Application of Section 250(b)(3)(A)(i)(VII) to Sales or Other Dispositions of Property, REG-117130-25, 91 Fed. Reg. _____ (proposed Aug. 20, 2026) (to be codified at 26 C.F.R. pt. 1)

The enactment of the Tax Cuts and Jobs Act of 2017 (TCJA) fundamentally reshaped the landscape of international corporate taxation, introducing the global intangible low-taxed income (GILTI) regime under Internal Revenue Code (I.R.C.) Section 951A and the foreign-derived intangible income (FDII) deduction under Section 250. Designed to neutralize tax considerations when choosing whether to serve foreign markets through domestic operations or controlled foreign corporations (CFCs), Section 250 originally allowed a domestic corporation a deduction equal to 37.5 percent of its foreign-derived deduction eligible income (FDDEI), reducing the effective corporate tax rate on qualifying income.

However, under the original statutory framework, Section 250 did not generally exclude income or gain derived from sales or other dispositions of intangible property or depreciable, amortizable, or depletable business property from deduction eligible income (DEI). This loophole allowed taxpayers to claim FDII benefits with respect to certain major asset dispositions. Treasury and the Internal Revenue Service (IRS) noted that this treatment could undermine the legislative intent, as it could “undermine the policy objectives of the TCJA’s changes to the U.S. international tax system, which were principally directed toward curbing erosion of the U.S. tax base through the offshoring of property that generates ongoing foreign-market intangible income”.

To address this systemic risk, Congress enacted the One, Big, Beautiful Bill Act (OBBBA) on July 4, 2025, as Public Law 119-21, 139 Stat. 72. Section 70322(a)(1) of the OBBBA amended Section 250(b)(3)(A)(i) to add a seventh category of gross income that is excluded from the determination of DEI: Section 250(b)(3)(A)(i)(VII). Specifically, this amendment excludes “income and gain from the sale or other disposition (including pursuant to the deemed sale or other deemed disposition or a transaction subject to section 367(d)) of intangible property (as defined in section 367(d)(4)), and any other property of a type that is subject to depreciation, amortization, or depletion by the seller, respectively”. Furthermore, Section 70322(a)(2) of the OBBBA amended Section 250(b)(5)(E) (subsequently redesignated Section 250(b)(2)(E) for taxable years beginning after December 31, 2025) to provide that the broad Section 250 definition of “sale”—which includes leases, licenses, exchanges, and other dispositions—does not apply for purposes of this new exclusion. Thus, leases and licenses are preserved from exclusion and may remain within the DEI base.

Following preliminary guidance in Notice 2025-78, 2025-52 I.R.B. 874, Treasury and the IRS have released these Proposed Regulations (REG-117130-25) to establish “administrable standards, reduce uncertainty, improve consistency among similarly situated taxpayers, and prevent inappropriate claims of FDDEI with respect to income from the disposition of intangible property and business assets that Congress excluded from DEI”.

Revisions, Additions, and Deletions to the Section 250 Regulatory Framework

The Proposed Regulations execute several targeted amendments to the existing regulations under 26 CFR Part 1 to implement the statutory mandates of the OBBBA.

First, the Proposed Regulations introduce the concept of “excluded property sales income” under Prop. Treas. Reg. § 1.250(b)-1(c)(15)(vii) as a new category of gross income excluded from the determination of DEI. The scope and operational definitions for this category are housed in the newly added Prop. Treas. Reg. § 1.250(b)-1(h). Under Prop. Treas. Reg. § 1.250(b)-1(h)(1), the term is defined to mean “any income and gain derived from the sale or other disposition... of... (i) Intangible property (as defined in §1.250(b)-3(b)(11)); or (ii) Other excluded property (as defined in paragraph (h)(2)(ii) of this section)”.
Second, the Proposed Regulations revise Treas. Reg. § 1.250(b)-1(c)(12) to clarify that “foreign-derived deduction eligible income or FDDEI means, with respect to a domestic corporation for a taxable year, the excess (if any, and not to exceed DEI) of the corporation’s gross FDDEI for the year, over the deductions properly allocable to gross FDDEI for the year”. This revision ensures that FDDEI remains a structural subset of DEI. This clarification conforms the regulations to the OBBBA amendments, which removed the deemed intangible income (DII) and deemed tangible income return (DTIR) components from the FDII calculation and replaced the term “foreign-derived intangible income” with “foreign-derived deduction eligible income,” rendering the “foreign-derived ratio” in Treas. Reg. § 1.250(b)-1(c)(13) obsolete.
Third, to conform to the statutory exclusion of intangible property sales, the Proposed Regulations delete and reserve several examples in Treas. Reg. § 1.250(b)-4(d)(2)(iv)(B) that involve the sale of intangible property, specifically paragraphs (d)(2)(iv)(B)(3) through (5), and (8).

