[Code of Federal Regulations]
[Title 26, Volume 1]
[Revised as of April 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.47-2]

[Page 303-305]
 
                       TITLE 26--INTERNAL REVENUE
 
     CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
 
PART 1--INCOME TAXES--Table of Contents
 
Sec. 1.47-2  ``Disposition'' and ``cessation''.

    (a) General rule--(1) ``Disposition''. For purposes of this section 
and Sec. 1.47-1 and Secs. 1.47-3 through 1.47-6, the term 
``disposition'' includes a sale in a sale-and-leaseback transaction, a 
transfer upon the foreclosure of a security interest and a gift, but 
such term does not include a mere transfer of title to a creditor upon 
creation of a security interest. See paragraph (g) of Sec. 1.47-3 for 
treatment of certain sale-and-leaseback transactions.
    (2) ``Cessation''. (i) A determination of whether section 38 
property ceases to be section 38 property with respect to the taxpayer 
must be made for each taxable year subsequent to the credit year. Thus, 
in each such taxable year the taxpayer must determine, as if such 
property were placed in service in such taxable year, whether such 
property would qualify as section 38 property (within the meaning of 
Sec. 1.48-1) in the hands of the taxpayer for such taxable year.
    (ii) Section 38 property does not cease to be section 38 property 
with respect to the taxpayer in any taxable year subsequent to the 
credit year merely because under the taxpayer's depreciation practice no 
deduction for depreciation with respect to such property is allowable to 
the taxpayer for the taxable year, provided that the property continues 
to be used in the taxpayer's trade or business (or in the production of 
income) and otherwise qualifies as section 38 property with respect to 
the taxpayer.
    (iii) This subparagraph may be illustrated by the following 
examples:

    Example 1. A, an individual who makes his returns on the basis of 
the calendar year, on January 1, 1962, acquired and placed in service in 
his trade or business an item of section 38 property with an estimated 
useful life of eight years. On January 1, 1965, A removes the item of 
section 38 property from use in his trade or business by converting such 
item to personal use. Therefore no deduction for depreciation with 
respect to such item of property is allowable to A for the taxable year 
1965. On January 1, 1965, such item of property ceases to be section 38 
property with respect to A.
    Example 2. On January 1, 1965, A placed in service an item of 
section 38 property with a basis of $10,000 and an estimated useful life 
of 4 years. A depreciates such item, which has a salvage value of $2,000 
(after taking into account section 167(f)), on the declining balance 
method at a rate of 50 percent (that is, twice the straight line rate of 
25 percent). With respect to such item, A is allowed deductions for 
depreciation of $5,000 for 1965, $2,500 for 1966, and $500 for 1967. A 
is not allowed a deduction for depreciation for 1968 although he 
continues to use such item in his trade or business. Such item does not 
cease to be section 38 property with respect to A in 1968.

    (b) Leased property--(1) In general. For purposes of paragraph (a) 
of Sec. 1.47-1, generally the mere leasing of section 38 property by a 
lessor who took the basis of such property into account in computing his 
qualified investment for the credit year shall not be considered to be a 
disposition. However, in a case where a lease is treated as a sale for 
income tax purposes such transaction is considered to be a disposition. 
Leased section 38 property ceases to be section

[[Page 304]]

38 property with respect to the lessor if, in any taxable year 
subsequent to the credit year, such property would not qualify as 
section 38 property (as defined in Sec. 1.48-1) in the hands of the 
lessor, the lessee, or any sublessee. Thus, if, in a taxable year 
subsequent to the credit year, a lessee uses the property predominantly 
outside the United States, such property shall be considered to have 
ceased to be section 38 property with respect to the lessor.
    (2) Where lessor elects to treat lessee as purchaser. For purposes 
of paragraph (a) of Sec. 1.47-1, if, under Sec. 1.48-4, the lessor of 
new section 38 property made a valid election to treat the lessee as 
having purchased such property for purposes of the credit allowed by 
section 38, the following rules apply in determining whether such 
property is disposed of, or otherwise ceases to be section 38 property 
with respect to the lessee:
    (i) Generally, a mere disposition by the lessor of property subject 
to a lease shall not be considered to be a disposition by the lessee.
    (ii) If the lessor makes a disposition of property subject to a 
lease to a person who may not, under Sec. 1.48-4, make a valid election 
to treat the lessee as having purchased such property for purposes of 
the credit allowed by section 38 (such as a person described in 
paragraph (a)(5) of Sec. 1.48-4), such property shall be considered to 
have ceased to be section 38 property with respect to the lessee on the 
date of such disposition.
    (iii) If a lease is terminated and the property is transferred by 
the lessee to the lessor or to any other person, such transfer shall be 
considered to be a disposition by the lessee.
    (iv) If the lessee actually purchases such property in the credit 
year or in a taxable year subsequent to the credit year, such purchase 
shall not be considered to be a disposition.
    (v) The property ceases to be section 38 property with respect to 
the lessee if in any taxable year subsequent to the credit year such 
property would not qualify as section 38 property (as defined in 
Sec. 1.48-1) in the hands of the lessor, the lessee, or any sublessee. 
Thus, for example, if, in a taxable year subsequent to the credit year, 
a sublessee uses the property predominantly outside the United States, 
the property ceases to be section 38 property with respect to the 
lessee.
    (c) Reduction in basis of section 38 property--(1) General rule. If, 
in the credit year or in any taxable year subsequent to the credit year, 
the basis (or cost) of section 38 property is reduced, for example, as a 
result of a refund of part of the cost of the property, then such 
section 38 property shall be treated as having ceased to be section 38 
property with respect to the taxpayer to the extent of the amount of 
such reduction in basis (or cost) on the date the refund which results 
in such reduction in basis (or cost) is received or accrued, except that 
for purposes of Sec. 1.47-1(a) the actual useful life of the property 
treated as having ceased to be section 38 property shall be considered 
to be less than 3 years.
    (2) Example. Subparagraph (1) of this paragraph may be illustrated 
by the following example:

