[Code of Federal Regulations]
[Title 26, Volume 9]
[Revised as of April 1, 2002]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.857-3]

[Page 77-78]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1--INCOME TAXES--Table of Contents
 
Sec. 1.857-3  Net income from foreclosure property.

    (a) In general. For purposes of section 857(b)(40(B), net income 
from foreclosure property means the aggregate of--
    (1) All gains and losses from sales or other dispositions of 
foreclosure property described in section 1221(1), and,
    (2) The difference (hereinafter called ``net gain or loss from 
operations'') between (i) the gross income derived from foreclosure 
property (as defined in section 856(e)) to the extent such gross income 
is not described in subparagraph (A), (B), (C), (D), (E), or (G) of 
section 856(c)(3), and (ii) the deductions allowed by chapter 1 of the 
Code which are directly connected with the production of such gross 
income.

Thus, the sum of the gains and losses from sales or other dispositions 
of foreclosure property described in section 1221(1) is aggregated with 
the net gain or loss from operations in arriving at net income from 
foreclosure property. For example, if for a taxable year a real estate 
investment trust has gain of $100 from the sale of an item of 
foreclosure property described in section 1221(1), a loss of $50 from 
the sale of an item of foreclosure property described in section 
1221(1), gross income of $25 from the rental of foreclosure property 
that is not gross income described in subparagraph (A), (B), (C), (D), 
or (G) of section 856(c)(3), and deductions of $35 allowed by chapter 1 
of the Code which are directly connected with the production of the 
rental income, the net income from foreclosure property for the taxable 
years is $40 (($100-$50)+($25-$35)).
    (b) Directly connected deductions. A deduction which is otherwise 
allowed by chapter 1 of the Code is ``directly connected'' with the 
production of gross income from the foreclosure property if it has a 
proximate and primary relationship to the earning of the income. Thus, 
in the case of gross income from real property that is foreclosure 
property, ``directly connected'' deductions would include depreciation 
on the property, interest paid or accrued on the indebtedness of the 
trust (whether or not secured by the property) to the extent 
attributable to the carrying of the property, real estate taxes, and 
fees paid to an independent contractor hired to manage the property. On 
the other hand, general overhead and administrative expenses of the 
trust are not ``directly connected'' deductions.

[[Page 78]]

Thus, salaries of officers and other administrative employees of the 
trust are not ``directly connected'' deductions. The net operating loss 
deduction provided by section 172 is not allowed in computing net income 
from foreclosure property.
    (c) Net loss from foreclosure property. The tax imposed by section 
857(b)(4) applies only if there is net income from foreclosure property. 
If there is a net loss from foreclosure property (that is, if the 
aggregate computed under paragraph (a) of this section results in a 
negative amount) the loss is taken into account in computing real estate 
investment trust taxable income under section 857(b)(2).
    (d) Gross income not subject to tax on foreclosure property. If the 
gross income derived from foreclosure property consists of two classes, 
a deduction directly connected with the production of both classes 
(including interest attributable to the carrying of the property) must 
be apportioned between them. The two classes are:
    (1) Gross income which is taken into account in computing net income 
from foreclosure property and
    (2) Other income (such as income described in subparagraph (A), (B), 
(C), (D), or (G) of section 856(c)(3)).

The apportionment may be made on any reasonable basis.
    (e) Allocation and apportionment of interest. For purposes of 
determining the amount of interest attributable to the carrying of 
foreclosure property under paragraph (b) of this section, the following 
rules apply:
    (1) Deductible interest. Interest is taken into account under this 
paragraph (e) only if it is otherwise deductible under chapter 1 of the 
Code.
    (2) Interest specifically allocated to property. Interest that is 
specifically allocated to an item of property is attributable only to 
the carrying of that property. Interest is specifically allocated to an 
item of property if (i) the indebtedness on which the interest is paid 
or accrued is secured only by that property, (ii) such indebtedness was 
specifically incurred for the purpose of purchasing, constructing, 
maintaining, or improving that property, and (iii) the proceeds of the 
borrowing were applied for that purpose.
    (3) Other interest. Interest which is not specifically allocated to 
property is apportioned between foreclosure property and other property 
under the principles of Sec. 1.861-8(e)(2)(v).
    (4) Effective date. The rules in this paragraph (e) are mandatory 
for all taxable years ending after February 6, 1981.

(Sec. 856(d)(4) (90 Stat. 1750; 26 U.S.C. 856(d)(4)); sec. 856(e)(5) (88 
Stat. 2113; 26 U.S.C. 856(e)(5)); sec. 856(f)(2) (90 Stat. 1751; 26 
U.S.C. (856(f)(2)); sec. 856(g)(2) (90 Stat. 1753; 26 U.S.C. 856(g)(2)); 
sec. 858(a) (74 Stat. 1008; 26 U.S.C. 858(a)); sec. 859(c) (90 Stat. 
1743; 26 U.S.C. 859(c)); sec. 859(e) (90 Stat. 1744; 26 U.S.C. 859(e)); 
sec. 6001 (68A Stat. 731; 26 U.S.C. 6001); sec. 6011 (68A Stat. 732; 26 
U.S.C. 6011); sec. 6071 (68A Stat. 749, 26 U.S.C. 6071); sec. 6091 (68A 
Stat. 752; 26 U.S.C. 6091); sec. 7805 (68A Stat. 917; 26 U.S.C. 7805), 
Internal Revenue Code of 1954))

[T.D. 7767, 46 FR 11277, Feb. 6, 1981]