[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2021 Edition]
[From the U.S. Government Publishing Office]



[[Page i]]

          

                                          Title 26

                                      Internal Revenue
                                 ________________________

                            Part 1 (Sec. Sec.  1.301 to 1.400)

                         Revised as of April 1, 2021

          Containing a codification of documents of general 
          applicability and future effect

          As of April 1, 2021
                    Published by the Office of the Federal Register 
                    National Archives and Records Administration as a 
                    Special Edition of the Federal Register

[[Page ii]]

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[[Page iii]]




                            Table of Contents



                                                                    Page
  Explanation.................................................       v

  Title 26:
          Chapter I--Internal Revenue Service, Department of 
          the Treasury (Continued)                                   3
  Finding Aids:
      Table of CFR Titles and Chapters........................     801
      Alphabetical List of Agencies Appearing in the CFR......     821
      Table of OMB Control Numbers............................     831
      List of CFR Sections Affected...........................     849

[[Page iv]]





                     ----------------------------

                     Cite this Code: CFR
                     To cite the regulations in 
                       this volume use title, 
                       part and section number. 
                       Thus, 26 CFR 1.301-1 
                       refers to title 26, part 
                       1, section 301-1.

                     ----------------------------

[[Page v]]



                               EXPLANATION

    The Code of Federal Regulations is a codification of the general and 
permanent rules published in the Federal Register by the Executive 
departments and agencies of the Federal Government. The Code is divided 
into 50 titles which represent broad areas subject to Federal 
regulation. Each title is divided into chapters which usually bear the 
name of the issuing agency. Each chapter is further subdivided into 
parts covering specific regulatory areas.
    Each volume of the Code is revised at least once each calendar year 
and issued on a quarterly basis approximately as follows:

Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1

    The appropriate revision date is printed on the cover of each 
volume.

LEGAL STATUS

    The contents of the Federal Register are required to be judicially 
noticed (44 U.S.C. 1507). The Code of Federal Regulations is prima facie 
evidence of the text of the original documents (44 U.S.C. 1510).

HOW TO USE THE CODE OF FEDERAL REGULATIONS

    The Code of Federal Regulations is kept up to date by the individual 
issues of the Federal Register. These two publications must be used 
together to determine the latest version of any given rule.
    To determine whether a Code volume has been amended since its 
revision date (in this case, April 1, 2021), consult the ``List of CFR 
Sections Affected (LSA),'' which is issued monthly, and the ``Cumulative 
List of Parts Affected,'' which appears in the Reader Aids section of 
the daily Federal Register. These two lists will identify the Federal 
Register page number of the latest amendment of any given rule.

EFFECTIVE AND EXPIRATION DATES

    Each volume of the Code contains amendments published in the Federal 
Register since the last revision of that volume of the Code. Source 
citations for the regulations are referred to by volume number and page 
number of the Federal Register and date of publication. Publication 
dates and effective dates are usually not the same and care must be 
exercised by the user in determining the actual effective date. In 
instances where the effective date is beyond the cut-off date for the 
Code a note has been inserted to reflect the future effective date. In 
those instances where a regulation published in the Federal Register 
states a date certain for expiration, an appropriate note will be 
inserted following the text.

OMB CONTROL NUMBERS

    The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires 
Federal agencies to display an OMB control number with their information 
collection request.

[[Page vi]]

Many agencies have begun publishing numerous OMB control numbers as 
amendments to existing regulations in the CFR. These OMB numbers are 
placed as close as possible to the applicable recordkeeping or reporting 
requirements.

PAST PROVISIONS OF THE CODE

    Provisions of the Code that are no longer in force and effect as of 
the revision date stated on the cover of each volume are not carried. 
Code users may find the text of provisions in effect on any given date 
in the past by using the appropriate List of CFR Sections Affected 
(LSA). For the convenience of the reader, a ``List of CFR Sections 
Affected'' is published at the end of each CFR volume. For changes to 
the Code prior to the LSA listings at the end of the volume, consult 
previous annual editions of the LSA. For changes to the Code prior to 
2001, consult the List of CFR Sections Affected compilations, published 
for 1949-1963, 1964-1972, 1973-1985, and 1986-2000.

``[RESERVED]'' TERMINOLOGY

    The term ``[Reserved]'' is used as a place holder within the Code of 
Federal Regulations. An agency may add regulatory information at a 
``[Reserved]'' location at any time. Occasionally ``[Reserved]'' is used 
editorially to indicate that a portion of the CFR was left vacant and 
not dropped in error.

INCORPORATION BY REFERENCE

    What is incorporation by reference? Incorporation by reference was 
established by statute and allows Federal agencies to meet the 
requirement to publish regulations in the Federal Register by referring 
to materials already published elsewhere. For an incorporation to be 
valid, the Director of the Federal Register must approve it. The legal 
effect of incorporation by reference is that the material is treated as 
if it were published in full in the Federal Register (5 U.S.C. 552(a)). 
This material, like any other properly issued regulation, has the force 
of law.
    What is a proper incorporation by reference? The Director of the 
Federal Register will approve an incorporation by reference only when 
the requirements of 1 CFR part 51 are met. Some of the elements on which 
approval is based are:
    (a) The incorporation will substantially reduce the volume of 
material published in the Federal Register.
    (b) The matter incorporated is in fact available to the extent 
necessary to afford fairness and uniformity in the administrative 
process.
    (c) The incorporating document is drafted and submitted for 
publication in accordance with 1 CFR part 51.
    What if the material incorporated by reference cannot be found? If 
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CFR INDEXES AND TABULAR GUIDES

    A subject index to the Code of Federal Regulations is contained in a 
separate volume, revised annually as of January 1, entitled CFR Index 
and Finding Aids. This volume contains the Parallel Table of Authorities 
and Rules. A list of CFR titles, chapters, subchapters, and parts and an 
alphabetical list of agencies publishing in the CFR are also included in 
this volume.
    An index to the text of ``Title 3--The President'' is carried within 
that volume.

[[Page vii]]

    The Federal Register Index is issued monthly in cumulative form. 
This index is based on a consolidation of the ``Contents'' entries in 
the daily Federal Register.
    A List of CFR Sections Affected (LSA) is published monthly, keyed to 
the revision dates of the 50 CFR titles.

REPUBLICATION OF MATERIAL

    There are no restrictions on the republication of material appearing 
in the Code of Federal Regulations.

INQUIRIES

    For a legal interpretation or explanation of any regulation in this 
volume, contact the issuing agency. The issuing agency's name appears at 
the top of odd-numbered pages.
    For inquiries concerning CFR reference assistance, call 202-741-6000 
or write to the Director, Office of the Federal Register, National 
Archives and Records Administration, 8601 Adelphi Road, College Park, MD 
20740-6001 or e-mail [email protected].

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ELECTRONIC SERVICES

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free). E-mail, [email protected].
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law numbers, Federal Register finding aids, and related information. 
Connect to NARA's website at www.archives.gov/federal-register.
    The e-CFR is a regularly updated, unofficial editorial compilation 
of CFR material and Federal Register amendments, produced by the Office 
of the Federal Register and the Government Publishing Office. It is 
available at www.ecfr.gov.

    Oliver A. Potts,
    Director,
    Office of the Federal Register
    April 1, 2021







[[Page ix]]



                               THIS TITLE

    Title 26--Internal Revenue is composed of twenty-two volumes. The 
contents of these volumes represent all current regulations codified 
under this title by the Internal Revenue Service, Department of the 
Treasury, as of April 1, 2021. The first fifteen volumes comprise part 1 
(Subchapter A--Income Tax) and are arranged by sections as follows: 
Sec. Sec.  1.0-1.60; Sec. Sec.  1.61-1.139; Sec. Sec.  1.140-1.169; 
Sec. Sec.  1.170-1.300; Sec. Sec.  1.301-1.400; Sec. Sec.  1.401-1.409; 
Sec. Sec.  1.410-1.440; Sec. Sec.  1.441-1.500; Sec. Sec.  1.501-1.640; 
Sec. Sec.  1.641-1.850; Sec. Sec.  1.851-1.907; Sec. Sec.  1.908-1.1000; 
Sec. Sec.  1.1001-1.1400; Sec. Sec.  1.1401-1.1550; and Sec.  1.1551 to 
end of part 1. The sixteenth volume containing parts 2-29, includes the 
remainder of subchapter A and all of Subchapter B--Estate and Gift 
Taxes. The last six volumes contain parts 30-39 (Subchapter C--
Employment Taxes and Collection of Income Tax at Source); parts 40-49; 
parts 50-299 (Subchapter D--Miscellaneous Excise Taxes); parts 300-499 
(Subchapter F--Procedure and Administration); parts 500-599 (Subchapter 
G--Regulations under Tax Conventions); and part 600 to end (Subchapter 
H--Internal Revenue Practice).

    The OMB control numbers for title 26 appear in Sec.  602.101 of this 
chapter. For the convenience of the user, Sec.  602.101 appears in the 
Finding Aids section of the volumes containing parts 1 to 599.

    For this volume, Gabrielle E. Burns was Chief Editor. The Code of 
Federal Regulations publication program is under the direction of John 
Hyrum Martinez, assisted by Stephen J. Frattini.

[[Page 1]]



                       TITLE 26--INTERNAL REVENUE




         (This book contains part 1, Sec. Sec. 1.301 to 1.400)

  --------------------------------------------------------------------
                                                                    Part

chapter i--Internal Revenue Service, Department of the 
  Treasury (Continued)......................................           1

[[Page 3]]



    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)




  --------------------------------------------------------------------


  Editorial Note: IRS published a document at 45 FR 6088, Jan. 25, 1980, 
deleting statutory sections from their regulations. In chapter I cross 
references to the deleted material have been changed to the 
corresponding sections of the IRS Code of 1954 or to the appropriate 
regulations sections. When either such change produced a redundancy, the 
cross reference has been deleted. For further explanation, see 45 FR 
20795, Mar. 31, 1980.

                  SUBCHAPTER A--INCOME TAX (CONTINUED)
Part                                                                Page
1               Income taxes (Continued)....................           5

Supplementary Publications: Internal Revenue Service Looseleaf 
  Regulations System.

  Additional supplementary publications are issued covering Alcohol and 
Tobacco Tax Regulations, and Regulations Under Tax Conventions.

[[Page 5]]



                   SUBCHAPTER A_INCOME TAX (CONTINUED)





PART 1_INCOME TAXES (CONTINUED)--Table of Contents



                  Normal Taxes and Surtaxes (Continued)

                 CORPORATE DISTRIBUTIONS AND ADJUSTMENTS

                      DISTRIBUTIONS BY CORPORATIONS

                          Effects on Recipients

Sec.
1.301-1 Rules applicable with respect to distributions of money and 
          other property.
1.302-1 General.
1.302-2 Redemptions not taxable as dividends.
1.302-3 Substantially disproportionate redemption.
1.302-4 Termination of shareholder's interest.
1.303-1 General.
1.303-2 Requirements.
1.303-3 Application of other sections.
1.304-1 General.
1.304-2 Acquisition by related corporation (other than subsidiary).
1.304-3 Acquisition by a subsidiary.
1.304-4 Special rules for the use of related corporations to avoid the 
          application of section 304.
1.304-5 Control.
1.304-6 Amount constituting a dividend. [Reserved]
1.304-7 Certain acquisitions by foreign acquiring corporations.
1.305-1 Stock dividends.
1.305-2 Distributions in lieu of money.
1.305-3 Disproportionate distributions.
1.305-4 Distributions of common and preferred stock.
1.305-5 Distributions on preferred stock.
1.305-6 Distributions of convertible preferred.
1.305-7 Certain transactions treated as distributions.
1.305-8 Effective dates.
1.306-1 General
1.306-2 Exception
1.306-3 Section 306 stock defined.
1.306-4 Effective/applicability date.
1.307-1 General.
1.307-2 Exception.

                         effects on corporation

1.312-1 Adjustment to earnings and profits reflecting distributions by 
          corporations.
1.312-2 Distribution of inventory assets.
1.312-3 Liabilities.
1.312-4 Examples of adjustments provided in section 312(c).
1.312-5 Special rule for partial liquidations and certain redemptions.
1.312-6 Earnings and profits.
1.312-7 Effect on earnings and profits of gain or loss realized after 
          February 28, 1913.
1.312-8 Effect on earnings and profits of receipt of tax-free 
          distributions requiring adjustment or allocation of basis of 
          stock.
1.312-9 Adjustments to earnings and profits reflecting increase in value 
          accrued before March 1, 1913.
1.312-10 Allocation of earnings in certain corporate separations.
1.312-11 Effect on earnings and profits of certain other tax-free 
          exchanges, tax-free distributions, and tax-free transfers from 
          one corporation to another.
1.312-12 Distributions of proceeds of loans guaranteed by the United 
          States.
1.312-15 Effect of depreciation on earnings and profits.

              definitions; constructive ownership of stock

1.316-1 Dividends.
1.316-2 Sources of distribution in general.
1.317-1 Property defined.
1.318-1 Constructive ownership of stock; introduction.
1.318-2 Application of general rules.
1.318-3 Estates, trusts, and options.
1.318-4 Constructive ownership as actual ownership; exceptions.

                         Corporate Liquidations

                          effects on recipients

1.331-1 Corporate liquidations.
1.332-1 Distributions in liquidation of subsidiary corporation; general.
1.332-2 Requirements for nonrecognition of gain or loss.
1.332-3 Liquidations completed within one taxable year.
1.332-4 Liquidations covering more than one taxable year.
1.332-5 Distributions in liquidation as affecting minority interests.
1.332-6 Records to be kept and information to be filed with return.
1.332-7 Indebtedness of subsidiary to parent.
1.332-8 Recognition of gain on liquidation of certain holding companies.
1.334-1 Basis of property received in liquidations.
1.336-0 Table of contents.
1.336-1 General principles, nomenclature, and definitions for a section 
          336(e) election.
1.336-2 Availability, mechanics, and consequences of section 336(e) 
          election.

[[Page 6]]

1.336-3 Aggregate deemed asset disposition price; various aspects of 
          taxation of the deemed asset disposition.
1.336-4 Adjusted grossed-up basis.
1.336-5 Effective/applicability dates.

                         effects on corporation

1.337-1 Nonrecognition for property distributed to parent in complete 
          liquidation of subsidiary.
1.337(d)-1 Transitional loss limitation rule.
1.337(d)-1T [Reserved]
1.337(d)-2 Loss limitation window period.
1.337(d)-2T Loss limitation window period (temporary).
1.337(d)-3 Gain recognition upon certain partnership transactions 
          involving a partner's stock.
1.337(d)-4 Taxable to tax-exempt.
1.337(d)-5 Old transitional rules imposing tax on property owned by a C 
          corporation that becomes property of a RIC or REIT .
1.337(d)-6 New transitional rules imposing tax on property owned by a C 
          corporation that becomes property of a RIC or REIT.
1.337(d)-7 Tax on property owned by a C corporation that becomes 
          property of a RIC or REIT.
1.338-0 Outline of topics.
1.338-1 General principles; status of old target and new target.
1.338-2 Nomenclature and definitions; mechanics of the section 338 
          election.
1.338-3 Qualification for the section 338 election.
1.338-4 Aggregate deemed sale price; various aspects of taxation of the 
          deemed asset sale.
1.338-5 Adjusted grossed-up basis.
1.338-6 Allocation of ADSP and AGUB among target assets.
1.338-7 Allocation of redetermined ADSP and AGUB among target assets.
1.338-8 Asset and stock consistency.
1.338-9 International aspects of section 338.
1.338-10 Filing of returns.
1.338-11 Effect of section 338 election on insurance company targets.
1.338(h)(10)-1 Deemed asset sale and liquidation.
1.338(i)-1 Effective/applicability date.

                               definition

1.346-1 Partial liquidation.
1.346-2 Treatment of certain redemptions.
1.346-3 Effect of certain sales.

               Corporate Organizations and Reorganizations

                         corporate organizations

1.351-1 Transfer to corporation controlled by transferor.
1.351-2 Receipt of property.
1.351-3 Records to be kept and information to be filed.

              effects on shareholders and security holders

1.354-1 Exchanges of stock and securities in certain reorganizations.
1.355-0 Table of contents.
1.355-1 Distribution of stock and securities of controlled corporation.
1.355-2 Limitations.
1.355-3 Active conduct of a trade or business.
1.355-4 Non pro rata distributions, etc.
1.355-5 Records to be kept and information to be filed.
1.355-6 Recognition of gain on certain distributions of stock or 
          securities in controlled corporation.
1.355-7 Recognition of gain on certain distributions of stock or 
          securities in connection with an acquisition.
1.355-8 Definition of predecessor and successor and limitations on gain 
          recognition under section 355(e) and section 355(f).
1.356-1 Receipt of additional consideration in connection with an 
          exchange.
1.356-2 Receipt of additional consideration not in connection with an 
          exchange.
1.356-3 Rules for treatment of securities as ``other property''.
1.356-4 Exchanges for section 306 stock.
1.356-5 Transactions involving gift or compensation.
1.356-6 Rules for treatment of nonqualified preferred stock as other 
          property.
1.356-7 Rules for treatment of nonqualified preferred stock and other 
          preferred stock received in certain transactions.
1.357-1 Assumption of liability.
1.357-2 Liabilities in excess of basis.
1.358-1 Basis to distributees.
1.358-2 Allocation of basis among nonrecognition property.
1.358-3 Treatment of assumption of liabilities.
1.358-4 Exceptions.
1.358-5 Special rules for assumption of liabilities.
1.358-6 Stock basis in certain triangular reorganizations.
1.358-7 Transfers by partners and partnerships to corporations.

                         effects on corporation

1.361-0 Table of contents.
1.361-1 Nonrecognition of gain or loss to corporations.
1.362-1 Basis to corporations.
1.362-2 Certain contributions to capital.
1.362-3 Basis of importation property acquired in loss importation 
          transaction.
1.362-4 Basis of loss duplication property.
1.367(a)-1 Transfers to foreign corporations subject to section 367(a): 
          In general.
1.367(a)-1T Transfers to foreign corporations subject to section 367(a): 
          In general (temporary).

[[Page 7]]

1.367(a)-2 Exception for transfers of property for use in the active 
          conduct of a trade or business.
1.367(a)-3 Treatment of transfers of stock or securities to foreign 
          corporations.
1.367(a)-4 Special rule applicable to U.S. depreciated property.
1.367(a)-5 [Reserved]
1.367(a)-6 Transfer of foreign branch with previously deducted losses.
1.367(a)-6T Transfer of foreign branch with previously deducted losses 
          (temporary).
1.367(a)-7 Outbound transfers of property described in section 361(a) or 
          (b).
1.367(a)-7T Outbound transfers of property described in section 361(a) 
          or (b).
1.367(a)-8 Gain recognition agreement requirements.
1.367(a)-9T Treatment of deemed section 351 exchanges pursuant to 
          section 304(a)(1) (temporary).
1.367(b)-0 Table of contents.
1.367(b)-1 Other transfers.
1.367(b)-2 Definitions and special rules.
1.367(b)-3 Repatriation of foreign corporate assets in certain 
          nonrecognition transactions.
1.367(b)-3T Repatriation of foreign corporate assets in certain 
          nonrecognition transactions (temporary).
1.367(b)-4 Acquisition of foreign corporate stock or assets by a foreign 
          corporation in certain nonrecognition transactions.
1.367(b)-5 Distributions of stock described in section 355.
1.367(b)-6 Effective/applicability dates and coordination rules.
1.367(b)-7 Carryover of earnings and profits and foreign income taxes in 
          certain foreign-to-foreign nonrecognition transactions.
1.367(b)-8 Allocation of earnings and profits and foreign income taxes 
          in certain foreign corporate separations. [Reserved]
1.367(b)-9 Special rule for F reorganizations and similar transactions.
1.367(b)-10 Acquisition of parent stock or securities for property in 
          triangular reorganizations.
1.367(b)-12 Subsequent treatment of amounts attributed or included in 
          income.
1.367(b)-13 Special rules for determining basis and holding period.
1.367(d)-1 Transfers of intangible property to foreign corporations.
1.367(d)-1T Transfers of intangible property to foreign corporations 
          (temporary).
1.367(e)-0 Outline of Sec. Sec. 1.367(e)-1 and 1.367(e)-2.
1.367(e)-1 Distributions described in section 367(e)(1).
1.367(e)-2 Distributions described in section 367(e)(2).

                        special rule; definitions

1.368-1 Purpose and scope of exception of reorganization exchanges.
1.368-2 Definition of terms.
1.368-3 Records to be kept and information to be filed with returns.

                       Insolvency Reorganizations

                               Carryovers

1.381(a)-1 General rule relating to carryovers in certain corporate 
          acquisitions.
1.381(b)-1 Operating rules applicable to carryovers in certain corporate 
          acquisitions.
1.381(c)(1)-1 Net operating loss carryovers in certain corporate 
          acquisitions.
1.381(c)(1)-2 Net operating loss carryovers; two or more dates of 
          distribution or transfer in the taxable year.
1.381(c)(2)-1 Earnings and profits.
1.381(c)(3)-1 Capital loss carryovers.
1.381(c)(4)-1 Method of accounting.
1.381(c)(5)-1 Inventory method.
1.381(c)(6)-1 Depreciation method.
1.381(c)(8)-1 Installment method.
1.381(c)(9)-1 Amortization of bond discount or premium.
1.381(c)(10)-1 Deferred exploration and development expenditures.
1.381(c)(11)-1 Contributions to pension plan, employees' annuity plans, 
          and stock bonus and profit-sharing plans.
1.381(c)(12)-1 Recovery of bad debts, prior taxes, or delinquency 
          amounts.
1.381(c)(13)-1 Involuntary conversions.
1.381(c)(14)-1 Dividend carryover to personal holding company.
1.381(c)(15)-1 Indebtedness of certain personal holding companies.
1.381(c)(16)-1 Obligations of distributor or transferor corporation.
1.381(c)(17)-1 Deficiency dividend of personal holding company.
1.381(c)(18)-1 Depletion on extraction of ores or minerals from the 
          waste or residue of prior mining.
1.381(c)(19)-1 Charitable contribution carryovers in certain 
          acquisitions.
1.381(c)(20)-1 Carryforward of disallowed business interest.
1.381(c)(21)-1 Pre-1954 adjustments resulting from change in method of 
          accounting.
1.381(c)(22)-1 Successor life insurance company.
1.381(c)(23)-1 Investment credit carryovers in certain corporate 
          acquisitions.
1.381(c)(24)-1 Work incentive program credit carryovers in certain 
          corporate acquisitions.
1.381(c)(25)-1 Deficiency dividend of a qualified investment entity.
1.381(c)(26)-1 Credit for employment of certain new employees.
1.381(d)-1 Operations loss carryovers of life insurance companies.

[[Page 8]]

1.382-1 Table of contents.
1.382-1T Table of contents (temporary).
1.382-2 General rules for ownership change.
1.382-2T Definition of ownership change under section 382, as amended by 
          the Tax Reform Act of 1986 (temporary).
1.382-3 Definitions and rules relating to a 5-percent shareholder.
1.382-4 Constructive ownership of stock.
1.382-5 Section 382 limitation. [Reserved]
1.382-6 Allocation of income and loss to periods before and after the 
          change date for purposes of section 382.
1.382-7 Built-in gains and losses.
1.382-8 Controlled groups.
1.382-9 Special rules under section 382 for corporations under the 
          jurisdiction of a court in a title 11 or similar case.
1.382-10 Special rules for determining time and manner of acquisition of 
          an interest in a loss corporation.
1.382-11 Reporting requirements.
1.382-12 Determination of adjusted Federal long-term rate.
1.383-0 Effective date.
1.383-1 Special limitations on certain capital losses and excess 
          credits.
1.383-2 Limitations on certain capital losses and excess credits in 
          computing alternative minimum tax. [Reserved]
1.385-1 General provisions.
1.385-3 Certain distributions of debt instruments and similar 
          transactions.
1.385-4 Treatment of consolidated groups.

    Authority: 26 U.S.C. 7805, unless otherwise noted.
    Section 1.301-1 also issued under 26 U.S.C. 357(d)(3).
    Section 1.301-1T also issued under 26 U.S.C. 357(d)(3).
    Section 1.304-5 also issued under 26 U.S.C. 304.
    Section 1.304-7 also issued under 26 U.S.C. 304(b)(5)(C).
    Section 1.305-3 also issued under 26 U.S.C. 305.
    Section 1.305-5 also issued under 26 U.S.C. 305.
    Section 1.305-7 also issued under 26 U.S.C. 305.
    Section 1.332-8 also issued under 26 U.S.C. 332(d)(4).
    Section 1.334-1 also issued under 26 U.S.C. 367(b).
    Section 1.336-1 is also issued under 26 U.S.C. 336.
    Section 1.336-2 is also issued under 26 U.S.C. 336.
    Section 1.336-3 is also issued under 26 U.S.C. 336.
    Section 1.336-4 is also issued under 26 U.S.C. 336.
    Section 1.336-5 is also issued under 26 U.S.C. 336.
    Section 1.337(d)-1 also issued under 26 U.S.C. 337(d).
    Section 1.337(d)-2 also issued under 26 U.S.C. 337(d).
    Section 1.337(d)-3 also issued under 26 U.S.C. 337(d).
    Section 1.337(d)-4 also issued under 26 U.S.C. 337.
    Section 1.337(d)-5 also issued under 26 U.S.C. 337.
    Section 1.337(d)-6 also issued under 26 U.S.C. 337.
    Section 1.337(d)-7 also issued under 26 U.S.C. 337.
    Section 1.337(d)-7T also issued under 26 U.S.C. 337(d) and 355(h).
    Section 1.338-1 also issued under 26 U.S.C. 337(d), 338, and 1502.
    Section 1.338-2 also issued under 26 U.S.C. 337(d), 338, and 1502.
    Section 1.338-3 also issued under 26 U.S.C. 337(d), 338, and 1502.
    Section 1.338-4 also issued under 26 U.S.C. 337(d), 338, and 1502.
    Section 1.338-5 also issued under 26 U.S.C. 337(d), 338, and 1502.
    Section 1.338-6 also issued under 26 U.S.C. 337(d), 338, and 1502.
    Section 1.338-7 also issued under 26 U.S.C. 337(d), 338, and 1502.
    Section 1.338-8 also issued under 26 U.S.C. 337(d), 338, and 1502.
    Section 1.338-9 also issued under 26 U.S.C. 337(d), 338, and 1502.
    Section 1.338-10 also issued under 26 U.S.C. 337(d), 338, and 1502.
    Section 1.338-11 also issued under 26 U.S.C. 338.
    Section 1.338-11T also issued under 26 U.S.C. 338.
    Section 1.338(h)(10)-1 also issued under 26 U.S.C. 337(d), 338, and 
1502.
    Section 1.338(h)(10)-1T also issued under 26 U.S.C. 337(d), 338 and 
1502.
    Section 1.338(i)-1 also issued under 26 U.S.C. 337(d), 338, and 
1502.
    Section 1.351-1 also issued under 26 U.S.C. 351.
    Section 1.351-2 also issued under 26 U.S.C. 351(g)(4).
    Section 1.354-1 also issued under 26 U.S.C. 351(g)(4).
    Section 1.355-1 also issued under 26 U.S.C. 351(g)(4).
    Section 1.355-2(g) and (i) also issued under 26 U.S.C. 355(b)(3)(D).
    Section 1.355-2T(g) and (i) are also issued under 26 U.S.C. 
355(b)(3)(D).
    Section 1.355-6 also issued under 26 U.S.C. 355(d)(9).
    Section 1.355-7 also issued under 26 U.S.C. 355(e)(5).
    Section 1.355-8 also issued under 26 U.S.C. 336(e), 355(e)(3)(B), 
355(e)(5), and 355(f).
    Section 1.356-6 also issued under 26 U.S.C. 351(g)(4).
    Section 1.356-7 also issued under 26 U.S.C. 351(g)(4).

[[Page 9]]

    Section 1.358-2 also issued under 26 U.S.C. 358(b)(1).
    Section 1.358-5 also issued under 26 U.S.C. 358(h)(2).
    Section 1.358-5T also issued under 26 U.S.C. 358(h)(2).
    Section 1.358-7 also issued under Public Law 106-554, 114 Stat. 
2763, 2763A-638 (2001).
    Section 1.362-3 also issued under 26 U.S.C. 367(b).
    Section 1.362-4 also issued under 26 U.S.C. 362(e)(2)(C)(ii).
    Section 1.367(a)-1 also issued under 26 U.S.C. 367(a).
    Section 1.367(a)-1T also issued under 26 U.S.C. 367(a).
    Section 1.367(a)-3 also issued under 26 U.S.C. 367(a).
    Section 1.367(a)-3T also issued under 26 U.S.C. 367(a).
    Section 1.367(a)-7 also issued under 26 U.S.C. 367(a), (b), (c), and 
337(d).
    Section 1.367(a)-8 also issued under 26 U.S.C. 367(a) and (b).
    Section 1.367(a)-9T also issued under 26 U.S.C. 367(a) and (b).
    Section 1.367(b)-0 also issued under 26 U.S.C. 367(b).
    Section 1.367(b)-1 also issued under 26 U.S.C. 367(a) and (b).
    Section 1.367(b)-2 also issued under 26 U.S.C. 367(a) and (b).
    Sections 1.367(b)-2(c)(1) and (2) also issued under 26 U.S.C. 
367(b)(1) and (2).
    Section 1.367(b)-2(d)(3) also issued under 26 U.S.C. 367(b)(1) and 
(2).
    Section 1.367(b)-3 also issued under 26 U.S.C. 367(a) and (b).
    Section 1.367(b)-3T also issued under 26 U.S.C. 367(a) and (b).
    Section 1.367(b)-4 also issued under 26 U.S.C. 367(a) and (b) and 
954(c)(6)(A).
    Section 1.367(b)-4(b)(1) also issued under 26 U.S.C. 367(b).
    Section 1.367(b)-4(d) also issued under 26 U.S.C. 367(b)(1) and (2).
    Section 1.367(b)-6 also issued under 26 U.S.C. 367(b).
    Section 1.367(b)-7 also issued under 26 U.S.C. 367(a) and (b), 26 
U.S.C. 902, and 26 U.S.C. 904.
    Section 1.367(b)-8 also issued under 26 U.S.C. 367(b).
    Section 1.367(b)-9 also issued under 26 U.S.C. 367(a) and (b), 26 
U.S.C. 902, and 26 U.S.C. 904.
    Section 1.367(b)-10 also issued under 26 U.S.C. 367(b).
    Section 1.367(b)-12 also issued under 26 U.S.C. 367(a) and (b).
    Section 1.367(b)-13 also issued under 26 U.S.C. 367(b).
    Section 1.367(d)-1 also issued under 26 U.S.C. 367(d).
    Section 1.367(e)-1 also issued under 26 U.S.C. 367(e)(1).
    Section 1.367(e)-1(a) also issued under 26 U.S.C. 367(e).
    Section 1.367(e)-2 also issued under 26 U.S.C. 367(e)(2).
    Section 1.382-1 also issued under 26 U.S.C. 382(m).
    Section 1.382-2 also issued under 26 U.S.C. 382(k)(1), (l)(3), (m), 
and 26 U.S.C. 383.
    Section 1.382-2T also issued under 26 U.S.C. 382(g)(4)(C), (i), 
(k)(1) and (6), (l)(3), (m), and 26 U.S.C. 383.
    Section 1.382-3 also issued under 26 U.S.C. 382(g)(4)(C) and 26 
U.S.C. 382(m).
    Section 1.382-4 also issued under 26 U.S.C. 382(l)(3) and 382(m).
    Section 1.382-5 also issued under 26 U.S.C. 382(m).
    Section 1.382-5T also issued under 26 U.S.C. 382(m).
    Section 1.382-6 also issued under 26 U.S.C. 382(b)(3)(A), 26 
U.S.C.(d)(1), 26 U.S.C. 382(m), and 26 U.S.C.383(d).
    Section 1.382-7 also issued under 26 U.S.C 382(m).
    Section 1.382-7T also issued under 26 U.S.C. 382(m).
    Section 1.382-8 also issued under 26 U.S.C. 382(m).
    Section 1.382-9 also issued under 26 U.S.C. 382(l)(3) and (m).
    Section 1.382-10 also issued under 26 U.S.C 382(m).
    Section 1.382-10T is also issued under 26 U.S.C. 382(m).
    Section 1.382-12 also issued under 26 U.S.C. 382(f) and 26 U.S.C. 
382(m).
    Section 1.383-0 also issued under 26 U.S.C. 382(m) and 26 U.S.C. 
383.
    Section 1.383-1 also issued under 26 U.S.C. 382(m) and 26 U.S.C. 
383.
    Section 1.383-2 also issued under 26 U.S.C. 383.
    Section 1.385-1 also issued under 26 U.S.C. 385.
    Section 1.385-3 also issued under 26 U.S.C. 385, 701, 1502, 
1504(a)(5)(A), and 7701(l).
    Section 1.385-4 also issued under 26 U.S.C. 385 and 1502.

    Source: T.D. 6500, 25 FR 11607, Nov. 26, 1960; 25 FR 14021, Dec. 31, 
1960, unless otherwise noted.

[[Page 10]]

                 CORPORATE DISTRIBUTIONS AND ADJUSTMENTS

                      DISTRIBUTIONS BY CORPORATIONS

                          Effects on Recipients



Sec. 1.301-1  Rules applicable with respect to distributions of money
and other property.

    (a) General. Section 301 provides the general rule for treatment of 
distributions on or after June 22, 1954, of property by a corporation to 
a shareholder with respect to its stock. The term property is defined in 
section 317(a). Such distributions, except as otherwise provided in this 
chapter, shall be treated as provided in section 301(c). Under section 
301(c), distributions may be included in gross income, applied against 
and reduce the adjusted basis of the stock, treated as gain from the 
sale or exchange of property, or (in the case of certain distributions 
out of increase in value accrued before March 1, 1913) may be exempt 
from tax. The amount of the distributions to which section 301 applies 
is determined in accordance with the provisions of section 301(b). The 
basis of property received in a distribution to which section 301 
applies is determined in accordance with the provisions of section 
301(d). Accordingly, except as otherwise provided in this chapter, a 
distribution on or after June 22, 1954, of property by a corporation to 
a shareholder with respect to its stock shall be included in gross 
income to the extent the amount distributed is considered a dividend 
under section 316. For examples of distributions treated otherwise, see 
sections 116, 301(c)(2), 301(c)(3)(B), 301(e), 302(b), 303, and 305. See 
also part II (relating to distributions in partial or complete 
liquidation), part III (relating to corporate organizations and 
reorganizations), and part IV (relating to insolvency reorganizations), 
subchapter C, chapter 1 of the Code.
    (b) Time of inclusion in gross income and of determination of fair 
market value. A distribution made by a corporation to its shareholders 
shall be included in the gross income of the distributees when the cash 
or other property is unqualifiedly made subject to their demands. 
However, if such distribution is a distribution other than in cash, the 
fair market value of the property shall be determined as of the date of 
distribution without regard to whether such date is the same as that on 
which the distribution is includible in gross income. For example, if a 
corporation distributes a taxable dividend in property (the adjusted 
basis of which exceeds its fair market value on December 31, 1955) on 
December 31, 1955, which is received by, or unqualifiedly made subject 
to the demand of, its shareholders on January 2, 1956, the amount to be 
included in the gross income of the shareholders will be the fair market 
value of such property on December 31, 1955, although such amount will 
not be includible in the gross income of the shareholders until January 
2, 1956.
    (c) Application of section to shareholders. Section 301 is not 
applicable to an amount paid by a corporation to a shareholder unless 
the amount is paid to the shareholder in his capacity as such.
    (d) Distributions to corporate shareholders. (1) If the shareholder 
is a corporation, the amount of any distribution to be taken into 
account under section 301(c) shall be:
    (i) The amount of money distributed,
    (ii) An amount equal to the fair market value of any property 
distributed which consists of any obligations of the distributing 
corporation, stock of the distributing corporation treated as property 
under section 305(b), or rights to acquire such stock treated as 
property under section 305(b), plus
    (iii) In the case of a distribution not described in subdivision 
(iv) of this subparagraph, an amount equal to (a) the fair market value 
of any other property distributed or, if lesser, (b) the adjusted basis 
of such other property in the hands of the distributing corporation 
(determined immediately before the distribution and increased for any 
gain recognized to the distributing corporation under section 311 (b), 
(c), or (d), or under section 341(f), 617(d), 1245(a), 1250(a), 1251(c), 
1252(a), or 1254(a)), or
    (iv) In the case of a distribution made after November 8, 1971, to a 
shareholder which is a foreign corporation, an amount equal to the fair 
market value of any other property distributed, but only if the 
distribution received by

[[Page 11]]

such shareholder is not effectively connected for the taxable year with 
the conduct of a trade or business in the United States by such 
shareholder.
    (2) In the case of a distribution the amount of which is determined 
by reference to the adjusted basis described in subparagraph (1)(iii)(b) 
of this paragraph:
    (i) That portion of the distribution which is a dividend under 
section 301(c)(1) may not exceed such adjusted basis, or
    (ii) If the distribution is not out of earnings and profits, the 
amount of the reduction in basis of the shareholder's stock, and the 
amount of any gain resulting from such distribution, are to be 
determined by reference to such adjusted basis of the property which is 
distributed.
    (3) Notwithstanding paragraph (d)(1)(iii), if a distribution of 
property described in such paragraph is made after December 31, 1962, by 
a foreign corporation to a shareholder which is a corporation, the 
amount of the distribution to be taken into account under section 301(c) 
shall be determined under section 301(b)(1)(C) and paragraph (n) of this 
section.
    (e) Adjusted basis. In determining the adjusted basis of property 
distributed in the hands of the distributing corporation immediately 
before the distribution for purposes of section 301(b)(1)(B)(ii), 
(b)(1)(C)(i), and (d)(2)(B), the basis to be used shall be the basis for 
determining gain upon a sale or exchange.
    (f) Examples. The application of this section (except paragraph (n)) 
may be illustrated by the following examples:

    Example 1. On January 1, 1955, A, an individual owned all of the 
stock of Corporation M with an adjusted basis of $2,000. During 1955, A 
received distributions from Corporation M totaling $30,000, consisting 
of $10,000 in cash and listed securities having a basis in the hands of 
Corporation M and a fair market value on the date distributed of 
$20,000. Corporation M's taxable year is the calendar year. As of 
December 31, 1954, Corporation M had earnings and profits accumulated 
after February 28, 1913, in the amount of $26,000, and it had no 
earnings and profits and no deficit for 1955. Of the $30,000 received by 
A, $26,000 will be treated as an ordinary dividend; the remaining $4,000 
will be applied against the adjusted basis of his stock; the $2,000 in 
excess of the adjusted basis of his stock will either be treated as gain 
from the sale or exchange of property (under section 301(c)(3)(A)) or, 
if out of increase in value accrued before March 1, 1913, will (under 
section 301(c)(3)(B)) be exempt from tax. If A subsequently sells his 
stock in Corporation M, the basis for determining gain or loss on the 
sale will be zero.
    Example 2. The facts are the same as in Example 1 with the 
exceptions that the shareholder of Corporation M is Corporation W and 
that the securities which were distributed had an adjusted basis to 
Corporation M of $15,000. The distribution received by Corporation W 
totals $25,000 consisting of $10,000 in cash and securities with an 
adjusted basis of $15,000. The total $25,000 will be treated as a 
dividend to Corporation W since the earnings and profits of Corporation 
M ($26,000) are in excess of the amount of the distribution.
    Example 3. Corporation X owns timber land which it acquired prior to 
March 1, 1913, at a cost of $50,000 with $5,000 allocated as the 
separate cost of the land. On March 1, 1913, this property had a fair 
market value of $150,000 of which $135,000 was attributable to the 
timber and $15,000 to the land. All of the timber was cut prior to 1955 
and the full appreciation in the value thereof, $90,000 ($135,000-
$45,000), realized through depletion allowances based on March 1, 1913, 
value. None of this surplus from realized appreciation had been 
distributed. In 1955, Corporation X sold the land for $20,000 thereby 
realizing a gain of $15,000. Of this gain, $10,000 is due to realized 
appreciation in value which accrued before March 1, 1913 ($15,000-
$5,000). Of the gain of $15,000, $5,000 is taxable. Therefore, at 
December 31, 1955, Corporation X had a surplus from realized 
appreciation in the amount of $100,000. It had no accumulated earnings 
and profits and no deficit at January 1, 1955. The net earnings for 1955 
(including the $5,000 gain on the sale of the land) were $20,000. During 
1955, Corporation X distributed $75,000 to its stockholders. Of this 
amount, $20,000 will be treated as a dividend. The remaining $55,000, 
which is a distribution of realized appreciation, will be applied 
against and reduce the adjusted basis of the shareholders' stock. If any 
part of the $55,000 is in excess of the adjusted basis of a 
shareholder's stock, such part will be exempt from tax.

    (g) Reduction for liabilities--(1) General rule. For the purpose of 
section 301, no reduction shall be made for the amount of any liability, 
unless the liability is assumed by the shareholder within the meaning of 
section 357(d).
    (2) No reduction below zero. Any reduction pursuant to paragraph 
(g)(1) of this section shall not cause the amount

[[Page 12]]

of the distribution to be reduced below zero.
    (3) Effective dates--(i) In general. This paragraph (g) applies to 
distributions occurring after January 4, 2001.
    (ii) Retroactive application. This paragraph (g) also applies to 
distributions made on or before January 4, 2001, if the distribution is 
made as part of a transaction described in, or substantially similar to, 
the transaction in Notice 99-59 (1999-2 C.B. 761), including 
transactions designed to reduce gain (see Sec. 601.601(d)(2) of this 
chapter). For rules for distributions on or before January 4, 2001 
(other than distributions on or before that date to which this paragraph 
(g) applies), see rules in effect on January 4, 2001 (see Sec. 1.301-
1(g) as contained in 26 CFR part 1 revised April 1, 2001).
    (h) Basis. The basis of property received in the distribution to 
which section 301 applies shall be--
    (1) If the shareholder is not a corporation, the fair market value 
of such property;
    (2) If the shareholder is a corporation--
    (i) In the case of a distribution of the obligations of the 
distributing corporation or of the stock of such corporation or rights 
to acquire such stock (if such stock or rights are treated as property 
under section 305(b)), the fair market value of such obligations, stock, 
or rights;
    (ii) In the case of the distribution of any other property, except 
as provided in subdivision (iii) (relating to certain distributions by a 
foreign corporation) or subdivision (iv) (relating to certain 
distributions to foreign corporate distributees) of this subparagraph, 
whichever of the following is the lesser--
    (a) The fair market value of such property; or
    (b) The adjusted basis (in the hands of the distributing corporation 
immediately before the distribution) of such property increased in the 
amount of gain to the distributing corporation which is recognized under 
section 311(b) (relating to distributions of LIFO inventory), section 
311(c) (relating to distributions of property subject to liabilities in 
excess of basis), section 311(d) (relating to appreciated property used 
to redeem stock), section 341(f) (relating to certain sales of stock of 
consenting corporations), section 617(d) (relating to gain from 
dispositions of certain mining property), section 1245(a) or 1250(a) 
(relating to gain from dispositions of certain depreciable property), 
section 1251(c) (relating to gain from disposition of farm recapture 
property), section 1252(a) (relating to gain from disposition of farm 
land), or 1254(a) (relating to gain from disposition of interest in 
natural resource recapture property);
    (iii) In the case of the distribution by a foreign corporation of 
any other property after December 31, 1962, in a distribution not 
described in subdivision (iv) of this subparagraph, the amount 
determined under paragraph (n) of this section;
    (iv) In the case of the distribution of any other property made 
after November 8, 1971, to a shareholder which is a foreign corporation, 
the fair market value of such property, but only if the distribution 
received by such shareholder is not effectively connected for the 
taxable year with the conduct of a trade or business in the United 
States by such shareholder.
    (i) [Reserved]
    (j) Transfers for less than fair market value. If property is 
transferred by a corporation to a shareholder which is not a corporation 
for an amount less than its fair market value in a sale or exchange, 
such shareholder shall be treated as having received a distribution to 
which section 301 applies. In such case, the amount of the distribution 
shall be the difference between the amount paid for the property and its 
fair market value. If property is transferred in a sale or exchange by a 
corporation to a shareholder which is a corporation, for an amount less 
than its fair market value and also less than its adjusted basis, such 
shareholder shall be treated as having received a distribution to which 
section 301 applies, and--
    (1) Where the fair market value of the property equals or exceeds 
its adjusted basis in the hands of the distributing corporation the 
amount of the distribution shall be the excess of the adjusted basis 
(increased by the

[[Page 13]]

amount of gain recognized under section 311 (b), (c), or (d), or under 
section 341(f), 617(d), 1245(a), 1250(a), 1251(c), 1252(a), or 1254(a) 
to the distributing corporation) over the amount paid for the property;
    (2) Where the fair market value of the property is less than its 
adjusted basis in the hands of the distributing corporation, the amount 
of the distribution shall be the excess of such fair market value over 
the amount paid for the property. If property is transferred in a sale 
or exchange after December 31, 1962, by a foreign corporation to a 
shareholder which is a corporation for an amount less than the amount 
which would have been computed under paragraph (n) of this section if 
such property had been received in a distribution to which section 301 
applied, such shareholder shall be treated as having received a 
distribution to which section 301 applies, and the amount of the 
distribution shall be the excess of the amount which would have been 
computed under paragraph (n) of this section with respect to such 
property over the amount paid for the property. In all cases, the 
earnings and profits of the distributing corporation shall be decreased 
by the excess of the basis of the property in the hands of the 
distributing corporation over the amount received therefor. In computing 
gain or loss from the subsequent sale of such property, its basis shall 
be the amount paid for the property increased by the amount of the 
distribution.

If property is transferred in a sale or exchange after December 31, 
1962, by a foreign corporation to a shareholder which is a corporation 
for an amount less than the amount which would have been computed under 
paragraph (n) of this section if such property had been received in a 
distribution to which section 301 applied, such shareholder shall be 
treated as having received a distribution to which section 301 applies, 
and the amount of the distribution shall be the excess of the amount 
which would have been computed under paragraph (n) of this section with 
respect to such property over the amount paid for the property. 
Notwithstanding the preceding provisions of this paragraph, if property 
is transferred in a sale or exchange after November 8, 1971, by a 
corporation to a shareholder which is a foreign corporation, for an 
amount less than its fair market value, and if paragraph (d)(1)(iv) of 
this section would apply if such property were received in a 
distribution to which section 301 applies, such shareholder shall be 
treated as having received a distribution to which section 301 applies 
and the amount of the distribution shall be the difference between the 
amount paid for the property and its fair market value. In all cases, 
the earnings and profits of the distributing corporation shall be 
decreased by the excess of the basis of the property in the hands of the 
distributing corporation over the amount received therefor. In computing 
gain or loss from the subsequent sale of such property, its basis shall 
be the amount paid for the property increased by the amount of the 
distribution.
    (k) Application of rule respecting transfers for less than fair 
market value. The application of paragraph (j) of this section may be 
illustrated by the following examples:

    Example 1. On January 1, 1955, A, an individual shareholder of 
corporation X, purchased property from that corporation for $20. The 
fair market value of such property was $100, and its basis in the hands 
of corporation X was $25. The amount of the distribution determined 
under section 301(b) is $80. If A were a corporation, the amount of the 
distribution would be $5 (assuming that sections 311 (b) and (c), 
1245(a), and 1250(a) do not apply), the excess of the basis of the 
property in the hands of corporation X over the amount received 
therefor. The basis of such property to corporation A would be $25. If 
the basis of the property in the hands of corporation X were $10, the 
corporate shareholder, A, would not receive a distribution. The basis of 
such property to corporation A would be $20. Whether or not A is a 
corporation, the excess of the amount paid over the basis of the 
property in the hands of corporation X ($20 over $10) would be a taxable 
gain to corporation X.
    Example 2. On January 1, 1963, corporation A, which is a shareholder 
of corporation B (a foreign corporation engaged in business within the 
United States), purchased one share of corporation X stock from B for 
$20. The fair market value of the share was $100, and its adjusted basis 
in the hands of B was $25. Assume that if the share of corporation X 
stock had been received by A in a distribution to which section 301 
applied, the amount

[[Page 14]]

of the distribution under paragraph (n) of this section would have been 
$55. The amount of the distribution under section 301 is $35, i.e., $55 
(amount computed under paragraph (n) of this section) minus $20 (amount 
paid for the property). The basis of such property to A is $55.

    (l) Transactions treated as distributions. A distribution to 
shareholders with respect to their stock is within the terms of section 
301 although it takes place at the same time as another transaction if 
the distribution is in substance a separate transaction whether or not 
connected in a formal sense. This is most likely to occur in the case of 
a recapitalization, a reincorporation, or a merger of a corporation with 
a newly organized corporation having substantially no property. For 
example, if a corporation having only common stock outstanding, 
exchanges one share of newly issued common stock and one bond in the 
principal amount of $10 for each share of outstanding common stock, the 
distribution of the bonds will be a distribution of property (to the 
extent of their fair market value) to which section 301 applies, even 
though the exchange of common stock for common stock may be pursuant to 
a plan of reorganization under the terms of section 368(a)(1)(E) 
(recapitalization) and even though the exchange of common stock for 
common stock may be tax free by virtue of section 354.
    (m) Cancellation of indebtedness. The cancellation of indebtedness 
of a shareholder by a corporation shall be treated as a distribution of 
property.
    (n) [Reserved]
    (o) Distributions of certain property by DISC's to corporate 
shareholders. See Sec. 1.997-1 for the rule that if a corporation which 
is a DISC or former DISC (as defined in section 992(a)(1) or (3) as the 
case may be) makes a distribution of property (other than money and 
other than the obligations of the DISC or former DISC) out of 
accumulated DISC income (as defined in section 996(f)(1)) or previously 
taxed income (as defined in section 996(f)(2)), such distribution of 
property shall be treated as if it were made to an individual and that 
the basis of the property distributed, in the hands of the recipient 
corporation, shall be determined as if such property were distributed to 
an individual.
    (p) Cross references. For certain rules relating to adjustments to 
earnings and profits and for determining the extent to which a 
distribution is a dividend, see sections 312 and 316 and regulations 
thereunder.
    (q) Split-dollar and other life insurance arrangements--(1) Split-
dollar life insurance arrangements--(i) Distribution of economic 
benefits. The provision by a corporation to its shareholder pursuant to 
a split-dollar life insurance arrangement, as defined in Sec. 1.61-
22(b)(1) or (2), of economic benefits described in Sec. 1.61-22(d) or 
of amounts described in Sec. 1.61-22(e) is treated as a distribution of 
property, the amount of which is determined under Sec. 1.61-22(d) and 
(e), respectively.
    (ii) Distribution of entire contract or undivided interest therein. 
A transfer (within the meaning of Sec. 1.61-22(c)(3)) of the ownership 
of a life insurance contract (or an undivided interest therein) that is 
part of a split-dollar life insurance arrangement is a distribution of 
property, the amount of which is determined pursuant to Sec. 1.61-
22(g)(1) and (2).
    (2) Other life insurance arrangements. A payment by a corporation on 
behalf of a shareholder of premiums on a life insurance contract or an 
undivided interest therein that is owned by the shareholder constitutes 
a distribution of property, even if such payment is not part of a split-
dollar life insurance arrangement under Sec. 1.61-22(b).
    (3) When distribution is made--(i) In general. Except as provided in 
paragraph (q)(3)(ii) of this section, paragraph (b) of this section 
shall apply to determine when a distribution described in paragraph 
(q)(1) or (2) of this section is taken into account by a shareholder.
    (ii) Exception. Notwithstanding paragraph (b) of this section, a 
distribution described in paragraph (q)(1)(ii) of this section shall be 
treated as made by a corporation to its shareholder at the time that the 
life insurance contract, or an undivided interest therein, is 
transferred (within the meaning of Sec. 1.61-22(c)(3)) to the 
shareholder.

[[Page 15]]

    (4) Effective date--(i) General rule. This paragraph (q) applies to 
split-dollar and other life insurance arrangements entered into after 
September 17, 2003. For purposes of this paragraph (q)(4), a split-
dollar life insurance arrangement is entered into as determined under 
Sec. 1.61-22(j)(1)(ii).
    (ii) Modified arrangements treated as new arrangements. If a split-
dollar life insurance arrangement entered into on or before September 
17, 2003 is materially modified (within the meaning of Sec. 1.61-
22(j)(2)) after September 17, 2003, the arrangement is treated as a new 
arrangement entered into on the date of the modification.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960]

    Editorial Note: For Federal Register citations affecting Sec. 
1.301-1, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.govinfo.gov.



Sec. 1.302-1  General.

    (a) Under section 302(d), unless otherwise provided in subchapter C, 
chapter 1 of the Code, a distribution in redemption of stock shall be 
treated as a distribution of property to which section 301 applies if 
the distribution is not within any of the provisions of section 302(b). 
A distribution in redemption of stock shall be considered a distribution 
in part or full payment in exchange for the stock under section 302(a) 
provided paragraph (1), (2), (3), or (4) of section 302(b) applies. 
Section 318(a) (relating to constructive ownership of stock) applies to 
all redemptions under section 302 except that in the termination of a 
shareholder's interest certain limitations are placed on the application 
of section 318(a)(1) by section 302(c)(2). The term redemption of stock 
is defined in section 317(b). Section 302 does not apply to that portion 
of any distribution which qualifies as a distribution in partial 
liquidation under section 346. For special rules relating to redemption 
of stock to pay death taxes see section 303. For special rules relating 
to redemption of section 306 stock see section 306. For special rules 
relating to redemption of stock in partial or complete liquidation see 
section 331.
    (b) If, in connection with a partial liquidation under the terms of 
section 346, stock is redeemed in an amount in excess of the amount 
specified by section 331(a)(2), section 302(b) shall first apply as to 
each shareholder to which it is applicable without limitation because of 
section 331(a)(2). That portion of the total distribution which is used 
in all redemptions from specific shareholders which are within the terms 
of section 302(a) shall be excluded in determining the application of 
sections 346 and 331(a)(2). For example, Corporation X has $50,000 which 
is attributable to the sale of one of two active businesses and which, 
if distributed in redemption of stock, would qualify as a partial 
liquidation under the terms of section 346(b). Corporation X distributes 
$60,000 to its shareholders in redemption of stock, $20,000 of which is 
in redemption of all of the stock of shareholder A within the meaning of 
section 302(b)(3). The $20,000 distributed in redemption of the stock of 
shareholder A will be excluded in determining the application of 
sections 346 and 331(a)(2). The entire $60,000 will be treated as in 
part or full payment for stock ($20,000 qualifying under section 302(a) 
and $40,000 qualifying under sections 346 and 331(a)(2)).



Sec. 1.302-2  Redemptions not taxable as dividends.

    (a) In general. The fact that a redemption fails to meet the 
requirements of paragraph (2), (3) or (4) of section 302(b) shall not be 
taken into account in determining whether the redemption is not 
essentially equivalent to a dividend under section 302(b)(1). See, 
however, paragraph (b) of this section. For example, if a shareholder 
owns only nonvoting stock of a corporation which is not section 306 
stock and which is limited and preferred as to dividends and in 
liquidation, and one-half of such stock is redeemed, the distribution 
will ordinarily meet the requirements of paragraph (1) of section 302(b) 
but will not meet the requirements of paragraph (2), (3) or (4) of such 
section. The determination of whether or not a distribution is within 
the phrase ``essentially equivalent to a dividend'' (that is, having the 
same effect as a distribution without any redemption of stock) shall be 
made without regard to the earnings and profits of the corporation at 
the time of the

[[Page 16]]

distribution. For example, if A owns all the stock of a corporation and 
the corporation redeems part of his stock at a time when it has no 
earnings and profits, the distribution shall be treated as a 
distribution under section 301 pursuant to section 302(d).
    (b) Redemption not essentially equivalent to a dividend--(1) In 
general. The question whether a distribution in redemption of stock of a 
shareholder is not essentially equivalent to a dividend under section 
302(b)(1) depends upon the facts and circumstances of each case. One of 
the facts to be considered in making this determination is the 
constructive stock ownership of such shareholder under section 318(a). 
All distributions in pro rata redemptions of a part of the stock of a 
corporation generally will be treated as distributions under section 301 
if the corporation has only one class of stock outstanding. However, for 
distributions in partial liquidation, see section 302(e). The redemption 
of all of one class of stock (except section 306 stock) either at one 
time or in a series of redemptions generally will be considered as a 
distribution under section 301 if all classes of stock outstanding at 
the time of the redemption are held in the same proportion. 
Distributions in redemption of stock may be treated as distributions 
under section 301 regardless of the provisions of the stock certificate 
and regardless of whether all stock being redeemed was acquired by the 
stockholders from whom the stock was redeemed by purchase or otherwise.
    (2) Statement. Unless Sec. 1.331-1(d) applies, every significant 
holder that transfers stock to the issuing corporation in exchange for 
property from such corporation must include on or with such holder's 
return for the taxable year of such exchange a statement entitled, 
``STATEMENT PURSUANT TO Sec. 1.302-2(b)(2) BY [INSERT NAME AND TAXPAYER 
IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A SIGNIFICANT HOLDER OF THE 
STOCK OF [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF 
ISSUING CORPORATION].'' If a significant holder is a controlled foreign 
corporation (within the meaning of section 957), each United States 
shareholder (within the meaning of section 951(b)) with respect thereto 
must include this statement on or with its return. The statement must 
include--
    (i) The fair market value and basis of the stock transferred by the 
significant holder to the issuing corporation; and
    (ii) A description of the property received by the significant 
holder from the issuing corporation.
    (3) Definitions. For purposes of this section:
    (i) Significant holder means any person that, immediately before the 
exchange--
    (A) Owned at least five percent (by vote or value) of the total 
outstanding stock of the issuing corporation if the stock owned by such 
person is publicly traded; or
    (B) Owned at least one percent (by vote or value) of the total 
outstanding stock of the issuing corporation if the stock owned by such 
person is not publicly traded.
    (ii) Publicly traded stock means stock that is listed on--
    (A) A national securities exchange registered under section 6 of the 
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
    (B) An interdealer quotation system sponsored by a national 
securities association registered under section 15A of the Securities 
Exchange Act of 1934 (15 U.S.C. 78o-3).
    (iii) Issuing corporation means the corporation that issued the 
shares of stock, some or all of which were transferred by a significant 
holder to such corporation in the exchange described in paragraph (b)(2) 
of this section.
    (4) Cross reference. See section 6043 of the Internal Revenue Code 
for requirements relating to a return by a liquidating corporation.
    (c) Basis adjustments. In any case in which an amount received in 
redemption of stock is treated as a distribution of a dividend, proper 
adjustment of the basis of the remaining stock will be made with respect 
to the stock redeemed. (For adjustments to basis required for certain 
redemptions of corporate shareholders that are treated as extraordinary 
dividends, see section 1059 and the regulations thereunder.)

[[Page 17]]

The following examples illustrate the application of this rule:

    Example 1. A, an individual, purchased all of the stock of 
Corporation X for $100,000. In 1955 the corporation redeems half of the 
stock for $150,000, and it is determined that this amount constitutes a 
dividend. The remaining stock of Corporation X held by A has a basis of 
$100,000.
    Example 2. H and W, husband and wife, each own half of the stock of 
Corporation X. All of the stock was purchased by H for $100,000 cash. In 
1950 H gave one-half of the stock to W, the stock transferred having a 
value in excess of $50,000. In 1955 all of the stock of H is redeemed 
for $150,000, and it is determined that the distribution to H in 
redemption of his shares constitutes the distribution of a dividend. 
Immediately after the transaction, W holds the remaining stock of 
Corporation X with a basis of $100,000.
    Example 3. The facts are the same as in Example (2) with the 
additional facts that the outstanding stock of Corporation X consists of 
1,000 shares and all but 10 shares of the stock of H is redeemed. 
Immediately after the transaction, H holds 10 shares of the stock of 
Corporation X with a basis of $50,000, and W holds 500 shares with a 
basis of $50,000.
    (d) Effective/applicability date. Paragraphs (b)(2), (b)(3) and 
(b)(4) of this section apply to any taxable year beginning on or after 
May 30, 2006. However, taxpayers may apply paragraphs (b)(2), (b)(3) and 
(b)(4) of this section to any original Federal income tax return 
(including any amended return filed on or before the due date (including 
extensions) of such original return) timely filed on or after May 30, 
2006. For taxable years beginning before May 30, 2006, see Sec. 1.302-2 
as contained in 26 CFR part 1 in effect on April 1, 2006.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 8724, 62 FR 
38028, July 26, 1997; T.D. 9264, 71 FR 30593, May 30, 2006; T.D. 9329, 
72 FR 32796, June 14, 2007]



Sec. 1.302-3  Substantially disproportionate redemption.

    (a) Section 302(b)(2) provides for the treatment of an amount 
received in redemption of stock as an amount received in exchange for 
such stock if--
    (1) Immediately after the redemption the shareholder owns less than 
50 percent of the total combined voting power of all classes of stock as 
provided in section 302(b)(2)(B),
    (2) The redemption is a substantially disproportionate redemption 
within the meaning of section 302(b)(2)(C), and
    (3) The redemption is not pursuant to a plan described in section 
302(b)(2)(D).

Section 318(a) (relating to constructive ownership of stock) shall apply 
both in making the disproportionate redemption test and in determining 
the percentage of stock ownership after the redemption. The requirements 
under section 302(b)(2) shall be applied to each shareholder separately 
and shall be applied only with respect to stock which is issued and 
outstanding in the hands of the shareholders. Section 302(b)(2) only 
applies to a redemption of voting stock or to a redemption of both 
voting stock and other stock. Section 302(b)(2) does not apply to the 
redemption solely of nonvoting stock (common or preferred). However, if 
a redemption is treated as an exchange to a particular shareholder under 
the terms of section 302(b)(2), such section will apply to the 
simultaneous redemption of nonvoting preferred stock (which is not 
section 306 stock) owned by such shareholder and such redemption will 
also be treated as an exchange. Generally, for purposes of this section, 
stock which does not have voting rights until the happening of an event, 
such as a default in the payment of dividends on preferred stock, is not 
voting stock until the happening of the specified event. Subsection 
302(b)(2)(D) provides that a redemption will not be treated as 
substantially disproportionate if made pursuant to a plan the purpose or 
effect of which is a series of redemptions which result in the aggregate 
in a distribution which is not substantially disproportionate. Whether 
or not such a plan exists will be determined from all the facts and 
circumstances.
    (b) The application of paragraph (a) of this section is illustrated 
by the following example:

    Example. Corporation M has outstanding 400 shares of common stock of 
which A, B, C and D each own 100 shares or 25 percent. No stock is 
considered constructively owned by A, B, C or D under section 318. 
Corporation M redeems 55 shares from A, 25 shares from B, and 20 shares 
from C. For the redemption to be disproportionate as to any shareholder, 
such shareholder must own after the redemptions less than 20 percent (80 
percent of 25

[[Page 18]]

percent) of the 300 shares of stock then outstanding. After the 
redemptions, A owns 45 shares (15 percent), B owns 75 shares (25 
percent), and C owns 80 shares (26\2/3\ percent). The distribution is 
disproportionate only with respect to A.



Sec. 1.302-4  Termination of shareholder's interest.

    Section 302(b)(3) provides that a distribution in redemption of all 
of the stock of the corporation owned by a shareholder shall be treated 
as a distribution in part or full payment in exchange for the stock of 
such shareholder. In determining whether all of the stock of the 
shareholder has been redeemed, the general rule of section 302(c)(1) 
requires that the rules of constructive ownership provided in section 
318(a) shall apply. Section 302(c)(2), however, provides that section 
318(a)(1) (relating to constructive ownership of stock owned by members 
of a family) shall not apply where the specific requirements of section 
302(c)(2) are met. The following rules shall be applicable in 
determining whether the specific requirements of section 302(c)(2) are 
met:
    (a) Statement. The agreement specified in section 302(c)(2)(A)(iii) 
shall be in the form of a statement entitled, ``STATEMENT PURSUANT TO 
SECTION 302(c)(2)(A)(iii) BY [INSERT NAME AND TAXPAYER IDENTIFICATION 
NUMBER (IF ANY) OF TAXPAYER OR RELATED PERSON, AS THE CASE MAY BE], A 
DISTRIBUTEE (OR RELATED PERSON) OF [INSERT NAME AND EMPLOYER 
IDENTIFICATION NUMBER (IF ANY) OF DISTRIBUTING CORPORATION].'' The 
distributee must include such statement on or with the distributee's 
first return for the taxable year in which the distribution described in 
section 302(b)(3) occurs. If the distributee is a controlled foreign 
corporation (within the meaning of section 957), each United States 
shareholder (within the meaning of section 951(b)) with respect thereto 
must include this statement on or with its return. The distributee must 
represent in the statement--
    (1) THE DISTRIBUTEE (OR RELATED PERSON) HAS NOT ACQUIRED, OTHER THAN 
BY BEQUEST OR INHERITANCE, ANY INTEREST IN THE CORPORATION (AS DESCRIBED 
IN SECTION 302(c)(2)(A)(i)) SINCE THE DISTRIBUTION; and
    (2) THE DISTRIBUTEE (OR RELATED PERSON) WILL NOTIFY THE INTERNAL 
REVENUE SERVICE OF ANY ACQUISITION, OTHER THAN BY BEQUEST OR 
INHERITANCE, OF SUCH AN INTEREST IN THE CORPORATION WITHIN 30 DAYS AFTER 
THE ACQUISITION, IF THE ACQUISITION OCCURS WITHIN 10 YEARS FROM THE DATE 
OF THE DISTRIBUTION.
    (b) Substantiation information. The distributee who files an 
agreement under section 302(c)(2)(A)(iii) shall retain copies of income 
tax returns and any other records indicating fully the amount of tax 
which would have been payable had the redemption been treated as a 
distribution subject to section 301.
    (c) Stock of parent, subsidiary or successor corporation redeemed. 
If stock of a parent corporation is redeemed, section 302(c)(2)(A), 
relating to acquisition of an interest in the corporation within 10 
years after termination shall be applied with reference to an interest 
both in the parent corporation and any subsidiary of such parent 
corporation. If stock of a parent corporation is sold to a subsidiary in 
a transaction described in section 304, section 302(c)(2)(A) shall be 
applicable to the acquisition of an interest in such subsidiary 
corporation or in the parent corporation. If stock of a subsidiary 
corporation is redeemed, section 302(c)(2)(A) shall be applied with 
reference to an interest both in such subsidiary corporation and its 
parent. Section 302(c)(2)(A) shall also be applied with respect to an 
interest in a corporation which is a successor corporation to the 
corporation the interest in which has been terminated.
    (d) Redeemed shareholder as creditor. For the purpose of section 
302(c)(2)(A)(i), a person will be considered to be a creditor only if 
the rights of such person with respect to the corporation are not 
greater or broader in scope than necessary for the enforcement of his 
claim. Such claim must not in any sense be proprietary and must not be 
subordinate to the claims of general creditors. An obligation in the 
form of a debt may thus constitute a proprietary interest. For example, 
if

[[Page 19]]

under the terms of the instrument the corporation may discharge the 
principal amount of its obligation to a person by payments, the amount 
or certainty of which are dependent upon the earnings of the 
corporation, such a person is not a creditor of the corporation. 
Furthermore, if under the terms of the instrument the rate of purported 
interest is dependent upon earnings, the holder of such instrument may 
not, in some cases, be a creditor.
    (e) Acquisition of assets pursuant to creditor's rights. In the case 
of a distributee to whom section 302(b)(3) is applicable, who is a 
creditor after such transaction, the acquisition of the assets of the 
corporation in the enforcement of the rights of such creditor shall not 
be considered an acquisition of an interest in the corporation for 
purposes of section 302(c)(2) unless stock of the corporation, its 
parent corporation, or, in the case of a redemption of stock of a parent 
corporation, of a subsidiary of such corporation is acquired.
    (f) Constructive ownership rules applicable. In determining whether 
an entire interest in the corporation has been terminated under section 
302(b)(3), under all circumstances paragraphs (2), (3), (4), and (5) of 
section 318(a) (relating to constructive ownership of stock) shall be 
applicable.
    (g) Avoidance of Federal income tax. Section 302(c)(2)(B) provides 
that section 302(c)(2)(A) shall not apply--
    (1) If any portion of the stock redeemed was acquired directly or 
indirectly within the 10-year period ending on the date of the 
distribution by the distributee from a person, the ownership of whose 
stock would (at the time of distribution) be attributable to the 
distributee under section 318(a), or
    (2) If any person owns (at the time of the distribution) stock, the 
ownership of which is attributable to the distributee under section 
318(a), such person acquired any stock in the corporation directly or 
indirectly from the distributee within the 10-year period ending on the 
date of the distribution, and such stock so acquired from the 
distributee is not redeemed in the same transaction,unless the 
acquisition (described in subparagraph (1) of this paragraph) or the 
disposition by the distributee (described in subparagraph (2) of this 
paragraph) did not have as one of its principal purposes the avoidance 
of Federal income tax. A transfer of stock by the transferor, within the 
10-year period ending on the date of the distribution, to a person whose 
stock would be attributable to the transferor shall not be deemed to 
have as one of its principal purposes the avoidance of Federal income 
tax merely because the transferee is in a lower income tax bracket than 
the transferor.
    (h) Effective/applicability date. Paragraph (a) of this section 
applies to any taxable year beginning on or after May 30, 2006. However, 
taxpayers may apply paragraph (a) of this section to any original 
Federal income tax return (including any amended return filed on or 
before the due date (including extensions) of such original return) 
timely filed on or after May 30, 2006. For taxable years beginning 
before May 30, 2006, see Sec. 1.302-4 as contained in 26 CFR part 1 in 
effect on April 1, 2006.

(Sec. 302(c)(2)(A)(iii) (68A Stat. 87; 26 U.S.C. 302 (c)(2)(A)(iii)))

[T.D. 7535, 43 FR 10686, Mar. 15, 1978, as amended by T.D. 9264, 71 FR 
30594, 30607, May 30, 2006; T.D. 9329, 72 FR 32796, 32808, June 14, 
2007]



Sec. 1.303-1  General.

    Section 303 provides that in certain cases a distribution in 
redemption of stock, the value of which is included in determining the 
value of the gross estate of a decedent, shall be treated as a 
distribution in full payment in exchange for the stock so redeemed.



Sec. 1.303-2  Requirements.

    (a) Section 303 applies only where the distribution is with respect 
to stock of a corporation the value of whose stock in the gross estate 
of the decedent for Federal estate tax purposes is an amount in excess 
of (1) 35 percent of the value of the gross estate of such decedent, or 
(2) 50 percent of the taxable estate of such decedent. For the purposes 
of such 35 percent and 50 percent requirements, stock of two or more 
corporations shall be treated as the stock of a single corporation if 
more than 75 percent in value of the outstanding stock of each such 
corporation is included in determining the

[[Page 20]]

value of the decedent's gross estate. For the purpose of the 75 percent 
requirement, stock which, at the decedent's death, represents the 
surviving spouse's interest in community property shall be considered as 
having been included in determining the value of the decedent's gross 
estate.
    (b) For the purpose of section 303(b)(2)(A)(i), the term gross 
estate means the gross estate as computed in accordance with section 
2031 (or, in the case of the estate of a decedent nonresident not a 
citizen of the United States, in accordance with section 2103). For the 
purpose of section 303(b)(2)(A)(ii), the term taxable estate means the 
taxable estate as computed in accordance with section 2051 (or, in the 
case of the estate of a decedent nonresident not a citizen of the United 
States, in accordance with section 2106). In case the value of an estate 
is determined for Federal estate tax purposes under section 2032 
(relating to alternate valuation), then, for purposes of section 
303(b)(2), the value of the gross estate, the taxable estate, and the 
stock shall each be determined on the applicable date prescribed in 
section 2032.
    (c)(1) In determining whether the estate of the decedent is 
comprised of stock of a corporation of sufficient value to satisfy the 
percentage requirements of section 303(b)(2)(A) and section 
303(b)(2)(B), the total value, in the aggregate, of all classes of stock 
of the corporation includible in determining the value of the gross 
estate is taken into account. A distribution under section 303(a) may be 
in redemption of the stock of the corporation includible in determining 
the value of the gross estate, without regard to the class of such 
stock.
    (2) The above may be illustrated by the following example:

    Example. The gross estate of the decedent has a value of $1,000,000, 
the taxable estate is $700,000, and the sum of the death taxes and 
funeral and administration expenses is $275,000. Included in determining 
the gross estate of the decedent is stock of three corporations which, 
for Federal estate tax purposes, is valued as follows:

Corporation A:
  Common stock...............................................   $100,000
  Preferred stock............................................    100,000
Corporation B:
  Common stock...............................................     50,000
  Preferred stock............................................    350,000
Corporation C: Common stock..................................    200,000
 


The stock of Corporation A and Corporation C included in the estate of 
the decedent constitutes all of the outstanding stock of both 
corporations. The stock of Corporation A and the stock of Corporation C, 
treated as the stock of a single corporation under section 303(b)(2)(B), 
has a value in excess of $350,000 (35 percent of the gross estate or 50 
percent of the taxable estate). Likewise, the stock of Corporation B has 
a value in excess of $350,000. The distribution by one or more of the 
above corporations, within the period prescribed in section 303(b)(1), 
of amounts not exceeding, in the aggregate, $275,000, in redemption of 
preferred stock or common stock of such corporation or corporations, 
will be treated as in full payment in exchange for the stock so 
redeemed.

