The temporary regulations include rules in §§1.904(g)-1T and 1.904(g)-2T which address the establishment, maintenance, and recapture of overall domestic loss accounts.

Section 1.904(g)-1T(b)(1) provides that taxpayers must establish overall domestic loss accounts for an overall domestic loss. It further provides that a separate overall domestic loss account must be maintained for each separate category of foreign source income that is offset by a domestic loss.

Section 1.904(g)-1T(b)(2) explains when an overall domestic loss is sustained. Generally, an overall domestic loss is treated as sustained in the later of the taxable years in which the domestic loss is incurred or the foreign source income offset by the domestic loss is earned. Accordingly, in the case of a domestic loss that is carried back to offset foreign source income in a prior taxable year in which the taxpayer elects to credit foreign taxes, the resulting overall domestic loss is treated as sustained in the taxable year the domestic loss is incurred, not in the prior taxable year in which the domestic loss offsets foreign source income. In the case of a domestic loss that is carried forward to offset foreign source income in a later taxable year, however, the overall domestic loss is treated as sustained in the year in which the domestic loss offsets foreign source income, not the earlier year in which the domestic loss is incurred. Accordingly, if a taxpayer incurs a domestic loss in a pre-2007 taxable year, and the loss is carried forward as part of a net operating loss and applied to offset foreign source income in a post-2006 taxable year, the resulting overall domestic loss is treated as sustained in the post-2006 taxable year.

Section 1.904(g)-1T(c) provides that an overall domestic loss is sustained when a domestic loss offsets foreign source taxable income in the same taxable year or a preceding taxable year by reason of a carryback, provided the taxpayer has elected to take a credit for its foreign taxes in the year of the offset. A domestic loss is the amount by which U.S. source gross income is exceeded by deductions properly allocated and apportioned thereto. See §1.904(g)-1T(c).

Section 1.904(g)-1T(d) describes additions to overall domestic loss accounts. This includes any overall domestic losses of the taxpayer, as determined above, as well as any allocation from another taxpayer of an overall domestic loss account under §1.1502-9T, described in Part V of this preamble, and certain adjustments for capital gains and losses. Section 1.904(g)-1T(e) describes reductions to overall domestic loss accounts, including reductions for recaptured amounts and any allocation to another taxpayer of an overall domestic loss account under §1.1502-9T.

Section 1.904(g)-2T provides that overall domestic losses are recaptured by treating a portion of a taxpayer’s U.S. source taxable income as foreign source income. If the taxpayer has overall domestic loss accounts attributable to more than one separate category, the recharacterized income will be allocated among those categories on a pro rata basis. The amount of U.S. source income subject to recapture is the lesser of the aggregate balance in the overall domestic loss account, or fifty percent of the taxpayer’s U.S. source taxable income. Unlike the overall foreign loss recapture provisions in section 904(f), section 904(g) does not permit a taxpayer to elect to recharacterize more than fifty percent of its U.S. source taxable income. Recapture continues until the balance in the overall domestic loss account has been reduced to zero.

As discussed below, the 1987 regulations do not reflect the enactment of the separate limitation loss provisions of section 904(f)(5) as part of the 1986 Act. These temporary regulations include new provisions regarding the establishment and recapture of separate limitation loss accounts. Section 1.904(f)-7T provides that taxpayers must establish a separate limitation loss account with respect to a separate category to the extent a foreign source loss in that category offsets foreign source income in another separate category. This section also provides definitions and rules relating to the maintenance of these accounts.

Section 1.904(f)-8T provides rules for the recapture of separate limitation loss accounts. Separate limitation loss accounts are recaptured by recharacterizing a portion of the foreign source income in the separate category with the loss account as income in the separate category in which foreign source income of a prior year was offset to create the loss account. The amount of foreign source income subject to recharacterization is the lesser of the balance in a separate limitation loss account or the amount of foreign source income for the taxable year in that same separate category. There is no fifty-percent limitation with respect to separate limitation loss account recapture. If there is more than one separate limitation loss account in a single separate category and the aggregate balance in all those loss accounts exceeds the income in the separate category, income is recharacterized in proportion to the balance in each account. Recapture with respect to a particular separate limitation loss account continues until the balance in the separate limitation loss account has been reduced to zero.

The 1987 regulations set forth rules governing the determination and maintenance of overall foreign loss accounts, as well as the recapture of overall foreign losses and the allocation of net operating losses and net capital losses. The regulations do not reflect changes made to the overall foreign loss rules of section 904(f) as part of the 1986 Act and certain subsequent changes to section 904(f), such as the enactment in the AJCA of section 904(f)(3)(D), addressing dispositions of stock in controlled foreign corporations. These temporary regulations update the existing regulations to take into account certain changes made to the overall foreign loss rules since the 1987 regulations were promulgated.

