[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1238-1]

[Page 329-330]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1238-1  Amortization in excess of depreciation.

    (a) In general. Section 1238 provides that if a taxpayer is entitled 
to a deduction for amortization of an emergency facility under section 
168, and if the facility is later sold or exchanged, any gain realized 
shall be considered as ordinary income to the extent that the 
amortization deduction exceeds normal depreciation. Thus, under section 
1238 gain from a sale or exchange of property shall be considered as 
ordinary income to the extent that its adjusted basis is less than its 
adjusted basis would be if it were determined without regard to section 
168. If an entire facility is certified under section 168(e), the 
taxpayer may use allowances for depreciation based on any rate and 
method which would have been proper if the basis of the facility were 
not subject to amortization under section 168, in determining what the 
adjusted basis of the facility would be if it were determined without 
regard to section 168. If only a portion of a facility is certified 
under section 168(e), allowances for depreciation based on the rate and 
method properly used with respect to the uncertified part of the 
facility are used in determining what the adjusted basis of the facility 
would be if it were determined without regard to section 168. The 
principles of this paragraph may be illustrated by the following 
examples:

    Example 1. On December 31, 1954, a taxpayer making his income tax 
returns on a calendar year basis acquires at a cost of $20,000 an 
emergency facility (used in his business) 50 percent of the adjusted 
basis of which has been certified under section 168(e). The facility 
would normally have a useful life of 20 years and a salvage value of 
$2,000 allocable equally between the certified and uncertified portions. 
Under section 168 the taxpayer elects to begin the 60-month amortization 
period on January 1, 1955. He takes amortization deductions with respect 
to the certified portion in the amount of $4,000 for the years 1955 and 
1956 (24 months). On December 31, 1956, he sells the facility for a 
price of $19,000 which is allocable equally between the certified and 
uncertified portions. The adjusted basis of the certified portion on 
that date is $6,000 ($10,000 cost, less $4,000 amortization). With 
respect to the uncertified portion, the straight line method of 
depreciation is used and a deduction for depreciation in the amount of 
$450 is claimed and allowed for the year 1955. The adjusted basis of the 
uncertified portion on January 1, 1956, is $9,550 ($10,000 cost, less 
$450 depreciation). The depreciation allowance for the uncertified 
portion for the year 1956 would be limited to $50, the amount by which 
the adjusted basis of such portion at the beginning of the year exceeded 
its aliquot portion of the sales price. Thus, on December 31, 1956, the 
adjusted basis of the uncertified portion would be $9,500. Without 
regard to section 168, and using the rate and method the taxpayer 
properly applied to the uncertified portion of the facility, the 
adjusted basis of the certified portion on December 31, 1956, would be 
$9,500, computed in the same manner as the adjusted basis of the 
uncertified portion. The difference between the facility's actual 
adjusted basis ($15,500) and its adjusted basis determined without 
regard to section 168 ($19,000), is $3,500. Accordingly, the entire 
$3,500 gain on the sale of the facility ($19,000 sale price, less 
$15,500 adjusted basis) is treated as ordinary income.
    Example 2. Assume that the entire facility in example (1) had been 
certified under section 168(e) and that, therefore, the adjusted basis 
of the facility on December 31, 1956, is $12,000. Assume further that 
the taxpayer adopts straight line depreciation as a proper method of 
depreciation for determining the adjusted basis of the facility without 
regard to section 168. Thus, the adjusted basis, without regard to 
section 168, would be $19,000. This amount is $7,000 more than the 
$12,000 adjusted basis under section 168. Hence, the entire $7,000 gain 
on the sale of the facility ($19,000 sale price less $12,000 adjusted 
basis) is treated as ordinary income.

    (b) Substituted basis. If a taxpayer acquires other property in an 
exchange for an emergency facility with respect to which amortization 
deductions have been allowed or allowable, and if the basis in his hands 
of the other property is determined by reference to the basis of the 
emergency facility, then the

[[Page 330]]

basis of the other property is determined with regard to section 168, 
and therefore the provisions of section 1238 apply with respect to gain 
realized on a subsequent sale or exchange of the other property. The 
provisions of section 1238 also apply to gain realized on the sale or 
exchange of an emergency facility (or other property acquired, as 
described in the preceding sentence, in exchange for an emergency 
facility) by a taxpayer in whose hands the basis of the facility (or 
other property) is determined by reference to its basis in the hands of 
another person to whom deductions were allowable or allowed with respect 
to the facility under section 168.

[T.D. 6500, 25 FR 12020, Nov. 26, 1960, as amended by T.D. 6825, 30 FR 
7281, June 2, 1965]