    (d) If stock includible in determining the value of the gross estate 
of a decedent is exchanged for new stock, the basis of which is 
determined by reference to the basis of the old stock, the redemption of 
the new stock will be treated the same under section 303 as the 
redemption of the old stock would have been. Thus section 303 shall 
apply with respect to a distribution in redemption of stock received by 
the estate of a decedent (1) in connection with a reorganization under 
section 368, (2) in a distribution or exchange under section 355 (or so 
much of section 356 as relates to section 355), (3) in an exchange under 
section 1036 or (4) in a distribution to which section 305(a) applies. 
Similarly, a distribution in redemption of stock will qualify under 
section 303, notwithstanding the fact that the stock redeemed is section 
306 stock to the extent that the conditions of section 303 are met.
    (e) Section 303 applies to distributions made after the death of the 
decedent and (1) before the expiration of the 3-year period of 
limitations for the assessment of estate tax provided in section 6501(a) 
(determined without the application of any provisions of law extending 
or suspending the running of such period of limitations), or within 90 
days after the expiration of such period, or (2) if a petition for 
redetermination of a deficiency in such estate tax has been filed with 
the Tax Court within the time prescribed in section 6213, at any time 
before the expiration of 60 days after the decision of the Tax Court 
becomes final. The extension of

[[Page 21]]

the period of distribution provided in section 303(b)(1)(B) has 
reference solely to bona fide contests in the Tax Court and will not 
apply in the case of a petition for redetermination of a deficiency 
which is initiated solely for the purpose of extending the period within 
which section 303 would otherwise be applicable.
    (f) While section 303 will most frequently have application in the 
case where stock is redeemed from the executor or administrator of an 
estate, the section is also applicable to distributions in redemption of 
stock included in the decedent's gross estate and held at the time of 
the redemption by any person who acquired the stock by any of the means 
comprehended by part III, subchapter A, chapter 11 of the Code, 
including the heir, legatee, or donee of the decedent, a surviving joint 
tenant, surviving spouse, appointee, or taker in default of appointment, 
or a trustee of a trust created by the decedent. Thus section 303 may 
apply with respect to a distribution in redemption of stock from a donee 
to whom the decedent has transferred stock in contemplation of death 
where the value of such stock is included in the decedent's gross estate 
under section 2035. Similarly, section 303 may apply to the redemption 
of stock from a beneficiary of the estate to whom an executor has 
distributed the stock pursuant to the terms of the will of the decedent. 
However, section 303 is not applicable to the case where stock is 
redeemed from a stockholder who has acquired the stock by gift or 
purchase from any person to whom such stock has passed from the 
decedent. Nor is section 303 applicable to the case where stock is 
redeemed from a stockholder who has acquired the stock from the executor 
in satisfaction of a specific monetary bequest.
    (g)(1) The total amount of the distributions to which section 303 
may apply with respect to redemptions of stock included in the gross 
estate of a decedent may not exceed the sum of the estate, inheritance, 
legacy, and succession taxes (including any interest collected as a part 
of such taxes) imposed because of the decedent's death and the amount of 
funeral and administration expenses allowable as deductions to the 
estate. Where there is more than one distribution in redemption of stock 
described in section 303(b)(2) during the period of time prescribed in 
section 303(b)(1), the distributions shall be applied against the total 
amount which qualifies for treatment under section 303 in the order in 
which the distributions are made. For this purpose, all distributions in 
redemption of such stock shall be taken into account, including 
distributions which under another provision of the Code are treated as 
in part or full payment in exchange for the stock redeemed.
    (2) Subparagraph (1) of this paragraph may be illustrated by the 
following example:

    Example. (i) The gross estate of the decedent has a value of 
$800,000, the taxable estate is $500,000, and the sum of the death taxes 
and funeral and administrative expenses is $225,000. Included in 
determining the gross estate of the decedent is the stock of a 
corporation which for Federal estate tax purposes is valued at $450,000. 
During the first year of administration, one-third of such stock is 
distributed to a legatee and shortly thereafter this stock is redeemed 
by the corporation for $150,000. During the second year of 
administration, another one-third of such stock includible in the estate 
is redeemed for $150,000.
    (ii) The first distribution of $150,000 is applied against the 
$225,000 amount that qualifies for treatment under section 303, 
regardless of whether the first distribution was treated as in payment 
in exchange for stock under section 302(a). Thus, only $75,000 of the 
second distribution may be treated as in full payment in exchange for 
stock under section 303. The tax treatment of the remaining $75,000 
would be determined under other provisions of the Code.

    (h) For the purpose of section 303, the estate tax or any other 
estate, inheritance, legacy, or succession tax shall be ascertained 
after the allowance of any credit, relief, discount, refund, remission 
or reduction of tax.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6724, 29 FR 
5343, Apr. 21, 1964; T.D. 7346, 40 FR 10669, Mar. 7, 1975]



Sec. 1.303-3  Application of other sections.

    (a) The sole effect of section 303 is to exempt from tax as a 
dividend a distribution to which such section is applicable when made in 
redemption of stock includible in a decedent's gross

[[Page 22]]

estate. Such section does not, however, in any other manner affect the 
principles set forth in sections 302 and 306. Thus, if stock of a 
corporation is owned equally by A, B, and the C Estate, and the 
corporation redeems one-half of the stock of each shareholder, the 
determination of whether the distributions to A and B are essentially 
equivalent to dividends shall be made without regard to the effect which 
section 303 may have upon the taxability of the distribution to the C 
Estate.
    (b) See section 304 relative to redemption of stock through the use 
of related corporations.



Sec. 1.304-1  General.

    (a) Except as provided in paragraph (b) of this section, section 304 
is applicable where a shareholder sells stock of one corporation to a 
related corporation as defined in section 304. Sales to which section 
304 is applicable shall be treated as redemptions subject to sections 
302 and 303.
    (b) In the case of--
    (1) Any acquisition of stock described in section 304 which occurred 
before June 22, 1954, and
    (2) Any acquisition of stock described in section 304 which occurred 
on or after June 22, 1954, and on or before December 31, 1958, pursuant 
to a contract entered into before June 22, 1954.

The extent to which the property received in return for such acquisition 
shall be treated as a dividend shall be determined as if the Internal 
Revenue Code of 1939 continued to apply in respect of such acquisition 
and as if the Internal Revenue Code of 1954 had not been enacted. See 
section 391. In cases to which this paragraph applies, the basis of the 
stock received by the acquiring corporation shall be determined as if 
the Internal Revenue Code of 1939 continued to apply in respect of such 
acquisition and as if the Internal Revenue Code of 1954 had not been 
enacted.

[T.D. 6533, 26 FR 401, Jan. 19, 1961]



Sec. 1.304-2  Acquisition by related corporation 
(other than subsidiary).

    (a) If a corporation, in return for property, acquires stock of 
another corporation from one or more persons, and the person or persons 
from whom the stock was acquired were in control of both such 
corporations before the acquisition, then such property shall be treated 
as received in redemption of stock of the acquiring corporation. The 
stock received by the acquiring corporation shall be treated as a 
contribution to the capital of such corporation. See section 362(a) for 
determination of the basis of such stock. The transferor's basis for his 
stock in the acquiring corporation shall be increased by the basis of 
the stock surrendered by him. (But see below in this paragraph for 
subsequent reductions of basis in certain cases.) As to each person 
transferring stock, the amount received shall be treated as a 
distribution of property under section 302(d), unless as to such person 
such amount is to be treated as received in exchange for the stock under 
the terms of section 302(a) or section 303. In applying section 302(b), 
reference shall be had to the shareholder's ownership of stock in the 
issuing corporation and not to his ownership of stock in the acquiring 
corporation (except for purposes of applying section 318(a)). In 
determining control and applying section 302(b), section 318(a) 
(relating to the constructive ownership of stock) shall be applied 
without regard to the 50-percent limitation contained in section 
318(a)(2)(C) and (3)(C). A series of redemptions referred to in section 
302(b)(2)(D) shall include acquisitions by either of the corporations of 
stock of the other and stock redemptions by both corporations. If 
section 302(d) applies to the surrender of stock by a shareholder, his 
basis for his stock in the acquiring corporation after the transaction 
(increased as stated above in this paragraph) shall not be decreased 
except as provided in section 301. If section 302(d) does not apply, the 
property received shall be treated as received in a distribution in 
payment in exchange for stock of the acquiring corporation under section 
302(a), which stock has a basis equal to the amount by which the 
shareholder's basis for his stock in the acquiring corporation was 
increased on account of the contribution to capital as provided for 
above in this paragraph. Accordingly, such amount shall be applied in 
reduction of the shareholder's

[[Page 23]]

basis for his stock in the acquiring corporation. Thus, the basis of 
each share of the shareholder's stock in the acquiring corporation will 
be the same as the basis of such share before the entire transaction. 
The holding period of the stock which is considered to have been 
redeemed shall be the same as the holding period of the stock actually 
surrendered.
    (b) In any case in which two or more persons, in the aggregate, 
control two corporations, section 304(a)(1) will apply to sales by such 
persons of stock in either corporation to the other (whether or not made 
simultaneously) provided the sales by each of such persons are related 
to each other. The determination of whether the sales are related to 
each other shall be dependent upon the facts and circumstances 
surrounding all of the sales. For this purpose, the fact that the sales 
may occur during a period of one or more years (such as in the case of a 
series of sales by persons who together control each of such 
corporations immediately prior to the first of such sales and 
immediately subsequent to the last of such sales) shall be disregarded, 
provided the other facts and circumstances indicate related 
transactions.
    (c) The application of section 304(a)(1) may be illustrated by the 
following examples:

    Example 1. Corporation X and corporation Y each have outstanding 200 
shares of common stock. One-half of the stock of each corporation is 
owned by an individual, A, and one-half by another individual, B, who is 
unrelated to A. On or after August 31, 1964, A sells 30 shares of 
corporation X stock to corporation Y for $50,000, such stock having an 
adjusted basis of $10,000 to A. After the sale, A is considered as 
owning corporation X stock as follows: (i) 70 shares directly, and (ii) 
15 shares constructively, since by virtue of his 50-percent ownership of 
Y he constructively owns 50 percent of the 30 shares owned directly by 
Y. Since A's percentage of ownership of X's voting stock after the sale 
(85 out of 200 shares, or 42.5%) is not less than 80 percent of his 
percentage of ownership of X's voting stock before the sale (100 out of 
200 shares, or 50%), the transfer is not ``substantially 
disproportionate'' as to him as provided in section 302(b)(2). Under 
these facts, and assuming that section 302(b)(1) is not applicable, the 
entire $50,000 is treated as a dividend to A to the extent of the 
earnings and profits of corporation Y. The basis of the corporation X 
stock to corporation Y is $10,000, its adjusted basis to A. The amount 
of $10,000 is added to the basis of the stock of corporation Y in the 
hands of A.
    Example 2. The facts are the same as in Example (1) except that A 
sells 80 shares of corporation X stock to corporation Y, and the sale 
occurs before August 31, 1964. After the sale, A is considered as owning 
corporation X stock as follows: (i) 20 shares directly, and (ii) 90 
shares indirectly, since by virtue of his 50-percent ownership of Y he 
constructively owns 50 percent of the 80 shares owned directly by Y and 
50 percent of the 100 shares attributed to Y because they are owned by 
Y's stockholder, B. Since after the sale A owns a total of more than 50 
percent of the voting power of all of the outstanding stock of X (110 
out of 200 shares, or 55%), the transfer is not ``substantially 
disproportionate'' as to him as provided in section 302(b)(2).
    Example 3. Corporation X and corporation Y each have outstanding 100 
shares of common stock. A, an individual, owns one-half the stock of 
corporation X, and C owns one-half the stock of corporation Y. A, B, and 
C are unrelated. A sells 30 shares of the stock of corporation X to 
corporation Y for $50,000, such stock having an adjusted basis of 
$10,000 to him. After the sale, A is considered as owning 35 shares of 
the stock of corporation X (20 shares directly and 15 constructively 
because one-half of the 30 shares owned by corporation Y are attributed 
to him). Since before the sale he owned 50 percent of the stock of 
corporation X and after the sale he owned directly and constructively 
only 35 percent of such stock, the redemption is substantially 
disproportionate as to him pursuant to the provisions of section 
302(b)(2). He, therefore, realizes a gain of $40,000 ($50,000 minus 
$10,000). If the stock surrendered is a capital asset, such gain is 
long-term or short-term capital gain depending on the period of time 
that such stock was held. The basis to A for the stock of corporation Y 
is not changed as a result of the entire transaction. The basis to 
corporation Y for the stock of corporation X is $50,000, i.e., the basis 
of the transferor ($10,000), increased in the amount of gain recognized 
to the transferor ($40,000) on the transfer.
    Example 4. Corporation X and corporation Y each have outstanding 100 
shares of common stock. H, an individual, W, his wife, S, his son, and 
G, his grandson, each own 25 shares of stock of each corporation. H 
sells all of his 25 shares of stock of corporation X to corporation Y. 
Since both before and after the transaction H owned directly and 
constructively 100 percent of the stock of corporation X, and assuming 
that section 302(b)(1) is not applicable, the amount received by him for 
his stock of corporation X

[[Page 24]]

is treated as a dividend to him to the extent of the earnings and 
profits of corporation Y.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33 FR 
11997, Aug. 23, 1968]



Sec. 1.304-3  Acquisition by a subsidiary.

    (a) If a subsidiary acquires stock of its parent corporation from a 
shareholder of the parent corporation, the acquisition of such stock 
shall be treated as though the parent corporation had redeemed its own 
stock. For the purpose of this section, a corporation is a parent 
corporation if it meets the 50 percent ownership requirements of section 
304(c). The determination whether the amount received shall be treated 
as an amount received in payment in exchange for the stock shall be made 
by applying section 303, or by applying section 302(b) with reference to 
the stock of the issuing parent corporation. If such distribution would 
have been treated as a distribution of property (pursuant to section 
302(d)) under section 301, the entire amount of the selling price of the 
stock shall be treated as a dividend to the seller to the extent of the 
earnings and profits of the parent corporation determined as if the 
distribution had been made to it of the property that the subsidiary 
exchanged for the stock. In such cases, the transferor's basis for his 
remaining stock in the parent corporation will be determined by 
including the amount of the basis of the stock of the parent corporation 
sold to the subsidiary.
    (b) Section 304(a)(2) may be illustrated by the following example:

    Example. Corporation M has outstanding 100 shares of common stock 
which are owned as follows: B, 75 shares, C, son of B, 20 shares, and D, 
daughter of B, 5 shares. Corporation M owns the stock of Corporation X. 
B sells his 75 shares of Corporation M stock to Corporation X. Under 
section 302(b)(3) this is a termination of B's entire interest in 
Corporation M and the full amount received from the sale of his stock 
will be treated as payment in exchange for this stock, provided he 
fulfills the requirements of section 302(c)(2) (relating to an 
acquisition of an interest in the corporations).



Sec. 1.304-4  Special rules for the use of related corporations to
avoid the application of section 304.

    (a) Scope and purpose. This section applies to determine the amount 
of a property distribution constituting a dividend (and the source 
thereof) under section 304(b)(2), for certain transactions involving 
controlled corporations. The purpose of this section is to prevent the 
avoidance of the application of section 304 to a controlled corporation.
    (b) Amount and source of dividend. For purposes of determining the 
amount constituting a dividend (and source thereof) under section 
304(b)(2), the following rules shall apply:
    (1) Deemed acquiring corporation. A corporation (deemed acquiring 
corporation) shall be treated as acquiring for property the stock of a 
corporation (issuing corporation) acquired for property by another 
corporation (acquiring corporation) that is controlled by the deemed 
acquiring corporation, if a principal purpose for creating, organizing, 
or funding the acquiring corporation by any means (including through 
capital contributions or debt) is to avoid the application of section 
304 to the deemed acquiring corporation. See paragraph (c) Example 1 of 
this section for an illustration of this paragraph.
    (2) Deemed issuing corporation. The acquiring corporation shall be 
treated as acquiring for property the stock of a corporation (deemed 
issuing corporation) controlled by the issuing corporation if, in 
connection with the acquisition for property of stock of the issuing 
corporation by the acquiring corporation, the issuing corporation 
acquired stock of the deemed issuing corporation with a principal 
purpose of avoiding the application of section 304 to the deemed issuing 
corporation. See paragraph (c) Example 2 of this section for an 
illustration of this paragraph.
    (c) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1. (i) Facts. P, a domestic corporation, wholly owns CFC1, a 
controlled foreign corporation with substantial accumulated earnings and 
profits. CFC1 is organized in Country X, which imposes a high rate of 
tax on the income of CFC1. P also wholly owns

[[Page 25]]

CFC2, a controlled foreign corporation with accumulated earnings and 
profits of $200x. CFC2 is organized in Country Y, which imposes a low 
rate of tax on the income of CFC2. P wishes to own all of its foreign 
corporations in a direct chain and to repatriate the cash of CFC2. In 
order to avoid having to obtain Country X approval for the acquisition 
of CFC1 (a Country X corporation) by CFC2 (a Country Y corporation) and 
to avoid the dividend distribution from CFC2 to P that would result if 
CFC2 were the acquiring corporation, P causes CFC2 to form CFC3 in 
Country X and to contribute $100x to CFC3. CFC3 then acquires all of the 
stock of CFC1 from P for $100x.
    (ii) Result. Because a principal purpose for creating, organizing, 
or funding CFC3 (acquiring corporation) is to avoid the application of 
section 304 to CFC2 (deemed acquiring corporation), under paragraph 
(b)(1) of this section, for purposes of determining the amount of the 
$100x distribution constituting a dividend (and source thereof) under 
section 304(b)(2), CFC2 shall be treated as acquiring the stock of CFC1 
(issuing corporation) from P for $100x. As a result, P receives a $100x 
distribution out of the earnings and profits of CFC2 to which section 
301(c)(1) applies.
    Example 2. (i) Facts. P, a domestic corporation, wholly owns CFC1, a 
controlled foreign corporation with substantial accumulated earnings and 
profits. The CFC1 stock has a basis of $100x. CFC1 is organized in 
Country X. P also wholly owns CFC2, a controlled foreign corporation 
with zero accumulated earnings and profits. CFC2 is organized in Country 
Y. P wishes to own all of its foreign corporations in a direct chain and 
to repatriate the cash of CFC2. In order to avoid having to obtain 
Country X approval for the acquisition of CFC1 (a Country X corporation) 
by CFC2 (a Country Y corporation) and to avoid a dividend distribution 
from CFC1 to P, P forms a new corporation (CFC3) in Country X and 
transfers the stock of CFC1 to CFC3 in exchange for CFC3 stock. P then 
transfers the stock of CFC3 to CFC2 in exchange for $100x.
    (ii) Result. Because a principal purpose for the transfer of the 
stock of CFC1 (deemed issuing corporation) by P to CFC3 (issuing 
corporation) is to avoid the application of section 304 to CFC1, under 
paragraph (b)(2) of this section, for purposes of determining the amount 
of the $100x distribution constituting a dividend (and source thereof) 
under section 304(b)(2), CFC2 (acquiring corporation) shall be treated 
as acquiring the stock of CFC1 from P for $100x . As a result, P 
receives a $100x distribution out of the earnings and profits of CFC1 to 
which section 301(c)(1) applies.

    (d) Effective/applicability date. This section applies to 
acquisitions of stock occurring on or after December 29, 2009.

[T.D. 9606, 77 FR 75845, Dec. 26, 2012]



Sec. 1.304-5  Control.

    (a) Control requirement in general. Section 304(c)(1) provides that, 
for purposes of section 304, control means the ownership of stock 
possessing at least 50 percent of the total combined voting power of all 
classes of stock entitled to vote or at least 50 percent of the total 
value of shares of all classes of stock. Section 304(c)(3) makes section 
318(a) (relating to constructive ownership of stock), as modified by 
section 304(c)(3)(B), applicable to section 304 for purposes of 
determining control under section 304(c)(1).
    (b) Effect of section 304(c)(2)(B)--(1) In general. In determining 
whether the control test with respect to both the issuing and acquiring 
corporations is satisfied, section 304(a)(1) considers only the person 
or persons that--
    (i) Control the issuing corporation before the transaction;
    (ii) Transfer issuing corporation stock to the acquiring corporation 
for property; and
    (iii) Control the acquiring corporation thereafter.
    (2) Application. Section 317 defines property to include money, 
securities, and any other property except stock (or stock rights) in the 
distributing corporation. However, section 304(c)(2)(B) provides a 
special rule to extend the relevant group of persons to be tested for 
control of both the issuing and acquiring corporations to include the 
person or persons that do not acquire property, but rather solely stock 
from the acquiring corporation in the transaction. Section 304(c)(2)(B) 
provides that if two or more persons in control of the issuing 
corporation transfer stock of such corporation to the acquiring 
corporation, and if the transferors are in control of the acquiring 
corporation after the transfer, the person or persons in control of each 
corporation include each of those transferors. Because the purpose of 
section 304(c)(2)(B) is to include in the relevant control group the 
person or persons that retain or acquire acquiring corporation stock in 
the transaction,

[[Page 26]]

only the person or persons transferring stock of the issuing corporation 
that retain or acquire any proprietary interest in the acquiring 
corporation are taken into account for purposes of applying section 
304(c)(2)(B).
    (3) Example. This section may be illustrated by the following 
example.

    Example. (a) A, the owner of 20% of T's only class of stock, 
transfers that stock to P solely in exchange for all of the P stock. 
Pursuant to the same transaction, P, solely in exchange for cash, 
acquires the remaining 80% of the T stock from T's other shareholder, B, 
who is unrelated to A and P.
    (b) Although A and B together were in control of T (the issuing 
corporation) before the transaction and A and B each transferred T stock 
to P (the acquiring corporation), sections 304(a)(1) and (c)(2)(B) do 
not apply to B because B did not retain or acquire any proprietary 
interest in P in the transaction. Section 304(a)(1) also does not apply 
to A because A (or any control group of which A was a member) did not 
control T before the transaction and P after the transaction.

    (c) Effective date. This section is effective on January 20, 1994.

[T.D. 8515, 59 FR 2960, Jan. 20, 1994]



Sec. 1.304-6  Amount constituting a dividend. [Reserved]



Sec. 1.304-7  Certain acquisitions by foreign acquiring corporations.

    (a) Scope. This section provides rules regarding the application of 
section 304(b)(5)(B) to an acquisition of stock described in section 304 
by an acquiring corporation that is foreign (foreign acquiring 
corporation). Paragraph (b) of this section provides the rule for 
determining which earnings and profits are taken into account for 
purposes of applying section 304(b)(5)(B). Paragraph (c) of this section 
provides rules addressing the use of a partnership, option (or similar 
interest), or other arrangement. Paragraph (d) of this section provides 
examples that illustrate the rules of this section. Paragraph (e) of 
this section provides the applicability date.
    (b) Earnings and profits taken into account. For purposes of 
applying section 304(b)(5)(B), only the earnings and profits of the 
foreign acquiring corporation are taken into account in determining 
whether more than 50 percent of the dividends arising from the 
acquisition (determined without regard to section 304(b)(5)(B)) would 
neither be subject to tax under chapter 1 of subtitle A of the Internal 
Revenue Code for the taxable year in which the dividends arise (subject 
to tax) nor be includible in the earnings and profits of a controlled 
foreign corporation (includible by a controlled foreign corporation). 
For purposes of this section, a controlled foreign corporation has the 
meaning provided in section 957 and without regard to section 953(c), 
determined without applying subparagraphs (A), (B), and (C) of section 
318(a)(3) so as to consider a United States person as owning stock which 
is owned by a person who is not a United States person.
    (c) Use of a partnership, option (or similar interest), or other 
arrangement. If a partnership, option (or similar interest), or other 
arrangement, is used with a principal purpose of avoiding the 
application of this section (for example, to treat a transferor as a 
controlled foreign corporation), then the partnership, option (or 
similar interest), or other arrangement will be disregarded for purposes 
of applying this section.
    (d) Examples. The following examples illustrate the rules of this 
section. For purposes of the examples, assume the following facts in 
addition to the facts stated in the examples:
    (1) FA is a foreign corporation that is not a controlled foreign 
corporation;
    (2) FA wholly owns DT, a domestic corporation;
    (3) DT wholly owns FS1, a controlled foreign corporation; and
    (4) No portion of a dividend from FS1 would be treated as from 
sources within the United States under section 861.

    Example 1-- (i) Facts. DT has earnings and profits of $51x, and FS1 
has earnings and profits of $49x. FA transfers DT stock with a fair 
market value of $100x to FS1 in exchange for $100x of cash.
    (ii) Analysis. Under section 304(a)(2), the $100x of cash is treated 
as a distribution in redemption of the stock of DT. The redemption of 
the DT stock is treated as a distribution to which section 301 applies 
pursuant to section 302(d), which ordinarily would be sourced first from 
FS1 under section 304(b)(2)(A). Without regard to the application of 
section 304(b)(5)(B), more than 50 percent of the dividend arising from 
the acquisition, taking into account only the earnings and profits of 
FS1 pursuant to paragraph (b)

[[Page 27]]

of this section, would neither be subject to tax nor includible by a 
controlled foreign corporation. In particular, no portion of a dividend 
from FS1 would be subject to tax or includible by a controlled foreign 
corporation. Accordingly, section 304(b)(5)(B) and paragraph (b) of this 
section apply to the transaction, and no portion of the distribution of 
$100x is treated under section 301(c)(1) as a dividend out of the 
earnings and profits of FS1. Furthermore, the $100x of cash is treated 
as a dividend to the extent of the earnings and profits of DT ($51x).
    Example 2-- (i) Facts. FA and DT own 40 percent and 60 percent, 
respectively, of the capital and profits interests of PRS, a foreign 
partnership. PRS wholly owns FS2, a controlled foreign corporation. The 
FS2 stock has a fair market value of $100x. FS1 has earnings and profits 
of $150x. PRS transfers all of its FS2 stock to FS1 in exchange for 
$100x of cash. DT enters into a gain recognition agreement that complies 
with the requirements set forth in section 4.01 of Notice 2012-15, 2012-
9 I.R.B 424, with respect to the portion (60 percent) of the FS2 stock 
that DT is deemed to transfer to FS1 in an exchange described in section 
367(a)(1). See Sec. 1.367(a)-1T(c)(3)(i)(A).
    (ii) Analysis. Under section 304(a)(1), PRS and FS1 are treated as 
if PRS transferred its FS2 stock to FS1 in an exchange described in 
section 351(a) solely for FS1 stock, and, in turn, FS1 redeemed such FS1 
stock in exchange for $100x of cash. The redemption of the FS1 stock is 
treated as a distribution to which section 301 applies pursuant to 
section 302(d). Without regard to the application of section 
304(b)(5)(B), more than 50 percent of a dividend arising from the 
acquisition, taking into account only the earnings and profits of FS1 
pursuant to paragraph (b) of this section, would be subject to tax. In 
particular, 60 percent of a dividend from FS1 would be included in DT's 
distributive share of PRS's partnership income and therefore would be 
subject to tax. Accordingly, section 304(b)(5)(B) does not apply, and 
the entire distribution of $100x is treated under section 301(c)(1) as a 
dividend out of the earnings and profits of FS1.

    (e) Applicability date. This section applies to acquisitions that 
are completed on or after September 22, 2014.

[T.D. 9834, 83 FR 32532, July 12, 2018]



Sec. 1.305-1  Stock dividends.

    (a) In general. Under section 305, a distribution made by a 
corporation to its shareholders in its stock or in rights to acquire its 
stock is not included in gross income except as provided in section 
305(b) and the regulations promulgated under the authority of section 
305(c). A distribution made by a corporation to its shareholders in its 
stock or rights to acquire its stock which would not otherwise be 
included in gross income by reason of section 305 shall not be so 
included merely because such distribution was made out of Treasury stock 
or consisted of rights to acquire Treasury stock. See section 307 for 
rules as to basis of stock and stock rights acquired in a distribution.
    (b) Amount of distribution. (1) In general, where a distribution of 
stock or rights to acquire stock of a corporation is treated as a 
distribution of property to which section 301 applies by reason of 
section 305(b), the amount of the distribution, in accordance with 
section 301(b) and Sec. 1.301-1, is the fair market value of such stock 
or rights on the date of distribution. See Example (1) of Sec. 1.305-
2(b).
    (2) Where a corporation which regularly distributes its earnings and 
profits, such as a regulated investment company, declares a dividend 
pursuant to which the shareholders may elect to receive either money or 
stock of the distributing corporation of equivalent value, the amount of 
the distribution of the stock received by any shareholder electing to 
receive stock will be considered to equal the amount of the money which 
could have been received instead. See Example (2) of Sec. 1.305-2(b).
    (3) For rules for determining the amount of the distribution where 
certain transactions, such as changes in conversion ratios or periodic 
redemptions, are treated as distributions under section 305(c), see 
Examples (6), (8), (9), and (15) of Sec. 1.305-3(e).
    (c) Adjustment in purchase price. A transfer of stock (or rights to 
acquire stock) or an increase or decrease in the conversion ratio or 
redemption price of stock which represents an adjustment of the price to 
be paid by the distributing corporation in acquiring property (within 
the meaning of section 317(a)) is not within the purview of section 305 
because it is not a distribution with respect to its stock. For example, 
assume that on January 1, 1970, pursuant to a reorganization, 
corporation X acquires all the stock of corporation Y solely in exchange 
for its convertible preferred class B stock. Under the

[[Page 28]]

terms of the class B stock, its conversion ratio is to be adjusted in 
1976 under a formula based upon the earnings of corporation Y over the 
6-year period ending on December 31, 1975. Such an adjustment in 1976 is 
not covered by section 305.
    (d) Definitions. (1) For purposes of this section and Sec. Sec. 
1.305-2 through 1.305-7, the term stock includes rights or warrants to 
acquire such stock.
    (2) For purposes of Sec. Sec. 1.305-2 through 1.305-7, the term 
shareholder includes a holder of rights or warrants or a holder of 
convertible securities.

[T.D. 7281, 38 FR 18532, July 12, 1973; 38 FR 19910, July 25, 1973]



Sec. 1.305-2  Distributions in lieu of money.

    (a) In general. Under section 305(b)(1), if any shareholder has the 
right to an election or option with respect to whether a distribution 
shall be made either in money or any other property, or in stock or 
rights to acquire stock of the distributing corporation, then, with 
respect to all shareholders, the distribution of stock or rights to 
acquire stock is treated as a distribution of property to which section 
301 applies regardless of--
    (1) Whether the distribution is actually made in whole or in part in 
stock or in stock rights;
    (2) Whether the election or option is exercised or exercisable 
before or after the declaration of the distribution;
    (3) Whether the declaration of the distribution provides that the 
distribution will be made in one medium unless the shareholder 
specifically requests payment in the other;
    (4) Whether the election governing the nature of the distribution is 
provided in the declaration of the distribution or in the corporate 
charter or arises from the circumstances of the distribution; or
    (5) Whether all or part of the shareholders have the election.
    (b) Examples. The application of section 305(b)(1) may be 
illustrated by the following examples:

    Example 1. (i) Corporation X declared a dividend payable in 
additional shares of its common stock to the holders of its outstanding 
common stock on the basis of two additional shares for each share held 
on the record date but with the provision that, at the election of any 
shareholder made within a specified period prior to the distribution 
date, he may receive one additional share for each share held on the 
record date plus $12 principal amount of securities of corporation Y 
owned by corporation X. The fair market value of the stock of 
corporation X on the distribution date was $10 per share. The fair 
market value of $12 principal amount of securities of corporation Y on 
the distribution date was $11 but such securities had a cost basis to 
corporation X of $9.
    (ii) The distribution to all shareholders of one additional share of 
stock of corporation X (with respect to which no election applies) for 
each share outstanding is not a distribution to which section 301 
applies.
    (iii) The distribution of the second share of stock of corporation X 
to those shareholders who do not elect to receive securities of 
corporation Y is a distribution of property to which section 301 
applies, whether such shareholders are individuals or corporations. The 
amount of the distribution to which section 301 applies is $10 per share 
of stock of corporation X held on the record date (the fair market value 
of the stock of corporation X on the distribution date).
    (iv) The distribution of securities of corporation Y in lieu of the 
second share of stock of corporation X to the shareholders of 
corporation X whether individuals or corporations, who elect to receive 
such securities, is also a distribution of property to which section 301 
applies.
    (v) In the case of the individual shareholders of corporation X who 
elects to receive such securities, the amount of the distribution to 
which section 301 applies is $11 per share of stock of corporation X 
held on the record date (the fair market value of the $12 principal 
amount of securities of corporation Y on the distribution date).
    (vi) In the case of the corporate shareholders of corporation X 
electing to receive such securities, the amount of the distribution to 
which section 301 applies is $9 per share of stock of corporation X held 
on the record date (the basis of the securities of corporation Y in the 
hands of corporation X).
    Example 2. On January 10, 1970, corporation X, a regulated 
investment company, declared a dividend of $1 per share on its common 
stock payable on February 11, 1970, in cash or in stock of corporation X 
of equivalent value determined as of January 22, 1970, at the election 
of the shareholder made on or before January 22, 1970. The amount of the 
distribution to which section 301 applies is $1 per share whether the 
shareholder elects to take cash or stock and whether the shareholder is 
an individual or a corporation. Such amount will also be used in 
determining the dividend

[[Page 29]]

paid deduction of corporation X and the reduction in earnings and 
profits of corporation X.

[T.D. 7281, 38 FR 18532, July 12, 1973]



Sec. 1.305-3  Disproportionate distributions.

    (a) In general. Under section 305(b)(2), a distribution (including a 
deemed distribution) by a corporation of its stock or rights to acquire 
its stock is treated as a distribution of property to which section 301 
applies if the distribution (or a series of distributions of which such 
distribution is one) has the result of (1) the receipt of money or other 
property by some shareholders, and (2) an increase in the proportionate 
interests of other shareholders in the assets or earnings and profits of 
the corporation. Thus, if a corporation has two classes of common stock 
outstanding and cash dividends are paid on one class and stock dividends 
are paid on the other class, the stock dividends are treated as 
distributions to which section 301 applies.
    (b) Special rules. (1) As used in section 305(b)(2), the term a 
series of distributions encompasses all distributions of stock made or 
deemed made by a corporation which have the result of the receipt of 
cash or property by some shareholders and an increase in the 
proportionate interests of other shareholders.
    (2) In order for a distribution of stock to be considered as one of 
a series of distributions it is not necessary that such distribution be 
pursuant to a plan to distribute cash or property to some shareholders 
and to increase the proportionate interests of other shareholders. It is 
sufficient if there is an actual or deemed distribution of stock (of 
which such distribution is one) and as a result of such distribution or 
distributions some shareholders receive cash or property and other 
shareholders increase their proportionate interests. For example, if a 
corporation pays quarterly stock dividends to one class of common 
shareholders and annual cash dividends to another class of common 
shareholders the quarterly stock dividends constitute a series of 
distributions of stock having the result of the receipt of cash or 
property by some shareholders and an increase in the proportionate 
interests of other shareholders. This is so whether or not the stock 
distributions and the cash distributions are steps in an overall plan or 
are independent and unrelated. Accordingly, all the quarterly stock 
dividends are distributions to which section 301 applies.
    (3) There is no requirement that both elements of section 305(b)(2) 
(i.e., receipt of cash or property by some shareholders and an increase 
in proportionate interests of other shareholders) occur in the form of a 
distribution or series of distributions as long as the result of a 
distribution or distributions of stock is that some shareholders' 
proportionate interests increase and other shareholders in fact receive 
cash or property. Thus, there is no requirement that the shareholders 
receiving cash or property acquire the cash or property by way of a 
corporate distribution with respect to their shares, so long as they 
receive such cash or property in their capacity as shareholders, if 
there is a stock distribution which results in a change in the 
proportionate interests of some shareholders and other shareholders 
receive cash or property. However, in order for a distribution of 
property to meet the requirement of section 305(b)(2), such distribution 
must be made to a shareholder in his capacity as a shareholder, and must 
be a distribution to which section 301, 356(a)(2), 871(a)(1)(A), 
881(a)(1), 852(b), or 857(b) applies. (Under section 305(d)(2), the 
payment of interest to a holder of a convertible debenture is treated as 
a distribution of property to a shareholder for purposes of section 
305(b)(2).) For example if a corporation makes a stock distribution to 
its shareholders and, pursuant to a prearranged plan with such 
corporation, a related corporation purchases such stock from those 
shareholders who want cash, in a transaction to which section 301 
applies by virtue of section 304, the requirements of section 305(b)(2) 
are satisfied. In addition, a distribution of property incident to an 
isolated redemption of stock (for example, pursuant to a tender offer) 
will not cause section 305(b)(2) to apply even though the redemption 
distribution is treated as a distribution of property to

[[Page 30]]

which section 301, 871(a)(1)(A), 881(a)(1), or 356(a)(2) applies.
    (4) Where the receipt of cash or property occurs more than 36 months 
following a distribution or series of distributions of stock, or where a 
distribution or series of distributions of stock is made more than 36 
months following the receipt of cash or property, such distribution or 
distributions will be presumed not to result in the receipt of cash or 
property by some shareholders and an increase in the proportionate 
interest of other shareholders, unless the receipt of cash or property 
and the distribution or series of distributions of stock are made 
pursuant to a plan. For example, if, pursuant to a plan, a corporation 
pays cash dividends to some shareholders on January 1, 1971 and 
increases the proportionate interests of other shareholders on March 1, 
1974, such increases in proportionate interests are distributions to 
which section 301 applies.
    (5) In determining whether a distribution or a series of 
distributions has the result of a disproportionate distribution, there 
shall be treated as outstanding stock of the distributing corporation 
(i) any right to acquire such stock (whether or not exercisable during 
the taxable year), and (ii) any security convertible into stock of the 
distributing corporation (whether or not convertible during the taxable 
year).
    (6) In cases where there is more than one class of stock 
outstanding, each class of stock is to be considered separately in 
determining whether a shareholder has increased his proportionate 
interest in the assets or earnings and profits of a corporation. The 
individual shareholders of a class of stock will be deemed to have an 
increased interest if the class of stock as a whole has an increased 
interest in the corporation.
    (c) Distributions of cash in lieu of fractional shares. (1) Section 
305(b)(2) will not apply if--
    (i) A corporation declares a dividend payable in stock of the 
corporation and distributes cash in lieu of fractional shares to which 
shareholders would otherwise be entitled, or
    (ii) Upon a conversion of convertible stock or securities a 
corporation distributes cash in lieu of fractional shares to which 
shareholders would otherwise be entitled.

Provided the purpose of the distribution of cash is to save the 
corporation the trouble, expense, and inconvenience of issuing and 
transferring fractional shares (or scrip representing fractional 
shares), or issuing full shares representing the sum of fractional 
shares, and not to give any particular group of shareholders an 
increased interest in the assets or earnings and profits of the 
corporation. For purposes of paragraph (c)(1)(i) of this section, if the 
total amount of cash distributed in lieu of fractional shares is 5 
percent or less of the total fair market value of the stock distributed 
(determined as of the date of declaration), the distribution shall be 
considered to be for such valid purpose.
    (2) In a case to which subparagraph (1) of this paragraph applies, 
the transaction will be treated as though the fractional shares were 
distributed as part of the stock distribution and then were redeemed by 
the corporation. The treatment of the cash received by a shareholder 
will be determined under section 302.
    (d) Adjustment in conversion ratio. (1)(i) Except as provided in 
subparagraph (2) of this paragraph, if a corporation has convertible 
stock or convertible securities outstanding (upon which it pays or is 
deemed to pay dividends or interest in money or other property) and 
distributes a stock dividend (or rights to acquire such stock) with 
respect to the stock into which the convertible stock or securities are 
convertible, an increase in proportionate interest in the assets or 
earnings and profits of the corporation by reason of such stock dividend 
shall be considered to have occurred unless a full adjustment in the 
conversion ratio or conversion price to reflect such stock dividend is 
made. Under certain circumstances, however, the application of an 
adjustment formula which in effect provides for a ``credit'' where stock 
is issued for consideration in excess of the conversion price may not 
satisfy the requirement for a ``full adjustment.'' Thus, if under a 
``conversion price'' antidilution formula the formula provides for a 
``credit'' where

[[Page 31]]

stock is issued for consideration in excess of the conversion price (in 
effect as an offset against any decrease in the conversion price which 
would otherwise be required when stock is subsequently issued for 
consideration below the conversion price) there may still be an increase 
in proportionate interest by reason of a stock dividend after 
application of the formula, since any downward adjustment of the 
conversion price that would otherwise be required to reflect the stock 
dividend may be offset, in whole or in part, by the effect of prior 
sales made at prices above the conversion price. On the other hand, if 
there were no prior sales of stock above the conversion price then a 
full adjustment would occur upon the application of such an adjustment 
formula and there would be no change in proportionate interest. 
Similarly, if consideration is to be received in connection with the 
issuance of stock, such as in the case of a rights offering or a 
distribution of warrants, the fact that such consideration is taken into 
account in making the antidilution adjustment will not preclude a full 
adjustment. See paragraph (b) of the example in this subparagraph for a 
case where the application of an adjustment formula with a cumulative 
feature does not result in a full adjustment and where a change in 
proportionate interest therefore occurs. See paragraph (c) for a case 
where the application of an adjustment formula with a cumulative feature 
does result in a full adjustment and where no change in proportionate 
interest therefore occurs. See paragraph (d) for an application of an 
antidilution formula in the case of a rights offering. See paragraph (e) 
for a case where the application of a noncumulative type adjustment 
formula will in all cases prevent a change in proportionate interest 
from occurring in the case of a stock dividend, because of the omission 
of the cumulative feature.
    (ii) The principles of this subparagraph may be illustrated by the 
following example.

    Example. (a) Corporation S has two classes of securities 
outstanding, convertible debentures and common stock. At the time of 
issuance of the debentures the corporation had 100 shares of common 
stock outstanding. Each debenture is interest-paying and is convertible 
into common stock at a conversion price of $2. The debenture's 
conversion price is subject to reduction pursuant to the following 
formula:

    (Number of common shares outstanding at date of issue of debentures 
times initial conversion price) plus (Consideration received upon 
issuance of additional common shares) divided by (Number of common 
shares outstanding at date of issue of debentures) plus (Number of 
additional common shares issued)


Under the formula, common stock dividends are treated as an issue of 
common stock for zero consideration. If the computation results in a 
figure which is less than the existing conversion price the conversion 
price is reduced. However, under the formula, the existing conversion 
price is never increased. The formula works upon a cumulative basis 
since the numerator includes the consideration received upon the 
issuance of all common shares subsequent to the issuance of the 
debentures, and the reduction effected by the formula because of a sale 
or issuance of common stock below the existing conversion price is thus 
limited by any prior sales made above the existing conversion price.
    (b) In 1972 corporation S sells 100 common shares at $3 per share. 
In 1973 the corporation declares a stock dividend of 20 shares to all 
holders of common stock. Under the antidilution formula no adjustment 
will be made to the conversion price of the debentures to reflect the 
stock dividend to common stockholders since the prior sale of common 
stock in excess of the conversion price in 1972 offsets the reduction in 
the conversion price which would otherwise result, as follows:

100 x $2 + $300 / 100 + 120 = $500 / 220 = $2.27

Since $2.27 is greater than the existing conversion price of $2 no 
adjustment is required. As a result, there is an increase in 
proportionate interest of the common stockholders by reason of the stock 
dividend and the additional shares of common stock will be treated, 
pursuant to section 305(b)(2), as a distribution of property to which 
section 301 applies.
    (c) Assume the same facts as above, but instead of selling 100 
common shares at $3 per share in 1972, assume corporation S sold no 
shares. Application of the antidilution formula would give rise to an 
adjustment in the conversion price as follows:

100 x $2 + $0 / 100 + 20 = $200 / 120 = $1.67

The conversion price, being reduced from $2 to $1.67, fully reflects the 
stock dividend distributed to the common stockholders. Hence, the 
distribution of common stock is not treated under section 305(b)(2) as 
one to which section 301 applies because the distribution does not 
increase the proportionate

[[Page 32]]

interests of the common shareholders as a class.
    (d) Corporation S distributes to its shareholders rights entitling 
the shareholders to purchase a total of 20 shares at $1 per share. 
Application of the antidilution formula would produce an adjustment in 
the conversion price as follows:

100 x $2 + 20 x $1 / 100 + 20 = $220 / 120 = $1.83

The conversion price, being reduced from $2 to $1.83, fully reflects the 
distribution of rights to purchase stock at a price lower than the 
conversion price. Hence, the distribution of the rights is not treated 
under section 305(b)(2) as one to which section 301 applies because the 
distribution does not increase the proportionate interests of the common 
shareholders as a class.
    (e) Assume the same facts as in (b) above, but instead of using a 
``conversion price'' antidilution formula which operates on a cumulative 
basis, assume corporation S has employed a formula which operates as 
follows with respect to all stock dividends: The conversion price in 
effect at the opening of business on the day following the dividend 
record date is reduced by multiplying such conversion price by a 
fraction the numerator of which is the number of shares of common stock 
outstanding at the close of business on the record date and the 
denominator of which is the sum of such shares so outstanding and the 
number of shares constituting the stock dividend. Under such a formula 
the following adjustment would be made to the conversion price upon the 
declaration of a stock dividend of 20 shares in 1973:

200 / 200 + 20 = 200 / 220 x $2 = $1.82

The conversion price, being reduced from $2 to $1.82, fully reflects the 
stock dividend distributed to the common stockholders. Hence, the 
distribution of common stock is not treated under section 305(b)(2) as 
one to which section 301 applies because the distribution does not 
increase the proportionate interests of the common shareholders as a 
class.

    (2)(i) A distributing corporation either must make the adjustment 
required by subparagraph (1) of this paragraph as of the date of the 
distribution of the stock dividend, or must elect (in the manner 
provided in subdivision (iii) of this subparagraph) to make such 
adjustment within the time provided in subdivision (ii) of this 
subparagraph.
    (ii) If the distributing corporation elects to make such adjustment, 
such adjustment must be made no later than the earlier of (a) 3 years 
after the date of the stock dividend, or (b) that date as of which the 
aggregate stock dividends for which adjustment of the conversion ratio 
has not previously been made total at least 3 percent of the issued and 
outstanding stock with respect to which such stock dividends were 
distributed.
    (iii) The election provided by subdivision (ii) of this subparagraph 
shall be made by filing with the income tax return for the taxable year 
during which the stock dividend is distributed--
    (a) A statement that an adjustment will be made as provided by that 
subdivision, and
    (b) A description of the antidilution provisions under which the 
adjustment will be made.
    (3) Notwithstanding the preceding subparagraph, if a distribution 
has been made before July 12, 1973, and the adjustment required by 
subparagraph (1) or the election to make such adjustment was not made 
before such date, the adjustment or the election to make such 
adjustment, as the case may be, shall be considered valid if made no 
later than 15 days following the date of the first annual meeting of the 
shareholders after July 12, 1973, or July 12, 1974, whichever is 
earlier. If the election is made within such period, and, if the income 
tax return has been filed before the time of such election, the 
statement of adjustment and the description of the antidilution 
provisions required by subparagraph (2)(iii) shall be filed with the 
Internal Revenue Service Center with which the income tax return was 
filed.
    (4) See Sec. 1.305-7(b) for a discussion of antidilution 
adjustments in connection with the application of section 305(c) in 
conjunction with section 305(b).
    (e) Examples. The application of section 305(b)(2) to distributions 
of stock and section 305(c) to deemed distributions of stock may be 
illustrated by the following examples:

    Example 1. Corporation X is organized with two classes of common 
stock, class A and class B. Each share of stock is entitled to share 
equally in the assets and earnings and profits of the corporation. 
Dividends may be paid in stock or in cash on either class of stock 
without regard to the medium of payment of dividends on the other class. 
A dividend is declared on the class A stock payable in additional shares 
of class A stock and a dividend is declared on class B stock payable in 
cash. Since the class A shareholders as a

[[Page 33]]

class will have increased their proportionate interests in the assets 
and earnings and profits of the corporation and the class B shareholders 
will have received cash, the additional shares of class A stock are 
distributions of property to which section 301 applies. This is true 
even with respect to those shareholders who may own class A stock and 
class B stock in the same proportion.
    Example 2. Corporation Y is organized with two classes of stock, 
class A common, and class B, which is nonconvertible and limited and 
preferred as to dividends. A dividend is declared upon the class A stock 
payable in additional shares of class A stock and a dividend is declared 
on the class B stock payable in cash. The distribution of class A stock 
is not one to which section 301 applies because the distribution does 
not increase the proportionate interests of the class A shareholders as 
a class.
    Example 3. Corporation K is organized with two classes of stock, 
class A common, and class B, which is nonconvertible preferred stock. A 
dividend is declared upon the class A stock payable in shares of class B 
stock and a dividend is declared on the class B stock payable in cash. 
Since the class A shareholders as a class have an increased interest in 
the assets and earnings and profits of the corporation, the stock 
distribution is treated as a distribution to which section 301 applies. 
If, however, a dividend were declared upon the class A stock payable in 
a new class of preferred stock that is subordinated in all respects to 
the class B stock, the distribution would not increase the proportionate 
interests of the class A shareholders in the assets or earnings and 
profits of the corporation and would not be treated as a distribution to 
which section 301 applies.
    Example 4. (i) Corporation W has one class of stock outstanding, 
class A common. The corporation also has outstanding interest paying 
securities convertible into class A common stock which have a fixed 
conversion ratio that is not subject to full adjustment in the event 
stock dividends or rights are distributed to the class A shareholders. 
Corporation W distributes to the class A shareholders rights to acquire 
additional shares of class A stock. During the year, interest is paid on 
the convertible securities.
    (ii) The stock rights and convertible securities are considered to 
be outstanding stock of the corporation and the distribution increases 
the proportionate interests of the class A shareholders in the assets 
and earnings and profits of the corporation. Therefore, the distribution 
is treated as a distribution to which section 301 applies. The same 
result would follow if, instead of convertible securities, the 
corporation had outstanding convertible stock. If, however, the 
conversion ratio of the securities or stock were fully adjusted to 
reflect the distribution of rights to the class A shareholders, the 
rights to acquire class A stock would not increase the proportionate 
interests of the class A shareholders in the assets and earnings and 
profits of the corporation and would not be treated as a distribution to 
which section 301 applies.
    Example 5. (i) Corporation S is organized with two classes of stock, 
class A common and class B convertible preferred. The class B is fully 
protected against dilution in the event of a stock dividend or stock 
split with respect to the class A stock; however, no adjustment in the 
conversion ratio is required to be made until the stock dividends equal 
3 percent of the common stock issued and outstanding on the date of the 
first such stock dividend except that such adjustment must be made no 
later than 3 years after the date of the stock dividend. Cash dividends 
are paid annually on the class B stock.
    (ii) Corporation S pays a 1 percent stock dividend on the class A 
stock in 1970. In 1971, another 1 percent stock dividend is paid and in 
1972 another 1 percent stock dividend is paid. The conversion ratio of 
the class B stock is increased in 1972 to reflect the three stock 
dividends paid on the class A stock. The distributions of class A stock 
are not distributions to which section 301 applies because they do not 
increase the proportionate interests of the class A shareholders in the 
assets and earnings and profits of the corporation.
    Example 6. (i) Corporation M is organized with two classes of stock 
outstanding, class A and class B. Each class B share may be converted, 
at the option of the holder, into class A shares. During the first year, 
the conversion ratio is one share of class A stock for each share of 
class B stock. At the beginning of each subsequent year, the conversion 
ratio is increased by 0.05 share of class A stock for each share of 
class B stock. Thus, during the second year, the conversion ratio would 
be 1.05 shares of class A stock for each share of class B stock, during 
the third year, the ratio would be 1.10 shares, etc.
    (ii) M pays an annual cash dividend on the class A stock. At the 
beginning of the second year, when the conversion ratio is increased to 
1.05 shares of class A stock for each share of class B stock, a 
distribution of 0.05 shares of class A stock is deemed made under 
section 305(c) with respect to each share of class B stock, since the 
proportionate interests of the class B shareholders in the assets or 
earnings and profits of M are increased and the transaction has the 
effect described in section 305(b)(2). Accordingly, sections 305(b)(2) 
and 301 apply to the transaction.
    Example 7. (i) Corporation N has two classes of stock outstanding, 
class A and class B. Each class B share is convertible into class A 
stock. However, in accordance with a specified formula, the conversion 
ratio is decreased each time a cash dividend is paid on the class B 
stock to reflect the amount of

[[Page 34]]

the cash dividend. The conversion ratio is also adjusted in the event 
that cash dividends are paid on the class A stock to increase the number 
of class A shares into which the class B shares are convertible to 
compensate the class B shareholders for the cash dividend paid on the 
class A stock.
    (ii) In 1972, a $1 cash dividend per share is declared and paid on 
the class B stock. On the date of payment, the conversion ratio of the 
class B stock is decreased. A distribution of stock is deemed made under 
section 305(c) to the class A shareholders, since the proportionate 
interest of the class A shareholders in the assets or earnings and 
profits of the corporation is increased and the transaction has the 
effect described in section 305(b)(2). Accordingly, sections 305(b)(2) 
and 301 apply to the transaction.
    (iii) In the following year a cash dividend is paid on the class A 
stock and none is paid on the class B stock. The increase in conversion 
rights of the class B shares is deemed to be a distribution under 
section 305(c) to the class B shareholders since their proportionate 
interest in the assets or earnings and profits of the corporation is 
increased and since the transaction has the effect described in section 
305(b)(2). Accordingly, sections 305(b)(2) and 301 apply to the 
transaction.
    Example 8. Corporation T has 1,000 shares of stock outstanding. C 
owns 100 shares. Nine other shareholders each owns 100 shares. Pursuant 
to a plan for periodic redemptions, T redeems up to 5 percent of each 
shareholder's stock each year. During the year, each of the nine other 
shareholders has 5 shares of his stock redeemed for cash. Thus, C's 
proportionate interest in the assets and earnings and profits of T is 
increased. Assuming that the cash received by the nine other 
shareholders is taxable under section 301, C is deemed under section 
305(c) to have received a distribution under section 305(b)(2) of 5.25 
shares of T stock to which section 301 applies. The amount of C's 
distribution is measured by the fair market value of the number of 
shares which would have been distributed to C had the corporation sought 
to increase his interest by 0.47 percentage points (C owned 10 percent 
of the T stock immediately before the redemption and 10.47 percent 
immediately thereafter) and the other shareholders continued to hold 900 
shares (i.e.,
    (a) 100 / 955 = 10.47% (percent of C's ownership after redemption)
    (b) 100 + x / 1000 + x = 10.47%; x = 5.25 (additional shares 
considered to be distributed to C)).

Since in computing the amount of additional shares deemed to be 
distributed to C the redemption of shares is disregarded, the redemption 
of shares will be similarly disregarded in determining the value of the 
stock of the corporation which is deemed to be distributed. Thus, in the 
example, 1,005.25 shares of stock are considered as outstanding after 
the redemption. The value of each share deemed to be distributed to C is 
then determined by dividing the 1,005.25 shares into the aggregate fair 
market value of the actual shares outstanding (955) after the 
redemption.
    Example 9. (i) Corporation O has a stock redemption program under 
which, instead of paying out earnings and profits to its shareholders in 
the form of dividends, it redeems the stock of its shareholders up to a 
stated amount which is determined by the earnings and profits of the 
corporation. If the stock tendered for redemption exceeds the stated 
amount, the corporation redeems the stock on a pro rata basis up to the 
stated amount.
    (ii) During the year corporation O offers to distribute $10,000 in 
redemption of its stock. At the time of the offering, corporation O has 
1,000 shares outstanding of which E and F each owns 150 shares and G and 
H each owns 350 shares. The corporation redeems 15 shares from E and 35 
shares from G. F and H continue to hold all of their stock.
    (iii) F and H have increased their proportionate interests in the 
assets and earnings and profits of the corporation. Assuming that the 
cash E and G receive is taxable under section 301, F will be deemed 
under section 305(c) to have received a distribution under section 
305(b)(2) of 16.66 shares of stock to which section 301 applies and H 
will be deemed under section 305(c) to have received a distribution 
under section 305(b)(2) of 38.86 shares of stock to which section 301 
applies. The amount of the distribution to F and H is measured by the 
number of shares which would have been distributed to F and H had the 
corporation sought to increase the interest of F by 0.79 percentage 
points (F owned 15 percent of the stock immediately before the 
redemption and 15.79 percent immediately thereafter) and the interest of 
H by 1.84 percentage points (H owned 35 percent of the stock immediately 
before the redemption and 36.84 percent immediately thereafter) and E 
and G had continued to hold 150 shares and 350 shares, respectively 
(i.e.,
    (a) 150 / 950 + 350 / 950 = 52.63% (percent of F and H's ownership 
after redemption)
    (b) 500 + y / 1000 + y = 52.63%; y = 55.52 (additional shares 
considered to be distributed to F and H)
    (c)(1) 150 / 500 x 55.52 = 16.66 (shares considered to be 
distributed to F)
    (2) 350 / 500 x 55.52 = 38.86 (shares considered to be distributed 
to H)).

Since in computing the amount of additional shares deemed to be 
distributed to F and H the redemption of shares is disregarded, the 
redemption of shares will be similarly disregarded in determining the 
value of the stock of the corporation which is deemed to be distributed. 
Thus, in the example, 1,055.52 shares of stock are considered as 
outstanding after the redemption. The value of each

[[Page 35]]

share deemed to be distributed to F and H is then determined by dividing 
the 1,055.52 shares into the aggregate fair market value of the actual 
shares outstanding (950) after the redemption.
    Example 10. Corporation P has 1,000 shares of stock outstanding. T 
owns 700 shares of the P stock and G owns 300 shares of the P stock. In 
a single and isolated redemption to which section 301 applies, the 
corporation redeems 150 shares of T's stock. Since this is an isolated 
redemption and is not a part of a periodic redemption plan, G is not 
treated as having received a deemed distribution under section 305(c) to 
which sections 305(b)(2) and 301 apply even though he has an increased 
proportionate interest in the assets and earnings and profits of the 
corporation.
    Example 11. Corporation Q is a large corporation whose sole class of 
stock is widely held. However, the four largest shareholders are 
officers of the corporation and each owns 8 percent of the outstanding 
stock. In 1974, in a distribution to which section 301 applies, the 
corporation redeems 1.5 percent of the stock from each of the four 
largest shareholders in preparation for their retirement. From 1970 
through 1974, the corporation distributes annual stock dividends to its 
shareholders. No other distributions were made to these shareholders. 
Since the 1974 redemptions are isolated and are not part of a plan for 
periodically redeeming the stock of the corporation, the shareholders 
receiving stock dividends will not be treated as having received a 
distribution under section 305(b)(2) even though they have an increased 
proportionate interest in the assets and earnings and profits of the 
corporation and whether or not the redemptions are treated as 
distributions to which section 301 applies.
    Example 12. Corporation R has 2,000 shares of class A stock 
outstanding. Five shareholders own 300 shares each and five shareholders 
own 100 shares each. In preparation for the retirement of the five major 
shareholders, corporation R, in a single and isolated transaction, has a 
recapitalization in which each share of class A stock may be exchanged 
either for five shares of new class B nonconvertible preferred stock 
plus 0.4 share of new class C common stock, or for two shares of new 
class C common stock. As a result of the exchanges, each of the five 
major shareholders receives 1,500 shares of class B nonconvertible 
preferred stock and 120 shares of class C common stock. The remaining 
shareholders each receives 200 shares of class C common stock. None of 
the exchanges are within the purview of section 305.
    Example 13. Corporation P is a widely-held company whose shares are 
listed for trading on a stock exchange. P distributes annual cash 
dividends to its shareholders. P purchases shares of its common stock 
directly from small stockholders (holders of record of 100 shares or 
less) or through brokers where the holders may not be known at the time 
of purchase. Where such purchases are made through brokers, they are 
pursuant to the rules and regulations of the Securities and Exchange 
Commission. The shares are purchased for the purpose of issuance to 
employee stock investment plans, to holders of convertible stock or 
debt, to holders of stock options, or for future acquisitions. Provided 
the purchases are not pursuant to a plan to increase the proportionate 
interest of some shareholders and distribute property to other 
shareholders, the remaining shareholders of P are not treated as having 
received a deemed distribution under section 305(c) to which section 
305(b)(2) and 301 apply, even though they have an increased 
proportionate interest in the assets and earnings and profits of the 
corporation.
    Example 14. Corporation U is a large manufacturing company whose 
products are sold through independent dealers. In order to assist 
individuals who lack capital to become dealers, the corporation has an 
established investment plan under which it provides 75 percent of the 
capital necessary to form a dealership corporation and the individual 
dealer provides the remaining 25 percent. Corporation U receives class A 
stock and a note representing its 75 percent interest. The individual 
dealer receives class B stock representing his 25 percent interest. The 
class B stock is nonvoting until all the class A shares are redeemed. At 
least 70 percent of the earnings and profits of the dealership 
corporation must be used each year to retire the note and to redeem the 
class A stock. The class A stock is redeemed at a fixed price. The 
individual dealer has no control over the redemption of stock and has no 
right to have his stock redeemed during the period the plan is in 
existence. U's investment is thus systematically eliminated and the 
individual becomes the sole owner of the dealership corporation. Since 
this type of plan is akin to a security arrangement, the redemptions of 
the class A stock will not be deemed under section 305(c) as 
distributions taxable under sections 305(b)(2) and 301 during the years 
in which the class A stock is redeemed.
    Example 15. (i) Facts. Corporation V is organized with two classes 
of stock, class A common and class B convertible preferred. The class B 
stock is issued for $100 per share and is convertible at the holder's 
option into class A at a fixed ratio that is not subject to full 
adjustment in the event stock dividends or rights are distributed to the 
class A shareholders. The class B stock pays no dividends but it is 
mandatorily redeemable in 10 years for $200. Under sections 305(c) and 
305(b)(4), the entire redemption premium (i.e., the excess of the 
redemption price over the issue

[[Page 36]]

price) is deemed to be a distribution of preferred stock on preferred 
stock which is taxable as a distribution of property under section 301. 
This amount is considered to be distributed over the 10-year period 
under principles similar to the principles of section 1272(a). During 
the year, the corporation declares a dividend on the class A stock 
payable in additional shares of class A stock.
    (ii) Analysis. The distribution on the class A stock is a 
distribution to which sections 305(b)(2) and 301 apply since it 
increases the proportionate interests of the class A shareholders in the 
assets and earnings and profits of the corporation and the class B 
shareholders have received property (i.e., the constructive distribution 
described above). If, however, the conversion ratio of the class B stock 
were subject to full adjustment to reflect the distribution of stock to 
class A shareholders, the distribution of stock dividends on the class A 
stock would not increase the proportionate interest of the class A 
shareholders in the assets and earnings and profits of the corporation 
and such distribution would not be a distribution to which section 301 
applies.
    (iii) Effective date. This Example 15 applies to stock issued on or 
after December 20, 1995. For previously issued stock, see Sec. 1.305-
3(e) Example (15) (as contained in the 26 CFR part 1 edition revised 
April 1, 1995).

[T.D. 7281, 38 FR 18532, July 12, 1973; 38 FR 19910, 19911, July 25, 
1973, as amended by T.D. 7329, 39 FR 36860, Oct. 15, 1974; T.D. 8643, 60 
FR 66136, Dec. 21, 1995]



Sec. 1.305-4  Distributions of common and preferred stock.

    (a) In general. Under section 305(b)(3), a distribution (or a series 
of distributions) by a corporation which results in the receipt of 
preferred stock whether or not convertible into common stock) by some 
common shareholders and the receipt of common stock by other common 
shareholders is treated as a distribution of property to which section 
301 applies. For the meaning of the term a series of distribution, see 
subparagraphs (1) through (6) of Sec. 1.305-3(b).
    (b) Examples. The application of section 305(b)(3) may be 
illustrated by the following examples:

    Example 1. Corporation X is organized with two classes of common 
stock, class A and class B. Dividends may be paid in stock or in cash on 
either class of stock without regard to the medium of payment of 
dividends on the other class. A dividend is declared on the class A 
stock payable in additional shares of class A stock and a dividend is 
declared on class B stock payable in newly authorized class C stock 
which is nonconvertible and limited and preferred as to dividends. Both 
the distribution of class A shares and the distribution of new class C 
shares are distributions to which section 301 applies.
    Example 2. Corporation Y is organized with one class of stock, class 
A common. During the year the corporation declares a dividend on the 
class A stock payable in newly authorized class B preferred stock which 
is convertible into class A stock no later than 6 months from the date 
of distribution at a price that is only slightly higher than the market 
price of class A stock on the date of distribution. Taking into account 
the dividend rate, redemption provisions, the marketability of the 
convertible stock, and the conversion price, it is reasonable to 
anticipate that within a relatively short period of time some 
shareholders will exercise their conversion rights and some will not. 
Since the distribution can reasonably be expected to result in the 
receipt of preferred stock by some common shareholders and the receipt 
of common stock by other common shareholders, the distribution is a 
distribution of property to which section 301 applies.

[T.D. 7281, 38 FR 18536, July 12, 1973]



Sec. 1.305-5  Distributions on preferred stock.

    (a) In general. Under section 305(b)(4), a distribution by a 
corporation of its stock (or rights to acquire its stock) made (or 
deemed made under section 305(c)) with respect to its preferred stock is 
treated as a distribution of property to which section 301 applies 
unless the distribution is made with respect to convertible preferred 
stock to take into account a stock dividend, stock split, or any similar 
event (such as the sale of stock at less than the fair market value 
pursuant to a rights offering) which would otherwise result in the 
dilution of the conversion right. For purposes of the preceding 
sentence, an adjustment in the conversion ratio of convertible preferred 
stock made solely to take into account the distribution by a closed end 
regulated investment company of a capital gain dividend with respect to 
the stock into which such stock is convertible shall not be considered a 
``similar event.'' The term preferred stock generally refers to stock 
which, in relation to other classes of stock outstanding, enjoys certain 
limited rights and privileges (generally associated with specified 
dividend and liquidation priorities)

[[Page 37]]

but does not participate in corporate growth to any significant extent. 
The distinguishing feature of preferred stock for the purposes of 
section 305(b)(4) is not its privileged position as such, but that such 
privileged position is limited, and that such stock does not participate 
in corporate growth to any significant extent. However, a right to 
participate which lacks substance will not prevent a class of stock from 
being treated as preferred stock. Thus, stock which enjoys a priority as 
to dividends and on liquidation but which is entitled to participate, 
over and above such priority, with another less privileged class of 
stock in earnings and profits and upon liquidation, may nevertheless be 
treated as preferred stock for purposes of section 305 if, taking into 
account all the facts and circumstances, it is reasonable to anticipate 
at the time a distribution is made (or is deemed to have been made) with 
respect to such stock that there is little or no likelihood of such 
stock actually participating in current and anticipated earnings and 
upon liquidation beyond its preferred interest. Among the facts and 
circumstances to be considered are the prior and anticipated earnings 
per share, the cash dividends per share, the book value per share, the 
extent of preference and of participation of each class, both absolutely 
and relative to each other, and any other facts which indicate whether 
or not the stock has a real and meaningful probability of actually 
participating in the earnings and growth of the corporation. The 
determination of whether stock is preferred for purposes of section 305 
shall be made without regard to any right to convert such stock into 
another class of stock of the corporation. The term preferred stock, 
however, does not include convertible debentures.
    (b) Redemption premium--(1) In general. If a corporation issues 
preferred stock that may be redeemed under the circumstances described 
in this paragraph (b) at a price higher than the issue price, the 
difference (the redemption premium) is treated under section 305(c) as a 
constructive distribution (or series of constructive distributions) of 
additional stock on preferred stock that is taken into account under 
principles similar to the principles of section 1272(a). However, 
constructive distribution treatment does not result under this paragraph 
(b) if the redemption premium does not exceed a de minimis amount, as 
determined under the principles of section 1273(a)(3). For purposes of 
this paragraph (b), preferred stock that may be acquired by a person 
other than the issuer (the third person) is deemed to be redeemable 
under the circumstances described in this paragraph (b), and references 
to the issuer include the third person, if--
    (i) This paragraph (b) would apply to the stock if the third person 
were the issuer; and
    (ii) Either--
    (A) The acquisition of the stock by the third person would be 
treated as a redemption for federal income tax purposes (under section 
304 or otherwise); or
    (B) The third person and the issuer are members of the same 
affiliated group (having the meaning for this purpose given the term by 
section 1504(a), except that section 1504(b) shall not apply) and a 
principal purpose of the arrangement for the third person to acquire the 
stock is to avoid the application of section 305 and paragraph (b)(1) of 
this section.
    (2) Mandatory redemption or holder put. Paragraph (b)(1) of this 
section applies to stock if the issuer is required to redeem the stock 
at a specified time or the holder has the option (whether or not 
currently exercisable) to require the issuer to redeem the stock. 
However, paragraph (b)(1) of this section will not apply if the issuer's 
obligation to redeem or the holder's ability to require the issuer to 
redeem is subject to a contingency that is beyond the legal or practical 
control of either the holder or the holders as a group (or through a 
related party within the meaning of section 267(b) or 707(b)), and that, 
based on all of the facts and circumstances as of the issue date, 
renders remote the likelihood of redemption. For purposes of this 
paragraph, a contingency does not include the possibility of default, 
insolvency, or similar circumstances, or that a redemption may be 
precluded by applicable law which requires that the issuer have a 
particular level of capital, surplus, or similar items. A

[[Page 38]]

contingency also does not include an issuer's option to require earlier 
redemption of the stock. For rules applicable if stock may be redeemed 
at more than one time, see paragraph (b)(4) of this section.
    (3) Issuer call--(i) In general. Paragraph (b)(1) of this section 
applies to stock by reason of the issuer's right to redeem the stock 
(even if the right is immediately exercisable), but only if, based on 
all of the facts and circumstances as of the issue date, redemption 
pursuant to that right is more likely than not to occur. However, even 
if redemption is more likely than not to occur, paragraph (b)(1) of this 
section does not apply if the redemption premium is solely in the nature 
of a penalty for premature redemption. A redemption premium is not a 
penalty for premature redemption unless it is a premium paid as a result 
of changes in economic or market conditions over which neither the 
issuer nor the holder has legal or practical control.
    (ii) Safe harbor. For purposes of this paragraph (b)(3), redemption 
pursuant to an issuer's right to redeem is not treated as more likely 
than not to occur if--
    (A) The issuer and the holder are not related within the meaning of 
section 267(b) or 707(b) (for purposes of applying sections 267(b) and 
707(b) (including section 267(f)(1)), the phrase ``20 percent'' shall be 
substituted for the phrase ``50 percent'');
    (B) There are no plans, arrangements, or agreements that effectively 
require or are intended to compel the issuer to redeem the stock 
(disregarding, for this purpose, a separate mandatory redemption 
obligation described in paragraph (b)(2) of this section); and
    (C) Exercise of the right to redeem would not reduce the yield of 
the stock, as determined under principles similar to the principles of 
section 1272(a) and the regulations under sections 1271 through 1275.
    (iii) Effect of not satisfying safe harbor. The fact that a 
redemption right is not described in paragraph (b)(3)(ii) of this 
section does not affect the determination of whether a redemption 
pursuant to the right to redeem is more likely than not to occur.
    (4) Coordination of multiple redemption provisions. If stock may be 
redeemed at more than one time, the time and price at which redemption 
is most likely to occur must be determined based on all of the facts and 
circumstances as of the issue date. Any constructive distribution under 
paragraph (b)(1) of this section will result only with respect to the 
time and price identified in the preceding sentence. However, if 
redemption does not occur at that identified time, the amount of any 
additional premium payable on any later redemption date, to the extent 
not previously treated as distributed, is treated as a constructive 
distribution over the period from the missed call or put date to that 
later date, to the extent required under the principles of this 
paragraph (b).
    (5) Consistency. The issuer's determination as to whether there is a 
constructive distribution under this paragraph (b) is binding on all 
holders of the stock, other than a holder that explicitly discloses that 
its determination as to whether there is a constructive distribution 
under this paragraph (b) differs from that of the issuer. Unless 
otherwise prescribed by the Commissioner, the disclosure must be made on 
a statement attached to the holder's timely filed federal income tax 
return for the taxable year that includes the date the holder acquired 
the stock. The issuer must provide the relevant information to the 
holder in a reasonable manner. For example, the issuer may provide the 
name or title and either the address or telephone number of a 
representative of the issuer who will make available to holders upon 
request the information required for holders to comply with this 
provision of this paragraph (b).
    (c) Cross reference. For rules for applying sections 305(b)(4) and 
305(c) to recapitalizations, see Sec. 1.305-7(c).
    (d) Examples. The application of sections 305(b)(4) and 305(c) may 
be illustrated by the following examples:

    Example 1. (i) Corporation T has outstanding 1,000 shares of $100 
par 5-percent cumulative preferred stock and 10,000 shares of no-par 
common stock. The corporation is 4 years in arrears on dividends to the 
preferred

[[Page 39]]

shareholders. The issue price of the preferred stock is $100 per share. 
Pursuant to a recapitalization under section 368(a)(1)(E), the preferred 
shareholders exchange their preferred stock, including the right to 
dividend arrearages, on the basis of one old preferred share for 1.20 
newly authorized class A preferred shares. Immediately following the 
recapitalization, the new class A shares are traded at $100 per share. 
The class A shares are entitled to a liquidation preference of $100. The 
preferred shareholders have increased their proportionate interest in 
the assets or earnings and profits of corporation T since the fair 
market value of 1.20 shares of class A preferred stock ($120) exceeds 
the issue price of the old preferred stock ($100). Accordingly, the 
preferred shareholders are deemed under section 305(c) to receive a 
distribution in the amount of $20 on each share of old preferred stock 
and the distribution is one to which sections 305(b)(4) and 301 apply.
    (ii) The same result would occur if the fair market value of the 
common stock immediately following the recapitalization were $20 per 
share and each share of preferred stock were exchanged for one share of 
the new class A preferred stock and one share of common stock.
    Example 2. Corporation A, a publicly held company whose stock is 
traded on a securities exchange (or in the over-the-counter market) has 
two classes of stock outstanding, common and cumulative preferred. Each 
share of preferred stock is convertible into .75 shares of common stock. 
There are no dividend arrearages. At the time of issue of the preferred 
stock, there was no plan or prearrangement by which it was to be 
exchanged for common stock. The issue price of the preferred stock is 
$100 per share. In order to retire the preferred stock, corporation A 
recapitalizes in a transaction to which section 368(a)(1)(E) applies and 
each share of preferred stock is exchanged for one share of common 
stock. Immediately after the recapitalization the common stock has a 
fair market value of $110 per share. Notwithstanding the fact that the 
fair market value of the common stock received in the exchange 
(determined immediately following the recapitalization) exceeds the 
issue price of the preferred stock surrendered, the recapitalization is 
not deemed under section 305(c) to result in a distribution to which 
sections 305(b)(4) and 301 apply since the recapitalization is not 
pursuant to a plan to periodically increase a shareholder's 
proportionate interest in the assets or earnings and profits and does 
not involve dividend arrearages.
    Example 3. Corporation V is organized with two classes of stock, 
1,000 shares of class A common and 1,000 shares of class B convertible 
preferred. Each share of class B stock may be converted into two shares 
of class A stock. Pursuant to a recapitalization under section 
368(a)(1)(E), the 1,000 shares of class A stock are surrendered in 
exchange for 500 shares of new class A common and 500 shares of newly 
authorized class C common. The conversion right of class B stock is 
changed to one share of class A stock and one share of class C stock for 
each share of class B stock. The change in the conversion right is not 
deemed under section 305(c) to be a distribution on preferred stock to 
which sections 305(b)(4) and 301 apply.
    Example 4. (i) Facts. Corporation X is a domestic corporation with 
only common stock outstanding. In connection with its acquisition of 
Corporation T, X issues 100 shares of its 4% preferred stock to the 
shareholders of T, who are unrelated to X both before and after the 
transaction. The issue price of the preferred stock is $40 per share. 
Each share of preferred stock is convertible at the shareholder's 
election into three shares of X common stock. At the time the preferred 
stock is issued, the X common stock has a value of $10 per share. The 
preferred stock does not provide for its mandatory redemption or for 
redemption at the option of the holder. It is callable at the option of 
X at any time beginning three years from the date of issuance for $100 
per share. There are no other plans, arrangements, or agreements that 
effectively require or are intended to compel X to redeem the stock.
    (ii) Analysis. The preferred stock is described in the safe harbor 
rule of paragraph (b)(3)(ii) of this section because X and the former 
shareholders of T are unrelated, there are no plans, arrangements, or 
agreements that effectively require or are intended to compel X to 
redeem the stock, and calling the stock for $100 per share would not 
reduce the yield of the preferred stock. Therefore, the $60 per share 
call premium is not treated as a constructive distribution to the 
shareholders of the preferred stock under paragraph (b) of this section.
    Example 5. (i) Facts--(A) Corporation Y is a domestic corporation 
with only common stock outstanding. On January 1, 1996, Y issues 100 
shares of its 10% preferred stock to a holder. The holder is unrelated 
to Y both before and after the stock issuance. The issue price of the 
preferred stock is $100 per share. The preferred stock is--
    (1) Callable at the option of Y on or before January 1, 2001, at a 
price of $105 per share plus any accrued but unpaid dividends; and
    (2) Mandatorily redeemable on January 1, 2006, at a price of $100 
per share plus any accrued but unpaid dividends.
    (B) The preferred stock provides that if Y fails to exercise its 
option to call the preferred stock on or before January 1, 2001, the 
holder will be entitled to appoint a majority of Y's directors. Based on 
all of the facts and circumstances as of the issue date, Y is likely to 
have the legal and financial capacity to exercise its right to redeem. 
There are no