Section 1.904(f)-1(a) states that the 1987 regulations apply to taxpayers that sustain overall foreign losses (as defined in paragraph (c) of that section) in taxable years beginning after December 31, 1975. However, paragraph (c) of that section only defines overall foreign losses for taxable years beginning after December 31, 1982, and before January 1, 1987.

While it is beyond the scope of this project to undertake a full revision of the 1987 regulations to reflect all intervening statutory changes made to section 904(f), the Treasury Department and the IRS believe that as part of this regulations project the principles of the 1987 regulations should be extended to apply to overall foreign losses sustained in taxable years beginning after December 31, 1986, modified so as to take into account statutory amendments. New §1.904(f)-1T(a)(2) adopts such a rule.

The Treasury Department and the IRS believe the application of the fifty-percent limitation on the amount of foreign source income subject to recapture in a taxable year under the overall foreign loss recapture provisions also needs to be clarified as part of this regulations project. Section 1.904(f)-2(c)(1) provides that the amount of foreign source taxable income subject to recapture in a taxable year is the lesser of the balance in the applicable overall foreign loss account in a given separate category or fifty percent of the taxpayer’s foreign source taxable income in that same separate category. For example, recapture of a general category overall foreign loss would be limited to the lesser of the balance in the general category overall foreign loss account or fifty percent of the general category taxable income for the taxable year.

The legislative history to the 1986 Act clarifies that the fifty-percent limitation is to be applied to the full amount of the taxpayer’s foreign source income, not on a separate-category-by-separate-category basis. See H.R. Conf. Rep. No. 99-841 at II-590 (1986). This clarification was incorporated by reference into Notice 89-3, paragraph 3(b), and reflected in instructions to Form 1118 (Foreign Tax Credit — Corporations). The temporary regulations modify the fifty-percent limitation to reflect this clarification.

Section 1.904(f)-2T(c)(1) provides that the foreign source taxable income subject to recharacterization is the lesser of the aggregate amount of maximum potential recapture in all overall foreign loss accounts or fifty percent of the taxpayer’s total foreign source income. If the aggregate amount of maximum potential recapture in all overall foreign loss accounts exceeds fifty percent of the taxpayer’s total foreign source taxable income, foreign source taxable income in each separate category with an overall foreign loss account is recharacterized in an amount equal to the separate category’s allocable portion of the section 904(f)(1) recapture amount. The maximum potential recapture from any separate category is the lesser of the balance in the overall foreign loss account or the foreign source taxable income for the current year in the same separate category.

Other revisions to the 1987 regulations include updating provisions to reflect statutory and regulatory changes affecting capital gains and losses, in particular those provisions that were superseded by the regulations promulgated under section 904(b) in T.D. 9141, 2004-2 C.B. 359 (July 20, 2004). In addition, §1.904(f)-3 is made obsolete by the ordering rules added in §1.904(g)-3T and is removed accordingly.

Under the specific grant of regulatory authority in section 904(g)(4), these temporary regulations provide ordering rules for coordinating the section 904(f) overall foreign loss and separate limitation loss provisions and the section 904(g) overall domestic loss provisions.

Section 1.904(g)-3T provides ordering rules for the allocation of net operating losses, net capital losses, U.S. source losses, and separate limitation losses, and the recapture of separate limitation losses, overall foreign losses, and overall domestic losses. While these rules generally follow the ordering rules set forth in Notice 89-3, some changes were appropriate to take into account the enactment of the overall domestic loss provisions.

These temporary regulations generally follow the rules of Notice 89-3 for the carryover and carryback of net operating losses. Under §1.904(g)-3T(b)(1), net operating losses that are carried back to a prior year are allocated to income in the carryback year in accordance with the allocation rules for absorbing and allocating net operating loss carryovers. However, the income against which the net operating loss is allocated is the income after application of the overall foreign loss, separate limitation loss and overall domestic loss allocation and recapture rules for the carryback year.

The rules for net operating loss carryforwards vary for full and partial carryovers of the net operating loss. In the case of a full net operating loss carryover, the U.S. source losses and foreign losses in separate categories that are part of the net operating loss are carried forward and combined with U.S. source income or loss and foreign source income or loss in the same categories as the respective portions of the net operating loss.

In the case of a partial net operating loss carryover, several steps apply. In applying these steps it is important to distinguish the net operating loss, which is the total net operating loss, and the net operating loss carryover, which is the portion of the net operating loss that is absorbed in the carryover year. First, the U.S. source portion of the net operating loss (but not in excess of the net operating loss carryover) is carried over to the extent of U.S. source income in the carryover year. Second, the separate limitation losses that are part of the net operating loss are tentatively carried to the extent of taxable income in the same separate category. This amount is tentative because the total amount of matching net operating losses and separate limitation income may exceed the net operating loss carryover amount remaining after the first step. To the extent the total amount of these tentative loss carryovers is in fact limited by the amount of the remaining net operating loss carryover, then the tentative carryovers in each separate category are reduced on a pro rata basis so that their sum equals the amount of the remaining net operating loss carryover amount.

