[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.166-3]

[Page 916-917]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.166-3  Partial or total worthlessness.

    (a) Partial worthlessness--(1) Applicable to specific debts only. A 
deduction under section 166(a)(2) on account of partially worthless 
debts shall be allowed with respect to specific debts only.
    (2) Charge-off required. (i) If, from all the surrounding and 
attending circumstances, the district director is satisfied that a debt 
is partially worthless, the amount which has become worthless shall be 
allowed as a deduction under section 166(a)(2) but only to the extent 
charged off during the taxable year.
    (ii) If a taxpayer claims a deduction for a part of a debt for the 
taxable year within which that part of the debt is

[[Page 917]]

charged off and the deduction is disallowed for that taxable year, then, 
in a case where the debt becomes partially worthless after the close of 
that taxable year, a deduction under section 166(a)(2) shall be allowed 
for a subsequent taxable year but not in excess of the amount charged 
off in the prior taxable year plus any amount charged off in the 
subsequent taxable year. In such instance, the charge-off in the prior 
taxable year shall, if consistently maintained as such, be sufficient to 
that extent to meet the charge-off requirement of section 166(a)(2) with 
respect to the subsequent taxable year.
    (iii) Before a taxpayer may deduct a debt in part, he must be able 
to demonstrate to the satisfaction of the district director the amount 
thereof which is worthless and the part thereof which has been charged 
off.
    (3) Significantly modified debt--(i) Deemed charge-off. If a 
significant modification of a debt instrument (within the meaning of 
Sec. 1.1001-3) during a taxable year results in the recognition of gain 
by a taxpayer under Sec. 1.1001-1(a), and if the requirements of 
paragraph (a)(3)(ii) of this section are met, there is a deemed charge-
off of the debt during that taxable year in the amount specified in 
paragraph (a)(3)(iii) of this section.
    (ii) Requirements for deemed charge-off. A debt is deemed to have 
been charged off only if--
    (A) The taxpayer (or, in the case of a debt that constitutes 
transferred basis property within the meaning of section 7701(a)(43), a 
transferor taxpayer) has claimed a deduction for partial worthlessness 
of the debt in any prior taxable year; and
    (B) Each prior charge-off and deduction for partial worthlessness 
satisfied the requirements of paragraphs (a) (1) and (2) of this 
section.
    (iii) Amount of deemed charge-off. The amount of the deemed charge-
off, if any, is the amount by which the tax basis of the debt exceeds 
the greater of the fair market value of the debt or the amount of the 
debt recorded on the taxpayer's books and records reduced as appropriate 
for a specific allowance for loan losses. The amount of the deemed 
charge-off, however, may not exceed the amount of recognized gain 
described in paragraph (a)(3)(i) of this section.
    (iv) Effective date. This paragraph (a)(3) applies to significant 
modifications of debt instruments occurring on or after September 23, 
1996.
    (b) Total worthlessness. If a debt becomes wholly worthless during 
the taxable year, the amount thereof which has not been allowed as a 
deduction from gross income for any prior taxable year shall be allowed 
as a deduction for the current taxable year.

[T.D. 6500, 25 FR 11402, Nov. 29, 1960, as amended by T.D. 8763, 63 FR 
4396, Jan. 29, 1998]