[[Page 40]]

other facts and circumstances as of the issue date that would affect 
whether Y will call the preferred stock on or before January 1, 2001.
    (ii) Analysis. Under paragraph (b)(3)(i) of this section, paragraph 
(b)(1) of this section applies because, by virtue of the change of 
control provision and the absence of any contrary facts, it is more 
likely than not that Y will exercise its option to call the preferred 
stock on or before January 1, 2001. The safe harbor rule of paragraph 
(b)(3)(ii) of this section does not apply because the provision that 
failure to call will cause the holder to gain control of the corporation 
is a plan, arrangement, or agreement that effectively requires or is 
intended to compel Y to redeem the preferred stock. Under paragraph 
(b)(4) of this section, the constructive distribution occurs over the 
period ending on January 1, 2001. Redemption is most likely to occur on 
that date, because that is the date on which the corporation minimizes 
the rate of return to the holder while preventing the holder from 
gaining control. The de minimis exception of paragraph (b)(1) of this 
section does not apply because the $5 per share difference between the 
redemption price and the issue price exceeds the amount determined under 
the principles of section 1273(a)(3) (5 x .0025 x $105 = $1.31). 
Accordingly, $5 per share, the difference between the redemption price 
and the issue price, is treated as a constructive distribution received 
by the holder on an economic accrual basis over the five-year period 
ending on January 1, 2001, under principles similar to the principles of 
section 1272(a).
    Example 6. Corporation A, a publicly held company whose stock is 
traded on a securities exchange (or in the over-the-counter market) has 
two classes of stock outstanding, common and preferred. The preferred 
stock is nonvoting and nonconvertible, limited and preferred as to 
dividends, and has a fixed liquidation preference. There are no dividend 
arrearages. At the time of issue of the preferred stock, there was no 
plan or prearrangement by which it was to be exchanged for common stock. 
In order to retire the preferred stock, corporation A recapitalizes in a 
transaction to which section 368(a)(1)(E) applies and the preferred 
stock is exchanged for common stock. The transaction is not deemed to be 
a distribution under section 305(c) and sections 305(b) and 301 do not 
apply to the transaction. The same result would follow if the preferred 
stock was exchanged in any reorganization described in section 368(a)(1) 
for a new preferred stock having substantially the same market value and 
having no greater call price or liquidation preference than the old 
preferred stock, whether the new preferred stock has voting rights or is 
convertible into common stock of corporation A at a fixed ratio subject 
to change solely to take account of stock dividends, stock splits, or 
similar transactions with respect to the stock into which the preferred 
stock is convertible.
    Example 7. (i) Facts--(A) Corporation Z is a domestic corporation 
with only common stock outstanding. On January 1, 1996, Z issues 100 
shares of its 10% preferred stock to C, an individual unrelated to Z 
both before and after the stock issuance. The issue price of the 
preferred stock is $100 per share. The preferred stock is--
    (1) Not callable for a period of 5 years from the issue date;
    (2) Callable at the option of Z on January 1, 2001, at a price of 
$110 per share plus any accrued but unpaid dividends;
    (3) Callable at the option of Z on July 1, 2002, at a price of $120 
per share plus any accrued but unpaid dividends; and
    (4) Mandatorily redeemable on January 1, 2004, at a price of $150 
per share plus any accrued but unpaid dividends.
    (B) There are no other plans, arrangements, or agreements between Z 
and C concerning redemption of the stock. Moreover, there are no other 
facts and circumstances as of the issue date that would affect whether Z 
will call the preferred stock on either January 1, 2001, or July 1, 
2002.
    (ii) Analysis. This stock is described in paragraph (b)(2) of this 
section because it is mandatorily redeemable. It is also potentially 
described in paragraph (b)(3)(i) of this section because it is callable 
at the option of the issuer. The safe harbor rule of paragraph 
(b)(3)(ii) of this section does not apply to the option to call on 
January 1, 2001, because the call would reduce the yield of the stock 
when compared to the yield produced by the January 1, 2004, mandatory 
redemption feature. Moreover, absent any other facts indicating a 
contrary result, the fact that redemption on January 1, 2001, would 
produce the lowest yield indicates that redemption is most likely to 
occur on that date. Under paragraph (b)(4) of this section, paragraph 
(b)(1) of this section applies with respect to the issuer's right to 
call on January 1, 2001, because redemption is most likely to occur on 
January 1, 2001, for $110 per share. The de minimis exception of 
paragraph (b)(1) of this section does not apply because the $10 per 
share difference between the redemption price payable in 2001 and the 
issue price exceeds the amount determined under the principles of 
section 1273(a)(3) (5 x .0025 x $110 = $1.38). Accordingly, $10 per 
share, the difference between the redemption price and the issue price, 
is treated as a constructive distribution received by the holder on an 
economic accrual basis over the five-year period ending January 1, 2001, 
under principles similar to the principles of section 1272(a).
    (iii) Coordination rules--(A) If Z does not exercise its option to 
call the preferred stock on January 1, 2001, paragraph (b)(4) of this

[[Page 41]]

section provides that the principles of paragraph (b) of this section 
must be applied to determine if any remaining constructive distribution 
occurs. Under paragraphs (b)(3)(i) and (b)(4) of this section, paragraph 
(b)(1) of this section applies because, absent any other facts 
indicating a contrary result, the fact that redemption on July 1, 2002, 
would produce a lower yield than the yield produced by the mandatory 
redemption feature indicates that redemption on that date is most likely 
to occur. The safe harbor rule of paragraph (b)(3)(ii) of this section 
does not apply to the option to call on July 1, 2002, because, as of 
January 1, 2001, a call by Z on July 1, 2002, for $120 would reduce the 
yield of the stock. The de minimis exception of paragraph (b)(1) of this 
section does not apply because the $10 per share difference between the 
redemption price and the issue price (revised as of the missed call date 
as provided by paragraph (b)(4) of this section) exceeds the amount 
determined under the principles of section 1273(a)(3) (1 x .0025 x $120 
= $.30). Accordingly, the $10 per share of additional redemption premium 
that is payable on July 1, 2002, is treated as a constructive 
distribution received by the holder on an economic accrual basis over 
the period between January 1, 2001, and July 1, 2002, under principles 
similar to the principles of section 1272(a).
    (B) If Z does not exercise its second option to call the preferred 
stock on July 1, 2002, then the $30 additional redemption premium that 
is payable on January 1, 2004, is treated as a constructive distribution 
under paragraphs (b)(2) and (b)(1) of this section. The de minimis 
exception of paragraph (b)(1) of this section does not apply because the 
$30 per share difference between the redemption price and the issue 
price (revised as of the second missed call date) exceeds the amount 
determined under the principles of section 1273(a)(3) (1 x .0025 x $150 
= $.38). The holder is treated as receiving the constructive 
distribution on an economic accrual basis over the period between July 
1, 2002, and January 1, 2004, under principles similar to the principles 
of section 1272(a).
    Example 8. (i) Facts. The facts are the same as in paragraph (i) of 
Example 7, except that, based on all of the facts and circumstances as 
of the issue date (including an expected lack of funds on the part of 
Z), it is unlikely that Z will exercise the right to redeem on either 
January 1, 2001, or July 1, 2002.
    (ii) Analysis. The safe harbor rule of paragraph (b)(3)(ii) of this 
section does not apply to the option to call on either January 1, 2001, 
or July 1, 2002, because each call would reduce the yield of the stock. 
Under paragraph (b)(3)(i) of this section, neither option to call is 
more likely than not to occur, because, based on all of the facts and 
circumstances as of the issue date (including an expected lack of funds 
on the part of Z), it is not more likely than not that Z will exercise 
either option. However, the $50 per share redemption premium that is 
payable on January 1, 2004, is treated as a constructive distribution 
under paragraphs (b)(1) and (2) of this section, regardless of whether Z 
is anticipated to have sufficient funds to redeem on that date, because 
Z is required to redeem the stock on that date. The de minimis exception 
of paragraph (b)(1) of this section does not apply because the $50 per 
share difference between the redemption price and the issue price 
exceeds the amount determined under the principles of section 
1273(a)(3)(8 x .0025 x $150 = $3).
    Example 9. Corporation Q is organized with 10,000 shares of class A 
stock and 1,000 shares of class B stock. The terms of the class B stock 
require that the class B have a preference of $5 per share with respect 
to dividends and $100 per share with respect to liquidation. In 
addition, upon a distribution of $10 per share to the class A stock, 
class B participates equally in any additional dividends. The terms also 
provide that upon liquidation the class B stock participates equally 
after the class A stock receives $100 per share. Corporation Q has no 
accumulated earnings and profits. In 1971 it earned $10,000, the highest 
earnings in its history. The corporation is in an industry in which it 
is reasonable to anticipate a growth in earnings of 5 percent per year. 
In 1971 the book value of corporation Q's assets totalled $100,000. In 
that year the corporation paid a dividend of $5 per share to the class B 
stock and $.50 per share to the class A. In 1972 the corporation had no 
earnings and in lieu of a $5 dividend distributed one share of class B 
stock for each outstanding share of class B. No distribution was made to 
the class A stock. Since, in 1972, it was not reasonable to anticipate 
that the class B stock would participate in the current and anticipated 
earnings and growth of the corporation beyond its preferred interest, 
the class B stock is preferred stock and the distribution of class B 
shares to the class B shareholders is a distribution to which sections 
305(b)(4) and 301 apply.
    Example 10. Corporation P is organized with 10,000 shares of class A 
stock and 1,000 shares of class B stock. The terms of the class B stock 
require that the class B have a preference of $5 per share with respect 
to dividends and $100 per share with respect to liquidation. In 
addition, upon a distribution of $5 per share to the class A stock, 
class B participates equally in any additional dividends. The terms also 
provide that upon liquidation the class B stock participates equally 
after the class A receives $100 per share. Corporation P has accumulated 
earnings and profits of $100,000. In 1971 it earned $75,000. The 
corporation is in an industry in which it is reasonable to anticipate a 
growth in earnings of 10 percent per year. In 1971 the book value of 
corporation P's assets totalled

[[Page 42]]

$5 million. In that year the corporation paid a dividend of $5 per share 
to the class B stock, $5 per share to the class A stock, and it 
distributed an additional $1 per share to both class A and class B 
stock. In 1972 the corporation had earnings of $82,500. In that year it 
paid a dividend of $5 per share to the class B stock and $5 per share to 
the class A stock. In addition, the corporation declared stock dividends 
of one share of class B stock for every 10 outstanding shares of class B 
and one share of class A stock for every 10 outstanding shares of class 
A. Since, in 1972, it was reasonable to anticipate that both the class B 
stock and the class A stock would participate in the current and 
anticipated earnings and growth of the corporation beyond their 
preferred interests, neither class is preferred stock and the stock 
dividends are not distributions to which section 305(b)(4) applies.

    (e) Effective date. The rules of paragraph (b) of this section and 
Examples 4, 5, 7, and 8 of paragraph (d) of this section apply to stock 
issued on or after December 20, 1995. For rules applicable to previously 
issued stock, see Sec. 1.305-5 (b) and (d) Examples (4), (5), and (7) 
(as contained in the 26 CFR part 1 edition revised April 1, 1995). 
Although the rules of paragraph (b) of this section and the revised 
examples do not apply to stock issued before December 20, 1995, the 
rules of sections 305(c)(1), (2), and (3) apply to stock described 
therein issued on or after October 10, 1990, except as provided in 
section 11322(b)(2) of the Revenue Reconciliation Act of 1990 (Public 
Law 101-508 Stat.). Moreover, except as provided in section 11322(b)(2) 
of the Revenue Reconciliation Act of 1990 (Public Law 101-508 Stat.), 
with respect to stock issued on or after October 10, 1990, and issued 
before December 20, 1995, the economic accrual rule of section 305(c)(3) 
will apply to the entire call premium on stock that is not described in 
paragraph (b)(2) of this section if the premium is considered to be 
unreasonable under the principles of Sec. 1.305-5(b) (as contained in 
the 26 CFR part 1 edition revised April 1, 1995). A call premium 
described in the preceding sentence will be accrued over the period of 
time during which the preferred stock cannot be called for redemption.

[T.D. 7281, 38 FR 18536, July 12, 1973, as amended by T.D. 7329, 39 FR 
36860, Oct. 15, 1974; T.D. 8643, 60 FR 66136, Dec. 21, 1995]



Sec. 1.305-6  Distributions of convertible preferred.

    (a) In general. (1) Under section 305(b)(5), a distribution by a 
corporation of its convertible preferred stock or rights to acquire such 
stock made or considered as made with respect to its stock is treated as 
a distribution of property to which section 301 applies unless the 
corporation establishes that such distribution will not result in a 
disproportionate distribution as described in Sec. 1.305-3.
    (2) The distribution of convertible preferred stock is likely to 
result in a disproportionate distribution when both of the following 
conditions exist: (i) The conversion right must be exercised within a 
relatively short period of time after the date of distribution of the 
stock; and (ii) taking into account such factors as the dividend rate, 
the redemption provisions, the marketability of the convertible stock, 
and the conversion price, it may be anticipated that some shareholders 
will exercise their conversion rights and some will not. On the other 
hand, where the conversion right may be exercised over a period of many 
years and the dividend rate is consistent with market conditions at the 
time of distribution of the stock, there is no basis for predicting at 
what time and the extent to which the stock will be converted and it is 
unlikely that a disproportionate distribution will result.
    (b) Examples. The application of section 305(b)(5) may be 
illustrated by the following examples:

    Example 1. Corporation Z is organized with one class of stock, class 
A common. During the year the corporation declares a dividend on the 
class A stock payable in newly authorized class B preferred stock which 
is convertible into class A stock for a period of 20 years from the date 
of issuance. Assuming dividend rates are normal in light of existing 
conditions so that there is no basis for predicting the extent to which 
the stock will be converted, the circumstances will ordinarily be 
sufficient to establish that a disproportionate distribution will not 
result since it is impossible to predict the extent to which the class B 
stock will be converted into class A stock. Accordingly, the 
distribution of class B stock is not one to which section 301 applies.
    Example 2. Corporation X is organized with one class of stock, class 
A common. During the year the corporation declares a dividend

[[Page 43]]

on the class A stock payable in newly authorized redeemable class C 
preferred stock which is convertible into class A common stock no later 
than 4 months from the date of distribution at a price slightly higher 
than the market price of class A stock on the date of distribution. By 
prearrangement with corporation X, corporation Y, an insurance company, 
agrees to purchase class C stock from any shareholder who does not wish 
to convert. By reason of this prearrangement, it is anticipated that the 
shareholders will either sell the class C stock to the insurance company 
(which expects to retain the shares for investment purposes) or will 
convert. As a result, some of the shareholders exercise their conversion 
privilege and receive additional shares of class A stock, while other 
shareholders sell their class C stock to corporation Y and receive cash. 
The distribution is a distribution to which section 301 applies since it 
results in the receipt of property by some shareholders and an increase 
in the proportionate interests of other shareholders.

[T.D. 7281, 38 FR 18538, July 12, 1973]



Sec. 1.305-7  Certain transactions treated as distributions.

    (a) In general. Under section 305(c), a change in conversion ratio, 
a change in redemption price, a difference between redemption price and 
issue price, a redemption which is treated as a distribution to which 
section 301 applies, or any transaction (including a recapitalization) 
having a similar effect on the interest of any shareholder may be 
treated as a distribution with respect to any shareholder whose 
proportionate interest in the earnings and profits or assets of the 
corporation is increased by such change, difference, redemption, or 
similar transaction. In general, such change, difference, redemption, or 
similar transaction will be treated as a distribution to which sections 
305(b) and 301 apply where--
    (1) The proportionate interest of any shareholder in the earnings 
and profits or assets of the corporation deemed to have made such 
distribution is increased by such change, difference, redemption, or 
similar transaction; and
    (2) Such distribution has the result described in paragraph (2), 
(3), (4), or (5) of section 305(b).

Where such change, difference, redemption, or similar transaction is 
treated as a distribution under the provisions of this section, such 
distribution will be deemed made with respect to any shareholder whose 
interest in the earnings and profits or assets of the distributing 
corporation is increased thereby. Such distribution will be deemed to be 
a distribution of the stock of such corporation made by the corporation 
to such shareholder with respect to his stock. Depending upon the facts 
presented, the distribution may be deemed to be made in common or 
preferred stock. For example, where a redemption premium exists with 
respect to a class of preferred stock under the circumstances described 
in Sec. 1.305-5(b) and the other requirements of this section are also 
met, the distribution will be deemed made with respect to such preferred 
stock, in stock of the same class. Accordingly, the preferred 
shareholders are considered under sections 305(b)(4) and 305(c) to have 
received a distribution of preferred stock to which section 301 applies. 
See the examples in Sec. Sec. 1.305-3(e) and 1.305-5(d) for further 
illustrations of the application of section 305(c).
    (b) Antidilution provisions. (1) For purposes of applying section 
305(c) in conjunction with section 305(b), a change in the conversion 
ratio or conversion price of convertible preferred stock (or 
securities), or in the exercise price of rights or warrants, made 
pursuant to a bona fide, reasonable, adjustment formula (including, but 
not limited to, either the so-called ``market price'' or ``conversion 
price'' type of formulas) which has the effect of preventing dilution of 
the interest of the holders of such stock (or securities) will not be 
considered to result in a deemed distribution of stock. An adjustment in 
the conversion ratio or price to compensate for cash or property 
distributions to other shareholders that are taxable under section 301, 
356(a)(2), 871(a)(1)(A), 881(a)(1), 852(b), or 857(b) will not be 
considered as made pursuant to a bona fide adjustment formula.
    (2) The principles of this paragraph may be illustrated by the 
following example:

    Example. (i) Corporation U has two classes of stock outstanding, 
class A and class B. Each class B share is convertible into class A 
stock. In accordance with a bonafide, reasonable, antidilution 
provision, the conversion price is adjusted if the corporation transfers

[[Page 44]]

class A stock to anyone for a consideration that is below the conversion 
price.
    (ii) The corporation sells class A stock to the public at the 
current market price but below the conversion price. Pursuant to the 
antidilution provision, the conversion price is adjusted downward. Such 
a change in conversion price will not be deemed to be a distribution 
under section 305(c) for the purposes of section 305(b).

    (c) Recapitalizations. (1) A recapitalization (whether or not an 
isolated transaction) will be deemed to result in a distribution to 
which section 305(c) and this section apply if--
    (i) It is pursuant to a plan to periodically increase a 
shareholder's proportionate interest in the assets or earnings and 
profits of the corporation, or
    (ii) A shareholder owning preferred stock with dividends in arrears 
exchanges his stock for other stock and, as a result, increases his 
proportionate interest in the assets or earnings and profits of the 
corporation. An increase in a preferred shareholder's proportionate 
interest occurs in any case where the fair market value or the 
liquidation preference, whichever is greater, of the stock received in 
the exchange (determined immediately following the recapitalization), 
exceeds the issue price of the preferred stock surrendered.
    (2) In a case to which subparagraph (1)(ii) of this paragraph 
applies, the amount of the distribution deemed under section 305(c) to 
result from the recapitalization is the lesser of (i) the amount by 
which the fair market value or the liquidation preference, whichever is 
greater, of the stock received in the exchange (determined immediately 
following the recapitalization) exceeds the issue price of the preferred 
stock surrendered, or (ii) the amount of the dividends in arrears.
    (3) For purposes of applying subparagraphs (1) and (2) of this 
paragraph with respect to stock issued before July 12, 1973, the term 
issue price of the preferred stock surrendered shall mean the greater of 
the issue price or the liquidation preference (not including dividends 
in arrears) of the stock surrendered.
    (4) For an illustration of the application of this paragraph, see 
Example (12) of Sec. 1.305-3(e) and Examples (1), (2), (3), and (6) of 
Sec. 1.305-5(d).
    (5) For rules relating to redemption premiums on preferred stock, 
see Sec. 1.305-5(b).

[T.D. 7281, 38 FR 18538, July 12, 1973, as amended by T.D. 8643, 60 FR 
66138, Dec. 21, 1995]



Sec. 1.305-8  Effective dates.

    (a) In general. Section 421(b) of the Tax Reform Act of 1969 (83 
Stat. 615) provides as follows:

    (b) Effective dates. (1) Except as otherwise provided in this 
subsection, the amendment made by subsection (a) shall apply with 
respect to distributions (or deemed distributions) made after January 
10, 1969, in taxable years ending after such date.
    (2)(A) Section 305(b)(2) of the Internal Revenue Code of 1954 (as 
added by subsection (a) shall not apply to a distribution (or deemed 
distribution) of stock made before January 1, 1991, with respect to 
stock (i) outstanding on January 10, 1969, (ii) issued pursuant to a 
contract binding on January 10, 1969, on the distributing corporation, 
(iii) which is additional stock of that class of stock which (as of 
January 10, 1969) had the largest fair market value of all classes of 
stock of the corporation (taking into account only stock outstanding on 
January 10, 1969, or issued pursuant to a contract binding on January 
10, 1969), (iv) described in subparagraph (c)(iii), or (v) issued in a 
prior distribution described in clause (i), (ii), (iii), or (iv).
    (B) Subparagraph (A) shall apply only if--
    (i) The stock as to which there is a receipt of property was 
outstanding on January 10, 1969 (or was issued pursuant to a contract 
binding on January 10, 1969, on the distributing corporation), and
    (ii) If such stock and any stock described in subparagraph (A)(i) 
were also outstanding on January 10, 1968, a distribution of property 
was made on or before January 10, 1969, with respect to such stock, and 
a distribution of stock was made on or before January 10, 1969, with 
respect to such stock described in subparagraph (A)(i).
    (C) Subparagraph (A) shall cease to apply when at any time after 
October 9, 1969, the distributing corporation issues any of its stock 
(other than in a distribution of stock with respect to stock of the same 
class) which is not--
    (i) Nonconvertible preferred stock,
    (ii) Additional stock of that class of stock which meets the 
requirements of subparagraph (A)(iii), or
    (iii) Preferred stock which is convertible into stock which meets 
the requirements of subparagraph (A)(iii) at a fixed conversion ratio 
which takes account of all stock dividends and stock splits with respect 
to the

[[Page 45]]

stock into which such convertible stock is convertible.
    (D) For purposes of this paragraph, the term stock includes rights 
to acquire such stock.
    (3) In cases to which Treasury Decision 6990 (promulgated January 
10, 1969) would not have applied, in applying paragraphs (1) and (2) 
April 22, 1969, shall be substituted for January 10, 1969.
    (4) Section 305(b)(4) of the Internal Revenue Code of 1954 (as added 
by subsection (a)) shall not apply to any distribution (or deemed 
distribution) with respect to preferred stock (including any increase in 
the conversation ratio of convertible stock) made before January 1, 
1991, pursuant to the terms relating to the issuance of such stock which 
were in effect on January 10, 1969.
    (5) With respect to distributions made or considered as made after 
January 10, 1969, in taxable years ending after such date, to the extent 
that the amendment made by subsection (a) does not apply by reason of 
paragraph (2), (3), or (4) of this subsection, section 305 of the 
Internal Revenue Code of 1954 (as in effect before the amendment made by 
subsection (a)) shall continue to apply.

    (b) Rules of application. (1) The rules contained in section 
421(b)(2) of the Tax Reform Act of 1969 (83 Stat. 615), hereinafter 
called ``the Act'', shall apply with respect to the application of 
section 305(b)(2), section 305(b)(3), and section 305(b)(5). Thus, for 
example, section 305(b)(5) of the Code will not apply to a distribution 
of convertible preferred stock made before January 1, 1991, with respect 
to stock outstanding on January 10, 1969 (or which was issued pursuant 
to a contract binding on the distributing corporation on January 10, 
1969), provided the distribution is pursuant to the terms relating to 
the issuance of such stock which were in effect on January 10, 1969.
    (2)(i) For purposes of section 421(b)(2)(A), (B)(i), and (C) of the 
Act, stock is considered as outstanding on January 10, 1969, if it could 
be acquired on such date or some future date by the exercise of a right 
or conversion privilege in existence on such date (including a right or 
conversion privilege with respect to stock issued pursuant to a contract 
binding, on January 10, 1969, on the distributing corporation). Thus, if 
on January 10, 1969, corporation X has outstanding 1,000 shares of class 
A common stock and 3,000 shares of class B common stock which are 
convertible on a one-to-one basis into class A stock, corporation X is 
considered for purposes of section 421(b)(2)(A), (B)(i), and (C) of the 
Act to have outstanding on January 10, 1969, 4,000 shares of class A 
stock (1,000 shares actually outstanding and 3,000 shares that could be 
acquired by the exercise of the conversion privilege contained in the 
class B stock) and 3,000 shares of class B stock.
    (ii) For the purposes of section 421(b)(2)(A) (other than for the 
purpose of determining under section 421(b)(2)(A)(iii) that class of 
stock which as of January 10, 1969, had the largest fair market value of 
all classes of stock of the corporation), (B)(i), and (C) of the Act, 
stock will be considered as outstanding on January 10, 1969, if it is 
issued pursuant to a conversion privilege contained in stock issued, 
mediately or immediately, as a stock dividend with respect to stock 
outstanding on January 10, 1969.
    (3) If, after applying subparagraph (2) of this paragraph, the class 
of stock which as of January 10, 1969, had the largest fair market value 
of all classes of stock of the corporation is a class of stock which is 
convertible into another class of nonconvertible stock, then for 
purposes of section 421(b)(2)(C)(ii) of the Act stock issued upon 
conversion of any such convertible stock (whether or not outstanding on 
January 10, 1969) into stock of such other class shall be deemed to be 
stock which meets the requirements of section 421(b)(2)(A)(iii) of the 
Act.
    (4) For purposes of section 421(b) of the Act, stock of a 
corporation held in its treasury will not be considered as outstanding 
and a distribution of such stock will be considered to be an issuance of 
such stock on the date of distribution. Stock of a parent corporation 
held by its subsidiary is not considered treasury stock.
    (5) The following stock shall not be taken into account for purposes 
of applying section 421(b)(2)(B)(i) of the Act: (i) Stock issued after 
January 10, 1969, and before October 10, 1969 (other than stock which 
was issued pursuant to a contract binding on January 10, 1969, on the 
distributing corporation); (ii) stock described in section 
421(b)(2)(C)(i), (ii), or (iii) of the Act;

[[Page 46]]

and (iii) stock issued, mediately or immediately, as a stock dividend 
with respect to stock of the same class outstanding on January 10, 1969. 
For example, if on June 1, 1970, corporation Y issues additional stock 
of that class of stock which as of January 10, 1969, had the largest 
fair market value of all classes of stock of the corporation, such 
additional stock will not be taken into account for the purpose of 
meeting the requirement under section 421(b)(2)(B)(i) of the Act that 
the stock as to which there is a receipt of property must have been 
outstanding on January 10, 1969, and thus subparagraph (A) of section 
421(b)(2) of the Act will not, where otherwise applicable, cease to 
apply.
    (6) Section 421(b)(2)(A) of the Act, if otherwise applicable, will 
not cease to apply if the distributing corporation issues after October 
9, 1969, securities which are convertible into stock that meets the 
requirements of section 421(b)(2)(A)(iii) of the Act at a fixed 
conversion ratio which takes account of all stock dividends and stock 
splits with respect to the stock into which the securities are 
convertible.
    (7) Under section 421(b)(4) of the Act, section 305(b)(4) does not 
apply to any distribution (or deemed distribution) by a corporation with 
respect to preferred stock made before January 1, 1991, if such 
distribution is pursuant to the terms relating to the issuance of such 
stock which were in effect on January 10, 1969. For example, if as of 
January 10, 1969, a corporation had followed the practice of paying 
stock dividends on preferred stock (or of periodically increasing the 
conversion ratio of convertible preferred stock) or if the preferred 
stock provided for a redemption price in excess of the issue price, then 
section 305(b)(4) would not apply to any distribution of stock made (or 
which would be considered made if section 305(b)(4) applied) before 
January 1, 1991, pursuant to such practice.
    (8) If section 421(b)(2) is not applicable and, for that reason, a 
distribution (or deemed distribution) is treated as a distribution to 
which section 301 applies by virtue of the application of section 
305(b)(2), (b)(3), or (b)(5), it is irrelevant that, by reason of the 
application of section 421(b)(4) of such Act, section 305(b)(4) is not 
applicable to the distribution.

[T.D. 7281, 38 FR 18539, July 12, 1973]



Sec. 1.306-1  General.

    (a) Section 306 provides, in general, that the proceeds from the 
sale or redemption of certain stock (referred to as ``section 306 
stock'') shall be treated either as ordinary income or as a distribution 
of property to which section 301 applies. Section 306 stock is defined 
in section 306(c) and is usually preferred stock received either as a 
nontaxable dividend or in a transaction in which no gain or loss is 
recognized. Section 306(b) lists certain circumstances in which the 
special rules of section 306(a) shall not apply.
    (b)(1) If a shareholder sells or otherwise disposes of section 306 
stock (other than by redemption or within the exceptions listed in 
section 306(b)), the entire proceeds received from such disposition 
shall be treated as ordinary income to the extent that the fair market 
value of the stock sold, on the date distributed to the shareholder, 
would have been a dividend to such shareholder had the distributing 
corporation distributed cash in lieu of stock. Any excess of the amount 
received over the sum of the amount treated as ordinary income plus the 
adjusted basis of the stock disposed of, shall be treated as gain from 
the sale of a capital asset or noncapital asset as the case may be. No 
loss shall be recognized. No reduction of earnings and profits results 
from any disposition of stock other than a redemption. The term 
disposition under section 306(a)(1) includes, among other things, 
pledges of stock under certain circumstances, particularly where the 
pledgee can look only to the stock itself as its security.
    (2) Section 306(a)(1) may be illustrated by the following examples:

    Example 1. On December 15, 1954, A and B owned equally all of the 
stock of Corporation X which files its income tax return on a calendar 
year basis. On that date Corporation X distributed pro rata 100 shares 
of preferred stock as a dividend on its outstanding common stock. On 
December 15, 1954, the preferred stock had a fair market value of 
$10,000. On December 31, 1954, the earnings and profits of Corporation X 
were $20,000.

[[Page 47]]

The 50 shares of preferred stock so distributed to A had an allocated 
basis to him of $10 per share or a total of $500 for the 50 shares. Such 
shares had a fair market value of $5,000 when issued. A sold the 50 
shares of preferred stock on July 1, 1955, for $6,000. Of this amount 
$5,000 will be treated as ordinary income; $500 ($6,000 minus $5,500) 
will be treated as gain from the sale of a capital or noncapital asset 
as the case may be.
    Example 2. The facts are the same as in Example 1 except that A sold 
his 50 shares of preferred stock for $5,100. Of this amount $5,000 will 
be treated as ordinary income. No loss will be allowed. There will be 
added back to the basis of the common stock of Corporation X with 
respect to which the preferred stock was distributed, $400, the 
allocated basis of $500 reduced by the $100 received.
    Example 3. The facts are the same as in Example 1 except that A sold 
25 of his shares of preferred stock for $2,600. Of this amount $2,500 
will be treated as ordinary income. No loss will be allowed. There will 
be added back to the basis of the common stock of Corporation X with 
respect to which the preferred stock was distributed, $150, the 
allocated basis of $250 reduced by the $100 received.

    (c) The entire amount received by a shareholder from the redemption 
of section 306 stock shall be treated as a distribution of property 
under section 301. See also section 303 (relating to distribution in 
redemption of stock to pay death taxes).

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7556, 43 FR 
34128, Aug. 3, 1978]



Sec. 1.306-2  Exception.

    (a) If a shareholder terminates his entire stock interest in a 
corporation--
    (1) By a sale or other disposition within the requirements of 
section 306(b)(1)(A), or
    (2) By redemption under section 302(b)(3) (through the application 
of section 306(b)(1)(B)),

the amount received from such disposition shall be treated as an amount 
received in part or full payment for the stock sold or redeemed. In the 
case of a sale, only the stock interest need be terminated. In 
determining whether an entire stock interest has been terminated under 
section 306(b)(1)(A), all of the provisions of section 318(a) (relating 
to constructive ownership of stock) shall be applicable. In determining 
whether a shareholder has terminated his entire interest in a 
corporation by a redemption of his stock under section 302(b)(3), all of 
the provisions of section 318(a) shall be applicable unless the 
shareholder meets the requirements of section 302(c)(2) (relating to 
termination of all interest in the corporation). If the requirements of 
section 302(c)(2) are met, section 318(a)(1) (relating to members of a 
family) shall be inapplicable. Under all circumstances paragraphs (2), 
(3), (4), and (5) of section 318(a) shall be applicable.
    (b) Section 306(a) does not apply to--
    (1) Redemptions of section 306 stock pursuant to a partial or 
complete liquidation of a corporation to which part II (section 331 and 
following), subchapter C, chapter 1 of the Code applies,
    (2) Exchanges of section 306 stock solely for stock in connection 
with a reorganization or in an exchange under section 351, 355, or 
section 1036 (relating to exchanges of stock for stock in the same 
corporation) to the extent that gain or loss is not recognized to the 
shareholder as the result of the exchange of the stock (see paragraph 
(d) of Sec. 1.306-3 relative to the receipt of other property), and
    (3) A disposition or redemption, if it is established to the 
satisfaction of the Commissioner that the distribution, and the 
disposition or redemption, was not in pursuance of a plan having as one 
of its principal purposes the avoidance of Federal income tax. However, 
in the case of a prior or simultaneous disposition (or redemption) of 
the stock with respect to which the section 306 stock disposed of (or 
redeemed) was issued, it is not necessary to establish that the 
distribution was not in pursuance of such a plan. For example, in the 
absence of such a plan and of any other facts the first sentence of this 
subparagraph would be applicable to the case of dividends and isolated 
dispositions of section 306 stock by minority shareholders. Similarly, 
in the absence of such a plan and of any other facts, if a shareholder 
received a distribution of 100 shares of section 306 stock on his 
holdings of 100 shares of voting common stock in a corporation and sells 
his voting common stock before he disposes of his section 306 stock, the 
subsequent disposition of his

[[Page 48]]

section 306 stock would not ordinarily be considered a disposition one 
of the principal purposes of which is the avoidance of Federal income 
tax.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33 FR 
11998, Aug. 23, 1968]



Sec. 1.306-3  Section 306 stock defined.

    (a) For the purpose of subchapter C, chapter 1 of the code, the term 
section 306 stock means stock which meets the requirements of section 
306(c)(1). Any class of stock distributed to a shareholder in a 
transaction in which no amount is includible in the income of the 
shareholder or no gain or loss is recognized may be section 306 stock, 
if a distribution of money by the distributing corporation in lieu of 
such stock would have been a dividend in whole or in part. However, 
except as provided in section 306(g), if no part of a distribution of 
money by the distributing corporation in lieu of such stock would have 
been a dividend, the stock distributed will not constitute section 306 
stock.
    (b) For the purpose of section 306, rights to acquire stock shall be 
treated as stock. Such rights shall not be section 306 stock if no part 
of the distribution would have been a dividend if money had been 
distributed in lieu of the rights. When stock is acquired by the 
exercise of rights which are treated at section 306 stock, the stock 
acquired is section 306 stock. Upon the disposition of such stock (other 
than by redemption or within the exceptions listed in section 306(b)), 
the proceeds received from the disposition shall be treated as ordinary 
income to the extent that the fair market value of the stock rights, on 
the date distributed to the shareholder, would have been a dividend to 
the shareholder had the distributing corporation distributed cash in 
lieu of stock rights. Any excess of the amount realized over the sum of 
the amount treated as ordinary income plus the adjusted basis of the 
stock, shall be treated as gain from the sale of the stock.
    (c) Section 306(c)(1)(A) provides that section 306 stock is any 
stock (other than common issued with respect to common) distributed to 
the shareholder selling or otherwise disposing thereof if, under section 
305(a) (relating to distributions of stock and stock rights) any part of 
the distribution was not included in the gross income of the 
distributee.
    (d) Section 306(c)(1)(B) includes in the definition of section 306 
stock any stock except common stock, which is received by a shareholder 
in connection with a reorganization under section 368 or in a 
distribution or exchange under section 355 (or so much of section 356 as 
relates to section 355) provided the effect of the transaction is 
substantially the same as the receipt of a stock dividend, or the stock 
is received in exchange for section 306 stock. If, in a transaction to 
which section 356 is applicable, a shareholder exchanges section 306 
stock for stock and money or other property, the entire amount of such 
money and of the fair market value of the other property (not limited to 
the gain recognized) shall be treated as a distribution of property to 
which section 301 applies. Common stock received in exchange for section 
306 stock in a recapitalization shall not be considered section 306 
stock. Ordinarily, section 306 stock includes stock which is not common 
stock received in pursuance of a plan of reorganization (within the 
meaning of section 368(a)) or received in a distribution or exchange to 
which section 355 (or so much of section 356 as relates to section 355) 
applies if cash received in lieu of such stock would have been treated 
as a dividend under section 356(a)(2) or would have been treated as a 
distribution to which section 301 applies by virtue of section 356(b) or 
section 302(d). The application of the preceding sentence is illustrated 
by the following examples:

    Example 1. Corporation A, having only common stock outstanding, is 
merged in a statutory merger (qualifying as a reorganization under 
section 368(a)) with Corporation B. Pursuant to such merger, the 
shareholders of Corporation A received both common and preferred stock 
in Corporation B. The preferred stock received by such shareholders is 
section 306 stock.
    Example 2. X and Y each own one-half of the 2,000 outstanding shares 
of preferred stock and one-half of the 2,000 outstanding shares of 
common stock of Corporation C. Pursuant to a reorganization within the

[[Page 49]]

meaning of section 368(a)(1)(E) (recapitalization) each shareholder 
exchanges his preferred stock for preferred stock of a new issue which 
is not substantially different from the preferred stock previously held. 
Unless the preferred stock exchanged was itself section 306 stock the 
preferred stock received is not section 306 stock.

    (e) Section 306(c)(1)(C) includes in the definition of section 306 
stock any stock (except as provided in section 306(c)(1)(B)) the basis 
of which in the hands of the person disposing of such stock, is 
determined by reference to section 306 stock held by such shareholder or 
any other person. Under this paragraph common stock can be section 306 
stock. Thus, if a person owning section 306 stock in Corporation A 
transfers it to Corporation B which is controlled by him in exchange for 
common stock of Corporation B in a transaction to which section 351 is 
applicable, the common stock so received by him would be section 306 
stock and subject to the provisions of section 306(a) on its 
disposition. In addition, the section 306 stock transferred is section 
306 stock in the hands of Corporation B, the transferee. Section 306 
stock transferred by gift remains section 306 stock in the hands of the 
donee. Stock received in exchange for section 306 stock under section 
1036(a) (relating to exchange of stock for stock in the same 
corporation) or under so much of section 1031(b) as relates to section 
1036(a) becomes section 306 stock and acquires, for purposes of section 
306, the characteristics of the section 306 stock exchanged. The entire 
amount of the fair market value of the other property received in such 
transaction shall be considered as received upon a disposition (other 
than a redemption) to which section 306(a) applies. Section 306 stock 
ceases to be so classified if the basis of such stock is determined by 
reference to its fair market value on the date of the decedent-
stockholder's death under section 1014 or the optional valuation date 
under section 2032. Section 306 stock continues to be so classified if 
the basis of such stock is determined under section 1022.
    (f) If section 306 stock which was distributed with respect to 
common stock is exchanged for common stock in the same corporation 
(whether or not such exchange is pursuant to a conversion privilege 
contained in section 306 stock), such common stock shall not be section 
306 stock. This paragraph applies to exchanges not coming within the 
purview of section 306(c)(1)(B). Common stock which is convertible into 
stock other than common stock or into property, shall not be considered 
common stock. It is immaterial whether the conversion privilege is 
contained in the stock or in some type of collateral agreement.
    (g) If there is a substantial change in the terms and conditions of 
any stock, then, for the purpose of this section--
    (1) The fair market value of such stock shall be the fair market 
value at the time of distribution or the fair market value at the time 
of such change, whichever is higher;
    (2) Such stock's ratable share of the amount which would have been a 
dividend if money had been distributed in lieu of stock shall be 
determined by reference to the time of distribution or by reference to 
the time of such change, whichever ratable share is higher; and
    (3) Section 306(c)(2) shall be inapplicable if there would have been 
a dividend to any extent if money had been distributed in lieu of the 
stock either at the time of the distribution or at the time of such 
change.
    (h) When section 306 stock is disposed of, the amount treated under 
section 306(a)(1)(A) as ordinary income, for the purposes of part I, 
subchapter N, chapter 1 of the Code, be treated as derived from the same 
source as would have been the source if money had been received from the 
corporation as a dividend at the time of the distribution of such stock. 
If the amount is determined to be derived from sources within the United 
States, the amount shall be considered to be fixed or determinable 
annual or periodic gains, profits, and income within the meaning of 
section 871(a) or section 881(a), relating, respectively, to the tax on 
nonresident alien individuals and on foreign corporations not engaged in 
business in the United States.
    (i) Section 306 shall be inapplicable to stock received before June 
22, 1954, and to stock received on or after June 22, 1954, in 
transactions subject to the

[[Page 50]]

provisions of the Internal Revenue Code of 1939.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7281, 38 FR 
18540, July 12, 1973; T.D. 7556, 43 FR 34128, Aug. 3, 1978; T.D. 9811, 
82 FR 6237, Jan. 19, 2017]



Sec. 1.306-4  Effective/applicability date.

    The provisions of Sec. Sec. 1.306-1 through 1.306-3 are applicable 
on or after June 22, 1954. The provisions of Sec. 1.306-3 relating to 
section 1022 are effective on and after January 19, 2017.

[T.D. 9811, 82 FR 6237, Jan. 19, 2017]



Sec. 1.307-1  General.

    (a) If a shareholder receives stock or stock rights as a 
distribution on stock previously held and under section 305 such 
distribution is not includible in gross income then, except as provided 
in section 307(b) and Sec. 1.307-2, the basis of the stock with respect 
to which the distribution was made shall be allocated between the old 
and new stocks or rights in proportion to the fair market values of each 
on the date of distribution. If a shareholder receives stock or stock 
rights as a distribution on stock previously held and pursuant to 
section 305 part of the distribution is not includible in gross income, 
then (except as provided in section 307(b) and Sec. 1.307-2) the basis 
of the stock with respect to which the distribution is made shall be 
allocated between (1) the old stock and (2) that part of the new stock 
or rights which is not includible in gross income, in proportion to the 
fair market values of each on the date of distribution. The date of 
distribution in each case shall be the date the stock or the rights are 
distributed to the stockholder and not the record date. The general rule 
will apply with respect to stock rights only if such rights are 
exercised or sold.
    (b) The application of paragraph (a) of this section is illustrated 
by the following example:

    Example. A taxpayer in 1947 purchased 100 shares of common stock at 
$100 per share and in 1954 by reason of the ownership of such stock 
acquired 100 rights entitling him to subscribe to 100 additional shares 
of such stock at $90 a share. Immediately after the issuance of the 
rights, each of the shares of stock in respect of which the rights were 
acquired had a fair market value, ex-rights, of $110 and the rights had 
a fair market value of $19 each. The basis of the rights and the common 
stock for the purpose of determining the basis for gain or loss on a 
subsequent sale or exercise of the rights or a sale of the old stock is 
computed as follows:

100 (shares) x $100 = $10,000, cost of old stock (stock in respect of 
          which the rights were acquired).
100 (shares) x $110 = $11,000, market value of old stock.
100 (rights) x $19 = $1,900, market value of rights.
11,000/12,900 of $10,000 = $8,527.13, cost of old stock apportioned to 
          such stock.
1,900/12,900 of $10,000 = $1,472.87, cost of old stock apportioned to 
          rights.


If the rights are sold, the basis for determining gain or loss will be 
$14.7287 per right. If the rights are exercised, the basis of the new 
stock acquired will be the subscription price paid therefor ($90) plus 
the basis of the rights exercised ($14.7287 each) or $104.7287 per 
share. The remaining basis of the old stock for the purpose of 
determining gain or loss on a subsequent sale will be $85.2713 per 
share.



Sec. 1.307-2  Exception.

    The basis of rights to buy stock which are excluded from gross 
income under section 305(a), shall be zero if the fair market value of 
such rights on the date of distribution is less than 15 percent of the 
fair market value of the old stock on that date, unless the shareholder 
elects to allocate part of the basis of the old stock to the rights as 
provided in paragraph (a) of Sec. 1.307-1. The election shall be made 
by a shareholder with respect to all the rights received by him in a 
particular distribution in respect of all the stock of the same class 
owned by him in the issuing corporation at the time of such 
distribution. Such election to allocate basis to rights shall be in the 
form of a statement attached to the shareholder's return for the year in 
which the rights are received. This election, once made, shall be 
irrevocable with respect to the rights for which the election was made. 
Any shareholder making such an election shall retain a copy of the 
election and of the tax return with which it was filed, in order to 
substantiate the use of an allocated basis upon a subsequent disposition 
of the stock acquired by exercise.

[[Page 51]]

                         effects on corporation



Sec. 1.312-1  Adjustment to earnings and profits reflecting 
distributions by corporations.

    (a) In general, on the distribution of property by a corporation 
with respect to its stock, its earnings, and profits (to the extent 
thereof) shall be decreased by--
    (1) The amount of money,
    (2) The principal amount of the obligations of such corporation 
issued in such distribution, and
    (3) The adjusted basis of other property.

For special rule with respect to distributions to which section 312(e) 
applies, see Sec. 1.312-5.
    (b) The adjustment provided in section 312(a)(3) and paragraph 
(a)(3) of this section with respect to a distribution of property (other 
than money or its own obligations) shall be made notwithstanding the 
fact that such property has appreciated or depreciated in value since 
acquisition.
    (c) The application of paragraphs (a) and (b) of this section may be 
illustrated by the following examples:

    Example 1. Corporation A distributes to its sole shareholder 
property with a value of $10,000 and a basis of $5,000. It has $12,500 
in earnings and profits. The reduction in earnings and profits by reason 
of such distribution is $5,000. Such is the reduction even though the 
amount of $10,000 is includible in the income of the shareholder (other 
than a corporation) as a dividend.
    Example 2. The facts are the same as in Example (1) above except 
that the property has a basis of $15,000 and the earnings and profits of 
the corporation are $20,000. The reduction in earnings and profits is 
$15,000. Such is the reduction even though only the amount of $10,000 is 
includible in the income of the shareholder as a dividend.

    (d) In the case of a distribution of stock or rights to acquire 
stock a portion of which is includible in income by reason of section 
305(b), the earnings and profits shall be reduced by the fair market 
value of such portion. No reduction shall be made if a distribution of 
stock or rights to acquire stock is not includible in income under the 
provisions of section 305.
    (e) No adjustment shall be made in the amount of the earnings and 
profits of the issuing corporation upon a disposition of section 306 
stock unless such disposition is a redemption.



Sec. 1.312-2  Distribution of inventory assets.

    Section 312(b) provides for the increase and the decrease of the 
earnings and profits of a corporation which distributes, with respect to 
its stock, inventory assets as defined in section 312(b)(2), where the 
fair market value of such assets exceeds their adjusted basis. The rules 
provided in section 312(b) (relating to distributions of certain 
inventory assets) shall be applicable without regard to the method used 
in computing inventories for the purpose of the computation of taxable 
income. Section 312(b) does not apply to distributions described in 
section 312(e).



Sec. 1.312-3  Liabilities.

    The amount of any reductions in earnings and profits described in 
section 312 (a) or (b) shall be (a) reduced by the amount of any 
liability to which the property distributed was subject and by the 
amount of any other liability of the corporation assumed by the 
shareholder in connection with such distribution, and (b) increased by 
the amount of gain recognized to the corporation under section 311 (b), 
(c), or (d), or under section 341(f), 617(d), 1245(a), 1250(a), 1251(c), 
1252(a), or 1254(a).

[T.D. 7209, 37 FR 20804, Oct. 5, 1972, as amended by T.D. 8586, 60 FR 
2500, Jan. 10, 1995]



Sec. 1.312-4  Examples of adjustments provided in section 312(c).

    The adjustments provided in section 312(c) may be illustrated by the 
following examples:

    Example 1. On December 2, 1954, Corporation X distributed to its 
sole shareholder, A, an individual, as a dividend in kind a vacant lot 
which was not an inventory asset. On that date, the lot had a fair 
market value of $5,000 and was subject to a mortgage of $2,000. The 
adjusted basis of the lot was $3,100. The amount of the earnings and 
profits was $10,000. The amount of the dividend received by A is $3,000 
($5,000, the fair market value, less $2,000, the amount of the mortgage) 
and the reduction in the earnings and profits of Corporation X is $1,100 
($3,100, the basis, less $2,000, the amount of mortgage).

[[Page 52]]

    Example 2. The facts are the same as in Example (1) above with the 
exception that the amount of the mortgage to which the property was 
subject was $4,000. The amount of the dividend received by A is $1,000, 
and there is no reduction in the earnings and profits of the corporation 
as a result of the distribution (disregarding such reduction as may 
result from an increase in tax to Corporation X because, of gain 
resulting from the distribution). There is a gain of $900 recognized to 
Corporation X, the difference between the basis of the property ($3,100) 
and the amount of the mortgage ($4,000), under section 311(c) and an 
increase in earnings and profits of $900.
    Example 3. Corporation A, having accumulated earnings and profits of 
$100,000, distributed in kind to its shareholders, not in liquidation, 
inventory assets which had a basis to it on the ``Lifo'' method (section 
472) of $46,000 and on the basis of cost or market (section 471) of 
$50,000. The inventory had a fair market value of $55,000 and was 
subject to a liability of $35,000. This distribution results in a net 
decrease in earnings and profits of Corporation A of $11,000, (without 
regard to any tax on Corporation A) computed as follows:

``Fifo'' basis of inventory..........................   $50,000
Less: ``Lifo'' basis of inventory....................    46,000
                                                      ----------
Gain recognized--addition to earnings and profits (section        $4,000
 311(b)).......................................................
Adjustment to earnings and profits required by
 section 312(b)(1)(A):
  Fair market value of inventory.....................   $55,000
  Less: ``Lifo'' basis plus adjustment under section     50,000    5,000
   311(b)............................................
                                                      ------------------
 Total increase in earnings and profits........................    9,000
Decrease in earnings and profits--under section         $55,000
 312(b)(1)(B)(i).....................................
Less: Liability assumed..............................    35,000
                                                      ----------
Net amount of distribution (decrease in earnings)..............   20,000
                                                      -----------
 Net decrease in earnings and profits..........................   11,000
 



Sec. 1.312-5  Special rule for partial liquidations and certain
redemptions.

    The part of the distribution properly chargeable to capital account 
within the provisions of section 312(e) shall not be considered a 
distribution of earnings and profits within the meaning of section 301 
for the purpose of determining taxability of subsequent distributions by 
the corporation.



Sec. 1.312-6  Earnings and profits.

    (a) In determining the amount of earnings and profits (whether of 
the taxable year, or accumulated since February 28, 1913, or accumulated 
before March 1, 1913) due consideration must be given to the facts, and, 
while mere bookkeeping entries increasing or decreasing surplus will not 
be conclusive, the amount of the earnings and profits in any case will 
be dependent upon the method of accounting properly employed in 
computing taxable income (or net income, as the case may be). For 
instance, a corporation keeping its books and filing its income tax 
returns under subchapter E, chapter 1 of the Code, on the cash receipts 
and disbursements basis may not use the accrual basis in determining 
earnings and profits; a corporation computing income on the installment 
basis as provided in section 453 shall, with respect to the installment 
transactions, compute earnings and profits on such basis; and an 
insurance company subject to taxation under section 831 shall exclude 
from earnings and profits that portion of any premium which is unearned 
under the provisions of section 832(b)(4) and which is segregated 
accordingly in the unearned premium reserve.
    (b) Among the items entering into the computation of corporate 
earnings and profits for a particular period are all income exempted by 
statute, income not taxable by the Federal Government under the 
Constitution, as well as all items includible in gross income under 
section 61 or corresponding provisions of prior revenue acts. Gains and 
losses within the purview of section 1002 or corresponding provisions of 
prior revenue acts are brought into the earnings and profits at the time 
and to the extent such gains and losses are recognized under that 
section. Interest on State bonds and certain other obligations, although 
not taxable when received by a corporation, is taxable to the same 
extent as other dividends when distributed to shareholders in the form 
of dividends.
    (c)(1) In the case of a corporation in which depletion or 
depreciation is a factor in the determination of income, the only 
depletion or depreciation deductions to be considered in the computation 
of the total earnings and profits are those based on cost or other basis 
without regard to March 1, 1913, value. In computing the earnings and 
profits for any period beginning after February 28, 1913, the only 
depletion or

[[Page 53]]

depreciation deductions to be considered are those based on (i) cost or 
other basis, if the depletable or depreciable asset was acquired 
subsequent to February 28, 1913, or (ii) adjusted cost or March 1, 1913, 
value, whichever is higher, if acquired before March 1, 1913. Thus, 
discovery or percentage depletion under all revenue acts for mines and 
oil and gas wells is not to be taken into consideration in computing the 
earnings and profits of a corporation. Similarly, where the basis of 
property in the hands of a corporation is a substituted basis, such 
basis, and not the fair market value of the property at the time of the 
acquisition by the corporation, is the basis for computing depletion and 
depreciation for the purpose of determining earnings and profits of the 
corporation.
    (2) The application of subparagraph (1) of this paragraph may be 
illustrated by the following example:

    Example. Oil producing property which A had acquired in 1949 at a 
cost of $28,000 was transferred to Corporation Y in December 1951, in 
exchange for all of its capital stock. The fair market value of the 
stock and of the property as of the date of the transfer was $247,000. 
Corporation Y, after four years' operation, effected in 1955 a cash 
distribution to A in the amount of $165,000. In determining the extent 
to which the earnings and profits of Corporation Y available for 
dividend distributions have been increased as the result of production 
and sale of oil, the depletion to be taken into account is to be 
computed upon the basis of $28,000 established in the nontaxable 
exchange in 1951 regardless of the fair market value of the property or 
of the stock issued in exchange therefor.

    (d) A loss sustained for a year before the taxable year does not 
affect the earnings and profits of the taxable year. However, in 
determining the earnings and profits accumulated since February 28, 
1913, the excess of a loss sustained for a year subsequent to February 
28, 1913, over the undistributed earnings and profits accumulated since 
February 28, 1913, and before the year for which the loss was sustained, 
reduces surplus as of March 1, 1913, to the extent of such excess. If 
the surplus as of March 1, 1913, was sufficient to absorb such excess, 
distributions to shareholders after the year of the loss are out of 
earnings and profits accumulated since the year of the loss to the 
extent of such earnings.
    (e) With respect to the effect on the earnings and profits 
accumulated since February 28, 1913, of distributions made on or after 
January 1, 1916, and before August 6, 1917, out of earnings or profits 
accumulated before March 1, 1913, which distributions were specifically 
declared to be out of earnings and profits accumulated before March 1, 
1913, see section 31(b) of the Revenue Act of 1916, as added by section 
1211 of the Revenue Act of 1917 (40 Stat. 336).



Sec. 1.312-7  Effect on earnings and profits of gain or loss realized
after February 28, 1913.

    (a) In order to determine the effect on earnings and profits of gain 
or loss realized from the sale or other disposition (after February 28, 
1913) of property by a corporation, section 312(f)(1) prescribed certain 
rules for--
    (1) The computation of the total earnings and profits of the 
corporation of most frequent application in determining invested 
capital; and
    (2) The computation of earnings and profits of the corporation for 
any period beginning after February 28, 1913, of most frequent 
application in determining the source of dividend distributions.

Such rules are applicable whenever under any provision of subtitle A of 
the Code it is necessary to compute either the total earnings and 
profits of the corporation or the earnings and profits for any period 
beginning after February 28, 1913. For example, since the earnings and 
profits accumulated after February 28, 1913, or the earnings and profits 
of the taxable year, are earnings and profits for a period beginning 
after February 28, 1913, the determination of either must be in 
accordance with the regulations prescribed by this section for the 
ascertainment of earnings and profits for any period beginning after 
February 28, 1913. Under subparagraph (1) of this paragraph, such gain 
or loss is determined by using the adjusted basis (under the law 
applicable to the year in which the sale or other disposition was made) 
for determining gain, but disregarding value as of March 1, 1913. Under 
subparagraph (2) of this paragraph, there is used such

[[Page 54]]

adjusted basis for determining gain, giving effect to the value as of 
March 1, 1913, whenever applicable. In both cases the rules are the same 
as those governing depreciation and depletion in computing earnings and 
profits (see Sec. 1.312-6). Under both subparagraphs (1) and (2) of 
this paragraph, the adjusted basis is subject to the limitations of the 
third sentence of section 312(f)(1) requiring the use of adjustments 
proper in determining earnings and profits. The proper adjustments may 
differ under section 312(f)(1)(A) and (B) depending upon the basis to 
which the adjustments are to be made. If the application of section 
312(f)(1)(B) results in a loss and if the application of section 
312(f)(1)(A) to the same transaction reaches a different result, then 
the loss under section 312(f)(1)(B) will be subject to the adjustment 
thereto required by section 312(g)(2). (See Sec. 1.312-9.)
    (b)(1) The gain or loss so realized increases or decreases the 
earnings and profits to, but not beyond, the extent to which such gain 
or loss was recognized in computing taxable income (or net income, as 
the case may be) under the law applicable to the year in which such sale 
or disposition was made. As used in this paragraph, the term 
``recognized'' has reference to that kind of realized gain or loss which 
is recognized for income tax purposes by the statute applicable to the 
year in which the gain or loss was realized. For example, see section 
356. A loss (other than a wash sale loss with respect to which a 
deduction is disallowed under the provisions of section 1091 or 
corresponding provisions of prior revenue laws) may be recognized though 
not allowed as a deduction (by reason, for example, of the operation of 
sections 267 and 1211 and corresponding provisions of prior revenue 
laws) but the mere fact that it is not allowed does not prevent decrease 
in earnings and profits by the amount of such disallowed loss. Wash sale 
losses, however, disallowed under section 1091 and corresponding 
provisions of prior revenue laws, are deemed nonrecognized losses and do 
not reduce earnings or profits. The recognized gain or loss for the 
purpose of computing earnings and profits is determined by applying the 
recognition provisions to the realized gain or loss computed under the 
provisions of section 312(f)(1) as distinguished from the realized gain 
or loss used in computing taxable income (or net income, as the case may 
be).
    (2) The application of subparagraph (1) of this paragraph may be 
illustrated by the following examples:

    Example 1. Corporation X on January 1, 1952, owned stock in 
Corporation Y which it had acquired from Corporation Y in December 1951, 
in an exchange transaction in which no gain or loss was recognized. The 
adjusted basis to Corporation X of the property exchanged by it for the 
stock in Corporation Y was $30,000. The fair market value of the stock 
in Corporation Y when received by Corporation X was $930,000. On April 
9, 1955, Corporation X made a cash distribution of $900,000 and, except 
for the possible effect of the transaction in 1951, had no earnings or 
profits accumulated after February 28, 1913, and had no earnings or 
profits for the taxable year. The amount of $900,000 representing the 
excess of the fair market value of the stock of Corporation Y over the 
adjusted basis of the property exchanged therefor was not recognized 
gain to Corporation X under the provisions of section 112 of the 
Internal Revenue Code of 1939. Accordingly, the earnings and profits of 
Corporation X are not increased by $900,000, the amount of the gain 
realized but not recognized in the exchange, and the distribution was 
not a taxable dividend. The basis in the hands of Corporation Y of the 
property acquired by it from Corporation X is $30,000. If such property 
is thereafter sold by Corporation Y, gain or loss will be computed on 
such basis of $30,000, and earnings and profits will be increased or 
decreased accordingly.
    Example 2. On January 2, 1910, Corporation M acquired nondepreciable 
property at a cost of $1,000. On March 1, 1913, the fair market value of 
such property in the hands of Corporation M was $2,200. On December 31, 
1952, Corporation M transfers such property to Corporation N in exchange 
for $1,900 in cash and all Corporation N's stock, which has a fair 
market value of $1,100. For the purpose of computing the total earnings 
and profits of Corporation M, the gain on such transaction is $2,000 
(the sum of $1,900 in cash and stock worth $1,100 minus $1,000, the 
adjusted basis for computing gain, determined without regard to March 1, 
1913, value), $1,900 of which is recognized under section 356, since 
this was the amount of money received, although for the purpose of 
computing net income the gain is only $800 (the sum of $1,900 in cash 
and stock worth $1,100, minus $2,200, the adjusted basis for computing 
gain determined by giving effect to March 1, 1913, value). Such earnings 
and profits will therefore be increased by only $800 as a reputing

[[Page 55]]

the earnings and profits of Corporation M for any period beginning after 
February 28, 1913, however, the gain arising from the transaction, like 
the taxable gain, is only $800, all of which is recognized under section 
112(c) of the Internal Revenue Code of 1939, the money received being in 
excess of such amount. Such earnings and profits will therefore be 
increased by only $800 as a result of the transaction. For increase in 
that part of the earnings and profits consisting of increase in value of 
property accrued before, but realized on or after March 1, 1913, see 
Sec. 1.312-9.
    Example 3. On July 31, 1955, Corporation R owned oil-producing 
property acquired after February 28, 1913, at a cost of $200,000, but 
having an adjusted basis (by reason of taking percentage depletion) of 
$100,000 for determining gain. However, the adjusted basis of such 
property to be used in computing gain or loss for the purpose of 
earnings and profits is, because of the provisions of the third sentence 
of section 312(f)(1), $150,000. On such day Corporation R transferred 
such property to Corporation S in exchange for $25,000 in cash and all 
of the stock of Corporation S, which had a fair market value of 
$100,000. For the purpose of computing taxable income, Corporation R has 
realized a gain of $25,000 as a result of this transaction, all of which 
is recognized under section 356. For the purpose of computing earnings 
and profits, however, Corporation R has realized a loss of $25,000, none 
of which is recognized owing to the provisions of section 356(c). The 
earnings and profits of Corporation R are therefore neither increased 
nor decreased as a result of the transaction. The adjusted basis of the 
Corporation S stock in the hands of Corporation R for purposes of 
computing earnings and profits, however, will be $125,000 (though only 
$100,000 for the purpose of computing taxable income), computed as 
follows:

Basis of property transferred................................   $200,000
Less money received on exchange..............................     25,000
Plus gain or minus loss recognized on exchange...............       None
                                                              ----------
 Basis of stock..............................................    175,000
Less adjustments (same as those used in determining adjusted      50,000
 basis of property transferred)..............................
                                                              ----------
 Adjusted basis of stock.....................................    125,000
 


If, therefore, Corporation R should subsequently sell the Corporation S 
stock for $100,000, a loss of $25,000 will again be realized for the 
purpose of computing earnings and profits, all of which will be 
recognized and will be applied to decrease the earnings and profits of 
Corporation R.

    (c)(1) The third sentence of section 312(f)(1) provides for cases in 
which the adjustments, prescribed in section 1016, to the basis 
indicated in section 312(f)(1)(A) or (B), as the case may be, differ 
from the adjustments to such basis proper for the purpose of determining 
earnings or profits. The adjustments provided by such third sentence 
reflect the treatment provided by Sec. Sec. 1.312-6 and 1.312-15 
relative to cases where the deductions for depletion and depreciation in 
computing taxable income (or net income, as the case may be) differ from 
the deductions proper for the purpose of computing earnings and profits.
    (2) The effect of the third sentence of section 312(f)(1) may be 
illustrated by the following examples:

    Example 1. Corporation X purchased on January 2, 1931, an oil lease 
at a cost of $10,000. The lease was operated only for the years 1931 and 
1932. The deduction for depletion in each of the years 1931 and 1932 
amounted to $2,750, of which amount $1,750 represented percentage 
depletion in excess of depletion based on cost. The lease was sold in 
1955 for $15,000. Under section 1016(a)(2), in determining the gain or 
loss from the sale of the property, the basis must be adjusted for cost 
depletion of $1,000 in 1931 and percentage depletion of $2,750 in 1932. 
However, the adjustment of such basis, proper for the determination of 
earnings and profits, is $1,000 for each year, or $2,000. Hence, the 
cost is to be adjusted only to the extent of $2,000, leaving an adjusted 
basis of $8,000 and the earnings and profits will be increased by 
$7,000, and not by $8,750. The difference of $1,750 is equal to the 
amount by which the percentage depletion for the year 1932 ($2,750) 
exceeds the depletion on cost for that year ($1,000) and has already 
been applied in the computation of earnings and profits for the year 
1932 by taking into account only $1,000 instead of $2,750 for depletion 
in the computation of such earnings and profits. (See Sec. 1.316-1.)
    Example 2. If, in Example (1), above, the property, instead of being 
sold, is exchanged in a transaction described in section 1031 for like 
property having a fair market value of $7,750 and cash of $7,250, then 
the increase in earnings and profits amounts to $7,000, that is, $15,000 
($7,750 plus $7,250) minus the basis of $8,000. However, in computing 
taxable income of Corporation X, the gain is $8,750, that is, $15,000 
minus $6,250 ($10,000 less depletion of $3,750), of which only $7,250 is 
recognized because the recognized gain cannot exceed the sum of money 
received in the transaction. See section 1031(b) and the corresponding 
provisions of prior revenue laws. If, however, the cash received was 
only $2,250 and the value of the property received was $12,750, then the 
increase in earnings and profits would be $2,250, that amount being the 
gain recognized under section 1031.
    Example 3. On January 1, 1973, corporation X purchased for $10,000 a 
depreciable asset with an estimated useful life of 20 years and

[[Page 56]]

no salvage value. In computing depreciation on the asset, corporation X 
used the declining balance method with a rate twice the straight line 
rate. On December 31, 1976, the asset was sold for $9,000. Under section 
1016(a)(2), the basis of the asset is adjusted for depreciation allowed 
for the years 1973 through 1976, or a total of $3,439. Thus, X realizes 
a gain of $2,439 (the excess of the amount realized, $9,000, over the 
adjusted basis, $6,561). However, the proper adjustment to basis for the 
purpose of determining earnings and profits is only $2,000, i.e., the 
total amount which, under Sec. 1.312-15, was applied in the computation 
of earnings and profits for the years 1973-76. Hence, upon sale of the 
asset, earnings and profits are increased by only $1,000, i.e., the 
excess of the amount realized, $9,000, over the adjusted basis for 
earnings and profits purposes, $8,000.

    (d) For adjustment and allocation of the earnings and profits of the 
transferor as between the transferor and the transferee in cases where 
the transfer of property by one corporation to another corporation 
results in the nonrecognition in whole or in part of gain or loss, see 
Sec. 1.312-10; and see section 381 for earnings and profits of 
successor corporations in certain transactions.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7221, 37 FR 
24746, Nov. 21, 1972]



Sec. 1.312-8  Effect on earnings and profits of receipt of tax-free
distributions requiring adjustment or allocation of basis of stock.

    (a) In order to determine the effect on earnings and profits, where 
a corporation receives (after February 28, 1913) from a second 
corporation a distribution which (under the law applicable to the year 
in which the distribution was made) was not a taxable dividend to the 
shareholders of the second corporation, section 312(f) prescribes 
certain rules. It provides that the amount of such distribution shall 
not increase the earnings and profits of the first or receiving 
corporation in the following cases: (1) No such increase shall be made 
in respect of the part of such distribution which (under the law 
applicable to the year in which the distribution was made) is directly 
applied in reduction of the basis of the stock in respect of which the 
distribution was made and (2) no such increase shall be made if (under 
the law applicable to the year in which the distribution was made) the 
distribution causes the basis of the stock in respect of which the 
distribution was made to be allocated between such stock and the 
property received (or such basis would but for section 307(b) be so 
allocated). Where, therefore, the law (applicable to the year in which 
the distribution was made, as, for example, a distribution in 1934 from 
earnings and profits accumulated before March 1, 1913) requires that the 
amount of such distribution shall be applied against and reduce the 
basis of the stock with respect to which the distribution was made, 
there is no increase in the earnings and profits by reason of the 
receipt of such distribution. Similarly, where there is received by a 
corporation a distribution from another corporation in the form of a 
stock dividend and the law applicable to the year in which such 
distribution was made requires the allocation, as between the old stock 
and the stock received as a dividend, of the basis of the old stock (or 
such basis would but for section 307(b) be so allocated), then there is 
no increase in the earnings and profits by reason of the receipt of such 
stock dividend even though such stock dividend constitutes income within 
the meaning of the sixteenth amendment to the Constitution.
    (b) The principles set forth in paragraph (a) of this section may be 
illustrated by the following examples:

    Example 1. Corporation X in 1955 distributed to Corporation Y, one 
of its shareholders, $10,000 which was out of earnings or profits 
accumulated before March 1, 1913, and did not exceed the adjusted basis 
of the stock in respect of which the distribution was made. This amount 
of $10,000 was, therefore, a tax-free distribution and under the 
provisions of section 301(c)(2) must be applied against and reduce the 
adjusted basis of the stock in respect of which the distribution was 
made. The earnings and profits of Corporation Y are not increased by 
reason of the receipt of this distribution.
    Example 2. Corporation Z in 1955 had outstanding common and 
preferred stock of which Corporation Y held 100 shares of the common and 
no preferred. The stock had a cost basis to Corporation Y of $100 per 
share, or a total cost of $10,000. In December of that year it received 
a dividend of 100 shares of the preferred stock of Corporation Z. Such 
distribution is a stock dividend which, under

[[Page 57]]

section 305, was not taxable and was accordingly not included in the 
gross income of Corporation Y. The original cost of $10,000 is allocated 
to the 200 shares of Corporation Z none of which has been sold or 
otherwise disposed of by Corporation Y. See section 307 and Sec. 1.307-
1. The earnings and profits of Corporation Y are not increased by reason 
of the receipt of such stock dividend.



Sec. 1.312-9  Adjustments to earnings and profits reflecting increase
in value accrued before March 1, 1913.

    (a) In order to determine, for the purpose of ascertaining the 
source of dividend distributions, that part of the earnings and profits 
which is represented by increase in value of property accrued before, 
but realized on or after, March 1, 1913, section 312(g) prescribes 
certain rules.
    (b)(1) Section 312(g)(1) sets forth the general rule with respect to 
computing the increase to be made in that part of the earnings and 
profits consisting of increase in value of property accrued before, but 
realized on or after, March 1, 1913.
    (2) The effect of section 312(g)(1) may be illustrated by the 
following examples:

    Example 1. Corporation X acquired nondepreciable property before 
March 1, 1913, at a cost of $10,000. Its fair market value as of March 
1, 1913, was $12,000 and it was sold in 1955 for $15,000. The increase 
in earnings and profits based on the value as of March 1, 1913, 
representing earnings and profits accumulated since February 28, 1913, 
is $3,000. If the basis is determined without regard to the value as of 
March 1, 1913, there would be an increase in earnings and profits of 
$5,000. The difference of $2,000 ($5,000 minus $3,000) represents the 
increase to be made in that part of the earnings and profits of 
Corporation X consisting of the increase in value of property accrued 
before, but realized on or after, March 1, 1913.
    Example 2. Corporation Y acquired depreciable property in 1908 at a 
cost of $100,000. Assuming no additions or betterments, and that the 
depreciation sustained before March 1, 1913, was $10,000, the adjusted 
cost as of that date was $90,000. Its fair market value as of March 1, 
1913, was $94,000 and on February 28, 1955, it was sold for $25,000. For 
the purpose of determining gain from the sale, the basis of the property 
is the fair market value of $94,000 as of March 1, 1913, adjusted for 
depreciation for the period subsequent to February 28, 1913, computed on 
such fair market value. If the amount of the depreciation deduction 
allowed after February 28, 1913, and properly allowable for each of such 
years to the date of the sale in 1955 is the aggregate sum of $81,467, 
the adjusted basis for determining gain in 1955 ($94,000 less $81,467) 
is $12,533 and the gain would be $12,467 ($25,000 less $12,533). The 
increase in earnings and profits accumulated since February 28, 1913, by 
reason of the sale, based on the value as of March 1, 1913, adjusted for 
depreciation is $12,467. If the depreciation since February 28, 1913, 
had been based on the adjusted cost of $90,000 ($100,000 less $10,000) 
instead of the March 1, 1913, value of $94,000, the depreciation 
sustained from that date to the date of sale would have been $78,000 
instead of $81,467 and the actual gain on the sale based on the cost of 
$100,000 adjusted by depreciation on such cost to $12,000 ($100,000 
reduced by the sum of $10,000 and $78,000) would be $13,000 ($25,000 
less $12,000). If the adjusted basis of the property was determined 
without regard to the value as of March 1, 1913, there would be an 
increase in earnings and profits of $13,000. The difference of $533 
($13,000 minus $12,467) represents the increase to be made in that part 
of the earnings and profits of Corporation Y consisting of the increase 
in value of property accrued before, but realized on or after, March 1, 
1913 (assuming that the proper increase in such surplus had been made 
each year for the difference between depreciation based on cost and the 
depreciation based on March 1, 1913, value). Thus, the total increase in 
that part of earnings and profits consisting of the increase in value of 
property accrued before, but realized on or after, March 1, 1913, is 
$4,000 ($94,000 less $90,000).

