Sec. 3124. Prevention of arbitrage of deductible interest expense and tax-exempt interest income

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So much of section 265(b) as precedes paragraph

(3)is amended to read as follows: In the case of a C corporation or a financial institution, no deduction shall be allowed for that portion of the taxpayer’s interest expense which is allocable to tax-exempt interest. For purposes of paragraph (1), the portion of the taxpayer’s interest expense which is allocable to tax-exempt interest is an amount which bears the same ratio to such interest expense as— the taxpayer’s average adjusted bases (within the meaning of section 1016) of tax-exempt obligations acquired on or after February 26, 2014 (August 7, 1986, in the case of a financial institution), bears to such average adjusted bases for all assets of the taxpayer. . Section 265(b) is amended by striking paragraphs

(3)and (7). Section 163(d)(1) is amended to read as follows: In the case of a taxpayer other than a corporation, the amount allowed as a deduction under this chapter for investment interest for any taxable year— shall be reduced by the amount of tax-exempt interest received by the taxpayer during such taxable year, and shall not (after any reduction under subparagraph (A)) exceed the net investment income of the taxpayer for such taxable year. . Section 163(d)(2) is amended by striking paragraph

(1)and inserting paragraph (1)(B) . Section 163(d)(5)(A) is amended by striking and at the end of clause (i), by striking the period at the end of clause (ii)(II) and inserting , and , and by adding at the end the following new clause: any property held for the production of tax-exempt interest (including any shares of stock of a regulated investment company which during the taxable year of the holder thereof distributes exempt-interest dividends). . Section 265(a) is amended by— striking paragraph

(2)and inserting the following new paragraph: For pro rata allocation rules in the case of corporations and financial institutions, see subsection (b). For limitation on investment interest in the case of other taxpayers, see section 163(d). , and by striking paragraphs

(4)and

(5)and by redesignating paragraph

(6)as paragraph (4). Section 265(b), as amended by subsection (a), is amended by inserting after paragraph

(2)the following new paragraph: For purposes of this subsection, interest includes any amount paid or incurred— by any person making a short sale in connection with personal property used in such short sale, or by any other person for the use of any collateral with respect to such short sale. If— the taxpayer provides cash as collateral for any short sale, and the taxpayer receives no material earnings on such cash during the period of the sale, subparagraph (A)(i) shall not apply to such short sale. . Section 265(b)(6) is amended to read as follows: This section shall be applied before the application of section 263A (relating to capitalization of certain expenses where taxpayer produces property). . Section 163(n)(2) is amended to read as follows: For disallowance of deduction for interest relating to tax-exempt income, see sections 163(d) and 265(b) . The amendments made by subsection (a)(1) shall apply to taxable years ending on or after February 26, 2014. The amendments made by subsection (a)(2) shall apply to obligations issued on or after February 26, 2014. The amendments made by subsection

(b)shall apply to taxable years beginning after December 31, 2014.