The Core Definitions and Statutory Baseline

To prevent administrative complexity, Prop. Treas. Reg. § 1.250(b)-1(h)(2)(ii) defines “other excluded property” by reference to existing, familiar statutory and regulatory tax concepts rather than creating a bespoke classification regime. Under this definition, property is excluded if, in the hands of the “excluded seller” (defined as the domestic corporation or partnership making the sale), the property is:

Property of a character subject to the allowance for depreciation under Section 167;
Property subject to an allowance for amortization that is not described in the depreciation clause; or
Property subject to the allowance for depletion under Section 611.

For depreciable property, Treasury intentionally adopted the phrase “property of a character subject to the allowance for depreciation under section 167” as an established “term of art commonly used to describe property depreciated under section 167, including by Congress in other Code provisions that reference section 167, such as sections 174A(c)(1)..., 197(f)(7)..., 1221(a)(2)..., and 1231(b)(1)”. By relying on these existing standards, the IRS reduces the “administrative burden” because “taxpayers generally already classify property for purposes of depreciation, amortization, depletion, inventory accounting, and gain characterization”.

Under Prop. Treas. Reg. § 1.250(b)-1(h)(2)(iii), a “sale or other disposition” is determined strictly under “general Federal income tax principles, including deemed sales, other deemed dispositions, and transactions subject to section 367(d)”. Crucially, the regulations explicitly state that a “sale or other disposition does not include a transaction that would be characterized under general tax principles as a lease or license”. This approach ensures that taxpayers do not need to “characterize the same transaction differently for section 250 than for other Federal income tax purposes”.

Software Transactions and the Intangible Property Boundary

In response to Notice 2025-78, numerous commenters requested clarification regarding the treatment of software and other digital content under the new rules. The Proposed Regulations address these comments by coordinating the definition of intangible property with the existing classification rules under Treas. Reg. § 1.861-18.

Under Prop. Treas. Reg. § 1.250(b)-1(h)(1)(i), intangible property is defined by reference to Treas. Reg. § 1.250(b)-3(b)(11), which explicitly provides that “intangible property does not include a copyrighted article as defined in §1.861-18(c)(3)”. A copyrighted article includes any copy of digital content from which the work can be perceived, reproduced, or otherwise communicated.

The IRS’s legal analysis justifies this distinction by emphasizing that “treating sales of copyrighted articles as excluded property sales income solely because the articles embody copyrightable content could disadvantage sales of copyrighted articles relative to other transaction forms, including certain licenses, cloud transactions, and services”. Such a result would exceed the scope of the statutory exclusion, which “is directed at dispositions of intangible property rather than ordinary-course sales of copyrighted articles”.

To illustrate this, the Proposed Regulations add Prop. Treas. Reg. § 1.250(b)-1(h)(4)(ii) (Example 2). In the facts of the example, a domestic corporation (DC) transfers copies of Program X in perpetuity to unrelated foreign customers and also uses separate copies of Program X in its own business. The IRS’s analysis concludes that:

The transfer of copies is a sale of copyrighted articles under Treas. Reg. § 1.861-18(c)(3).
These copies are not intangible property under Treas. Reg. § 1.250(b)-3(b)(11).
The sold copies are not “other excluded property” because in the hands of DC, “those copies of Program X are not property that is of a character subject to the allowance for depreciation under section 167 or amortization”.
Importantly, the fact that DC uses separate copies of the software internally (which may be depreciable/amortizable in its hands) “does not affect this analysis, even if DC’s internal use copies are other excluded property”. Thus, the sales gain is not excluded from DEI.

In contrast, if foreign customers only receive a right to use the software for two years, the arrangement is classified as a lease of a copyrighted article under Treas. Reg. § 1.861-18(f)(2). Because there has been “no sale or other disposition of other excluded property, DC’s income or gain from the lease of copies of Program X is not excluded property sales income” and remains eligible for DEI/FDDEI.

The IRS also rejected comments asking to modify Example 1 of Notice 2025-78, which characterizes a transfer of all substantial rights in a copyright as a sale of intangible property despite being labeled a license. Commenters sought to introduce the form of consideration and the transferee’s use as factors. The IRS firmly rejected this, stating that “the sale versus license determination does not depend on the form of consideration or the transferee’s use of the intangible property,” citing established judicial and administrative precedents, specifically E.I. du Pont de Nemours & Co. v. United States, 432 F.2d 1052 (3d Cir. 1970) and Rev. Rul. 57-40, 1957-1 C.B. 266.

Rejecting the Remanufacturing Exception and Depreciation Recapture Limitation

A major point of contention during the comment period on Notice 2025-78 involved taxpayers that use high-value assets (such as machinery or transportation equipment) in their domestic trade or business and later “repurpose, remanufacture, or refurbish” those assets for sale to foreign customers. Commenters argued for a “remanufacturing exception,” asserting that including such sales in the exclusion is inappropriate because the gain reflects “new investment, value creation, and foreign-market expansion” which is economically similar to newly manufactured inventory. Alternatively, they proposed a “depreciation recapture limitation,” which would limit the exclusion solely to the amount of prior depreciation recaptured, allowing any gain in excess of prior depreciation to remain eligible for DEI/FDDEI.