    (c)(1) Section 312(g)(2) is an exception to the general rule in 
section 312(g)(1) and also operates as a limitation on the application 
of section 312(f). It provides that, if the application of section 
312(f)(1)(B) to a sale or other disposition after February 28, 1913, 
results in a loss which is to be applied in decrease of earnings and 
profits for any period beginning after February 28, 1913, then, 
notwithstanding section 312(f) and in lieu of the rule provided in 
section 312(g)(1), the amount of such loss so to be applied shall be 
reduced by the amount, if any, by which the adjusted basis of the 
property used in determining the loss, exceeds the adjusted basis 
computed without regard to the fair market value of the property on 
March 1, 1913. If the amount so applied in reduction of the loss exceeds 
such loss, the excess over such loss shall increase that part of the 
earnings and profits consisting of increase in value

[[Page 58]]

of property accrued before, but realized on or after March 1, 1913.
    (2) The application of section 312(g)(2) may be illustrated by the 
following examples:

    Example 1. Corporation Y acquired nondepreciable property before 
March 1, 1913, at a cost of $8,000. Its fair market value as of March 1, 
1913, was $13,000, and it was sold in 1955 for $10,000. Under section 
312(f)(1)(B) the adjusted basis would be $13,000 and there would be a 
loss of $3,000. The application of section 312(f)(1)(B) would result in 
a loss from the sale in 1955 to be applied in decrease of earnings and 
profits for that year. Section 312(g)(2), however, applies and the loss 
of $3,000 is reduced by the amount by which the adjusted basis of 
$13,000 exceeds the cost of $8,000 (the adjusted basis computed without 
regard to the value on March 1, 1913), namely $5,000. The amount of the 
loss is, accordingly, reduced from $3,000 to zero and there is no 
decrease in earnings and profits of Corporation Y for the year 1955 as a 
result of the sale. The amount applied in reduction of the decrease, 
namely, $5,000, exceeds $3,000. Accordingly, as a result of the sale the 
excess of $2,000 increases that part of the earnings and profits of 
Corporation Y consisting of increase in value of property accrued 
before, but realized on or after March 1, 1913.
    Example 2. Corporation Z acquired nondepreciable property before 
March 1, 1913, at a cost of $10,000. Its fair market value as of March 
1, 1913, was $12,000, and it was sold in 1955 for $8,000. Under section 
312(f)(1)(B) the adjusted basis would be $12,000 and there would be a 
loss of $4,000. The application of section 312(f)(1)(B) would result in 
a loss from the sale in 1955 to be applied in decrease of earnings and 
profits for that year. Section 312(g)(2), however, applies and the loss 
of $4,000 is reduced by the amount by which the adjusted basis of 
$12,000 exceeds the cost of $10,000 (the adjusted basis computed without 
regard to the value on March 1, 1913), namely, $2,000. The amount of the 
loss is, accordingly, reduced from $4,000 to $2,000 and the decrease in 
earnings and profits of Corporation Z for the year 1955 as a result of 
the sale is $2,000 instead of $4,000. The amount applied in reduction of 
the decrease, namely, $2,000, does not exceed $4,000. Accordingly, as a 
result of the sale there is no increase in that part of the earnings and 
profits of Corporation Z consisting of increase in value of property 
accrued before, but realized on or after, March 1, 1913.



Sec. 1.312-10  Allocation of earnings in certain corporate separations.

    (a) If one corporation transfers part of its assets constituting an 
active trade or business to another corporation in a transaction to 
which section 368(a)(1)(4) applies and immediately thereafter the stock 
and securities of the controlled corporation are distributed in a 
distribution or exchange to which section 355 (or so much of section 356 
as relates to section 355) applies, the earnings and profits of the 
distributing corporation immediately before the transaction shall be 
allocated between the distributing corporation and the controlled 
corporation. In the case of a newly created controlled corporation, such 
allocation generally shall be made in proportion to the fair market 
value of the business or businesses (and interests in any other 
properties) retained by the distributing corporation and the business or 
businesses (and interests in any other properties) of the controlled 
corporation immediately after the transaction. In a proper case, 
allocation shall be made between the distributing corporation and the 
controlled corporation in proportion to the net basis of the assets 
transferred and of the assets retained or by such other method as may be 
appropriate under the facts and circumstances of the case. The term net 
basis means the basis of the assets less liabilities assumed or 
liabilities to which such assets are subject. The part of the earnings 
and profits of the taxable year of the distributing corporation in which 
the transaction occurs allocable to the controlled corporation shall be 
included in the computation of the earnings and profits of the first 
taxable year of the controlled corporation ending after the date of the 
transaction.
    (b) If a distribution or exchange to which section 355 applies (or 
so much of section 356 as relates to section 355) is not in pursuance of 
a plan meeting the requirements of a reorganization as defined in 
section 368(a)(1)(D), the earnings and profits of the distributing 
corporation shall be decreased by the lesser of the following amounts:
    (1) The amount by which the earnings and profits of the distributing 
corporation would have been decreased if it had transferred the stock of 
the controlled corporation to a new corporation in a reorganization to 
which section 368(a)(1)(D) applied and immediately thereafter 
distributed the stock of such new corporation or,

[[Page 59]]

    (2) The net worth of the controlled corporation. (For this purpose 
the term net worth means the sum of the basis of all of the properties 
plus cash minus all liabilities.)

If the earnings and profits of the controlled corporation immediately 
before the transaction are less than the amount of the decrease in 
earnings and profits of the distributing corporation (including a case 
in which the controlled corporation has a deficit) the earnings and 
profits of the controlled corporation, after the transaction, shall be 
equal to the amount of such decrease. If the earnings and profits of the 
controlled corporation immediately before the transaction are more than 
the amount of the decrease in the earnings and profits of the 
distributing corporation, they shall remain unchanged.
    (c) In no case shall any part of a deficit of a distributing 
corporation within the meaning of section 355 be allocated to a 
controlled corporation.



Sec. 1.312-11  Effect on earnings and profits of certain other 
tax-free exchanges, tax-free distributions, and tax-free transfer
s from one corporation to another.
          

    (a) In a transfer described in section 381(a), the acquiring 
corporation, as defined in Sec. 1.381(a)-1(b)(2), and only that 
corporation, succeeds to the earnings and profits of the distributor or 
transferor corporation (within the meaning of Sec. 1.381(a)-1(a)). 
Except as provided in Sec. 1.312-10, in all other cases in which 
property is transferred from one corporation to another, no allocation 
of the earnings and profits of the transferor is made to the transferee.
    (b) The general rule provided in section 316 that every distribution 
is made out of earnings or profits to the extent thereof and from the 
most recently accumulated earnings or profits does not apply to:
    (1) The distribution, in pursuance of a plan of reorganization, by 
or on behalf of a corporation a party to the reorganization, or in a 
transaction subject to section 355, to its shareholders--
    (i) Of stock or securities in such corporation or in another 
corporation a party to the reorganization in any taxable year beginning 
before January 1, 1934, without the surrender by the distributees of 
stock or securities in such corporation (see section 112(g) of the 
Revenue Act of 1932 (47 Stat. 197)); or
    (ii) Of stock (other than preferred stock) in another corporation 
which is a party to the reorganization without the surrender by the 
distributees of stock in the distributing corporation if the 
distribution occurs after October 20, 1951, and is subject to section 
112(b)(11) of the Internal Revenue Code of 1939; or
    (iii) Of stock or securities in such corporation or in another 
corporation a party to the reorganization in any taxable year beginning 
before January 1, 1939, or on or after such date, in exchange for its 
stock or securities in a transaction to which section 112(b)(3) of the 
Internal Revenue Code of 1939 was applicable; or
    (iv) Of stock or securities in such corporation or in another 
corporation in exchange for its stock or securities in a transaction 
subject to section 354 or 355,

if no gain to the distributees from the receipt of such stock or 
securities was recognized by law.
    (2) The distribution in any taxable year (beginning before January 
1, 1939, or on or after such date) of stock or securities, or other 
property or money, to a corporation in complete liquidation of another 
corporation, under the circumstances described in section 112(b)(6) of 
the Revenue Act of 1936 (49 Stat. 1679), the Revenue Act of 1938 (52 
Stat. 485), of the Internal Revenue Code of 1939, or section 332 of the 
Internal Revenue Code of 1954.
    (3) The distribution in any taxable year (beginning after December 
31, 1938), of stock or securities, or other property or money, in the 
case of an exchange or distribution described in section 371 of the 
Internal Revenue Code of 1939 or in section 1081 of the Internal Revenue 
Code of 1954 (relating to exchanges and distributions in obedience to 
orders of the Securities and Exchange Commission), if no gain to the 
distributee from the receipt of such stock, securities, or other 
property or money was recognized by law.

[[Page 60]]

    (4) A stock dividend which was not subject to tax in the hands of 
the distributee because either it did not constitute income to him 
within the meaning of the sixteenth amendment to the Constitution or 
because exempt to him under section 115(f) of the Revenue Act of 1934 
(48 Stat. 712) or a corresponding provision of a prior Revenue Act, or 
section 305 of the Code.
    (5) The distribution, in a taxable year of the distributee beginning 
after December 31, 1931, by or on behalf of an insolvent corporation, in 
connection with a section 112(b)(10) reorganization under the Internal 
Revenue Code of 1939, or in a transaction subject to section 371 of the 
Internal Revenue Code of 1954, of stock or securities in a corporation 
organized or made use of to effectuate the plan of reorganization, if 
under section 112(e) of the Internal Revenue Code of 1939 or section 371 
of the Internal Revenue Code of 1954 no gain to the distributee from the 
receipt of such stock or securities was recognized by law.
    (c) A distribution described in paragraph (b) of this section does 
not diminish the earnings or profits of any corporation. In such cases, 
the earnings or profits remain intact and available for distribution as 
dividends by the corporation making such distribution, or by another 
corporation to which the earnings or profits are transferred upon such 
reorganization or other exchange. In the case, however, of amounts 
distributed in liquidation (other than a taxfree liquidation or 
reorganization described in paragraph (b)(1), (2), (3), or (5) of this 
section) the earnings or profits of the corporation making the 
distribution are diminished by the portion of such distribution properly 
chargeable to earnings or profits accumulated after February 28, 1913, 
after first deducting from the amount of such distribution the portion 
thereof allocable to capital account.
    (d) For the purposes of this section, the terms reorganization and 
party to the reorganization shall, for any taxable year beginning before 
January 1, 1934, have the meanings assigned to such terms in section 112 
of the Revenue Act of 1932 (47 Stat. 196); for any taxable year 
beginning after December 31, 1933, and before January 1, 1936, have the 
meanings assigned to such terms in section 112 of the Revenue Act of 
1934 (48 Stat. 704); for any taxable year beginning after December 31, 
1935, and before January 1, 1938, have the meanings assigned to such 
terms in section 112 of the Revenue Act of 1936 (49 Stat. 1678); for any 
taxable year beginning after December 31, 1937, and before January 1, 
1939, have the meanings assigned to such terms in section 112 of the 
Revenue Act of 1938 (52 Stat. 485); and for any taxable year beginning 
after December 31, 1938, and ending before June 22, 1954, providing no 
election is made under section 393(b)(2) of the Internal Revenue Code of 
1954, have the meanings assigned to such terms in section 112(g)(1) of 
the Internal Revenue Code of 1939.
    (e) Effective/applicability date. Paragraph (a) of this section 
applies to transactions occurring on or after November 10, 2014.

[ T.D. 6500, 25 FR 11607, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 9700, 79 FR 66617, Nov. 10, 2014]



Sec. 1.312-12  Distributions of proceeds of loans guaranteed by the 
United States.

    (a) The provisions of section 312(j) are applicable with respect to 
a loan, any portion of which is guaranteed by an agency of the United 
States Government without regard to the percentage of such loan subject 
to such guarantee.
    (b) The application of section 312(j) is illustrated by the 
following example:

    Example. Corporation A borrowed $1,000,000 for the purpose of 
construction of an apartment house, the cost and adjusted basis of which 
was $900,000. This loan was guaranteed by an agency of the United States 
Government. One year after such loan was made and after the completion 
of construction of the building (but before such corporation had 
received any income) it distributed $100,000 cash to its shareholders. 
The earnings and profits of the taxable year of such corporation are 
increased (pursuant to section 312(j)) by $100,000 immediately prior to 
such distribution and are decreased by $100,000 immediately after such 
distribution. Such decrease, however, does not reduce the earnings and 
profits below zero. Two years later, it has no accumulated earnings and 
has earnings of the taxable year of $100,000. Before it has made any 
payments on the loan, it distributes $200,000 to its shareholders. The

[[Page 61]]

earnings and profits of the taxable year of the corporation ($100,000) 
are increased by $100,000, the excess of the amount of the guaranteed 
loan over the adjusted basis of the apartment house (calculated without 
adjustment for depreciation). The entire amount of each distribution is 
treated as a distribution out of earnings and profits and, accordingly, 
as a taxable dividend.



Sec. 1.312-15  Effect of depreciation on earnings and profits.

    (a) Depreciation for taxable years beginning after June 30, 1972--
(1) In general. Except as provided in subparagraph (2) of this paragraph 
and paragraph (c) of this section, for purposes of computing the 
earnings and profits of a corporation (including a real estate 
investment trust as defined in section 856) for any taxable year 
beginning after June 30, 1972, the allowance for depreciation (and 
amortization, if any) shall be deemed to be the amount which would be 
allowable for such year if the straight line method of depreciation had 
been used for all property for which depreciation is allowable for each 
taxable year beginning after June 30, 1972. Thus, for taxable years 
beginning after June 30, 1972, in determining the earnings and profits 
of a corporation, depreciation must be computed under the straight line 
method, notwithstanding that in determining taxable income the 
corporation uses an accelerated method of depreciation described in 
subparagraph (A), (B), or (C) of section 312(m)(2) or elects to amortize 
the basis of property under section 169, 184, 187, or 188, or any 
similar provision. See Sec. 1.168(k)-1(f)(7) with respect to the 
treatment of the additional first year depreciation deduction allowable 
under section 168(k) for qualified property or 50-percent bonus 
depreciation property, and Sec. 1.1400L(b)-1(f)(7) with respect to the 
treatment of the additional first year depreciation deduction allowable 
under section 1400L(b) for qualified New York Liberty Zone property, for 
purposes of computing the earnings and profits of a corporation. 
Further, see Sec. 1.168(k)-2(g)(7) with respect to the treatment of the 
additional first year depreciation deduction allowable under section 
168(k), as amended by the Tax Cuts and Jobs Act, Public Law 115-97 (131 
Stat. 2054 (December 22, 2017)), for purposes of computing the earnings 
and profits of a corporation.
    (2) Exception. (i) If, for any taxable year beginning after June 30, 
1972, a method of depreciation is used by a corporation in computing 
taxable income which the Secretary or his delegate has determined 
results in a reasonable allowance under section 167(a) and which is not 
a declining balance method of depreciation (described in Sec. 1.167(b)-
2), the sum of the years-digits method (described in Sec. 1.167(b)-3), 
or any other method allowed solely by reason of the application of 
subsection (b)(4) or (j)(1)(C) of section 167, then the adjustment to 
earnings and profits for depreciation for such year shall be determined 
under the method so used (in lieu of the straight line method).
    (ii) The Commissioner has determined that the ``unit of production'' 
(see Sec. 1.167(b)-0(b)), and the ``machine hour'' methods of 
depreciation, when properly used under appropriate circumstances, meet 
the requirements of subdivision (i) of this subparagraph. Thus, the 
adjustment to earnings and profits for depreciation (for the taxable 
year for which either of such methods is properly used under appropriate 
circumstances) shall be determined under whichever of such methods is 
used to compute taxable income.
    (3) Determinations under straight line method. (i) In the case of 
property with respect to which an allowance for depreciation is claimed 
in computing taxable income, the determination of the amount which would 
be allowable under the straight line method shall be based on the manner 
in which the corporation computes depreciation in determining taxable 
income. Thus, if an election under Sec. 1.167(a)-11 is in effect with 
respect to the property, the amount of depreciation which would be 
allowable under the straight line method shall be determined under Sec. 
1.167(a)-11(g)(3). On the other hand, if property is not depreciated 
under the provisions of Sec. 1.167(a)-11, the amount of depreciation 
which would be allowable under the straight line method shall be 
determined under Sec. 1.167(b)-1. Any election made under section 
167(f), with respect to reducing the amount of salvage value taken into 
account in computing the depreciation allowance for certain

[[Page 62]]

property, or any convention adopted under Sec. 1.167(a)-10(b) or Sec. 
1.167(a)-11(c)(2), with respect to additions and retirements from 
multiple asset accounts, which is used in computing depreciation for 
taxable income shall be used in computing depreciation for earnings and 
profits purposes.
    (ii) In the case of property with respect to which an election to 
amortize is in effect under section 169, 184, 187, or 188, or any 
similar provision, the amount which would be allowable under the 
straight line method of depreciation shall be determined under the 
provisions of Sec. 1.167(b)-1. Thus, the cost or other basis of the 
property, less its estimated salvage value, is to be deducted in equal 
annual amounts over the period of the estimated useful life of the 
property. In computing the amount of depreciation for earnings and 
profits purposes, a taxpayer may utilize the provisions of section 
167(f) (relating to the reduction in the amount of salvage value taken 
into account in computing the depreciation allowance for certain 
property) and any convention which could have been adopted for such 
property under Sec. 1.167(a)-10(b) (relating to additions and 
retirements from multiple asset accounts).
    (b) Transitional rules--(1) Depreciation. If, for the taxable year 
which includes June 30, 1972, (i) the allowance for depreciation of any 
property is computed under a method other than the straight line method 
or a method described in paragraph (a)(2) of this section, and (ii) 
paragraph (a)(1) of this section applies to such property for the first 
taxable year beginning after June 30, 1972, then adjustments to earnings 
and profits for depreciation of such property for taxable years 
beginning after June 30, 1972, shall be determined as if the corporation 
changed to the straight line method with respect to such property as of 
the first day of the first taxable year beginning after June 30, 1972. 
Thus, if an election under Sec. 1.167 (a)-11 is in effect with respect 
to the property, the change shall be made under the provisions of Sec. 
1.167(a)-11(c)(1)(iii), except that no statement setting forth the 
vintage accounts for which the change is made shall be furnished with 
the income tax return of the year of change if the change is only for 
purposes of computing earnings and profits. In all other cases, the 
unrecovered cost or other basis of the property (less a reasonable 
estimate for salvage) as of such first day shall be recovered through 
equal annual allowances over the estimated remaining useful life 
determined in accordance with the circumstances existing at that time. 
See paragraph (a)(3)(i) of this section for rules relating to the 
applicability of section 167(f) in determining salvage value.
    (2) Amortization. If, for the taxable year which includes June 30, 
1972, the basis of any property is amortized under section 169, 184, 
187, or 188, or any similar provision, then adjustments to earnings and 
profits for depreciation or amortization of such property for taxable 
years beginning after June 30, 1972, shall be determined as if the 
unrecovered cost or other basis of the property (less a reasonable 
estimate for salvage) as of the first day of the first taxable year 
beginning after June 30, 1972, were recovered through equal annual 
allowances over the estimated remaining useful life of the property 
determined in accordance with the circumstances existing at that time. 
See paragraph (a)(3)(ii) of this section for rules relating to the 
applicability of section 167(f).
    (c) Certain foreign corporations. Paragraphs (a) and (b) of this 
section shall not apply in computing the earnings and profits of a 
foreign corporation for any taxable year for which less than 20 percent 
of the gross income from all sources of such corporation is derived from 
sources within the United States.
    (d) Books and records. Wherever different methods of depreciation 
are used for taxable income and earnings and profits purposes, records 
shall be maintained which show the depreciation taken for earnings and 
profits purposes each year and which will allow computation of the 
adjusted basis of the property in each account using the depreciation 
taken for earnings and profits purposes.
    (e) Applicability date of qualified property. The last sentence of 
paragraph (a)(1) of this section applies to the taxpayer's taxable years 
ending on or after September 24, 2019. However, a

[[Page 63]]

taxpayer may choose to apply the last sentence in paragraph (a)(1) of 
this section for the taxpayer's taxable years ending on or after 
September 28, 2017. A taxpayer may rely on the last sentence in 
paragraph (a)(1) of this section in regulation project REG-104397-18 
(2018-41 I.R.B. 558) (see Sec. 601.601(d)(2)(ii)(b) of this chapter) 
for the taxpayer's taxable years ending on or after September 28, 2017, 
and ending before the taxpayer's taxable year that includes September 
24, 2019.

[T.D. 7221, 37 FR 24746, Nov. 21, 1972, as amended by T.D. 9283, 71 FR 
51746, Aug. 31, 2006; T.D. 9874, 84 FR 50149, Sept. 24, 2019]

              definitions; constructive ownership of stock



Sec. 1.316-1  Dividends.

    (a)(1) The term dividend for the purpose of subtitle A of the Code 
(except when used in subchapter L, chapter 1 of the Code, in any case 
where the reference is to dividends and similar distributions of 
insurance companies paid to policyholders as such) comprises any 
distribution of property as defined in section 317 in the ordinary 
course of business, even though extraordinary in amount, made by a 
domestic or foreign corporation to its shareholders out of either--
    (i) Earnings and profits accumulated since February 28, 1913, or
    (ii) Earnings and profits of the taxable year computed without 
regard to the amount of the earnings and profits (whether of such year 
or accumulated since February 28, 1913) at the time the distribution was 
made.

The earnings and profits of the taxable year shall be computed as of the 
close of such year, without diminution by reason of any distributions 
made during the taxable year. For the purpose of determining whether a 
distribution constitutes a dividend, it is unnecessary to ascertain the 
amount of the earnings and profits accumulated since February 28, 1913, 
if the earnings and profits of the taxable year are equal to or in 
excess of the total amount of the distributions made within such year.
    (2) Where a corporation distributes property to its shareholders on 
or after June 22, 1954, the amount of the distribution which is a 
dividend to them may not exceed the earnings and profits of the 
distributing corporation.
    (3) The rule of (2) above may be illustrated by the following 
example:

    Example. X and Y, individuals, each own one-half of the stock of 
Corporation A which has earnings and profits of $10,000. Corporation A 
distributes property having a basis of $6,000 and a fair market value of 
$16,000 to its shareholders, each shareholder receiving property with a 
basis of $3,000 and with a fair market value of $8,000 in a distribution 
to which section 301 applies. The amount taxable to each shareholder as 
a dividend under section 301(c) is $5,000.

    (b)(1) In the case of a corporation which, under the law applicable 
to the taxable year in which a distribution is made, is a personal 
holding company or which, for the taxable year in respect of which a 
distribution is made under section 563 (relating to dividends paid 
within 2\1/2\ months after the close of the taxable year), or section 
547 (relating to deficiency dividends), or corresponding provisions of a 
prior income tax law, was under the applicable law a personal holding 
company, the term dividend, in addition to the meaning set forth in the 
first sentence of section 316, also means a distribution to its 
shareholders as follows: A distribution within a taxable year of the 
corporation, or of a shareholder, is a dividend to the extent of the 
corporation's undistributed personal holding company income (determined 
under section 545 without regard to distributions under section 
316(b)(2)) for the taxable year in which, or, in the case of a 
distribution under section 563 or section 547, the taxable year in 
respect of which, the distribution was made. This subparagraph does not 
apply to distributions in partial or complete liquidation of a personal 
holding company. In the case of certain complete liquidations of a 
personal holding company see subparagraph (2) of this paragraph.
    (2) In the case of a corporation which, under the law applicable to 
the taxable year in which a distribution is made, is a personal holding 
company or which, for the taxable year in respect of which a 
distribution is made under section 563, or section 547, or corresponding 
provisions of a prior income tax law, was under the applicable law a 
personal holding company, the term dividend, in

[[Page 64]]

addition to the meaning set forth in the first sentence of section 316, 
also means, in the case of a complete liquidation occurring within 24 
months after the adoption of a plan of liquidation, a distribution of 
property to its shareholders within such period, but--
    (i) Only to the extent of the amounts distributed to distributees 
other than corporate shareholders, and
    (ii) Only to the extent that the corporation designates such amounts 
as a dividend distribution and duly notifies such distributees in 
accordance with subparagraph (5) of this paragraph, but
    (iii) Not in excess of the sum of such distributees' allocable share 
of the undistributed personal holding company income for such year 
(determined under section 545 without regard to sections 562(b) and 
316(b)(2)(B)).

Section 316(b)(2)(B) and this subparagraph apply only to distributions 
made in any taxable year of the distributing corporation beginning after 
December 31, 1963. The amount designated with respect to a noncorporate 
distributee may not exceed the amount actually distributed to such 
distributee. For purposes of determining a noncorporate distributee's 
gain or loss on liquidation, amounts distributed in complete liquidation 
to such distributee during a taxable year are reduced by the amounts 
designated as a dividend with respect to such distributee for such year. 
For purposes of section 333(e)(1), a shareholder's ratable share of the 
earnings and profits of the corporation accumulated after February 28, 
1913, shall be reduced by the amounts designated as a dividend with 
respect to such shareholder (even though such designated amounts are 
distributed during the 1-month period referred to in section 333).
    (3) For purposes of subparagraph (2)(iii) of this paragraph--
    (i) Except as provided in subdivision (ii) of this subparagraph, the 
sum of the noncorporate distributees' allocable share of undistributed 
personal holding company income for the taxable year in which, or in 
respect of which, the distribution was made (computed without regard to 
sections 562(b) and 316(b)(2)(B)) shall be determined by multiplying 
such undistributed personal holding company income by the ratio which 
the aggregate value of the stock held by all noncorporate shareholders 
immediately before the record date of the last liquidating distribution 
in such year bears to the total value of all stock outstanding on such 
date. For rules applicable in a case where the distributing corporation 
has more than one class of stock, see subdivision (iii) of this 
subparagraph.
    (ii) If more than one liquidating distribution was made during the 
year, and if, after the record date of the first distribution but before 
the record date of the last distribution, there was a change in the 
relative shareholdings as between noncorporate shareholders and 
corporate shareholders, then the sum of the noncorporate distributees' 
allocable share of undistributed personal holding company income for the 
taxable year in which, or in respect of which, the distributions were 
made (computed without regard to sections 562(b) and 316(b)(2)(B)) shall 
be determined as follows:
    (a) First, allocate the corporation's undistributed personal holding 
company income among the distributions made during the taxable year by 
reference to the ratio which the aggregate amount of each distribution 
bears to the total amount of all distributions during such year;
    (b) Second, determine the noncorporate distributees' allocable share 
of the corporation's undistributed personal holding company income for 
each distribution by multiplying the amount determined under (a) of this 
subdivision (ii) for each distribution by the ratio which the aggregate 
value of the stock held by all noncorporate shareholders immediately 
before the record date of such distribution bears to the total value of 
all stock outstanding on such date; and
    (c) Last, determine the sum of the noncorporate distributees' 
allocable share of the corporation's undistributed personal holding 
company income for all such distributions.

For rules applicable in a case where the distributing corporation has 
more than one class of stock, see subdivision (iii) of this 
subparagraph.
    (iii) Where the distributing corporation has more than one class of 
stock--

[[Page 65]]

    (a) The undistributed personal holding company income for the 
taxable year in which, or in respect of which the distribution was made 
shall be treated as a fund from which dividends may properly be paid and 
shall be allocated between or among the classes of stock in a manner 
consistent with the dividend rights of such classes under local law and 
the pertinent governing instruments, such as, for example, the 
distributing corporation's articles or certificate of incorporation and 
bylaws;
    (b) The noncorporate distributees' allocable share of the 
undistributed personal holding company income for each class of stock 
shall be determined separately in accordance with the rules set forth in 
subdivisions (i) or (ii) of this subparagraph, as if each class of stock 
were the only class of stock outstanding; and
    (c) The sum of the noncorporate distributees' allocable share of the 
undistributed personal holding company income for the taxable year in 
which, or in respect of which, the distribution was made shall be the 
sum of the noncorporate distributees' allocable share of the 
undistributed personal holding company income for all classes of stock.
    (iv) For purposes of this subparagraph, in any case where the record 
date of a liquidating distribution cannot be ascertained, the record 
date of the distribution shall be the date on which the liquidating 
distribution was actually made.
    (4) The amount designated as a dividend to a noncorporate 
distributee for any taxable year of the distributing corporation may not 
exceed an amount equal to the sum of the noncorporate distributees' 
allocable share of undistributed personal holding company income (as 
determined under subparagraph (3) of this paragraph) for such year 
multiplied by the ratio which the aggregate value of the stock held by 
such distributee immediately before the record date of the liquidating 
distribution or, if the record date cannot be ascertained, immediately 
before the date on which the liquidating distribution was actually made, 
bears to the aggregate value of stock outstanding held by all 
noncorporate distributees on such date. In any case where more than one 
liquidating distribution is made during the taxable year, the aggregate 
amount which may be designated as a dividend to a noncorporate 
distributee for such year may not exceed the aggregate of the amounts 
determined by applying the principle of the preceding sentence to the 
amounts determined under subparagraphs (3)(ii)(a) and (b) of this 
paragraph for each distribution. Where the distributing corporation has 
more than one class of stock, the limitation on the amount which may be 
designated as a dividend to a noncorporate distributee for any taxable 
year shall be determined by applying the rules of this subparagraph 
separately with respect to the noncorporate distributees' allocable 
share of the undistributed personal holding company income for each 
class of stock (as determined under subparagraphs (3)(iii)(a) and (b) of 
this paragraph).
    (5) A corporation may designate as a dividend to a shareholder all 
or part of a distribution in complete liquidation described in section 
316(b)(2)(B) of this paragraph by:
    (i) Claiming a dividends paid deduction for such amount in its 
return for the year in which, or in respect of which, the distribution 
is made,
    (ii) Including such amount as a dividend in Form 1099 filed in 
respect of such shareholder pursuant to section 6042(a) and the 
regulations thereunder and in a written statement of dividend payments 
furnished to such shareholder pursuant to section 6042(c) and Sec. 
1.6042-4, and
    (iii) Indicating on the written statement of dividend payments 
furnished to such shareholder the amount included in such statement 
which is designated as a dividend under section 316(b)(2)(B) and this 
paragraph.

If a corporation complies with the procedure prescribed in the preceding 
sentence, it satisfies both the designation and notification 
requirements of section 316(b)(2)(B)(ii) and paragraph (b)(2)(ii) of 
this section. An amount designated as a dividend shall not be included 
as a distribution in liquidation on Form 1099L filed pursuant to Sec. 
1.6043-2 (relating to returns of information respecting distributions in 
liquidation). If a corporation designates a

[[Page 66]]

dividend in accordance with this subparagraph, it shall attach to the 
return in which it claims a deduction for such designated dividend a 
schedule indicating all facts necessary to determine the sum of the 
noncorporate distributees' allocable share of undistributed personal 
holding company income (determined in accordance with subparagraph (3) 
of this paragraph) for the year in which, or in respect of which, the 
distribution is made.
    (c) Except as provided in section 316(b)(1), the term dividend 
includes any distribution of property to shareholders to the extent made 
out of accumulated or current earnings and profits. See, however, 
section 331 (relating to distributions in complete or partial 
liquidation), section 301(e) (relating to distributions by personal 
service corporations), section 302(b) (relating to redemptions treated 
as amounts received from the sale or exchange of stock), and section 303 
(relating to distributions in redemption of stock to pay death taxes). 
See also section 305(b) for certain distributions of stock or stock 
rights treated as distributions of property.
    (d) In the case of a corporation which, under the law applicable to 
the taxable year in respect of which a distribution is made under 
section 860 (relating to deficiency dividends), was a regulated 
investment company (within the meaning of section 851), or a real estate 
investment trust (within the meaning of section 856), the term dividend, 
in addition to the meaning set forth in paragraphs (a) and (b) of 
section 316, means a distribution of property to its shareholders which 
constitutes a ``deficiency dividend'' as defined in section 860(f).
    (e) The application of section 316 may be illustrated by the 
following examples:

    Example 1. At the beginning of the calendar year 1955, Corporation M 
had an operating deficit of $200,000 and the earnings and profits for 
the year amounted to $100,000. Beginning on March 16, 1955, the 
corporation made quarterly distributions of $25,000 during the taxable 
year to its shareholders. Each distribution is a taxable dividend in 
full, irrespective of the actual or the pro rata amount of the earnings 
and profits on hand at any of the dates of distribution, since the total 
distributions made during the year ($100,000) did not exceed the total 
earnings and profits of the year ($100,000).
    Example 2. At the beginning of the calendar year 1955, Corporation 
N, a personal holding company, had no accumulated earnings and profits. 
During that year it made no earnings and profits but, due to the 
disallowance of certain deductions, its undistributed personal holding 
company income (determined under section 545 without regard to 
distributions under section 316(b)(2)) was $16,000. It distributed to 
shareholders on December 15, 1955, $15,000, and on February 1, 1956, 
$1,000, the latter amount being claimed as a deduction under section 563 
in its personal holding company schedule for 1955 filed with its return 
for 1955 on March 15, 1956. Both distributions are taxable dividends in 
full, since they do not exceed the undistributed personal holding 
company income (determined without regard to such distributions) for 
1955, the taxable year in which the distribution of $15,000 was made and 
with respect to which the distribution of $1,000 was made. It is 
immaterial whether Corporation N is a personal holding company for the 
taxable year 1956 or whether it had any income for that year.
    Example 3. In 1959, a deficiency in personal holding company tax was 
established against Corporation O for the taxable year 1955 in the 
amount of $35,500 based on an undistributed personal holding company 
income of $42,000. Corporation O complied with the provisions of section 
547 and in December 1959 distributed $42,000 to its stockholders as 
``deficiency dividends.'' The distribution of $42,000 is a taxable 
dividend since it does not exceed $42,000 (the undistributed personal 
holding company income for 1955, the taxable year with respect to which 
the distribution was made). It is immaterial whether Corporation O is a 
personal holding company for the taxable year 1959 or whether it had any 
income for that year.
    Example 4. At the beginning of the taxable year 1955, Corporation P, 
a personal holding company, had a deficit in earnings and profits of 
$200,000. During that year it made earnings and profits of $90,000. For 
that year, however, it had an undistributed personal holding income 
(determined under section 545 without regard to distributions under 
section 316(b)(2)) of $80,000. During such taxable year it distributed 
to its shareholders $100,000. The distribution of $100,000 is a taxable 
dividend to the extent of $90,000 since its earnings and profits for 
that year, $90,000, exceed $80,000, the undistributed personal holding 
company income determined without regard to such distribution.
    Example 5. Corporation O, a calendar year taxpayer, is completely 
liquidated on December 31, 1964, pursuant to a plan of liquidation 
adopted July 1, 1964. No distributions in liquidation were made pursuant 
to the plan of liquidation adopted July 1, 1964, until the

[[Page 67]]

distribution in complete liquidation on December 31, 1964. Corporation O 
has undistributed personal holding company income of $300,000 for the 
year 1964 (computed without regard to section 562(b) or section 
316(b)(2)(B)). On December 31, 1964, immediately before the record date 
of the distribution in complete liquidation, individual A owns 200 
shares of Corporation O's outstanding stock and Corporation P owns the 
remaining 100 shares of outstanding stock. All shares are equal in 
value. The noncorporate distributees' allocable share of undistributed 
personal holding company income for 1964 is $200,000

200 shares / 300 shares x $300,000.


If at least $200,000 is distributed to A in the liquidation, then 
Corporation O may designate $200,000 to A as a dividend in accordance 
with paragraph (b)(5) of this section, and, if such amount is 
designated, then A must treat $200,000 as a dividend to which section 
301 applies. For an example of the treatment of the distribution to 
Corporation P see paragraph (b)(2)(iii) of Sec. 1.562-1.
    Example 6. Corporation Q, a calendar year taxpayer, is completely 
liquidated on December 31, 1964, pursuant to a plan of liquidation 
adopted July 1, 1964. No distributions in liquidation were made pursuant 
to the plan of liquidation adopted July 1, 1964, until the distribution 
in complete liquidation on December 31, 1964. Corporation Q has 
undistributed personal holding company income of $40,000 for the year 
1964 (computed without regard to section 562(b) or section 
316(b)(2)(B)). On December 31, 1964, immediately before the record date 
of the distribution in complete liquidation, Corporation Q has 
outstanding 300 shares of common stock and 100 shares of noncumulative 
preferred stock. Corporation Q's articles of incorporation provide that 
the preferred stock is entitled to dividends of $10 per share per year. 
Of Corporation Q's stock, individual B owns 200 shares of the common 
stock and 50 shares of the preferred stock, and Corporation R owns all 
remaining shares. All of the common shares are equal in value, and all 
of the preferred shares are equal in value. No dividends had been paid 
on the preferred stock during the year 1964. Of the $40,000 of 
undistributed personal holding company income, $1,000 must be allocated 
to the preferred stock because of the rights of the holders of such 
stock, under Q's articles of incorporation, to receive that amount in 
dividends for the year 1964. The noncorporate distributees' allocable 
share of undistributed personal holding company income for 1964 is 
$26,500.

50 preferred shares / 100 preferred shares x $1,000 + 200 common shares 
          / 300 common shares x $39,000


If at least $26,500 is distributed to B in the liquidation, then 
corporation Q may designate $26,500 to B as a dividend in accordance 
with paragraph (b)(5) of this section, and, if such amount is 
designated, then B must treat $26,500 as a dividend to which section 301 
applies.
    Example 7. In 1979, a deficiency of $46,000 in the tax on real 
estate investment trust taxable income is established against 
corporation R for the taxable year 1977, based on an increase in real 
estate investment trust taxable income of $100,000. Corporation R 
complied with the provisions of section 860 and in December 1979 
distributed to its stockholders $100,000, which qualified as 
``deficiency dividends'' under section 860. The distribution of $100,000 
is a taxable dividend. It is immaterial whether corporation R is a real 
estate investment trust for the taxable year 1979 or whether it had 
accumulated or current earnings and profits in 1979. See section 
316(b)(3).

(Sec. 860(l) (92 Stat. 2849, 26 U.S.C. 860(l)); sec. 860(g) (92 Stat. 
2850, 26 U.S.C. 860(g)); and sec. 7805 (68A Stat. 917, 26 U.S.C. 7805))

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6625, 27 FR 
12541, Dec. 19, 1962; T.D. 6949, 33 FR 5519, Apr. 9, 1968; T.D. 7767, 46 
FR 11264, Feb. 6, 1981; T.D. 7936, 49 FR 2105, Jan. 18, 1984]



Sec. 1.316-2  Sources of distribution in general.

    (a) For the purpose of income taxation every distribution made by a 
corporation is made out of earnings and profits to the extent thereof 
and from the most recently accumulated earnings and profits. In 
determining the source of a distribution, consideration should be given 
first, to the earnings and profits of the taxable year; second, to the 
earnings and profits accumulated since February 28, 1913, only in the 
case where, and to the extent that, the distributions made during the 
taxable year are not regarded as out of the earnings and profits of that 
year; third, to the earnings and profits accumulated before March 1, 
1913, only after all the earnings and profits of the taxable year and 
all the earnings and profits accumulated since February 28, 1913, have 
been distributed; and, fourth, to sources other than earnings and 
profits only after the earnings and profits have been distributed.
    (b) If the earnings and profits of the taxable year (computed as of 
the close of the year without diminution by reason of any distributions 
made during the year and without regard to the amount of earnings and 
profits at the

[[Page 68]]

time of the distribution) are sufficient in amount to cover all the 
distributions made during that year, then each distribution is a taxable 
dividend. See Sec. 1.316-1. If the distributions made during the 
taxable year exceed the earnings and profits of such year, then that 
proportion of each distribution which the total of the earnings and 
profits of the year bears to the total distributions made during the 
year shall be regarded as out of the earnings and profits of that year. 
The portion of each such distribution which is not regarded as out of 
earnings and profits of the taxable year shall be considered a taxable 
dividend to the extent of the earnings and profits accumulated since 
February 28, 1913, and available on the date of the distribution. In any 
case in which it is necessary to determine the amount of earnings and 
profits accumulated since February 28, 1913, and the actual earnings and 
profits to the date of a distribution within any taxable year (whether 
beginning before January 1, 1936, or, in the case of an operating 
deficit, on or after that date) cannot be shown, the earnings and 
profits for the year (or accounting period, if less than a year) in 
which the distribution was made shall be prorated to the date of the 
distribution not counting the date on which the distribution was made.
    (c) The provisions of the section may be illustrated by the 
following example:

    Example. At the beginning of the calendar year 1955, Corporation M 
had $12,000 in earnings and profits accumulated since February 28, 1913. 
Its earnings and profits for 1955 amounted to $30,000. During the year 
it made quarterly cash distributions of $15,000 each. Of each of the 
four distributions made, $7,500 (that portion of $15,000 which the 
amount of $30,000, the total earnings and profits of the taxable year, 
bears to $60,000, the total distributions made during the year) was paid 
out of the earnings and profits of the taxable year; and of the first 
and second distributions, $7,500 and $4,500, respectively, were paid out 
of the earnings and profits accumulated after February 28, 1913, and 
before the taxable year, as follows:

----------------------------------------------------------------------------------------------------------------
                         Distributions during 1955                            Portion  Portion out
----------------------------------------------------------------------------  out of   of earnings
                                                                             earnings  accumulated
                                                                                and     since Feb.  Taxable amt.
                                                                              profits   28, 1913,      of each
                               Date                                 Amount    of the    and before  distribution
                                                                              taxable  the taxable
                                                                               year        year
----------------------------------------------------------------------------------------------------------------
March 10.........................................................   $15,000    $7,500      $7,500      $15,000
June 10..........................................................    15,000     7,500       4,500       12,000
September 10.....................................................    15,000     7,500  ...........       7,500
December 10......................................................    15,000     7,500  ...........       7,500
                                                                  ----------------------------------------------
  Total amount taxable as dividends..............................  ........  ........  ...........      42,000
----------------------------------------------------------------------------------------------------------------


    (d) Any distribution by a corporation out of earnings and profits 
accumulated before March 1, 1913, or out of increase in value of 
property accrued before March 1, 1913 (whether or not realized by sale 
or other disposition, and, if realized, whether before, on, or after 
March 1, 1913), is not a dividend within the meaning of subtitle A of 
the Code.
    (e) A reserve set up out of gross income by a corporation and 
maintained for the purpose of making good any loss of capital assets on 
account of depletion or depreciation is not a part of surplus out of 
which ordinary dividends may be paid. A distribution made from a 
depletion or a depreciation reserve based upon the cost or other basis 
of the property will not be considered as having been paid out of 
earnings and profits, but the amount thereof shall be applied against 
and reduce the cost or other basis of the stock upon which declared. If 
such a distribution is in excess of the basis, the excess shall be taxed 
as a gain from the sale or other disposition of property as provided in 
section 301(c)(3)(A). A distribution from a depletion reserve based upon 
discovery value to the extent that such reserve represents the excess of 
the discovery value over the cost or other basis for determining gain or 
loss, is, when received by the shareholders, taxable as an ordinary 
dividend. The amount by which a corporation's percentage depletion 
allowance for any year exceeds depletion sustained on cost or other 
basis, that is, determined without regard to discovery or percentage 
depletion allowances for the year

[[Page 69]]

of distribution or prior years, constitutes a part of the corporation's 
``earnings and profits accumulated after February 28, 1913,'' within the 
meaning of section 316, and, upon distribution to shareholders, is 
taxable to them as a dividend. A distribution made from that portion of 
a depletion reserve based upon a valuation as of March 1, 1913, which is 
in excess of the depletion reserve based upon cost, will not be 
considered as having been paid out of earnings and profits, but the 
amount of the distribution shall be applied against and reduce the cost 
or other basis of the stock upon which declared. See section 301. No 
distribution, however, can be made from such a reserve until all the 
earnings and profits of the corporation have first been distributed.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 9914, 85 FR 
66476, Oct. 20, 2020]



Sec. 1.317-1  Property defined.

    The term property, for purposes of part 1, subchapter C, chapter 1 
of the Code, means any property (including money, securities, and 
indebtedness to the corporation) other than stock, or rights to acquire 
stock, in the corporation making the distribution.



Sec. 1.318-1  Constructive ownership of stock; introduction.

    (a) For the purposes of certain provisions of chapter 1 of the Code, 
section 318(a) provides that stock owned by a taxpayer includes stock 
constructively owned by such taxpayer under the rules set forth in such 
section. An individual is considered to own the stock owned, directly or 
indirectly, by or for his spouse (other than a spouse who is legally 
separated from the individual under a decree of divorce or separate 
maintenance), and by or for his children, grandchildren, and parents. 
Under section 318(a)(2) and (3), constructive ownership rules are 
established for partnerships and partners, estates and beneficiaries, 
trusts and beneficiaries, and corporations and stockholders. If any 
person has an option to acquire stock, such stock is considered as owned 
by such person. The term option includes an option to acquire such an 
option and each of a series of such options.
    (b) In applying section 318(a) to determine the stock ownership of 
any person for any one purpose--
    (1) A corporation shall not be considered to own its own stock by 
reason of section 318(a)(3)(C);
    (2) In any case in which an amount of stock owned by any person may 
be included in the computation more than one time, such stock shall be 
included only once, in the manner in which it will impute to the person 
concerned the largest total stock ownership; and
    (3) In determining the 50-percent requirement of section 
318(a)(2)(C) and (3)(C), all of the stock owned actually and 
constructively by the person concerned shall be aggregated.

[T.D. 6969, 33 FR 11999, Aug. 23, 1968]



Sec. 1.318-2  Application of general rules.

    (a) The application of paragraph (b) of Sec. 1.318-1 may be 
illustrated by the following examples:

    Example 1. H, an individual, owns all of the stock of corporation A. 
Corporation A is not considered to own the stock owned by H in 
corporation A.
    Example 2. H, an individual, his wife, W, and his son, S, each own 
one-third of the stock of the Green Corporation. For purposes of 
determining the amount of stock owned by H, W, or S for purposes of 
section 318(a)(2)(C) and (3)(C), the amount of stock held by the other 
members of the family shall be added pursuant to paragraph (b)(3) of 
Sec. 1.318-1 in applying the 50-percent requirement of such section. H, 
W, or S, as the case may be, is for this purpose deemed to own 100 
percent of the stock of the Green Corporation.

    (b) The application of section 318(a)(1), relating to members of a 
family, may be illustrated by the following example:

    Example. An individual, H, his wife, W, his son, S, and his grandson 
(S's son), G, own the 100 outstanding shares of stock of a corporation, 
each owning 25 shares. H, W, and S are each considered as owning 100 
shares. G is considered as owning only 50 shares, that is, his own and 
his father's.

    (c) The application of section 318(a)(2) and (3), relating to 
partnerships, trusts and corporations, may be illustrated by the 
following examples:


[[Page 70]]


    Example 1. A, an individual, has a 50 percent interest in a 
partnership. The partnership owns 50 of the 100 outstanding shares of 
stock of a corporation, the remaining 50 shares being owned by A. The 
partnership is considered as owning 100 shares. A is considered as 
owning 75 shares.
    Example 2. A testamentary trust owns 25 of the outstanding 100 
shares of stock of a corporation. A, an individual, who holds a vested 
remainder in the trust having a value, computed actuarially equal to 4 
percent of the value of the trust property, owns the remaining 75 
shares. Since the interest of A in the trust is a vested interest rather 
than a contingent interest (whether or not remote), the trust is 
considered as owning 100 shares. A is considered as owning 76 shares.
    Example 3. The facts are the same as in (2), above, except that A's 
interest in the trust is a contingent remainder. A is considered as 
owning 76 shares. However, since A's interest in the trust is a remote 
contingent interest, the trust is not considered as owning any of the 
shares owned by A.
    Example 4. A and B, unrelated individuals, own 70 percent and 30 
percent, respectively, in value of the stock of Corporation M. 
Corporation M owns 50 of the 100 outstanding shares of stock of 
Corporation O, the remaining 50 shares being owned by A. Corporation M 
is considered as owning 100 shares of Corporation O, and A is considered 
as owning 85 shares.
    Example 5. A and B, unrelated individuals, own 70 percent and 30 
percent, respectively, of the stock of corporation M. A, B, and 
corporation M all own stock of corporation O. Since B owns less than 50 
percent in value of the stock of corporation M, neither B nor 
corporation M constructively owns the stock of corporation O owned by 
the other. However, for purposes of certain sections of the Code, such 
as sections 304 and 856(d), the 50-percent limitation of section 
318(a)(2)(C) and (3)(C) is disregarded or is reduced to less than 30 
percent. For such purposes, B constructively owns his proportionate 
share of the stock of corporation O owned directly by corporation M, and 
corporation M constructively owns the stock of corporation O owned by B.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33 FR 
11999, Aug. 23, 1968]



Sec. 1.318-3  Estates, trusts, and options.

    (a) For the purpose of applying section 318(a), relating to estates, 
property of a decedent shall be considered as owned by his estate if 
such property is subject to administration by the executor or 
administrator for the purpose of paying claims against the estate and 
expenses of administration notwithstanding that, under local law, legal 
title to such property vests in the decedent's heirs, legatees or 
devisees immediately upon death. The term beneficiary includes any 
person entitled to receive property of a decedent pursuant to a will or 
pursuant to laws of descent and distribution. A person shall no longer 
be considered a beneficiary of an estate when all the property to which 
he is entitled has been received by him, when he no longer has a claim 
against the estate arising out of having been a beneficiary, and when 
there is only a remote possibility that it will be necessary for the 
estate to seek the return of property or to seek payment from him by 
contribution or otherwise to satisfy claims against the estate or 
expenses of administration. When, pursuant to the preceding sentence, a 
person ceases to be a beneficiary, stock owned by him shall not 
thereafter be considered owned by the estate, and stock owned by the 
estate shall not thereafter be considered owned by him. The application 
of section 318(a) relating to estates may be illustrated by the 
following examples:

    Example 1. (a) A decedent's estate owns 50 of the 100 outstanding 
shares of stock of corporation X. The remaining shares are owned by 
three unrelated individuals, A, B, and C, who together own the entire 
interest in the estate. A owns 12 shares of stock of corporation X 
directly and is entitled to 50 percent of the estate. B owns 18 shares 
directly and has a life estate in the remaining 50 percent of the 
estate. C owns 20 shares directly and also owns the remainder interest 
after B's life estate.
    (b) If section 318(a)(5)(C) applies (see paragraph (c)(3) of Sec. 
1.318-4), the stock of corporation X is considered to be owned as 
follows: the estate is considered as owning 80 shares, 50 shares 
directly, 12 shares constructively through A, and 18 shares 
constructively through B; A is considered as owning 37 shares, 12 shares 
directly, and 25 shares constructively (50 percent of the 50 shares 
owned directly by the estate); B is considered as owning 43 shares, 18 
shares directly and 25 shares constructively (50 percent of the 50 
shares owned directly by the estate); C is considered as owning 20 
shares directly and no shares constructively. C is not considered a 
beneficiary of the estate under section 318(a) since he has no direct 
present interest in the property held by the estate nor in the income 
produced by such property.
    (c) If section 318(a)(5)(C) does not apply, A is considered as 
owning nine additional

[[Page 71]]

shares (50 percent of the 18 shares owned constructively by the estate 
through B), and B is considered as owning six additional shares (50 
percent of the 12 shares owned constructively by the estate through A).
    Example 2. Under the will of A, Blackacre is left to B for life, 
remainder to C, an unrelated individual. The residue of the estate 
consisting of stock of a corporation is left to D. B and D are 
beneficiaries of the estate under section 318(a). C is not considered a 
beneficiary since he has no direct present interest in Blackacre nor in 
the income produced by such property. The stock owned by the estate is 
considered as owned proportionately by B and D.

    (b) For the purpose of section 318(a)(2)(B) stock owned by a trust 
will be considered as being owned by its beneficiaries only to the 
extent of the interest of such beneficiaries in the trust. Accordingly, 
the interest of income beneficiaries, remainder beneficiaries, and other 
beneficiaries will be computed on an actuarial basis. Thus, if a trust 
owns 100 percent of the stock of Corporation A, and if, on an actuarial 
basis, W's life interest in the trust is 15 percent, Y's life interest 
is 25 percent, and Z's remainder interest is 60 percent, under this 
provision W will be considered to be the owner of 15 percent of the 
stock of Corporation A, Y will be considered to be the owner of 25 
percent of such stock, and Z will be considered to be the owner of 60 
percent of such stock. The factors and methods prescribed in Sec. 
20.2031-7 of this chapter (Estate Tax Regulations) for use in 
ascertaining the value of an interest in property for estate tax 
purposes shall be used in determining a beneficiary's actuarial interest 
in a trust for purposes of this section. See Sec. 20.2031-7 of this 
chapter (Estate Tax Regulations) for examples illustrating the use of 
these factors and methods.
    (c) The application of section 318(a) relating to options may be 
illustrated by the following example:

    Example. A and B, unrelated individuals, own all of the 100 
outstanding shares of stock of a corporation, each owning 50 shares. A 
has an option to acquire 25 of B's shares and has an option to acquire a 
further option to acquire the remaining 25 of B's shares. A is 
considered as owning the entire 100 shares of stock of the corporation.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33 FR 
11999, Aug. 23, 1968]



Sec. 1.318-4  Constructive ownership as actual ownership; exceptions.

    (a) In general. Section 318(a)(5)(A) provides that, except as 
provided in section 318(a)(5) (B) and (C), stock constructively owned by 
a person by reason of the application of section 318(a) (1), (2), (3), 
or (4) shall be considered as actually owned by such person for purposes 
of applying section 318(a) (1), (2), (3), and (4). For example, if a 
trust owns 50 percent of the stock of corporation X, stock of 
corporation Y owned by corporation X which is attributed to the trust 
may be further attributed to the beneficiaries of the trust.
    (b) Constructive family ownership. Section 318(a)(5)(B) provides 
that stock constructively owned by an individual by reason of ownership 
by a member of his family shall not be considered as owned by him for 
purposes of making another family member the constructive owner of such 
stock under section 318(a)(1). For example, if F and his two sons, A and 
B, each own one-third of the stock of a corporation, under section 
318(a)(1), A is treated as owning constructively the stock owned by his 
father but is not treated as owning the stock owned by B. Section 
318(a)(5)(B) prevents the attribution of the stock of one brother 
through the father to the other brother, an attribution beyond the scope 
of section 318(a)(1) directly.
    (c) Reattribution. (1) Section 318(a)(5)(C) provides that stock 
constructively owned by a partnership, estate, trust, or corporation by 
reason of the application of section 318(a)(3) shall not be considered 
as owned by it for purposes of applying section 318(a)(2) in order to 
make another the constructive owner of such stock. For example, if two 
unrelated individuals are beneficiaries of the same trust, stock held by 
one which is attributed to the trust under section 318(a)(3) is not 
reattributed from the trust to the other beneficiary. However, stock 
constructively owned by reason of section 318(a)(2) may be reattributed 
under section 318(a)(3). Thus, for example, if all the stock of 
corporations X and Y is owned by A, stock of corporation Z held by X is 
attributed to Y through A.
    (2) Section 318(a)(5)(C) does not prevent reattribution under 
section 318(a)(2) of stock constructively owned

[[Page 72]]

by an entity under section 318(a)(3) if the stock is also constructively 
owned by the entity under section 318(a)(4). For example, if individuals 
A and B are beneficiaries of a trust and the trust has an option to buy 
stock from A, B is considered under section 318(a)(2)(B) as owning a 
proportionate part of such stock.
    (3) Section 318(a)(5)(C) is effective on and after August 31, 1964, 
except that for purposes of sections 302 and 304 it does not apply with 
respect to distributions in payment for stock acquisitions or 
redemptions if such acquisitions or redemptions occurred before August 
31, 1964.

[T.D. 6969, 33 FR 11999, Aug. 23, 1968]

                         Corporate Liquidations

                          effects on recipients



Sec. 1.331-1  Corporate liquidations.

    (a) In general. Section 331 contains rules governing the extent to 
which gain or loss is recognized to a shareholder receiving a 
distribution in complete or partial liquidation of a corporation. Under 
section 331(a)(1), it is provided that amounts distributed in complete 
liquidation of a corporation shall be treated as in full payment in 
exchange for the stock. Under section 331(a)(2), it is provided that 
amounts distributed in partial liquidation of a corporation shall be 
treated as in full or part payment in exchange for the stock. For this 
purpose, the term partial liquidation shall have the meaning ascribed in 
section 346. If section 331 is applicable to the distribution of 
property by a corporation, section 301 (relating to the effects on a 
shareholder of distributions of property) has no application other than 
to a distribution in complete liquidation to which section 316(b)(2)(B) 
applies. See paragraph (b)(2) of Sec. 1.316-1.
    (b) Gain or loss. The gain or loss to a shareholder from a 
distribution in partial or complete liquidation is to be determined 
under section 1001 by comparing the amount of the distribution with the 
cost or other basis of the stock. The gain or loss will be recognized to 
the extent provided in section 1002 and will be subject to the 
provisions of parts I, II, and III (section 1201 and following), 
subchapter P, chapter 1 of the Code.
    (c) Recharacterization. A liquidation which is followed by a 
transfer to another corporation of all or part of the assets of the 
liquidating corporation or which is preceded by such a transfer may, 
however, have the effect of the distribution of a dividend or of a 
transaction in which no loss is recognized and gain is recognized only 
to the extent of ``other property.'' See sections 301 and 356.
    (d) Reporting requirement--(1) General rule. Every significant 
holder that transfers stock to the issuing corporation in exchange for 
property from such corporation must include on or with such holder's 
return for the year of such exchange the statement described in 
paragraph (d)(2) of this section unless--
    (i) The property is part of a distribution made pursuant to a 
corporate resolution reciting that the distribution is made in complete 
liquidation of the corporation; and
    (ii) The issuing corporation is completely liquidated and dissolved 
within one year after the distribution.
    (2) Statement. If required by paragraph (d)(1) of this section, a 
significant holder must include on or with such holder's return a 
statement entitled, ``STATEMENT PURSUANT TO Sec. 1.331-1(d) BY [INSERT 
NAME AND TAXPAYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A 
SIGNIFICANT HOLDER OF THE STOCK OF [INSERT NAME AND EMPLOYER 
IDENTIFICATION NUMBER (IF ANY) OF ISSUING CORPORATION].'' If a 
significant holder is a controlled foreign corporation (within the 
meaning of section 957), each United States shareholder (within the 
meaning of section 951(b)) with respect thereto must include this 
statement on or with its return. The statement must include--
    (i) The fair market value and basis of the stock transferred by the 
significant holder to the issuing corporation; and
    (ii) A description of the property received by the significant 
holder from the issuing corporation.
    (3) Definitions. For purposes of this section:

[[Page 73]]

    (i) Significant holder means any person that, immediately before the 
exchange--
    (A) Owned at least five percent (by vote or value) of the total 
outstanding stock of the issuing corporation if the stock owned by such 
person is publicly traded; or
    (B) Owned at least one percent (by vote or value) of the total 
outstanding stock of the issuing corporation if the stock owned by such 
person is not publicly traded.
    (ii) Publicly traded stock means stock that is listed on--
    (A) A national securities exchange registered under section 6 of the 
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
    (B) An interdealer quotation system sponsored by a national 
securities association registered under section 15A of the Securities 
Exchange Act of 1934 (15 U.S.C. 78o-3).
    (iii) Issuing corporation means the corporation that issued the 
shares of stock, some or all of which were transferred by a significant 
holder to such corporation in the exchange described in paragraph (d)(1) 
of this section.
    (4) Cross reference. See section 6043 of the Code for requirements 
relating to a return by a liquidating corporation.
    (e) Example. The provisions of this section may be illustrated by 
the following example:

    Example. A, an individual who makes his income tax returns on the 
calendar year basis, owns 20 shares of stock of the P Corporation, a 
domestic corporation, 10 shares of which were acquired in 1951 at a cost 
of $1,500 and the remainder of 10 shares in December 1954 at a cost of 
$2,900. He receives in April 1955 a distribution of $250 per share in 
complete liquidation, or $2,500 on the 10 shares acquired in 1951, and 
$2,500 on the 10 shares acquired in December 1954. The gain of $1,000 on 
the shares acquired in 1951 is a long-term capital gain to be treated as 
provided in parts I, II, and III (section 1201 and following), 
subchapter P, chapter 1 of the Code. The loss of $400 on the shares 
acquired in 1954 is a short-term capital loss to be treated as provided 
in parts I, II, and III (section 1201 and following), subchapter P, 
chapter 1 of the Code.
    (f) Effective/applicability date. Paragraph (d) of this section 
applies to any taxable year beginning on or after May 30, 2006. However, 
taxpayers may apply paragraph (d) of this section to any original 
Federal income tax return (including any amended return filed on or 
before the due date (including extensions) of such original return) 
timely filed on or after May 30, 2006. For taxable years beginning 
before May 30, 2006, see Sec. 1.331-1 as contained in 26 CFR part 1 in 
effect on April 1, 2006.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6949, 33 FR 
5521, Apr. 9, 1968; T.D. 9264, 71 FR 30594, May 30, 2006; T.D. 9329, 72 
FR 32797, June 14, 2007]



Sec. 1.332-1  Distributions in liquidation of subsidiary corporation;
general.

    Under the general rule prescribed by section 331 for the treatment 
of distributions in liquidation of a corporation, amounts received by 
one corporation in complete liquidation of another corporation are 
treated as in full payment in exchange for stock in such other 
corporation, and gain or loss from the receipt of such amounts is to be 
determined as provided in section 1001. Section 332 excepts from the 
general rule property received, under certain specifically described 
circumstances, by one corporation as a distribution in complete 
liquidation of the stock of another corporation and provides for the 
nonrecognition of gain or loss in those cases which meet the statutory 
requirements. Section 367 places a limitation on the application of 
section 332 in the case of foreign corporations. See section 334(b) for 
the basis for determining gain or loss from the subsequent sale of 
property received upon complete liquidations such as described in this 
section. See section 453(d)(4)(A) relative to distribution of 
installment obligations by subsidiary.



Sec. 1.332-2  Requirements for nonrecognition of gain or loss.

    (a) The nonrecognition of gain or loss under section 332 is limited 
to the receipt of property by a corporation that is the actual owner of 
stock (in the liquidating corporation) meeting the requirements of 
section 1504(a)(2). The recipient corporation must have been the owner 
of the specified amount of such stock on the date of the adoption of the 
plan of liquidation and have continued so to be at all times until the 
receipt of the property. If the recipient corporation does not continue 
qualified with

[[Page 74]]

respect to the ownership of stock of the liquidating corporation and if 
the failure to continue qualified occurs at any time prior to the 
completion of the transfer of all the property, the provisions for the 
nonrecognition of gain or loss do not apply to any distribution received 
under the plan.
    (b) Section 332 applies only to those cases in which the recipient 
corporation receives at least partial payment for the stock which it 
owns in the liquidating corporation. If section 332 is not applicable, 
see section 165(g) relative to allowance of losses on worthless 
securities.
    (c) To constitute a distribution in complete liquidation within the 
meaning of section 332, the distribution must be (1) made by the 
liquidating corporation in complete cancellation or redemption of all of 
its stock in accordance with a plan of liquidation, or (2) one of a 
series of distributions in complete cancellation or redemption of all 
its stock in accordance with a plan of liquidation. Where there is more 
than one distribution, it is essential that a status of liquidation 
exist at the time the first distribution is made under the plan and that 
such status continue until the liquidation is completed. Liquidation is 
completed when the liquidating corporation and the receiver or trustees 
in liquidation are finally divested of all the property (both tangible 
and intangible). A status of liquidation exists when the corporation 
ceases to be a going concern and its activities are merely for the 
purpose of winding up its affairs, paying its debts, and distributing 
any remaining balance to its shareholders. A liquidation may be 
completed prior to the actual dissolution of the liquidating 
corporation. However, legal dissolution of the corporation is not 
required. Nor will the mere retention of a nominal amount of assets for 
the sole purpose of preserving the corporation's legal existence 
disqualify the transaction. (See 26 CFR (1939) 39.22(a)-20 (Regulations 
118).)
    (d) If a transaction constitutes a distribution in complete 
liquidation within the meaning of the Internal Revenue Code of 1954 and 
satisfies the requirements of section 332, it is not material that it is 
otherwise described under the local law. If a liquidating corporation 
distributes all of its property in complete liquidation and if pursuant 
to the plan for such complete liquidation a corporation owning the 
specified amount of stock in the liquidating corporation receives 
property constituting amounts distributed in complete liquidation within 
the meaning of the Code and also receives other property attributable to 
shares not owned by it, the transfer of the property to the recipient 
corporation shall not be treated, by reason of the receipt of such other 
property, as not being a distribution (or one of a series of 
distributions) in complete cancellation or redemption of all of the 
stock of the liquidating corporation within the meaning of section 332, 
even though for purposes of those provisions relating to corporate 
reorganizations the amount received by the recipient corporation in 
excess of its ratable share is regarded as acquired upon the issuance of 
its stock or securities in a tax-free exchange as described in section 
361 and the cancellation or redemption of the stock not owned by the 
recipient corporation is treated as occurring as a result of a taxfree 
exchange described in section 354.
    (e) The application of these rules may be illustrated by the 
following example:

    Example. On September 1, 1954, the M Corporation had outstanding 
capital stock consisting of 3,000 shares of common stock, par value $100 
a share, and 1,000 shares of preferred stock, par value $100 a share, 
which preferred stock was limited and preferred as to dividends and had 
no voting rights. On that date, and thereafter until the date of 
dissolution of the M Corporation, the O Corporation owned 2,500 shares 
of common stock of the M Corporation. By statutory merger consummated on 
October 1, 1954, pursuant to a plan of liquidation adopted on September 
1, 1954, the M Corporation was merged into the O Corporation, the O 
Corporation under the plan issuing stock which was received by the other 
holders of the stock of the M Corporation. The receipt by the O 
Corporation of the properties of the M Corporation is a distribution 
received by the O Corporation in complete liquidation of the M 
Corporation within the meaning of section 332, and no gain or loss is 
recognized as the result of the receipt of such properties.
    (f) Applicability date. The first sentence of paragraph (a) of this 
section

[[Page 75]]

applies to plans of complete liquidation adopted after March 28, 1985, 
except as specified in section 1804(e)(6)(B)(ii) and (iii) of Pubic Law 
99-514.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 9759, 81 FR 17071, Mar. 28, 2016]



Sec. 1.332-3  Liquidations completed within one taxable year.

    If in a liquidation completed within one taxable year pursuant to a 
plan of complete liquidation, distributions in complete liquidation are 
received by a corporation which owns the specified amount of stock in 
the liquidating corporation and which continues qualified with respect 
to the ownership of such stock until the transfer of all the property 
within such year is completed (see paragraph (a) of Sec. 1.332-2), then 
no gain or loss shall be recognized with respect to the distributions 
received by the recipient corporation. In such case no waiver or bond is 
required of the recipient corporation under section 332.



Sec. 1.332-4  Liquidations covering more than one taxable year.

    (a) If the plan of liquidation is consummated by a series of 
distributions extending over a period of more than one taxable year, the 
nonrecognition of gain or loss with respect to the distributions in 
liquidation shall, in addition to the requirements of Sec. 1.332-2, be 
subject to the following requirements:
    (1) In order for the distribution in liquidation to be brought 
within the exception provided in section 332 to the general rule for 
computing gain or loss with respect to amounts received in liquidation 
of a corporation, the entire property of the corporation shall be 
transferred in accordance with a plan of liquidation, which plan shall 
include a statement showing the period within which the transfer of the 
property of the liquidating corporation to the recipient corporation is 
to be completed. The transfer of all the property under the liquidation 
must be completed within three years from the close of the taxable year 
during which is made the first of the series of distributions under the 
plan.
    (2) For each of the taxable years which falls wholly or partly 
within the period of liquidation, the recipient corporation shall, at 
the time of filing its return, file with the district director of 
internal revenue a waiver of the statute of limitations on assessment. 
The waiver shall be executed on such form as may be prescribed by the 
Commissioner and shall extend the period of assessment of all income and 
profits taxes for each such year to a date not earlier than one year 
after the last date of the period for assessment of such taxes for the 
last taxable year in which the transfer of the property of such 
liquidating corporation to the controlling corporation may be completed 
in accordance with section 332. Such waiver shall also contain such 
other terms with respect to assessment as may be considered by the 
Commissioner to be necessary to insure the assessment and collection of 
the correct tax liability for each year within the period of 
liquidation.
    (3) For each of the taxable years which falls wholly or partly 
within the period of liquidation, the recipient corporation may be 
required to file a bond, the amount of which shall be fixed by the 
district director. The bond shall contain all terms specified by the 
Commissioner, including provisions unequivocally assuring prompt payment 
of the excess of income and profits taxes (plus penalty, if any, and 
interest) as computed by the district director without regard to the 
provisions of sections 332 and 334(b) over such taxes computed with 
regard to such provisions, regardless of whether such excess may or may 
not be made the subject of a notice of deficiency under section 6212 and 
regardless of whether it may or may not be assessed. Any bond required 
under section 332 shall have such surety or sureties as the Commissioner 
may require. However, see 6 U.S.C. 15, providing that where a bond is 
required by law or regulations, in lieu of surety or sureties there may 
be deposited bonds or notes of the United States. Only surety companies 
holding certificates of authority from the Secretary as acceptable 
sureties on Federal bonds will be approved as sureties. The bonds shall 
be executed in triplicate so that the Commissioner, the taxpayer, and 
the surety or the depositary may each have a copy. On and after 
September 1, 1953, the functions

[[Page 76]]

of the Commissioner with respect to such bonds shall be performed by the 
district director for the internal revenue district in which the return 
was filed and any bond filed on or after such date shall be filed with 
such district director.
    (b) Pending the completion of the liquidation, if there is a 
compliance with paragraph (a) (1), (2), and (3) of this section and 
Sec. 1.332-2 with respect to the nonrecognition of gain or loss, the 
income and profits tax liability of the recipient corporation for each 
of the years covered in whole or in part by the liquidation shall be 
determined without the recognition of any gain or loss on account of the 
receipt of the distributions in liquidation. In such determination, the 
basis of the property or properties received by the recipient 
corporation shall be determined in accordance with section 334(b). 
However, if the transfer of the property is not completed within the 
three-year period allowed by section 332 or if the recipient corporation 
does not continue qualified with respect to the ownership of stock of 
the liquidating corporation as required by that section, gain or loss 
shall be recognized with respect to each distribution and the tax 
liability for each of the years covered in whole or in part by the 
liquidation shall be recomputed without regard to the provisions of 
section 332 or section 334(b) and the amount of any additional tax due 
upon such recomputation shall be promptly paid.



Sec. 1.332-5  Distributions in liquidation as affecting minority
interests.

    Upon the liquidation of a corporation in pursuance of a plan of 
complete liquidation, the gain or loss of minority shareholders shall be 
determined without regard to section 332, since it does not apply to 
that part of distributions in liquidation received by minority 
shareholders.



Sec. 1.332-6  Records to be kept and information to be filed with 
return.

    (a) Statement filed by recipient corporation. If any recipient 
corporation received a liquidating distribution from the liquidating 
corporation pursuant to a plan (whether or not that recipient 
corporation has received or will receive other such distributions from 
the liquidating corporation in other tax years as part of the same plan) 
during the current tax year, such recipient corporation must include a 
statement entitled, ``STATEMENT PURSUANT TO SECTION 332 BY [INSERT NAME 
AND EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A CORPORATION 
RECEIVING A LIQUIDATING DISTRIBUTION,'' on or with its return for such 
year. If any recipient corporation is a controlled foreign corporation 
(within the meaning of section 957), each United States shareholder 
(within the meaning of section 951(b)) with respect thereto must include 
this statement on or with its return. The statement must include--
    (1) The name and employer identification number (if any) of the 
liquidating corporation;
    (2) The date(s) of all distribution(s) (whether or not pursuant to 
the plan) by the liquidating corporation during the current tax year;
    (3) The fair market value and basis of assets of the liquidating 
corporation that have been or will be transferred to any recipient 
corporation, aggregated as follows:
    (i) Importation property distributed in a loss importation 
transaction, as defined in Sec. 1.362-3(c)(2) and (3) (except that 
``section 332 liquidation'' is substituted for ``section 362 
transaction''), respectively;
    (ii) Property with respect to which gain or loss was recognized on 
the distribution;
    (iii) Property not described in paragraph (a)(3)(i) or (ii) of this 
section;
    (4) The date and control number of any private letter ruling(s) 
issued by the Internal Revenue Service in connection with the 
liquidation;
    (5) The following representation: THE PLAN OF COMPLETE LIQUIDATION 
WAS ADOPTED ON [INSERT DATE (mm/dd/yyyy)]; and
    (6) A representation by such recipient corporation either that--
    (i) THE LIQUIDATION WAS COMPLETED ON [INSERT DATE (mm/dd/yyyy)]; or
    (ii) THE LIQUIDATION IS NOT COMPLETE AND THE TAXPAYER HAS TIMELY 
FILED [INSERT EITHER FORM 952, ``Consent To Extend the

[[Page 77]]

Time to Assess Tax Under Section 332(b),'' OR NUMBER AND NAME OF THE 
SUCCESSOR FORM].
    (b) Filings by the liquidating corporation. The liquidating 
corporation must timely file Form 966, ``Corporate Dissolution or 
Liquidation,'' (or its successor form) and its final Federal corporate 
income tax return. See also section 6043 of the Code.
    (c) Definitions. For purposes of this section:
    (1) Plan means the plan of complete liquidation within the meaning 
of section 332.
    (2) Recipient corporation means the corporation described in section 
332(b)(1).
    (3) Liquidating corporation means the corporation that makes a 
distribution of property to a recipient corporation pursuant to the 
plan.
    (4) Liquidating distribution means a distribution of property made 
by the liquidating corporation to a recipient corporation pursuant to 
the plan.
    (d) Substantiation information. Under Sec. 1.6001-1(e), taxpayers 
are required to retain their permanent records and make such records 
available to any authorized Internal Revenue Service officers and 
employees. In connection with a liquidation described in this section, 
these records should specifically include information regarding the 
amount, basis, and fair market value of all distributed property, and 
relevant facts regarding any liabilities assumed or extinguished as part 
of such liquidation.
    (e) Effective/applicability date. This section applies to any 
taxable year beginning on or after May 30, 2006. However, taxpayers may 
apply this section to any original Federal income tax return (including 
any amended return filed on or before the due date (including 
extensions) of such original return) timely filed on or after May 30, 
2006. For taxable years beginning before May 30, 2006, see Sec. 1.332-6 
as contained in 26 CFR part 1 in effect on April 1, 2006. Paragraph 
(a)(3) of this section applies with respect to liquidations under 
section 332 occurring on or after March 28, 2016, and also with respect 
to liquidations under section 332 occurring before such date as a result 
of an entity classification election under Sec. 301.7701-3 of this 
chapter filed on or after March 28, 2016, unless such liquidation is 
pursuant to a binding agreement that was in effect prior to March 28, 
2016 and at all times thereafter.

[T.D. 9329, 72 FR 32797, June 14, 2007, as amended by T.D. 9759, 81 FR 
17071, Mar. 28, 2016]



Sec. 1.332-7  Indebtedness of subsidiary to parent.

    If section 332(a) is applicable to the receipt of the subsidiary's 
property in complete liquidation, then no gain or loss shall be 
recognized to the subsidiary upon the transfer of such properties even 
though some of the properties are transferred in satisfaction of the 
subsidiary's indebtedness to its parent. See section 337(b)(1). However, 
any gain or loss realized by the parent corporation on such satisfaction 
of indebtedness, shall be recognized to the parent corporation at the 
time of the liquidation. For example, if the parent corporation 
purchased its subsidiary's bonds at a discount and upon liquidation of 
the subsidiary the parent corporation receives payment for the face 
amount of such bonds, gain shall be recognized to the parent 
corporation. Such gain shall be measured by the difference between the 
cost or other basis of the bonds to the parent and the amount received 
in payment of the bonds.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 9759, 81 FR 17071, Mar. 28, 2016]



Sec. 1.332-8  Recognition of gain on liquidation of certain holding companies.