    Example. (i) On January 1, 1962, A, a cash basis taxpayer, acquired 
from X Cooperative an item of section 38 property with a basis of $100 
and an estimated useful life of 10 years which he placed in service on 
such date. The amount of qualified investment with respect to such asset 
was $100. For the taxable year 1962 A was allowed under section 38 a 
credit of $7 against his liability for tax. On June 1, 1963, A receives 
a $10 patronage dividend from X Cooperative with respect to such asset. 
Under paragraph (c)(2)(i) of Sec. 1.1385-1, the basis of the asset in 
A's hands is reduced by $10.
    (ii) Under subparagraph (1) of this paragraph, on June 1, 1963, the 
item of section 38 property ceases to be section 38 property with 
respect to A to the extent of $10 of the original $100 basis.

    (d) Retirements. A retirement of section 38 property, including a 
normal retirement (as defined in paragraph (b) of Sec. 1.167(a)-8, 
relating to definition of normal and abnormal retirements), whether from 
a single asset account or a multiple asset account, and an abandonment, 
are dispositions for purposes of paragraph (a) of Sec. 1.47-1.
    (e) Conversion of section 38 property to personal use. (1) If, for 
any taxable year subsequent to the credit year--
    (i) A deduction for depreciation is allowable to the taxpayer with 
respect to

[[Page 305]]

only a part of section 38 property because such property is partially 
devoted to personal use, and
    (ii) The part of the property (expressed as a percentage of its 
total basis (or cost)) with respect to which a deduction for 
depreciation is allowable for such taxable year is less than the part of 
the property with respect to which a deduction for depreciation was 
allowable in the credit year,

then such property shall be considered as having ceased to be section 38 
property with respect to the taxpayer to such extent. Further, property 
ceases to be section 38 property with respect to the taxpayer to the 
extent that a deduction for depreciation thereon is disallowed under 
section 274 (relating to disallowance of certain entertainment, etc., 
expenses).
    (2) Examples. Subparagraph (1) of this paragraph may be illustrated 
by the following examples:

    Example 1. (i) A, a calendar-year taxpayer, acquired and placed in 
service on January 1, 1962, an automobile with a basis of $2,400 and an 
estimated useful life of four years. In the taxable year 1962 the 
automobile was used by A 80 percent of the time in his trade or business 
and was used 20 percent of the time for personal purposes. Thus, for the 
taxable year 1962 only 80 percent of the basis of the automobile 
qualified as section 38 property since a deduction for depreciation was 
allowable to A only with respect to 80 percent of the basis of the 
automobile. In the taxable year 1963 the automobile is used by A only 60 
percent of the time in his trade or business. Thus, for the taxable year 
1963 a deduction for depreciation is allowable to A only with respect to 
60 percent of the basis of the automobile.
    (ii) Under subparagraph (1) of this paragraph, on January 1, 1963, 
the automobile ceases to be section 38 property with respect to A to the 
extent of 20 percent (80 percent minus 60 percent) of the $2,400 basis 
of the automobile.
    Example 2. (i) The facts are the same as in example 1 and in 
addition for the taxable year 1964 a deduction for depreciation is 
allowable to A only with respect to 40 percent of the basis of the 
property.
    (ii) Under subparagraph (1) of this paragraph, on January 1, 1964, 
the automobile ceases to be section 38 property with respect to A to the 
extent of 20 percent (60 percent minus 40 percent) of the $2,400 basis 
of the automobile.

[T.D. 6931, 32 FR 14032, Oct. 10, 1967, as amended by T.D. 7203, 37 FR 
17128, Aug. 25, 1972]