Third, any net operating loss carryover remaining after the first and second steps is carried over proportionately from any remaining loss in each separate category and combined with foreign source loss, if any, in the same separate categories in the carryover year. Finally, any remaining U.S. source loss is carried over to the extent of the net operating loss carryover remaining after the third step, if any, and combined with U.S. source loss, if any, in the carryover year.

The temporary regulations deviate from the net operating loss rules of Notice 89-3 in the final two steps. The temporary regulations require the U.S. source loss and foreign source losses in the separate categories that are carried over to be combined with U.S. source income or loss and foreign source income or loss in the same categories as the respective portions of the net operating loss. Then, the temporary regulations provide these losses are allocated against other income as part of the general loss allocation rules for current year losses. Notice 89-3, however, requires the allocation of the net operating loss against income in other separate categories before allocation of current year losses. The Treasury Department and the IRS believe there is no difference in result whether the net operating losses carried into a taxable year are allocated before or at the same time as current year losses, given the treatment of U.S. losses in §1.904(g)-3T. However, the approach of the temporary regulations provides added simplicity in application of the ordering rules as well as greater consistency with the rules for full net operating loss carryovers.

The rules for the allocation of net operating losses apply similarly to net capital loss carryovers.

Separate limitation losses are first allocated to separate limitation income for the taxable year in other separate categories on a proportionate basis. Separate limitation loss accounts are increased as a result of any such allocations. To the extent the separate limitation losses exceed separate limitation income for the year, those losses are allocated against U.S. income, if any, for the taxable year and overall foreign loss accounts are increased.

Unlike Notice 89-3, the temporary regulations also provide that offsetting separate limitation loss accounts are netted against one another. For example, if a taxpayer has a separate limitation loss account in the general category with respect to passive category income, and in the next year incurs a passive category separate limitation loss that offsets general category income, the two accounts will be netted against each other, rather than both being carried forward until each one is recaptured.

U.S. source losses are allocated against separate limitation income on a proportionate basis, and overall domestic loss accounts are increased appropriately. Under the ordering rules in Notice 89-3, U.S. losses sustained in the current taxable year are allocated after all other losses are allocated and after separate limitation losses and overall foreign losses are recaptured. With the addition of section 904(g), Congress expressed that domestic losses and foreign source losses should be treated with greater parity. To that end, the Treasury Department and the IRS believe the ordering rules of Notice 89-3 should be amended. Accordingly, the temporary regulations provide that U.S. losses are allocated in the same manner as foreign losses, before any income is recharacterized.

To the extent a taxpayer has any separate limitation income for the taxable year after losses are allocated in steps one through three, a portion of such income will be subject to recharacterization in order to recapture prior year overall foreign losses, if any.

To the extent a taxpayer has any separate limitation income for the taxable year after overall foreign losses are recaptured in step four, then such income will be subject to recharacterization in order to recapture prior year separate limitation losses, if any.

To the extent a taxpayer has any U.S. source income after losses are allocated in steps one through three, but not taking into account any foreign source income that is recharacterized as U.S. source income under step four, then a portion of such income will be subject to recharacterization in order to recapture prior year overall domestic losses, if any.

The temporary regulations coordinate the overall foreign loss and overall domestic loss regimes by providing that the recapture of overall foreign and domestic loss accounts is done independently. Accordingly, income recharacterized under one recapture provision is not taken into account in determining the amount of income subject to recharacterization under the other recapture provision. For example, foreign source income that is recharacterized as U.S. source income in order to recapture an overall foreign loss account will not then be included in the determination of U.S. source income subject to recharacterization as foreign source income in order to recapture an overall domestic loss account.

Section 1.1502-9T revises §1.1502-9 to include rules for the application of section 904(g) to consolidated groups and their members. Section 1.1502-9 provides rules only for the application of section 904(f) to consolidated groups and their members. Under those rules, consolidated overall foreign loss (COFL) accounts and consolidated separate limitation loss (CSLL) accounts are determined by the consolidated group on an aggregate basis under the principles of §§1.1502-11 and 1.1502-12. When a new member joins the group, its separate overall foreign loss and separate limitation loss accounts are combined with the appropriate COFL and CSLL accounts of the group. When a member leaves the group, it is allocated a pro rata portion of each of the group’s COFL and CSLL accounts based on the member’s share of the group’s assets that generate income subject to recharacterization under the corresponding loss account. The temporary regulations do not alter these provisions addressing COFL and CSLL accounts. The revisions simply extend these principles to provide parallel treatment for consolidated overall domestic loss accounts.

This section lists the headings for §§1.904-1 through 1.904-7.

