (e)(3)](#e-3) of this section do not affect the computation of cost of goods sold or sales proceeds for a taxpayer that hedges inventory purchases or sales. Similarly, the rules of [paragraph (e)(4)](#e-4) of this section do not increase or decrease the interest income or expense of a taxpayer that hedges a debt instrument or a liability. - (g) **Effective date.** This section applies to hedging transactions entered into on or after October 1, 1994. - (h) **Consent to change methods of accounting.** The Commissioner grants consent for a taxpayer to change its methods of accounting for transactions that are entered into on or after October 1, 1994, and that are described in [paragraph (a)](#a) of this section. This consent is granted only for changes for the taxable year containing October 1, 1994. The taxpayer must describe its new methods of accounting in a statement that is included in its Federal income tax return for that taxable year. # §1.446-5. Debt issuance costs. - (a) **In general.** This section provides rules for allocating debt issuance costs over the term of the debt. For purposes of this section, the term debt issuance costs means those transaction costs incurred by an issuer of debt (that is, a borrower) that are required to be capitalized under [§ 1.263(a)-5](/cfr/26/1.263..5.md). If these costs are otherwise deductible, they are deductible by the issuer over the term of the debt as determined under [paragraph (b)](#b) of this section. - (b) **Method of allocating debt issuance costs—** - (1) **In general.** Solely for purposes of determining the amount of debt issuance costs that may be deducted in any period, these costs are treated as if they adjusted the yield on the debt. To effect this, the issuer treats the costs as if they decreased the issue price of the debt. See [§ 1.1273-2](/cfr/26/1.1273-2.md) to determine issue price. Thus, debt issuance costs increase or create original issue discount and decrease or eliminate bond issuance premium. - (2) **Original issue discount.** Any resulting original issue discount is taken into account by the issuer under the rules in [§ 1.163-7](/cfr/26/1.163-7.md), which generally require the use of a constant yield method (as described in [§ 1.1272-1](/cfr/26/1.1272-1.md)) to compute how much original issue discount is deductible for a period. However, see [§ 1.163-7(b)](/cfr/26/1.163-7.md?p=b) for special rules that apply if the total original issue discount on the debt is de minimis. - (3) **Bond issuance premium.** Any remaining bond issuance premium is taken into account by the issuer under the rules of [§ 1.163-13](/cfr/26/1.163-13.md), which generally require the use of a constant yield method for purposes of allocating bond issuance premium to accrual periods. - (c) **Examples.** The following examples illustrate the rules of this section: - (d) **Effective date.** This section applies to debt issuance costs paid or incurred for debt instruments issued on or after December 31, 2003. - (e) **Accounting method changes—** - (1) **Consent to change.** An issuer required to change its method of accounting for debt issuance costs to comply with this section must secure the consent of the Commissioner in accordance with the requirements of [§ 1.446-1(e)](/cfr/26/1.446-1.md?p=e). [Paragraph (e)(2)](#e-2) of this section provides the Commissioner's automatic consent for certain changes. - (2) **Automatic consent.** The Commissioner grants consent for an issuer to change its method of accounting for debt issuance costs incurred for debt instruments issued on or after December 31, 2003. Because this change is made on a cut-off basis, no items of income or deduction are omitted or duplicated and, therefore, no adjustment under [section 481](/cfr/26/481.md) is allowed. The consent granted by this [paragraph (e)(2)](#e-2) applies provided— - (i) The change is made to comply with this section; - (ii) The change is made for the first taxable year for which the issuer must account for debt issuance costs under this section; and - (iii) The issuer attaches to its federal income tax return for the taxable year containing the change a statement that it has changed its method of accounting under this section. # §1.446-6. REMIC inducement fees. - (a) **Purpose.** This section provides specific timing rules for the clear reflection of income from an inducement fee received in connection with becoming the holder of a noneconomic REMIC residual interest. An inducement fee must be included in income over a period reasonably related to the period during which the applicable REMIC is expected to generate taxable income or net loss allocable to the holder of the noneconomic residual interest. - (b) **Definitions.** For purposes of this section: - (1) **Applicable REMIC.** The applicable REMIC is the REMIC that issued the noneconomic residual interest with respect to which the inducement fee is paid. - (2) **Inducement fee.** An inducement fee is the amount paid to induce a person to become the holder of a noneconomic residual interest in an applicable REMIC. - (3) **Noneconomic residual interest.