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Purchase Money Indebtedness

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					                                § 2.1–14                                                                26 CFR Ch. I (4–1–05 Edition)

                                § 2.1–14 Deposit of earnings and re-                       fund in the construction, reconstruc-
                                     ceipts.                                               tion, reconditioning, or acquisition of
                                   (a) Earnings. A citizen may deposit                     new vessels, or for the liquidation of
                                all or any part of earnings derived from                   purchase-money indebtedness on such
                                the operation, within the scope of § 2.1–                  vessels. For incurrence of tax liability
                                3, of a vessel or vessels owned either by                  due to noncompliance with the require-
                                himself or any other person, if such                       ments of section 511 of the Act and the
                                earnings are intended for construction                     regulations in this part with respect to
                                or acquisition of new vessels. Such                        deposits in the construction reserve
                                earnings may include payments re-                          fund, see the provisions of § 2.1–23.
                                ceived by an owner, as compensation
                                for use of his vessel, from other persons                  § 2.1–17   Basis of new vessel.
                                by whom it is so operated. Earnings                          The basis for determining gain or
                                from other sources may not be depos-                       loss and for depreciation for the pur-
                                ited. The earnings from operation of                       pose of the Federal income tax with re-
                                vessels which are eligible for deposit                     spect to a new vessel constructed, re-
                                are the net earnings determined with-                      constructed, reconditioned, or acquired
                                out regard to any deduction for depre-                     by the taxpayer, or with respect to
                                ciation, obsolescence, or amortization                     which purchase-money indebtedness is
                                with respect to such vessels.                              liquidated as provided in section 511(g)
                                   (b) Receipts. Receipts from deposited                   of the Act, with funds deposited in the
                                funds, in the form of interest or other-                   construction reserve fund, is reduced
                                wise, may be deposited.                                    by the amount of the unrecognized
                                § 2.1–15 Time for making deposits.                         gain represented in the funds allocated
                                                                                           under the provisions of the regulations
                                   (a) Proceeds of sale or indemnification.                in this part to the cost of such vessel.
                                Deposits of amounts representing pro-                      (See § 2.1–18.)
                                ceeds of the sale or indemnification for
                                loss of a vessel or share therein must                     § 2.1–18 Allocation of gain for tax pur-
                                be made within 60 days after receipt by                         poses.
                                the taxpayer.
                                   (b) Earnings and receipts. Earnings                        (a) General rules of allocation. As pro-
                                and receipts for the taxable year may                      vided in § 2.1–17, if amounts on deposit
                                be deposited at any time. (See § 2.1–14.)                  in a construction reserve fund are ex-
                                                                                           pended, obligated, or withdrawn for
                                § 2.1–16 Tax liability as to earnings de-                  construction, reconstruction, recondi-
                                     posited.                                              tioning, or acquisition of new vessels,
                                   Deposit in the construction reserve                     or for the liquidation of purchase-
                                fund of earnings from the operation of                     money indebtedness of such vessels,
                                a vessel or vessels, or receipts, in the                   the portion thereof which represents
                                form of interest or otherwise, with re-                    gain shall be applied in reduction of
                                spect to amounts previously deposited                      the basis of such new vessels. The rules
                                does not exempt the taxpayer from tax                      set forth below in this paragraph shall
                                liability with respect thereto nor post-                   apply in allocating the unrecognized
                                pone the time such earnings or receipts                    gain to the amounts so expended, obli-
                                are includible in gross income. Earn-                      gated, or withdrawn:
                                ings and receipts deposited in a con-                         (1) If the ‘‘net proceeds’’ of a sale or
                                struction reserve fund established in                      ‘‘net indemnity’’ in respect of a loss
                                accordance with the provisions of sec-                     are deposited in more than one deposit,
                                tion 511 of the Act and the regulations                    the portion thereof representing unrec-
                                in this part will be deemed to have                        ognized gain shall be considered as hav-
                                been accumulated for the reasonable                        ing been deposited first.
                                needs of the business within the mean-                        (2) Amounts expended, obligated, or
                                ing of Part 1 (section 531 and fol-                        withdrawn from the construction re-
                                lowing), Subchapter G, Chapter I of the                    serve fund shall be applied against
                                Internal Revenue Code of 1954, so long                     amounts deposited in the order of de-
                                as the requirements of section 511 of                      posit.
                                the Act and the regulations in this part                      (3) If any deposit consists in part of
                                are satisfied relative to the use of the                   gain not recognized under section 511(c)

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                                Internal Revenue Service, Treasury                                                                   § 2.1–19