* * * * *

Par. 3. Section 1.904(b)-0 is added. The entries for §§1.904(b)-1 and 1.904(b)-2 in §1.904-0 are redesignated as entries in new §1.904(b)-0.

This section lists the headings for §§1.904(b)-1 and 1.904(b)-2.

Par. 4. Section 1.904(f)-0 is added and amended as follows:

1. The entries for §§1.904(f)-1, 1.904(f)-2, 1.904(f)-3, 1.904(f)-4, 1.904(f)-5, 1.904(f)-6 and 1.904(f)-12 in §1.904-0 are redesignated as entries in new §1.904(f)-0.

2. The entry for §1.904(f)-1(a) is redesignated as §1.904(f)-1(a)(1) and a new entry for §1.904(f)-1(a)(2) is added.

3. The entries for §1.904(f)-1(d)(2), (d)(3), and (d)(4) are revised and the entry for §1.904(f)-1(d)(5) is removed.

4. The entries for §1.904(f)-2(c) and (c)(1) are revised.

5. The entries for §1.904(f)-3 are removed.

6. New entries for §§1.904(f)-7 and 1.904(f)-8 are added.

The additions and revisions read as follows:

This section lists the headings for §§1.904(f)-1 through 1.904(f)-8 and 1.904(f)-12.

(a)(1) Overview of regulations.

(2) [Reserved]. For further guidance, see the entry for §1.904(f)-1T(a)(2) in §1.904(f)-0T.

* * * * *

(d) * * *

(2) Overall foreign losses of another taxpayer.

(3) Additions to overall foreign loss account created by loss carryovers.

(4) [Reserved]. For further guidance, see the entry for §1.904(f)-1T(d)(4) in §1.904(f)-0T.

* * * * *

* * * * *

(c) and (c)(1) [Reserved]. For further guidance, see the entries for §1.904(f)-2T(c) and (c)(1) in §1.904(f)-0T.

* * * * *

[Reserved]. For further guidance, see the entries for §1.904(f)-7T in §1.904(f)-0T.

[Reserved]. For further guidance, see the entries for §1.904(f)-8T in §1.904(f)-0T.

Par. 5. Section 1.904(f)-0T is added to read as follows:

This section lists the headings for §§1.904(f)-1T, 1.904(f)-2T, 1.904(f)-7T and 1.904(f)-8T.

(a)(1) [Reserved]. For further guidance, see the entry for §1.904(f)-1(a)(1) in §1.904(f)-0.

(2) Application to post-1986 taxable years.

(b) through (d)(3) [Reserved]. For further guidance, see the entries for §1.904(f)-1(b) through (d)(3) in §1.904(f)-0.

(d)(4) Adjustments for capital gains and losses.

(e) through (f) [Reserved]. For further guidance, see the entries for §1.904(f)-1(e) through (f) in §1.904(f)-0.

(g) Effective/applicability date.

(h) Expiration date.

(a) and (b) [Reserved]. For further guidance, see the entries for §1.904(f)-2(a) and (b) in §1.904(f)-0.

(c) Section 904(f)(1) recapture.

(1) In general.

(c)(2) through (d) [Reserved]. For further guidance, see the entries for §1.904(f)-2(c)(2) through (d) in §1.904(f)-0.

(e) Effective/applicability date.

(f) Expiration date.

(a) Overview of regulations.

(b) Definitions.

(1) Separate category.

(2) Separate limitation income.

(3) Separate limitation loss.

(c) Separate limitation loss account.

(d) Additions to separate limitation loss accounts.

(1) General rule.

(2) Separate limitation losses of another taxpayer.

(3) Additions to separate limitation loss account created by loss carryovers.

(e) Reductions of separate limitation loss accounts.

(1) Pre-recapture reduction for amounts allocated to other taxpayers.

(2) Reduction for offsetting loss accounts.

(3) Reduction for amounts recaptured.

(f) Effective/applicability date.

(g) Expiration date.

(a) In general.

(b) Effect of recharacterization of separate limitation income on associated taxes.

(c) Effective/applicability date.

(d) Expiration date.

Par. 6. Section 1.904(f)-1 is amended as follows:

1. Redesignate paragraph (a) as (a)(1).

2. Add a new paragraph (a)(2).

3. In paragraph (d)(1), remove the language “paragraph (d)(4) of this section” and add the language “paragraph (d)(3) of this section” in its place.

4. Remove paragraphs (d)(2), (d)(5), and Example 4 and Example 5 in paragraph (f).

5. Redesignate paragraph (d)(3) as paragraph (d)(2), and paragraph (d)(4) as paragraph (d)(3).

6. In newly-redesignated paragraph (d)(3), remove the language “§1.904(f)-1(d)(5)” and add the language “§1.904(f)-1(d)(4)” in its place.

7. Add new paragraphs (d)(4) and (g).

The revisions and additions read as follows:

* * * * *

(a) * * *

(2) [Reserved]. For further guidance, see §1.904(f)-1T(a)(2).

