26 U.S.C. § 470 — Limitation on deductions allocable to property used by governments or other tax-exempt entities

(a) Limitation on losses. A "tax-exempt use loss" cannot be deducted in the year it happens. Except where this section says otherwise, that loss is blocked for that year. (b) Disallowed loss carried to next year. A loss blocked under (a) isn't lost forever. It becomes a deduction for that same property in the next taxable year instead. (c) Definitions. (1) "Tax-exempt use loss" means: add up (i) all deductions other than interest that go with the tax-exempt use property, plus (ii) all interest deductions that go with it. Then compare that total to (B) the income the property earned. If the deductions are bigger than the income, the difference is the tax-exempt use loss. (2) "Tax-exempt use property" (A) generally has the same meaning as in section 168(h), but applied a special way here: you ignore paragraphs (1)(C) and (3) of that section, and you treat section 197 intangible property and certain film/sound-recording property described in section 167(f) as if they were tangible property. (B) There's an exception for partnerships: property isn't "tax-exempt use property" just because of section 168(h)(6). (C) A cross-reference points to section 7701(e) for how partnerships are treated as leases under section 168(h). (d) Exception for certain leases. This section does not apply to a lease if it meets all four of these tests: (1) Availability of funds. (A) At no point during the lease can more than an "allowable amount" of funds be tied up in the arrangements described in (B), or set aside (or expected to be set aside) for the lessor, a lender, or the lessee's own obligations. Money only counts as "set aside" if a reasonable person, looking at the facts, would say it is. (B) Those arrangements include things like a defeasance arrangement, a loan from the lessee to the lessor or a lender, a deposit, a cash-collateralized letter of credit, a payment undertaking agreement, prepaid rent, a sinking fund, a guaranteed investment contract, financial guaranty insurance, or anything similar. (C) The "allowable amount" is normally 20% of the lessor's adjusted basis in the property when the lease starts. Regulations can raise that percentage — but never above 50% — if the lessee's credit-worthiness requires it. If the lessee has an option to buy the property for a fixed price (not fair market value), the allowable amount at the time that option can be used can't be more than 50% of the option price. The allowable amount is zero for any arrangement involving a loan from the lessee to the lessor or a lender, a deposit/letter of credit/payment undertaking from a lender otherwise involved in the deal, or (where a lender is involved) credit support the lessor gets that isn't junior to that lender's claim. A "loan" here doesn't include amounts already treated as a loan under section 467. (2) Lessor must make a substantial equity investment. (A) The lessor must have an unconditional at-risk equity investment of at least 20% of the property's adjusted basis when the lease starts, must keep that investment throughout the lease, and the property's fair market value at the end of the lease must reasonably be expected to be at least 20% of that basis. (B) That end-of-lease value gets reduced to the extent someone other than the lessor bears the risk of the property losing value. (C) This paragraph doesn't apply to leases of 5 years or less. (3) Lessee may not bear more than minimal risk of loss. (A) There can be no arrangement making the lessee bear any part of the loss if the property's value at lease-end turned out to be 25% less than expected, or more than half the loss if the property's end-of-lease value turned out to be zero. (B) The Secretary can write regulations treating a lease as failing this test if the lessee bears more than a minimal risk of loss. (C) This paragraph doesn't apply to leases of 5 years or less. (4) Property with a class life of more than 7 years. For a lease of property (other than fixed-wing aircraft and vessels) with a class life over 7 years, if the lessee has a purchase option, that option's price must equal the property's fair market value at the time it's exercised. (e) Special rules. (1) Former tax-exempt use property. If property used to be tax-exempt use property but isn't anymore, a deduction carried forward under (b) can only be used up to the amount of net income the property earns that year; any leftover carries to the next year the same way. "Former tax-exempt use property" means property that isn't tax-exempt use property this year but was in some earlier year. (2) Disposing of the entire interest. If a taxpayer sells or gives up their whole interest in the property during the year, the rules work the same way as the similar rule in section 469(g). (3) Coordination with section 469. This section is applied first, before section 469. (4) Coordination with sections 1031 and 1033 (tax-free exchanges). (A) The tax-free treatment in those sections doesn't apply if either the property being exchanged is tax-exempt use property under a lease signed before March 13, 2004 that wouldn't have passed the (d) tests, or the replacement property is tax-exempt use property under a lease that doesn't pass the (d) tests. (B) When the lessor gets property through such an exchange, its adjusted basis for this section is the smaller of the property's fair market value when the lease starts, or what the basis would have been if sections 1031/1033 hadn't applied. (f) Other definitions. (1) "Lessor," "lessee," and "lender" each include a related party as defined in section 197(f)(9)(C)(i). (2) "Lease term" has the meaning given in section 168(i)(3). (3) "Lender" means someone who lends money to the lessor that is secured — or works economically like it's secured — by the lease or the property. (4) "Loan" includes any similar arrangement. (g) Regulations. The Secretary must write regulations needed to carry out this section, including rules that let similar property under the same lease be grouped together, and rules for figuring out how to divide up interest expense for purposes of this section.