The Treasury Department and the IRS flatly rejected both recommendations. Under their statutory analysis, the phrase “other property of a type that is subject to depreciation, amortization, or depletion by the seller” under Section 250(b)(3)(A)(i)(VII)(bb) “would include, for example, property that has been subject to any depreciation in the hands of the seller”. Consequently, “property previously depreciated in a trade or business and repurposed, remanufactured, or refurbished into inventory would retain its characterization as property subject to depreciation”.

Furthermore, the IRS concluded that “the requested depreciation recapture limitation is contrary to section 250(b)(3)(A)(i)(VII), which excludes all income and gain from the sale or other disposition of referenced property and does not suggest a limitation to depreciation recapture”. Thus, under Prop. Treas. Reg. § 1.250(b)-1(h)(4)(iii) (Example 3), the sale of an asset with an adjusted depreciable basis of zero (fully depreciated under Section 167) constitutes “excluded property sales income” in its entirety. This applies even if the seller acquired the asset in a nonrecognition transaction where it was already fully depreciated by the prior owner, because the asset remains “property that is of a character subject to the allowance for depreciation under section 167 in the hands of [the seller]”.

The Inventory Clarification and the Related-Party Anti-Abuse Backstop

To protect ordinary-course commercial operations, the Proposed Regulations clarify that “other excluded property” does not include “property that has always been held as inventory by the seller because such property would not be ‘of a character’ subject to the allowance for depreciation”.

The IRS’s economic analysis underscores the necessity of this clarification. If inventory were treated as excluded property merely because it is of a type that the buyer could depreciate (e.g., aircraft, industrial machinery, or vehicles), the exclusion “could apply broadly to ordinary foreign-market sales of manufactured products”. Such an overbroad reading “could substantially narrow the category of income that would otherwise be considered as FDDEI, which would dampen the intended incentive for domestic corporations to serve foreign markets from the United States”. Thus, the regulations adopt an “asset-by-asset approach” to distinguish “between a seller’s disposition of its own business assets and the seller’s ordinary-course sales of inventory”.

However, to prevent taxpayers from abusing this inventory carveout, Prop. Treas. Reg. § 1.250(b)-1(h)(3) establishes a related-party anti-abuse rule. Under this rule, property generally retains its “other excluded property” character if it is transferred within a modified affiliated group in a basis-carryover transaction (such as a Section 351 or Section 721 exchange) if the transfer was executed “with a principal purpose of avoiding the application of section 250(b)(3)(A)(i)(VII)(bb)”.

The IRS justifies this restriction by noting that the inventory clarification is “intended to preserve DEI treatment for legitimate ordinary-course sales of inventory to foreign customers, not to permit taxpayers to avoid the statutory exclusion by moving depreciable, amortizable, or depletable property through related parties or intermediary entities before sale”. The related-party anti-abuse rule serves as a “backstop to the inventory clarification, so that the clarification protects ordinary-course inventory sales without allowing taxpayers to convert excluded property sales income into FDDEI through related-party reclassification or similar transactions”.

This anti-abuse rule is illustrated in Prop. Treas. Reg. § 1.250(b)-1(h)(4)(vi) (Example 6), where DC1 transfers depreciable cars to a partnership (PRS) under Section 721, which then transfers them to DC2 under Section 351. DC2 holds the cars as inventory and sells them to a foreign customer. Because the cars were other excluded property in the hands of DC1, were transferred in basis-carryover transactions within a modified affiliated group, and were transferred with a principal purpose of avoiding the exclusion, they retain their character as other excluded property in the hands of DC2. DC2’s subsequent gains from the sales of the cars are thus treated as excluded property sales income.

Applicability Dates, Transitional Guidance, and Taxpayer Reliance

The Treasury Department and the IRS expect to finalize REG-117130-25 by January 4, 2027.

Pursuant to the retroactive rulemaking authority conferred by Section 7805(b)(2) (which permits regulations to apply retroactively to prevent abuse or implement recent statutory changes), the proposed exclusions for “excluded property sales income” under Prop. Treas. Reg. § 1.250(b)-1(c)(15)(vii) and Prop. Treas. Reg. § 1.250(b)-1(h) are generally proposed to apply to sales or other dispositions occurring after June 16, 2025.

In contrast, the proposed amendment to Treas. Reg. § 1.250(b)-1(c)(12) (clarifying that FDDEI is a subset of, and limited by, DEI) is proposed to apply prospectively to taxable years beginning after December 31, 2025.

For the transitional period, taxpayers are provided with two layers of administrative reliance:

Notice 2025-78 Reliance: Taxpayers may rely on the rules described in Notice 2025-78 for sales or other dispositions occurring after June 16, 2025, and before these Proposed Regulations are published in the Federal Register, provided they apply those rules in their entirety and in a consistent manner.
Proposed Regulations Reliance: Taxpayers may rely on these Proposed Regulations for sales or other dispositions occurring before the date final regulations are published in the Federal Register, provided that the taxpayer and its related parties (within the meaning of Treas. Reg. § 1.250(b)-1(c)(19)) follow the Proposed Regulations in their entirety and in a consistent manner for all applicable taxable years.

Prepared with assistance from Gemini Notebook.