26 CFR 1.642(h)-5: (h)-5 Examples.

Paragraphs (a) and (b) of this section (Examples 1 and 2) illustrate the application of section 642(h).

(a) Example 1: Computations under section 642(h) when an estate has a net operating loss—(1) Facts. On January 31, 2020, A dies leaving a will that provides for the distribution of all of A's estate equally to B and an existing trust for C. The period of administration of the estate terminates on December 31, 2020, at which time all the property of the estate is distributed to B and the trust. For tax purposes, B and the trust report income on a calendar year basis. During the period of administration, the estate has the following items of income and deductions:

Table 1 to Paragraph (a)(1)

Income:

Taxable interest $2,500

Business income 3,000

Total income 5,500

Table 2 to Paragraph (a)(1)

Deductions:

Business expenses (including administrative expense allocable to business income) 5,000

Administrative expenses not allocable to business income that would not have been incurred if property had not been held in a trust or estate (section 67(e) deductions) 9,800

Total deductions 14,800

(2) Computation of net operating loss. (i) The amount of the net operating loss carryover is computed as follows:

Table 3 to Paragraph (a)(2)(i)

Gross income $5,500

Total deductions 14,800

Less adjustment under section 172(d)(4) (allowable non-business expenses ($9,800) limited to non-business income ($2,500)) 7,300

Deductions as adjusted 7,500

Net operating loss 2,000

(ii) Under section 642(h)(1), B and the trust are each allocated $1,000 of the $2,000 unused net operating loss carryover of the terminated estate in 2020, with the allowance of any net operating loss carryover to B and the trust determined under section 172. Neither B nor the trust can carry back any of the net operating loss of A's estate made available to them under section 642(h)(1). See § 1.642(h)-1(b).

(3) Section 642(h)(2) excess deductions. The $7,300 of non-business deductions not taken into account in determining the net operating loss of the estate are excess deductions on termination of the estate under section 642(h)(2). Under § 1.642(h)-2(b)(1), such deductions retain their character as section 67(e) deductions. Under § 1.642(h)-4, B and the trust each are allocated $3,650 of excess deductions based on B's and the trust's respective shares of the burden of each cost.

(4) Consequences for C. The net operating loss carryover and excess deductions are not allowable directly to C, the trust beneficiary. To the extent the distributable net income of the trust is reduced by the net operating loss carryover and excess deductions, however, C may receive an indirect benefit from the carryover and excess deductions.

(b) Example 2: Computations under section 642(h)(2)—(1) Facts. D dies in 2019 leaving an estate of which the residuary legatees are E (75%) and F (25%). The estate's income and deductions in its final year are as follows:

Table 4 to Paragraph (b)(1)

Income:

Dividends $3,000

Taxable Interest 500

Rent 2,000

Capital Gain 1,000

Total Income 6,500

Table 5 to Paragraph (b)(1)

Deductions:

Section 62(a)(4) deductions:

Rental real estate expenses 2,000

Section 67(e) deductions:

Probate fees 1,500

Estate tax preparation fees 8,000

Legal fees 2,500

Total Section 67(e) deductions 12,000

Non-miscellaneous itemized deductions:

Personal property taxes 3,500

Total deductions 17,500

(2) Determination of character. Pursuant to § 1.642(h)-2(b)(2), the character and amount of the excess deductions is determined by allocating the deductions among the estate's items of income as provided under § 1.652(b)-3. Under § 1.652(b)-3(a), the $2,000 of rental real estate expenses is allocated to the $2,000 of rental income. In the exercise of the executor's discretion pursuant to § 1.652(b)-3(b), D's executor allocates $3,500 of personal property taxes and $1,000 of section 67(e) deductions to the remaining income. As a result, the excess deductions on termination of the estate are $11,000, all consisting of section 67(e) deductions.

(3) Allocations among beneficiaries. Pursuant to § 1.642(h)-4, the excess deductions are allocated in accordance with E's (75 percent) and F's (25 percent) interests in the residuary estate. E's share of the excess deductions is $8,250, all consisting of section 67(e) deductions. F's share of the excess deductions is $2,750, also all consisting of section 67(e) deductions.

(4) Separate statement. If the executor instead allocated $4,500 of section 67(e) deductions to the remaining income of the estate, the excess deductions on termination of the estate would be $11,000, consisting of $7,500 of section 67(e) deductions and $3,500 of personal property taxes. The non-miscellaneous itemized deduction for personal property taxes may be subject to limitation on the returns of both B and C's trust under section 164(b)(6)(B) and would have to be separately stated as provided in § 1.642(h)-2(b)(1).

(c) Applicability date. This section is applicable to taxable years beginning after October 19, 2020. Taxpayers may choose to apply this section to taxable years beginning after December 31, 2017, and on or before October 19, 2020.