AMENDMENTS RELATED TO TITLE V OF THE REFORM ACT.

SEC. 1005. AMENDMENTS RELATED TO TITLE V OF THE REFORM ACT. (a) Amendments Related to Section 501 of the Reform Act.— (1) Clause (ii) of section 469(e)(1)(A) of the 1986 Code (relating to certain income not treated as income from passive activity) is amended by inserting “not derived in the ordinary course of a trade or business which is” after “gain or loss”. (2) (A) Subparagraph (A) of section 469(g)(1) of the 1986 Code (relating to disposition of interests in passive activities in fully taxable transactions) is amended to read as follows: “(A) In general.—If all gain or loss realized on such disposition is recognized, the excess of— “(i) the sum of— “(I) any loss from such activity for such taxable year (determined after application of subsection (b)), plus “(II) any loss realized on such disposition, over “(ii) net income or gain for such taxable year from all passive activities (determined without regard to losses described in clause (i)), shall be treated as a loss which is not from a passive activity.” (B) Subparagraph (C) of section 469(g)(1) of the 1986 Code is amended to read as follows: “(C) Income from prior years.—To the extent provided in regulations, income or gain from the activity for preceding taxable years shall be taken into account under 102 STAT. 3388subparagraph (A)(ii) for the taxable year to the extent necessary to prevent the avoidance of this section.” (3) Subparagraph (A) of section 469(g)(2) of the 1986 Code is amended— (A) by striking out “paragraph (1)” and inserting in lieu thereof “paragraph (1)(A)”; and (B) by striking out “such losses” the first place it appears and inserting in lieu thereof “losses described in paragraph (1)(A)”. (4) Section 469(g)(3) of the 1986 Code is amended— (A) by striking out “realized (or to be realized)” and inserting in lieu thereof “(realized or to be realized”, and (B) by inserting a closing parenthesis after “completed”. (5) Paragraph (4) of section 469(h) of the 1986 Code (relating to certain closely held C corporations and personal service corporations) is amended by inserting “only” before “if”. (6) Paragraph (1) of section 469(i) of the 1986 Code (relating to $25,000 onset for rental real estate activities) is amended by striking out “in the taxable year in which such portion of such loss or credit arose” and inserting in lieu thereof “in such taxable year (and if any portion of such loss or credit arose in another taxable year, in such other taxable year)”. (7) Subparagraph (C) of section 469(i)(6) of the 1986 Code (relating to interest as a limited partner) is amended by striking out “No” and inserting in lieu thereof “Except as provided in regulations, no”. (8) Subparagraph (A) of section 469(j)(6) of the 1986 Code (relating to special rule for gifts) is amended by inserting “with respect to which a deduction has not been allowed by reason of subsection (a)” before “, and”. (9) Section 469(j) of the 1986 Code (relating to definitions and special rules) is amended by adding at the end thereof the following new paragraphs: “(10) Coordination with section 280a.—If a passive activity involves the use of a dwelling unit to which section 280A(c)(5) applies for any taxable year, any income, deduction, gain, or loss allocable to such use shall not be taken into account for purposes of this section for such taxable year. “(11) Aggregation of members of affiliated groups.—Except as provided in regulations, all members of an affiliated group which files a consolidated return shall be treated as 1 corporation.” (10) Section 501(c) of the Reform Act is amended by adding at the end thereof the following new paragraph: “(4) Income from sales of passive activities in taxable years beginning before january 1, 1987.—If— “(A) gain is recognized in a taxable year beginning after December 31, 1986, from a sale or exchange of an interest in an activity in a taxable year beginning before January 1, 1987, and “(B) such gain would have been treated as gain from a passive activity had section 469 of the Internal Revenue Code of 1986 (as added by this section) been in effect for the taxable year in which the sale or exchange occurred and for all succeeding taxable years, then such gain shall be treated as gain from a passive activity for purposes of such section.” 102 STAT. 3389 (11) Subsection (j) of section 469 of the 1986 Code is amended by adding at the end thereof the following new paragraph: “(12) Special rule for distributions by estates or trusts.— If any interest in a passive activity is distributed by an estate or trust— “(A) the basis of such interest immediately before such distribution shall be increased by the amount of any passive activity losses allocable to such interest, and “(B) such losses shall not be allowable as a deduction for any taxable year.” (12) Subsection (m) of section 469 of the 1986 Code, as redesignated by section 10211 of the Revenue Act of 1987, is amended by striking all that precedes subparagraph (B) of paragraph (3) thereof and inserting in lieu thereof the following: “(m) Phase-In of Disallowance of Losses and Credits for Interest Held Before Date of Enactment.— (1) In general.