    (a) Definition of controlled foreign corporation. For purposes of 
section 332(d)(3), a controlled foreign corporation has the meaning 
provided in section 957, determined without applying section 
318(a)(3)(A), (B), and (C) so as to consider a United States person as 
owning stock which is owned by a person who is not a United States 
person.
    (b) Applicability date. This section applies to distributions in 
complete liquidation occurring on or after October 1, 2019, and to 
distributions in complete liquidation occurring before October 1,

[[Page 78]]

2019, that result from an entity classification election made under 
Sec. 301.7701-3 of this chapter that is filed on or after October 1, 
2019. For distributions in complete liquidation occurring before October 
1, 2019, other than distributions in complete liquidation occurring 
before October 1, 2019, that result from an entity classification 
election made under Sec. 301.7701-3 of this chapter that is filed on or 
after October 1, 2019, a taxpayer may apply this section to 
distributions in complete liquidation occurring during the last taxable 
year of a distributee foreign corporation beginning before January 1, 
2018, and each subsequent taxable year of the foreign corporation, 
provided that the taxpayer and United States persons that are related 
(within the meaning of section 267 or 707) to the taxpayer consistently 
apply this section with respect to all foreign corporations.

[T.D. 9908, 85 FR 59431, Sept. 22, 2020]



Sec. 1.334-1  Basis of property received in liquidations.

    (a) In general. Section 334 sets forth rules for determining a 
distributee's basis in property received in a distribution in complete 
liquidation of a corporation. The general rule is set forth in section 
334(a) and provides that, if property is received in a distribution in 
complete liquidation of a corporation and if gain or loss is recognized 
on the receipt of the property, then the distributee's basis in the 
property is the fair market value of the property at the time of the 
distribution. However, if property is received in a complete liquidation 
to which section 332 applies, including property received in 
satisfaction of an indebtedness described in section 337(b)(1), see 
section 334(b)(1) and paragraph (b) of this section.
    (b) Liquidations under section 332--(1) General rule. Except as 
otherwise provided in paragraph (b)(2) or (3) of this section, if a 
corporation (P) meeting the ownership requirements of section 332(b)(1) 
receives property from a subsidiary (S) in a complete liquidation to 
which section 332 applies (section 332 liquidation), including property 
received in a transfer in satisfaction of indebtedness that satisfies 
the requirements of section 337(b)(1), P's basis in the property 
received is the same as S's basis in the property immediately before the 
property was distributed. However, see Sec. 1.460-4(k)(3)(iv)(B)(2) for 
rules relating to adjustments to the basis of certain contracts 
accounted for using a long-term contract method of accounting that are 
acquired in a section 332 liquidation.
    (2) Basis in property with respect to which gain or loss was 
recognized. Except as otherwise provided in Subtitle A of the Internal 
Revenue Code (Code) and this subchapter of the Income Tax Regulations, 
if S recognizes gain or loss on the distribution of property to P in a 
section 332 liquidation, P's basis in that property is the fair market 
value of the property at the time of the distribution. Section 
334(b)(1)(A) (certain tax-exempt distributions under section 337(b)(2)); 
see also, for example, Sec. 1.367(e)-2(b)(3)(i).
    (3) Basis in importation property received in loss importation 
transaction--(i) Purpose. The purpose of section 334(b)(1)(B) and this 
paragraph (b)(3) is to modify the application of this section to prevent 
P from importing a net built-in loss in a transaction described in 
section 332. See paragraph (b)(3)(iii)(A) of this section for 
definitions of terms used in this paragraph (b)(3).
    (ii) Determination of basis. Notwithstanding paragraph (b)(1) of 
this section, if a section 332 liquidation is a loss importation 
transaction, P's basis in each importation property received from S in 
the liquidation is an amount that is equal to the value of the property. 
The basis of property received in a section 332 liquidation that is not 
importation property received in a loss importation transaction is 
determined under generally applicable basis rules without regard to 
whether the liquidation also involves the receipt of importation 
property in a loss importation transaction.
    (iii) Operating rules--(A) In general. For purposes of section 
334(b)(1)(B) and this paragraph (b)(3), the provisions of Sec. 1.362-3 
(basis of importation property received in a loss importation 
transaction) apply, adjusted as appropriate to apply to section 332 
liquidations. Thus, when used in this paragraph

[[Page 79]]

(b)(3), the terms ``importation property,'' ``loss importation 
transaction,'' and ``value'' have the same meaning as in Sec. 1.362-
3(c)(2), (3), and (4), respectively, except that ``the section 332(b)(1) 
distributee corporation'' is substituted for ``Acquiring'' and ``section 
332 liquidation'' is substituted for ``section 362 transaction.'' 
Similarly, when gain or loss on property would be owned or treated as 
owned by multiple persons, the provisions of Sec. 1.362-3(d)(2) apply 
to tentatively divide the property in applying this section, 
substituting ``section 332 liquidation'' for ``section 362 transaction'' 
and making such other adjustments as necessary.
    (B) Time for making determinations. For purposes of section 
334(b)(1)(B) and this paragraph (b)(3)--
    (1) P's basis in distributed property. P's basis in each property S 
distributes to P in the section 332 liquidation is determined 
immediately after S distributes each such property;
    (2) Value of distributed property. The value of each property S 
distributes to P in the section 332 liquidation is determined 
immediately after S distributes the property;
    (3) Importation property. The determination of whether each property 
distributed by S is importation property is made as of the time S 
distributes each such property;
    (4) Loss importation transaction. The determination of whether a 
section 332 liquidation is a loss importation transaction is made 
immediately after S makes the final liquidating distribution to P.
    (C) Effect of basis determination under this paragraph (b)(3)--(1) 
Determination by reference to transferor's basis. A determination of 
basis under section 334(b)(1)(B) and this paragraph (b)(3) is a 
determination by reference to the transferor's basis, including for 
purposes of sections 1223(2) and 7701(a)(43). However, solely for 
purposes of applying section 755, a determination of basis under this 
paragraph (b)(3) is treated as a determination not by reference to the 
transferor's basis.
    (2) Not tax-exempt income or noncapital, nondeductible expense. The 
application of this paragraph (b)(3) does not give rise to an item 
treated as tax-exempt income under Sec. 1.1502-32(b)(2)(ii) or as a 
noncapital, nondeductible expense under Sec. 1.1502-32(b)(2)(iii).
    (3) No effect on earnings and profits. Any determination of basis 
under this paragraph (b)(3) does not reduce or otherwise affect the 
calculation of the all earnings and profits amount provided in Sec. 
1.367(b)-2(d).
    (iv) Examples. The examples in this paragraph (b)(3)(iv) illustrate 
the application of section 334(b)(1)(B) and the provisions of this 
paragraph (b)(3). Unless the facts indicate otherwise, the examples use 
the following nomenclature and assumptions: USP is a domestic 
corporation that has not elected to be an S corporation within the 
meaning of section 1361(a)(1); FC, CFC1, and CFC2 are controlled foreign 
corporations within the meaning of section 957(a), which are not engaged 
in a U.S. trade or business, have no U.S. real property interests, and 
have no other relationships, activities, or interests that would cause 
their property to be subject to any tax imposed under subtitle A of the 
Code (federal income tax); there is no applicable income tax treaty; and 
all persons and transactions are unrelated. All other relevant facts are 
set forth in the examples:

    Example 1. Basic application of this paragraph (b)(3). (i) 
Distribution of importation property in a loss importation transaction. 
(A) Facts. USP owns the sole outstanding share of FC stock. FC owns 
three assets, A1 (basis $40, value $50), A2 (basis $120, value $30), and 
A3 (basis $140, value $20). On Date 1, FC distributes A1, A2, and A3 to 
USP in a complete liquidation that qualifies under section 332.
    (B) Importation property. Under Sec. 1.362-3(d)(2), the fact that 
any gain or loss recognized by a CFC may affect an income inclusion 
under section 951(a) does not alone cause gain or loss recognized by the 
CFC to be treated as taken into account in determining a federal income 
tax liability for purposes of this section. Thus, if FC had sold either 
A1, A2, or A3 immediately before the transaction, no gain or loss 
recognized on the sale would have been taken into account in determining 
a federal income tax liability. Further, if USP had sold A1, A2, or A3 
immediately after the transaction, USP would take into account any gain 
or loss recognized on the sale in determining its federal income tax 
liability. Therefore, A1, A2, and A3 are all importation properties. See 
paragraph (b)(3)(iii)(A) of this section and Sec. 1.362-3(c)(2).

[[Page 80]]

    (C) Loss importation transaction. Immediately after the 
distribution, USP's aggregate basis in the importation properties, A1, 
A2, and A3, would, but for section 334(b)(1)(B) and this section, be 
$300 ($40 + $120 + $140) and the properties' aggregate value would be 
$100 ($50 + $30 + $20). Therefore, the importation properties' aggregate 
basis would exceed their aggregate value and the distribution is a loss 
importation transaction. See paragraph (b)(3)(iii)(A) of this section 
and Sec. 1.362-3(c)(3).
    (D) Basis of importation property distributed in loss importation 
transaction. Because the importation properties, A1, A2, and A3, were 
transferred in a loss importation transaction, the basis in each of the 
importation properties received is equal to its value immediately after 
FC distributes the property. Accordingly, USP's basis in A1 is $50; 
USP's basis in A2 is $30; and USP's basis in A3 is $20.
    (ii) Distribution of both importation and non-importation property 
in a loss importation transaction. (A) Facts. The facts are the same as 
in paragraph (i)(A) of this Example 1 except that FC is engaged in a 
U.S. trade or business and A3 is used in that U.S. trade or business.
    (B) Importation property. A1 and A2 are importation properties for 
the reasons set forth in paragraph (i)(B) of this Example 1. However, if 
FC had sold A3 immediately before the transaction, FC would take into 
account any gain or loss recognized on the sale in determining its 
federal income tax liability. Therefore, A3 is not importation property. 
See paragraph (b)(3)(iii)(A) of this section and Sec. 1.362-3(c)(2).
    (C) Loss importation transaction. Immediately after the 
distribution, USP's aggregate basis in the importation properties, A1 
and A2, would, but for section 334(b)(1)(B) and this section, be $160 
($40 + $120). Further, the properties' aggregate value would be $80 ($50 
+ $30). Therefore, the importation properties' aggregate basis would 
exceed their aggregate value and the distribution is a loss importation 
transaction. See paragraph (b)(3)(iii)(A) of this section and Sec. 
1.362-3(c)(3).
    (D) Basis of importation property distributed in loss importation 
transaction. Because the importation properties, A1 and A2, were 
transferred in a loss importation transaction, the basis in each of the 
importation properties received is equal to its value immediately after 
FC distributes the property. Accordingly, USP's basis in A1 is $50 and 
USP's basis in A2 is $30.
    (E) Basis of other property. Because A3 is not importation property 
distributed in a loss importation transaction, USP's basis in A3 is 
determined under generally applicable basis rules. Accordingly, USP's 
basis in A3 is $140, the adjusted basis that FC had in the property 
immediately before the distribution. See section 334(b)(1).
    (iii) FC not wholly owned. The facts are the same as in paragraph 
(i)(A) of this Example 1 except that USP owns only 80% of the sole 
outstanding class of FC stock and the remaining 20% is owned by 
individual X. Further, on Date 1 and pursuant to the plan of 
liquidation, FC distributes A1 and A2 to USP and A3 to X. A1 and A2 are 
importation properties, the distribution to USP is a loss importation 
transaction, and USP's bases in A1 and A2 are equal to their value ($50 
and $30, respectively) for the reasons set forth in paragraphs (ii)(C) 
and (D) of this Example 1. Under section 334(a), X's basis in A3 is $20.
    (iv) Importation property, no net built in loss. (A) Facts. The 
facts are the same as in paragraph (i)(A) of this Example 1 except that 
the value of A2 is $230.
    (B) Importation property. A1, A2, and A3, are importation properties 
for the reasons set forth in paragraph (i)(B) of this Example 1.
    (C) Loss importation transaction. Immediately after the 
distribution, USP's aggregate basis in the importation properties, A1, 
A2, and A3, would, but for section 334(b)(1)(B) and this section, be 
$300 ($40 + $120 + $140). However, the properties' aggregate value would 
also be $300 ($50 + $230 + $20). Therefore, the importation properties' 
aggregate basis would not exceed their aggregate value and the 
distribution is not a loss importation transaction. See paragraph 
(b)(3)(iii)(A) of this section and Sec. 1.362-3(c)(3).
    (D) Basis of importation property not distributed in loss 
importation transaction. Because the importation properties, A1, A2, and 
A3, were not distributed in a loss importation transaction, the basis of 
each of the importation properties is determined under the generally 
applicable basis rules. Accordingly, immediately after the distribution, 
USP's basis in A1 is $40, USP's basis in A2 is $120, and USP's basis in 
A3 is $140, the adjusted bases that FC had in the properties immediately 
before the distribution. See section 334(b)(1).
    (v) CFC stock as importation property distributed in loss 
importation transaction. (A) Facts. USP owns the sole outstanding share 
of FC stock. FC owns the sole outstanding share of CFC1 stock (basis 
$80, value $100) and the sole outstanding share of CFC2 stock (basis 
$100, value $5). On Date 1, FC distributes its shares of CFC1 and CFC2 
stock to USP in a complete liquidation that qualifies under section 332.
    (B) Importation property. No special rule applies to the treatment 
of property that is the stock of a CFC. Thus, if FC had sold either the 
CFC1 share or the CFC2 share immediately before the transaction, no gain 
or loss recognized on the sale would have been taken into account in 
determining a federal income tax liability. Further, if USP had sold 
either the CFC1 share or the CFC2 share immediately after the 
transaction, USP

[[Page 81]]

would take into account any gain or loss recognized on the sale in 
determining its federal income tax liability. Thus, the CFC1 share and 
the CFC2 share are importation property. See paragraph (b)(3)(iii)(A) of 
this section and Sec. 1.362-3(c)(2).
    (C) Loss importation transaction. Immediately after the 
distribution, USP's aggregate basis in importation property (the CFC1 
share and the CFC2 share) would, but for section 334(b)(1)(B) and this 
section, be $180 ($80 + $100) and the shares' aggregate value is $105 
($100 + $5). Therefore, the importation property's aggregate basis would 
exceed their aggregate value and the distribution is a loss importation 
transaction. See paragraph (b)(3)(iii)(A) of this section and Sec. 
1.362-3(c)(3).
    (D) Basis of importation property distributed in loss importation 
transaction. Because the importation property (the CFC1 share and the 
CFC2 share) was transferred in a loss importation transaction, USP's 
basis in each of the shares received is equal to its value immediately 
after FC distributes the shares. Accordingly, USP's basis in the CFC1 
share is $100 and USP's basis in the CFC2 share is $5.
    Example 2. Multiple step liquidation. (i) Facts. USP owns the sole 
outstanding share of FC stock. On January 1 of year 1, FC adopts a plan 
of liquidation. FC makes the following distributions to USP in a 
transaction that qualifies as a complete liquidation under section 332. 
In year 1, FC distributes A1 and, immediately before the distribution, 
FC's basis in A1 is $100 and A1's value is $120. In Year 2, FC 
distributes A2, and, immediately before the distribution, FC's basis in 
A2 is $100 and A2's value is $120. In year 3, in its final liquidating 
distribution, FC distributes A3 and, immediately before the 
distribution, FC's basis in A3 is $100 and A3's value is $120. As of the 
time of the final distribution, USP had depreciated the bases of A1 and 
A2 to $90 and $95, respectively; the value of A1 had appreciated to 
$160; and, the value of A2 has declined to $0.
    (ii) Importation property. If FC had sold either A1, A2, or A3 
immediately before it was distributed, no gain or loss recognized on the 
sale would have been taken into account in determining a federal income 
tax liability. Further, if USP had sold either A1, A2, or A3 immediately 
after it was distributed, USP would take into account any gain or loss 
recognized on the sale in determining its federal income tax liability. 
Therefore, A1, A2, and A3 are all importation properties. See paragraph 
(b)(3)(iii)(A) of this section and Sec. 1.362-3(c)(2).
    (iii) Loss importation transaction. Immediately after it was 
distributed, USP's basis in each of the importation properties, A1, A2, 
and A3, would, but for section 334(b)(1)(B) and this section, have been 
$100. Further, immediately after each such property was distributed, its 
value was $120. Thus, the properties' aggregate basis, $300, would not 
have exceeded the properties' aggregate value, $360. Accordingly, the 
distribution is not a loss importation transaction irrespective of the 
fact that, when the liquidation was completed, the properties' aggregate 
basis was $285 and the properties' aggregate value was $280. See 
paragraph (b)(3)(iii)(B) of this section and Sec. 1.362-3(c)(3).
    (iv) Basis of importation property not distributed in loss 
importation transaction. Because the importation properties, A1, A2, and 
A3, were not distributed in a loss importation transaction, the basis of 
each of the importation properties is determined under the generally 
applicable basis rules. Accordingly, USP takes each of the properties 
with a basis of $100 and, immediately after the final distribution, has 
an adjusted basis of $90 in A1 (USP's $100 basis less the $10 
depreciation), $95 in A2 (USP's $100 basis less the $5 depreciation), 
and $100 in A3. See section 334(b).

    (c) Applicability date. This section applies with respect to 
liquidations occurring on or after March 28, 2016, and also with respect 
to liquidations occurring before such date as a result of an entity 
classification election under Sec. 301.7701-3 of this chapter filed on 
or after March 28, 2016, unless such liquidation is pursuant to a 
binding agreement that was in effect prior to March 28, 2016 and at all 
times thereafter. In addition, taxpayers may apply this section to any 
section 332 liquidation occurring after October 22, 2004.

[T.D. 9759, 81 FR 17071, Mar. 28, 2016]



Sec. 1.336-0  Table of contents.

    This section lists captions contained in Sec. Sec. 1.336-1, 1.336-
2, 1.336-3, 1.336-4, and 1.336-5.

 Sec. 1.336-1 General principles, nomenclature, and definitions for a 
                        section 336(e) election.

    (a) Overview.
    (1) In general.
    (2) Consistency rules.
    (b) Definitions.
    (1) Seller.
    (2) Purchaser.
    (3) Target; S corporation target; old target; new target.
    (4) S corporation shareholders.
    (5) Disposed of; disposition.
    (i) In general.
    (ii) Exception for disposition of stock in certain section 355 
transactions.
    (iii) Transactions with related persons.
    (iv) No consideration paid.
    (v) Disposed of stock reacquired by certain persons.

[[Page 82]]

    (6) Qualified stock disposition.
    (i) In general.
    (ii) Overlap with qualified stock purchase.
    (A) In general.
    (B) Exception.
    (7) 12-month disposition period.
    (8) Disposition date.
    (9) Disposition date assets.
    (10) Domestic corporation.
    (11) Section 336(e) election.
    (12) Related persons.
    (13) Liquidation.
    (14) Deemed asset disposition.
    (15) Deemed disposition tax consequences.
    (16) 80-percent purchaser.
    (17) Recently disposed stock.
    (18) Nonrecently disposed stock.
    (c) Nomenclature.

   Sec. 1.336-2 Availability, mechanics, and consequences of section 
                            336(e) election.

    (a) Availability of election.
    (b) Deemed transaction.
    (1) Dispositions not described in section 355(d)(2) or (e)(2).
    (i) Old target--deemed asset disposition.
    (A) In general.
    (B) Gains and losses.
    (1) Gains.
    (2) Losses.
    (i) In general.
    (ii) Stock distributions.
    (iii) Amount and allocation of disallowed loss.
    (iv) Tiered targets.
    (3) Examples.
    (C) Tiered targets.
    (ii) New target--deemed purchase.
    (iii) Old target and seller--deemed liquidation.
    (A) In general.
    (B) Tiered targets.
    (iv) Seller--distribution of target stock.
    (v) Seller--retention of target stock.
    (2) Dispositions described in section 355(d)(2) or (e)(2).
    (i) Old target--deemed asset disposition.
    (A) In general.
    (1) Old target not deemed to liquidate.
    (2) Exception.
    (B) Gains and losses.
    (1) Gains.
    (2) Losses.
    (i) In general.
    (ii) Stock distributions.
    (iii) Amount and allocation of disallowed loss.
    (iv) Tiered targets.
    (3) Examples.
    (C) Tiered targets.
    (ii) Old target--deemed purchase.
    (A) In general.
    (B) Tiered targets.
    (C) Application of section 197(f)(9), section 1091, and other 
provisions to old target.
    (iii) Seller--distribution of target stock.
    (A) In general.
    (B) Tiered targets.
    (iv) Seller--retention of target stock.
    (v) Qualification under section 355.
    (vi) Earnings and profits.
    (c) Purchaser.
    (d) Minority shareholders.
    (1) In general.
    (2) Sale, exchange, or distribution of target stock by a minority 
shareholder.
    (3) Retention of target stock by a minority shareholder.
    (e) Treatment consistent with an actual asset disposition.
    (f) Treatment of target under other provisions of the Internal 
Revenue Code.
    (g) Special rules.
    (1) Target as two corporations.
    (2) Treatment of members of a consolidated group.
    (3) International provisions.
    (i) Source and foreign tax credit.
    (ii) Allocation of foreign taxes.
    (A) General rule.
    (B) Taxes imposed on partnerships and disregarded entities.
    (iii) Disallowance of foreign tax credits under section 901(m).
    (h) Making the section 336(e) election.
    (1) Consolidated group.
    (2) Non-consolidated/non-S corporation target.
    (3) S corporation target.
    (4) Tiered targets.
    (5) Section 336(e) election statement.
    (i) In general.
    (ii) Target subsidiaries.
    (6) Contents of section 336(e) election statement.
    (7) Asset Allocation Statement.
    (8) Examples.
    (i) [Reserved]
    (j) Protective section 336(e) election.
    (k) Examples.

Sec. 1.336-3 Aggregate deemed asset disposition price; various aspects 
              of taxation of the deemed asset disposition.

    (a) Scope.
    (b) Determination of ADADP.
    (1) General rule.
    (2) Time and amount of ADADP.
    (i) Original determination.
    (ii) Redetermination of ADADP.
    (c) Grossed-up amount realized on the disposition of recently 
disposed stock of target.
    (1) Determination of amount.
    (2) Example.
    (d) Liabilities of old target.
    (1) In general.
    (2) Time and amount of liabilities.
    (e) Deemed disposition tax consequences.
    (f) Other rules apply in determining ADADP.
    (g) Examples.

                Sec. 1.336-4 Adjusted grossed-up basis.

    (a) Scope.

[[Page 83]]

    (b) Modifications to the principles in Sec. 1.338-5.
    (1) Purchasing corporation; purchaser.
    (2) Acquisition date; disposition date.
    (3) Section 338 election; section 338(h)(10) election; section 
336(e) election.
    (4) New target; old target.
    (5) Recently purchased stock; recently disposed stock.
    (6) Nonrecently purchased stock; nonrecently disposed stock.
    (c) Gain recognition election.
    (1) In general.
    (2) 80-percent purchaser.
    (3) Non-80-percent purchaser.
    (4) Gain recognition election statement.
    (d) Examples.

               Sec. 1.336-5 Effective/applicability date.

[T.D. 9619, 78 FR 28474, May 15, 2013]



Sec. 1.336-1  General principles, nomenclature, and definitions
for a section 336(e) election.

    (a) Overview--(1) In general. Section 336(e) authorizes the 
promulgation of regulations under which, in certain circumstances, a 
sale, exchange, or distribution of the stock of a corporation may be 
treated as an asset sale. This section and Sec. Sec. 1.336-2 through 
1.336-5 provide the rules for and consequences of making such election. 
This section provides the definitions and nomenclature. Generally, 
except to the extent inconsistent with section 336(e), the results of 
section 336(e) should coincide with those of section 338(h)(10). 
Accordingly, to the extent not inconsistent with section 336(e) or these 
regulations, the principles of section 338 and the regulations under 
section 338 apply for purposes of these regulations. For example, Sec. 
1.338(h)(10)-1(d)(8), concerning the availability of the section 453 
installment method, may apply with respect to section 336(e).
    (2) Consistency rules. In general, the principles of Sec. 1.338-8, 
concerning asset and stock consistency, apply with respect to section 
336(e). However, for this purpose, the application of Sec. 1.338-
8(b)(1) is modified such that Sec. 1.338-8(b)(1)(iii) applies to an 
asset if the asset is owned, immediately after its acquisition and on 
the disposition date, by a person or by a related person (as defined in 
Sec. 1.336-1(b)(12)) to a person that acquires, by sale, exchange, 
distribution, or any combination thereof, five percent or more, by 
value, of the stock of target in the qualified stock disposition.
    (b) Definitions. For purposes of Sec. Sec. 1.336-1 through 1.336-5 
(except as otherwise provided):
    (1) Seller. The term seller means any domestic corporation that 
makes a qualified stock disposition of stock of another corporation. 
Seller includes both a transferor and a distributor of target stock. 
Generally, all members of a consolidated group that dispose of target 
stock are treated as a single seller. See Sec. 1.336-2(g)(2).
    (2) Purchaser. The term purchaser means one or more persons that 
acquire or receive the stock of another corporation in a qualified stock 
disposition. A purchaser includes both a transferee and a distributee of 
target stock.
    (3) Target; S corporation target; old target; new target. The term 
target means any domestic corporation the stock of which is sold, 
exchanged, or distributed in a qualified stock disposition. An S 
corporation target is a target that is an S corporation immediately 
before the disposition date; any other target is a non-S corporation 
target. Except as the context otherwise requires, a reference to target 
includes a reference to an S corporation target. In the case of a 
transaction not described in section 355(d)(2) or (e)(2), old target 
refers to target for periods ending on or before the close of target's 
disposition date and new target refers to target for subsequent periods. 
In the case of a transaction described in section 355(d)(2) or (e)(2), 
old target refers to target for periods ending on or before the 
disposition date as well as for subsequent periods.
    (4) S corporation shareholders. S corporation shareholders are the S 
corporation target's shareholders. Unless otherwise provided, a 
reference to S corporation shareholders refers both to S corporation 
shareholders who dispose of and those who do not dispose of their S 
corporation target stock.
    (5) Disposed of; disposition--(i) In general. The term disposed of 
refers to a transfer of stock in a disposition. The term disposition 
means any sale, exchange, or distribution of stock, but only if--

[[Page 84]]

    (A) The basis of the stock in the hands of the purchaser is not 
determined in whole or in part by reference to the adjusted basis of 
such stock in the hands of the person from whom the stock is acquired, 
is not determined under section 1014(a) (relating to property acquired 
from a decedent), or is not determined under section 1022 (relating to 
the basis of property acquired from certain decedents who died in 2010);
    (B) Except as provided in paragraph (b)(5)(ii) of this section, the 
stock is not sold, exchanged, or distributed in a transaction to which 
section 351, 354, 355, or 356 applies and is not sold, exchanged, or 
distributed in any transaction described in regulations in which the 
transferor does not recognize the entire amount of the gain or loss 
realized in the transaction; and
    (C) The stock is not sold, exchanged, or distributed to a related 
person.
    (ii) Exception for disposition of stock in certain section 355 
transactions. Notwithstanding paragraph (b)(5)(i)(B) of this section, a 
distribution of stock to a person who is not a related person in a 
transaction in which the full amount of stock gain would be recognized 
pursuant to section 355(d)(2) or (e)(2) shall be considered a 
disposition.
    (iii) Transactions with related persons. In determining whether 
stock is sold, exchanged, or distributed to a related person, the 
principles of section 338(h)(3)(C) and Sec. 1.338-3(b)(3) shall apply.
    (iv) No consideration paid. Stock in target may be considered 
disposed of if, under general principles of tax law, seller is 
considered to sell, exchange, or distribute stock of target 
notwithstanding that no amount may be paid for (or allocated to) the 
stock.
    (v) Disposed of stock reacquired by certain persons. Stock disposed 
of by seller to another person under this section that is reacquired by 
seller or a member of seller's consolidated group during the 12-month 
disposition period shall not be considered as disposed of. Similarly, 
stock disposed of by an S corporation shareholder to another person 
under this section that is reacquired by the S corporation shareholder 
or by a person related (within the meaning of paragraph (b)(12) of this 
section) to the S corporation shareholder during the 12-month 
disposition period shall not be considered as disposed of.
    (6) Qualified stock disposition--(i) In general. The term qualified 
stock disposition means any transaction or series of transactions in 
which stock meeting the requirements of section 1504(a)(2) of a domestic 
corporation is either sold, exchanged, or distributed, or any 
combination thereof, by another domestic corporation or by the S 
corporation shareholders in a disposition, within the meaning of 
paragraph (b)(5) of this section, during the 12-month disposition 
period.
    (ii) Overlap with qualified stock purchase--(A) In general. Except 
as provided in paragraph (b)(6)(ii)(B) of this section, a transaction 
satisfying the definition of a qualified stock disposition under 
paragraph (b)(6)(i) of this section, which also qualifies as a qualified 
stock purchase (as defined in section 338(d)(3)), will not be treated as 
a qualified stock disposition.
    (B) Exception. If, as a result of the deemed sale of old target's 
assets pursuant to a section 336(e) election, there would be, but for 
paragraph (b)(6)(ii)(A) of this section, a qualified stock disposition 
of the stock of a subsidiary of target, then paragraph (b)(6)(ii)(A) 
shall not apply to the disposition of the stock of the subsidiary.
    (7) 12-month disposition period. The term 12-month disposition 
period means the 12-month period beginning with the date of the first 
sale, exchange, or distribution of stock included in a qualified stock 
disposition.
    (8) Disposition date. The term disposition date means, with respect 
to any corporation, the first day on which there is a qualified stock 
disposition with respect to the stock of such corporation.
    (9) Disposition date assets. Disposition date assets are the assets 
of target held at the beginning of the day after the disposition date 
(but see Sec. 1.338-1(d) (regarding certain transactions on the 
disposition date)).
    (10) Domestic corporation. The term domestic corporation has the 
same meaning as in Sec. 1.338-2(c)(9).
    (11) Section 336(e) election. A section 336(e) election is an 
election to apply

[[Page 85]]

section 336(e) to target. A section 336(e) election is made by making an 
election for target under Sec. 1.336-2(h).
    (12) Related persons. Two persons are related if stock of a 
corporation owned by one of the persons would be attributed under 
section 318(a), other than section 318(a)(4), to the other. However, 
neither section 318(a)(2)(A) nor section 318(a)(3)(A) apply to attribute 
stock ownership from a partnership to a partner, or from a partner to a 
partnership, if such partner owns, directly or indirectly, interests 
representing less than five percent of the value of the partnership.
    (13) Liquidation. Any reference to a liquidation is treated as a 
reference to the transfer described in Sec. 1.336-2(b)(1)(iii) 
notwithstanding its ultimate characterization for Federal income tax 
purposes.
    (14) Deemed asset disposition. The deemed sale of old target's 
assets is, without regard to its characterization for Federal income tax 
purposes, referred to as the deemed asset disposition.
    (15) Deemed disposition tax consequences. Deemed disposition tax 
consequences refers to, in the aggregate, the Federal income tax 
consequences (generally, the income, gain, deduction, and loss) of the 
deemed asset disposition. Deemed disposition tax consequences also 
refers to the Federal income tax consequences of the transfer of a 
particular asset in the deemed asset disposition.
    (16) 80-percent purchaser. An 80-percent purchaser is any purchaser 
that, after application of the attribution rules of section 318(a), 
other than section 318(a)(4), owns 80 percent or more of the voting 
power or value of target stock.
    (17) Recently disposed stock. The term recently disposed stock means 
any stock in target that is not held by seller, a member of seller's 
consolidated group, or an S corporation shareholder immediately after 
the close of the disposition date and that was disposed of by seller, a 
member of seller's consolidated group, or an S corporation shareholder 
during the 12-month disposition period.
    (18) Nonrecently disposed stock. The term nonrecently disposed stock 
means stock in target that is held on the disposition date by a 
purchaser or a person related (as described in Sec. 1.336-1(b)(12)) to 
the purchaser who owns, on the disposition date, with the application of 
section 318(a), other than section 318(a)(4), at least 10 percent of the 
total voting power or value of the stock of target and that is not 
recently disposed stock.
    (c) Nomenclature. For purposes of Sec. Sec. 1.336-1 through 1.336-
5, except as otherwise provided, Parent, Seller, Target, Sub, S 
Corporation Target, and Target Subsidiary are domestic corporations and 
A, B, C, and D are individuals, none of whom are related to Parent, 
Seller, Target, Sub, S Corporation Target, Target Subsidiary, or each 
other.

[T.D. 9619, 78 FR 28474, May 15, 2013, as amended by T.D. 9811, 82 FR 
6237, Jan. 19, 2017]



Sec. 1.336-2  Availability, mechanics, and consequences of section 
336(e) election.

    (a) Availability of election. A section 336(e) election is available 
if seller or S corporation shareholder(s) dispose of stock of another 
corporation (target) in a qualified stock disposition (as defined in 
Sec. 1.336-1(b)(6)). A section 336(e) election is irrevocable. A 
section 336(e) election is not available for transactions described in 
section 336(e) that do not constitute qualified stock dispositions.
    (b) Deemed transaction--(1) Dispositions not described in section 
355(d)(2) or (e)(2)--(i) Old target--deemed asset disposition--(A) In 
general. This paragraph (b)(1) provides the Federal income tax 
consequences of a section 336(e) election made with respect to a 
qualified stock disposition not described, in whole or in part, in 
section 355(d)(2) or (e)(2). For the Federal income tax consequences of 
a section 336(e) election made with respect to a qualified stock 
disposition described, in whole or in part, in section 355(d)(2) or 
(e)(2), see paragraph (b)(2) of this section. In general, if a section 
336(e) election is made, seller (or S corporation shareholders) are 
treated as not having sold, exchanged, or distributed the stock disposed 
of in the qualified stock disposition. Instead, old target is treated as

[[Page 86]]

selling its assets to an unrelated person in a single transaction at the 
close of the disposition date (but before the deemed liquidation 
described in paragraph (b)(1)(iii) of this section) in exchange for the 
aggregate deemed asset disposition price (ADADP) as determined under 
Sec. 1.336-3. ADADP is allocated among the disposition date assets in 
the same manner as the aggregate deemed sale price (ADSP) is allocated 
under Sec. Sec. 1.338-6 and 1.338-7 in order to determine the amount 
realized from each of the sold assets. Old target realizes the deemed 
disposition tax consequences from the deemed asset disposition before 
the close of the disposition date while old target is owned by seller or 
the S corporation shareholders. If old target is an S corporation 
target, old target's S election continues in effect through the close of 
the disposition date (including the time of the deemed asset disposition 
and the deemed liquidation) notwithstanding section 1362(d)(2)(B). Also, 
if old target is an S corporation target (but not a qualified subchapter 
S subsidiary), any direct or indirect subsidiaries of old target that 
old target has elected to treat as qualified subchapter S subsidiaries 
under section 1361(b)(3) remain qualified subchapter S subsidiaries 
through the close of the disposition date.
    (B) Gains and losses--(1) Gains. Except as provided in Sec. 
1.338(h)(10)-1(d)(8) (regarding the installment method), old target 
shall recognize all of the gains realized on the deemed asset 
disposition.
    (2) Losses--(i) In general. Except as provided in paragraphs 
(b)(1)(i)(B)(2)(ii), (iii), and (iv) of this section, old target shall 
recognize all of the losses realized on the deemed asset disposition.
    (ii) Stock distributions. Notwithstanding paragraphs (b)(1)(i)(A) 
and (b)(1)(iii)(A) of this section, for purposes of determining the 
amount of target's losses that are disallowed on the deemed asset 
disposition, seller is still treated as selling, exchanging, or 
distributing its target stock disposed of in the 12-month disposition 
period. If target's losses realized on the deemed sale of all of its 
assets exceed target's gains realized (a net loss), the portion of such 
net loss attributable to a distribution of target stock during the 12-
month disposition period is disallowed. The total amount of disallowed 
loss and the allocation of disallowed loss is determined in the manner 
provided in paragraphs (b)(1)(i)(B)(2)(iii) and (iv) of this section.
    (iii) Amount and allocation of disallowed loss. The total disallowed 
loss pursuant to paragraph (b)(1)(i)(B)(2)(ii) of this section shall be 
determined by multiplying the net loss realized on the deemed asset 
disposition by the disallowed loss fraction. The numerator of the 
disallowed loss fraction is the value of target stock, determined on the 
disposition date, distributed by seller during the 12-month disposition 
period, whether or not a part of the qualified stock disposition (for 
example, stock distributed to a related person), and the denominator of 
the disallowed loss fraction is the sum of the value of target stock, 
determined on the disposition date, disposed of by sale or exchange in 
the qualified stock disposition during the 12-month disposition period 
and the value of target stock, determined on the disposition date, 
distributed by seller during the 12-month disposition period, whether or 
not a part of the qualified stock disposition. The amount of the 
disallowed loss allocated to each asset disposed of in the deemed asset 
disposition is determined by multiplying the total amount of the 
disallowed loss by the loss allocation fraction. The numerator of the 
loss allocation fraction is the amount of loss realized with respect to 
the asset and the denominator of the loss allocation fraction is the sum 
of the amount of losses realized with respect to each loss asset 
disposed of in the deemed asset disposition. To the extent old target's 
losses from the deemed asset disposition are not disallowed under this 
paragraph, such losses may be disallowed under other provisions of the 
Internal Revenue Code or general principles of tax law, in the same 
manner as if such assets were actually sold to an unrelated person.
    (iv) Tiered targets. If an asset of target is the stock of a 
subsidiary corporation of target for which a section 336(e) election is 
made, any gain or loss realized on the deemed sale of the stock of the 
subsidiary corporation is disregarded

[[Page 87]]

in determining the amount of disallowed loss. For purposes of 
determining the amount of disallowed loss on the deemed asset 
disposition by a subsidiary of target for which a section 336(e) 
election is made, the amount of subsidiary stock deemed sold in the 
deemed asset disposition of target's assets multiplied by the disallowed 
loss fraction with respect to the corporation that is deemed to have 
disposed of stock of the subsidiary is considered to have been 
distributed. In determining the disallowed loss fraction with respect to 
the deemed asset disposition of any subsidiary of target, disregard any 
sale, exchange, or distribution of its stock that was made after the 
disposition date if such stock was included in the deemed asset 
disposition of the corporation deemed to have disposed of the subsidiary 
stock.
    (3) Examples. The following examples illustrate this paragraph 
(b)(1)(i)(B).

    Example 1. (i) Facts. Parent owns 60 of the 100 outstanding shares 
of the common stock of Seller, Seller's only class of stock outstanding. 
The remaining 40 shares of the common stock of Seller are held by 
shareholders unrelated to Seller or each other. Seller owns 95 of the 
100 outstanding shares of Target common stock, and all 100 shares of 
Target preferred stock that is described in section 1504(a)(4). The 
remaining 5 shares of Target common stock are owned by A. On January 1 
of Year 1, Seller sells 72 shares of Target common stock to B for 
$3,520. On July 1 of Year 1, Seller distributes 12 shares of Target 
common stock to Parent and 8 shares to its unrelated shareholders in a 
distribution described in section 301. Seller retains 3 shares of Target 
common stock and all 100 shares of Target preferred stock immediately 
after July 1. The value of Target common stock on July 1 is $60 per 
share. The value of Target preferred stock on July 1 is $36 per share. 
Target has three assets, Asset 1, a Class IV asset, with a basis of 
$1,776 and a fair market value of $2,000, Asset 2, a Class V asset, with 
a basis of $2,600 and a fair market value of $2,750, and Asset 3, a 
Class V asset, with a basis of $3,900 and a fair market value of $3,850. 
Seller incurred no selling costs on the sale of the 72 shares of Target 
common stock to B. Target has no liabilities. A section 336(e) election 
is made.
    (ii) Consequences--Deemed Asset Sale. Because at least 80 percent 
((72 + 8)/100) of Target stock, other than stock described in section 
1504(a)(4), was disposed of (within the meaning of Sec. 1.336-1(b)(5)) 
by Seller during the 12-month disposition period, a qualified stock 
disposition occurred. July 1 of Year 1, the first day on which there was 
a qualified stock disposition with respect to Target stock, is the 
disposition date. Accordingly, pursuant to the section 336(e) election, 
for Federal income tax purposes, Seller generally is not treated as 
selling the 72 shares of Target common stock sold to B or distributing 
the 8 shares of Target common stock distributed to its unrelated 
shareholders. However, Seller is still treated as distributing the 12 
shares of Target common stock distributed to Parent because Seller and 
Parent are related persons within the meaning of Sec. 1.336-1(b)(12) 
and accordingly the 12 shares are not part of the qualified stock 
disposition. Target is treated as if, on July 1, it sold all of its 
assets to an unrelated person in exchange for the ADADP, $8,000, which 
is allocated $2,000 to Asset 1, $2,500 to Asset 2, and $3,500 to Asset 3 
(see Example 1 of Sec. 1.336-3(g) for the determination and allocation 
of ADADP).
    (iii) Consequences--Amount and Allocation of Disallowed Loss. Old 
Target realized a net loss of $276 on the deemed asset disposition ($224 
gain realized on Asset 1, $100 loss realized on Asset 2, and $400 loss 
realized on Asset 3). However, 20 shares of Target common stock were 
distributed by Seller during the 12-month disposition period (8 shares 
distributed to Seller's unrelated shareholders in the qualified stock 
disposition plus 12 shares distributed to Parent that were not part of 
the qualified stock disposition). Therefore, because there was a net 
loss realized on the deemed asset disposition and a portion of the stock 
of Target was distributed during the 12-month disposition period, a 
portion of the loss on the deemed sale of each of Target's loss assets 
is disallowed. The total amount of disallowed loss equals $60 ($276 net 
loss realized on the deemed disposition of Assets 1, 2, and 3 multiplied 
by the disallowed loss fraction, the numerator of which is $1,200, the 
value on July 1, the disposition date, of the 20 shares of Target common 
stock distributed during the 12-month disposition period, and the 
denominator of which is $5,520, the sum of $4,320, the value on July 1 
of the 72 shares of Target common stock sold to B and $1,200, the value 
on July 1 of the 20 shares of Target common stock distributed during the 
12-month disposition period). The portion of the disallowed loss 
allocated to Asset 2 is $12 ($60 total disallowed loss multiplied by the 
loss allocation fraction, the numerator of which is $100, the loss 
realized on the deemed disposition of Asset 2 and the denominator of 
which is $500, the sum of the losses realized on the deemed disposition 
of Assets 2 and 3). The portion of the disallowed loss allocated to 
Asset 3 is $48 ($60 total disallowed loss multiplied by the loss 
allocation fraction, the numerator of which is $400, the loss realized 
on the deemed disposition of Asset 3 and the denominator of which is 
$500, the sum of the losses realized on the deemed disposition

[[Page 88]]

of Assets 2 and 3). Accordingly, Old Target recognizes $224 of gain on 
Asset 1, recognizes $88 of loss on Asset 2 (realized loss of $100 less 
allocated disallowed loss of $12), and recognizes $352 of loss on Asset 
3 (realized loss of $400 less allocated disallowed loss of $48) or a 
recognized net loss of $216 on the deemed asset disposition.
    Example 2. (i) Facts. The facts are the same as in Example 1 except 
that Asset 2 is the stock of Target Subsidiary, a corporation of which 
Target owns 100 of the 110 shares of common stock, the only outstanding 
class of Target Subsidiary stock. The remaining 10 shares of Target 
Subsidiary stock are owned by D. The value of Target Subsidiary stock on 
July 1 is $27.50 per share. Target Subsidiary has two assets, Asset 4, a 
Class IV asset, with a basis of $800 and a fair market value of $1,000, 
and Asset 5, a Class IV asset, with a basis of $2,200 and a fair market 
value of $2,025. Target Subsidiary has no liabilities. A section 336(e) 
election with respect to Target Subsidiary is also made.
    (ii) Consequences--Target. The ADADP on the deemed sale of Target's 
assets is determined and allocated in the same manner as in Example 1. 
However, Target's loss realized on the deemed sale of Target Subsidiary 
is disregarded in determining the amount of disallowed loss on the 
deemed asset disposition of Target's assets. Thus, the net loss is only 
$176 ($224 gain realized on Asset 1 and $400 loss realized on Asset 3), 
and the amount of disallowed loss equals $38.26 ($176 net loss 
multiplied by the disallowed loss fraction with respect to Target stock, 
$1,200/$5,520). The entire disallowed loss is allocated to Asset 3.
    (iii) Consequences--Target Subsidiary. The deemed sale of the stock 
of Target Subsidiary is disregarded and instead Target Subsidiary is 
deemed to sell all of its assets to an unrelated person. The ADADP on 
the deemed asset disposition of Target Subsidiary is $2,750, which is 
allocated $909 to Asset 4 and $1,841 to Asset 5 (see Example 2 of Sec. 
1.336-3(g) for the determination and allocation of ADADP). Old Target 
Subsidiary realized $109 of gain on Asset 4 and realized $359 of loss on 
Asset 5 in the deemed asset disposition. Although Old Target Subsidiary 
realized a net loss of $250 on the deemed asset disposition ($109 gain 
on Asset 4 and $359 loss on Asset 5), a portion of this net loss is 
disallowed because a portion of Target stock was distributed during the 
12-month disposition period. For purposes of determining the amount of 
disallowed loss on the deemed sale of the assets of Target Subsidiary, 
the portion of the 100 shares of Target Subsidiary stock deemed sold by 
Target pursuant to the section 336(e) election for Target Subsidiary 
multiplied by the disallowed loss fraction with respect to Target stock 
is treated as having been distributed. Thus, for purposes of determining 
the amount of disallowed loss on the deemed asset disposition of Target 
Subsidiary's assets, 21.74 shares of Target Subsidiary stock (100 shares 
of Target Subsidiary stock owned by Target multiplied by the disallowed 
loss fraction with respect to Target stock, $1,200/$5,520) are treated 
as having been distributed by Target during the 12-month disposition 
period. The total amount of disallowed loss with respect to the deemed 
asset disposition of Target Subsidiary's assets equals $54 ($250 net 
loss realized on the deemed disposition of Assets 4 and 5 multiplied by 
the disallowed loss fraction with respect to Target Subsidiary, the 
numerator of which is $598, the value on July 1, the disposition date, 
of the 21.74 shares of Target Subsidiary stock deemed distributed during 
the 12-month disposition period (21.74 shares x $27.50) and the 
denominator of which is $2,750 (the sum of $2,152, the value on July 1 
of the 78.26 shares of Target Subsidiary stock deemed sold in the 
qualified stock disposition pursuant to the section 336(e) election for 
Target Subsidiary (78.26 shares x $27.50) and $598, the value on July 1 
of the 21.74 shares of Target Subsidiary stock deemed distributed during 
the 12-month disposition period)). (The 10 shares of Target Subsidiary 
owned by D are not part of the qualified stock disposition and therefore 
are not included in the denominator of the disallowed loss fraction.) 
All of the disallowed loss is allocated to Asset 5, the only loss asset. 
Accordingly, Old Target Subsidiary recognizes $109 of gain on Asset 4 
and recognizes $305 of loss on Asset 5 (realized loss of $359 less 
disallowed loss of $54) or a net loss of $196 on the deemed asset 
disposition.
    Example 3. (i) Facts. The facts are the same as in Example 2 except 
that on August 1 of Year 1, Target sells 50 of its shares of Target 
Subsidiary stock and distributes the remaining 50 shares.
    (ii) Consequences. Because the 100 shares of Target Subsidiary stock 
that were sold and distributed on August 1 were deemed disposed of on 
July 1 in the deemed asset disposition of Target, the August 1 sale and 
distribution of Target Subsidiary stock are disregarded in determining 
the amount of disallowed loss. Accordingly, the consequences are the 
same as in Example 2.

    (C) Tiered targets. In the case of parent-subsidiary chains of 
corporations making section 336(e) elections, the deemed asset 
disposition of a higher-tier subsidiary is considered to precede the 
deemed asset disposition of a lower-subsidiary.
    (ii) New target--deemed purchase. New target is treated as acquiring 
all of its assets from an unrelated person in a single transaction at 
the close of the disposition date (but before the deemed liquidation) in 
exchange for an amount

[[Page 89]]

equal to the adjusted grossed-up basis (AGUB) as determined under Sec. 
1.336-4. New target allocates the consideration deemed paid in the 
transaction in the same manner as new target would under Sec. Sec. 
1.338-6 and 1.338-7 in order to determine the basis in each of the 
purchased assets. If new target qualifies as a small business 
corporation within the meaning of section 1361(b) and wants to be an S 
corporation, a new election under section 1362(a) must be made. 
Notwithstanding paragraph (b)(1)(iii) of this section (deemed 
liquidation of old target), new target remains liable for the tax 
liabilities of old target (including the tax liability for the deemed 
disposition tax consequences). For example, new target remains liable 
for the tax liabilities of the members of any consolidated group that 
are attributable to taxable years in which those corporations and old 
target joined in the same consolidated return. See Sec. 1.1502-6(a).
    (iii) Old target and seller--deemed liquidation--(A) In general. If 
old target is an S corporation, S corporation shareholders (whether or 
not they sell or exchange their stock) take their pro rata share of the 
deemed disposition tax consequences into account under section 1366 and 
increase or decrease their basis in target stock under section 1367. Old 
target and seller (or S corporation shareholders) are treated as if, 
before the close of the disposition date, after the deemed asset 
disposition described in paragraph (b)(1)(i)(A) of this section, and 
while target is owned by seller or S corporation shareholders, old 
target transferred all of the consideration deemed received from new 
target in the deemed asset disposition to seller or S corporation 
shareholders, any S corporation election for old target terminated, and 
old target ceased to exist. The transfer from old target to seller or S 
corporation shareholders is characterized for Federal income tax 
purposes in the same manner as if the parties had actually engaged in 
the transactions deemed to occur because of this section and taking into 
account other transactions that actually occurred or are deemed to 
occur. For example, the transfer may be treated as a distribution in 
pursuance of a plan of reorganization, a distribution in complete 
cancellation or redemption of all of its stock, one of a series of 
distributions in complete cancellation or redemption of all of its stock 
in accordance with a plan of liquidation, or part of a circular flow of 
cash. In most cases, the transfer will be treated as a distribution in 
complete liquidation to which sections 331 or 332 and sections 336 or 
337 apply.
    (B) Tiered targets. In the case of parent-subsidiary chains of 
corporations making section 336(e) elections, the deemed liquidation of 
a lower-tier subsidiary corporation is considered to precede the deemed 
liquidation of a higher-tier subsidiary.
    (iv) Seller--distribution of target stock. In the case of a 
distribution of target stock in a qualified stock disposition, seller 
(the distributor) is deemed to purchase from an unrelated person, on the 
disposition date, immediately after the deemed liquidation of old 
target, the amount of stock distributed in the qualified stock 
disposition (new target stock) and to have distributed such new target 
stock to its shareholders. Seller recognizes no gain or loss on the 
distribution of such stock.
    (v) Seller--retention of target stock. If seller or an S corporation 
shareholder retains any target stock after the disposition date, seller 
or the S corporation shareholder is treated as purchasing the stock so 
retained from an unrelated person (new target stock) on the day after 
the disposition date for its fair market value. The holding period for 
the retained stock starts on the day after the disposition date. For 
purposes of this paragraph (b)(1)(v), the fair market value of all of 
the target stock equals the grossed-up amount realized on the sale, 
exchange, or distribution of recently disposed stock of target (see 
Sec. 1.336-3(c)).
    (2) Dispositions described in section 355(d)(2) or (e)(2)--(i) Old 
target--deemed asset disposition--(A) In general. This paragraph (b)(2) 
provides the Federal income tax consequences of a section 336(e) 
election made with respect to a qualified stock disposition resulting, 
in whole or in part, from a disposition described in section 355(d)(2) 
or (e)(2). Old target is treated as selling its assets to an unrelated 
person in a single transaction at the close of the disposition

[[Page 90]]

date in exchange for the ADADP as determined under Sec. 1.336-3. ADADP 
is allocated among the disposition date assets in the same manner as 
ADSP is allocated under Sec. Sec. 1.338-6 and 1.338-7 in order to 
determine the amount realized from each of the sold assets. Old target 
realizes the deemed disposition tax consequences from the deemed asset 
disposition before the close of the disposition date while old target is 
owned by seller.
    (1) Old target not deemed to liquidate. In general, unlike a section 
338(h)(10) election or a section 336(e) election made with respect to a 
qualified stock disposition not described, in whole or in part, in 
section 355(d)(2) or (e)(2), old target is not deemed to liquidate after 
the deemed asset disposition.
    (2) Exception. If an election is made under Sec. 1.1502-
13(f)(5)(ii)(E), then solely for purposes of Sec. 1.1502-
13(f)(5)(ii)(C), immediately after the deemed asset disposition of old 
target, old target is deemed to liquidate into seller.
    (B) Gains and losses--(1) Gains. Except as provided in Sec. 
1.338(h)(10)-1(d)(8) (regarding the installment method), old target 
shall recognize all of the gains realized on the deemed asset 
disposition.
    (2) Losses--(i) In general. Except as provided in paragraphs 
(b)(2)(i)(B)(2)(ii), (iii), and (iv) of this section, old target shall 
recognize all of the losses realized on the deemed asset disposition.
    (ii) Stock distributions. If target's losses realized on the deemed 
sale of all of its assets exceed target's gains realized (a net loss), 
the portion of such net loss attributable to a distribution of target 
stock during the 12-month disposition period is disallowed. The total 
amount of disallowed loss and the allocation of disallowed loss is 
determined in the manner provided in paragraphs (b)(2)(i)(B)(2)(iii) and 
(iv) of this section.
    (iii) Amount and allocation of disallowed loss. The total disallowed 
loss pursuant to paragraph (b)(2)(i)(B)(2)(ii) of this section shall be 
determined by multiplying the net loss realized on the deemed asset 
disposition by the disallowed loss fraction. The numerator of the 
disallowed loss fraction is the value of target stock, determined on the 
disposition date, distributed by seller during the 12-month disposition 
period, whether or not a part of the qualified stock disposition (for 
example, stock distributed to a related person), and the denominator of 
the disallowed loss fraction is the sum of the value of target stock, 
determined on the disposition date, disposed of by sale or exchange in 
the qualified stock disposition during the 12-month disposition period 
and the value of target stock, determined on the disposition date, 
distributed by seller during the 12-month disposition period, whether or 
not a part of the qualified stock disposition. The amount of the 
disallowed loss allocated to each asset disposed of in the deemed asset 
disposition is determined by multiplying the total amount of the 
disallowed loss by the loss allocation fraction. The numerator of the 
loss allocation fraction is the amount of loss realized with respect to 
the asset and the denominator of the loss allocation fraction is the sum 
of the amount of losses realized with respect to each loss asset 
disposed of in the deemed asset disposition. To the extent old target's 
losses from the deemed asset disposition are not disallowed under this 
paragraph, such losses may be disallowed under other provisions of the 
Internal Revenue Code or general principles of tax law, in the same 
manner as if such assets were actually sold to an unrelated person.
    (iv) Tiered targets. If an asset of target is the stock of a 
subsidiary corporation of target for which a section 336(e) election is 
made, any gain or loss realized on the deemed sale of the stock of the 
subsidiary corporation is disregarded in determining the amount of 
disallowed loss. For purposes of determining the amount of disallowed 
loss on the deemed asset disposition by a subsidiary of target for which 
a section 336(e) election is made, see paragraph (b)(1)(i)(B)(2) of this 
section.
    (3) Examples. The following examples illustrate this paragraph 
(b)(2)(i)(B).

    Example 1. (i) Facts. Seller owns 90 of the 100 outstanding shares 
of Target common stock, the only class of Target stock outstanding. The 
remaining 10 shares of Target common stock are owned by C. On January 1 
of Year 1, Seller sells 10 shares of Target common stock to D for $910. 
On July 1, in an unrelated transaction, Seller distributes its remaining 
80 shares of Target common stock

[[Page 91]]

to its unrelated shareholders in a distribution described in section 
355(d)(2) or (e)(2). On July 1, the value of Target common stock is $100 
per share. Target has three assets, Asset 1 with a basis of $1,220, 
Asset 2 with a basis of $3,675, and Asset 3 with a basis of $5,725. 
Seller incurred no selling costs on the sale of the 10 shares of Target 
common stock to D. Target has no liabilities. A section 336(e) election 
is made.
    (ii) Consequences. Because at least 80 percent of Target stock ((10 
+ 80)/100) was disposed of (within the meaning of Sec. 1.336-1(b)(5)) 
by Seller during the 12-month disposition period, a qualified stock 
disposition occurred. July 1 of Year 1, the first day on which there was 
a qualified stock disposition with respect to Target, is the disposition 
date. Accordingly, pursuant to the section 336(e) election, for Federal 
income tax purposes, Target is treated as if, on July 1, it sold all of 
its assets to an unrelated person in exchange for the ADADP, $9,900, as 
determined under Sec. 1.336-3. Assume that the ADADP is allocated 
$2,000 to Asset 1, $3,300 to Asset 2, and $4,600 to Asset 3 under Sec. 
1.336-3. Old Target realized a net loss of $720 on the deemed asset 
disposition ($780 gain realized on Asset 1, $375 loss realized on Asset 
2, and $1,125 loss realized on Asset 3). However, because a portion of 
Target stock was distributed during the 12-month disposition period and 
there was a net loss on the deemed asset disposition, a portion of the 
loss on each of the loss assets is disallowed. The total amount of 
disallowed loss equals $640 ($720 net loss realized on the deemed 
disposition of Assets 1, 2, and 3 multiplied by the disallowed loss 
fraction, the numerator of which is $8,000, the value on July 1, the 
disposition date, of the 80 shares of Target common stock distributed by 
Seller during the 12-month disposition period, and the denominator of 
which is $9,000, the sum of $1,000, the value on July 1 of the 10 shares 
of Target common stock sold to D, and $8,000, the value on July 1 of the 
80 shares of Target common stock distributed by Seller during the 12-
month disposition period). The portion of the disallowed loss allocated 
to Asset 2 is $160 ($640 total disallowed loss on the deemed asset 
disposition multiplied by the loss allocation fraction, the numerator of 
which is $375, the loss realized on the deemed disposition of Asset 2, 
and the denominator of which is $1,500, the sum of the losses realized 
on the deemed disposition of Assets 2 and 3). The portion of the 
disallowed loss allocated to Asset 3 is $480 ($640 total disallowed loss 
on the deemed asset disposition multiplied by the loss allocation 
fraction, the numerator of which is $1,125, the loss realized on the 
deemed disposition of Asset 3, and the denominator of which is $1,500, 
the sum of the losses realized on the deemed disposition of Assets 2 and 
3). Accordingly, Old Target recognizes $780 of gain on Asset 1, 
recognizes $215 of loss on Asset 2 (realized loss of $375 less allocated 
disallowed loss of $160), and recognizes $645 of loss on Asset 3 
(realized loss of $1,125 less allocated disallowed loss of $480) or a 
recognized net loss of $80 on the deemed asset disposition.
    Example 2. (i) Facts. The facts are the same as in Example 1 except 
that Asset 2 is 100 shares of common stock of Target Subsidiary, a 
wholly-owned subsidiary of Target. The value of Target Subsidiary common 
stock on July 1 is $40 per share. Target Subsidiary has two assets, 
Asset 4 with a basis of $500 and Asset 5 with a basis of $3,000. Target 
Subsidiary has no liabilities. A section 336(e) election is also made 
with respect to Target Subsidiary.
    (ii) Consequences--Target. The ADADP on the deemed sale of Target's 
assets is determined and allocated in the same manner as in Example 1. 
However, Old Target's loss realized on the deemed sale of Target 
Subsidiary is disregarded in determining the amount of the disallowed 
loss on the deemed asset disposition of Old Target's assets. Thus, the 
realized net loss is only $345 ($780 gain on Asset 1 and $1,125 loss on 
Asset 3), and the amount of disallowed loss equals $307, the $345 
realized net loss multiplied by the disallowed loss fraction with 
respect to Target stock, $8,000/$9,000. The entire disallowed loss is 
allocated to Asset 3. Accordingly, Old Target recognizes $780 of gain on 
Asset 1 and recognizes $818 of loss on Asset 3 (realized loss of $1,125 
less allocated disallowed loss of $307) or a recognized net loss of $38 
on the deemed asset disposition.
    (iii) Consequences--Target Subsidiary. Because the deemed sale of 
Target Subsidiary is not a transaction described in section 355(d)(2) or 
(e)(2), the tax consequences of the deemed sale of Target Subsidiary are 
determined under paragraph (b)(1) of this section and not this paragraph 
(b)(2). The deemed sale of the stock of Target Subsidiary is disregarded 
and instead Target Subsidiary is deemed to sell all of its assets to an 
unrelated person. The ADADP on the deemed asset disposition of Target 
Subsidiary as determined under Sec. 1.336-3 is $3,300. Assume that the 
ADADP is allocated $900 to Asset 4 and $2,400 to Asset 5 under Sec. 
1.336-3. Old Target Subsidiary realized a net loss of $200 on the deemed 
asset disposition ($400 gain realized on Asset 4 and $600 loss realized 
on Asset 5). However, because a portion of Target stock was distributed 
during the 12-month disposition period, for purposes of determining the 
amount of disallowed loss on the deemed sale of the assets of Target 
Subsidiary, the portion of the 100 shares of Target Subsidiary stock 
deemed sold pursuant to the section 336(e) election for Target 
Subsidiary multiplied by the disallowed loss fraction with respect to 
Target stock are treated as having been distributed. Thus, for

[[Page 92]]

purposes of determining the amount of disallowed loss on the deemed 
asset disposition of Target Subsidiary's assets, 88.89 shares of Target 
Subsidiary common stock (100 shares owned by Target multiplied by the 
disallowed loss fraction with respect to Target stock, $8,000/$9,000) 
are treated as distributed during the 12-month disposition period. The 
total amount of disallowed loss with respect to the deemed asset 
disposition of Target Subsidiary's assets equals $177.78 ($200 net loss 
realized on the deemed disposition of Assets 4 and 5 multiplied by the 
disallowed loss fraction with respect to Target Subsidiary, the 
numerator of which is $3,556, the value on July 1, the disposition date, 
of the 88.89 shares of Target Subsidiary common stock deemed distributed 
during the 12-month disposition period (88.89 shares x $40) and the 
denominator of which is $4,000 (the sum of $444, the value on July 1 of 
the 11.11 shares of Target Subsidiary common stock deemed sold in the 
qualified stock disposition pursuant to the section 336(e) election for 
Target Subsidiary (11.11 shares x $40) and $3,556, the value on July 1 
of the 88.89 shares of Target Subsidiary common stock deemed distributed 
during the 12-month disposition period)). All of the disallowed loss is 
allocated to Asset 5, the only loss asset. Accordingly, Old Target 
Subsidiary recognizes $400 of gain on Asset 4 and recognizes $422.22 of 
loss on Asset 5 (realized loss of $600 less allocated disallowed loss of 
$177.78) or a recognized net loss of $22.22 on the deemed asset 
disposition.

    (C) Tiered targets. In the case of parent-subsidiary chains of 
corporations making section 336(e) elections, the deemed asset 
disposition of a higher-tier subsidiary is considered to precede the 
deemed asset disposition of a lower-tier subsidiary.
    (ii) Old target--deemed purchase--(A) In general. Immediately after 
the deemed asset disposition described in paragraph (b)(2)(i)(A) of this 
section, old target is treated as acquiring all of its assets from an 
unrelated person in a single, separate transaction at the close of the 
disposition date (but before the distribution described in paragraph 
(b)(2)(iii)(A) of this section) in exchange for an amount equal to the 
AGUB as determined under Sec. 1.336-4. Old target allocates the 
consideration deemed paid in the transaction in the same manner as new 
target would under Sec. Sec. 1.338-6 and 1.338-7 in order to determine 
the basis in each of the purchased assets.
    (B) Tiered targets. In the case of parent-subsidiary chains of 
corporations making section 336(e) elections with respect to a qualified 
stock disposition described, in whole or in part, in section 355(d)(2) 
or (e)(2), old target's deemed purchase of all its assets is considered 
to precede the deemed asset disposition of a lower-tier subsidiary.
    (C) Application of section 197(f)(9), section 1091, and other 
provisions to old target. Solely for purposes of section 197(f)(9), 
section 1091, and any other provision designated in the Internal Revenue 
Bulletin by the Internal Revenue Service (see Sec. 601.601(d)(2)(ii) of 
this chapter), old target, in its capacity as seller of assets in the 
deemed asset disposition described in paragraph (b)(2)(i)(A) of this 
section, shall be treated as a separate and distinct taxpayer from, and 
unrelated to, old target in its capacity as acquirer of assets in the 
deemed purchase described in paragraph (b)(2)(ii)(A) of this section and 
for subsequent periods.
    (iii) Seller--distribution of target stock--(A) In general. 
Immediately after old target's deemed purchase of its assets described 
in paragraph (b)(2)(ii) of this section, seller is treated as 
distributing the stock of old target actually distributed to its 
shareholders in the qualified stock disposition. No gain or loss is 
recognized by seller on the distribution. Additionally, if stock of 
target is sold, exchanged, or distributed outside of the section 355 
transaction but still as part of a qualified stock disposition 
described, in whole or in part, in section 355(d)(2) or (e)(2), no gain 
or loss is recognized by seller on such sale, exchange, or distribution.
    (B) Tiered targets. In the case of parent-subsidiary chains of 
corporations making section 336(e) elections with respect to a qualified 
stock disposition described, in whole or in part, in section 355(d)(2) 
or (e)(2), the Federal income tax consequences of the section 336(e) 
election for a subsidiary of target shall be determined under paragraph 
(b)(1) of this section unless the stock of the subsidiary of target is 
actually disposed of in a qualified stock disposition described, in 
whole or in part, in section 355(d)(2) or (e)(2). The deemed liquidation 
of a lower-tier subsidiary pursuant to paragraph (b)(1)(iii) of this 
section is considered to precede the deemed liquidation of a higher-tier 
subsidiary. The deemed liquidation of

[[Page 93]]

the highest tier subsidiary of target is considered to precede the 
distribution of old target stock described in paragraph (b)(2)(iii)(A) 
of this section.
    (iv) Seller--retention of target stock. If seller retains any target 
stock after the disposition date, seller is treated as having disposed 
of the old target stock so retained, on the disposition date, in a 
transaction in which no gain or loss is recognized, and then, on the day 
after the disposition date, purchasing the stock so retained from an 
unrelated person for its fair market value. The holding period for the 
retained stock starts on the day after the disposition date. For 
purposes of this paragraph (b)(2)(iv), the fair market value of all of 
the target stock equals the grossed-up amount realized on the sale, 
exchange, or distribution of recently disposed stock of target (see 
Sec. 1.336-3(c)).
    (v) Qualification under section 355. Old target's deemed sale of all 
its assets to an unrelated person and old target's deemed purchase of 
all its assets from an unrelated person will not cause the distribution 
of old target to fail to satisfy the requirements of section 355. 
Similarly, any deemed transactions under paragraph (b)(1) or (b)(2) of 
this section that a subsidiary of target is treated as engaging in will 
not cause the distribution of old target to fail to satisfy the 
requirements of section 355. For purposes of applying section 
355(a)(1)(D), seller is treated as having disposed of any stock disposed 
of in the qualified stock disposition on the date seller actually sold, 
exchanged, or distributed such stock. Further, seller's deemed 
disposition of retained old target stock under paragraph (b)(2)(iv) of 
this section is disregarded for purposes of applying section 
355(a)(1)(D).
    (vi) Earnings and profits. The earnings and profits of seller and 
target shall be determined pursuant to Sec. 1.312-10 and, if 
applicable, Sec. 1.1502-33(e). For this purpose, target will not be 
treated as a newly created controlled corporation and any increase or 
decrease in target's earnings and profits pursuant to the deemed asset 
disposition will increase or decrease, as the case may be, target's 
earnings and profits immediately before the allocation described in 
Sec. 1.312-10.
    (c) Purchaser. Generally, the making of a section 336(e) election 
will not affect the Federal income tax consequences to which purchaser 
would have been subject with respect to the acquisition of target stock 
if a section 336(e) election was not made. Thus, notwithstanding 
Sec. Sec. 1.336-2(b)(1)(i)(A), 1.336-2(b)(1)(iv), and 1.336-
2(b)(2)(iii)(A), purchaser will still be treated as having purchased, 
received in an exchange, or received in a distribution, the stock of 
target so acquired on the date actually acquired. However, see section 
1223(1)(B) with respect to the holding period for stock acquired 
pursuant to a distribution qualifying under section 355 (or so much of 
section 356 that relates to section 355). The Federal income tax 
consequences of the deemed asset disposition and liquidation of target 
may affect purchaser's consequences. For example, if seller distributes 
the stock of target to its shareholders in a qualified stock disposition 
for which a section 336(e) election is made, any increase in seller's 
earnings and profits as a result of old target's deemed asset 
disposition and liquidation into seller may increase the amount of a 
distribution to the shareholders constituting a dividend under section 
301(c)(1).
    (d) Minority shareholders--(1) In general. This paragraph (d) 
describes the treatment of shareholders of old target other than seller, 
a member of seller's consolidated group, and S corporation shareholders 
(whether or not they sell or exchange their stock of target). A 
shareholder to which this paragraph (d) applies is referred to as a 
minority shareholder.
    (2) Sale, exchange, or distribution of target stock by a minority 
shareholder. A minority shareholder recognizes gain or loss (as 
permitted under the general principles of tax law) on its sale, 
exchange, or distribution of target stock.
    (3) Retention of target stock by a minority shareholder. A minority 
shareholder who retains its target stock does not recognize gain or loss 
under this section with respect to its shares of target stock. The 
minority shareholder's basis and holding period for that target stock 
are not affected by the section 336(e) election. Notwithstanding this 
treatment of the minority shareholder,

[[Page 94]]

if a section 336(e) election is made, target will still be treated as 
disposing of all of its assets in the deemed asset disposition.
    (e) Treatment consistent with an actual asset disposition. Except as 
otherwise provided, no provision in this section shall produce a Federal 
income tax result under subtitle A of the Internal Revenue Code that 
would not occur if the parties had actually engaged in the transactions 
deemed to occur because of this section, taking into account other 
transactions that actually occurred or are deemed to occur. See Sec. 
1.338-1(a)(2) regarding the application of other rules of law.
    (f) Treatment of target under other provisions of the Internal 
Revenue Code. The provisions Sec. 1.338-1(b) apply with respect to the 
treatment of new target after a section 336(e) election, treating any 
reference to section 338 or 338(h)(10) as a reference to section 336(e).
    (g) Special rules--(1) Target as two corporations. Although target 
is a single corporation under corporate law, if a section 336(e) 
election is made, then, except with respect to a distribution described 
in section 355(d)(2) or (e)(2) and as provided in Sec. 1.338-1(b)(2), 
two separate corporations, old target and new target, generally are 
considered to exist for purposes of subtitle A of the Internal Revenue 
Code.
    (2) Treatment of members of a consolidated group. For purposes of 
Sec. Sec. 1.336-1 through 1.336-5, all members of seller's consolidated 
group are treated as a single seller, regardless of which member or 
members actually dispose of any stock. Accordingly, any dispositions of 
stock made by members of the same consolidated group shall be treated as 
made by one corporation, and any stock owned by members of the same 
consolidated group and not disposed of will be treated as stock retained 
by seller.
    (3) International provisions--(i) Source and foreign tax credit. The 
principles of section 338(h)(16) apply to section 336(e) elections for 
targets with foreign operations to ensure that the source and foreign 
tax credit limitation are properly determined.
    (ii) Allocation of foreign taxes--(A) General rule. Except as 
provided in paragraph (g)(3)(ii)(B) of this section, if a section 336(e) 
election is made for target and target's taxable year under foreign law 
(if any) does not close at the end of the disposition date, foreign tax 
paid or accrued by new target with respect to such foreign taxable year 
is allocated between old target and new target. If there is more than 
one section 336(e) election with respect to target during target's 
foreign taxable year, foreign tax paid or accrued with respect to that 
foreign taxable year is allocated among all old targets and new targets. 
The allocation is made based on the respective portions of the taxable 
income (as determined under foreign law) for the foreign taxable year 
that are attributable under the principles of Sec. 1.1502-76(b) to the 
period of existence of each old target and new target during the foreign 
taxable year.
    (B) Taxes imposed on partnerships and disregarded entities. If a 
section 336(e) election is made for target and target holds an interest 
in a disregarded entity or partnership, the rules of Sec. 1.901-2(f)(4) 
apply to determine the person who is considered for U.S. Federal income 
tax purposes to pay foreign tax imposed at the entity level on the 
income of the disregarded entity or partnership.
    (iii) Disallowance of foreign tax credits under section 901(m). For 
rules that may apply to disallow foreign tax credits with respect to 
income not subject to United States taxation by reason of a covered 
asset acquisition, see section 901(m).
    (h) Making the section 336(e) election--(1) Consolidated group. If 
seller(s) and target are members of the same consolidated group, a 
section 336(e) election is made by completing the following 
requirements:
    (i) Seller(s) and target must enter into a written, binding 
agreement, on or before the due date (including extensions) of the 
consolidated group's consolidated Federal income tax return for the 
taxable year that includes the disposition date, to make a section 
336(e) election;
    (ii) The common parent of the consolidated group must retain a copy 
of the written agreement;

[[Page 95]]

    (iii) The common parent of the consolidated group must attach the 
section 336(e) election statement, described in paragraphs (h)(5) and 
(6) of this section, to the group's timely filed (including extensions) 
consolidated Federal income tax return for the taxable year that 
includes the disposition date; and
    (iv) The common parent of the consolidated group must provide a copy 
of the section 336(e) election statement to target on or before the due 
date (including extensions) of the consolidated group's consolidated 
Federal income tax return.
    (2) Non-consolidated/non-S corporation target. If target is neither 
a member of the same consolidated group as seller nor an S corporation, 
a section 336(e) election is made by completing the following 
requirements:
    (i) Seller and target must enter into a written, binding agreement, 
on or before the due date (including extensions) of seller's or target's 
Federal income tax return for the taxable year that includes the 
disposition date, whichever is earlier, to make a section 336(e) 
election;
    (ii) Seller and target each must retain a copy of the written 
agreement; and
    (iii) Seller and target each must attach the section 336(e) election 
statement, described in paragraphs (h)(5) and (6) of this section, to 
its timely filed (including extensions) Federal income tax return for 
the taxable year that includes the disposition date. However, seller's 
section 336(e) election statement may disregard paragraph (h)(6)(xii) of 
this section (concerning a gain recognition election).
    (3) S corporation target. A section 336(e) election for an S 
corporation target is made by completing the following requirements:
    (i) All of the S corporation shareholders, including those who do 
not dispose of any stock in the qualified stock disposition, and the S 
corporation target must enter into a written, binding agreement, on or 
before the due date (including extensions) of the Federal income tax 
return of the S corporation target for the taxable year that includes 
the disposition date, to make a section 336(e) election;
    (ii) S corporation target must retain a copy of the written 
agreement; and
    (iii) S corporation target must attach the section 336(e) election 
statement, described in paragraphs (h)(5) and (6) of this section, to 
its timely filed (including extensions) Federal income tax return for 
the taxable year that includes the disposition date.
    (4) Tiered targets. In the case of parent-subsidiary chains of 
corporations making section 336(e) elections, in order to make a section 
336(e) election for a lower-tier target (target subsidiary), the 
requirements described in paragraph (h)(1) or (h)(2), of this section, 
whichever is applicable to the qualified stock disposition of target 
subsidiary, must be satisfied. The written agreement described in 
paragraph (h)(1) or (h)(2) of this section for the section 336(e) 
election with respect to target subsidiary may be either a separate 
written agreement between target subsidiary and the corporation deemed 
to dispose of the stock of target subsidiary or may be included in the 
written agreement between seller(s) (or the S corporation shareholders) 
and target.
    (5) Section 336(e) election statement--(i) In general. The section 
336(e) election statement must be entitled ``THIS IS AN ELECTION UNDER 
SECTION 336(e) TO TREAT THE DISPOSITION OF THE STOCK OF [insert name and 
employer identification number of target] AS A DEEMED SALE OF SUCH 
CORPORATION'S ASSETS.'' The section 336(e) election statement must 
include the information described in paragraph (h)(6) of this section. 
The relevant information for each S corporation shareholder and, 
notwithstanding paragraph (g)(2) of this section, each consolidated 
group member that disposes of or retains target stock must be set forth 
individually, not in the aggregate.
    (ii) Target subsidiaries. In the case of a section 336(e) election 
for a target subsidiary, a separate statement must be filed for each 
target subsidiary. In preparing the section 336(e) election statement 
with respect to a target subsidiary, any reference to seller in 
paragraph (h)(6) of this section should be considered a reference to the 
corporation deemed to dispose of the stock of the target subsidiary and 
any reference

[[Page 96]]

to target in paragraphs (h)(5)(i) and (h)(6) of this section should be 
considered a reference to the target subsidiary.
    (6) Contents of section 336(e) election statement. The section 
336(e) election statement must include:
    (i) The name, address, taxpayer identifying number (TIN), taxable 
year, and state of incorporation (if any) of the seller(s) or the S 
corporation shareholder(s);
    (ii) The name, address, employer identification number (EIN), 
taxable year, and state of incorporation of the common parent, if any, 
of seller(s);
    (iii) The name, address, EIN, taxable year, and state of 
incorporation of target;
    (iv) The name, address, TIN, taxable year, and state of 
incorporation (if any) of any 80-percent purchaser;
    (v) The name, address, TIN, taxable year, and state of incorporation 
(if any) of any purchaser that holds nonrecently disposed stock within 
the meaning of Sec. 1.336-1(b)(18);
    (vi) The disposition date;
    (vii) The percentage of target stock that was disposed of by each 
seller or S corporation shareholder in the qualified stock disposition;
    (viii) The percentage of target stock that was disposed of by each 
seller or S corporation shareholder in the qualified stock disposition 
on or before the disposition date;
    (ix) A statement regarding whether target realized a net loss on the 
deemed asset disposition;
    (x) If target realized a net loss on the deemed asset disposition, a 
statement regarding whether any stock of target or that of any higher-
tier corporation up through the highest-tier corporation for which a 
section 336(e) election was made by any seller(s) or S corporation 
shareholder(s) was distributed during the 12-month disposition period. 
If so, also provide a statement regarding whether any stock of target or 
that of any higher-tier corporation up through the highest-tier 
corporation for which a section 336(e) election was made was actually 
sold or exchanged (rather than deemed sold in a deemed asset 
disposition) by any seller(s) or S corporation shareholder(s) in a 
qualified stock disposition;
    (xi) The percentage of target stock that was retained by each seller 
or S corporation shareholder after the disposition date;
    (xii) The name, address, and TIN of any purchaser that made a gain 
recognition election pursuant to Sec. 1.336-4(c). A copy of the gain 
recognition election statement must be retained by the filer of the 
section 336(e) election statement designated as the appropriate party in 
Sec. 1.336-4(c)(3); and
    (xiii) A statement that each of the seller(s) or S corporation 
shareholder(s) (as applicable) and target have executed a written, 
binding agreement to make a section 336(e) election.
    (7) Asset Allocation Statement. Old target and new target must 
report information concerning the deemed sale of target's assets on Form 
8883, ``Asset Allocation Statement Under Section 338,'' (making 
appropriate adjustments to report the results of the section 336(e) 
election), or on any successor form prescribed by the Internal Revenue 
Service, in accordance with forms, instructions, or other appropriate 
guidance provided by the Internal Revenue Service. In addition, in the 
case of a section 336(e) election as the result of a transaction 
described in section 355(d)(2) or (e)(2), old target should file two 
Forms 8883, (or successor forms), one in its capacity as the seller of 
the assets in the deemed asset disposition described in paragraph 
(b)(2)(i) of this section and one in its capacity as the purchaser of 
the assets in the deemed purchase described in paragraph (b)(2)(ii) of 
this section.
    (8) Examples. The following examples illustrate the provisions of 
paragraph (h) of this section.