* * * * *

(d) * * *

(4) [Reserved]. For further guidance, see §1.904(f)-1T(d)(4).

* * * * *

(g) [Reserved]. For further guidance, see §1.904(f)-1T(g).

Par. 7. Section 1.904(f)-1T is added to read as follows:

(a)(1) [Reserved]. For further guidance, see §1.904(f)-1(a)(1).

(2) Application to post-1986 taxable years. The principles of §§1.904(f)-1 through 1.904(f)-5 shall apply to overall foreign loss sustained in taxable years beginning after December 31, 1986, modified so as to take into account the effect of statutory amendments.

(b) through (d)(3) [Reserved]. For further guidance, see §1.904(f)-1(b) through (d)(3).

(d)(4) Adjustments for capital gains and losses. If a taxpayer has capital gains or losses, the taxpayer shall make adjustments to such capital gains and losses to the extent required under section 904(b)(2) and §1.904(b)-1 before applying the provisions of §1.904(f)-1T. See §1.904(b)-1(h).

(e) and (f) [Reserved]. For further guidance, see §1.904(f)-1(e) and (f).

(g) Effective/applicability date. This section applies to taxable years beginning after December 21, 2007.

(h) Expiration date. The applicability of this section expires on December 20, 2010.

Par. 8. Section 1.904(f)-2 is amended as follows:

1. Revise paragraph (c)(1).

2. Revise paragraph (c)(5) Example 4.

3. Add a new paragraph (e).

The revisions and addition read as follows:

* * * * *

(c) * * * (1) [Reserved]. For further guidance, see §1.904(f)-2T(c)(1).

(5) * * *

Example 4. [Reserved]. For further guidance see §1.904(f)-2T(c)(5) Example 4.

* * * * *

(e) [Reserved]. For further guidance, see §1.904(f)-2T(e).

Par. 9. Section 1.904(f)-2T is added to read as follows:

(a) and (b) [Reserved]. For further guidance, see §1.904(f)-2(a) and (b).

(c) Section 904(f)(1) recapture—(1) In general. In a year in which a taxpayer elects the benefits of section 901 or 30A, the amount of foreign source taxable income subject to recharacterization in a taxable year in which paragraph (a) of this section is applicable is the lesser of the aggregate amount of maximum potential recapture in all overall foreign loss accounts or fifty percent of the taxpayer’s total foreign source taxable income. If the aggregate amount of maximum potential recapture in all overall foreign loss accounts exceeds fifty percent of the taxpayer’s total foreign source taxable income, foreign source taxable income in each separate category with an overall foreign loss account is recharacterized in an amount equal to the section 904(f)(1) recapture amount, multiplied by the maximum potential recapture in the overall foreign loss account, divided by the aggregate amount of maximum potential recapture in all overall foreign loss accounts. The maximum potential recapture in any account is the lesser of the balance in that overall foreign loss account (after reduction of such accounts in accordance with §1.904(f)-1(e)) or the foreign source taxable income for the year in the same separate category as the loss account. If, in any year, in accordance with section 164(a) and section 275(a)(4)(A), a taxpayer deducts rather than credits its foreign taxes, recapture is applied to the extent of the lesser of—

(i) The balance in the overall foreign loss account in each separate category; or

(ii) Foreign source taxable income minus foreign taxes in each separate category.

(c)(2) through (5) Example 3 [Reserved]. For further guidance, see §1.904(f)-2(c)(2) through (5) Example 3.

Example 4. Y Corporation is a domestic corporation that does business in the United States and abroad. On December 31, 2007, the balance in Y’s general category overall foreign loss account is $500, all of which is attributable to a loss incurred in 2007. Y has no other loss accounts subject to recapture. For 2008, Y has U.S. source taxable income of $400 and foreign source taxable income of $300 in the general category and $900 in the passive category. Under paragraph (c)(1) of this section, the amount of Y’s general category income subject to recharacterization is the lesser of the aggregate maximum potential recapture or 50 percent of the total foreign source taxable income. In this case Y’s aggregate maximum potential recapture is $300 (the lesser of the $500 balance in the general category overall foreign loss account or $300 foreign source income in the general category for the year), which is less than $600, or 50 percent of total foreign source taxable income ($1200 x 50%). Therefore, pursuant to paragraph (c) of this section, $300 of foreign source income in the general category is recharacterized as U.S. source income. The balance in Y’s general category overall foreign loss account is reduced by $300 to $200 in accordance with §1.904(f)-1(e)(2).

(c)(5) Example 5 through (d) [Reserved]. For further guidance, see §1.904(f)-2(c)(5) Example 5 through §1.904(f)-2(d).

(e) Effective/applicability date. This section applies to taxable years beginning after December 21, 2007.

(f) Expiration date. The applicability of this section expires on December 20, 2010.