—In the case of any passive activity loss or passive activity credit for any taxable year beginning in calendar years 1987 through 1990, subsection (a) shall not apply to the applicable percentage of that portion of such loss (or such credit) which is attributable to preenactment interests. (2) Applicable percentage.—For purposes of this subsection, the applicable percentage shall be determined in accordance with the following table: “In the case of taxable years beginning in: The applicable percentage is: 1987 65 1988 40 1989 20 1990 10. (3) Portion of loss or credit attributable to preenactment interests.— For purposes of this subsection— “(A) In general.— The portion of the passive activity loss (or passive activity credit) for any taxable year which is attributable to preenactment interests is the lesser of— “(i) the amount of the passive activity loss (or passive activity credit) which is disallowed for the taxable year under subsection (a) (without regard to this subsection), or “(ii) the amount of the passive activity loss (or passive activity credit) which would be disallowed for the taxable year (without regard to this subsection and without regard to any amount allocable to an activity for the taxable year under subsection (b)) taking into account only preenactment interests.” (b) Amendments Related to Section 502 of the Reform Act.— (1) Subparagraph (A) of section 502(d)(1) of the Reform Act (defining qualified investor) is amended to read as follows: “(A) if— “(i) in the case of a project placed in service on or before August 16, 1986, such person held an interest in such project on August 16, 1986, and such person made his initial investment after December 31, 1983, or “(ii) in the case of a project placed in service after August 16, 1986, such person made his initial investment after December 31, 1983, and such person held an interest in such project on December 31, 1986, and”. 102 STAT. 3390 (2) Subsection (d) of section 502 of the Reform Act (defining qualified investor) is amended by adding after paragraph (2) the following new paragraph: “(3) Special rule for certain partnerships.—In the case of any property which is held by a partnership— “(A) which placed such property in service on or after December 31, 1985, and before August 17, 1986, and continuously held such property through the close of the taxable year for which the determination is being made, and “(B) which was not treated as a new partnership or as terminated at any time on or after the date on which such property was placed in service and through the close of the taxable year for which the determination is being made, paragraph (I)(A)(i) shall be applied by substituting ‘December 31, 1988’ for ‘August 16, 1986’ the 2nd place it appears.” (3) The subsection (d) of section 502 of the Reform Act which relates to special rules is redesignated as subsection (e). (c) Amendments Related to Section 511 of the Reform Act.— (1) Subparagraph (A) of section 163(d)(3) of the 1986 Code (defining investment interest) is amended by striking out “incurred or continued to purchase or carry” and inserting in lieu thereof “properly allocable to”. (2) Subparagraph (B) of section 163(d)(4) of the 1986 Code is amended to read as follows: “(B) Investment income.— The term ‘investment income’ means the sum of— “(i) gross income (other than gain taken into account under clause (ii)) from property held for investment, and “(ii) any net gain attributable to the disposition of property held for investment.” (3) Subparagraph (A) of section 163(d)(6) of the 1986 Code is amended to read as follows: “(A) In general.— The amount of interest paid or accrued during any such taxable year which is disallowed under this subsection shall not exceed the sum of— “(i) the amount which would be disallowed under this subsection if— “(I) paragraph (1) were applied by substituting ‘the sum of the ceiling amount and the net investment income’ for ‘the net investment income’, and “(II) paragraphs (4)(E) and (5)(A)(ii) did not apply, and “(ii) the applicable percentage of the excess of— “(I) the amount which (without regard to this paragraph) is not allowable as a deduction under this subsection for the taxable year, over “(II) the amount described in clause (i). The preceding sentence shall not apply to any interest treated as paid or accrued during the taxable year under paragraph (2).” (4) Subparagraph (A) of section 163(h)(2) of the 1986 Code is amended by striking out “incurred or continued in connection with the conduct of’ and inserting in lieu thereof “properly allocable to”. 102 STAT. 3391 (5) Subparagraph (C) of section 163(h)(3) of the 1986 Code (defining qualified residence interest) is amended to read as follows: “(C) Cost not less than balance of indebtedness incurred on or before august 16, 1986.— “(i) In general.— The amount under subparagraph (B)(ii)(I) at any time after August 16, 1986, shall not be less than the outstanding principal amount (as of such time) of indebtedness— “(I) which was incurred on or before August 16, 1986, and which was secured by the qualified residence on August 16, 1986, or “(II) which is secured by the qualified residence and was incurred after August 16, 1986, to re-finance indebtedness described in subclause (I) (or refinanced indebtedness meeting the requirements of this subclause) to the extent (immediately after the refinancing) the principal amount of the indebtedness resulting from the refinancing does not exceed the principal amount of the refinanced indebtedness (immediately before the refinancing), “(ii) Limitation on period of refinancing.