                                of the Act, then any expenditure, obli-                    amount of the unrecognized gain to be ap-
                                gation, or withdrawal applied against                      plied against the basis of the new vessel is
                                such deposit shall be considered to con-                   $550,000, computed as follows: Gain of $400,000
                                                                                           represented in the 1963 deposits, plus the
                                sist of gain in the same proportion that                   same proportion of the $250,000 gain rep-
                                the part of the deposit which con-                         resented in the March 1964 deposit ($1,000,000)
                                stitutes gain bears to the total amount                    which the amount ($600,000) allocated to the
                                of the deposit.                                            vessel is of the amount of the deposit, i.e.,
                                  (b) Date of obligation. The date funds                   $400,000 plus 600,000/1,000,000 of $250,000 or
                                are obligated under a contract for the                     $150,000, a total of $550,000. This reduces the
                                construction, reconstruction, recondi-                     basis of the new vessel to $1,200,000 ($l,750,000
                                tioning, or acquisition of new vessels,                    less $550,000).
                                                                                             (2) In 1965, the taxpayer sells a third vessel
                                or for the liquidation of purchase-                        for $3,000,000, realizing a gain of $900,000. The
                                money indebtedness on such vessels,                        $3,000,000 is received and deposited in the
                                rather than the date of payment from                       construction reserve fund in June 1965, mak-
                                the fund, will determine the order of                      ing a total in the fund of $3,400,000. In De-
                                application against the deposits in the                    cember 1965, the taxpayer contracts for the
                                fund. When a contract for the construc-                    construction of a second new vessel to cost a
                                tion, reconstruction, reconditioning, or                   maximum of $3,200,000, thereby obligating
                                                                                           that amount of the fund, and in June 1966,
                                acquisition of new vessels, or for the                     receives permission to withdraw the unobli-
                                liquidation of purchase-money indebt-                      gated balance amounting to $200,000. To the
                                edness on such vessels is entered into,                    cost of the second new vessel must be allo-
                                amounts on deposit in the construction                     cated the $400,000 balance of the March 1964
                                reserve fund will be deemed to be obli-                    deposit and $2,800,000 of the June 1965 de-
                                gated to the extent of the amount of                       posit. The unrecognized gain to be applied
                                the taxpayer’s liability under the con-                    against the basis of such new vessel is that
                                                                                           proportion of the gain represented in each
                                tract. Deposits will be deemed to be so                    deposit which the portion of the deposit allo-
                                obligated in the order of deposit, each                    cated to the vessel bears to the amount of
                                new contract obligating the earliest de-                   such deposit, i.e., 400,000/1,000,000 of $250,000,
                                posit not previously expended, obli-                       or $100,000 plus 2,800,000/3,000,000 of $900,000, or
                                gated, or withdrawn. If the liability                      $840,000 making a total of $940,000. The
                                under the contract exceeds the amount                      $200,000 withdrawal is applied against the
                                in the construction reserve fund, the                      June 1965 deposit and the portion thereof
                                                                                           which represents gain will be recognized as
                                contract will be deemed to obligate, to                    income for 1965, the year in which realized.
                                the extent of that part of such excess                     The computation of the recognized gain is as
                                not otherwise satisfied, the earliest de-                  follows: 200,000/3,000,000 of $900,000, or $60,000.
                                posit or deposits thereafter made.
                                  (c) Illustration. The foregoing rules                    § 2.1–19 Requirements as to new ves-
                                are illustrated in the following exam-                          sels.
                                ple:                                                          (a) Requirements. For the purposes of
                                  Example. (1) A taxpayer who makes his re-                section 511 of the Act and the regula-
                                turns on the calendar year basis sells a ves-              tions in this part, the new vessel must
                                sel in 1963 for $1,000,000, realizing a gain of            be—
                                $400,000. Payment of $100,000 is received in                  (1) Documented under the laws of the
                                March 1963 when the contract is signed, and                United States when it is acquired by
                                the balance of $900,000 is received in June                the taxpayer, or the taxpayer must
                                1963 on delivery of the vessel. The $1,000,000 is          agree that when acquired it will be doc-
                                deposited in a construction reserve fund in
                                July 1963. In December 1963, the taxpayer
                                                                                           umented under the laws of the United
                                also deposits $150,000, representing earnings              States;
                                of that year. In 1964, he sells another vessel                (2)(i) Constructed in the United
                                for $1,000,000, realizing a gain of $250,000. The          States after December 31, 1939, or (ii)
                                sale price of $1,000,000 is received on delivery           its construction has been financed
                                of the vessel in February 1964, and deposited              under Title V or Title VII of the Act,
                                in the construction reserve fund in March                  or (iii) its construction has been aided
                                1964. In September 1964, the taxpayer pur-                 by a mortgage insured under Title XI
                                chases for cash out of the construction re-
                                serve fund a new vessel for $1,750,000. To the
                                                                                           of the Act; and
                                cost of this vessel must be allocated the 1963                (3) Either (i) of such type, size, and
                                deposits of $1,150,000 and $600,000 of the                 speed as the Administration deter-
                                March 1964 deposit. This leaves in the fund                mines to be suitable for use on the high
                                $400,000 of the March 1964 deposit. The                    seas or Great Lakes in carrying out the

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