Par. 10. Section 1.904(f)-3 is revised to read as follows:

§1.904(f)-3 Allocation of net operating losses and net capital losses. For rules relating to the allocation of net operating losses and net capital losses, see §1.904(g)-3T.

Par. 11. Sections 1.904(f)-7, 1.904(f)-7T, 1.904(f)-8, and 1.904(f)-8T are added to read as follows:

[Reserved]. For further guidance, see §1.904(f)-7T.

(a) Overview of regulations. This section provides rules for determining a taxpayer’s separate limitation losses, for establishing separate limitation loss accounts, and for making additions to and reductions from such accounts for purposes of section 904(f). Section 1.904(f)-8T provides rules for recharacterizing the balance in any separate limitation loss account under the general recharacterization rule of section 904(f)(5)(C).

(b) Definitions. The definitions in paragraphs (b)(1) through (4) of this section apply for purposes of this section and §§1.904(f)-8T and 1.904(g)-3T.

(1) Separate category means each separate category of income described in section 904(d) and any other category of income described in §1.904-4(m). For example, income subject to section 901(j) or 904(h)(10) is income in a separate category.

(2) Separate limitation income means, with respect to any separate category, the taxable income from sources outside the United States, separately computed for that category for the taxable year. Separate limitation income shall be determined by taking into account any adjustments for capital gains and losses under section 904(b)(2) and §1.904(b)-1. See §1.904(b)-1(h)(1)(i).

(3) Separate limitation loss means, with respect to any separate category, the amount by which the foreign source gross income in that category is exceeded by the sum of expenses, losses and other deductions (not including any net operating loss deduction under section 172(a) or any expropriation loss or casualty loss described in section 907(c)(4)(B)(iii)) properly allocated and apportioned thereto for the taxable year. Separate limitation losses are determined separately for each separate category. Accordingly, income and deductions attributable to a separate category are not netted with income and deductions attributable to another separate category for purposes of determining the amount of a separate limitation loss. Separate limitation losses shall be determined by taking into account any adjustments for capital gains and losses under section 904(b)(2) and §1.904(b)-1. See §1.904(b)-1(h)(1)(i).

(c) Separate limitation loss account. Any taxpayer that sustains a separate limitation loss that is allocated to reduce separate limitation income of the taxpayer under the rules of §1.904(g)-3T must establish a separate limitation loss account for the loss. The taxpayer must establish separate loss accounts for each separate category in which a separate limitation loss is incurred that is allocated to reduce other separate limitation income. A separate account must then be established for each separate category to which a portion of the loss is allocated. The balance in any separate limitation loss account represents the amount of separate limitation income that is subject to recharacterization (as income in another separate category) in a subsequent year pursuant to §1.904(f)-8T and section 904(f)(5)(F). From year to year, amounts may be added to or subtracted from the balance in such loss accounts, as provided in paragraphs (d) and (e) of this section.

(d) Additions to separate limitation loss accounts—(1) General rule. A taxpayer’s separate limitation loss as defined in paragraph (b)(3) of this section shall be added to the applicable separate limitation loss accounts at the end of the taxable year to the extent that the separate limitation loss has reduced separate limitation income in one or more other separate categories of the taxpayer during the taxable year. For rules with respect to net operating loss carryovers, see paragraph (d)(3) of this section and §1.904(g)-3T.

(2) Separate limitation losses of another taxpayer. If any portion of any separate limitation loss account of another taxpayer is allocated to the taxpayer in accordance with §1.1502-9T (relating to consolidated separate limitation losses) the taxpayer shall add such amount to its applicable separate limitation loss account.

(3) Additions to separate limitation loss account created by loss carryovers. The taxpayer shall add to each separate limitation loss account all net operating loss carryovers to the current taxable year to the extent that separate limitation losses included in the net operating loss carryovers reduced foreign source income in other separate categories for the taxable year.

(e) Reductions of separate limitation loss accounts. The taxpayer shall subtract the following amounts from its separate limitation loss accounts at the end of its taxable year in the following order as applicable:

(1) Pre-recapture reduction for amounts allocated to other taxpayers. A separate limitation loss account is reduced by the amount of any separate limitation loss account which is allocated to another taxpayer in accordance with §1.1502-9T (relating to consolidated separate limitation losses).

(2) Reduction for offsetting loss accounts. A separate limitation account is reduced to take into account any netting of separate limitation loss accounts under §1.904(g)-3T(c).

(3) Reduction for amounts recaptured. A separate limitation loss account is reduced by the amount of any separate limitation income that is earned in the same separate category as the separate limitation loss that resulted in the account and that is recharacterized in accordance with §1.904(f)-8T (relating to recapture of separate limitation losses) or section 904(f)(5)(F) (relating to recapture of separate limitation loss accounts out of gain realized from dispositions).

