[Code of Federal Regulations]
[Title 26, Volume 9]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.904(f)-2]

[Page 751-758]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.904(f)-2  Recapture of overall foreign losses.

    (a) In general. A taxpayer shall be required to recapture an overall 
foreign loss as provided in this section. Recapture is accomplished by 
treating as United States source income a portion of the taxpayer's 
foreign source taxable income of the same limitation as the foreign 
source loss that resulted in an overall foreign loss account. As a 
result, if the taxpayer elects the benefits of section 901 or section 
936, the taxpayer's foreign tax credit limitation with respect to such 
income is decreased. As provided in Sec. 1.904 (f)-1(e)(2), the balance 
in a taxpayer's overall foreign loss account is reduced by the amount of 
loss recaptured. Recapture continues until such time as the amount of 
foreign source taxable income recharacterized as United States source 
income equals the amount in the overall foreign loss account. As 
provided in Sec. 1.904 (f)-1(e)(2), the balance in a overall foreign 
loss account is reduced at the end of each taxable year by the amount of 
the loss recaptured during that taxable year. Regardless of whether 
recapture occurs in a year in which a taxpayer elects the benefits of 
section 901 or in a year in which a taxpayer deducts its foreign taxes 
under section 164, the overall foreign loss account is recaptured only 
to the extent of foreign source taxable income remaining after applying 
the appropriate section 904(b) adjustments, if any, as provided in 
paragraph (b) of this section.
    (b) Determination of taxable income from sources without the United 
States for purposes of recapture--(1) In general. For purposes of 
determining the amount of an overall foreign loss subject to recapture, 
the taxpayer's taxable income from sources without the United States 
shall be computed with respect to each of the separate limitations 
described in Sec. 1.904 (f)-1(c)(2) in accordance with the rules set 
forth in Sec. 1.904 (f)-1(c) (1) and (3). This computation is made 
without taking into account foreign source taxable income (and 
deductions properly allocated and apportioned thereto) subject to other 
separate limitations. Before applying the recapture rules to foreign 
source taxable income, the following provisions shall be applied to such 
income in the following order:
    (i) Former section 904(b)(3)(C) (prior to its removal by the Tax 
Reform Act of 1986) and the regulations thereunder shall be applied to 
treat certain foreign source gain as United States source gain; and
    (ii) Section 904(b)(2) and the regulations thereunder shall be 
applied to make adjustments in the foreign tax credit limitation 
fraction for certain capital gains and losses.
    (c) Section 904(f)(1) recapture--(1) In general. In a year in which 
a taxpayer elects the benefits of sections 901 or 936, the amount of any 
foreign source taxable income subject to recapture in a taxable year in 
which paragraph (a) of this section is applicable is the lesser of the 
balance in the applicable overall foreign loss account (after reduction 
of such account in accordance with Sec. 1.904 (f)-1(e)) or fifty 
percent of the taxpayer's foreign source taxable income of the same 
limitation as the loss that resulted in the overall foreign loss account 
(as determined under paragraph (b) of this section). If, in any year, in 
accordance with sections 164(a) and section 275(a)(4)(A), a taxpayer 
deducts rather than credits its foreign

[[Page 752]]