** A REMIC residual interest is a noneconomic residual interest if it is a noneconomic residual interest within the meaning of [§ 1.860E-1(c)(2)](/cfr/26/1.860E-1.md?p=c-2). - (4) **Remaining anticipated weighted average life.** The remaining anticipated weighted average life is the anticipated weighted average life determined using the methodology set forth in [§ 1.860E-1(a)(3)(iv)](/cfr/26/1.860E-1.md?p=a-3-iv) applied as of the date of acquisition of the noneconomic residual interest. - (5) **REMIC.** The term REMIC has the same meaning in this section as given in [§ 1.860D-1](/cfr/26/1.860D-1.md). - (c) **General rule.** All taxpayers, regardless of their overall method of accounting, must recognize an inducement fee over the remaining expected life of the applicable REMIC in a manner that reasonably reflects, without regard to this paragraph, the after-tax costs and benefits of holding that noneconomic residual interest. - (d) **Special rule on disposition of a residual interest.** If any portion of an inducement fee received with respect to becoming the holder of a noneconomic residual interest in an applicable REMIC has not been recognized in full by the holder as of the time the holder transfers, or otherwise ceases to be the holder for Federal tax purposes of, that residual interest in the applicable REMIC, then the holder must include the unrecognized portion of the inducement fee in income at that time. This rule does not apply to a transaction to which [section 381(c)(4)](/cfr/26/381.md?p=c-4) applies. - (e) **Safe harbors.** If inducement fees are recognized in accordance with a method described in this [paragraph (e)](#e), that method complies with the requirements of [paragraph (c)](#c) of this section. - (1) **The book method.** Under the book method, an inducement fee is recognized in accordance with the method of accounting, and over the same period, used by the taxpayer for financial reporting purposes (including consolidated financial statements to shareholders, partners, beneficiaries, and other proprietors and for credit purposes), provided that the inducement fee is included in income for financial reporting purposes over a period that is not shorter than the period during which the applicable REMIC is expected to generate taxable income. - (2) **The modified REMIC regulatory method.** Under the modified REMIC regulatory method, the inducement fee is recognized ratably over the remaining anticipated weighted average life of the applicable REMIC as if the inducement fee were unrecognized gain being included in gross income under [§ 1.860F-2(b)(4)(iii)](/cfr/26/1.860F-2.md?p=b-4-iii). - (3) **Additional safe harbor methods.** The Commissioner, by revenue ruling or revenue procedure (see [§ 1.601(d)(2)](/cfr/26/1.601.md?p=d-2) of this chapter), may provide additional safe harbor methods for recognizing inducement fees relating to noneconomic REMIC residual interests. - (f) **Method of accounting.** The treatment of inducement fees is a method of accounting to which the provisions of sections [446](/cfr/26/446.md) and [481](/cfr/26/481.md) and the regulations thereunder apply. A taxpayer is generally permitted to adopt a method of accounting for inducement fees that satisfies the requirements of [paragraph (c)](#c) of this section. Once a taxpayer adopts a method of accounting for inducement fees, that method must be applied consistently to all inducement fees received in connection with noneconomic REMIC residual interests and may be changed only with the consent of the Commissioner, as provided by [section 446(e)](/cfr/26/446.md?p=e) and the regulations and procedures thereunder. - (g) **Effective date.** This section is applicable for taxable years ending on or after May 11, 2004. # §1.446-7. Net asset value method for certain money market fund shares. - (a) **In general.** This section provides a permissible method of accounting (the net asset value method, or NAV method) for gain or loss on shares in a money market fund (or MMF). - (b) **Definitions.** For purposes of this section— - (1) **Computation period.** Computation periods are the periods (of either equal or varying length) that a taxpayer selects for computing gain and loss under the NAV method for shares in an MMF. Computation periods must possess all of the following attributes: - (i) Every day during the taxable year falls within one, and only one, computation period; - (ii) Each computation period contains days from only one taxable year; and - (iii) If the taxpayer is a regulated investment company (RIC) that is not described in [section 4982(f)](/cfr/26/4982.md?p=f)— - (A) The same computation periods are used for purposes of both income tax accounting under chapter 1 and excise tax computations under [section 4982](/cfr/26/4982.md); and - (B) The requirements in paragraphs [(b)(1)(i)](#b-1-i) and [(ii)](#b-1-ii) of this section are also satisfied if applied by substituting the RIC's [section 4982](/cfr/26/4982.md) period for the RIC's taxable year. - (2) **Ending value.** The ending value of a taxpayer's shares in an MMF for a computation period is the aggregate fair market value of the taxpayer's shares at the end of that computation period. - (3) **Fair market value.