(f) Effective/applicability date. This section applies to taxpayers that sustain separate limitation losses in taxable years beginning after December 21, 2007. For taxable years beginning after December 31, 1986, and on or before December 21, 2007, see section 904(f)(5).

(g) Expiration date. The applicability of this section expires on December 20, 2010.

[Reserved]. For further guidance, see §1.904(f)-8T.

(a) In general. A taxpayer shall recapture a separate limitation loss account as provided in this section. If the taxpayer has a separate limitation loss account or accounts in any separate category (the “loss category”) and the loss category has income in a subsequent taxable year, the income shall be recharacterized as income in that other category or categories. The amount of income recharacterized shall not exceed the separate limitation loss accounts for the loss category as determined under §1.904(f)-7T, including the aggregate separate limitation loss accounts from the loss category not previously recaptured under this paragraph (a). If the taxpayer has more than one separate limitation loss account in a loss category, and there is not enough income in the loss category to recapture the entire amount in all the loss accounts, then separate limitation income in the loss category shall be recharacterized as separate limitation income in the separate limitation loss categories on a proportionate basis. This is determined by multiplying the total separate limitation income subject to recapture by a fraction, the numerator of which is the amount in a particular loss account and the denominator of which is the total amount in all loss accounts for the separate category.

(b) Effect of recapture of separate limitation income on associated taxes. Recharacterization of income under paragraph (a) of this section shall not result in the recharacterization of any tax. The rules of §1.904-6, including the rules that the taxes are allocated on an annual basis and that foreign taxes paid on U.S. source income shall be allocated to the separate category that includes that U.S. source income (see §1.904-6(a)), shall apply for purposes of allocating taxes to separate categories. Allocation of taxes pursuant to §1.904-6 shall be made before the recapture of any separate limitation loss accounts of the taxpayer pursuant to the rules of this section.

(c) Effective/applicability date. This section applies to taxpayers that sustain separate limitation losses in taxable years beginning after December 21, 2007. For taxable years beginning after December 31, 1986, and on or before December 21, 2007, see section 904(f)(5).

(d) Expiration date. The applicability of this section expires on December 20, 2010.

Par. 12. Section 1.904(g)-0 is added to read as follows:

This section lists the headings for §§1.904(g)-1 through 1.904(g)-3.

[Reserved]. For further guidance, see the entries for §1.904(g)-1T in §1.904(g)-0T.

[Reserved]. For further guidance, see the entries for §1.904(g)-2T in §1.904(g)-0T.

[Reserved]. For further guidance, see the entries for §1.904(g)-3T in §1.904(g)-0T.

Par. 13. Section 1.904(g)-0T is added to read as follows:

This section lists the headings for §§1.904(g)-1T through 1.904(g)-3T.

(a) Overview of regulations.

(b) Overall domestic loss accounts.

(1) In general.

(2) Taxable year in which overall domestic loss is sustained.

(c) Determination of a taxpayer’s overall domestic loss.

(1) Overall domestic loss defined.

(2) Domestic loss defined.

(3) Qualified taxable year defined.

(4) Method of allocation and apportionment of deductions.

(d) Additions to overall domestic loss accounts.

(1) General rule.

(2) Overall domestic loss of another taxpayer.

(3) Adjustments for capital gains and losses.

(e) Reductions of overall domestic loss accounts.

(1) Pre-recapture reduction for amounts allocated to other taxpayers.

(2) Reduction for amounts recaptured.

(f) Effective/applicability date.

(g) Expiration date.

(a) In general.

(b) Determination of U.S. source taxable income for purposes of recapture.

(c) Section 904(g)(1) recapture.

(d) Effective/applicability date.

(e) Expiration date.

(a) In general.

(b) Step One: Allocation of net operating loss and net capital loss carryovers.

(1) In general.

(2) Full net operating loss carryover.

(3) Partial net operating loss carryover.

(4) Net capital loss carryovers.

(c) Step Two: Allocation of separate limitation losses.

(d) Step Three: Allocation of U.S. source losses.

(e) Step Four: Recapture of overall foreign loss accounts.

(f) Step Five: Recapture of separate limitation loss accounts.

(g) Step Six: Recapture of overall domestic loss accounts.

(h) Examples.

(i) Effective/applicability date.

(j) Expiration date.

Par. 14. Sections 1.904(g)-1, 1.904(g)-1T, 1.904(g)-2, 1.904(g)-2T, 1.904(g)-3, and 1.904(g)-3T are added to read as follows:

[Reserved]. For further guidance, see §1.904(g)-1T.

(a) Overview of regulations. This section provides rules for determining a taxpayer’s overall domestic losses, for establishing overall domestic loss accounts, and for making additions to and reductions from such accounts for purposes of section 904(g). Section 1.904(g)-2T provides rules for recapturing the balance in any overall domestic loss account under the general recharacterization rule of section 904(g)(1). Section 1.904(g)-3T provides ordering rules for the allocation of net operating losses, net capital losses, U.S. source losses, and separate limitation losses, and the recapture of separate limitation losses, overall foreign losses and overall domestic losses.