taxes, recapture is applied to the extent of the lesser of (i) the 
balance in the applicable overall foreign loss account or (ii) foreign 
source taxable income of the same limitation type that resulted in the 
overall foreign loss minus foreign taxes imposed on such income.
    (2) Election to recapture more of the overall foreign loss than is 
required under paragraph (c)(1). In a year in which a taxpayer elects 
the benefits of sections 901 or 936, a taxpayer may make an annual 
revocable election to recapture a greater portion of the balance in an 
overall foreign loss account than is required to be recaptured under 
paragraph (c)(1) of this section. A taxpayer may make such an election 
or amend a prior election by attaching a statement to its annual Form 
1116 or 1118. If an amendment is made to a prior year's election, an 
amended tax return should be filed. The statement attached to the Form 
1116 or 1118 must indicate the percentage and dollar amount of the 
taxpayer's foreign source taxable income that is being recharacterized 
as United States source income and the percentage and dollar amount of 
the balance (both before and after recapture) in the overall foreign 
loss account that is being recaptured. Except for the special recapture 
rules for section 936 corporations and for recapture of pre-1983 overall 
foreign losses determined on a combined basis, the taxpayer that elects 
to credit its foreign taxes may not elect to recapture an amount in 
excess of the taxpayer's foreign source taxable income subject to the 
same limitation as the loss that resulted in the overall foreign loss 
account.
    (3) Special rule for recapture of losses incurred prior to section 
936 election. If a corporation elects the application of section 936 and 
at the time of the election has a balance in any overall foreign loss 
account, such losses will be recaptured from the possessions source 
income of the electing section 936 corporation that qualifies for the 
section 936 credit, including qualified possession source investment 
income as defined in section 936(d)(2), even though the overall foreign 
loss to be recaptured may not be attributable to a loss in an income 
category of a type that would meet the definition of qualified 
possession source investment income. For purposes of recapturing an 
overall foreign loss incurred by a consolidated group including a 
corporation that subsequently elects to use section 936, the electing 
section 936 corporation's possession source income that qualifies for 
the section 936 credit, including qualified possession source investment 
income, shall be used to recapture the section 936 corporation's share 
of previously incurred overall foreign loss accounts. Rules for 
determining the section 936 corporation's share of the consolidated 
groups overall foreign loss accounts are provided in Sec. 1.1502-9(c).
    (4) Recapture of pre-1983 overall foreign losses determined on a 
combined basis. If a taxpayer computed its overall foreign losses on a 
combined basis in accordance with Sec. 1.904(f)-1(c)(1) for taxable 
years beginning before January 1, 1983, any losses recaptured in taxable 
years beginning after December 31, 1982, shall be recaptured from income 
subject to the general limitation, subject to the rules in Sec. 
1.904(f)-6 (a) and (b). Ordering rules for recapture of these losses are 
provided in Sec. 1.904(f)-6(c).
    (5) Illustrations. The rules of this paragraph (c) are illustrated 
by the following examples, all of which assume a United States corporate 
tax rate of 50 percent unless otherwise stated.

    Example 1. X Corporation is a domestic corporation that does 
business in the United States and abroad. On December 31, 1983, the 
balance in X's general limitation overall foreign loss account is $600, 
all of which is attributable to a loss incurred in 1983. For 1984, X has 
United States source taxable income of $500 and foreign source taxable 
income subject to the general limitation of $500. For 1984, X pays $200 
in foreign taxes and elects section 901. Under paragraph (c)(1) of this 
section, X is required to recapture $250 (the lesser of $600 or 50 
percent of $500) of its overall foreign loss. As a consequence, X's 
foreign tax credit limitation under the general limitation is $250/
$1,000x$500, or $125, instead of $500/$1,000x$500, or $250. The balance 
in X's general limitation overall foreign loss account is reduced by 
$250 in accordance with Sec. 1.904(f)-1(e)(2).
    Example 2. The facts are the same as in example 1 except that X 
makes an election to recapture its overall foreign loss to the extent of 
80 percent of its foreign source taxable income subject to the general 
limitation (or $400) in accordance with paragraph (c)(2) of this 
section. As a result of recapture,

[[Page 753]]

