Inventory property is personal property that is stock in trade or that is held primarily for sale to customers in the ordinary course of one’s trade or business. Income from the sale of inventory that you purchased is sourced where the property is sold. Generally, this is where title to the property passes to the buyer. For example, income from the sale of inventory in the United States is U.S. source income, whether you purchased it in the United States or in a foreign country.
The basic rule for determining the source of income from the sale of inventory property depends on whether the inventory was (a) purchased for resale or (b) manufactured by the seller.
The regulations under Section 863 indicate that income from the purchase and sale of inventory is sourced to the country where the sale takes place (that is, where the contract is closed). Prior to the TCJA, if the seller manufactured the property, gross income was generally sourced under a “50/50 allocation method” between the country of manufacture and the country of sale. The TCJA revises Section 863(b) to provide that gains, profits, and income derived from the sale or exchange of inventory property produced by the taxpayer in the United States will be sourced in the United States. Conversely, income derived from the sale or exchange of inventory property produced by the taxpayer in a foreign country will be foreign-source income. For a U.S. manufacturer or producer, the revised Section 863(b) lowers the overall foreign-source income. The application of the provision will lower the amount of FTC that can be used to offset total U.S. tax liability for the year.
Income from the sale of inventory property that you produced in the United States and sold outside the United States (or vice versa) is partly from sources in the United States and partly from sources outside the United States. These rules apply even if one’s tax home is not in the United States.
To determine the source of any gain from the sale of depreciable personal property, you must first figure the part of the gain that is not more than the total depreciation adjustments on the property. You allocate this part of the gain to sources in the United States based on the ratio of U.S. depreciation adjustments to total depreciation adjustments. The rest of this part of the gain is considered to be from sources outside the United States.
For this purpose, “U.S. depreciation adjustments” are the depreciation adjustments to the basis of the property that are allowable in figuring taxable income from U.S. sources. However, if the property is used predominantly in the United States during a tax year, all depreciation deductions allowable for that year are treated as U.S. depreciation adjustments. But there are some exceptions for certain transportation, communications, and other property used internationally.
Gain from the sale of depreciable property that is more than the total depreciation adjustments on the property is sourced as if the property were inventory property, as discussed previously.
A loss is sourced in the same way as the depreciation deductions were sourced. However, if the property was used predominantly in the United States, the entire loss reduces U.S. source income.
The basis of property usually means the cost (money plus the fair market value of other property or services) of property you acquire. Depreciation is an amount deducted to recover the cost or other basis of a trade or business asset. The amount you can deduct depends on the property’s cost, when you began using the property, how long it will take to recover one’s cost, and which depreciation method you use. A depreciation deduction is any deduction for depreciation or amortization or any other allowable deduction that treats a capital expenditure as a deductible expense.
Intangible property includes patents, copyrights, secret processes or formulas, goodwill, trademarks, trade names, or other like property. The gain from the sale of amortizable or depreciable intangible property, up to the previously allowable amortization or depreciation deductions, is sourced in the same way as the original deductions were sourced. This is the same as the source rule for gain from the sale of depreciable property.
Gain in excess of the amortization or depreciation deductions is sourced in the country where the property is used if the income from the sale is contingent on the productivity, use, or disposition of that property. If the income is not contingent on the productivity, use, or disposition of the property, the income is sourced according to one’s tax home as discussed earlier. If payments for goodwill do not depend on its productivity, use, or disposition, their source is the country in which the goodwill was generated.
Despite any of the earlier rules, if you do not have a tax home in the United States, but you maintain an office or other fixed place of business in the United States, treat the income from any sale of personal property (including inventory property) that is attributable to that office or place of business as U.S. source income. However, this rule does not apply to sales of inventory property for use, disposition, or consumption outside the United States if one’s office or other fixed place of business outside the United States materially participated in the sale.
If you have a tax home in the United States but maintain an office or other fixed place of business outside the United States, income from sales of personal property, other than inventory, depreciable property, or intangibles, that is attributable to that foreign office or place of business may be treated as U.S. source income. The income is treated as U.S. source income if an income tax of less than 10% of the income from the sale is paid to a foreign country. This rule also applies to losses if the foreign country would have imposed an income tax of less than 10% had the sale resulted in a gain.
| Applicable IRC sections for certain income sourcing rules | ||
| Source of income from the sale of purchased personal property | ||
| Property | Source rule | IRC Section |
| Inventory | Source Where Title Passes | 865(b), 861(a)(6) |
| Depreciable | Gain Representing Depreciation Sourced to Country in Which Depreciation Deducted | 865(c) |
| Intangible | If Sale at Fixed Price, Source to Seller’s Residence | 865(d) |
| If Sale Is Contingent on Use, Productivity, or Disposition, Source to Where Intangible Is Exploited | 865(d) | |
| Goodwill | Source to Country Where Goodwill Is Georgetown | 865(d)(3) |
| 80% Foreign Corporation | Place of Sale if Sale Occurs in Foreign Country in Which Foreign Affiliate Earns More Than 50% of Its Gross Income for Prior Three Years | 865(f) |
| Other | Seller’s Residence | 865(a) |
Knowledge check
1 Where is income from the use of intangible properties or rights sourced?The intangible property or rights are exploited.The intangible or property right is legally patented.The intangible property or rights were developed.None of the above.
2 Gross income from sale of purchased personal property is sourcedBased on the seller’s residence.Based on the purchaser’s residence.Where title to the purchased personal property