    Example 1. (i) Facts. Seller owns all of the stock of Target and 
Target owns all of the stock of Target Subsidiary. Seller is the common 
parent of a consolidated group that includes Target. However, Target 
Subsidiary is not included in the consolidated group pursuant to section 
1504(a)(3). On Date 1, Seller sells 80 percent of its Target stock to A 
and distributes the remaining 20 percent of Target stock to Seller's 
unrelated shareholders.
    (ii) Making of election for Target. Because Seller and Target are 
members of a consolidated group, in order to make a section 336(e) 
election for the qualified stock disposition of Target, the requirements 
of paragraph (h)(1) of this section must be satisfied.

[[Page 97]]

On or before the due date of Seller group's consolidated Federal income 
tax return that includes Date 1, Seller and Target must enter into a 
written, binding agreement to make a section 336(e) election; Seller 
must retain a copy of the written agreement; Seller must attach the 
section 336(e) election statement to the group's timely filed 
consolidated return for the taxable year that includes Date 1, and 
Seller must provide a copy of the section 336(e) election statement to 
Target on or before the due date (including extensions) of the 
consolidated return.
    (iii) Making of election for Target Subsidiary. Because Target and 
Target Subsidiary do not join in the filing of a consolidated Federal 
income tax return and Target Subsidiary is not an S corporation, in 
order to make a section 336(e) election for the qualified stock 
disposition of Target Subsidiary, the requirements of paragraph (h)(2) 
of this section must be satisfied. On or before the due date of Seller 
group's consolidated Federal income tax return that includes Date 1, or 
Target Subsidiary's Federal income tax return that includes Date 1, 
whichever is earlier, either Target Subsidiary must join in the written 
agreement described in paragraph (ii) of this Example 1 to make a 
section 336(e) election with respect to the qualified stock disposition 
of Target Subsidiary or Target and Target Subsidiary must enter into a 
separate written, binding agreement to make a section 336(e) election 
with respect to the qualified stock disposition of Target Subsidiary; 
Seller (as agent of the consolidated group that includes Target) and 
Target Subsidiary each must retain a copy of the written agreement; and 
Seller (as agent of the consolidated group that includes Target) and 
Target Subsidiary each must attach the section 336(e) election statement 
with respect to the qualified stock disposition of Target Subsidiary to 
its timely filed Federal income tax return for the taxable year that 
includes Date 1. In preparing the section 336(e) election statement, 
paragraph (i) of the statement should include the relevant information 
for Target, paragraph (ii) of the statement should include the relevant 
information for Seller, paragraph (iii) of the statement should include 
the relevant information for Target Subsidiary, paragraphs (vii) through 
(xi) of the statement should provide information for both Seller's 
actual sale and distribution of Target stock as well as information for 
Target's deemed sale of Target Subsidiary stock, and paragraph (xiii) of 
the statement should include a statement that Seller, Target, and Target 
Subsidiary, or Target and Target Subsidiary, whichever is appropriate, 
have executed a written, binding agreement to make a section 336(e) 
election with respect to the qualified stock disposition of Target 
Subsidiary.
    Example 2. (i) Facts. A and B each own 45 percent and C owns the 
remaining 10 percent of the stock of S Corporation Target, an S 
corporation. S Corporation Target owns 80 percent of the stock of Target 
Subsidiary and D owns the remaining 20 percent. On Date 1, A and B each 
sell all of their S Corporation Target stock to an unrelated individual. 
C retains his 10 percent of the stock of S Corporation Target.
    (ii) Making of election for S Corporation Target. Because S 
Corporation Target is an S Corporation Target, in order to make a 
section 336(e) election for the qualified stock disposition of S 
Corporation Target, the requirements of paragraph (h)(3) of this section 
must be satisfied. On or before the due date of S Corporation Target's 
Federal income tax return that includes Date 1, A, B, C, and S 
Corporation Target must enter into a written, binding agreement to make 
a section 336(e) election; S Corporation Target must retain a copy of 
the written agreement; and S Corporation Target must attach the section 
336(e) election statement to its timely filed Federal income tax return 
for the taxable year that includes Date 1.
    (iii) Making of election for Target Subsidiary. Because Target 
Subsidiary is neither a member of the same consolidated group as S 
Corporation Target nor is an S corporation, in order to make a section 
336(e) election for the qualified stock disposition of Target 
Subsidiary, the requirements of paragraph (h)(2) of this section must be 
satisfied. On or before the due date of S Corporation Target's Federal 
income tax return that includes Date 1, or Target Subsidiary's Federal 
income tax return that includes Date 1, whichever is earlier, either 
Target Subsidiary must join in the written agreement described in 
paragraph (ii) of this Example 2 to make a section 336(e) election with 
respect to the qualified stock disposition of Target Subsidiary or S 
Corporation Target and Target Subsidiary must enter into a separate 
written, binding agreement to make a section 336(e) election with 
respect to the qualified stock disposition of Target Subsidiary; S 
Corporation Target and Target Subsidiary each must retain a copy of the 
written agreement; and S Corporation Target and Target Subsidiary each 
must attach the section 336(e) election statement to its timely filed 
Federal income tax return for the taxable year that includes Date 1. In 
preparing the section 336(e) election statement, paragraph (i) of the 
statement should include the relevant information for S Corporation 
Target, paragraph (iii) of the statement should include the relevant 
information for Target Subsidiary, paragraphs (vii) through (xi) of the 
statement should provide information for both A's and B's actual sale 
and C's actual retention of S Corporation Target stock as well as 
information for S Corporation Target's deemed sale of Target Subsidiary 
stock, and paragraph (xiii) of the statement should

[[Page 98]]

include a statement that A, B, C, S Corporation Target, and Target 
Subsidiary, or S Corporation Target and Target Subsidiary, whichever is 
appropriate, have executed a written, binding agreement to make a 
section 336(e) election with respect to the qualified stock disposition 
of Target Subsidiary.

    (i) [Reserved]
    (j) Protective section 336(e) election. Taxpayers may make a 
protective election under section 336(e) in connection with a 
transaction. Such an election will have no effect if the transaction 
does not constitute a qualified stock disposition, as defined in Sec. 
1.336-1(b)(6), but will otherwise be binding and irrevocable.
    (k) Examples. The following examples illustrate the provisions of 
this section.

    Example 1. Sale of 100 percent of Target stock. (i) Facts. Parent 
owns all 100 shares of Target's only class of stock. Target's only 
assets are two parcels of land. Parcel 1 has a basis of $5,000 and 
Parcel 2 has a basis of $4,000. Target has no liabilities. On July 1 of 
Year 1, Parent sells all 100 shares of Target stock to A for $100 per 
share. Parent incurs no selling costs and A incurs no acquisition costs. 
On July 1, the value of Parcel 1 is $7,000 and the value of Parcel 2 is 
$3,000. A section 336(e) election is made.
    (ii) Consequences. The sale of Target stock constitutes a qualified 
stock disposition. July 1 of Year 1 is the disposition date. 
Accordingly, pursuant to the section 336(e) election, for Federal income 
tax purposes, rather than treating Parent as selling the stock of Target 
to A, the following events are deemed to occur. Target is treated as if, 
on July 1, it sold all of its assets to an unrelated person in exchange 
for the ADADP of $10,000, which is allocated $7,000 to Parcel 1 and 
$3,000 to Parcel 2 (see Sec. Sec. 1.336-3 and 1.338-6 for determination 
of amount and allocation of ADADP). Target recognizes gain of $2,000 on 
Parcel 1 and loss of $1,000 on Parcel 2. New Target is then treated as 
acquiring all its assets from an unrelated person in a single 
transaction in exchange for the amount of the AGUB of $10,000, which is 
allocated $7,000 to Parcel 1 and $3,000 to Parcel 2 (see Sec. Sec. 
1.336-4, 1.338-5, and 1.338-6 for determination of amount and allocation 
of AGUB). Old Target is treated as liquidating into Parent immediately 
thereafter, distributing the $10,000 deemed received in exchange for 
Parcel 1 and Parcel 2 in a transaction qualifying under section 332. 
Parent recognizes no gain or loss on the liquidation. A's basis in New 
Target stock is $100 per share, the amount paid for the stock.
    Example 2. Sale of 80 percent of Target stock. (i) Facts. The facts 
are the same as in Example 1 except that Parent only sells 80 shares of 
its Target stock to A and retains the other 20 shares.
    (ii) Consequences. The results are the same as in Example 1 except 
that Parent also is treated as purchasing from an unrelated person on 
July 2, the day after the disposition date, the 20 shares of Target 
stock (New Target stock) not sold to A, for their fair market value as 
determined under Sec. 1.336-2(b)(1)(v) of $2,000 ($100 per share).
    Example 3. Distribution of 100 percent of Target stock. (i) Facts. 
The facts are the same as in Example 1 except that instead of on July 1 
Parent selling 100 shares of Target stock to A, Parent distributes 100 
shares to its shareholders, all of whom are unrelated to Parent, in a 
transaction that does not qualify under section 355. The value of Target 
stock on July 1 is $100 per share.
    (ii) Consequences. The distribution of Target stock constitutes a 
qualified stock disposition. July 1 of Year 1 is the disposition date. 
Accordingly, pursuant to the section 336(e) election, for Federal income 
tax purposes, rather than treating Parent as distributing the stock of 
Target to its shareholders, the following events are deemed to occur. 
Target is treated as if, on July 1, it sold all of its assets to an 
unrelated person in exchange for the ADADP of $10,000, which is 
allocated $7,000 to Parcel 1 and $3,000 to Parcel 2 (see Sec. Sec. 
1.336-3 and 1.338-6 for determination of amount and allocation of 
ADADP). Target recognizes gain of $2,000 on Parcel 1 and loss of $1,000 
on Parcel 2. Because Target's losses realized on the deemed asset 
disposition do not exceed Target's gains realized on the deemed asset 
disposition, Target can recognize all of the losses from the deemed 
asset disposition (see Sec. 1.336-2(b)(1)(i)(B)). New Target is then 
treated as acquiring all its assets from an unrelated person in a single 
transaction in exchange for the amount of the AGUB of $10,000, which is 
allocated $7,000 to Parcel 1 and $3,000 to Parcel 2 (see Sec. Sec. 
1.336-4, 1.338-5, and 1.338-6 for determination of amount and allocation 
of AGUB). Old Target is treated as liquidating into Parent immediately 
thereafter, distributing the $10,000 deemed received in exchange for 
Parcel 1 and Parcel 2 in a transaction qualifying under section 332. 
Parent recognizes no gain or loss on the liquidation. On July 1, 
immediately after the deemed liquidation of Target, Parent is deemed to 
purchase from an unrelated person 100 shares of New Target stock and 
distribute those New Target shares to its shareholders. Parent 
recognizes no gain or loss on the deemed distribution of the shares 
under Sec. 1.336-2(b)(1)(iv). The shareholders receive New Target stock 
as a distribution pursuant to section 301 and their basis in New Target 
stock received is its fair market value pursuant to section 301(d).
    Example 4. Distribution of 80 percent of Target stock. (i) Facts. 
The facts are the same as

[[Page 99]]

in Example 3 except that Parent distributes only 80 shares of Target 
stock to its shareholders and retains the other 20 shares.
    (ii) Consequences. The results are the same as in Example 3 except 
that Parent is treated as purchasing on July 1 only 80 shares of New 
Target stock and as distributing only 80 shares of New Target stock to 
its shareholders and then as purchasing (and retaining) on July 2, the 
day after the disposition date, 20 shares of New Target stock at their 
fair market value as determined under Sec. 1.336-2(b)(1)(v), $2,000 
($100 per share).
    Example 5. Part sale, part distribution. (i) Facts. Parent owns all 
100 shares of Target's only class of stock. Target has two assets, both 
of which are buildings used in its business. Building 1 has a basis of 
$6,000 and Building 2 has a basis of $5,100. Target has no liabilities. 
On January 1 of Year 1, Parent sells 50 shares of Target to A for $88 
per share. Parent incurred no selling costs with respect to the sale of 
Target stock and A incurred no acquisition costs with respect to the 
purchase. On July 1 of Year 1, when the value of Target stock is $120 
per share, Parent distributes 30 shares of Target to Parent's unrelated 
shareholders. Parent retains the remaining 20 shares. On July 1, the 
value of Building 1 is $7,800 and the value of Building 2 is $4,200. A 
section 336(e) election is made.
    (ii) Consequences. Because the sale of the 50 shares and the 
distribution of the 30 shares occurred within a 12-month disposition 
period, the 80 shares of Target stock sold and distributed were disposed 
of in a qualified stock disposition. July 1 of Year 1 is the disposition 
date. On July 1, Target is treated as if it sold its assets to an 
unrelated person in exchange for the ADADP, $10,000 ($8,000 ((50 shares 
x $88) + (30 shares x $120))/.80 ($9,600 (80 shares x $120)/$12,000 (100 
shares x $120))), which is allocated to Buildings 1 and 2 in proportion 
to their fair market values, $6,500 to Building 1 and $3,500 to Building 
2 (see Sec. Sec. 1.336-3 and 1.338-6 for determination of amount and 
allocation of ADADP). Target realizes a gain of $500 on the deemed sale 
of Building 1 ($6,500-$6,000). Target realizes a loss of $1,600 on the 
deemed sale of Building 2 ($3,500-$5,100). Target recognizes all of its 
gains on the deemed asset disposition. However, because 30 shares of 
Target stock were distributed during the 12-month disposition period and 
there was a net loss of $1,100 realized on the deemed disposition of 
Buildings 1 and 2, $413 of the loss on the deemed sale is disallowed 
(see Sec. 1.336-2(b)(1)(i)(B)(2) for the determination of the 
disallowed loss amount). New Target is then treated as acquiring all its 
assets from an unrelated person in a single transaction in exchange for 
the amount of the AGUB, $10,000 ($8,000 ((50 shares x $88) + (30 shares 
x $120)) x 1.25 ((100-0)/80)), which is allocated to Buildings 1 and 2 
in proportion to their fair market values, $6,500 to Building 1 and 
$3,500 to Building 2 (see Sec. Sec. 1.336-4, 1.338-5, and 1.338-6 for 
determination of amount and allocation of AGUB). Old Target is treated 
as liquidating into Parent immediately after the deemed asset 
disposition, distributing the $10,000 deemed received in exchange for 
its assets in a transaction qualifying under section 332. Parent 
recognizes no gain or loss on the liquidation. Parent is then deemed to 
purchase 30 shares of New Target stock from an unrelated person on July 
1, and to distribute those 30 New Target shares to its shareholders. 
Parent recognizes no gain or loss on the deemed distribution of the 30 
shares under Sec. 1.336-2(b)(1)(iv). Parent is then deemed to purchase 
(and retain) on July 2, the day after the disposition date, 20 shares of 
New Target stock at their fair market value as determined under Sec. 
1.336-2(b)(1)(v), $2,000 ($100 per share (20 shares multiplied by $100 
fair market value per share ($10,000 grossed-up amount realized on the 
sale and distribution of 80 shares of target stock divided by 100 
shares)). A is treated as having purchased the 50 shares of New Target 
stock on January 1 of Year 1 at a cost of $88 per share, the same as if 
no section 336(e) election had been made. Parent's shareholders are 
treated as receiving New Target stock on July 1 of Year 1 as a 
distribution pursuant to section 301 and their basis in New Target stock 
received is $120 per share, its fair market value, pursuant to section 
301(d), the same as if no section 336(e) election had been made.
    Example 6. Sale of Target stock by consolidated group members. (i) 
Facts. Parent owns all of the stock of Sub and 50 of the 100 outstanding 
shares of Target stock. Sub owns the remaining 50 shares of Target 
stock. Target's assets have an aggregate basis of $9,000. Target has no 
liabilities. Parent, Sub, and Target file a consolidated Federal income 
tax return. On February 1 of Year 1, Parent sells 30 shares of its 
Target stock to A for $2,400. On March 1 of Year 1, Sub sells all 50 
shares of its Target stock to B for $5,600. Neither Parent nor Sub 
incurred any selling costs. Neither A nor B incurred any acquisition 
costs. A section 336(e) election is made.
    (ii) Consequences. Because Parent and Sub are members of the same 
consolidated group, their sale of Target stock is treated as made by one 
seller (see paragraph (g)(2) of this section), and the sales of Target 
stock constitute a qualified stock disposition. March 1 of Year 1 is the 
disposition date. For Federal income tax purposes, Parent and Sub are 
not treated as selling the stock of Target to A and B, respectively. 
Instead, the following events are deemed to occur. Old Target is treated 
as if, on March 1, it sold all its assets to unrelated person in 
exchange for the ADADP, $10,000 (see Sec. 1.336-3 for determination of 
ADADP), recognizing a net gain of

[[Page 100]]

$1,000. New Target is then treated as acquiring all its assets from an 
unrelated person in a single transaction in exchange for the amount of 
the AGUB, $10,000 (see Sec. Sec. 1.336-4 and 1.338-5 for the 
determination of AGUB). Old Target is treated as liquidating into Parent 
and Sub immediately thereafter, distributing the $10,000 deemed received 
in exchange for its assets in a transaction qualifying under section 332 
(see Sec. 1.1502-34). Neither Parent nor Sub recognizes gain or loss on 
the liquidation. Parent is then treated as purchasing from an unrelated 
person on March 2, the day after the disposition date, the 20 shares of 
Target stock (New Target stock) retained for their fair market value as 
determined under Sec. 1.336-2(b)(1)(v), $2,000 ($100 per share). A is 
treated as having purchased 30 shares of New Target stock on February 1 
of Year 1 at a cost of $2,400 ($80 per share), the same as if no section 
336(e) election had been made. B is treated as having purchased 50 
shares of New Target stock on March 1 of Year 1 at a cost of $5,600 
($112 per share), the same as if no section 336(e) election had been 
made.
    Example 7. Sale of Target stock by non-consolidated group members. 
(i) Facts. The facts are the same as in Example 6 except that Parent, 
Sub, and Target do not join in the filing of a consolidated Federal 
income tax return.
    (ii) Consequences. Because Parent and Sub do not join in the filing 
of a consolidated Federal income tax return and no single seller sells, 
exchanges, or distributes Target stock meeting the requirements of 
section 1504(a)(2), the transaction does not constitute a qualified 
stock disposition. The section 336(e) election made with respect to the 
disposition of Target stock has no effect.
    Example 8. Distribution of 80 percent of Target stock in complete 
redemption of a greater-than-50-percent shareholder. (i) Facts. A and B 
own 51 and 49 shares, respectively, of Seller's only class of stock. 
Seller owns all 100 shares of Target's only class of stock. Seller 
distributes 80 shares of Target stock to A in complete redemption of A's 
51 shares of Seller in a transaction that does not qualify under section 
355. A section 336(e) election is made.
    (ii) Consequences. Prior to the redemption, Seller and A would be 
related persons because, under section 318(a)(2)(C), any stock of a 
corporation that is owned by Seller would be attributed to A because A 
owns 50 percent or more of the value of the stock of Seller. However, 
for purposes of Sec. Sec. 1.336-1 through 1.336-5, the determination of 
whether Seller and A are related is made immediately after the 
redemption of A's stock. See Sec. Sec. 1.336-1(b)(5)(iii) and 1.338-
3(b)(3)(ii)(A). After the redemption, A no longer owns any stock of 
Seller. Accordingly, A and Seller are not related persons, as defined in 
Sec. 1.336-1(b)(12), and the distribution of Target stock constitutes a 
qualified stock disposition. For Federal income tax purposes, rather 
than Seller distributing the stock of Target to A, the following is 
deemed to occur. Old Target is treated as if it sold its assets to an 
unrelated person. New Target is then treated as acquiring all its assets 
from an unrelated person in a single transaction. Immediately 
thereafter, Old Target is treated as liquidating into Seller in a 
transaction qualifying under section 332. Seller recognizes no gain or 
loss on the liquidation. Seller is then treated as purchasing 80 shares 
of New Target stock from an unrelated person and then distributing the 
80 shares of New Target stock to A in exchange for A's 51 shares of 
Seller stock. Seller recognizes no gain or loss on the distribution of 
New Target stock pursuant to Sec. 1.336-2(b)(1)(iv). Seller is then 
treated as purchasing from an unrelated person on the day after the 
disposition date the 20 shares of Target stock (New Target stock) 
retained for their fair market value as determined under Sec. 1.336-
2(b)(1)(v). The Federal income tax consequences to A are the same as if 
no section 336(e) election had been made.
    Example 9. Pro-rata distribution of 80 percent of Target stock. (i) 
Facts. A and B own 60 and 40 shares, respectively, of Seller's only 
class of stock. Seller owns all 100 shares of Target's only class of 
stock. Seller distributes 48 shares of Target stock to A and 32 shares 
of Target stock to B in a transaction that does not qualify under 
section 355. A section 336(e) election is made.
    (ii) Consequences. Any stock of a corporation that is owned by 
Seller would be attributed to A under section 318(a)(2)(C) because, 
after the distribution, A owns 50 percent or more of the value of the 
stock of Seller. Therefore, after the distribution, A and Seller are 
related persons, as defined in Sec. 1.336-1(b)(12), and the 
distribution of Target stock to A is not a disposition. Because only 32 
percent of Target stock was sold, exchanged, or distributed to unrelated 
persons, there has not been a qualified stock disposition. Accordingly, 
the section 336(e) election made with respect to the distribution of 
Target stock has no effect.

    (h) Effective/applicability date. Paragraph (d)(3)(ii) of this 
section is applicable to any qualified stock purchase or qualified stock 
disposition (as defined in Sec. 1.336-1(b)(6)) for which the 
acquisition date or disposition date (as defined in Sec. 1.336-
1(b)(8)), respectively, is on or after May 15, 2013.
    (h) Effective/applicability date. Paragraph (d)(3)(ii) of this 
section is applicable to any qualified stock purchase or qualified stock 
disposition (as defined in Sec. 1.336-1(b)(6)) for which the 
acquisition date or disposition date (as

[[Page 101]]

defined in Sec. 1.336-1(b)(8)), respectively, is on or after May 15, 
2013.

[T.D. 9619, 78 FR 28474, May 15, 2013; 78 FR 53027, Aug. 28, 2013]



Sec. 1.336-3  Aggregate deemed asset disposition price; various 
aspects of taxation of the deemed asset disposition.

    (a) Scope. This section provides rules under section 336(e) to 
determine the aggregate deemed asset disposition price (ADADP) for 
Target. ADADP is the amount for which old Target is deemed to have sold 
all of its assets in the deemed asset disposition. ADADP is allocated 
among Target's assets in the same manner as the aggregate deemed sale 
price (ADSP) is allocated under Sec. 1.338-6 to determine the amount 
for which each asset is deemed to have been sold. If a subsequent 
increase or decrease is required under general principles of tax law 
with respect to an element of ADADP, the redetermined ADADP is allocated 
among Target's assets in the same manner as redetermined ADSP is 
allocated under Sec. 1.338-7.
    (b) Determination of ADADP--(1) General rule. ADADP is the sum of--
    (i) The grossed-up amount realized on the sale, exchange, or 
distribution of recently disposed stock of Target; and
    (ii) The liabilities of old Target.
    (2) Time and amount of ADADP--(i) Original determination. ADADP is 
initially determined at the beginning of the day after the disposition 
date of Target. General principles of tax law apply in determining the 
timing and amount of the elements of ADADP.
    (ii) Redetermination of ADADP. ADADP is redetermined at such time 
and in such amount as an increase or decrease would be required, under 
general principles of tax law, for the elements of ADADP. For example, 
ADADP is redetermined because of an increase or decrease in the amount 
realized on the sale or exchange of recently disposed stock of Target or 
because liabilities not originally taken into account in determining 
ADADP are subsequently taken into account. Increases or decreases with 
respect to the elements of ADADP result in the reallocation of ADADP 
among Target's assets in the same manner as ADSP under Sec. 1.338-7.
    (c) Grossed-up amount realized on the disposition of recently 
disposed stock of Target--(1) Determination of amount. The grossed-up 
amount realized on the disposition of recently disposed stock of Target 
is an amount equal to--
    (i) The sum of --
    (A) With respect to recently disposed of stock of Target that is not 
distributed in the qualified stock disposition, the amount realized on 
the sale or exchange of such recently disposed stock of Target, 
determined as if seller or S corporation shareholders were required to 
use old Target's accounting methods and characteristics and the 
installment method were not available and determined without regard to 
the selling costs taken into account under paragraph (c)(1)(iii) of this 
section, and
    (B) With respect to recently disposed of stock of Target that is 
distributed in the qualified stock disposition, the fair market value of 
such recently disposed stock of Target determined on the date of each 
distribution;
    (ii) Divided by the percentage of Target stock (by value, determined 
on the disposition date) attributable to the recently disposed stock;
    (iii) Less the selling costs incurred by seller or S corporation 
shareholders in connection with the sale or exchange of recently 
disposed stock that reduce its amount realized on the sale or exchange 
of the stock (for example, brokerage commissions and any similar costs 
to sell the stock).
    (2) Example. The following example illustrates this paragraph (c):

    Example. Target has two classes of stock outstanding, voting common 
stock and preferred stock described in section 1504(a)(4). Seller owns 
all 100 shares of each class of stock. On March 1 of Year 1, Seller 
sells 10 shares of Target voting common stock to A for $75. On April 1 
of Year 2, Seller distributes 15 shares of Target voting common stock 
with a fair market value of $120 to B. On May 1 of Year 2, Seller 
distributes 10 shares of Target voting common stock with a fair market 
value of $110 to C. On July 1 of Year 2, Seller sells 55 shares of 
Target voting common stock to D for $550. On July 1 of Year 2, the fair 
market value of all the Target voting common stock is $1,000 ($10 per 
share) and the fair market value of all the preferred stock is $600 ($6 
per share). Seller incurs $20 of selling costs with respect to the

[[Page 102]]

sale to A and $60 of selling costs with respect to the sale to D. The 
grossed-up amount realized on the sale, exchange, or distribution of 
recently disposed stock of Target is calculated as follows: The sum of 
the amount realized on the sale or exchange of recently disposed stock 
sold or exchanged (without regard to selling costs) and the fair market 
value of the recently disposed stock distributed is $780 ($120 + $110 + 
$550) (the 10 shares sold to A on March 1 of Year 1 is not recently 
disposed stock because it was not disposed of during the 12-month 
disposition period). The percentage of Target stock by value on the 
disposition date attributable to recently disposed stock equals 50% 
($800 (80 shares of recently disposed stock x $10, the fair market value 
of each share of Target common stock on the disposition date)/$1,600 
($1,000 (the total value of Target's common stock on the disposition 
date) + $600 (the total value of Target's preferred stock on the 
disposition date))). The grossed-up amount realized equals $1,500 
(($780/.50)-$60 selling costs).

    (d) Liabilities of old Target--(1) In general. In general, the 
liabilities of old Target are measured as of the beginning of the day 
after the disposition date. However, if a Target for which a section 
336(e) election is made engages in a transaction outside the ordinary 
course of business on the disposition date after the event resulting in 
the qualified stock disposition of Target or a higher-tier corporation, 
Target and all persons related thereto (either before or after the 
qualified stock disposition) under section 267(b) or section 707 must 
treat the transaction for all Federal income tax purposes as occurring 
at the beginning of the day following the transaction and after the 
deemed disposition by old Target. In order to be taken into account in 
ADADP, a liability must be a liability of Target that is properly taken 
into account in amount realized under general principles of tax law that 
would apply if old Target had sold its assets to an unrelated person for 
consideration that included the discharge of its liabilities. See Sec. 
1.1001-2(a). Such liabilities may include liabilities for the tax 
consequences resulting from the deemed asset disposition.
    (2) Time and amount of liabilities. The time for taking into account 
liabilities of old Target in determining ADADP and the amount of the 
liabilities taken into account is determined as if old Target had sold 
its assets to an unrelated person for consideration that included the 
discharge of the liabilities by the unrelated person. For example, if no 
amount of a Target liability is properly taken into account in amount 
realized as of the beginning of the day after the disposition date, the 
liability is not initially taken into account in determining ADADP, but 
it may be taken into account at some later date.
    (e) Deemed disposition tax consequences. Gain or loss on each asset 
in the deemed asset disposition is computed by reference to the ADADP 
allocated to that asset. ADADP is allocated in the same manner as is 
ADSP under Sec. 1.338-6. Although deemed disposition tax consequences 
may increase or decrease ADADP by creating or reducing a tax liability, 
the amount of the tax liability itself may be a function of the size of 
the deemed disposition tax consequences. Thus, these determinations may 
require trial and error computations.
    (f) Other rules apply in determining ADADP. ADADP may not be applied 
in such a way as to contravene other applicable rules. For example, a 
capital loss cannot be applied to reduce ordinary income in calculating 
the tax liability on the deemed asset disposition for purposes of 
determining ADADP.
    (g) Examples. The following examples illustrate this section.

    Example 1. (i) Facts. The facts are the same as in Example 1 of 
Sec. 1.336-2(b)(1)(i)(B)(3), that is, Parent owns 60 of the 100 
outstanding shares of the common stock of Seller, Seller's only class of 
stock outstanding. The remaining 40 shares of the common stock of Seller 
are held by shareholders unrelated to Seller or each other. Seller owns 
95 of the 100 outstanding shares of Target common stock, and all 100 
shares of Target preferred stock that is described in section 
1504(a)(4). The remaining 5 shares of Target common stock are owned by 
A. On January 1 of Year 1, Seller sells 72 shares of Target common stock 
to B for $3,520. On July 1 of Year 1, Seller distributes 12 shares of 
Target common stock to Parent and 8 shares to its unrelated shareholders 
in a distribution described in section 301. Seller retains 3 shares of 
Target common stock and all 100 shares of Target preferred stock 
immediately after July 1. The value of Target common stock on July 1 is 
$60 per share. The value of Target preferred stock on July 1 is $36 per 
share. Target has three assets, Asset 1, a Class IV asset, with a basis 
of $1,776 and a fair market value of $2,000, Asset 2, a Class V asset, 
with a basis of $2,600 and

[[Page 103]]

a fair market value of $2,750, and Asset 3, a Class V asset, with a 
basis of $3,900 and a fair market value of $3,850. Seller incurred no 
selling costs on the sale of the 72 shares of Target common stock to B. 
Target has no liabilities. A section 336(e) election is made.
    (ii) Determination of ADADP. The ADADP on the deemed asset 
disposition of Target is determined as follows. The grossed-up amount 
realized on the sale, exchange, or distribution of recently disposed 
stock of Target is $8,000, the sum of $3,520, the amount realized on the 
sale to B of the 72 shares of Target common stock and $480, the fair 
market value on the date distributed of the 8 shares of Target common 
stock distributed to Seller's unrelated shareholders in the qualified 
stock disposition, divided by .50, the percentage of Target stock by 
value, determined on the disposition date, attributable to the recently 
disposed stock ($4,800 (80 shares of Target common stock disposed of in 
the qualified stock disposition x $60, the value of a share of Target 
common stock on the disposition date) divided by $9,600 ((100, the total 
number of shares of Target common stock x $60, the value of a share of 
Target common stock on the disposition date) + (100, the total number of 
shares of Target preferred stock x $36, the value of a share of Target 
preferred stock on the disposition date))), minus $0, Seller's selling 
costs in connection with the sale of the 72 shares of Target common 
stock sold to B. The $8,000 grossed-up amount realized on the sale, 
exchange, or distribution of recently disposed stock of Target is then 
added to the liabilities of Old Target, $0, to arrive at the ADADP, 
$8,000.
    (iii) Allocation of ADADP. The ADADP of $8,000 is allocated first to 
Asset 1, the Class IV asset, but not in excess of Asset 1's fair market 
value, $2,000. The remaining ADADP of $6,000 is allocated between Assets 
2 and 3, both Class V assets, in proportion to their fair market values, 
but not in excess of their fair market values. Because the total fair 
market value of Assets 2 and 3, $6,600, exceeds the ADADP remaining 
after allocation of a portion of the ADADP to Asset 1, the $6,000 
remaining ADADP is allocated to Assets 2 and 3 in proportion to their 
respective fair market values. Accordingly, $2,500 is allocated to Asset 
2 ($6,000 x ($2,750/($2,750 + $3,850))) and $3,500 is allocated to Asset 
3 ($6,000 x ($3,850/($2,750 + $3,850))).
    Example 2. (i) Facts. The facts are the same as in Example 1 except 
that Asset 2 is the stock of Target Subsidiary, a corporation of which 
Target owns 100 of the 110 shares of common stock, the only outstanding 
class of Target Subsidiary stock. The remaining 10 shares of Target 
Subsidiary stock are owned by D. The value of Target Subsidiary stock on 
July 1 is $27.50 per share. Target Subsidiary has two assets, Asset 4, a 
Class IV asset, with a basis of $800 and a fair market value of $1,000, 
and Asset 5, a Class IV asset, with a basis of $2,200 and a fair market 
value of $2,025. Target Subsidiary has no liabilities. A section 336(e) 
election with respect to Target Subsidiary is also made.
    (ii) Determination of ADADP. The ADADP on the deemed asset 
disposition of Target Subsidiary is determined as follows. The grossed-
up amount realized on the sale, exchange, or distribution of recently 
disposed stock of Target Subsidiary is $2,750, ($2,500 ADADP allocable 
to Asset 2, the 100 shares of the stock of Target Subsidiary owned by 
Target, divided by .909, the percentage of Target Subsidiary stock by 
value, determined on the disposition date, attributable to the recently 
disposed stock ($2,750 (100 shares of the stock of Target Subsidiary 
deemed disposed in the qualified stock disposition x $27.50, the value 
of a share of Target Subsidiary stock on the disposition date) divided 
by $3,025 (110, the total number of shares of Target Subsidiary stock x 
$27.50, the value of a share of Target Subsidiary stock on the 
disposition date)), minus $0, Seller's selling costs in connection with 
the deemed sale of the 100 shares of Target Subsidiary stock). The 
$2,750 grossed-up amount realized on the sale, exchange, or distribution 
of recently disposed stock of Target Subsidiary is then added to the 
liabilities of Old Target Subsidiary, $0, to arrive at the ADADP of 
Target Subsidiary, $2,750.
    (iii) Allocation of ADADP. Because Assets 4 and 5 are each assets of 
the same class, and the total fair market value of Assets 4 and 5 
exceeds the $2,750 ADADP of Target Subsidiary, the $2,750 ADADP is 
allocated to Assets 4 and 5 in proportion to their respective fair 
market values. Accordingly, $909 is allocated to Asset 4 ($2,750 x 
($1,000/($1,000 + $2,025))) and $1,841 is allocated to Asset 5 ($2,750 x 
($2,025/($1,000 + $2,025))).
    Example 3. (i) Seller owns all 100 of the outstanding shares of the 
common stock of Target, the only class of Target stock outstanding. On 
January 1 of Year 1, Seller sells 10 shares of Target stock to A for 
$6,000 ($600 per share). On August 1 of Year 1, Seller distributes the 
remaining 90 shares of Target stock to its unrelated shareholders in a 
transaction described in section 355(d)(2) or (e)(2). The value of 
Target stock on August 1 is $560 per share. Target has two assets, Asset 
1, which is stock in trade of Target, a Class IV asset, with a basis of 
$15,000 and a value of $50,000, and Asset 2, which is stock in a 
publicly traded, unrelated corporation, a Class II asset, with a basis 
of $38,000 and a value of $16,000. Target has no liabilities other than 
any liabilities for Federal tax on account of the deemed asset 
disposition. Assume Target's Federal tax rate for any gain or income on 
the deemed asset disposition is 34 percent. Seller had no selling costs 
in connection with its sale of the 10 shares of Target stock. A section 
336(e) election is made.

[[Page 104]]

    (ii) Because at least 80 percent of Target stock was disposed of 
(within the meaning of Sec. 1.336-1(b)(5)) by Seller during the 12-
month disposition period, a qualified stock disposition occurred. August 
1 of Year 1 is the disposition date. Accordingly, pursuant to the 
section 336(e) election, for Federal income tax purposes, Target is 
treated as if, on August 1, it sold all of its assets to an unrelated 
person in exchange for the ADADP.
    (iii) Under these facts, although a portion of the qualified stock 
disposition was the result of a stock distribution, because the grossed-
up amount realized on the disposition of recently disposed stock of 
Target, $56,400 (($6,000 + ($560 x 90))/1) exceeds Target's total basis 
in its assets, none of the losses realized on the deemed asset 
disposition are disallowed under Sec. 1.336-2(b)(2)(i)(B)(2). Because 
the grossed-up amount realized on the disposition of recently disposed 
stock of Target exceeds the value of Asset 2, the ADADP allocated to 
Asset 2 equals the value of Asset 2, $16,000, and Target realizes a 
$22,000 loss on the deemed disposition of Asset 2. None of this loss is 
disallowed under section 1091. See Sec. 1.336-2(b)(2)(ii)(C). 
Accordingly, Target recognizes a $22,000 loss on the deemed disposition 
of Asset 2.
    (iv) The ADADP allocated to Asset 1 is determined as follows (for 
purposes of this Example 3, TotADADP is the total ADADP for the deemed 
asset disposition, A1ADADP is the tentative amount of the total ADADP 
allocated to Asset 1, A2ADADP is the amount of the total ADADP allocated 
to Asset 2, G is the grossed-up amount realized on the disposition of 
recently disposed stock of Target, L is Target's liabilities other than 
Target's tax liability for the deemed disposition tax consequences, 
TR is the applicable tax rate, and B1 is the adjusted basis 
of Asset 1 and B2 is the adjusted basis of Asset 2):
TotADADP = G + L + (TR x (TotADADP-B1-B2))
A1ADADP = TotADADP-A2ADADP
A2ADADP = $16,000
A1ADADP = TotADADP-$16,000
G = ($6,000 + ($560 x 90))/1
G = $56,400
TotADADP = $56,400 + 0 + (.34 x (TotADADP-$15,000-$38,000))
TotADADP = $56,400 + .34TotADADP-$18,020
.66TotADADP = $38,380
TotADADP = $58,152
A1ADADP = $42,152
    (v) Because A1ADADP, $42,152, does not exceed the value of Asset 1, 
$50,000, the entire A1ADADP is allocated to Asset 1. Old Target thus 
realizes and recognizes a gain of $27,152 on the deemed disposition of 
Asset 1 ($42,152-$15,000).

[T.D. 9619, 78 FR 28474, May 15, 2013]



Sec. 1.336-4  Adjusted grossed-up basis.

    (a) Scope. Except as provided in paragraphs (b) and (c) of this 
section or as the context otherwise requires, the principles of 
paragraphs (b) through (g) of Sec. 1.338-5 apply in determining the 
adjusted grossed-up basis (AGUB) for target and the consequences of a 
gain recognition election. AGUB is the amount for which new target is 
deemed to have purchased all of its assets in the deemed purchase under 
Sec. 1.336-2(b)(1)(ii) or the amount for which old target is deemed to 
have purchased all of its assets in the deemed purchase under Sec. 
1.336-2(b)(2)(ii). AGUB is allocated among target's assets in accordance 
with Sec. 1.338-6 to determine the price at which the assets are deemed 
to have been purchased. If a subsequent increase or decrease with 
respect to an element of AGUB is required under general principles of 
tax law, redetermined AGUB is allocated among target's assets in 
accordance with Sec. 1.338-7.
    (b) Modifications to the principles in Sec. 1.338-5. Solely for 
purposes of applying Sec. Sec. 1.336-1 through 1.336-4, the principles 
of Sec. 1.338-5 are modified as follows--
    (1) Purchasing corporation; purchaser. Any reference to the 
purchasing corporation shall be treated as a reference to a purchaser, 
as defined in Sec. 1.336-1(b)(2).
    (2) Acquisition date; disposition date. Any reference to the 
acquisition date shall be treated as a reference to the disposition 
date, as defined in Sec. 1.336-1(b)(8).
    (3) Section 338 election; section 338(h)(10) election; section 
336(e) election. Any reference to a section 338 election or a section 
338(h)(10) election shall be treated as a reference to a section 336(e) 
election, as defined in Sec. 1.336-1(b)(11).
    (4) New target; old target. In the case of a disposition described 
in section 355(d)(2) or (e)(2), any reference to new target shall be 
treated as a reference to old target in its capacity as the purchaser of 
assets pursuant to the section 336(e) election.
    (5) Recently purchased stock; recently disposed stock. Any reference 
to recently purchased stock shall be treated as a reference to recently 
disposed stock, as defined in Sec. 1.336-1(b)(17). In the case of

[[Page 105]]

a distribution of stock, for purposes of determining the purchaser's 
grossed-up basis of recently disposed stock, the purchaser's basis in 
recently disposed stock shall be deemed to be such stock's fair market 
value on the date it was acquired.
    (6) Nonrecently purchased stock; nonrecently disposed stock. Any 
reference to nonrecently purchased stock shall be treated as a reference 
to nonrecently disposed stock, as defined in Sec. 1.336-1(b)(18).
    (c) Gain recognition election--(1) In general. Any holder of 
nonrecently disposed stock of target may make a gain recognition 
election. The gain recognition election is irrevocable. Each owner of 
nonrecently disposed stock determines its basis amount, and therefore 
the gain recognized pursuant to the gain recognition election, by 
applying Sec. Sec. 1.338-5(c) and 1.338-5(d)(3)(ii) by reference to its 
own recently disposed stock and nonrecently disposed stock, and not by 
reference to all recently disposed stock and nonrecently disposed stock.
    (2) 80-percent purchaser. If a section 336(e) election is made for 
target, any 80-percent purchaser and all persons related to the 80-
percent purchaser are automatically deemed to have made a gain 
recognition election for its nonrecently disposed target stock.
    (3) Non-80-percent purchaser. If not automatically deemed made under 
paragraph (c)(2) of this section, a gain recognition election is made by 
a non-80-percent purchaser providing, on or before the due date for 
filing the section 336(e) election statement by the appropriate party, a 
gain recognition election statement, as described in paragraph (c)(4) of 
this section, to the appropriate party. If seller and target are members 
of the same consolidated group, seller is the appropriate party and the 
common parent of the consolidated group must retain the gain recognition 
election statement. If seller and target are members of the same 
affiliated group but do not join in the filing of a consolidated Federal 
income tax return, or if target is an S corporation, target is the 
appropriate party and target must retain the gain recognition election 
statement. If a non-80-percent purchaser makes a gain recognition 
election, all related persons to the non-80-percent purchaser must also 
make a gain recognition election. Otherwise, the gain recognition 
election for the non-80-percent purchaser will have no effect.
    (4) Gain recognition election statement. A gain recognition election 
statement must include the following declarations (or substantially 
similar declarations):
    (i) [Insert name, address, and taxpayer identifying number of person 
for whom gain recognition election is actually being made] has elected 
to recognize gain under Sec. 1.336-4(c) with respect to [his, hers, or 
its] nonrecently disposed stock.
    (ii) [Insert name of person for whom gain recognition election is 
actually being made] agrees to report any gain under the gain 
recognition election on [his, hers, or its] Federal income tax return 
(including an amended return, if necessary) for the taxable year that 
includes the disposition date of [insert name and employer 
identification number of target].
    (d) Examples. The following examples illustrate the provisions of 
this section.

    Example 1. On January 1 of Year 1, Seller owns 85 shares of Target 
stock, A owns 8 shares, B owns 4 shares, and C owns the remaining 3 
shares. Each of A's 8 shares, B's 4 shares, and C's 3 shares have a $5 
basis. Assume that Target has no liabilities. On July 1 of Year 2, 
Seller sells 70 shares of Target stock to A for $10 per share. On 
September 1 of Year 2, Seller sells 5 shares of Target stock to B and 5 
shares of Target stock to C for $14 per share. A section 336(e) election 
is made. A does not make a gain recognition election. A incurs $25 of 
acquisition costs and B and C each incur $10 of acquisition costs in 
connection with their respective Year 2 purchases. These costs are 
capitalized in the basis of Target stock. September 1 of Year 2 is the 
disposition date. Because A owns at least 10 percent of Target stock on 
September 1, the disposition date, and A's original 8 shares of Target 
stock owned on January 1 of Year 1 were not disposed of in the qualified 
stock disposition, A's original 8 shares of Target stock are nonrecently 
disposed stock. Although B's original 4 shares and C's original 3 shares 
were not disposed of in the qualified stock disposition, because neither 
B nor C owns, with the application of section 318(a), other than section 
318(a)(4), at least 10 percent of the total voting power or value of 
Target stock on the disposition

[[Page 106]]

date, their original shares are not nonrecently disposed stock. The 
grossed-up basis of recently disposed Target stock is $1,011, determined 
as follows: The purchasers' (A, B, and C) aggregate basis in the 
recently disposed target stock, determined without regard to acquisition 
costs, is $840 ((70 x $10) + (5 x $14) + (5 x $14)). This amount is 
multiplied by a fraction, the numerator of which is 100 minus 8, the 
percentage of Target stock that is nonrecently disposed stock, and the 
denominator of which is 80, the percentage of Target stock attributable 
to recently disposed stock ($840 x 92/80 = $966). This amount is then 
increased by the $45 of acquisition costs incurred by A, B, and C to 
arrive at the $1,011 grossed-up basis of recently disposed Target stock 
($966 + $45 = $1,011). New Target's AGUB is $1,051, the sum of $1,011, 
the grossed-up basis of recently disposed Target stock and $40 (8 x $5), 
A's basis in his nonrecently disposed Target stock.
    Example 2. The facts are the same as in Example 1 except that A 
makes a gain recognition election. Pursuant to the gain recognition 
election, A is treated as if he sold on September 1 of Year 2, the 
disposition date, his 8 shares of nonrecently disposed Target stock for 
the basis amount, and A's basis in nonrecently disposed target stock 
immediately after the deemed sale is the basis amount. A's basis amount 
equals his basis in his recently disposed Target stock without regard to 
acquisition costs, $700 (70 x $10), multiplied by a fraction, the 
numerator of which is 100 minus 8, the percentage of Target stock, by 
value, determined on the disposition date, which is A's nonrecently 
disposed Target stock, and the denominator of which is 70, the 
percentage of Target stock, by value, determined on the disposition 
date, which is A's recently disposed stock, which is then multiplied by 
a fraction, the numerator of which is 8, the percentage of Target stock, 
by value, determined on the disposition date, attributable to A's 
nonrecently disposed Target stock and the denominator of which is 100 
minus the numerator amount. Accordingly, A's basis amount is $80 ($700 x 
92/70 x 8/92). A therefore recognizes gain of $40 under the gain 
recognition election ($80 basis amount minus A's $40 basis in his 
nonrecently disposed stock prior to the gain recognition election). New 
Target's AGUB is $1,091, the sum of $1,011, the grossed-up basis of all 
recently disposed Target stock and $80, A's basis in his nonrecently 
disposed Target stock pursuant to the gain recognition election.
    Example 3. (i) The facts are the same as in Example 3 of Sec. 
1.336-3(g), that is, Seller owns all 100 of the outstanding shares of 
the common stock of Target, the only class of Target stock outstanding. 
On January 1 of Year 1, Seller sells 10 shares of Target stock to A for 
$6,000 ($600 per share). On August 1 of Year 1, Seller distributes the 
remaining 90 shares of Target stock to its unrelated shareholders in a 
transaction described in section 355(d)(2) or (e)(2). The value of 
Target stock on August 1 is $560 per share. Target has two assets, Asset 
1, which is stock in trade of Target, a Class IV asset, with a basis of 
$15,000 and a value of $50,000, and Asset 2, which is stock in a 
publicly traded, unrelated corporation, a Class II asset, with a basis 
of $38,000 and a value of $16,000. Target has no liabilities other than 
any liabilities for Federal tax on account of the deemed asset 
disposition. Assume Target's Federal tax rate for any gain or income on 
the deemed asset disposition is 34 percent. Seller had no selling costs 
in connection with its sale of the 10 shares of Target stock. A section 
336(e) election is made. In addition, A incurred $100 of acquisition 
costs with respect to the purchase of the 10 shares of Target stock. 
Target's AGUB in the assets deemed acquired pursuant to Sec. 1.336-
2(b)(2)(ii)(B) is determined as follows (for purposes of this Example 3, 
GRD is the grossed-up basis of recently disposed stock, BND is the basis 
in nonrecently disposed stock, TotL is Target's total liabilities, 
including Target's tax liability, and X is the A's total acquisition 
costs):
AGUB = GRD + BND + TotL
GRD = ($6,000 + ($560 x 90)) x ((100 - 0)/100) + X
GRD = ($6,000 + $50,400) x (100/100) + $100
GRD = $56,500
BND = $0
TotL = .34 x ($27,152 (Target's gain recognized on deemed disposition of 
          Asset 1) - $22,000 (Target's loss recognized on deemed 
          disposition of Asset 2)) (see Example 3 of Sec. 1.336-3(g) 
          for determination of Target's gain and loss recognized on 
          deemed disposition of Assets 1 and 2)
TotL = $1,752
AGUB = $56,500 + $0 + $1,752
AGUB = $58,252
    (ii) The AGUB allocated to Asset 2 is $16,000, the value of Asset 2. 
Because the excess of the total AGUB, $58,252, over the portion of the 
AGUB allocated to Asset 2, $16,000, does not exceed the value of Asset 
1, the AGUB allocated to Asset 1 is such excess, $42,252.

[T.D. 9619, 78 FR 28474, May 15, 2013]



1.336-5  Effective/applicability dates.

    The provisions of Sec. Sec. 1.336-1 through 1.336-4 apply to any 
qualified stock disposition for which the disposition date is on or 
after May 15, 2013. The provisions of Sec. 1.336-1(b)(5)(i)(A) relating 
to section 1022 are effective on and after January 19, 2017.

[T.D. 9619, 78 FR 28474, May 15, 2013, as amended by T.D. 9811, 82 FR 
6237, Jan. 19, 2017]

[[Page 107]]

                         effects on corporation



Sec. 1.337-1  Nonrecognition for property distributed to parent
in complete liquidation of subsidiary.

    (a) General rule. If sections 332(a) and 337 are applicable with 
respect to the receipt of a subsidiary`s property in complete 
liquidation, no gain or loss is recognized to the liquidating subsidiary 
with respect to such property (including property distributed with 
respect to indebtedness, see section 337(b)(1) and Sec. 1.332-7), 
except as provided in section 337(b)(2) (distributions to certain tax-
exempt distributees), section 367(e)(2) (distributions to foreign 
corporations), and section 897(d) (distributions of U.S. real property 
interests by foreign corporations).
    (b) Aplicability date. This section applies to any taxable year 
beginning on or after March 28, 2016.

[T.D. 9759, 81 FR 17074, Mar. 28, 2016]



Sec. 1.337(d)-1  Transitional loss limitation rule.

    (a) Loss limitation rule for transitional subsidiary--(1) General 
rule. No deduction is allowed for any loss recognized by a member of a 
consolidated group with respect to the disposition of stock of a 
transitional subsidiary. However, for transactions involving loss shares 
of subsidiary stock occurring on or after September 17, 2008, see Sec. 
1.1502-36. Further, this section does not apply to a transaction that is 
subject to Sec. 1.1502-36.
    (2) Allowable loss--(i) In general. Paragraph (a)(1) of this section 
does not apply to the extent the taxpayer establishes that the loss is 
not attributable to the recognition of built-in gain by any transitional 
subsidiary on the disposition of an asset (including stock and 
securities) after January 6, 1987.
    (ii) Statement of allowable loss. Paragraph (a)(2)(i) of this 
section applies only if a separate statement entitled ``Allowable Loss 
Under Sec. 1.337(d)-1(a)'' is filed with the taxpayer's return for the 
year of the stock disposition. If the separate statement is required to 
be filed with a return the due date (including extensions) of which is 
before January 16, 1991, or with a return due (including extensions) 
after January 15, 1991 but filed before that date, the statement may be 
filed with an amended return for the year of the disposition or with the 
taxpayer's first subsequent return the due date (including extensions) 
of which is after January 15, 1991.
    (iii) Contents of statement. The statement required under paragraph 
(a)(2)(ii) of this section must contain--
    (A) The name and employer identification number (E.I.N.) of the 
transitional subsidiary.
    (B) The basis of the stock of the transitional subsidiary 
immediately before the disposition.
    (C) The amount realized on the disposition.
    (D) The amount of the deduction not disallowed under paragraph 
(a)(1) of this section by reason of this paragraph (a)(2).
    (E) The amount of loss disallowed under paragraph (a)(1) of this 
section.
    (3) Coordination with loss deferral and other disallowance rules. 
(i) For purposes of this section, the rules of Sec. 1.1502-20(a)(3) 
apply, with appropriate adjustments to reflect differences between the 
approach of this section and that of Sec. 1.1502-20.
    (ii) Other loss deferral rules. If paragraph (a)(1) of this section 
applies to a loss subject to deferral or disallowance under any other 
provision of the Code or the regulations, the other provision applies to 
the loss only to the extent it is not disallowed under paragraph (a)(1).
    (4) Definitions. For purposes of this section--
    (i) The definitions in Sec. 1.1502-1 apply.
    (ii) Transitional subsidiary means any corporation that became a 
subsidiary of the group (whether or not the group was a consolidated 
group) after January 6, 1987. Notwithstanding the preceding sentence, a 
subsidiary is not a transitional subsidiary if the subsidiary (and each 
predecessor) was a member of the group at all times after the 
subsidiary's (and each predecessor's) organization.
    (iii) Built-in gain of a transitional subsidiary means gain 
attributable, directly or indirectly, in whole or in part, to any excess 
of value over basis, determined immediately before the transitional 
subsidiary became a subsidiary, with respect to any asset

[[Page 108]]

owned directly or indirectly by the transitional subsidiary at that 
time.
    (iv) Disposition means any event in which gain or loss is 
recognized, in whole or in part.
    (v) Value means fair market value.
    (5) Examples. For purposes of the examples in this section, unless 
otherwise stated, the group files consolidated returns on a calendar 
year basis, the facts set forth the only corporate activity, and all 
sales and purchases are with unrelated buyers or sellers. The basis of 
each asset is the same determining earnings and profits adjustments and 
taxable income. Tax liability and its effect on basis, value, and 
earnings and profits are disregarded. Investment adjustment system means 
the rules of Sec. 1.1502-32. The principles of this paragraph (a) are 
illustrated by the following examples:

    Example 1. Loss attributable to recognized built-in gain. (i) P buys 
all the stock of T for $100 on February 1, 1987, and T becomes a member 
of the P group. T has an asset with a value of $100 and basis of $0. T 
sells the asset in 1989 and recognizes $100 of built-in gain on the sale 
(i.e., the asset's value exceeded its basis by $100 at the time T became 
a member of the P group). Under the investment adjustment system, P's 
basis in the T stock increases to $200. P sells all the stock of T on 
December 31, 1989, and recognizes a loss of $100. Under paragraph (a)(1) 
of this section, no deduction is allowed to P for the $100 loss.
    (ii) Assume that, after T sells its asset but before P sells the T 
stock, T issues additional stock to unrelated persons and ceases to be a 
member of the P group. P then sells all its stock of T in 1997. Although 
T ceases to be a subsidiary within the meaning of Sec. 1.1502-1, T 
continues to be a transitional subsidiary within the meaning of this 
section. Consequently, under paragraph (a)(1) of this section, no 
deduction is allowed to P for its $100 loss.
    Example 2. Loss attributable to post-acquisition loss. P buys all 
the stock of T for $100 on February 1, 1987, and T becomes a member of 
the P group. T has $50 cash and an asset with $50 of built-in gain. 
During 1988, T retains the asset but loses $40 of the cash. The P group 
is unable to use the loss, and the loss becomes a net operating loss 
carryover attributable to T. Under the investment adjustment system, P's 
basis in the stock of T remains $100. P sells all the stock of T on 
December 31, 1988, for $60 and recognizes a $40 loss. Under paragraph 
(a)(2)(i) of this section, P establishes that it did not dispose of the 
built-in gain asset. None of P's loss is disallowed under paragraph 
(a)(1) if P satisfies the requirements of paragraph (a)(2)(ii) of this 
section.
    Example 3. Stacking rules--postacquisition loss offsets 
postacquisition gain. (i) P buys all the stock of T for $100 on February 
1, 1987, and T becomes a member of the P group. T has 2 assets. Asset 1 
has a basis and value of $50, and asset 2 has a basis of $0 and a value 
of $50. During 1989, asset 1 declines in value to $0, and T sells asset 
2 for $50, and reinvests the proceeds in asset 3. The value of asset 3 
appreciates to $90. Under the investment adjustment system, P's basis in 
the stock of T increases from $100 to $150 as a result of the gain 
recognized on the sale of asset 2 but is unaffected by the unrealized 
post-acquisition decline in the value of asset 1. On December 31, 1989, 
P sells all the stock of T for $90 and recognizes a $60 loss.
    (ii) Although T incurred a $50 post-acquisition loss of built-in 
gain because of the decline in the value of asset 1, T also recognized 
$50 of built-in gain. Under paragraph (a)(2) of this section, any loss 
on the sale of stock is treated first as attributable to recognized 
built-in gain. Thus, for purposes of determining under paragraph (a)(2) 
of this section whether P's $60 loss on the disposition of the T stock 
is attributable to the recognition of built-in gain on the disposition 
of an asset, T's unrealized post-acquisition gain of $40 offsets $40 of 
the $50 of unrealized post-acquisition loss. Therefore, $50 of the $60 
loss is attributable to the recognition of built-in gain on the 
disposition of an asset and is disallowed under paragraph (a)(1) of this 
section.
    Example 4. Stacking rules--built-in loss offsets built-in gain. (i) 
P buys all the stock of T for $50 on February 1, 1987, and T becomes a 
member of the P group. T has 2 assets. Asset 1 has a basis of $50 and a 
value of $0, and asset 2 has a basis of $0 and a value of $50. During 
1989, T sells asset 1 for $0 and asset 2 for $50, and reinvests the $50 
proceeds in asset 3. The value of asset 3 declines to $40. Under the 
investment adjustment system, P's basis in the stock of T remains $50 as 
a result of the offsetting gain and loss recognized on the sale of 
assets 1 and 2 and is unaffected by the unrealized post-acquisition 
decline in the value of asset 3. On December 31, 1989, P sells all the 
stock of T for $40 and recognizes a $10 loss.
    (ii) Although T recognized a $50 built-in gain on the sale of asset 
2, T also recognized a $50 built-in loss on the sale of asset 1. For 
purposes of determining under paragraph (a)(2) of this section whether 
P's $10 loss on the disposition of the T stock is attributable to the 
recognition of built-in gain on the disposition of an asset, T's 
recognized built-in gain is offset by its recognized built-in loss. Thus 
none of P's $10 loss is attributable to the recognition of built-in gain 
on the disposition of an asset.

[[Page 109]]

    (iii) The result would be the same if, instead of a $50 built-in 
loss in asset 2, T has a $50 net operating loss carryover when P buys 
the T stock, and the net operating loss carryover is used to offset the 
built-in gain.
    Example 5. Outside basis partially corresponds to inside basis. (i) 
Individual A owns all the stock of T, for which A has a basis of $60. On 
February 1, 1987, T owns 1 asset with a basis of $0 and a value of $100, 
P acquires all the stock of T from A in an exchange to which section 
351(a) applies, and T becomes a member of the P group. P has a carryover 
basis of $60 in the T stock. During 1988, T sells the asset and 
recognizes $100 of gain. Under the investment adjustment system, P's 
basis in the T stock increases from $60 to $160. T reinvests the $100 
proceeds in another asset, which declines in value to $90. On January 1, 
1989, P sells all the stock of T for $90 and recognizes a loss of $70.
    (ii) Although P's basis in the T stock was increased by $100 as a 
result of the recognition of built-in gain on the disposition of T's 
asset, only $60 of the $70 loss on the sale of the stock is attributable 
under paragraph (a)(2) of this section to the recognition of built-in 
gain from the disposition of the asset. (Had T's asset not declined in 
value to $90, the T stock would have been sold for $100, and a $60 loss 
would have been attributable to the recognition of the built-in gain.) 
Therefore, $60 of the $70 loss is disallowed under paragraph (a)(2), and 
$10 is not disallowed if P satisfies the requirements of paragraph 
(a)(2). If P had sold the stock of T for $95 because T's other assets 
had unrealized appreciation of $5, $60 of the $65 loss would still be 
attributable to T's recognition of built-in gain on the disposition of 
assets.
    Example 6. Creeping acquisition. P owns 60 percent of the stock of S 
on January 6, 1987. On February 1, 1987, P buys an additional 20 percent 
of the stock of S, and S becomes a member of the P group. P sells all 
the S stock on March 1, 1989 and recognizes a loss of $100. All 80 
percent of the stock of S owned by P is subject to the rules of this 
section and, under paragraph (a) (1) and (2) of this section, P is not 
allowed to deduct the $100 loss, except to the extent P establishes the 
loss is not attributable to the recognition by S of built-in gain on the 
disposition of assets.
    Example 7. Effect of post-acquisition appreciation. P buys all the 
stock of T for $100, and T becomes a member of the P group. T has an 
asset with a basis of $0 and a value of $100. T sells the asset for 
$100. Under the investment adjustment system, P's basis in the T stock 
increases to $200. T reinvests the proceeds of the sale in an asset that 
appreciates in value to $180. Five years after the sale, P sells all the 
stock of T for $180 and recognizes a $20 loss. Under paragraph (a)(1) of 
this section, no deduction is allowed to P for the $20 loss.
    Example 8. Deferred loss and recognized gain. (i) P is the common 
parent of a consolidated group, S is a wholly owned subsidiary of P, and 
T is a wholly owned subsidiary of S. S purchased all of the T stock on 
February 1, 1987 for $100, and T has an asset with a basis of $40 and a 
value of $100. T sells the asset for $100, recognizing $60 of gain. 
Under the investment adjustment system, S's basis in the T stock 
increases from $100 to $160. S sells its T stock to P for $100 in a 
deferred intercompany transaction, recognizing a $60 loss that is 
deferred under section 267(f) and Sec. 1.1502-13. P subsequently sells 
all the stock of T for $100 to X, a member of the same controlled group 
(as defined in section 267(f)) as P but not a member of the P 
consolidated group.
    (ii) Under paragraph (a)(3) of this section, the application of 
paragraph (a)(1) of this section to S's $60 loss is deferred, because 
S's loss is deferred under section 267(f) and Sec. 1.1502-13. Although 
P's sale of the T stock to X would cause S's deferred loss to be taken 
into account under Sec. 1.1502-13, Sec. 1.267(f)-1 provides that the 
loss is not taken into account because X is a member of the same 
controlled group as P and S. Nevertheless, under paragraph (a)(3) of 
this section, because the T stock ceases to be owned by a member of the 
P consolidated group, S's deferred loss is disallowed immediately before 
the sale and is never taken into account under section 267(f).

    (b) Indirect disposition of transitional subsidiary--(1) Loss 
limitation rule for transitional parent. No deduction is allowed for any 
loss recognized by a member of a consolidated group with respect to the 
disposition of stock of a transitional parent.
    (2) Allowable loss--(i) In general. Paragraph (b)(1) of this section 
does not apply to the extent the taxpayer establishes that the loss 
exceeds the amount that would be disallowed under paragraph (a) of this 
section if each highest tier transitional subsidiary's stock in which 
the transitional parent has a direct or indirect interest had been sold 
immediately before the disposition of the transitional parent's stock. 
In applying the preceding sentence, appropriate adjustments shall be 
made to take into account circumstances where less than all the stock of 
a transitional parent owned by members of a consolidated group is 
disposed of in the same transaction, or the stock of a transitional 
subsidiary or a transitional parent is directly owned by more than 1 
member.

[[Page 110]]

    (ii) Statement of allowable loss. Paragraph (b)(2)(i) of this 
section applies only if a separate statement entitled ``Allowable Loss 
Under Section 1.337(d)-1(b)'' is filed with the taxpayer's return for 
the year of the stock disposition. If the separate statement is required 
to be filed with a return the due date (including extensions) of which 
is before January 16, 1991, or with a return due (including extensions) 
after January 15, 1991 but filed before that date, the statement may be 
filed with an amended return for the year of the disposition or with the 
taxpayer's first subsequent return the due date (including extensions) 
of which is after January 15, 1991.
    (iii) Contents of statement. The statement required under paragraph 
(b)(2)(ii) of this section must contain--
    (A) The name and employer identification number (E.I.N.) of the 
transitional parent.
    (B) The basis of the stock of the transitional parent immediately 
before the disposition.
    (C) The amount realized on the disposition.
    (D) The amount of the deduction not disallowed under paragraph 
(b)(1) of this section by reason of this paragraph (b)(2).
    (E) The amount of loss disallowed under paragraph (b)(1) of this 
section.
    (3) Coordination with loss deferral and other disallowance rules. 
(i) For purposes of this section, the rules of Sec. 1.1502-20(a)(3) 
apply, with appropriate adjustments to reflect differences between the 
approach of this section and that of Sec. 1.1502-20.
    (ii) Other loss deferral rules. If paragraph (b)(1) of this section 
applies to a loss subject to deferral or disallowance under any other 
provision of the Code or the regulations, the other provision applies to 
the loss only to the extent it is not disallowed under paragraph (b)(1).
    (4) Definitions. For purposes of this section--
    (i) Transitional parent means any subsidiary, other than a 
transitional subsidiary, that owned at any time after January 6, 1987, a 
direct or indirect interest in the stock of a corporation that is a 
transitional subsidiary.
    (ii) Highest tier transitional subsidiary means the transitional 
subsidiary (or subsidiaries) in which the transitional parent has a 
direct or indirect interest and that is the highest transitional 
subsidiary (or subsidiaries) in a chain of members.
    (5) Examples. The principles of this paragraph (b) are illustrated 
by the following examples:

    Example 1. Ownership of chain of transitional subsidiaries. (i) P 
forms S with $200 on January 1, 1985, and S becomes a member of the P 
group. On February 1, 1987, S buys all the stock of T, and T buys all 
the stock of T1, and both T and T1 become members of the P group. On 
January 1, 1988, P sells all the stock of S and recognizes a $90 loss on 
the sale.
    (ii) Under paragraph (a)(4)(ii) of this section, both T and T1 are 
transitional subsidiaries, because they became members of the P group 
after January 6, 1987. Under paragraph (b)(4)(i) of this section, S is a 
transitional parent, because it owns a direct interest in stock of 
transitional subsidiaries and is not itself a transitional subsidiary.
    (iii) Under paragraph (b) (1) and (2) of this section, because S is 
a transitional parent, no deduction is allowed to P for its $90 loss 
except to the extent the loss exceeds the amount of S's loss that would 
have been disallowed if S had sold all the stock of T, S's highest tier 
transitional subsidiary, immediately before P's sale of all the S stock. 
Assume all the T stock would have been sold for a $90 loss and that all 
the loss would be attributable to the recognition of built-in gain from 
the disposition of assets. Because in that case $90 of loss would be 
disallowed, all of P's loss on the sale of the S stock is disallowed 
under paragraph (b).
    Example 2. Ownership of brother-sister transitional subsidiaries. 
(i) P forms S with $200 on January 1, 1985, and S becomes a member of 
the P group. On February 1, 1987, S buys all the stock of both T and T1, 
and T and T1 become members of the P group. On January 1, 1988, P sells 
all the stock of S and recognizes a $90 loss on the sale.
    (ii) Under paragraph (b) (1) and (2) of this section, no deduction 
is allowed to P for its $90 loss except to the extent P establishes that 
the loss exceeds the amount of S's stock losses that would be disallowed 
if S sold all the stock of T and T1, S's highest tier transitional 
subsidiaries, immediately before P's sale of all the S stock. Assume 
that all the T stock would have been sold for a $50 loss, all the T1 
stock of a $40 loss, and that the entire amount of each loss would be 
attributable to the recognition of built-in gain on the disposition of 
assets. Because $90 of loss would be disallowed with respect to the sale 
of S's T and T1 stock, P's $90 loss on the sale

[[Page 111]]

of all the S stock is disallowed under paragraph (b).

    (c) Successors--(1) General rule. This section applies, to the 
extent necessary to effectuate the purposes of this section, to--
    (i) Any property owned by a member or former member, the basis of 
which is determined, directly or indirectly, in whole or in part, by 
reference to the basis in a subsidiary's stock, and
    (ii) Any property owned by any other person whose basis in the 
property is determined, directly or indirectly, in whole or in part, by 
reference to a member's (or former member's) basis in a subsidiary's 
stock.
    (2) Examples. The principles of this paragraph (c) are illustrated 
by the following examples:

    Example 1. Merger into grandfathered subsidiary. P, the common 
parent of a group, owns all the stock of T, a transitional subsidiary. 
On January 1, 1989, T merges into S, a wholly owned subsidiary of P that 
is not a transitional subsidiary. Under paragraph (c)(1) of this 
section, all the stock of S is treated as stock of a transitional 
subsidiary. As a result, no deduction is allowed for any loss recognized 
by P on the disposition of any S stock, except to the extent the P group 
establishes under paragraph (a)(2) that the loss is not attributable to 
the recognition of built-in gain on the disposition of assets of T.
    Example 2. Nonrecognition exchange of transitional stock. (i) P, the 
common parent of a group, owns all the stock of T, a transitional 
subsidiary. On January 1, 1989, P transfers the stock of T to X, a 
corporation that is not a member of the P group, in exchange for 20 
percent of its stock in a transaction to which section 351(a) applies. T 
and X file separate returns.
    (ii) Under paragraph (c)(1) of this section, all the stock of X 
owned by P is treated as stock of a transitional subsidiary because P's 
basis for the X stock is determined by reference to its basis for the T 
stock. As a result, no deduction is allowed to P for any loss recognized 
on the disposition of the X stock, except to the extent permitted under 
paragraph (a) of this section.
    (iii) Under paragraph (c)(1), X is treated as a member subject to 
paragraph (a) of this section with respect to the T stock because X's 
basis for the stock is determined by reference to P's basis for the 
stock. Moreover, all of the T stock owned by X continues to be stock of 
a transitional subsidiary. As a result, no deduction is allowed to X for 
any loss recognized on the disposition of any T stock, except to the 
extent permitted under paragraph (a) of this section.