X's 1984 foreign tax credit limitation for income subject to the general 
limitation is $100/$1,000x$500, or $50, instead of $500/$1,000x$500, or 
$250. X's general limitation overall foreign loss account is reduced by 
$400 in accordance with Sec. 1.904(f)-1(e)(2).
    Example 3. The facts are the same as in example 1 except that X does 
not elect the benefits of section 901 in 1984 and instead deducts its 
foreign taxes paid. In 1984, X recaptures $300 of its overall foreign 
loss, the difference between X's foreign source taxable income of $500 
and $200 of foreign taxes paid. The balance in X's general limitation 
overall foreign loss account is reduced by $300 in accordance with Sec. 
1.904(f)-1(e)(2).
    Example 4. The facts are the same as in example 1 except that in 
1984, X also has $1,000 of foreign source DISC dividend income subject 
to the separate limitation for DISC dividends which carries a foreign 
tax of $50. Under paragraph (c)(1) of this section the amount of X's 
general limitation overall foreign loss subject to recapture is $250 
(the lesser of the balance in the overall foreign loss account or 50 
percent of the foreign source taxable income subject to the general 
limitation). There is no recapture with respect to the DISC dividend 
income. X's separate limitation for DISC dividend income is $1,000/
$2,000x$1,000, or $500. Its general limitation is $250/$2,000x$1,000, or 
$125, instead of $500/$2,000x$1,000, or $250. The balance in X's general 
limitation overall foreign loss account is reduced by $250 in accordance 
with Sec. 1.904(f)-1(e)(2).
    Example 5. On December 31, 1980, V, a domestic corporation that does 
business in the United States and abroad, has a balance in its section 
904(d)(1)(A-C) overall foreign loss account of $600. V also has a 
balance in its FORI limitation overall foreign loss account of $900. For 
1981, V has foreign source taxable income subject to the general 
limitation of $500 and $500 of United States source income. V also has 
foreign source taxable income subject to the FORI limitation of $800. V 
is required to recapture $250 of its section 904(d)(1)(A-C) overall 
foreign loss account (the lesser of $600 or 50% of $500) and its general 
limitation foreign tax credit limitation is $250/$1,800x$900, or $125 
instead of $500/$1,800x$900, or $250. V is also required to recapture 
$400 of its FORI limitation overall foreign loss account (the lesser of 
$900 or 50% of $800). V's foreign tax credit limitation for FORI is 
$400/$1,800x$900, or $200, instead of $800/$1,800x$900, or $400. The 
balance in V's FORI limitation overall foreign loss account is reduced 
to $500 and the balance in V's section 904(d)(1)(A-C) account is reduced 
to $350, in accordance with Sec. 1.904(f)-1(e)(2).
    Example 6. This example assumes a United States corporate tax rate 
of 46 percent (under section 11(b)) and an alternative rate of tax under 
section 1201(a) of 28 percent. W is a domestic corporation that does 
business in the United States and abroad. On December 31, 1984, W has 
$350 in its general limitation overall foreign loss account. For 1985, W 
has $500 of United States source taxable income, and has foreign source 
income subject to the general limitation as follows:

Foreign source taxable income other than net capital gain........   $720
Foreign source net capital gain..................................   $460


    Under paragraph (b)(2) of this section, foreign source taxable 
income for purposes of recapture includes foreign source capital gain 
net income, reduced, under section 904(b)(2), by the rate differential 
portion of foreign source net capital gain, which adjusts for the 
reduced tax rate for net capital gain under section 1201(a):

Foreign source capital gain net income.........................     $460
Rate differential portion of foreign source net capital gain        -180
 (18/46 of $460)...............................................
                                                                --------
Foreign source capital gain included in foreign source taxable      $280
 income........................................................


    The total foreign source taxable income of W for purposes of 
recapture in 1985 is $1,000 ($720+$280). Under paragraph (c)(1) of this 
section, W is required to recapture $350 (the lesser of $350 or 50 
percent of $1,000), and W's general limitation overall foreign loss 
account is reduced to zero. W's foreign tax credit limitation for income 
subject to the general limitation is $650/$1,500x$690 ((.46) 
(500+720)+(.28) (460)), or $299, instead of $1,000/$1,500x$690, or $460.
    (d) Recapture of overall foreign losses from dispositions under 
section 904(f)(3)--(1) In general. If a taxpayer disposes of property 
used or held for use predominantly without the United States in a trade 
or business during a taxable year and that property generates foreign 
source taxable income subject to a separate limitation to which 
paragraph (a) of this section is applicable, (i) gain will be recognized 
on the disposition of such property, (ii) such gain will be treated as 
foreign source income subject to the same limitation as the income the 
property generated, and (iii) the applicable overall foreign loss 
account shall be recaptured as provided in paragraphs (d)(2), (d)(3), 
and (d)(4) of this section. See paragraph (d)(5) of this section for 
definitions.
    (2) Treatment of net capital gain. If the gain from a disposition of 
property to which this paragraph (d) applies is treated as net capital 
gain, all references to such gain in paragraphs (d)(3) and (d)(4) of 
this section shall

[[Page 754]]