** The fair market value of a share in an MMF is determined as follows: - (i) **Presumption based on applicable published redemption amount.** For purposes of this section, the fair market value of a share in an MMF is presumed to be the applicable published redemption amount for the share. - (ii) **Published redemption amount.** The published redemption amount for a share in an MMF is the published amount for which the MMF would redeem the share (usually, the net asset value per share (NAV)), taking into account any corrections and not taking into account any liquidity fee described in [Rule 2a-7(c)(2)](/cfr/26/2a-7.md?p=c-2) under the Investment Company Act of 1940 ([17 CFR 270.2a-7(c)(2)](/cfr/17/270.2a-7.md?p=c-2)). - (iii) **Applicable published redemption amount.** The applicable published redemption amount is— - (A) For purposes of determining the ending value of a taxpayer's shares in an MMF for a computation period under [paragraph (b)(2)](#b-2) of this section, the last published redemption amount on the last day of that computation period; - (B) For purposes of determining the value of MMF shares received in a redemption or exchange described in [paragraph (b)(5)(ii)(A)](#b-5-ii-A) of this section, the published redemption amount for such MMF shares used to determine the consideration received in the redemption or exchange, or if the consideration received is not based on a published redemption amount, the first published redemption amount for such MMF shares after the redemption or exchange; - (C) For purposes of determining the amount received in a redemption or exchange described in [paragraph (b)(5)(ii)(B)](#b-5-ii-B) of this section in which the consideration received is based on a published redemption amount for the redeemed shares, that published redemption amount; and - (D) For purposes of determining the amount received in an exchange described in [paragraph (b)(5)(ii)(B)](#b-5-ii-B) of this section that is not described in [paragraph (b)(3)(iii)(C)](#b-3-iii-C) of this section, or the amount of any adjustment resulting from a disposition transaction described in [paragraph (b)(5)(iii)](#b-5-iii) of this section, the first published redemption amount for the exchanged or disposed of MMF shares after the exchange or other transaction. - (iv) **Facts and circumstances determination.** If there is no applicable published redemption amount or if circumstances indicate that the amount does not represent the fair market value of a share in the MMF, the fair market value is determined on the basis of all of the facts and circumstances. - (4) **Money market fund (or MMF).** An MMF is a regulated investment company that is permitted to hold itself out to investors as a money market fund under [Rule 2a-7](/cfr/26/2a-7.md) under the Investment Company Act of 1940 ([17 CFR 270.2a-7](/cfr/17/270.2a-7.md)). See [paragraph (c)(5)](#c-5) of this section for the treatment of shares in a single MMF held in more than one account. - (5) **Net investment—** - (i) **In general.** The net investment in an MMF for a computation period may be a positive amount, a negative amount, or zero. Except as provided in [paragraph (b)(5)(iii)](#b-5-iii) of this section, the net investment is equal to— - (A) The aggregate cost of shares in the MMF purchased during the computation period (including purchases through reinvestment of dividends); minus - (B) The aggregate amount received during the computation period in redemption of (or otherwise in exchange for) shares in the MMF in transactions in which gain or loss would be recognized if the taxpayer did not apply the NAV method to the shares. - (ii) **Aggregate amount received.** For purposes of [paragraph (b)(5)(i)(B)](#b-5-i-B) of this section, the amount received in a redemption or exchange of an MMF share is— - (A) If no property other than cash and shares in one or more other MMFs is received, the amount of any cash plus the fair market value of any MMF shares received; or - (B) If any property other than cash or shares in one or more other MMFs is received, the fair market value of the redeemed MMF share. - (iii) **Adjustments—** - (A) **Dispositions in which gain or loss is not recognized.** If, during the computation period, any shares in an MMF are disposed of in transactions in which gain or loss would not be recognized if the taxpayer did not apply the NAV method to the shares, the net investment in the MMF for the computation period is decreased by the fair market value of each such share at the time of its disposition. - (B) **Acquisitions other than by purchase.