    (d) Investment adjustments and earnings and profits--(1) In general. 
For purposes of determining investment adjustments under Sec. 1.1502-32 
and earnings and profits under Sec. 1.1502-33(c) with respect to a 
member of a consolidated group that owns stock in a subsidiary, any 
deduction that is disallowed under this section is treated as a loss 
arising and absorbed by the member in the tax year in which the 
disallowance occurs.
    (2) Example. (i) In 1986, P forms S with a contribution of $100, and 
S becomes a member of the P group. On February 1, 1987, S buys all the 
stock of T for $100. T has an asset with a basis of $0 and a value of 
$100. In 1988, T sells the asset for $100. Under the investment 
adjustment system, S's basis in the T stock increases to adjustment 
system, S's basis in the T stock increases to $200, P's basis in the S 
stock increases to $200, and P's earnings and profits and S's earnings 
and profits increase by $100. In 1989, S sells all of the T stock for 
$100, and S's recognized loss of $100 is disallowed under paragraph 
(a)(1) of this section.
    (ii) Under paragraph (d)(1) of this section, S's earnings and 
profits for 1989 are reduced by $100, the amount of the loss disallowed 
under paragraph (a)(1). As a result, P's basis in the S stock is reduced 
from $200 to $100 under the investment adjustment system. P's earnings 
and profits for 1989 are correspondingly reduced by $100.
    (e) Effective dates--(1) General rule. This section applies with 
respect to dispositions after January 6, 1987. For dispositions on or 
after November 19, 1990, however, this section applies only if the stock 
was deconsolidated (as that term is defined in Sec. 1.337(d)-2(b)(2)) 
before November 19, 1990, and only to the extent the disposition is not 
subject to Sec. 1.337(d)-2 or Sec. 1.1502-20.
    (2) Binding contract rule. For purposes of this paragraph (e), if a 
corporation became a subsidiary pursuant to a binding written contract 
entered into before January 6, 1987, and in continuous effect until the 
corporation became a subsidiary, or a disposition was pursuant to a 
binding written contract entered into before March 9, 1990, and

[[Page 112]]

in continuous effect until the disposition, the date the contract became 
binding shall be treated as the date the corporation became a subsidiary 
or as the date of disposition.
    (3) Application of Sec. 1.1502-20T to certain transactions--(i) In 
general. If a group files the certification described in paragraph 
(e)(3)(ii) of this section, it may apply Sec. 1.1502-20T (as contained 
in the CFR edition revised as of April 1, 1990), to all of its members 
with respect to all dispositions and deconsolidations by the certifying 
group to which Sec. 1.1502-20T otherwise applied by its terms 
occurring--
    (A) On or after March 9, 1990 (but only if not pursuant to a binding 
contract described in Sec. 1.337(d)-1T(e)(2) (as contained in the CFR 
edition revised as of April 1, 1990) that was entered into before March 
9, 1990); and
    (B) Before November 19, 1990 (or thereafter, if pursuant to a 
binding contract described in Sec. 1.1502-20T(g)(3) that was entered 
into on or after March 9, 1990 and before November 19, 1990).

The certification under this paragraph (e)(3)(i) with respect to the 
application of Sec. 1.1502-20T to any transaction described in this 
paragraph (e)(3)(i) may not be withdrawn and, if the certification is 
filed, Sec. 1.1502-20T must be applied to all such transactions on all 
returns (including amended returns) on which such transactions are 
included.
    (ii) Time and manner of filing certification. The certification 
described in paragraph (e)(3)(i) of this section must be made in a 
separate statement entitled ``[insert name and employer identification 
number of common parent] hereby certifies under Sec. 1.337(d)-1 (e)(3) 
that the group of which it is the common parent is applying Sec. 
1.1502-20T to all transactions to which that section otherwise applied 
by it terms.'' The statement must be signed by the common parent and 
filed with the group's income tax return for the taxable year of the 
first disposition or deconsolidation to which the certification applies. 
If the separate statement required under this paragraph (e)(3) is to be 
filed with a return the due date (including extensions) of which is 
before November 16, 1991, the statement may be filed with an amended 
return for the year of the disposition or deconsolidation that is filed 
within 180 days after September 13, 1991. Any other filings required 
under Sec. 1.1502-20T, such as the statement required under Sec. 
1.1502-20T(f)(5), may be made with the amended return, regardless of 
whether Sec. 1.1502-20T permits such filing by amended return.

[T.D. 8319, 55 FR 49031, Nov. 26, 1990, as amended by T.D. 8364, 56 FR 
47389, Sept. 19, 1991; 57 FR 53550, Nov. 12, 1992; T.D. 8560, 59 FR 
41674, 41675, Aug. 15, 1994; T.D. 8597, 60 FR 36679, July 18, 1995; T.D. 
9424, 73 FR 53947, Sept. 17, 2008]



Sec. 1.337(d)-1T  [Reserved]



Sec. 1.337(d)-2  Loss limitation rules.

    (a) Loss disallowance--(1) General rule. No deduction is allowed for 
any loss recognized by a member of a consolidated group with respect to 
the disposition of stock of a subsidiary. However, for transactions 
involving loss shares of subsidiary stock occurring on or after 
September 17, 2008, see Sec. 1.1502-36. Further, this section does not 
apply to a transaction that is subject to Sec. 1.1502-36.
    (2) Definitions. For purposes of this section:
    (i) The definitions in Sec. 1.1502-1 apply.
    (ii) Disposition means any event in which gain or loss is 
recognized, in whole or in part.
    (3) Coordination with loss deferral and other disallowance rules. 
For purposes of this section, the rules of Sec. 1.1502-20(a)(3) apply, 
with appropriate adjustments to reflect differences between the approach 
of this section and that of Sec. 1.1502-20.
    (4) Netting. Paragraph (a)(1) of this section does not apply to loss 
with respect to the disposition of stock of a subsidiary, to the extent 
that, as a consequence of the same plan or arrangement, gain is taken 
into account by members with respect to stock of the same subsidiary 
having the same material terms. If the gain to which this paragraph 
applies is less than the amount of the loss with respect to the 
disposition of the subsidiary's stock, the gain is applied to offset 
loss with respect to each share disposed of as a consequence of the same 
plan or arrangement in proportion to the amount

[[Page 113]]

of the loss deduction that would have been disallowed under paragraph 
(a)(1) of this section with respect to such share before the application 
of this paragraph (a)(4). If the same item of gain could be taken into 
account more than once in limiting the application of paragraphs (a)(1) 
and (b)(1) of this section, the item is taken into account only once.
    (b) Basis reduction on deconsolidation--(1) General rule. If the 
basis of a member of a consolidated group in a share of stock of a 
subsidiary exceeds its value immediately before a deconsolidation of the 
share, the basis of the share is reduced at that time to an amount equal 
to its value. If both a disposition and a deconsolidation occur with 
respect to a share in the same transaction, paragraph (a) of this 
section applies and, to the extent necessary to effectuate the purposes 
of this section, this paragraph (b) applies following the application of 
paragraph (a) of this section.
    (2) Deconsolidation. Deconsolidation means any event that causes a 
share of stock of a subsidiary that remains outstanding to be no longer 
owned by a member of any consolidated group of which the subsidiary is 
also a member.
    (3) Value. Value means fair market value.
    (4) Netting. Paragraph (b)(1) of this section does not apply to 
reduce the basis of stock of a subsidiary, to the extent that, as a 
consequence of the same plan or arrangement, gain is taken into account 
by members with respect to stock of the same subsidiary having the same 
material terms. If the gain to which this paragraph applies is less than 
the amount of basis reduction with respect to shares of the subsidiary's 
stock, the gain is applied to offset basis reduction with respect to 
each share deconsolidated as a consequence of the same plan or 
arrangement in proportion to the amount of the reduction that would have 
been required under paragraph (b)(1) of this section with respect to 
such share before the application of this paragraph (b)(4).
    (c) Allowable loss--(1) Application. This paragraph (c) applies with 
respect to stock of a subsidiary only if a separate statement entitled 
Sec. 1.337(d)-2(c) statement is included with the return in accordance 
with paragraph (c)(3) of this section.
    (2) General rule. Loss is not disallowed under paragraph (a)(1) of 
this section and basis is not reduced under paragraph (b)(1) of this 
section to the extent the taxpayer establishes that the loss or basis is 
not attributable to the recognition of built-in gain, net of directly 
related expenses, on the disposition of an asset (including stock and 
securities). Loss or basis may be attributable to the recognition of 
built-in gain on the disposition of an asset by a prior group. For 
purposes of this section, gain recognized on the disposition of an asset 
is built-in gain to the extent attributable, directly or indirectly, in 
whole or in part, to any excess of value over basis that is reflected, 
before the disposition of the asset, in the basis of the share, directly 
or indirectly, in whole or in part, after applying section 1503(e) and 
other applicable provisions of the Internal Revenue Code and 
regulations. Federal income taxes may be directly related to built-in 
gain recognized on the disposition of an asset only to the extent of the 
excess (if any) of the group's income tax liability actually imposed 
under Subtitle A of the Internal Revenue Code for the taxable year of 
the disposition of the asset over the group's income tax liability for 
the taxable year redetermined by not taking into account the built-in 
gain recognized on the disposition of the asset. For this purpose, the 
group's income tax liability actually imposed and its redetermined 
income tax liability are determined without taking into account the 
foreign tax credit under section 27(a) of the Internal Revenue Code.
    (3) Contents of statement and time of filing. The statement required 
under paragraph (c)(1) of this section must be included with or as part 
of the taxpayer's return for the year of the disposition or 
deconsolidation and must contain--
    (i) The name and employer identification number (E.I.N.) of the 
subsidiary; and
    (ii) The amount of the loss not disallowed under paragraph (a)(1) of 
this section by reason of this paragraph (c) and the amount of basis not 
reduced

[[Page 114]]

under paragraph (b)(1) of this section by reason of this paragraph (c).
    (4) Example. The principles of paragraphs (a), (b), and (c) of this 
section are illustrated by the examples in Sec. Sec. 1.337(d)-1(a)(5) 
and 1.1502-20(a)(5) (other than Examples 3, 4, and 5) and (b), with 
appropriate adjustments to reflect differences between the approach of 
this section and that of Sec. 1.1502-20, and by the following example. 
For purposes of the examples in this section, unless otherwise stated, 
the group files consolidated returns on a calendar year basis, the facts 
set forth the only corporate activity, and all sales and purchases are 
with unrelated buyers or sellers. The basis of each asset is the same 
for determining earnings and profits adjustments and taxable income. Tax 
liability and its effect on basis, value, and earnings and profits are 
disregarded. Investment adjustment system means the rules of Sec. 
1.1502-32. The example reads as follows:

    Example. Loss offsetting built-in gain in a prior group. (i) P buys 
all the stock of T for $50 in Year 1, and T becomes a member of the P 
group. T has 2 assets. Asset 1 has a basis of $50 and a value of $0, and 
asset 2 has a basis of $0 and a value of $50. T sells asset 2 during 
Year 3 for $50 and recognizes a $50 gain. Under the investment 
adjustment system, P's basis in the T stock increased to $100 as a 
result of the recognition of gain. In Year 5, all of the stock of P is 
acquired by the P1 group, and the former members of the P group become 
members of the P1 group. T then sells asset 1 for $0, and recognizes a 
$50 loss. Under the investment adjustment system, P's basis in the T 
stock decreases to $50 as a result of the loss. T's assets decline in 
value from $50 to $40. P then sells all the stock of T for $40 and 
recognizes a $10 loss.
    (ii) P's basis in the T stock reflects both T's unrecognized gain 
and unrecognized loss with respect to its assets. The gain T recognizes 
on the disposition of asset 2 is built-in gain with respect to both the 
P and P1 groups for purposes of paragraph (c)(2) of this section. In 
addition, the loss T recognizes on the disposition of asset 1 is built-
in loss with respect to the P and P1 groups for purposes of paragraph 
(c)(2) of this section. T's recognition of the built-in loss while a 
member of the P1 group offsets the effect on T's stock basis of T's 
recognition of the built-in gain while a member of the P group. Thus, 
P's $10 loss on the sale of the T stock is not attributable to the 
recognition of built-in gain, and the loss is therefore not disallowed 
under paragraph (c)(2) of this section.
    (iii) The result would be the same if, instead of having a $50 
built-in loss in asset 1 when it becomes a member of the P group, T has 
a $50 net operating loss carryover and the carryover is used by the P 
group.

    (d) Successors. For purposes of this section, the rules and examples 
of Sec. 1.1502-20(d) apply, with appropriate adjustments to reflect 
differences between the approach of this section and that of Sec. 
1.1502-20.
    (e) Anti-avoidance rules. For purposes of this section, the rules 
and examples of Sec. 1.1502-20(e) apply, with appropriate adjustments 
to reflect differences between the approach of this section and that of 
Sec. 1.1502-20.
    (f) Investment adjustments. For purposes of this section, the rules 
and examples of Sec. 1.1502-20(f) apply, with appropriate adjustments 
to reflect differences between the approach of this section and that of 
Sec. 1.1502-20.
    (g) Effective dates. This section applies with respect to 
dispositions and deconsolidations on or after March 3, 2005. In 
addition, this section applies to dispositions and deconsolidations for 
which an election is made under Sec. 1.1502-20(i)(2) to determine 
allowable loss under this section. If loss is recognized because stock 
of a subsidiary became worthless, the disposition with respect to the 
stock is treated as occurring on the date the stock became worthless. 
For dispositions and deconsolidations after March 6, 2002 and before 
March 3, 2005, see Sec. 1.337(d)-2T as contained in the 26 CFR part 1 
in effect on March 2, 2005.

[T.D. 9787, 70 FR 10322, Mar. 3, 2005, as amended by T.D. 9424, 73 FR 
53947, Sept. 17, 2008]



Sec. 1.337(d)-3  Gain recognition upon certain partnership 
transactions involving a partner's stock.

    (a) Purpose. The purpose of this section is to prevent corporate 
taxpayers from using a partnership to circumvent gain required to be 
recognized under section 311(b) or section 336(a). The rules of this 
section, including the determination of the amount of gain, must be 
applied in a manner that is consistent with and reasonably carries out 
this purpose.
    (b) In general. This section applies when a partnership, either 
directly or

[[Page 115]]

indirectly, owns, acquires, or distributes Stock of the Corporate 
Partner (within the meaning of paragraph (c)(2) of this section). Under 
paragraphs (d) or (e) of this section, a Corporate Partner (within the 
meaning of paragraph (c)(1) of this section) is required to recognize 
gain when a transaction has the effect of the Corporate Partner 
acquiring or increasing an interest in its own stock in exchange for 
appreciated property in a manner that contravenes the purpose of this 
section as set forth in paragraph (a) of this section. Paragraph (f) of 
this section sets forth exceptions under which a Corporate Partner does 
not recognize gain.
    (c) Definitions. The following definitions apply for purposes of 
this section:
    (1) Corporate Partner. A Corporate Partner is a person that is 
classified as a corporation for federal income tax purposes and holds or 
acquires an interest in a partnership.
    (2) Stock of the Corporate Partner--(i) In general. With respect to 
a Corporate Partner, Stock of the Corporate Partner includes the 
Corporate Partner's stock, or other equity interests, including options, 
warrants, and similar interests, in the Corporate Partner or a 
corporation that controls the Corporate Partner within the meaning of 
section 304(c) (except that section 318(a)(1) and (3) shall not apply). 
Stock of the Corporate Partner also includes interests in any entity to 
the extent that the value of the interest is attributable to Stock of 
the Corporate Partner.
    (ii) Affiliated partner exception. Stock of the Corporate Partner 
does not include any stock or other equity interests held or acquired by 
a partnership if all interests in the partnership's capital and profits 
are held by members of an affiliated group as defined in section 1504(a) 
that includes the Corporate Partner.
    (3) Section 337(d) Transaction. A Section 337(d) Transaction is a 
transaction (or series of transactions) that has the effect of an 
exchange by a Corporate Partner of its interest in appreciated property 
for an interest in Stock of the Corporate Partner owned, acquired, or 
distributed by a partnership. For example, a Section 337(d) Transaction 
may occur when --
    (i) A Corporate Partner contributes appreciated property to a 
partnership that owns Stock of the Corporate Partner;
    (ii) A partnership acquires Stock of the Corporate Partner;
    (iii) A partnership that owns Stock of the Corporate Partner 
distributes appreciated property to a partner other than a Corporate 
Partner;
    (iv) A partnership distributes Stock of the Corporate Partner to the 
Corporate Partner; or
    (v) A partnership agreement is amended in a manner that increases a 
Corporate Partner's interest in Stock of the Corporate Partner 
(including in connection with a contribution to, or distribution from, a 
partnership).
    (4) Gain Percentage. A Corporate Partner's Gain Percentage equals a 
fraction, the numerator of which is the Corporate Partner's interest (by 
value) in appreciated property effectively exchanged for Stock of the 
Corporate Partner under the test described in paragraphs (d)(1) and (2) 
of this section, and the denominator of which is the Corporate Partner's 
interest (by value) in that appreciated property immediately before the 
Section 337(d) Transaction. Paragraph (d) of this section requires a 
partnership to multiply the Gain Percentage by the Corporate Partner's 
aggregate gain in appreciated property to determine gain recognized 
under this section.
    (d) Deemed redemption rule--(1) In general. A Corporate Partner in a 
partnership that engages in a Section 337(d) Transaction recognizes gain 
at the time, and to the extent, that the Corporate Partner's interest in 
appreciated property (other than Stock of the Corporate Partner) is 
reduced in exchange for an increased interest in Stock of the Corporate 
Partner, as determined under paragraph (d)(2) of this section. This 
section does not apply to the extent a transaction has the effect of an 
exchange by a Corporate Partner of non-appreciated property for Stock of 
the Corporate Partner, or has the effect of an exchange by a Corporate 
Partner for property other than Stock of the Corporate Partner.
    (2) Corporate Partner's interest in partnership property. The 
Corporate Partner's interest with respect to both

[[Page 116]]

Stock of the Corporate Partner and the appreciated property that is the 
subject of the exchange is determined based on all facts and 
circumstances, including the allocation and distribution rights set 
forth in the partnership agreement. The Corporate Partner's interest in 
an identified share of Stock of the Corporate Partner will never be less 
than the Corporate Partner's largest interest (by value) in that share 
of Stock of the Corporate Partner that was taken into account when the 
partnership previously determined whether there had been a Section 
337(d) Transaction with respect to such share (regardless of whether the 
Corporate Partner recognized gain in the earlier transaction). See 
Example 7 of paragraph (h) of this section. However, this limitation 
will not apply if any reduction in the Corporate Partner's interest in 
the identified share of Stock of the Corporate Partner occurred as part 
of a plan or arrangement to circumvent the purpose of this section. See 
Example 8 of paragraph (h) of this section.
    (3) Amount and character of gain recognized on the exchange--(i) 
Amount of gain. The amount of gain the Corporate Partner recognizes 
under paragraph (d)(1) of this section equals the product of the 
Corporate Partner's Gain Percentage and the gain from the appreciated 
property that is the subject of the exchange that the Corporate Partner 
would recognize if, immediately before the Section 337(d) Transaction, 
all assets of the partnership and any assets contributed to the 
partnership in the Section 337(d) Transaction were sold in a fully 
taxable transaction for cash in an amount equal to the fair market value 
of such property (taking into account section 7701(g)), reduced, but not 
below zero, by any gain the Corporate Partner is required to recognize 
with respect to the appreciated property in the Section 337(d) 
Transaction under any other provision of this chapter. This gain is 
computed taking into account allocations of tax items applying the 
principles of section 704(c), including any remedial allocations under 
Sec. 1.704-3(d), and also taking into account any basis adjustments 
including adjustments made pursuant to section 743(b).
    (ii) Character of gain. The character of the gain that the Corporate 
Partner recognizes under paragraph (d)(1) of this section from the 
appreciated property that is the subject of the exchange shall be the 
character of the gain that the Corporate Partner would recognize if, 
immediately before the Section 337(d) Transaction, the Corporate Partner 
had disposed of the appreciated property that is the subject of the 
exchange in a fully taxable transaction for cash in an amount equal to 
the fair market value of such property (taking into account section 
7701(g)).
    (4) Basis adjustments--(i) Corporate Partner's basis in the 
partnership interest. The basis of the Corporate Partner's interest in 
the partnership is increased by the amount of gain that the Corporate 
Partner recognizes under this paragraph (d).
    (ii) Partnership's basis in partnership property. The partnership's 
adjusted tax basis in the appreciated property that is treated as the 
subject of the exchange under this paragraph (d) is increased by the 
amount of gain recognized with respect to that property by the Corporate 
Partner as a result of that exchange, regardless of whether the 
partnership has an election in effect under section 754. For basis 
recovery purposes, this basis increase is treated as property that is 
placed in service by the partnership in the taxable year of the Section 
337(d) Transaction.
    (e) Distribution of Stock of the Corporate Partner--(1) In general. 
This paragraph (e) applies to distributions to the Corporate Partner of 
Stock of the Corporate Partner to which section 732(f) does not apply 
and that have previously been the subject of a Section 337(d) 
Transaction or become the subject of a Section 337(d) Transaction as a 
result of the distribution. Upon the distribution of Stock of the 
Corporate Partner to the Corporate Partner, paragraph (d) of this 
section will apply as though immediately before the distribution the 
partners amended the partnership agreement to allocate to the Corporate 
Partner a 100 percent interest in that portion of the Stock of the 
Corporate Partner that is distributed, and to allocate an appropriately 
reduced interest in other partnership

[[Page 117]]

property away from the Corporate Partner.
    (2) Basis rules--(i) Basis allocation on distributions of stock and 
other property. If, as part of the same transaction, a partnership 
distributes Stock of the Corporate Partner and other property (other 
than cash) to the Corporate Partner, see Sec. 1.732-1(c)(1)(iii) for a 
rule allocating basis first to the Stock of the Corporate Partner before 
the distribution of the other property.
    (ii) Computation of basis. For purposes of determining the basis of 
property distributed to a partner in a transaction that includes the 
distribution of Stock of the Corporate Partner (other than the basis of 
the Corporate Partner in its own stock), the basis of the partner's 
remaining partnership interest, and the partnership's basis in 
undistributed Stock of the Corporate Partner, and for purposes of 
computing gain under paragraph (e)(3) of this section, the partnership's 
basis of Stock of the Corporate Partner distributed to the partner 
equals the greater of--
    (A) The partnership's basis of that distributed Stock of the 
Corporate Partner immediately before the distribution; or
    (B) The fair market value of that distributed Stock of the Corporate 
Partner immediately before the distribution less the partner's allocable 
share of gain from all of the Stock of the Corporate Partner if the 
partnership sold all of its assets in a fully taxable transaction for 
cash in an amount equal to the fair market value of such property 
(taking into account section 7701(g)) immediately before the 
distribution.
    (iii) Section 732(f) basis reduction. For purposes of determining 
the amount of the decrease to the basis of property held by a 
distributed corporation pursuant to section 732(f), the amount of this 
decrease shall be reduced by the amount of gain that a Corporate Partner 
has recognized under this section in the same Section 337(d) Transaction 
or in a prior Section 337(d) Transaction involving the property.
    (3) Gain recognition. The Corporate Partner will recognize gain on a 
distribution of Stock of the Corporate Partner to the Corporate Partner 
to the extent that the partnership's adjusted basis in the distributed 
Stock of the Corporate Partner (as determined under paragraph (e)(2)(ii) 
of this section) immediately before the distribution exceeds the 
Corporate Partner's adjusted basis in its partnership interest 
immediately after the distribution.
    (f) Exceptions--(1) De minimis rule--(i) In general. Unless Stock of 
the Corporate Partner is acquired as part of a plan to circumvent the 
purpose of this section, this section does not apply to a Corporate 
Partner if at the time that the partnership acquires Stock of the 
Corporate Partner or at the time of a revaluation event as described in 
Sec. 1.704-1(b)(2)(iv)(f) (without regard to whether or not the 
partnership revalues its assets)--
    (A) The Corporate Partner and any persons related to the Corporate 
Partner under section 267(b) or section 707(b) own in the aggregate less 
than 5 percent of the partnership;
    (B) The partnership holds Stock of the Corporate Partner with a 
value of less than 2 percent of the partnership's gross assets 
(including the Stock of the Corporate Partner); and
    (C) The partnership has never, at any point in time, held in the 
aggregate--
    (1) Stock of the Corporate Partner with a fair market value greater 
than $1,000,000; or
    (2) More than 2 percent of any particular class of Stock of the 
Corporate Partner.
    (ii) De minimis rule ceases to apply. If a partnership satisfies the 
conditions of the de minimis rule of paragraph (f)(1) of this section 
upon an acquisition of Stock of the Corporate Partner or revaluation 
event as described in Sec. 1.704-1(b)(2)(iv)(f), but later fails to 
satisfy the conditions of the de minimis rule upon a subsequent 
acquisition or revaluation event, then solely for purposes of paragraph 
(d) of this section, the Corporate Partner may compute its gain on the 
subsequent acquisition or revaluation event as if it had already 
recognized gain at the previous event. Neither the Corporate Partner nor 
the partnership increases its basis by the gain the Corporate Partner 
would have recognized if the de minimis rule of paragraph (f)(1) of this 
section did not apply to the prior acquisition or revaluation event.

[[Page 118]]

    (2) Certain dispositions of stock. Unless acquired as part of a plan 
to circumvent the purpose of this section, this section does not apply 
to Stock of the Corporate Partner that--
    (i) Is disposed of (by sale or distribution) by the partnership 
before the due date (including extensions) of its federal income tax 
return for the taxable year during which the Stock of the Corporate 
Partner is acquired (or for the taxable year in which the Corporate 
Partner becomes a partner, whichever is applicable); and
    (ii) Is not distributed to the Corporate Partner or a corporation 
that controls the Corporate Partner within the meaning of section 
304(c), except that section 318(a)(1) and (3) shall not apply.
    (g) Tiered partnerships. The rules of this section shall apply to 
tiered partnerships in a manner that is consistent with the purpose set 
forth in paragraph (a) of this section.
    (h) Examples. The following examples illustrate the principles of 
this section. All amounts in the following examples are reported in 
millions of dollars:
    Example 1. Deemed redemption rule--contribution of Stock of the 
Corporate Partner. (i) In Year 1, X, a corporation, and A, an 
individual, form partnership AX as equal partners in all respects. X 
contributes Asset 1 with a fair market value of $100 and a basis of $20. 
A contributes X stock, which is Stock of the Corporate Partner, with a 
basis and fair market value of $100.
    (ii) Because A and X are equal partners in AX in all respects, the 
partnership formation causes X's interest in X stock to increase from $0 
to $50 and its interest in Asset 1 to decrease from $100 to $50. Thus, 
the partnership formation is a Section 337(d) Transaction because the 
formation has the effect of an exchange by X of $50 of Asset 1 for $50 
of X stock.
    (iii) X must recognize gain under paragraph (d) of this section with 
respect to Asset 1 to prevent the circumvention of section 311(b) 
principles. X's gain equals the product of X's Gain Percentage and the 
gain from Asset 1 that X would recognize (decreased, but not below zero, 
by any gain that X recognized with respect to Asset 1 in the Section 
337(d) Transaction under any other provision of this chapter) if, 
immediately before the Section 337(d) Transaction, all assets were sold 
in a fully taxable transaction for cash in an amount equal to the fair 
market value of such property. If Asset 1 had been sold in a fully 
taxable transaction immediately before the formation of partnership AX, 
X's allocable share of gain would have been $80. X's Gain Percentage is 
50 percent (equal to a fraction, the numerator of which is X's $50 
interest in Asset 1 effectively exchanged for X stock, and the 
denominator of which is X's $100 interest in Asset 1 immediately before 
the Section 337(d) Transaction). Thus, X recognizes $40 of gain ($80 
multiplied by 50 percent) under the deemed redemption rule in paragraph 
(d) of this section. Under paragraph (d)(4)(i) of this section, X's 
basis in its AX partnership interest increases from $20 to $60. Under 
paragraph (d)(4)(ii) of this section, AX's basis in Asset 1 increases 
from $20 to $60 because Asset 1 is the appreciated property treated as 
the subject of the exchange.
    Example 2. Deemed redemption rule--contribution of stock in a 
corporation that controls the Corporate Partner. (i) In Year 1, X, a 
corporation, and A, an individual, form partnership AX as equal partners 
in all respects. X contributes Asset 1 with a fair market value of $100 
and a basis of $20. A contributes stock in P, with a basis and fair 
market value of $100. P is the sole owner of X. P's interest in X 
constitutes 10 percent of P's total assets.
    (ii) Because P controls X within the meaning of section 304(c), 
stock in P is Stock of the Corporate Partner under paragraph (c)(2)(i) 
of this section.
    (iii) Because A and X are equal partners in AX in all respects, the 
partnership formation causes X's interest in Stock of the Corporate 
Partner stock to increase from $0 to $50 and its interest in Asset 1 to 
decrease from $100 to $50. Thus, the partnership formation is a Section 
337(d) Transaction because the formation has the effect of an exchange 
by X of $50 of Asset 1 for $50 of Stock of the Corporate Partner.
    (iv) X must recognize gain under paragraph (d) of this section with 
respect to Asset 1 to prevent the circumvention of section 311(b) 
principles. X's gain equals the product of X's Gain Percentage and the 
gain from Asset 1 that X would recognize (decreased, but not below zero, 
by any gain that X recognized with respect to Asset 1 in the Section 
337(d) Transaction under any other provision of this chapter) if, 
immediately before the Section 337(d) Transaction, all assets were sold 
in a fully taxable transaction for cash in an amount equal to the fair 
market value of such property. If Asset 1 had been sold in a fully 
taxable transaction immediately before the formation of partnership AX, 
X's allocable share of gain would have been $80. X's Gain Percentage is 
50 percent (equal to a fraction, the numerator of which is X's $50 
interest in Asset 1 effectively exchanged for Stock of the Corporate 
Partner, and the denominator of which is X's $100 interest in Asset 1 
immediately before the Section 337(d) Transaction). Thus, X recognizes 
$40 of gain ($80 multiplied by 50 percent) under the deemed redemption 
rule in paragraph (d) of

[[Page 119]]

this section. Under paragraph (d)(4)(i) of this section, X's basis in 
its AX partnership interest increases from $20 to $60. Under paragraph 
(d)(4)(ii) of this section, AX's basis in Asset 1 increases from $20 to 
$60 because Asset 1 is the appreciated property treated as the subject 
of the exchange.
    Example 3. Distribution of Stock of the Corporate Partner--pro rata 
distribution. (i) The facts are the same as in Example 1(i) of this 
paragraph (h). AX liquidates in Year 9, when Asset 1 and the X stock 
each have a fair market value of $200. X and A each receive 50 percent 
of Asset 1 and 50 percent of the X stock in the liquidation. At the time 
AX liquidates, X's basis in its AX partnership interest is $60 and A's 
basis in its AX partnership interest is $100.
    (ii) When AX liquidates, X's interests in its stock and in Asset 1 
do not change. Thus, the liquidation is not a Section 337(d) Transaction 
because it does not have the effect of an exchange by X of appreciated 
property for Stock of the Corporate Partner.
    (iii) Paragraph (e) of this section applies because the distributed 
X stock was the subject of a previous Section 337(d) Transaction and 
because section 732(f) does not apply. Under Sec. 1.732-1(c)(1)(iii), 
the distribution to X of X stock is deemed to immediately precede the 
distribution of 50 percent of Asset 1 to X for purposes of determining 
X's basis in the distributed property. For purposes of determining X's 
basis in Asset 1 and X's gain on distribution, the basis of the 
distributed X stock is treated as $50, the greater of $50 (50 percent of 
the stock's $100 basis in the hands of the partnership), or $50, the 
fair market value of that distributed X stock ($100) less X's allocable 
share of gain from the distributed X stock if AX had sold all of its 
assets in a fully taxable transaction for cash in an amount equal to the 
fair market value of such property immediately before the distribution 
($50). Thus, X reduces its basis in its partnership interest by $50 
prior to the distribution of Asset 1. Accordingly, X's basis in the 
distributed portion of Asset 1 is $10. Because AX's basis in the 
distributed X stock immediately before the distribution ($50) does not 
exceed X's basis in its AX partnership interest immediately before the 
distribution ($60), X recognizes no gain under paragraph (e)(3) of this 
section.
    Example 4. Distribution of Stock of the Corporate Partner--non pro 
rata distribution. (i) The facts are the same as Example 3(i) of this 
paragraph (h), except that when AX liquidates, X receives 75 percent of 
the X stock and 25 percent of Asset 1 and A receives 25 percent of the X 
stock and 75 percent of Asset 1.
    (ii) The liquidation of AX causes X's interest in X stock to 
increase from $100 to $150 and its interest in Asset 1 to decrease from 
$100 to $50. Thus, AX's liquidating distributions of X stock and Asset 1 
to X are a Section 337(d) Transaction because the distributions have the 
effect of an exchange by X of $50 of Asset 1 for $50 of X stock.
    (iii)(A) X must recognize gain with respect to Asset 1 to prevent 
the circumvention of section 311(b) principles. Under paragraph (e)(1) 
of this section, paragraph (d) of this section is applied as if X and A 
amended the AX partnership agreement to allocate to X a 100 percent 
interest in the distributed portion of the X stock. X must recognize 
gain equal to the product of X's Gain Percentage and the gain from Asset 
1 that X would have recognized (decreased, but not below zero, by any 
gain X recognized with respect to Asset 1 in the Section 337(d) 
Transaction under any other provision of this chapter) if, immediately 
before the Section 337(d) Transaction, AX had sold all of its assets in 
a fully taxable transaction for cash in an amount equal to the fair 
market value of such property.
    (B) If Asset 1 had been sold in a fully taxable transaction 
immediately before the amendment of the AX partnership agreement, X's 
allocable share of gain would have been $90, or the sum of X's $40 
remaining gain under section 704(c) and $50 of the $100 post-
contribution appreciation. X's Gain Percentage is 50 percent (equal to a 
fraction, the numerator of which is X's $50 interest in Asset 1 
effectively exchanged for X stock, and the denominator of which is X's 
$100 interest in Asset 1 immediately before the Section 337(d) 
Transaction). Thus, X recognizes $45 of gain ($90 multiplied by 50 
percent) under the deemed redemption rule in paragraph (d) of this 
section. Under paragraph (d)(4)(i) of this section, X's basis in its AX 
partnership interest increases from $60 to $105. Under paragraph 
(d)(4)(ii) of this section, AX's basis in Asset 1 increases from $60 to 
$105 because Asset 1 is the appreciated property treated as the subject 
of the exchange.
    (iv)(A) Paragraph (e) of this section applies because the 
distributed X stock was the subject of a previous Section 337(d) 
Transaction and because section 732(f) does not apply. Under Sec. 
1.732-1(c)(1)(iii), AX is treated as first distributing the X stock to X 
before the distribution of 25 percent of Asset 1. For purposes of 
determining X's basis in Asset 1 and X's gain on distribution, the basis 
of the distributed X stock is treated as $100, the greater of $75 (75 
percent of the stock's $100 basis in the hands of the partnership) or 
$100, the fair market value of the distributed X stock ($150) less X's 
allocable share of gain if the partnership had sold all of the X stock 
immediately before the distribution for cash in an amount equal to its 
fair market value ($50). Thus, X will reduce its basis in its 
partnership interest by $100 prior to the distribution of Asset 1. 
Accordingly, X's basis in the distributed portion of Asset 1 is $5. 
Because

[[Page 120]]

AX's basis in the distributed X stock immediately before the 
distribution as computed for purposes of this section ($100) does not 
exceed X's basis in its AX partnership interest immediately before the 
distribution ($105), X recognizes no additional gain under paragraph 
(e)(3) of this section.
    (B) For purposes of determining A's basis in Asset 1 and A's gain on 
distribution, the basis of the distributed X stock is treated as $25, 
the greater of $25 (25 percent of the stock's $100 basis in the hands of 
the partnership) or $0, the fair market value of the distributed X stock 
($50) less A's allocable share of gain if the partnership had sold all 
of the X stock immediately before the distribution for cash in an amount 
equal to its fair market value ($50). Thus, A will reduce its basis in 
its partnership interest by $25 prior to the distribution of Asset 1. 
Accordingly, A's basis in the distributed portion of Asset 1 is $75. 
Because AX's basis in the distributed X stock immediately before the 
distribution as computed for purposes of this section ($100) does not 
exceed A's basis in its AX partnership interest immediately before the 
distribution ($100), A recognizes no additional gain under paragraph 
(e)(3) of this section.
    Example 5. Deemed redemption rule--subsequent purchase of Stock of 
the Corporate Partner. The facts are the same as Example 1(i) of this 
paragraph (h), except that A contributes cash of $100 instead of X 
stock. In a later year, when the value of Asset 1 has not changed, AX 
uses the contributed cash to purchase X stock for $100. AX's purchase of 
X stock has the effect of an exchange by X of appreciated property for X 
stock, and thus, is a Section 337(d) Transaction. X must recognize gain 
at the time, and to the extent, that X's share of appreciated property 
(other than X stock) is reduced in exchange for X stock. Thus, the 
consequences of the partnership's purchase of X stock are the same as 
those described in Example 1(ii) and (iii) of this paragraph (h), 
resulting in X recognizing $40 of gain.
    Example 6. Change in allocation ratios--amendment of partnership 
agreement. (i) The facts are the same as Example 3(i) of this paragraph 
(h), except that in Year 9, AX does not liquidate, and the AX 
partnership agreement is amended to allocate to X 80 percent of the 
income, gain, loss, and deduction from the X stock and to allocate to A 
80 percent of the income, gain, loss, and deduction from Asset 1. If AX 
had sold the partnership assets immediately before the change to the 
partnership agreement, X would have been allocated $90 of gain from 
Asset 1 and $50 of gain from the X stock.
    (ii) The amendment to the AX partnership agreement causes X's 
interest in its stock to increase from $100 (50 percent of the stock 
value immediately before the amendment of the agreement) to $160 (80 
percent of stock value immediately following amendment of agreement) and 
its interest in Asset 1 to decrease from $100 to $40. Thus, the 
amendment of the partnership agreement is a Section 337(d) Transaction 
because the amendment has the effect of an exchange by X of $60 of Asset 
1 for $60 of its stock.
    (iii) X must recognize gain equal to the product of X's Gain 
Percentage and the gain from Asset 1 that X would have recognized 
(decreased, but not below zero, by any gain X recognized with respect to 
Asset 1 in the Section 337(d) Transaction under any other provision of 
this chapter) if, immediately before the Section 337(d) Transaction, AX 
had sold all of its assets in a fully taxable transaction for cash in an 
amount equal to the fair market value of such property. If Asset 1 had 
been sold in a fully taxable transaction immediately before the 
amendment of the AX partnership agreement, X's allocable share of gain 
would have been $90, or the sum of X's $40 remaining gain under section 
704(c) and 50 percent of the $100 post-contribution appreciation. X's 
Gain Percentage is 60 percent (equal to a fraction, the numerator of 
which is X's $60 interest in Asset 1 effectively exchanged for X stock, 
and the denominator of which is X's $100 interest in Asset 1 immediately 
before the Section 337(d) Transaction). Thus, X recognizes $54 of gain 
($90 multiplied by 60 percent) under the deemed redemption rule in 
paragraph (d) of this section. Under paragraph (d)(4)(i) of this 
section, X's basis in its AX partnership interest increases from $60 to 
$114. Under paragraph (d)(4)(ii) of this section, AX's basis in Asset 1 
increases from $60 to $114 because Asset 1 is the appreciated property 
treated as the subject of the exchange.
    Example 7. Change in allocation ratios--admission and exit of a 
partner. (i) The facts are the same as Example 1(i) of this paragraph 
(h). In addition, in Year 2, when the values of Asset 1 and the X stock 
have not changed, B contributes $100 of cash to AX in exchange for a 
one-third interest in the partnership. Upon the admission of B as a 
partner, X's interest in Asset 1 decreases from $50 to $33.33, and its 
interest in B's contributed cash increases. B's admission is not a 
Section 337(d) Transaction because it does not have the effect of an 
exchange by X of its interest in Asset 1 for X stock. Accordingly, X 
does not recognize gain under paragraph (d) of this section.
    (ii) In Year 9, when the values of Asset 1 and the X stock have not 
changed, the partnership distributes $50 of cash and 50 percent of Asset 
1 (valued at $50) to B in liquidation of B's interest. X and A are equal 
partners in all respects after the distribution. Upon the liquidation of 
B's interest, X's interest in Asset 1 decreases from $33.33 to $25, and 
its interest in X stock increases from $33.33 to $50. AX's liquidation 
of B's interest has the effect of an exchange by X of appreciated

[[Page 121]]

property for X stock, and thus, is a Section 337(d) Transaction.
    (iii) Pursuant to paragraph (d)(2) of this section, X's interest in 
X stock and other appreciated property held by the partnership is 
determined based on all facts and circumstances, including allocation 
and distribution rights in the partnership agreement. However, paragraph 
(d)(2) of this section also requires that X's interest in its stock for 
purposes of paragraph (d) will never be less than the Corporate 
Partner's largest interest (by value) in those shares of Stock of the 
Corporate Partner taken into account when the partnership previously 
determined whether there had been a Section 337(d) Transaction 
(regardless of whether the Corporate Partner recognized gain in the 
earlier transaction). Although X's interest in X stock increases to $50 
upon AX's liquidation of B's interest, X's largest interest previously 
taken into account under paragraph (d)(1) of this section was $50. Thus, 
X's interest in its stock is not considered to be increased, and X 
therefore recognizes no gain under paragraph (d) of this section, 
provided that the transactions did not occur as part of a plan or 
arrangement to circumvent the purpose of this section.
    Example 8. Change in allocation ratios--plan to circumvent purpose 
of this section. (i) In Year 1, X, a corporation, and A, an individual, 
contribute $99 and $1, respectively, to newly-formed partnership AX, 
with X receiving a 99 percent interest in AX and A receiving a 1 percent 
interest in AX. AX borrows $100,000 from a third-party lender and uses 
the proceeds to purchase X stock, which is Stock of the Corporate 
Partner. Later, as part of a plan or arrangement to circumvent the 
purposes of this section, A contributes $99,999 of cash, which AX uses 
to repay the loan, and X contributes Asset 1 with a fair market value of 
$99,901 and basis of $20,000. After these contributions, A and X are 
equal partners in AX in all respects.
    (ii) Pursuant to paragraph (d)(2) of this section, X's interest in X 
stock and other appreciated property held by the partnership is 
determined based on all facts and circumstances, including allocation 
and distribution rights in the partnership agreement. Generally, 
pursuant to paragraph (d)(2) of this section, X's interest in X stock 
for purposes of paragraph (d) of this section will never be less than 
the Corporate Partner's largest interest (by value) in those shares of 
Stock of the Corporate Partner taken into account when the partnership 
previously determined whether there had been a Section 337(d) 
Transaction (regardless of whether the Corporate Partner recognized gain 
in the earlier transaction). This limitation does not apply, however, if 
the reduction in X's interest in X's stock occurred as part of a plan or 
arrangement to circumvent the purpose of this section. Because the 
transactions described in this example are part of a plan or arrangement 
to circumvent the purpose of this section, the limitation in paragraph 
(d)(2) of this section does not apply. Accordingly, the deemed 
redemption rule under paragraph (d) of this section applies to the 
transactions with the consequences described in Example 1(iii) of this 
paragraph (h), resulting in X recognizing $39,950.50 of gain.
    Example 9. Tiered partnership. (i) In Year 1, X, a corporation, and 
A, an individual, form partnership UTP. X contributes Asset 1 with a 
fair market value of $80 and a basis of $0 in exchange for an 80 percent 
interest in UTP. A contributes $20 of cash in exchange for a 20 percent 
interest in UTP. UTP and B, an individual, form partnership LTP as equal 
partners. UTP contributes Asset 1 and $20 of cash. B contributes X 
stock, which is Stock of the Corporate Partner, with a basis and fair 
market value of $100.
    (ii) Pursuant to paragraph (g) of this section, the rules of this 
section shall apply to tiered partnerships in a manner that is 
consistent with the purpose set forth in paragraph (a) of this section. 
Pursuant to paragraph (d)(1) of this section, if X is in a partnership 
that engages in a Section 337(d) Transaction, X must recognize gain at 
the time, and to the extent, that X's share of appreciated property is 
reduced in exchange for X stock. The formation of LTP causes X's 
interest in X stock to increase from $0 to $40 and its interest in Asset 
1 to decrease from $64 to $32. Thus, LTP's formation is a Section 337(d) 
Transaction because the formation has the effect of an exchange by X of 
$32 of Asset 1 for $32 of X stock.
    (iii) X must recognize gain with respect to Asset 1 to prevent the 
circumvention of section 311(b) principles. X must recognize gain equal 
to the product of X's Gain Percentage and the gain from Asset 1 
(decreased, but not below zero, by any gain X recognized with respect to 
Asset 1 in the Section 337(d) Transaction under any other provision of 
this chapter) that X would recognize if, immediately before the Section 
337(d) Transaction, all assets were sold in a fully taxable transaction 
for cash in an amount equal to the fair market value of such property. 
If Asset 1 had been sold in a fully taxable transaction immediately 
before LTP's formation, X's allocable share of gain would have been $80 
pursuant to section 704(c). X's Gain Percentage is 50 percent (equal to 
a fraction, the numerator of which is X's $32 interest in Asset 1 
effectively exchanged for X stock, and the denominator of which is X's 
$64 interest in Asset 1 immediately before the Section 337(d) 
Transaction). Thus, X recognizes $40 of gain ($80 multiplied by 50 
percent) under the deemed redemption rule in paragraph (d) of this 
section. Under paragraphs (d)(4)(i) and (ii) of this section, X's

[[Page 122]]

basis in its UTP partnership interest increases from $0 to $40, UTP's 
basis in its LTP partnership interest increases from $20 to $60, and 
LTP's basis in Asset 1 increases from $0 to $40 pursuant to paragraph 
(g) of this section.

    (i) Applicability date. This section applies to transactions 
occurring on or after June 12, 2015.

[T.D. 9833, 83 FR 26588, June 8, 2018]



Sec. 1.337(d)-4  Taxable to tax-exempt.

    (a) Gain or loss recognition--(1) General rule. Except as provided 
in paragraph (b) of this section, if a taxable corporation transfers all 
or substantially all of its assets to one or more tax-exempt entities, 
the taxable corporation must recognize gain or loss immediately before 
the transfer as if the assets transferred were sold at their fair market 
values. But see section 267 and paragraph (d) of this section concerning 
limitations on the recognition of loss.
    (2) Change in corporation's tax status treated as asset transfer. 
Except as provided in paragraphs (a)(3) and (b) of this section, a 
taxable corporation's change in status to a tax-exempt entity will be 
treated as if it transferred all of its assets to a tax-exempt entity 
immediately before the change in status becomes effective in a 
transaction to which paragraph (a)(1) of this section applies. For 
example, if a State, a political subdivision thereof, or an entity any 
portion of whose income is excluded from gross income under section 115, 
acquires the stock of a taxable corporation and thereafter any of the 
taxable corporation's income is excluded from gross income under section 
115, the taxable corporation will be treated as if it transferred all of 
its assets to a tax-exempt entity immediately before the stock 
acquisition.
    (3) Exceptions for certain changes in status--(i) To whom available. 
Paragraph (a)(2) of this section does not apply to the following 
corporations--
    (A) A corporation previously tax-exempt under section 501(a) which 
regains its tax-exempt status under section 501(a) within three years 
from the later of a final adverse adjudication on the corporation's tax 
exempt status, or the filing by the corporation, or by the Secretary or 
his delegate under section 6020(b), of a federal income tax return of 
the type filed by a taxable corporation;
    (B) A corporation previously tax-exempt under section 501(a) or that 
applied for but did not receive recognition of exemption under section 
501(a) before January 15, 1997, if such corporation is tax-exempt under 
section 501(a) within three years from January 28, 1999;
    (C) A newly formed corporation that is tax-exempt under section 
501(a) (other than an organization described in section 501(c)(7)) 
within three taxable years from the end of the taxable year in which it 
was formed;
    (D) A newly formed corporation that is tax-exempt under section 
501(a) as an organization described in section 501(c)(7) within seven 
taxable years from the end of the taxable year in which it was formed;
    (E) A corporation previously tax-exempt under section 501(a) as an 
organization described in section 501(c)(12), which, in a given taxable 
year or years prior to again becoming tax-exempt, is a taxable 
corporation solely because less than 85 percent of its income consists 
of amounts collected from members for the sole purpose of meeting losses 
and expenses; if, in a taxable year, such a corporation would be a 
taxable corporation even if 85 percent or more of its income consists of 
amounts collected from members for the sole purpose of meeting losses 
and expenses (a non-85 percent violation), paragraph (a)(3)(i)(A) of 
this section shall apply as if the corporation became a taxable 
corporation in its first taxable year that a non-85 percent violation 
occurred; or
    (F) A corporation previously taxable that becomes tax-exempt under 
section 501(a) as an organization described in section 501(c)(15) if 
during each taxable year in which it is described in section 501(c)(15) 
the organization is the subject of a court supervised rehabilitation, 
conservatorship, liquidation, or similar state proceeding; if such a 
corporation continues to be described in section 501(c)(15) in a taxable 
year when it is no longer the subject of a court supervised 
rehabilitation, conservatorship, liquidation, or similar state 
proceeding, paragraph (a)(2) of

[[Page 123]]

this section shall apply as if the corporation first became tax-exempt 
for such taxable year.
    (ii) Application for recognition. An organization is deemed to have 
or regain tax-exempt status within one of the periods described in 
paragraph (a)(3)(i)(A), (B), (C), or (D) of this section if it files an 
application for recognition of exemption with the Commissioner within 
the applicable period and the application either results in a 
determination by the Commissioner or a final adjudication that the 
organization is tax-exempt under section 501(a) during any part of the 
applicable period. The preceding sentence does not require the filing of 
an application for recognition of exemption by any organization not 
otherwise required, such as by Sec. Sec. 1.501(a)-1, 1.505(c)-1T, and 
1.508-1(a), to apply for recognition of exemption.
    (iii) Anti-abuse rule. This paragraph (a)(3) does not apply to a 
corporation that, with a principal purpose of avoiding the application 
of paragraph (a)(1) or (a)(2) of this section, acquires all or 
substantially all of the assets of another taxable corporation and then 
changes its status to that of a tax-exempt entity.
    (4) Related transactions. This section applies to any series of 
related transactions having an effect similar to any of the transactions 
to which this section applies.
    (b) Exceptions. Paragraph (a) of this section does not apply to--
    (1) Any assets transferred to a tax-exempt entity to the extent that 
the assets are used in an activity the income from which is subject to 
tax under section 511(a) (referred to hereinafter as a ``section 511(a) 
activity''). However, if assets used to any extent in a section 511(a) 
activity are disposed of by the tax-exempt entity, then, notwithstanding 
any other provision of law (except section 1031 or section 1033), any 
gain (not in excess of the amount not recognized by reason of the 
preceding sentence) shall be included in the tax-exempt entity's 
unrelated business taxable income. To the extent that the tax-exempt 
entity ceases to use the assets in a section 511(a) activity, the entity 
will be treated for purposes of this paragraph (b)(1) as having disposed 
of the assets on the date of the cessation for their fair market value. 
For purposes of paragraph (a)(1) of this section and this paragraph 
(b)(1)--
    (i) If during the first taxable year following the transfer of an 
asset or the corporation's change to tax-exempt status the asset will be 
used by the tax-exempt entity partly or wholly in a section 511(a) 
activity, the taxable corporation will recognize an amount of gain or 
loss that bears the same ratio to the asset's built-in gain or loss as 
100 percent reduced by the percentage of use for such taxable year in 
the section 511(a) activity bears to 100 percent. For purposes of 
determining the gain or loss, if any, to be recognized, the taxable 
corporation may rely on a written representation from the tax-exempt 
entity estimating the percentage of the asset's anticipated use in a 
section 511(a) activity for such taxable year, using a reasonable method 
of allocation, unless the taxable corporation has reason to believe that 
the tax-exempt entity's representation is not made in good faith;
    (ii) If for any taxable year the percentage of an asset's use in a 
section 511(a) activity decreases from the estimate used in computing 
gain or loss recognized under paragraph (b)(1)(i) of this section, 
adjusted for any decreases taken into account under this paragraph 
(b)(1)(ii) in prior taxable years, the tax-exempt entity shall recognize 
an amount of gain or loss that bears the same ratio to the asset's 
built-in gain or loss as the percentage point decrease in use in the 
section 511(a) activity for the taxable year bears to 100 percent;
    (iii) If property on which all or a portion of the gain or loss is 
not recognized by reason of the first sentence of paragraph (b)(1) of 
this section is disposed of in a transaction that qualifies for 
nonrecognition treatment under section 1031 or section 1033, the tax-
exempt entity must treat the replacement property as remaining subject 
to paragraph (b)(1) of this section to the extent that the exchanged or 
involuntarily converted property was so subject;

[[Page 124]]

    (iv) The tax-exempt entity must use the same reasonable method of 
allocation for determining the percentage that it uses the assets in a 
section 511(a) activity as it uses for other tax purposes, such as 
determining the amount of depreciation deductions. The tax-exempt entity 
also must use this same reasonable method of allocation for each taxable 
year that it holds the assets; and
    (v) An asset's built-in gain or loss is the amount that would be 
recognized under paragraph (a)(1) of this section except for this 
paragraph (b)(1);
    (2) Any transfer of assets to the extent gain or loss otherwise is 
recognized by the taxable corporation on the transfer. See, for example, 
sections 336, 337(b)(2), 367, and 1001;
    (3) Any transfer of assets to the extent the transaction qualifies 
for nonrecognition treatment under section 1031 or section 1033; or
    (4) Any forfeiture of a taxable corporation's assets in a criminal 
or civil action to the United States, the government of a possession of 
the United States, a state, the District of Columbia, the government of 
a foreign country, or a political subdivision of any of the foregoing; 
or any expropriation of a taxable corporation's assets by the government 
of a foreign country.
    (c) Definitions. For purposes of this section:
    (1) Taxable corporation. A taxable corporation is any corporation 
that is not a tax-exempt entity as defined in paragraph (c)(2) of this 
section.
    (2) Tax-exempt entity. A tax-exempt entity is--
    (i) Any entity that is exempt from tax under section 501(a) or 
section 529;
    (ii) A charitable remainder annuity trust or charitable remainder 
unitrust as defined in section 664(d);
    (iii) The United States, the government of a possession of the 
United States, a state, the District of Columbia, the government of a 
foreign country, or a political subdivision of any of the foregoing;
    (iv) An Indian Tribal Government as defined in section 7701(a)(40), 
a subdivision of an Indian Tribal Government determined in accordance 
with section 7871(d), or an agency or instrumentality of an Indian 
Tribal Government or subdivision thereof;
    (v) An Indian Tribal Corporation organized under section 17 of the 
Indian Reorganization Act of 1934, 25 U.S.C. 477, or section 3 of the 
Oklahoma Welfare Act, 25 U.S.C. 503;
    (vi) An international organization as defined in section 
7701(a)(18);
    (vii) An entity any portion of whose income is excluded under 
section 115; or
    (viii) An entity that would not be taxable under the Internal 
Revenue Code for reasons substantially similar to those applicable to 
any entity listed in this paragraph (c)(2) unless otherwise explicitly 
made exempt from the application of this section by statute or by action 
of the Commissioner.
    (3) Substantially all. The term substantially all has the same 
meaning as under section 368(a)(1)(C).
    (d) Loss limitation rule. For purposes of determining the amount of 
gain or loss recognized by a taxable corporation on the transfer of its 
assets to a tax-exempt entity under paragraph (a) of this section, if 
assets are acquired by the taxable corporation in a transaction to which 
section 351 applied or as a contribution to capital, or assets are 
distributed from the taxable corporation to a shareholder or another 
member of the taxable corporation's affiliated group, and in either case 
such acquisition or distribution is made as part of a plan a principal 
purpose of which is to recognize loss by the taxable corporation on the 
transfer of such assets to the tax-exempt entity, the losses recognized 
by the taxable corporation on such assets transferred to the tax-exempt 
entity will be disallowed. For purposes of the preceding sentence, the 
principles of section 336(d)(2) apply.
    (e) Effective date. This section is applicable to transfers of 
assets as described in paragraph (a) of this section occurring after 
January 28, 1999, unless the transfer is pursuant to a written agreement 
which is (subject to customary conditions) binding on or before January 
28, 1999.

[T.D. 8802, 63 FR 71594, Dec. 29, 1998]

[[Page 125]]



Sec. 1.337(d)-5  Old transitional rules imposing tax on property owned
by a C corporation that becomes property of a RIC or REIT

    (a) Treatment of C corporations--(1) Scope. This section applies to 
the net built-in gain of C corporation assets that become assets of a 
RIC or REIT by--
    (i) The qualification of a C corporation as a RIC or REIT; or
    (ii) The transfer of assets of a C corporation to a RIC or REIT in a 
transaction in which the basis of such assets are determined by 
reference to the C corporation's basis (a carryover basis).
    (2) Net built-in gain. Net built-in gain is the excess of aggregate 
gains (including items of income) over aggregate losses.
    (3) General rule. Unless an election is made pursuant to paragraph 
(b) of this section, the C corporation will be treated, for all purposes 
including recognition of net built-in gain, as if it had sold all of its 
assets at their respective fair market values on the deemed liquidation 
date described in paragraph (a)(7) of this section and immediately 
liquidated.
    (4) Loss. Paragraph (a)(3) of this section shall not apply if its 
application would result in the recognition of net built-in loss.
    (5) Basis adjustment. If a corporation is subject to corporate-level 
tax under paragraph (a)(3) of this section, the bases of the assets in 
the hands of the RIC or REIT will be adjusted to reflect the recognized 
net built-in gain. This adjustment is made by taking the C corporation's 
basis in each asset, and, as appropriate, increasing it by the amount of 
any built-in gain attributable to that asset, or decreasing it by the 
amount of any built-in loss attributable to that asset.
    (6) Exception--(i) In general. Paragraph (a)(3) of this section does 
not apply to any C corporation that--
    (A) Immediately prior to qualifying to be taxed as a RIC was subject 
to tax as a C corporation for a period not exceeding one taxable year; 
and
    (B) Immediately prior to being subject to tax as a C corporation was 
subject to the RIC tax provisions for a period of at least one taxable 
year.
    (ii) Additional requirement. The exception described in paragraph 
(a)(6)(i) of this section applies only to assets acquired by the 
corporation during the year when it was subject to tax as a C 
corporation in a transaction that does not result in its basis in the 
asset being determined by reference to a corporate transferor's basis.
    (7) Deemed liquidation date--(i) Conversions. In the case of a C 
corporation that qualifies to be taxed as a RIC or REIT, the deemed 
liquidation date is the last day of its last taxable year before the 
taxable year in which it qualifies to be taxed as a RIC or REIT.
    (ii) Carryover basis transfers. In the case of a C corporation that 
transfers property to a RIC or REIT in a carryover basis transaction, 
the deemed liquidation date is the day before the date of the transfer.
    (b) Section 1374 treatment--(1) In general. Paragraph (a) of this 
section will not apply if the transferee RIC or REIT elects (as 
described in paragraph (b)(3) of this section) to be subject to the 
rules of section 1374, and the regulations thereunder. The electing RIC 
or REIT will be subject to corporate-level taxation on the built-in gain 
recognized during the 10-year period on assets formerly held by the 
transferor C corporation. The built-in gains of electing RICs and REITs, 
and the corporate-level tax imposed on such gains, are subject to rules 
similar to the rules relating to net income from foreclosure property of 
REITs. See sections 857(a)(1)(A)(ii), and 857(b)(2)(B), (D), and (E). An 
election made under this paragraph (b) shall be irrevocable.
    (2) Ten-year recognition period. In the case of a C corporation that 
qualifies to be taxed as a RIC or REIT, the 10-year recognition period 
described in section 1374(d)(7) begins on the first day of the RIC's or 
REIT's taxable year for which the corporation qualifies to be taxed as a 
RIC or REIT. In the case of a C corporation that transfers property to a 
RIC or REIT in a carryover basis transaction, the 10-year recognition 
period begins on the day the assets are acquired by the RIC or REIT.
    (3) Making the election. A RIC or REIT validly makes a section 1374 
election with the following statement: ``[Insert name and employer 
identification

[[Page 126]]

number of electing RIC or REIT] elects under paragraph (b) of this 
section to be subject to the rules of section 1374 and the regulations 
thereunder with respect to its assets which formerly were held by a C 
corporation, [insert name and employer identification number of the C 
corporation, if different from name and employer identification number 
of RIC or REIT].'' This statement must be signed by an official 
authorized to sign the income tax return of the RIC or REIT and attached 
to the RIC's or REIT's Federal income tax return for the first taxable 
year in which the assets of the C corporation become assets of the RIC 
or REIT.
    (c) Special rule. In cases where the first taxable year in which the 
assets of the C corporation become assets of the RIC or REIT ends after 
June 10, 1987 but before March 8, 2000, the section 1374 election may be 
filed with the first Federal income tax return filed by the RIC or REIT 
after March 8, 2000.
    (d) Effective date. In the case of carryover basis transactions 
involving the transfer of property of a C corporation to a RIC or REIT, 
the regulations apply to transactions occurring on or after June 10, 
1987, and before January 2, 2002. In the case of a C corporation that 
qualifies to be taxed as a RIC or REIT, the regulations apply to such 
qualifications that are effective for taxable years beginning on or 
after June 10, 1987, and before January 2, 2002. However, RICs and REITs 
that are subject to section 1374 treatment under this section may not 
rely on paragraph (b)(1) of this section, but must apply paragraphs 
(c)(1)(i), (c)(2)(i), (c)(2)(ii), and (c)(3) of Sec. 1.337(d)-6, with 
respect to built-in gains and losses recognized in taxable years 
beginning on or after January 2, 2002. In lieu of applying this section, 
taxpayers may rely on Sec. 1.337(d)-6 to determine the tax consequences 
(for all taxable years) of any conversion transaction. For transactions 
and qualifications that occur on or after January 2, 2002, see Sec. 
1.337(d)-7.

[T.D. 8872, 65 FR 5776, Feb. 7, 2000, as amended by T.D. 8975, 67 FR 12, 
Jan. 2, 2002. Redesignated and amended by T.D. 9047, 68 FR 12819, Mar. 
19, 2003]



Sec. 1.337(d)-6  New transitional rules imposing tax on property owned
by a C corporation that becomes property of a RIC or REIT.

    (a) General rule--(1) Property owned by a C corporation that becomes 
property of a RIC or REIT. If property owned by a C corporation (as 
defined in paragraph (a)(2)(i) of this section) becomes the property of 
a RIC or REIT (the converted property) in a conversion transaction (as 
defined in paragraph (a)(2)(ii) of this section), then deemed sale 
treatment will apply as described in paragraph (b) of this section, 
unless the RIC or REIT elects section 1374 treatment with respect to the 
conversion transaction as provided in paragraph (c) of this section. See 
paragraph (d) of this section for exceptions to this paragraph (a).
    (2) Definitions--(i) C corporation. For purposes of this section, 
the term C corporation has the meaning provided in section 1361(a)(2) 
except that the term does not include a RIC or REIT.
    (ii) Conversion transaction. For purposes of this section, the term 
conversion transaction means the qualification of a C corporation as a 
RIC or REIT or the transfer of property owned by a C corporation to a 
RIC or REIT.
    (b) Deemed sale treatment--(1) In general. If property owned by a C 
corporation becomes the property of a RIC or REIT in a conversion 
transaction, then the C corporation recognizes gain and loss as if it 
sold the converted property to an unrelated party at fair market value 
on the deemed sale date (as defined in paragraph (b)(3) of this 
section). This paragraph (b) does not apply if its application would 
result in the recognition of a net loss. For this purpose, net loss is 
the excess of aggregate losses over aggregate gains (including items of 
income), without regard to character.
    (2) Basis adjustment. If a corporation recognizes a net gain under 
paragraph (b)(1) of this section, then the converted property has a 
basis in the hands of the RIC or REIT equal to the fair market value of 
such property on the deemed sale date.
    (3) Deemed sale date--(i) RIC or REIT qualifications. If the 
conversion transaction is a qualification of a C corporation as a RIC or 
REIT, then the deemed

[[Page 127]]

sale date is the end of the last day of the C corporation's last taxable 
year before the first taxable year in which it qualifies to be taxed as 
a RIC or REIT.
    (ii) Other conversion transactions. If the conversion transaction is 
a transfer of property owned by a C corporation to a RIC or REIT, then 
the deemed sale date is the end of the day before the day of the 
transfer.
    (4) Example. The rules of this paragraph (b) are illustrated by the 
following example:

    Example. Deemed sale treatment on merger into RIC. (i) X, a 
calendar-year taxpayer, has qualified as a RIC since January 1, 1991. On 
May 31, 1994, Y, a C corporation and calendar-year taxpayer, transfers 
all of its property to X in a transaction that qualifies as a 
reorganization under section 368(a)(1)(C). X does not elect section 1374 
treatment under paragraph (c) of this section and chooses not to rely on 
Sec. 1.337(d)-5. As a result of the transfer, Y is subject to deemed 
sale treatment under this paragraph (b) on its tax return for the short 
taxable year ending May 31, 1994. On May 31, 1994, Y's only assets are 
Capital Asset, which has a fair market value of $100,000 and a basis of 
$40,000 as of the end of May 30, 1994, and $50,000 cash. Y also has an 
unrestricted net operating loss carryforward of $12,000 and accumulated 
earnings and profits of $50,000. Y has no taxable income for the short 
taxable year ending May 31, 1994, other than gain recognized under this 
paragraph (b). In 1997, X sells Capital Asset for $110,000. Assume the 
applicable corporate tax rate is 35%.
    (ii) Under this paragraph (b), Y is treated as if it sold the 
converted property (Capital Asset and $50,000 cash) at fair market value 
on May 30, 1994, recognizing $60,000 of gain ($150,000 amount realized--
$90,000 basis). Y must report the gain on its tax return for the short 
taxable year ending May 31, 1994. Y may offset this gain with its 
$12,000 net operating loss carryforward and will pay tax of $16,800 (35% 
of $48,000).
    (iii) Under section 381, X succeeds to Y's accumulated earnings and 
profits. Y's accumulated earnings and profits of $50,000 increase by 
$60,000 and decrease by $16,800 as a result of the deemed sale. Thus, 
the aggregate amount of subchapter C earnings and profits that must be 
distributed to satisfy section 852(a)(2)(B) is $93,200 ($50,000 + 
$60,000 - $16,800). X's basis in Capital Asset is $100,000. On X's sale 
of Capital Asset in 1997, X recognizes $10,000 of gain, which is taken 
into account in computing X's net capital gain for purposes of section 
852(b)(3).

    (c) Election of section 1374 treatment--(1) In general--(i) Property 
owned by a C corporation that becomes property of a RIC or REIT. 
Paragraph (b) of this section does not apply if the RIC or REIT that was 
formerly a C corporation or that acquired property from a C corporation 
makes the election described in paragraph (c)(4) of this section. A RIC 
or REIT that makes such an election will be subject to tax on the net 
built-in gain in the converted property under the rules of section 1374 
and the regulations thereunder, as modified by this paragraph (c), as if 
the RIC or REIT were an S corporation.
    (ii) Property subject to the rules of section 1374 owned by a RIC, 
REIT, or S corporation that becomes property of a RIC or REIT. If 
property subject to the rules of section 1374 owned by a RIC, a REIT, or 
an S corporation (the predecessor) becomes the property of a RIC or REIT 
(the successor) in a continuation transaction, the rules of section 1374 
apply to the successor to the same extent that the predecessor was 
subject to the rules of section 1374 with respect to such property, and 
the 10-year recognition period of the successor with respect to such 
property is reduced by the portion of the 10-year recognition period of 
the predecessor that expired before the date of the continuation 
transaction. For this purpose, a continuation transaction means the 
qualification of the predecessor as a RIC or REIT or the transfer of 
property from the predecessor to the successor in a transaction in which 
the successor's basis in the transferred property is determined, in 
whole or in part, by reference to the predecessor's basis in that 
property.
    (2) Modification of section 1374 treatment--(i) Net recognized 
built-in gain for REITs--(A) Prelimitation amount. The prelimitation 
amount determined as provided in Sec. 1.1374-2(a)(1) is reduced by the 
portion of such amount, if any, that is subject to tax under section 
857(b)(4), (5), (6), or (7). For this purpose, the amount of a REIT's 
recognized built-in gain that is subject to tax under section 857(b)(5) 
is computed as follows:
    (1) Where the tax under section 857(b)(5) is computed by reference 
to section 857(b)(5)(A), the amount of a REIT's recognized built-in gain 
that is subject to tax under section 857(b)(5) is the tax imposed by 
section 857(b)(5)

[[Page 128]]

multiplied by a fraction the numerator of which is the amount of 
recognized built-in gain (without regard to recognized built-in loss and 
recognized built-in gain from prohibited transactions) that is not 
derived from sources referred to in section 856(c)(2) and the 
denominator of which is the gross income (without regard to gross income 
from prohibited transactions) of the REIT that is not derived from 
sources referred to in section 856(c)(2).
    (2) Where the tax under section 857(b)(5) is computed by reference 
to section 857(b)(5)(B), the amount of a REIT's recognized built-in gain 
that is subject to tax under section 857(b)(5) is the tax imposed by 
section 857(b)(5) multiplied by a fraction the numerator of which is the 
amount of recognized built-in gain (without regard to recognized built-
in loss and recognized built-in gain from prohibited transactions) that 
is not derived from sources referred to in section 856(c)(3) and the 
denominator of which is the gross income (without regard to gross income 
from prohibited transactions) of the REIT that is not derived from 
sources referred to in section 856(c)(3).
    (B) Taxable income limitation. The taxable income limitation 
determined as provided in Sec. 1.1374-2(a)(2) is reduced by an amount 
equal to the tax imposed under sections 857(b)(5), (6), and (7).
    (ii) Loss carryforwards, credits and credit carryforwards--(A) Loss 
carryforwards. Consistent with paragraph (c)(1)(i) of this section, net 
operating loss carryforwards and capital loss carryforwards arising in 
taxable years for which the corporation that generated the loss was not 
subject to subchapter M of chapter 1 of the Internal Revenue Code are 
allowed as a deduction against net recognized built-in gain to the 
extent allowed under section 1374 and the regulations thereunder. Such 
loss carryforwards must be used as a deduction against net recognized 
built-in gain for a taxable year to the greatest extent possible before 
such losses can be used to reduce other investment company taxable 
income for purposes of section 852(b) or other real estate investment 
trust taxable income for purposes of section 857(b) for that taxable 
year.
    (B) Credits and credit carryforwards. Consistent with paragraph 
(c)(1)(i) of this section, minimum tax credits and business credit 
carryforwards arising in taxable years for which the corporation that 
generated the credit was not subject to subchapter M of chapter 1 of the 
Internal Revenue Code are allowed to reduce the tax imposed on net 
recognized built-in gain under this paragraph (c) to the extent allowed 
under section 1374 and the regulations thereunder. Such credits and 
credit carryforwards must be used to reduce the tax imposed under this 
paragraph (c) on net recognized built-in gain for a taxable year to the 
greatest extent possible before such credits and credit carryforwards 
can be used to reduce the tax, if any, on other investment company 
taxable income for purposes of section 852(b) or on other real estate 
investment trust taxable income for purposes of section 857(b) for that 
taxable year.
    (iii) 10-year recognition period. In the case of a conversion 
transaction that is a qualification of a C corporation as a RIC or REIT, 
the 10-year recognition period described in section 1374(d)(7) begins on 
the first day of the RIC's or REIT's first taxable year. In the case of 
other conversion transactions, the 10-year recognition period begins on 
the day the property is acquired by the RIC or REIT.
    (3) Coordination with subchapter M rules--(i) Recognized built-in 
gains and losses subject to subchapter M. Recognized built-in gains and 
losses of a RIC or REIT are included in computing investment company 
taxable income for purposes of section 852(b)(2), real estate investment 
trust taxable income for purposes of section 857(b)(2), capital gains 
for purposes of sections 852(b)(3) and 857(b)(3), gross income derived 
from sources within any foreign country or possession of the United 
States for purposes of section 853, and the dividends paid deduction for 
purposes of sections 852(b)(2)(D), 852(b)(3)(A), 857(b)(2)(B), and 
857(b)(3)(A). In computing such income and deduction items, capital loss 
carryforwards and net operating loss carryforwards that are used by the 
RIC or REIT to reduce recognized built-in gains are allowed as a 
deduction, but only to the extent

[[Page 129]]

that they are otherwise allowable as a deduction against such income 
under the Internal Revenue Code (including section 852(b)(2)(B)).
    (ii) Treatment of tax imposed. The amount of tax imposed under this 
paragraph (c) on net recognized built-in gain for a taxable year is 
treated as a loss sustained by the RIC or the REIT during such taxable 
year. The character of the loss is determined by allocating the tax 
proportionately (based on recognized built-in gain) among the items of 
recognized built-in gain included in net recognized built-in gain. With 
respect to RICs, the tax imposed under this paragraph (c) on net 
recognized built-in gain is treated as attributable to the portion of 
the RIC's taxable year occurring after October 31.
    (4) Making the section 1374 election--(i) In general. A RIC or REIT 
makes a section 1374 election with the following statement: ``[Insert 
name and employer identification number of electing RIC or REIT] elects 
under Sec. 1.337-6(c) to be subject to the rules of section 1374 and 
the regulations thereunder with respect to its property that formerly 
was held by a C corporation, [insert name and employer identification 
number of the C corporation, if different from name and employer 
identification number of the RIC or REIT].'' However, a RIC or REIT need 
not file an election under this paragraph (c), but will be deemed to 
have made such an election if it can demonstrate that it informed the 
Internal Revenue Service prior to January 2, 2002 of its intent to make 
a section 1374 election. An election under this paragraph (c) is 
irrevocable.
    (ii) Time for making the election. An election under this paragraph 
(c) may be filed by the RIC or REIT with any Federal income tax return 
filed by the RIC or REIT on or before September 15, 2003, provided that 
the RIC or REIT has reported consistently with such election for all 
periods.
    (5) Example. The rules of this paragraph (c) are illustrated by the 
following example:

    Example. Section 1374 treatment on REIT election. (i) X, a C 
corporation that is a calendar-year taxpayer, elects to be taxed as a 
REIT on its 1994 tax return, which it files on March 15, 1995. As a 
result, X is a REIT for its 1994 taxable year and would be subject to 
deemed sale treatment under paragraph (b) of this section but for X's 
timely election of section 1374 treatment under this paragraph (c). X 
chooses not to rely on Sec. 1.337(d)-5. As of the beginning of the 1994 
taxable year, X's property consisted of Real Property, which is not 
section 1221(a)(1) property and which had a fair market value of 
$100,000 and an adjusted basis of $80,000, and $25,000 cash. X also had 
accumulated earnings and profits of $25,000, unrestricted capital loss 
carryforwards of $3,000, and unrestricted business credit carryforwards 
of $2,000. On July 1, 1997, X sells Real Property for $110,000. For its 
1997 taxable year, X has no other income or deduction items. Assume the 
highest corporate tax rate is 35%.
    (ii) Upon its election to be taxed as a REIT, X retains its $80,000 
basis in Real Property and its $25,000 accumulated earnings and profits. 
X retains its $3,000 of capital loss carryforwards and its $2,000 of 
business credit carryforwards. To satisfy section 857(a)(2)(B), X must 
distribute $25,000, an amount equal to its earnings and profits 
accumulated in non-REIT years, to its shareholders by the end of its 
1994 taxable year.
    (iii) Upon X's sale of Real Property in 1997, X recognizes gain of 
$30,000 ($110,000--$80,000). X's recognized built-in gain for purposes 
of applying section 1374 is $20,000 ($100,000 fair market value as of 
the beginning of X's first taxable year as a REIT--$80,000 basis). 
Because X's $30,000 of net income for the 1997 taxable year exceeds the 
net recognized built-in gain of $20,000, the taxable income limitation 
does not apply. X, therefore, has $20,000 net recognized built-in gain 
for the year. Assuming that X has not used its $3,000 of capital loss 
carryforwards in a prior taxable year and that their use is allowed 
under section 1374(b)(2) and Sec. 1.1374-5, X is allowed a $3,000 
deduction against the $20,000 net recognized built-in gain. X would owe 
tax of $5,950 (35% of $17,000) on its net recognized built-in gain, 
except that X may use its $2,000 of business credit carryforwards to 
reduce this tax, assuming that X has not used the credit carryforwards 
in a prior taxable year and that their use is allowed under section 
1374(b)(3) and Sec. 1.1374-6. Thus, X owes tax of $3,950 under this 
paragraph (c).
    (iv) For purposes of subchapter M of chapter 1 of the Internal 
Revenue Code, X's earnings and profits for the year increase by $26,050 
($30,000 capital gain on the sale of Real Property--$3,950 tax under 
this paragraph (c)). For purposes of section 857(b)(2) and (b)(3), X's 
net capital gain for the year is $23,050 ($30,000 capital gain reduced 
by $3,000 capital loss carryforward and further reduced by $3,950 tax).