mean such gain as adjusted under paragraph (b) of this section. The 
amount by which the overall foreign loss account shall be reduced shall 
be determined from such adjusted gain.
    (3) Dispositions where gain is recognized irrespective of section 
904(f)(3). If a taxpayer recognizes foreign source gain subject to a 
separate limitation on the disposition of property described in 
paragraph (d)(1) of this section, and there is a balance in a taxpayer's 
overall foreign loss account that is attributable to a loss under such 
limitation after applying paragraph (c) of this section, an additional 
portion of such balance shall be recaptured in accordance with 
paragraphs (a) and (b) of this section. The amount recaptured shall be 
the lesser of such balance or 100 percent of the foreign source gain 
recognized on the disposition that was not previously recharacterized.
    (4) Dispositions in which gain would not otherwise be recognized--
(1) Recognition of gain to the extent of the overall foreign loss 
account. If a taxpayer makes a disposition of property described in 
paragraph (d)(1) of this section in which any amount of gain otherwise 
would not be recognized in the year of the disposition, and such 
property was used or held for use to generate foreign source taxable 
income subject to a separate limitation under which the taxpayer had a 
balance in its overall foreign loss account (including a balance that 
arose in the year of the disposition), the taxpayer shall recognize 
foreign source taxable income in an amount equal to the lesser of:
    (A) The sum of the balance in the applicable overall foreign loss 
account (but only after such balance has been increased by amounts added 
to the account for the year of the disposition or has been reduced by 
amounts recaptured for the year of the disposition under paragraph (c) 
and paragraph (d)(3) of this section) plus the amount of any overall 
foreign loss that would be part of a net operating loss for the year of 
the disposition if gain from the disposition were not recognized under 
section 904(f)(3), plus the amount of any overall foreign loss that is 
part of a net operating loss carryover from a prior year, or
    (B) The excess of the fair market value of such property over the 
taxpayer's adjusted basis in such property.

The excess of the fair market value of such property over its adjusted 
basis shall be determined on an asset by asset basis. Losses from the 
disposition of an asset shall not be recognized. Any foreign source 
taxable income deemed received and recognized under this paragraph 
(d)(4)(i) will have the same character as if the property had been sold 
or exchanged in a taxable transaction and will constitute gain for all 
purposes.
    (ii) Basis adjustment. The basis of the property received in an 
exchange to which this paragraph (d)(4) applies shall be increased by 
the amount of gain deemed recognized, in accordance with applicable 
sections of subchapters C (relating to corporate distributions and 
adjustments), K (relating to partners and partnerships), O (relating to 
gain or loss on the disposition of property), and P (relating to capital 
gains and losses). If the property to which this paragraph (d)(4) 
applies was transferred by gift, the basis of such property in the hands 
of the donor immediately preceding such gift shall be increased by the 
amount of the gain deemed recognized.
    (iii) Recapture of overall foreign loss to the extent of amount 
recognized. The provisions of paragraphs (a) and (b) of this section 
shall be applied to the extent of 100 percent of the foreign source 
taxable income which is recognized under paragraph (d)(4)(i) of this 
section. However, amounts of foreign source gain that would not be 
recognized except by application of section 904(f)(3) and paragraph 
(d)(4)(i) of this section, and which are treated as United States source 
gain by application of section 904(b)(3)(C) (prior to its removal by the 
Tax Reform Act of 1986) and paragraph (b)(1) of this section, shall 
reduce the overall foreign loss account (subject to the adjustments 
described in paragraph (d)(2) of this section) if such gain is net 
capital gain, notwithstanding the fact that such amounts would otherwise 
not be recaptured under the ordering rules in paragraph (b) of this 
section.
    (iv) Priorities among dispositions in which gain is deemed to be 
recognized. If, in a single taxable year, a taxpayer

[[Page 755]]