— Subclause (I) of clause (i) shall not apply to any indebtedness after— “(I) the expiration of the term of the indebtedness described in clause (i)(1), or “(II) if the principal of the indebtedness described in clause (i)(1) is not amortized over its term, the expiration of the term of the 1st refinancing of such indebtedness (or if earlier, the date which is 30 years after the date of such refinancing).” (6) (A) The heading for section 163(h)(5) of the 1986 Code is amended to read as follows: “(5) Other definitions and special rules.—For purposes of this subsection—” (B) Paragraph (5) of section 163(h) of the 1986 Code is amended— (i) by striking out “For purposes of this subsection—” in subparagraph (A), and (ii) by striking out “For purposes of this paragraph, any” in subparagraph (B) and inserting in lieu thereof “Any”. (7) Clause (iii) of section 163(h)(5)(A) of the 1986 Code is amended by striking out “used or” in the heading thereof and by striking out “or use”. (8) Section 163(h)(5) of the 1986 Code is amended by adding at the end thereof the following new subparagraphs: “(C) Unenforceable security interests.—Indebtedness shall not fail to be treated as secured by any property solely because, under any applicable State or local homestead or other debtor protection law in effect on August 16, 1986, the security interest is ineffective or the enforceability of the security interest is restricted. “(D) Special rules for estates and trusts.—For purposes of determining whether any interest paid or accrued by an estate or trust is qualified residence interest, any residence held by such estate or trust shall be treated as a 102 STAT. 3392qualified residence of such estate or trust if such estate or trust establishes that such residence is a qualified residence of a beneficiary who has a present interest in such estate or trust or an interest in the residuary of such estate or trust.” (9) Paragraph (6) of section 163(h) of the 1986 Code is amended by striking out “subsection” the 3rd place it appears and inserting in lieu thereof “paragraph”. (10) Paragraph (2)(A) of section 511(d) of the Reform Act is amended to read as follows: “(2) (A) Sections 467(c)(5) and 1255(b)(2) are each amended by striking out ‘163(d),’.” (11) If— (A) any amount was disallowed as a deduction under section 163(d) of the Internal Revenue Code of 1954 (as in effect on the day before the date of the enactment of the Reform Act), (B) such amount would (but for this paragraph) be treated as investment interest paid or accrued by the taxpayer in the taxpayer’s first taxable year beginning after December 31, 1986, and (C) the taxpayer makes an election under this paragraph at such time and in such manner as the Secretary of the Treasury or his delegate shall prescribe, to the extent such amount is attributable to an activity subject to the limitations of section 469 of the 1986 Code, such amount shall not be treated as investment interest but shall be treated as a deduction allocable to such activity for such first taxable year. Subsection (m) of section 469 of the 1986 Code and section 501(c)(2) of the Reform Act shall not apply to any amount so treated. (12) Subparagraph (E) of section 163(h)(2) of the 1986 Code is amended by inserting before the period “or under section 6166A (as in effect before its repeal by the Economic Recovery Tax Act of 1981)”. (13) For purposes of applying the amendments made by this subsection and the amendments made by section 10102 of the Revenue Act of 1987, the provisions of this subsection shall be treated as having been enacted immediately before the enactment of the Revenue Act of 1987. (14) (A) For purposes of applying section 163(h) of the 1986 Code to any taxable year beginning during 1987, if, incident to a divorce or legal separation— (i) an individual acquires the interest of a spouse or former spouse in a qualified residence in a transfer to which section 1041 of the 1986 Code applies, and (ii) such individual incurs indebtedness which is secured by such qualified residence, the amount determined under paragraph (3)(B)(ii)(I) of section 163(h) of the 1986 Code (as in effect before the amendments made by the Revenue Act of 1987) with respect to such qualified residence shall be increased by the amount determined under subparagraph (B). (B) The amount determined under this subparagraph shall be equal to the excess (if any) of— (i) the lesser of the amount of the indebtedness described in subparagraph (A)(ii), or the fair market value of the 102 STAT. 3393spouse’s or former spouse’s interest in the qualified residence as of the time of the transfer, over (ii) the basis of the spouse or former spouse in such interest in such residence (adjusted only by the cost of any improvements to such residence). (15) Clause (i) of section 7872(d)(1)(E) of the 1986 Code is amended by striking out “section 163(d)(3)” and inserting in lieu thereof “section 163(d)(4)”.