** If, during the computation period, any shares in an MMF are acquired other than by purchase, the net investment in the MMF for the computation period is increased by the adjusted basis (for purposes of determining loss) of each such share immediately after its acquisition. If the adjusted basis of an acquired share would be determined by reference to the basis of a share or shares in an MMF that are being disposed of by the taxpayer in a transaction that is governed by [paragraph (b)(5)(iii)(A)](#b-5-iii-A) of this section, then the adjusted basis of each such disposed share is treated for purposes of this section as being the fair market value of that share at the time of its disposition. If the adjusted basis of an acquired share would be determined by reference to the basis of that share in the hands of the person from whom the share is acquired and that person was applying the NAV method to the share at the time of the transaction, then the adjusted basis of the share in the hands of the person from whom the share is acquired is treated for purposes of this section as being the fair market value of that share at the time of the transaction. - (6) **Section 4982 period.** If a taxpayer using the NAV method is a RIC to which [section 4982](/cfr/26/4982.md) applies, the [section 4982](/cfr/26/4982.md) period is the one-year period with respect to which gain or loss is determined for purposes of section [4982(e)(2)](/cfr/26/4982.md?p=e-2) and [(e)(6)](/cfr/26/4982.md?p=e-6). The preceding sentence is applied taking into account the application of [section 4982(e)(4)](/cfr/26/4982.md?p=e-4). See [paragraph (c)(8)](#c-8) of this section regarding the application of [section 4982(e)(6)](/cfr/26/4982.md?p=e-6). - (7) **Starting basis.** The starting basis of a taxpayer's shares in an MMF for a computation period is— - (i) Except as provided in [paragraph (b)(7)(ii)](#b-7-ii) of this section, the ending value of the taxpayer's shares in the MMF for the immediately preceding computation period; or - (ii) For the first computation period in a taxable year, if the taxpayer did not use the NAV method for shares in the MMF for the immediately preceding taxable year, the aggregate adjusted basis of the taxpayer's shares in the MMF at the end of the immediately preceding taxable year. - (c) **NAV method—** - (1) **Scope.** A taxpayer may use the NAV method described in this section to determine the gain or loss for a taxable year on the taxpayer's shares in an MMF. A taxpayer may have different methods of accounting, different computation periods, and gains or losses of differing character, for its shares in different MMFs. See [paragraph (c)(5)](#c-5) of this section for the treatment of shares in a single MMF held in more than one account. See [paragraph (c)(6)](#c-6) of this section for rules applicable to RICs to which [section 4982](/cfr/26/4982.md) applies. See [paragraph (c)(8)](#c-8) of this section for rules applicable to accounting method changes. - (2) **Net gain or loss for a taxable year—** - (i) **Determination for each computation period.** Subject to any adjustment under [paragraph (c)(2)(ii)](#c-2-ii) of this section, the net gain or loss for each computation period with respect to the shares in an MMF to which the NAV method applies equals the ending value, minus the starting basis, minus the net investment in the MMF for the computation period. If the computation produces a result that is greater than zero, the taxpayer has a gain for the computation period with respect to the shares in the MMF; if the computation produces a result that is less than zero, the taxpayer has a loss for the computation period with respect to the shares in the MMF; and if the computation produces a result that is equal to zero, the taxpayer has no gain or loss for the computation period with respect to the shares in the MMF. - (ii) **Adjustment of gain or loss to reflect any basis adjustments.** If, during a computation period, there is any downward (or upward) adjustment to the taxpayer's basis in the shares in the MMF under any provision of internal revenue law, then the net gain or loss for the computation period on shares in the MMF determined under [paragraph (c)(2)(i)](#c-2-i) of this section is increased (or decreased) by the amount of the adjustment. - (iii) **Timing of gains and losses.** Gain or loss determined under the NAV method with respect to a taxpayer's shares in an MMF during a computation period is treated as arising on the last day of the computation period. - (iv) **Determination of net gain or loss for each taxable year.** The taxpayer's net gain or loss for a taxable year on shares in an MMF is the sum of the net gains or losses on shares in the MMF for the computation period (or computation periods) that comprise the taxable year. - (3) **Character—** - (i) In the case of a taxpayer that applies the NAV method to shares in an MMF, the gain or loss with respect to those shares for a computation period is treated as gain or loss from a sale or exchange of a capital asset provided the sale or exchange of one or more of those shares during the computation period would give rise to capital gain or loss if the taxpayer did not apply the NAV method to the shares. - (ii) In the case of a taxpayer that applies the NAV method to shares in an MMF, the gain or loss with respect to those shares for a computation period is treated as ordinary gain or loss provided the sale or exchange of every one of those shares during the computation period would give rise to ordinary gain or loss if the taxpayer did not apply the NAV method to the shares. - (iii) See [paragraph (c)(5)](#c-5) of this section for the treatment of shares in a single MMF held in more than one account. - (4) **Holding period.