makes more than one disposition to which this paragraph (d)(4) is 
applicable, the rules of this paragraph (d)(4) shall be applied to each 
disposition in succession starting with the disposition which occurred 
earliest, until the balance in the applicable overall foreign loss 
account is reduced to zero. If the taxpayer simultaneously makes more 
than one disposition to which this paragraph (d)(4) is applicable, the 
rules of paragraph (d)(4) shall be applied so that the balance in the 
applicable overall foreign loss account to be recaptured will be 
allocated pro rata among the assets in proportion to the excess of the 
fair market value of each asset over the adjusted basis of each asset.
    (5) Definitions--(i) Disposition. A disposition to which this 
paragraph (d) applies includes a sale; exchange; distribution; gift; 
transfer upon the foreclosure of a security interest (but not a mere 
transfer of title to a creditor upon creation of a security interest or 
to a debtor upon termination of a security interest); involuntary 
conversion; contribution to a partnership, trust, or corporation; 
transfer at death; or any other transfer of property whether or not gain 
or loss is recognized under other provisions of the Code. However, a 
disposition to which this paragraph (d) applies does not include:
    (A) A distribution or transfer of property to a domestic corporation 
described in section 381 (a) (provided that paragraph (d)(6) of this 
section applies);
    (B) A disposition of property which is not a material factor in the 
realization of income by the taxpayer (as defined in paragraph 
(d)(5)(iv) of this section);
    (C) A transaction in which gross income is not realized; or
    (D) The entering into of a unitization or pooling agreement (as 
defined in Sec. 1.614-8(b)(6) of the regulations) containing a valid 
election under section 761(a)(2), and in which the source of the entire 
gain from any disposition of the interest created by the agreement would 
be determined to be foreign source under section 862(a)(5) if the 
disposition occurred presently.
    (ii) Property used in a trade or business. Property is used in a 
trade or business if it is held for the principal purpose of promoting 
the present or future conduct of the trade or business. This generally 
includes property acquired and held in the ordinary course of a trade or 
business or otherwise held in a direct relationship to a trade or 
business. In determining whether an asset is held in a direct 
relationship to a trade or business, principal consideration shall be 
given to whether the asset is used in the trade or business. Property 
will be treated as held in a direct relationship to a trade or business 
if the property was acquired with funds generated by that trade or 
business or if income generated from the asset is available for use in 
that trade or business. Property used in a trade or business may be 
tangible or intangible, real or personal property. It includes property, 
such as equipment, which is subject to an allowance for depreciation 
under section 167 or cost recovery under section 168. Property may be 
considered used in a trade or business even if it is a capital asset in 
the hands of the taxpayer. However, stock of another corporation shall 
not be considered property used in a trade or business if a substantial 
investment motive exists for acquiring and holding the stock. On the 
other hand, stock acquired or held to assure a source of supply for a 
trade or business shall be considered property used in that trade or 
business. Inventory is generally not considered property used in a trade 
or business. However, when disposed of in a manner not in the ordinary 
course of a trade or business, inventory will be considered property 
used in the trade or business. A partnership interest will be treated as 
property used in a trade or business if the underlying assets of the 
partnership would be property used in a trade or business. For purposes 
of section 904(f) (3) and Sec. 1.904(f)-2 (d) (1) and (5), a 
disposition of a partnership interest to which this section applies will 
be treated as a disposition of a proportionate share of each of the 
assets of the partnership. For purposes of allocating the purchase price 
of the interest and the seller's basis in the interest to those assets, 
the principles of Sec. 1.751-1(a) will apply.
    (iii) Property used predominantly outside the United States. 
Property will be considered used predominantly outside

[[Page 756]]

the United States if for a 3-year period ending on the date of the 
disposition (or, if shorter, the period during which the property has 
been used in the trade or business) such property was located outside 
the United States more than 50 percent of the time. An aircraft, 
railroad rolling stock, vessel, motor vehicle, container, or other 
property used for transportation purposes is deemed to be used 
predominantly outside the United States if, during the 3-year (or 
shorter) period, either such property is located outside the United 
States more than 50 percent of the time or more than 50 percent of the 
miles traversed in the use of such property are traversed outside the 
United States.
    (iv) Property which is a material factor in the realization of 
income. For purposes of this section, property used in a trade or 
business will be considered a material factor in the realization of 
income unless the taxpayer establishes that it is not (or, if the 
taxpayer did not realize income from the trade or business in the 
taxable year, would not be expected to be) necessary to the realization 
of income by the taxpayer.
    (6) Carryover of overall foreign loss accounts in a corporate 
acquisition to which section 381(a) applies. In the case of a 
distribution or transfer described in section 381(a), an overall foreign 
loss account of the distributing or transferor corporation shall be 
treated as an overall foreign loss account of the acquiring or 
transferee corporation as of the close of the date of the distribution 
or transfer. If the transferee corporation had an overall foreign loss 
account under the same separate limitation prior to the distribution or 
transfer, the balance in the transferor's account must be added to the 
transferee's account. If not, the transferee must adopt the transferor's 
overall foreign loss account. An overall foreign loss of the transferor 
will be treated as incurred by the transferee in the year prior to the 
year of the transfer.
    (7) Illustrations. The rules of this paragraph (d) are illustrated 
by the following examples which assume that the United States corporate 
tax rate is 50 percent (unless otherwise stated). For purposes of these 
examples, none of the foreign source gains are treated as net capital 
gains (unless so stated).