(b) Overall domestic loss accounts—(1) In general. Any taxpayer that sustains an overall domestic loss under paragraph (c) of this section must establish an account for such loss. Separate overall domestic loss accounts must be maintained with respect to each separate category in which foreign source income is offset by the domestic loss. The balance in each overall domestic loss account represents the amount of such overall domestic loss subject to recapture in a given year. From year to year, amounts may be added to or subtracted from the balances in such accounts as provided in paragraphs (d) and (e) of this section.

(2) Taxable year in which overall domestic loss is sustained. When a taxpayer incurs a domestic loss that is carried back as part of a net operating loss to offset foreign source income in a qualified taxable year, as defined in paragraph (c)(3) of this section, the resulting overall domestic loss is treated as sustained in the later year in which the domestic loss was incurred and not in the earlier year in which the loss offset foreign source income. Similarly, when a taxpayer incurs a domestic loss that is carried forward as part of a net operating loss and applied to offset foreign source income in a later taxable year, the resulting overall domestic loss is treated as sustained in the later year in which the domestic loss offsets foreign source income and not in the earlier year in which the loss was incurred. For example, if a taxpayer incurs a domestic loss in the 2007 taxable year that is carried back to the 2006 qualified taxable year and offsets foreign source income in 2006, the resulting overall domestic loss is treated as sustained in the 2007 taxable year. If a taxpayer incurs a domestic loss in a pre-2007 taxable year that is carried forward to a post-2006 qualified taxable year and offsets foreign source income in the post-2006 year, the resulting overall domestic loss is treated as sustained in the post-2006 year. The overall domestic loss account is established at the end of the later of the taxable year in which the domestic loss arose or the qualified taxable year to which the loss is carried and applied to offset foreign source income, and will be recaptured from U.S. source income arising in subsequent taxable years.

(c) Determination of a taxpayer’s overall domestic loss—(1) Overall domestic loss defined. For taxable years beginning after December 31, 2006, a taxpayer sustains an overall domestic loss—

(i) In any qualified taxable year in which its domestic loss for such taxable year offsets foreign source taxable income for the taxable year or for any preceding qualified taxable year by reason of a carryback; and

(ii) In any other taxable year in which the domestic loss for such taxable year offsets foreign source taxable income for any preceding qualified taxable year by reason of a carryback.

(2) Domestic loss defined. For purposes of this section and §§1.904(g)-2T and 1.904(g)-3T, the term domestic loss means the amount by which the U.S. source gross income for the taxable year is exceeded by the sum of the expenses, losses and other deductions properly apportioned or allocated to such income, taking into account any net operating loss carried forward from a prior taxable year, but not any loss carried back. If a taxpayer has any capital gains or losses, the amount of the taxpayer’s domestic loss shall be determined by taking into account adjustments under section 904(b)(2) and §1.904(b)-1. See §1.904(b)-1(h)(1)(iii).

(3) Qualified taxable year defined. For purposes of this section and §§1.904(g)-2T and 1.904(g)-3T, the term qualified taxable year means any taxable year for which the taxpayer chooses the benefits of section 901.

(4) Method of allocation and apportionment of deductions. In determining its overall domestic loss, a taxpayer shall allocate and apportion expenses, losses, and other deductions to U.S. gross income in accordance with sections 861(b) and 865 and the regulations thereunder, including §§1.861-8T through 1.861-14T.

(d) Additions to overall domestic loss accounts—(1) General rule. A taxpayer’s overall domestic loss as determined under paragraph (c) of this section shall be added to the applicable overall domestic loss account at the end of its taxable year to the extent that the overall domestic loss either reduces foreign source income for the year (but only if such year is a qualified taxable year) or reduces foreign source income for a qualified taxable year to which the loss has been carried back.

(2) Overall domestic loss of another taxpayer. If any portion of any overall domestic loss of another taxpayer is allocated to the taxpayer in accordance with §1.1502-9T (relating to consolidated overall domestic losses) the taxpayer shall add such amount to its applicable overall domestic loss account.

(3) Adjustments for capital gains and losses. If the taxpayer has capital gains or losses, the amount by which an overall domestic loss reduces foreign source income in a taxable year shall be determined in accordance with §1.904(b)-1(h)(1)(i) and (iii).

(e) Reductions of overall domestic loss accounts. The taxpayer shall subtract the following amounts from its overall domestic loss accounts at the end of its taxable year in the following order, if applicable:

(1) Pre-recapture reduction for amounts allocated to other taxpayers. An overall domestic loss account is reduced by the amount of any overall domestic loss which is allocated to another taxpayer in accordance with §1.1502-9T (relating to consolidated overall domestic losses).

(2) Reduction