** Capital gains and losses determined under the NAV method are treated as short-term capital gains and losses. - (5) **More than one account.** If a taxpayer holds shares in an MMF through more than one account, the taxpayer must treat its holdings in each account as a separate MMF for purposes of this section. A taxpayer therefore may have different methods of accounting, different computation periods, and gains or losses of differing character, for its shares of a single MMF held in different accounts. - (6) **Consistency requirement for MMF shareholders that are RICs.** If the taxpayer is a RIC that is not described in [section 4982(f)](/cfr/26/4982.md?p=f) (and therefore is subject to the [section 4982](/cfr/26/4982.md) excise tax), then, for each MMF, the taxpayer must use the NAV method for both income tax and excise tax computations or for neither computation. See [paragraph (c)(5)](#c-5) of this section for the treatment of shares in a single MMF held in more than one account. See [paragraph (c)(8)(ii)](#c-8-ii) of this section for changes to or from the NAV method by a RIC. - (7) **Treatment of ordinary gains and losses under section 4982(e)(6).** Under [section 4982(e)(6)(B)](/cfr/26/4982.md?p=e-6-B), this section is a specified mark to market provision, and therefore any ordinary gains and losses determined under the NAV method are governed by [section 4982(e)(6)(A)](/cfr/26/4982.md?p=e-6-A). - (8) **Accounting method changes—** - (i) **In general.** A change to or from the NAV method is a change in method of accounting to which the provisions of [section 446](/cfr/26/446.md) and the accompanying regulations apply. A taxpayer seeking to change to or from the NAV method must secure the consent of the Commissioner in accordance with [§ 1.446-1(e)](/cfr/26/1.446-1.md?p=e) and follow the administrative procedures issued under [§ 1.446-1(e)(3)(ii)](/cfr/26/1.446-1.md?p=e-3-ii) for obtaining the Commissioner's consent to change the taxpayer's accounting method. Any such change will be made on a cut-off basis. Because there will be no duplication or omission of amounts as a result of such a change to or from the NAV method, no adjustment under [section 481(a)](/cfr/26/481.md?p=a) will be required or permitted. - (ii) **RICs—** - (A) **In general.** A RIC that is subject to the excise tax under [section 4982](/cfr/26/4982.md) and that changes to or from the NAV method for its shares in an MMF for income tax purposes must apply the new method for excise tax purposes starting with the first day of the RIC's income tax year of change. If that first day is not the first day of the RIC's [section 4982](/cfr/26/4982.md) period that ends in or with the RIC's income tax year, then solely for purposes of applying the NAV method to compute the RIC's required distribution for the calendar year that ends with or within the RIC's income tax year of change, the [section 4982](/cfr/26/4982.md) period is bifurcated into two portions, each of which is treated as a separate taxable year. The first portion begins on the first day of the [section 4982](/cfr/26/4982.md) period and ends on the last day of the RIC's income tax year that precedes the year of change. The second portion begins on the first day of the income tax year of change and ends on the last day of the [section 4982](/cfr/26/4982.md) period. - (B) **Example.** If a RIC that holds MMF shares as capital assets changes from a realization method to the NAV method for its income tax year ending January 31, 2019, the [section 4982](/cfr/26/4982.md) period is bifurcated into two portions that are treated as separate taxable years solely for purposes of applying this section. For the portion starting on November 1, 2017, and ending on January 31, 2018, the RIC applies its realization method for excise tax purposes. For the portion starting on February 1, 2018, and ending on October 31, 2018, the RIC applies the NAV method for excise tax purposes, treating February 1, 2018, as the first day of the RIC's tax year for purposes of paragraphs [(b)(1)](#b-1) and [(6)](#b-6) of this section. The RIC's net gain or loss for this later portion is determined under [paragraph (c)(2)(iii)](#c-2-iii) of this section. This net gain or loss and any gains and losses for the earlier portion determined under the realization method are taken into account in determining the RIC's capital gain net income for the full one-year period described in [section 4982(b)(1)(B)](/cfr/26/4982.md?p=b-1-B). - (d) **Example.** The provisions of this section may be illustrated by the following example: - (e) **Effective/applicability date.** Except as provided in the following sentence, this section applies to taxable years ending on or after July 8, 2016. For taxable years ending on or after July 28, 2014, and beginning before July 8, 2016, however, shareholders of MMFs may rely either on this section or on § 1.446-7 of the 2014 proposed regulations REG-107012-14 (79 FR 43694).