    Example 1. X Corporation has a balance in its general limitation 
overall foreign loss account of $600 at the close of its taxable year 
ending December 31, 1984. In 1985, X sells assets used predominantly 
outside the United States in a trade or business and recognizes $1,000 
of gain on the sale under section 1001. This gain is subject to the 
general limitation. This sale is a disposition within the meaning of 
paragraph (d)(5)(i) of this section, and to which this paragraph (d) 
applies. X has no other foreign source taxable income in 1985 and has 
$1,000 of United States source taxable income. Under paragraph (c), X is 
required to recapture $500 (the lesser of the balance in X's general 
limitation overall foreign loss account ($600) or 50 percent of $1,000) 
of its overall foreign loss account. The balance in X's general 
limitation overall foreign loss account is reduced to $100 in accordance 
with Sec. 1.904(f)-1(e)(2). In addition, under paragraph (d)(3) of this 
section, X is required to recapture $100 (the lesser of the remaining 
balance in its general limitation overall foreign loss account ($100) or 
100 percent of its foreign source taxable income recognized on such 
disposition that has not been previously recharacterized ($500)). The 
total amount recaptured is $600. X's foreign tax credit limitation for 
income subject to the general limitation in 1985 is $200 ($400/
$2,000x$1,000) instead of $500 ($1,000/$2,000x$1,000). The balance in 
X's general limitation overall foreign loss account is reduced to zero 
in accordance with Sec. 1.904(f)-1(e)(2).
    Example 2. On December 31, 1984, Y Corporation has a balance in its 
general limitation overall foreign loss account of $1,500. In 1985, Y 
has $500 of United States source taxable income and $200 of foreign 
source taxable income subject to the general limitation. Y's foreign 
source taxable income is from the sale of property used predominantly 
outside of the United States in a trade or business. This sale is a 
disposition to which this paragraph (d) is applicable. In 1985, Y also 
transferred property used predominantly outside of the United States in 
a trade or business to another corporation. Under section 351, no gain 
was recognized on this transfer. Such property had been used to generate 
foreign source taxable income subject to the general limitation. The 
excess of the fair market value of the property transferred over Y's 
adjusted basis in such property was $2,000. In accordance with paragraph 
(c) of this section, Y is required to recapture $100 (the lesser of 
$1,500, the amount in Y's general limitation overall foreign loss 
account, or 50 percent of $200, the amount of general limitation foreign 
source taxable income for the current year) of its general limitation 
overall foreign loss. Y is then required to recapture an additional $100 
of its general limitation overall foreign loss account under paragraph 
(d)(3) of this section

[[Page 757]]

out of the remaining gain recognized on the sale of assets, because 100 
percent of such gain is subject to recapture. The balance in Y's general 
limitation overall foreign loss account is reduced to $1,300 in 
accordance with Sec. 1.904(f)-1(e)(2). Y corporation is then required 
to recognize $1,300 of foreign source taxable income on its section 351 
transfer under paragraph (d)(4) of this section. The remaining $700 of 
potential gain associated with the section 351 transfer is not 
recognized. Under paragraph (d)(4), 100 percent of the $1,300 is 
recharacterized as United States source taxable income, and Y's general 
limitation overall foreign loss account is reduced to zero. Y's entire 
taxable income for 1985 is:

U.S. source taxable income.................................         $500
Foreign source taxable income subject to the general                 200
 limitation that is recharacterized as U.S. source income
 by paragraphs (c) and (d)(3) of this section..............
Gain recognized under section 904(f)(3) and paragraph              1,300
 (d)(4) of this section, and rechar acterized as U.S.
 source income.............................................
                                                            ------------
    Total..................................................       $2,000



Y's foreign tax credit limitation for 1985 for income subject to the 
general limitation is $0 ($0/$2,000x$1,000) instead of $100 ($200/
$700x$350).
    Example 3. W Corporation is a calendar year domestic corporation 
with foreign branch operations in country C. As of December 31, 1984, W 
has no overall foreign loss accounts and has no net operating loss 
carryovers. W's entire taxable income in 1985 is:

U.S. source taxable income.................................         $800
Foreign source taxable income (loss) subject to the general     ($1,000)
 limitation................................................



W cannot carry back its 1985 NOL to any earlier year. As of December 31, 
1985, W therefore has $800 in its general limitation overall foreign 
loss account. In 1986, W earns $400 United States source taxable income 
and has an additional $1,000 loss from the operations of the foreign 
branch. Income in the loss category would be subject to the general 
limitation. Also in 1986, W disposes of property used predominately 
outside the United States in a trade or business. Such property 
generated income subject to the general limitation. The excess of the 
property's fair market value over its adjusted basis is $3,000. The 
disposition is of a type described in Sec. 1.904 (f)-2(d)(4)(i). W has 
no other income in 1986. Under Sec. 1.904 (f)-2(d)(4)(i), W is required 
to recognize foreign source taxable income on the disposition in an 
amount equal to the lesser of $2,000 ($800 (the balance in the general 
limitation overall foreign loss account as of 1985) + $400 (the increase 
in the general limitation overall foreign loss account attributable to 
the disposition year) + $600 (the general limitation overall foreign 
loss that is part of the NOL from 1986) + $200 (the general limitation 
overall foreign loss that is part of the NOL from 1985)) or $3,000. The 
$2,000 foreign source income required to be recognized under section 
904(f)(3) is reduced to $1,200 by the remaining $600 loss in 1986 and 
the $200 net operating loss carried forward from 1985. This $1,200 of 
income is subject to the general limitation. In computing foreign tax 
credit limitation for general limitation income, the $1,200 of foreign 
source income is treated as United States source income and, therefore, 
W's foreign tax credit limitation for income subject to the general 
limitation is zero. W's overall foreign loss account is reduced to zero.
    Example 4. Z Corporation has a balance in its FORI overall foreign 
loss account of $1,500 at the end of its taxable year 1980. In 1981, Z 
has $1,600 of foreign oil related income subject to the separate 
limitation for FORI income and no United States source income. In 
addition, in 1981, Z makes two dispositions of property used 
predominantly outside the United States in a trade or business on which 
no gain was recognized. Such property generated foreign oil related 
income. The excess of the fair market value of the property transferred 
in the first disposition over Z's adjusted basis in such property is 
$575. The excess of the fair market value of the property transferred in 
the second disposition over Z's adjusted basis in such property is 
$1,000. Under paragraph (c) of this section, Z is required to recapture 
$800 (the lesser of 50 percent of its foreign oil related income of 
$1,600 or the balance ($1,500) in its FORI overall foreign loss account) 
of its foreign oil related loss. In accordance with paragraphs (d)(4) 
(i) and (iv) of this section, Z is required to recognize foreign oil 
related income in the amount of $575 on the first disposition and, since 
the foreign oil related loss account is now reduced by $1,375 (the $800 
and $575 amounts previously recaptured), Z is required to recognize 
foreign oil related income in the amount of $125 on the second 
disposition. In accordance with paragraph (d)(4)(iii) of this section, 
the entire amount recognized is treated as United States source income 
and the balance in the FORI overall foreign loss account is reduced to 
zero under Sec. 1.904 (f)-1 (e)(2). Z's foreign tax credit limitation 
for FORI is $400 ($800/$2,300x$1,150) instead of $800 ($1,600/
$1,600x$800).
    Example 5. The facts are the same as in example 4, except that the 
gain from the two dispositions of property is treated as net capital 
gain and the United States corporate tax rate is assumed to be 46 
percent. As in example 4, Z is required to recapture $800 of its foreign 
oil related loss from its 1981 ordinary foreign oil related income. In 
accordance

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with paragraph (d)(4) (i) and (iv) of this section, Z is first required 
to recognize foreign oil related income (which is net capital gain) on 
the first disposition in the amount of $575. Under paragraphs (b) and 
(d) (2) of this section, this net capital gain is adjusted by 
subtracting the rate differential portion of such gain from the total 
amount of such gain to determine the amount by which the foreign oil 
related loss account is reduced, which is $350 ($575- ($575x18/46)). The 
balance remaining in Z's foreign oil related loss account after this 
step is $350. Therefore, this process will be repeated, in accordance 
with paragraph (d)(4)(iv) of this section, to recapture that remaining 
balance out of the gain deemed recognized on the second disposition, 
resulting in reduction of the foreign oil related loss account to zero 
and net capital gain required to be recognized from the second 
dispostion in the amount of $575, which must also be adjusted by 
subtracting the rate differential portion to determine the amount by 
which the foreign oil related loss account is reduced (which is $350). 
The $575 of net capital gain from each disposition is recharacterized as 
United States source net capital gain. Z's section 907 (b) foreign tax 
credit limitation is the same as in example 4, and Z has $1,150 
($575+$575) of United States source net capital gain.

[T.D. 8153, 52 FR 31997, Aug. 25, 1987; 52 FR 43434, Nov. 12, 1987]