    (d) Exceptions--(1) Gain otherwise recognized. Paragraph (a) of this 
section does not apply to any conversion transaction to the extent that 
gain or loss

[[Page 130]]

otherwise is recognized on such conversion transaction. See, for 
example, sections 336, 351(b), 351(e), 356, 357(c), 367, 368(a)(2)(F), 
and 1001.
    (2) Re-election of RIC or REIT status--(i) Generally. Except as 
provided in paragraphs (d)(2)(ii) and (iii) of this section, paragraph 
(a)(1) of this section does not apply to any corporation that--
    (A) Immediately prior to qualifying to be taxed as a RIC or REIT was 
subject to tax as a C corporation for a period not exceeding two taxable 
years; and
    (B) Immediately prior to being subject to tax as a C corporation was 
subject to tax as a RIC or REIT for a period of at least one taxable 
year.
    (ii) Property acquired from another corporation while a C 
corporation. The exception described in paragraph (d)(2)(i) of this 
section does not apply to property acquired by the corporation while it 
was subject to tax as a C corporation from any person in a transaction 
that results in the acquirer's basis in the property being determined by 
reference to a C corporation's basis in the property.
    (iii) RICs and REITs previously subject to section 1374 treatment. 
If the RIC or REIT had property subject to paragraph (c) of this section 
before the RIC or REIT became subject to tax as a C corporation as 
described in paragraph (d)(2)(i) of this section, then paragraph (c) of 
this section applies to the RIC or REIT upon its requalification as a 
RIC or REIT, except that the 10-year recognition period with respect to 
such property is reduced by the portion of the 10-year recognition 
period that expired before the RIC or REIT became subject to tax as a C 
corporation and by the period of time that the corporation was subject 
to tax as a C corporation.
    (e) Effective date. This section applies to conversion transactions 
that occur on or after June 10, 1987, and before January 2, 2002. In 
lieu of applying this section, taxpayers generally may apply Sec. 
1.337(d)-5 to determine the tax consequences (for all taxable years) of 
any conversion transaction that occurs on or after June 10, 1987 and 
before January 2, 2002, except that RICs and REITs that are subject to 
section 1374 treatment with respect to a conversion transaction may not 
rely on Sec. 1.337(d)-5(b)(1), but must apply paragraphs (c)(1)(i), 
(c)(2)(i), (c)(2)(ii), and (c)(3) of this section, with respect to 
built-in gains and losses recognized in taxable years beginning on or 
after January 2, 2002. Taxpayers are not prevented from relying on Sec. 
1.337(d)-5 merely because they elect section 1374 treatment in the 
manner described in paragraph (c)(4) of this section instead of in the 
manner described in Sec. 1.337(d)-5(b)(3) and (c). For conversion 
transactions that occur on or after January 2, 2002, see Sec. 1.337(d)-
7.

[T.D. 9047, 68 FR 12820, Mar. 18, 2003]



Sec. 1.337(d)-7  Tax on property owned by a C corporation that becomes
property of a RIC or REIT.

    (a) General rule--(1) Property owned by a C corporation that becomes 
property of a RIC or a REIT. If property owned by a C corporation (as 
defined in paragraph (a)(2)(i) of this section) becomes the property of 
a RIC or a REIT in a conversion transaction (as defined in paragraph 
(a)(2)(ii) of this section), then section 1374 treatment will apply as 
described in paragraph (b) of this section, unless the C corporation 
elects, or is treated as electing, deemed sale treatment with respect to 
the conversion transaction as provided in paragraph (c) of this section. 
See paragraph (d) of this section for exceptions to this paragraph (a).
    (2) Definitions. For purposes of this section:
    (i) C corporation. The term C corporation has the meaning provided 
in section 1361(a)(2) except that the term does not include a RIC or a 
REIT.
    (ii) Conversion transaction. The term conversion transaction means 
the qualification of a C corporation as a RIC or REIT or the transfer of 
property owned by a C corporation to a RIC or REIT.
    (iii) RIC. The term RIC means a regulated investment company within 
the meaning of section 851(a).
    (iv) REIT. The term REIT means a real estate investment trust within 
the meaning of section 856(a).
    (v) S corporation. The term S corporation has the meaning provided 
in section 1361(a)(1).

[[Page 131]]

    (vi) Section 355 distribution. The term section 355 distribution 
means any distribution to which section 355 (or so much of section 356 
as relates to section 355) applies, including a distribution on which 
the distributing corporation recognizes gain pursuant to sections 355(d) 
or 355(e).
    (vii) Converted property. The term converted property means--
    (A) Property owned by a C corporation that becomes the property of a 
RIC or a REIT; and
    (B) Any other property of a RIC or a REIT the basis of which is 
determined, directly or indirectly, in whole or in part, by reference to 
the basis of property described in paragraph (a)(2)(vii)(A) of this 
section.
    (viii) Distribution property. The term distribution property means--
    (A) Property owned immediately after a section 355 distribution by 
the distributing corporation, a controlled corporation (as those terms 
are defined in section 355(a)(1)), or a member of a separate affiliated 
group (as defined in section 355(b)(3)(B)) of which the distributing 
corporation or a controlled corporation is the common parent (but no 
formulation of the step transaction doctrine will be used to determine 
whether property acquired after the distribution is distribution 
property pursuant to this paragraph (a)(2)(viii)(A)); and
    (B) Property with a basis determined, directly or indirectly, in 
whole or in part, by reference to property described in paragraph 
(a)(2)(viii)(A) of this section.
    (b) Section 1374 treatment--(1) In general--(i) Property owned by a 
C corporation that becomes property of a RIC or REIT. If property owned 
by a C corporation becomes the property of a RIC or REIT in a conversion 
transaction, then the RIC or REIT will be subject to tax on the net 
built-in gain in the converted property under the rules of section 1374 
and the regulations thereunder, as modified by this paragraph (b), as if 
the RIC or REIT were an S corporation.
    (ii) Property subject to the rules of section 1374 owned by a RIC, 
REIT, or S corporation that becomes property of a RIC or REIT. If 
property subject to the rules of section 1374 owned by a RIC, a REIT, or 
an S corporation (the predecessor) becomes the property of a RIC or REIT 
(the successor) in a continuation transaction, the rules of section 1374 
apply to the successor to the same extent that the predecessor was 
subject to the rules of section 1374 with respect to such property, and 
the recognition period of the successor with respect to such property is 
reduced by the portion of the recognition period of the predecessor that 
expired before the date of the continuation transaction. For this 
purpose, a continuation transaction means the qualification of the 
predecessor as a RIC or REIT or the transfer of property from the 
predecessor to the successor in a transaction in which the successor's 
basis in the transferred property is determined, in whole or in part, by 
reference to the predecessor's basis in that property.
    (2) Modification of section 1374 treatment--(i) Net recognized 
built-in gain for REITs--(A) Prelimitation amount. The prelimitation 
amount determined as provided in Sec. 1.1374-2(a)(1) is reduced by the 
portion of such amount, if any, that is subject to tax under section 
857(b)(4), (5), (6), or (7). For this purpose, the amount of a REIT's 
recognized built-in gain that is subject to tax under section 857(b)(5) 
is computed as follows:
    (1) Where the tax under section 857(b)(5) is computed by reference 
to section 857(b)(5)(A), the amount of a REIT's recognized built-in gain 
that is subject to tax under section 857(b)(5) is the tax imposed by 
section 857(b)(5) multiplied by a fraction the numerator of which is the 
amount of recognized built-in gain (without regard to recognized built-
in loss and recognized built-in gain from prohibited transactions) that 
is not derived from sources referred to in section 856(c)(2) and the 
denominator of which is the gross income (without regard to gross income 
from prohibited transactions) of the REIT that is not derived from 
sources referred to in section 856(c)(2).
    (2) Where the tax under section 857(b)(5) is computed by reference 
to section 857(b)(5)(B), the amount of a REIT's recognized built-in gain 
that is subject to tax under section 857(b)(5) is the tax imposed by 
section 857(b)(5) multiplied by a fraction the numerator

[[Page 132]]

of which is the amount of recognized built-in gain (without regard to 
recognized built-in loss and recognized built-in gain from prohibited 
transactions) that is not derived from sources referred to in section 
856(c)(3) and the denominator of which is the gross income (without 
regard to gross income from prohibited transactions) of the REIT that is 
not derived from sources referred to in section 856(c)(3).
    (B) Taxable income limitation. The taxable income limitation 
determined as provided in Sec. 1.1374-2(a)(2) is reduced by an amount 
equal to the tax imposed under section 857(b)(5), (6), and (7).
    (ii) Loss carryforwards, credits and credit carryforwards--(A) Loss 
carryforwards. Consistent with paragraph (b)(1)(i) of this section, net 
operating loss carryforwards and capital loss carryforwards arising in 
taxable years for which the corporation that generated the loss was not 
subject to subchapter M of chapter 1 of the Internal Revenue Code are 
allowed as a deduction against net recognized built-in gain to the 
extent allowed under section 1374 and the regulations thereunder. Such 
loss carryforwards must be used as a deduction against net recognized 
built-in gain for a taxable year to the greatest extent possible before 
such losses can be used to reduce other investment company taxable 
income for purposes of section 852(b) or other real estate investment 
trust taxable income for purposes of section 857(b) for that taxable 
year.
    (B) Credits and credit carryforwards. Consistent with paragraph 
(b)(1)(i) of this section, minimum tax credits and business credit 
carryforwards arising in taxable years for which the corporation that 
generated the credit was not subject to subchapter M of chapter 1 of the 
Internal Revenue Code are allowed to reduce the tax imposed on net 
recognized built-in gain under this paragraph (b) to the extent allowed 
under section 1374 and the regulations thereunder. Such credits and 
credit carryforwards must be used to reduce the tax imposed under this 
paragraph (b) on net recognized built-in gain for a taxable year to the 
greatest extent possible before such credits and credit carryforwards 
can be used to reduce the tax, if any, on other investment company 
taxable income for purposes of section 852(b) or on other real estate 
investment trust taxable income for purposes of section 857(b) for that 
taxable year.
    (iii) Recognition period. For purposes of applying the rules of 
section 1374 and the regulations thereunder, as modified by paragraph 
(b) of this section, the term recognition period means the recognition 
period described in section 1374(d)(7), beginning--
    (A) In the case of a conversion transaction that is a qualification 
of a C corporation as a RIC or a REIT, on the first day of the RIC's or 
the REIT's first taxable year; and
    (B) In the case of other conversion transactions, on the day the RIC 
or the REIT acquires the property.
    (3) Coordination with subchapter M rules--(i) Recognized built-in 
gains and losses subject to subchapter M. Recognized built-in gains and 
losses of a RIC or REIT are included in computing investment company 
taxable income for purposes of section 852(b)(2), real estate investment 
trust taxable income for purposes of section 857(b)(2), capital gains 
for purposes of sections 852(b)(3) and 857(b)(3), gross income derived 
from sources within any foreign country or possession of the United 
States for purposes of section 853, and the dividends paid deduction for 
purposes of sections 852(b)(2)(D), 852(b)(3)(A), 857(b)(2)(B), and 
857(b)(3)(A). In computing such income and deduction items, capital loss 
carryforwards and net operating loss carryforwards that are used by the 
RIC or REIT to reduce recognized built-in gains are allowed as a 
deduction, but only to the extent that they are otherwise allowable as a 
deduction against such income under the Internal Revenue Code (including 
section 852(b)(2)(B)).
    (ii) Treatment of tax imposed. The amount of tax imposed under this 
paragraph (b) on net recognized built-in gain for a taxable year is 
treated as a loss sustained by the RIC or the REIT during such taxable 
year. The character of the loss is determined by allocating the tax 
proportionately (based on recognized built-in gain) among the items of 
recognized built-in gain included in net recognized built-in gain. With 
respect to RICs, the tax imposed

[[Page 133]]

under this paragraph (b) on net recognized built-in gain is treated as 
attributable to the portion of the RIC's taxable year occurring after 
October 31.
    (4) Section 355 distribution following a conversion transaction--(i) 
In general. If a REIT is described in paragraph (f)(1) of this section 
and the related section 355 distribution (as defined in paragraph 
(f)(1)(i) of this section) follows a conversion transaction, then for 
the taxable year in which the related section 355 distribution occurs, 
Sec. 1.1374-2(a)(1) and (2) (as modified by paragraph (b)(2)(i) of this 
section) do not apply, and the REIT's net recognized built-in gain for 
such taxable year is the amount of its net unrealized built-in gain 
limitation (as defined in Sec. 1.1374-2(a)(3)) for such taxable year.
    (ii) Basis adjustment--(A) In general. If a REIT recognizes gain 
under paragraph (b)(4)(i) of this section, the aggregate basis of the 
converted property held by the REIT at the end of the taxable year in 
which the related section 355 distribution occurs shall be increased by 
an amount equal to the amount of gain so recognized, increased by the 
amount of the REIT's recognized built-in loss for such taxable year, and 
reduced by the amount of the REIT's recognized built-in gain and 
recognized built-in gain carryover for such taxable year.
    (B) Allocation of basis increase. The aggregate increase in basis by 
reason of paragraph (b)(4)(ii)(A) of this section shall be allocated 
among the converted property in proportion to their respective built-in 
gains on the date of the conversion transaction.
    (5) Example. The rules of this paragraph (b) are illustrated by the 
following example:

    Example. Section 1374 treatment on REIT election. (i) X, a C 
corporation that is a calendar-year taxpayer, elects to be taxed as a 
REIT on its 2004 tax return, which it files on March 15, 2005. As a 
result, X is a REIT for its 2004 taxable year and is subject to section 
1374 treatment under this paragraph (b). X does not elect deemed sale 
treatment under paragraph (c) of this section. As of the beginning of 
the 2004 taxable year, X's property consisted of Real Property, which is 
not section 1221(a)(1) property and which had a fair market value of 
$100,000 and an adjusted basis of $80,000, and $25,000 cash. X also had 
accumulated earnings and profits of $25,000, unrestricted capital loss 
carryforwards of $3,000, and unrestricted business credit carryforwards 
of $2,000. On July 1, 2007, X sells Real Property for $110,000. For its 
2007 taxable year, X has no other income or deduction items. Assume the 
highest corporate tax rate is 35%.
    (ii) Upon its election to be taxed as a REIT, X retains its $80,000 
basis in Real Property and its $25,000 accumulated earnings and profits. 
X retains its $3,000 of capital loss carryforwards and its $2,000 of 
business credit carryforwards. To satisfy section 857(a)(2)(B), X must 
distribute $25,000, an amount equal to its earnings and profits 
accumulated in non-REIT years, to its shareholders by the end of its 
2004 taxable year.
    (iii) Upon X's sale of Real Property in 2007, X recognizes gain of 
$30,000 ($110,000--$80,000). X's recognized built-in gain for purposes 
of applying section 1374 is $20,000 ($100,000 fair market value as of 
the beginning of X's first taxable year as a REIT--$80,000 basis). 
Because X's $30,000 of net income for the 2007 taxable year exceeds the 
net recognized built-in gain of $20,000, the taxable income limitation 
does not apply. X, therefore, has $20,000 net recognized built-in gain 
for the year. Assuming that X has not used its $3,000 of capital loss 
carryforwards in a prior taxable year and that their use is allowed 
under section 1374(b)(2) and Sec. 1.1374-5, X is allowed a $3,000 
deduction against the $20,000 net recognized built-in gain. X would owe 
tax of $5,950 (35% of $17,000) on its net recognized built-in gain, 
except that X may use its $2,000 of business credit carryforwards to 
reduce the tax, assuming that X has not used the credit carryforwards in 
a prior taxable year and that their use is allowed under section 
1374(b)(3) and Sec. 1.1374-6. Thus, X owes tax of $3,950 under this 
paragraph (b).
    (iv) For purposes of subchapter M of chapter 1 of the Internal 
Revenue Code, X's earnings and profits for the year increase by $26,050 
($30,000 capital gain on the sale of Real Property--$3,950 tax under 
this paragraph (b)). For purposes of section 857(b)(2) and (b)(3), X's 
net capital gain for the year is $23,050 ($30,000 capital gain reduced 
by $3,000 capital loss carryforward and further reduced by $3,950 tax).

    (c) Election of deemed sale treatment--(1) In general. Paragraph (b) 
of this section does not apply if the C corporation that qualifies as a 
RIC or a REIT or transfers property to a RIC or a REIT makes the 
election described in paragraph (c)(5) of this section or is treated as 
making such election under paragraph (c)(6) of this section, except to 
the extent permitted by paragraph (c)(6)(ii) of this section. A C 
corporation that makes, or that is treated as making, such an election 
recognizes

[[Page 134]]

gain and loss as if it sold the converted property to an unrelated party 
at fair market value on the deemed sale date (as defined in paragraph 
(c)(3) of this section). See paragraph (c)(4) of this section concerning 
limitations on the use of loss in computing gain. Paragraph (c) of this 
section does not apply if its application would result in the 
recognition of a net loss. For this purpose, net loss is the excess of 
aggregate losses over aggregate gains (including items of income), 
without regard to character.
    (2) Basis adjustment. If a corporation recognizes a net gain under 
paragraph (c)(1) of this section, then the converted property has a 
basis in the hands of the RIC or REIT equal to the fair market value of 
such property on the deemed sale date.
    (3) Deemed sale date--(i) RIC or REIT qualifications. If the 
conversion transaction is a qualification of a C corporation as a RIC or 
REIT, then the deemed sale date is the end of the last day of the C 
corporation's last taxable year before the first taxable year in which 
it qualifies to be taxed as a RIC or REIT.
    (ii) Other conversion transactions. If the conversion transaction is 
a transfer of property owned by a C corporation to a RIC or REIT, then 
the deemed sale date is the end of the day before the day of the 
transfer.
    (4) Anti-stuffing rule. A C corporation must disregard converted 
property in computing gain or loss recognized on the conversion 
transaction under this paragraph (c), if--
    (i) The converted property was acquired by the C corporation in a 
transaction to which section 351 applied or as a contribution to 
capital;
    (ii) Such converted property had an adjusted basis immediately after 
its acquisition by the C corporation in excess of its fair market value 
on the date of acquisition; and
    (iii) The acquisition of such converted property by the C 
corporation was part of a plan a principal purpose of which was to 
reduce gain recognized by the C corporation in connection with the 
conversion transaction. For purposes of this paragraph (c)(4), the 
principles of section 336(d)(2) apply.
    (5) Making the deemed sale election. A C corporation (or a 
partnership to which the principles of this section apply under 
paragraph (e) of this section) makes the deemed sale election with the 
following statement: ``[Insert name and employer identification number 
of electing corporation or partnership] elects deemed sale treatment 
under Sec. 1.337(d)-7(c) with respect to its property that was 
converted to property of, or transferred to, a RIC or REIT, [insert name 
and employer identification number of the RIC or REIT, if different from 
the name and employer identification number of the C corporation or 
partnership].'' This statement must be attached to the Federal income 
tax return of the C corporation or partnership for the taxable year in 
which the deemed sale occurs. An election under this paragraph (c) is 
irrevocable.
    (6) Conversion transaction following a section 355 distribution--(i) 
In general. Except as provided in paragraph (c)(6)(ii) of this section, 
a C corporation described in paragraph (f)(1) of this section is treated 
as having made the election under paragraph (c)(5) of this section with 
respect to a conversion transaction if the conversion transaction occurs 
following the related section 355 distribution (as defined in paragraph 
(f)(1)(i) of this section) and the C corporation has not made such an 
election.
    (ii) Limitation. A C corporation treated as having made the election 
under paragraph (c)(5) of this section as a result of paragraph 
(c)(6)(i) of this section is not treated as having made the election 
with respect to property that the taxpayer establishes is not 
distribution property with respect to the related section 355 
distribution. For purposes of this paragraph (c)(6)(ii), any property 
with an adjusted basis in excess of its fair market value as of the date 
of the conversion transaction will not be treated as distribution 
property unless the taxpayer establishes that it owned such asset 
immediately after the related section 355 distribution. Paragraph (b) of 
this section will apply to property with respect to which the taxpayer 
is not treated as having made the election under paragraph (c)(5) of 
this section as a result of this paragraph (c)(6)(ii).

[[Page 135]]

    (7) Examples. The rules of this paragraph (c) are illustrated by the 
following examples:

    Example 1. Deemed sale treatment on merger into RIC. (i) X, a 
calendar-year taxpayer, has qualified as a RIC since January 1, 2001. On 
May 31, 2004, Y, a C corporation and calendar-year taxpayer, transfers 
all of its property to X in a transaction that qualifies as a 
reorganization under section 368(a)(1)(C). As a result of the transfer, 
Y would be subject to section 1374 treatment under paragraph (b) of this 
section but for its timely election of deemed sale treatment under this 
paragraph (c). As a result of such election, Y is subject to deemed sale 
treatment on its tax return for the short taxable year ending May 31, 
2004. On May 31, 2004, Y's only assets are Capital Asset, which has a 
fair market value of $100,000 and a basis of $40,000 as of the end of 
May 30, 2004, and $50,000 cash. Y also has an unrestricted net operating 
loss carryforward of $12,000 and accumulated earnings and profits of 
$50,000. Y has no taxable income for the short taxable year ending May 
31, 2004, other than gain recognized under this paragraph (c). In 2007, 
X sells Capital Asset for $110,000. Assume the applicable corporate tax 
rate is 35%.
    (ii) Under this paragraph (c), Y is treated as if it sold the 
converted property (Capital Asset and $50,000 cash) at fair market value 
on May 30, 2004, recognizing $60,000 of gain ($150,000 amount realized--
$90,000 basis). Y must report the gain on its tax return for the short 
taxable year ending May 31, 2004. Y may offset this gain with its 
$12,000 net operating loss carryforward and will pay tax of $16,800 (35% 
of $48,000).
    (iii) Under section 381, X succeeds to Y's accumulated earnings and 
profits. Y's accumulated earnings and profits of $50,000 increase by 
$60,000 and decrease by $16,800 as a result of the deemed sale. Thus, 
the aggregate amount of subchapter C earnings and profits that must be 
distributed to satisfy section 852(a)(2)(B) is $93,200 ($50,000 + 
$60,000-$16,800). X's basis in Capital Asset is $100,000. On X's sale of 
Capital Asset in 2007, X recognizes $10,000 of gain which is taken into 
account in computing X's net capital gain for purposes of section 
852(b)(3).
    Example 2. Loss limitation. (i) Assume the facts are the same as 
those described in Example 1, but that, prior to the reorganization, a 
shareholder of Y contributed to Y a capital asset, Capital Asset 2, 
which has a fair market value of $10,000 and a basis of $20,000, in a 
section 351 transaction.
    (ii) Assuming that Y's acquisition of Capital Asset 2 was made 
pursuant to a plan a principal purpose of which was to reduce the amount 
of gain that Y would recognize in connection with the conversion 
transaction, Capital Asset 2 would be disregarded in computing the 
amount of Y's net gain on the conversion transaction.

    (d) Exceptions--(1) Gain otherwise recognized. Paragraph (a)(1) of 
this section does not apply to any conversion transaction to the extent 
that gain or loss otherwise is recognized on such conversion transaction 
by the C corporation that either qualifies as a RIC or a REIT or that 
transfers property to a RIC or REIT. See, for example, sections 311(b), 
336(a), 351(b), 351(e), 356, 357(c), 367, 368(a)(2)(F), 1001, 1031(b), 
and 1033(a)(2).
    (2) Re-election of RIC or REIT status--(i) Generally. Except as 
provided in paragraphs (d)(2)(ii) and (iii) of this section, paragraph 
(a)(1) of this section does not apply to any corporation that--
    (A) Immediately prior to qualifying to be taxed as a RIC or REIT was 
subject to tax as a C corporation for a period not exceeding two taxable 
years; and
    (B) Immediately prior to being subject to tax as a C corporation was 
subject to tax as a RIC or REIT for a period of at least one taxable 
year.
    (ii) Property acquired from another corporation while a C 
corporation. The exception described in paragraph (d)(2)(i) of this 
section does not apply to property acquired by the corporation while it 
was subject to tax as a C corporation from any person in a transaction 
that results in the acquirer's basis in the property being determined by 
reference to a C corporation's basis in the property.
    (iii) RICs and REITs previously subject to section 1374 treatment. 
If the RIC or REIT had property subject to paragraph (b) of this section 
before the RIC or REIT became subject to tax as a C corporation as 
described in paragraph (d)(2)(i) of this section, then paragraph (b) of 
this section applies to the RIC or REIT upon its requalification as a 
RIC or REIT, except that the recognition period with respect to such 
property is reduced by the portion of the recognition period that 
expired before the RIC or REIT became subject to tax as a C corporation 
and by the period of time that the corporation was subject to tax as a C 
corporation.
    (3) Special rules for like-kind exchanges and involuntary 
conversions--(i) In general. Paragraph (a)(1) of this section

[[Page 136]]

does not apply to a conversion transaction to the extent that a C 
corporation transfers property with a built-in gain to a RIC or REIT, 
and the C corporation's gain is not recognized by reason of either 
section 1031 or 1033.
    (ii) Clarification regarding exchanged property previously subject 
to section 1374 treatment. Notwithstanding paragraph (d)(3)(i) of this 
section, if, in a transaction described in paragraph (d)(3)(i) of this 
section, a RIC or REIT surrenders property that was subject to section 
1374 treatment immediately prior to the transaction, the rules of 
section 1374(d)(6) will apply to continue section 1374 treatment to the 
replacement property acquired by the RIC or REIT in the transaction.
    (iii) Examples. The rules of this paragraph (d)(3) are illustrated 
by the following examples. In each of the examples, X is a REIT, Y is a 
C corporation, and X and Y are not related.

    Example 1. Section 1031(a) exchange. (i) Facts. X owned a building 
that it leased for commercial use (Property A). Y owned a building 
leased for commercial use (Property B). On January 1, Year 3, Y 
transferred Property B to X in exchange for Property A in a 
nonrecognition transaction under section 1031(a). Immediately before the 
exchange, Properties A and B each had a value of $100, X had an adjusted 
basis of $60 in Property A, Y had an adjusted basis of $70 in Property 
B, and X was not subject to section 1374 treatment with respect to 
Property A.
    (ii) Analysis. The transfer of property (Property B) by Y (a C 
corporation) to X (a REIT) is a conversion transaction within the 
meaning of paragraph (a)(2)(ii) of this section. The conversion 
transaction is a nonrecognition transaction under section 1031(a) as to 
Y; thus, Y does not recognize any of its $30 gain. Therefore, the 
conversion transaction is not subject to paragraph (a)(1) of this 
section by reason of paragraph (d)(3)(i) of this section.
    Example 2. Section 1031(a) exchange of section 1374 property. (i) 
Facts. The facts are the same as in Example 1, except that X had 
acquired Property A in a conversion transaction in Year 2, and 
immediately before the Year 3 exchange X was subject to section 1374 
treatment with respect to $25 of net built-in gain in Property A.
    (ii) Analysis. The Year 3 transfer of Property B by Y to X is a 
conversion transaction within the meaning of paragraph (a)(2)(ii) of 
this section. The conversion transaction is a nonrecognition transaction 
under section 1031(a) as to Y; thus, Y does not recognize any of its $30 
gain. Therefore, the Year 3 transfer is not subject to paragraph (a)(1) 
of this section by reason of paragraph (d)(3)(i) of this section. 
However, X had been subject to section 1374 treatment with respect to 
$25 of net built-in gain in Property A immediately before the Year 3 
transfer, and X's basis in Property B is determined (in whole or in 
part) by reference to its adjusted basis in Property A. Accordingly, the 
rules of section 1374(d)(6) apply and X is subject to section 1374 
treatment on Property B with respect to the $25 net built-in gain. See 
paragraph (d)(3)(ii) of this section.
    Example 3. Section 1031(b) exchange. (i) Facts. The facts are the 
same as in Example 1, except that immediately before the Year 3 exchange 
Property A had a value of $92, and X transferred Property A and $8 to Y 
in exchange for Property B in a nonrecognition transaction under section 
1031(b).
    (ii) Analysis. The transfer of Property B by Y to X is a conversion 
transaction within the meaning of paragraph (a)(2)(ii) of this section. 
Pursuant to section 1031(b), Y recognizes $8 of its gain. Paragraph 
(a)(1) of this section does not apply to the transaction to the extent 
of the $8 gain recognized by Y by reason of paragraph (d)(1) of this 
section, or to the extent of the $22 gain realized but not recognized by 
Y by reason of paragraph (d)(3)(i) of this section.
    Example 4. Section 1033(a) involuntary conversion of property held 
by a C corporation transferor. (i) Facts. Y owned uninsured, improved 
property (Property 1) that was involuntarily converted (within the 
meaning of section 1033(a)) in a fire. Y sold Property 1 for $100 to X, 
which owned an adjacent property and wanted Property 1 for use as a 
parking lot. Y had a $70 basis in Property 1 immediately before the 
sale. Y elected to defer gain recognition under section 1033(a)(2), and 
purchased qualifying replacement property (Property 2) for $100 from an 
unrelated party prior to the expiration of the period described in 
section 1033(a)(2)(B).
    (ii) Analysis. The transfer of Property 1 by Y to X is a conversion 
transaction within the meaning of paragraph (a)(2)(ii) of this section. 
The conversion transaction (combined with Y's purchase of Property 2) is 
a nonrecognition transaction under section 1033(a) as to Y; thus, Y does 
not recognize any of its $30 gain. Therefore, the conversion transaction 
is not subject to paragraph (a)(1) of this section by reason of 
paragraph (d)(3)(i) of this section.
    Example 5. Section 1033(a) involuntary conversion of property held 
by a REIT. (i) Facts. X owned property (Property 1). On January 1, Year 
2, Property 1 had a fair market value of $100 and a basis of $70, and X 
was not subject to section 1374 treatment with respect to Property 1. On 
that date, when Property 1 was under a threat of condemnation, X sold 
Property 1 to an unrelated party for $100 (First Transaction). X elected 
to defer gain

[[Page 137]]

recognition under section 1033(a)(2), and purchased qualifying 
replacement property (Property 2) for $100 from Y (Second Transaction) 
prior to the expiration of the period described in section 
1033(a)(2)(B).
    (ii) Analysis. The transfer of Property 2 by Y to X in the Second 
Transaction is a conversion transaction within the meaning of paragraph 
(a)(2)(ii) of this section. The Second Transaction (combined with the 
First Transaction) is a nonrecognition transaction under section 1033(a) 
as to X, but not as to Y. Assume no nonrecognition provision applied to 
Y; thus, Y recognized gain or loss on its sale of Property 2 in the 
Second Transaction, and the Second Transaction is not subject to 
paragraph (a)(1) of this section by reason of paragraph (d)(1) of this 
section.

    (4) Special rule if C corporation is a tax-exempt entity. Paragraph 
(a)(1) of this section does not apply to a conversion transaction in 
which the C corporation that owned the converted property is a tax-
exempt entity described in Sec. 1.337(d)-4(c)(2) to the extent that 
gain (if any) would not be subject to tax under Title 26 of the United 
States Code if a deemed sale election under paragraph (c)(5) of this 
section were made.
    (e) Special rule for partnerships--(1) In general. The principles of 
this section apply to property transferred by a partnership to a RIC or 
REIT to the extent of any gain or loss in the converted property that 
would be allocated directly or indirectly, through one or more 
partnerships, to a C corporation if the partnership sold the converted 
property to an unrelated party at fair market value on the deemed sale 
date (as defined in paragraph (c)(3) of this section). If the 
partnership were to elect deemed sale treatment under paragraph (c) of 
this section in lieu of section 1374 treatment under paragraph (b) of 
this section with respect to such transfer, then any net gain recognized 
by the partnership on the deemed sale must be allocated to the C 
corporation partner, but does not increase the capital account of any 
partner. Any adjustment to the partnership's basis in the RIC or REIT 
stock as a result of deemed sale treatment under paragraph (c) of this 
section shall constitute an adjustment to the basis of that stock with 
respect to the C corporation partner only. The principles of section 743 
apply to such basis adjustment.
    (2) Example; Transfer by partnership of property to REIT. (i) Facts. 
PRS, a partnership for Federal income tax purposes, has three partners: 
TE, a C corporation (within the meaning of paragraph (a)(2)(i) of this 
section) that is also a tax-exempt entity (within the meaning of Sec. 
1.337(d)-4(c)(2)), owns 50 percent of the capital and profits of PRS; A, 
an individual, owns 30 percent of the capital and profits of PRS; and Y, 
a C corporation (within the meaning of paragraph (a)(2)(i) of this 
section), owns the remaining 20 percent. PRS owns a building that it 
leases for commercial use (Property 1). On January 1, Year 2, when PRS 
has an adjusted basis in Property 1 of $100 and Property 1 has a fair 
market value of $500, PRS transfers Property 1 to X, a REIT, in exchange 
for stock of X in an exchange described in section 351. PRS does not 
elect deemed sale treatment under paragraph (c) of this section. TE 
would not be subject to tax with respect to any gain that would be 
allocated to it if PRS had sold Property 1 to an unrelated party at fair 
market value.
    (ii) Analysis. The transfer of Property 1 by PRS to X is a 
conversion transaction within the meaning of paragraph (a)(2)(ii) of 
this section to the extent of any gain or loss that would be allocated 
to any C corporation partner if PRS sold Property 1 at fair market value 
to an unrelated party on the deemed sale date. TE and Y are C 
corporations, but A is not a C corporation within the meaning of 
paragraph (a)(2)(i) of this section. Therefore, the transfer of Property 
1 by PRS to X is a conversion transaction within the meaning of 
paragraph (a)(2)(ii) of this section to the extent of the gain in 
Property 1 that would be allocated to TE and Y. Pursuant to paragraph 
(d)(4) of this section, paragraph (a)(1) of this section does not apply 
to the extent of the gain that would be allocated to TE if PRS had sold 
Property 1 to an unrelated party at fair market value on the deemed sale 
date. If PRS were to sell Property 1 to an unrelated party at fair 
market value on the deemed sale date, PRS would allocate $80 of built-in 
gain to Y. Thus, X is subject to section 1374 treatment on Property 1 
with respect to $80 of built-in gain.

[[Page 138]]

    (f) Conversion transaction preceding or following a section 355 
distribution--(1) In general. A C corporation or a REIT is described in 
this paragraph (f)(1) if--
    (i) The C corporation or the REIT engages in a conversion 
transaction involving a REIT during the twenty-year period beginning on 
the date that is ten years before the date of a section 355 distribution 
(the related section 355 distribution); and
    (ii) The C corporation or the REIT engaging in the related section 
355 distribution is either--
    (A) The distributing corporation or the controlled corporation, as 
those terms are defined in section 355(a)(1); or
    (B) A member of the separate affiliated group (as defined in section 
355(b)(3)(B)) of the distributing corporation or the controlled 
corporation.
    (2) Predecessors and successors. For purposes of this paragraph (f), 
any reference to a controlled corporation, a distributing corporation, 
or a member of the separate affiliated group of a distributing 
corporation or a controlled corporation includes a reference to any 
predecessor or successor of such corporation. Successors include 
corporations which succeed to and take into account items described in 
section 381(c) of the distributing corporation or the controlled 
corporation. Predecessors include corporations having such items to 
which the distributing corporation or the controlled corporation 
succeeded and took into account.
    (3) Exclusion of certain conversion transactions. A C corporation or 
a REIT is not described in paragraph (f)(1) of this section if--
    (i) The distributing corporation and the controlled corporation are 
both REITs immediately after the related section 355 distribution 
(including by reason of elections under section 856(c)(1) made after the 
related section 355 distribution that are effective before the related 
section 355 distribution) and at all times during the two years 
thereafter;
    (ii) Section 355(h)(1) does not apply to the related section 355 
distribution by reason of section 355(h)(2)(B); or
    (iii) The related section 355 distribution occurred before December 
7, 2015, or is described in a ruling request referred to in section 
311(c) of Division Q of the Consolidated Appropriations Act, 2016, 
Public Law 114-113, 129 Stat. 2422.
    (g) Effective/Applicability date--(1) In general. Except as provided 
in paragraph (g)(2) of this section, this section applies to conversion 
transactions that occur on or after January 2, 2002. For conversion 
transactions that occurred on or after June 10, 1987, and before January 
2, 2002, see Sec. Sec. 1.337(d)-5 and 1.337(d)-6.
    (2) Special rules--(i) Conversion transactions occurring on or after 
August 2, 2013 and certain prior conversion transactions. Paragraphs 
(a)(2)(i) through (v), (d)(1), (d)(3), (d)(4), and (e) of this section 
apply to conversion transactions that occur on or after August 2, 2013. 
However, taxpayers may apply paragraphs (a)(2)(i) through (v), (d)(1), 
(d)(3), (d)(4), and (e) of this section to conversion transactions that 
occurred before August 2, 2013. For conversion transactions that 
occurred on or after January 2, 2002 and before August 2, 2013, see 
Sec. 1.337(d)-7 as contained in 26 CFR part 1 in effect on April 1, 
2013.
    (ii) Conversion transactions occurring on or after June 7, 2019, and 
certain prior conversion transactions. Paragraphs (a)(1), (a)(2)(vi), 
(vii), and (viii), (b)(4), (c)(1) and (6), and (f) of this section apply 
to conversion transactions occurring on or after June 7, 2019, and to 
conversion transactions and related section 355 distributions for which 
the conversion transaction occurs before, and the related section 355 
distribution occurs on or after, June 7, 2019. For conversion 
transactions that occurred on or after June 7, 2016, and before June 7, 
2019 (other than conversion transactions and related section 355 
distributions for which the conversion transaction occurs before, and 
the related section 355 distribution occurs on or after, June 7, 2019), 
see Sec. Sec. 1.337(d)-7 and 1.337(d)-7T as contained in 26 CFR part 1 
in effect on April 1, 2019.
    (iii) Recognition period. Paragraphs (b)(1)(ii) and (d)(2)(iii) of 
this section apply to conversion transactions that occur on or after 
August 8, 2016. Paragraph (b)(2)(iii) of this section applies to 
conversion transactions that occur after February 17, 2017. For 
conversion transactions that occurred on or after

[[Page 139]]

August 8, 2016 and on or before February 17, 2017, see Sec. 1.337(d)-
7T(b)(2)(iii) in effect on August 8, 2016. However, taxpayers may apply 
paragraph (b)(2)(iii) of this section to conversion transactions that 
occurred on or after August 8, 2016 and on or before February 17, 2017. 
For conversion transactions that occurred on or after January 2, 2002 
and before August 8, 2016, see Sec. 1.337(d)-7 as contained in 26 CFR 
part 1 in effect on April 1, 2016.

[T.D. 9047, 68 FR 12822, Mar. 18, 2003, as amended by T.D. 9626, 78 FR 
46806, Aug. 2, 2013; T.D. 9770, 81 FR 36797, June 8, 2016; T.D. 9810, 82 
FR 5388, Jan. 18, 2017; T.D. 9862, 84 FR 26563, June 7, 2019]



Sec. 1.338-0  Outline of topics.

    This section lists the captions contained in the regulations under 
section 338 as follows:

 Sec. 1.338-1 General principles; status of old target and new target.

    (a) In general.
    (1) Deemed transaction.
    (2) Application of other rules of law.
    (3) Overview.
    (b) Treatment of target under other provisions of the Internal 
Revenue Code.
    (1) General rule for subtitle A.
    (2) Exceptions for subtitle A.
    (3) General rule for other provisions of the Internal Revenue Code.
    (c) Anti-abuse rule.
    (1) In general.
    (2) Examples.
    (d) Next day rule for post-closing transactions.
    (e) Effective/applicability date.

Sec. 1.338-2 Nomenclature and definitions; mechanics of the section 338 
                                election.

    (a) Scope.
    (b) Nomenclature.
    (c) Definitions.
    (1) Acquisition date.
    (2) Acquisition date assets.
    (3) Affiliated group.
    (4) Common parent.
    (5) Consistency period.
    (6) Deemed asset sale.
    (7) Deemed sale tax consequences.
    (8) Deemed sale return.
    (9) Domestic corporation.
    (10) Old target's final return.
    (11) Purchasing corporation.
    (12) Qualified stock purchase.
    (13) Related persons.
    (14) Section 338 election.
    (15) Section 338(h)(10) election.
    (16) Selling group.
    (17) Target; old target; new target.
    (18) Target affiliate.
    (19) 12-month acquisition period.
    (d) Time and manner of making election.
    (e) Special rules for foreign corporations or DISCs.
    (1) Elections by certain foreign purchasing corporations.
    (i) General rule.
    (ii) Qualifying foreign purchasing corporation.
    (iii) Qualifying foreign target.
    (iv) Triggering event.
    (v) Subject to United States tax.
    (2) Acquisition period.
    (3) Statement of section 338 may be filed by United States 
shareholders in certain cases.
    (4) Notice requirement for U.S. persons holding stock in foreign 
target.
    (i) General rule.
    (ii) Limitation.
    (iii) Form of notice.
    (iv) Timing of notice.
    (v) Consequence of failure to comply.
    (vi) Good faith effort to comply.

        Sec. 1.338-3 Qualification for the section 338 election.

    (a) Scope.
    (b) Rules relating to qualified stock purchases.
    (1) Purchasing corporation requirement.
    (2) Purchase.
    (3) Acquisitions of stock from related corporations.
    (i) In general.
    (ii) Time for testing relationship.
    (iii) Cases where section 338(h)(3)(C) applies--acquisitions treated 
as purchases.
    (iv) Examples.
    (4) Acquisition date for tiered targets.
    (i) Stock sold in deemed asset sale.
    (ii) Examples.
    (5) Effect of redemptions.
    (i) General rule.
    (ii) Redemptions from persons unrelated to the purchasing 
corporation.
    (iii) Redemptions from the purchasing corporation or related persons 
during 12-month acquisition period.
    (A) General rule.
    (B) Exception for certain redemptions from related corporations.
    (iv) Examples.
    (c) Effect of post-acquisition events on eligibility for section 338 
election.
    (1) Post-acquisition elimination of target.
    (2) Post-acquisition elimination of the purchasing corporation.
    (d) Consequences of post-acquisition elimination of target where 
section 338 election not made.
    (1) Scope.
    (2) Continuity of interest.
    (3) Control requirement.
    (4) Solely for voting stock requirement.
    (5) Example.

[[Page 140]]

 Sec. 1.338-4 Aggregate deemed sale price; various aspects of taxation 
                        of the deemed asset sale.

    (a) Scope.
    (b) Determination of ADSP.
    (1) General rule.
    (2) Time and amount of ADSP.
    (i) Original determination.
    (ii) Redetermination of ADSP.
    (iii) Example.
    (c) Grossed-up amount realized on the sale to the purchasing 
corporation of the purchasing corporation's recently purchased target 
stock.
    (1) Determination of amount.
    (2) Example.
    (d) Liabilities of old target.
    (1) In general.
    (2) Time and amount of liabilities.
    (e) Deemed sale tax consequences.
    (f) Other rules apply in determining ADSP.
    (g) Examples.
    (h) Deemed sale of target affiliate stock.
    (1) Scope.
    (2) In general.
    (3) Deemed sale of foreign target affiliate by a domestic target.
    (4) Deemed sale producing effectively connected income.
    (5) Deemed sale of insurance company target affiliate electing under 
section 953(d).
    (6) Deemed sale of DISC target affiliate.
    (7) Anti-stuffing rule.
    (8) Examples.

                Sec. 1.338-5 Adjusted grossed-up basis.

    (a) Scope.
    (b) Determination of AGUB.
    (1) General rule.
    (2) Time and amount of AGUB.
    (i) Original determination.
    (ii) Redetermination of AGUB.
    (iii) Examples.
    (c) Grossed-up basis of recently purchased stock.
    (d) Basis of nonrecently purchased stock; gain recognition election.
    (1) No gain recognition election.
    (2) Procedure for making gain recognition election.
    (3) Effect of gain recognition election.
    (i) In general.
    (ii) Basis amount.
    (iii) Losses not recognized.
    (iv) Stock subject to election.
    (e) Liabilities of new target.
    (1) In general.
    (2) Time and amount of liabilities.
    (3) Interaction with deemed sale tax consequences.
    (f) Adjustments by the Internal Revenue Service.
    (g) Examples.
    (h) Effective/applicability date.

     Sec. 1.338-6 Allocation of ADSP and AGUB among target assets.

    (a) Scope.
    (1) In general.
    (2) Fair market value.
    (i) In general.
    (ii) Transaction costs.
    (iii) Internal Revenue Service authority.
    (b) General rule for allocating ADSP and AGUB.
    (1) Reduction in the amount of consideration for Class I assets.
    (2) Other assets.
    (i) In general.
    (ii) Class II assets.
    (iii) Class III assets.
    (iv) Class IV assets.
    (v) Class V assets.
    (vi) Class VI assets.
    (vii) Class VII assets.
    (3) Other items designated by the Internal Revenue Service.
    (c) Certain limitations and other rules for allocation to an asset.
    (1) Allocation not to exceed fair market value.
    (2) Allocation subject to other rules.
    (3) Special rule for allocating AGUB when purchasing corporation has 
nonrecently purchased stock.
    (i) Scope.
    (ii) Determination of hypothetical purchase price.
    (iii) Allocation of AGUB.
    (4) Liabilities taken into account in determining amount realized on 
subsequent disposition.
    (5) Allocation to certain nuclear decommissioning funds.
    (d) Examples.

  Sec. 1.338-7 Allocation of redetermined ADSP and AGUB among target 
                                 assets.

    (a) Scope.
    (b) Allocation of redetermined ADSP and AGUB.
    (c) Special rules for ADSP.
    (1) Increases or decreases in deemed sale tax consequences taxable 
notwithstanding old target ceases to exist.
    (2) Procedure for transactions in which section 338(h)(10) is not 
elected.
    (i) Deemed sale tax consequences included in new target's return.
    (ii) Carryovers and carrybacks.
    (A) Loss carryovers to new target taxable years.
    (B) Loss carrybacks to taxable years of old target.
    (C) Credit carryovers and carrybacks.
    (3) Procedure for transactions in which section 338(h)(10) is 
elected.
    (d) Special rules for AGUB.
    (1) Effect of disposition or depreciation of acquisition date 
assets.
    (2) Section 38 property.

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    (e) Examples.

               Sec. 1.338-8 Asset and stock consistency.

    (a) Introduction.
    (1) Overview.
    (2) General application.
    (3) Extension of the general rules.
    (4) Application where certain dividends are paid.
    (5) Application to foreign target affiliates.
    (6) Stock consistency.
    (b) Consistency for direct acquisitions.
    (1) General rule.
    (2) Section 338(h)(10) elections.
    (c) Gain from disposition reflected in basis of target stock.
    (1) General rule.
    (2) Gain not reflected if section 338 election made for target.
    (3) Gain reflected by reason of distributions.
    (4) Controlled foreign corporations.
    (5) Gain recognized outside the consolidated group.
    (d) Basis of acquired assets.
    (1) Carryover basis rule.
    (2) Exceptions to carryover basis rule for certain assets.
    (3) Exception to carryover basis rule for de minimis assets.
    (4) Mitigation rule.
    (i) General rule.
    (ii) Time for transfer.
    (e) Examples.
    (1) In general.
    (2) Direct acquisitions.
    (f) Extension of consistency to indirect acquisitions.
    (1) Introduction.
    (2) General rule.
    (3) Basis of acquired assets.
    (4) Examples.
    (g) Extension of consistency if dividends qualifying for 100 percent 
dividends received deduction are paid.
    (1) General rule for direct acquisitions from target.
    (2) Other direct acquisitions having same effect.
    (3) Indirect acquisitions.
    (4) Examples.
    (h) Consistency for target affiliates that are controlled foreign 
corporations.
    (1) In general.
    (2) Income or gain resulting from asset dispositions.
    (i) General rule.
    (ii) Basis of controlled foreign corporation stock.
    (iii) Operating rule.
    (iv) Increase in asset or stock basis.
    (3) Stock issued by target affiliate that is a controlled foreign 
corporation.
    (4) Certain distributions.
    (i) General rule.
    (ii) Basis of controlled foreign corporation stock.
    (iii) Increase in asset or stock basis.
    (5) Examples.
    (i) [Reserved]
    (j) Anti-avoidance rules.
    (1) Extension of consistency period.
    (2) Qualified stock purchase and 12-month acquisition period.
    (3) Acquisitions by conduits.
    (i) Asset ownership.
    (A) General rule.
    (B) Application of carryover basis rule.
    (ii) Stock acquisitions.
    (A) Purchase by conduit.
    (B) Purchase of conduit by corporation.
    (C) Purchase of conduit by conduit.
    (4) Conduit.
    (5) Existence of arrangement.
    (6) Predecessor and successor.
    (i) Persons.
    (ii) Assets.
    (7) Examples.

           Sec. 1.338-9 International aspects of section 338.

    (a) Scope.
    (b) Application of section 338 to foreign targets.
    (1) In general.
    (2) Ownership of FT stock on the acquisition date.
    (3) Carryover FT stock.
    (i) Definition.
    (ii) Carryover of earnings and profits.
    (iii) Cap on carryover of earnings and profits.
    (iv) Post-acquisition date distribution of old FT earnings and 
profits.
    (v) Old FT earnings and profits unaffected by post-acquisition date 
deficits.
    (vi) Character of FT stock as carryover FT stock eliminated upon 
disposition.
    (4) Passive foreign investment company stock.
    (c) Dividend treatment under section 1248(e).
    (d) Allocation of foreign taxes.
    (e) Operation of section 338(h)(16). [Reserved]
    (f) Examples.

                    Sec. 1.338-10 Filing of returns.

    (a) Returns including tax liability from deemed asset sale.
    (1) In general.
    (2) Old target's final taxable year otherwise included in 
consolidated return of selling group.
    (i) General rule.
    (ii) Separate taxable year.
    (iii) Carryover and carryback of tax attributes.
    (iv) Old target is a component member of purchasing corporation's 
controlled group.
    (3) Old target is an S corporation.
    (4) Combined deemed sale return.
    (i) General rule.
    (ii) Gain and loss offsets.

[[Page 142]]

    (iii) Procedure for filing a combined return.
    (iv) Consequences of filing a combined return.
    (5) Deemed sale excluded from purchasing corporation's consolidated 
return.
    (6) Due date for old target's final return.
    (i) General rule.
    (ii) Application of Sec. 1.1502-76(c).
    (A) In general.
    (B) Deemed extension.
    (C) Erroneous filing of deemed sale return.
    (D) Erroneous filing of return for regular tax year.
    (E) Last date for payment of tax.
    (7) Examples.
    (b) Waiver.
    (1) Certain additions to tax.
    (2) Notification.
    (3) Elections or other actions required to be specified on a timely 
filed return.
    (i) In general.
    (ii) New target in purchasing corporation's consolidated return.
    (4) Examples.
    (c) Effective/applicability date.

   Sec. 1.338-11 Effect of section 338 election on insurance company 
                                targets.

    (a) In general.
    (b) Computation of ADSP and AGUB.
    (1) Reserves taken into account as a liability.
    (2) Allocation of ADSP and AGUB to specific insurance contracts.
    (c) Application of assumption reinsurance principles.
    (1) In general.
    (2) Reinsurance premium.
    (3) Ceding commission.
    (4) Examples.
    (d) Reserve increases by new target after the deemed asset sale.
    (1) In general.
    (2) Exceptions.
    (3) Amount of additional premium.
    (i) In general.
    (ii) Increases in unpaid loss reserves.
    (iii) Increases in other reserves.
    (4) Limitation on additional premium.
    (5) Treatment of additional premium under section 848.
    (6) Examples.
    (7) Effective/applicability date.
    (i) In general.
    (ii) Application to pre-effective date increases to reserves.
    (e) Effect of section 338 election on section 846(e) election.
    (1) In general.
    (2) Revocation of existing section 846(e) election.
    (f) Effect of section 338 election on old target's capitalization 
amounts under section 848.
    (1) Determination of net consideration for specified insurance 
contracts.
    (2) Determination of capitalization amount.
    (3) Section 381 transactions.
    (g) Effect of section 338 election on policyholders surplus account.
    (h) Effect of section 338 election on section 847 special estimated 
tax payments.

  Sec. 1.338-11T Effect of section 338 election on insurance company 
                          targets (temporary).

    (a) through (c) [Reserved]
    (d) Reserve increases by new target after the deemed asset sale.
    (1) In general.
    (2) Exceptions.
    (3) Amount of additional premium.
    (i) In general.
    (ii) Increases in unpaid loss reserves.
    (iii) Increases in other reserves.
    (4) Limitation on additional premium.
    (5) Treatment of additional premium under section 848.
    (6) Examples.
    (7) Effective dates.
    (i) In general.
    (ii) Application to pre-effective date increases to reserves.
    (e) Effect of section 338 election on section 846(e) election.
    (1) In general.
    (2) Revocation of existing section 846(e) election.
    (f) through (h) [Reserved]

         Sec. 1.338(h)(10)-1 Deemed asset sale and liquidation.

    (a) Scope.
    (b) Definitions.
    (1) Consolidated target.
    (2) Selling consolidated group.
    (3) Selling affiliate; affiliated target.
    (4) S corporation target.
    (5) S corporation shareholders.
    (6) Liquidation.
    (c) Section 338(h)(10) election.
    (1) In general.
    (2) Simultaneous joint election requirement.
    (3) Irrevocability.
    (4) Effect of invalid election.
    (d) Certain consequences of section 338(h)(10) election.
    (1) P.
    (2) New T.
    (3) Old T--deemed sale.
    (i) In general.
    (ii) Tiered targets.
    (4) Old T and selling consolidated group, selling affiliate, or S 
corporation shareholders--deemed liquidation; tax characterization.
    (i) In general.
    (ii) Tiered targets.
    (5) Selling consolidated group, selling affiliate, or S corporation 
shareholders.
    (i) In general.

[[Page 143]]

    (ii) Basis and holding period of T stock not acquired.
    (iii) T stock sale.
    (6) Nonselling minority shareholders other than nonselling S 
corporation shareholders.
    (i) In general.
    (ii) T stock sale.
    (iii) T stock not acquired.
    (7) Consolidated return of selling consolidated group.
    (8) Availability of the section 453 installment method.
    (i) In deemed asset sale.
    (ii) In deemed liquidation.
    (9) Treatment consistent with an actual asset sale.
    (e) Examples.
    (f) Inapplicability of provisions.
    (g) Required information.

              Sec. 1.338(i)-1 Effective dates.

    (a) In general.
    (b) Section 338(h)(10) elections for S corporation targets.
    (c) Section 338 elections for insurance company targets.
    (1) In general.
    (2) New target election for retroactive election.
    (i) Availability of election.
    (ii) Time and manner of making the election for new target.
    (3) Old target election for retroactive election.
    (i) Availability of election.
    (ii) Time and manner of making the election for old target.

[T.D. 8940, 66 FR 9929, Feb. 13, 2001, as amended by T.D. 9158, 70 FR 
55741, Sept. 16, 2004; T.D. 9257, 71 FR 17999, Apr. 10, 2006; T.D. 9264, 
71 FR 30595, May 30, 2006; T.D. 9358, 72 FR 51705, Sept. 11, 2007; T.D. 
9377, 73 FR 3871, Jan. 23, 2008; T.D. 9619, 78 FR 28489, May 15, 2013]



Sec. 1.338-1  General principles; status of old target and new target.

    (a) In general--(1) Deemed transaction. Elections are available 
under section 338 when a purchasing corporation acquires the stock of 
another corporation (the target) in a qualified stock purchase. One type 
of election, under section 338(g), is available to the purchasing 
corporation. Another type of election, under section 338(h)(10), is, in 
more limited circumstances, available jointly to the purchasing 
corporation and the sellers of the stock. (Rules concerning eligibility 
for these elections are contained in Sec. Sec. 1.338-2, 1.338-3, and 
1.338(h)(10)-1.) However, if, as a result of the deemed purchase of old 
target's assets pursuant to a section 336(e) election, there would be 
both a qualified stock purchase and a qualified stock disposition (as 
defined in Sec. 1.336-1(b)(6)) of the stock of a subsidiary of target, 
neither a section 338(g) election nor a section 338(h)(10) election may 
be made with respect to the qualified stock purchase of the subsidiary. 
Instead, a section 336(e) election may be made with respect to such 
purchase. See Sec. 1.336-1(b)(6)(ii). Although target is a single 
corporation under corporate law, if a section 338 election is made, then 
two separate corporations, old target and new target, generally are 
considered to exist for purposes of subtitle A of the Internal Revenue 
Code. Old target is treated as transferring all of its assets to an 
unrelated person in exchange for consideration that includes the 
discharge of its liabilities (see Sec. 1.1001-2(a)), and new target is 
treated as acquiring all of its assets from an unrelated person in 
exchange for consideration that includes the assumption of those 
liabilities. (Such transaction is, without regard to its 
characterization for Federal income tax purposes, referred to as the 
deemed asset sale and the income tax consequences thereof as the deemed 
sale tax consequences.) If a section 338(h)(10) election is made, old 
target is deemed to liquidate following the deemed asset sale.
    (2) Application of other rules of law. Other rules of law apply to 
determine the tax consequences to the parties as if they had actually 
engaged in the transactions deemed to occur under section 338 and the 
regulations thereunder except to the extent otherwise provided in those 
regulations. See also Sec. 1.338-6(c)(2). Other rules of law may 
characterize the transaction as something other than or in addition to a 
sale and purchase of assets; however, the transaction between old and 
new target must be a taxable transaction. For example, if the target is 
an insurance company for which a section 338 election is made, the 
deemed asset sale results in an assumption reinsurance transaction for 
the insurance contracts deemed transferred from old target to new 
target. See, generally, Sec. 1.817-4(d), and for special rules 
regarding the acquisition of insurance company targets, Sec. 1.338-11. 
See also Sec. 1.367(a)-8(k)(13) for a rule applicable to gain

[[Page 144]]

recognition agreements (filed under Sec. Sec. 1.367(a)-3(b)(1)(ii) and 
1.367(a)-8) and deemed asset sales as a result of an election under 
section 338(g).
    (3) Overview. Definitions and special nomenclature and rules for 
making the section 338 election are provided in Sec. 1.338-2. 
Qualification for the section 338 election is addressed in Sec. 1.338-
3. The amount for which old target is treated as selling all of its 
assets (the aggregate deemed sale price, or ADSP) is addressed in Sec. 
1.338-4. The amount for which new target is deemed to have purchased all 
its assets (the adjusted grossed-up basis, or AGUB) is addressed in 
Sec. 1.338-5. Section 1.338-6 addresses allocation both of ADSP among 
the assets old target is deemed to have sold and of AGUB among the 
assets new target is deemed to have purchased. Section 1.338-7 addresses 
allocation of ADSP or AGUB when those amounts subsequently change. Asset 
and stock consistency are addressed in Sec. 1.338-8. International 
aspects of section 338 are covered in Sec. 1.338-9. Rules for the 
filing of returns are provided in Sec. 1.338-10. Section 1.338-11 
provides special rules for insurance company targets. Eligibility for 
and treatment of section 338(h)(10) elections is addressed in Sec. 
1.338(h)(10)-1.
    (b) Treatment of target under other provisions of the Internal 
Revenue Code--(1) General rule for subtitle A. Except as provided in 
this section, new target is treated as a new corporation that is 
unrelated to old target for purposes of subtitle A of the Internal 
Revenue Code. Thus--
    (i) New target is not considered related to old target for purposes 
of section 168 and may make new elections under section 168 without 
taking into account the elections made by old target; and
    (ii) New target may adopt, without obtaining prior approval from the 
Commissioner, any taxable year that meets the requirements of section 
441 and any method of accounting that meets the requirements of section 
446. Notwithstanding Sec. 1.441-1T(b)(2), a new target may adopt a 
taxable year on or before the last day for making the election under 
section 338 by filing its first return for the desired taxable year on 
or before that date.
    (2) Exceptions for subtitle A. New target and old target are treated 
as the same corporation for purposes of--
    (i) The rules applicable to employee benefit plans (including those 
plans described in sections 79, 104, 105, 106, 125, 127, 129, 132, 137, 
and 220), qualified pension, profit-sharing, stock bonus and annuity 
plans (sections 401(a) and 403(a)), simplified employee pensions 
(section 408(k)), tax qualified stock option plans (sections 422 and 
423), welfare benefit funds (sections 419, 419A, 512(a)(3), and 4976), 
voluntary employees' beneficiary associations (section 501(c)(9) and the 
regulations thereunder), and tax on excess tax-exempt organization 
executive compensation (section 4960) and the regulations in part 53 
under section 4960;
    (ii) Sections 1311 through 1314 (relating to the mitigation of the 
effect of limitations), if a section 338(h)(10) election is not made for 
target;
    (iii) Section 108(e)(5) (relating to the reduction of purchase money 
debt);
    (iv) Section 45A (relating to the Indian Employment Credit), section 
51 (relating to the Work Opportunity Credit), section 51A (relating to 
the Welfare to Work Credit), and section 1396 (relating to the 
Empowerment Zone Act);
    (v) Sections 401(h) and 420 (relating to medical benefits for 
retirees);
    (vi) Section 414 (relating to definitions and special rules); and
    (vii) Section 846(e) (relating to an election to use an insurance 
company's historical loss payment pattern).
    (viii) Any other provision designated in the Internal Revenue 
Bulletin by the Internal Revenue Service. See Sec. 601.601(d)(2)(ii) of 
this chapter. See, for example, Sec. 1.1001-3(e)(4)(i)(F) providing 
that an election under section 338 does not result in the substitution 
of a new obligor on target's debt. See also, for example, Sec. 1.1502-
77(c)(8), providing that an election under section 338 does not result 
in a deemed termination of target's existence for purposes of the rules 
applicable to the agent for a consolidated group.
    (3) General rule for other provisions of the Internal Revenue Code. 
Except as provided in the regulations under section 338 or in the 
Internal Revenue Bulletin by the Internal Revenue Service

[[Page 145]]

(see Sec. 601.601(d)(2)(ii) of this chapter), new target is treated as 
a continuation of old target for purposes other than subtitle A of the 
Internal Revenue Code. For example--
    (i) New target is liable for old target's Federal income tax 
liabilities, including the tax liability for the deemed sale tax 
consequences and those tax liabilities of the other members of any 
consolidated group that included old target that are attributable to 
taxable years in which those corporations and old target joined in the 
same consolidated return (see Sec. 1.1502-6(a));
    (ii) Wages earned by the employees of old target are considered 
wages earned by such employees from new target for purposes of sections 
3101 and 3111 (Federal Insurance Contributions Act) and section 3301 
(Federal Unemployment Tax Act); and
    (iii) Old target and new target must use the same employer 
identification number.
    (c) Anti-abuse rule--(1) In general. The rules of this paragraph (c) 
apply for purposes of applying the regulations under sections 336(e), 
338, and 1060. The Commissioner is authorized to treat any property 
(including cash) transferred by old target in connection with the 
transactions resulting in the application of the residual method (and 
not held by target at the close of the acquisition date) as, 
nonetheless, property of target at the close of the acquisition date if 
the property so transferred is, within 24 months after the deemed asset 
sale, owned by new target, or is owned, directly or indirectly, by a 
member of the affiliated group of which new target is a member and 
continues after the acquisition date to be held or used primarily in 
connection with one or more of the activities of new target. In 
addition, the Commissioner is authorized to treat any property 
(including cash) transferred to old target in connection with the 
transactions resulting in the application of the residual method (and 
held by target at the close of the acquisition date) as, nonetheless, 
not being property of target at the close of the acquisition date if the 
property so transferred is, within 24 months after the deemed asset 
sale, not owned by new target but owned, directly or indirectly, by a 
member of the affiliated group of which new target is a member, or owned 
by new target but held or used primarily in connection with an activity 
conducted, directly or indirectly, by another member of the affiliated 
group of which new target is a member in combination with other property 
retained by or acquired, directly or indirectly, from the transferor of 
the property (or a member of the same affiliated group) to old target. 
For purposes of this paragraph (c)(1), an interest in an entity is 
considered held or used in connection with an activity if property of 
the entity is so held or used. The authority of the Commissioner under 
this paragraph (c)(1) includes the making of any appropriate correlative 
adjustments (avoiding, to the extent possible, the duplication or 
omission of any item of income, gain, loss, deduction, or basis).
    (2) Examples. The following examples illustrate this paragraph (c):

    Example 1. Prior to a qualified stock purchase under section 338, 
target transfers one of its assets to a related party. The purchasing 
corporation then purchases the target stock and also purchases the 
transferred asset from the related party. After its purchase of target, 
the purchasing corporation and target are members of the same affiliated 
group. A section 338 election is made. Under an arrangement with the 
purchaser, the separately transferred asset is used primarily in 
connection with target's activities. Applying the anti-abuse rule of 
this paragraph (c), the Commissioner may consider target to own the 
transferred asset for purposes of applying the residual method under 
section 338.
    Example 2. T owns all the stock of T1. T1 leases intellectual 
property to T, which T uses in connection with its own activities. P, a 
purchasing corporation, wishes to buy the T-T1 chain of corporations. P, 
in connection with its planned purchase of the T stock, contracts to 
consummate a purchase of all the stock of T1 on March 1 and of all the 
stock of T on March 2. Section 338 elections are thereafter made for 
both T and T1. Immediately after the purchases, P, T and T1 are members 
of the same affiliated group. T continues to lease the intellectual 
property from T1 and that is the primary use of the intellectual 
property. Thus, an asset of T, the T1 stock, was removed from T's own 
assets prior to the qualified stock purchase of the T stock, T1's own 
assets are used after the deemed asset sale in connection with T's own 
activities, and the T1 stock is after the deemed asset sale owned by P, 
a member of

[[Page 146]]

the same affiliated group of which T is a member. Applying the anti-
abuse rule of this paragraph (c), the Commissioner may, for purposes of 
application of the residual method under section 338 both to T and to 
T1, consider P to have bought only the stock of T, with T at the time of 
the qualified stock purchases of both T and T1 (the qualified stock 
purchase of T1 being triggered by the deemed sale under section 338 of 
T's assets) owning T1. The Commissioner accordingly would allocate 
consideration to T's assets as though the T1 stock were one of those 
assets, and then allocate consideration within T1 based on the amount 
allocated to the T1 stock at the T level.

    (d) Next day rule for post-closing transactions. If a target 
corporation for which an election under section 338 is made engages in a 
transaction outside the ordinary course of business on the acquisition 
date after the event resulting in the qualified stock purchase of the 
target or a higher tier corporation, the target and all persons related 
thereto (either before or after the qualified stock purchase) under 
section 267(b) or section 707 must treat the transaction for all Federal 
income tax purposes as occurring at the beginning of the day following 
the transaction and after the deemed purchase by new target.
    (e) Effective/applicability date. Paragraphs (a)(1) and (c)(1) of 
this section are applicable to any qualified stock disposition for which 
the disposition date (as defined in Sec. 1.336-1(b)(8)) is on or after 
May 15, 2013.

[T.D. 8940, 66 FR 9929, Feb. 13, 2001, as amended by T.D. 9002, 67 FR 
43540, June 28, 2002; T.D. 9257, 71 FR 18000, Apr. 10, 2006; T.D. 9377, 
73 FR 3871, Jan. 23, 2008; T.D. 9446, 74 FR 6957, Feb. 11, 2009; T.D. 
9619, 78 FR 28489, May 15, 2013; T.D. 9715, 80 FR 17317, Apr. 1, 2015; 
T.D. 9932, 85 FR 86511, Dec. 30, 2020; T.D. 9938, 86 FR 6219, Jan. 19, 
2021]



Sec. 1.338-2  Nomenclature and definitions; mechanics of the section 
338 election.

    (a) Scope. This section prescribes rules relating to elections under 
section 338.
    (b) Nomenclature. For purposes of the regulations under section 338 
(except as otherwise provided):
    (1) T is a domestic target corporation that has only one class of 
stock outstanding. Old T refers to T for periods ending on or before the 
close of T's acquisition date; new T refers to T for subsequent periods.
    (2) P is the purchasing corporation.
    (3) The P group is an affiliated group of which P is a member.
    (4) P1, P2, etc., are domestic corporations that are members of the 
P group.
    (5) T1, T2, etc., are domestic corporations that are target 
affiliates of T. These corporations (T1, T2, etc.) have only one class 
of stock outstanding and may also be targets.
    (6) S is a domestic corporation (unrelated to P and B) that owns T 
prior to the purchase of T by P. (S is referred to in cases in which it 
is appropriate to consider the effects of having all of the outstanding 
stock of T owned by a domestic corporation.)
    (7) A, a U.S. citizen or resident, is an individual (unrelated to P 
and B) who owns T prior to the purchase of T by P. (A is referred to in 
cases in which it is appropriate to consider the effects of having all 
of the outstanding stock of T owned by an individual who is a U.S. 
citizen or resident. Ownership of T by A and ownership of T by S are 
mutually exclusive circumstances.)
    (8) B, a U.S. citizen or resident, is an individual (unrelated to T, 
S, and A) who owns the stock of P.
    (9) F, used as a prefix with the other terms in this paragraph (b), 
connotes foreign, rather than domestic, status. For example, FT is a 
foreign corporation (as defined in section 7701(a)(5)) and FA is an 
individual other than a U.S. citizen or resident.
    (10) CFC, used as a prefix with the other terms in this paragraph 
(b) referring to a corporation, connotes a controlled foreign 
corporation (as defined in section 957, taking into account section 
953(c)). A corporation identified with the prefix F may be a controlled 
foreign corporation. (The prefix CFC is used when the corporation's 
status as a controlled foreign corporation is significant.)
    (c) Definitions. For purposes of the regulations under section 338 
(except as otherwise provided):
    (1) Acquisition date. The term acquisition date has the same meaning 
as in section 338(h)(2).
    (2) Acquisition date assets. Acquisition date assets are the assets 
of the target held at the beginning of the day after

[[Page 147]]

the acquisition date (but see Sec. 1.338-1(d) (regarding certain 
transactions on the acquisition date)).
    (3) Affiliated group. The term affiliated group has the same meaning 
as in section 338(h)(5). Corporations are affiliated on any day they are 
members of the same affiliated group.
    (4) Common parent. The term common parent has the same meaning as in 
section 1504.
    (5) Consistency period. The consistency period is the period 
described in section 338(h)(4)(A) unless extended pursuant to Sec. 
1.338-8(j)(1).
    (6) Deemed asset sale. The deemed asset sale is the transaction 
described in Sec. 1.338-1(a)(1) that is deemed to occur for purposes of 
subtitle A of the Internal Revenue Code if a section 338 election is 
made.
    (7) Deemed sale tax consequences. Deemed sale tax consequences 
refers to, in the aggregate, the Federal income tax consequences 
(generally, the income, gain, deduction, and loss) of the deemed asset 
sale. Deemed sale tax consequences also refers to the Federal income tax 
consequences of the transfer of a particular asset in the deemed asset 
sale.
    (8) Deemed sale return. The deemed sale return is the return on 
which target's deemed sale tax consequences are reported that does not 
include any other items of target. Target files a deemed sale return 
when a section 338 election (but not a section 338(h)(10) election) is 
filed for target and target is a member of a selling group (defined in 
paragraph (c)(16) of this section) that files a consolidated return for 
the period that includes the acquisition date. See Sec. 1.338-10. If 
target is an S corporation for the period that ends on the day before 
the acquisition date and a section 338 election (but not a section 
338(h)(10) election) is filed for target, see Sec. 1.338-10(a)(3).
    (9) Domestic corporation. A domestic corporation is a corporation--
    (i) That is domestic within the meaning of section 7701(a)(4) or 
that is treated as domestic for purposes of subtitle A of the Internal 
Revenue Code (e.g., to which an election under section 953(d) or 1504(d) 
applies); and
    (ii) That is not a DISC, a corporation described in section 1248(e), 
or a corporation to which an election under section 936 applies.
    (10) Old target's final return. Old target's final return is the 
income tax return of old target for the taxable year ending at the close 
of the acquisition date that includes the deemed sale tax consequences. 
However, if a deemed sale return is filed for old target, the deemed 
sale return is considered old target's final return.
    (11) Purchasing corporation. The term purchasing corporation has the 
same meaning as in section 338(d)(1). The purchasing corporation may 
also be referred to as purchaser. Unless otherwise provided, any 
reference to the purchasing corporation is a reference to all members of 
the affiliated group of which the purchasing corporation is a member. 
See sections 338(h)(5) and (8). Also, unless otherwise provided, any 
reference to the purchasing corporation is, with respect to a deemed 
purchase of stock under section 338(a)(2), a reference to new target 
with respect to its own deemed purchase of stock in another target.
    (12) Qualified stock purchase. The term qualified stock purchase has 
the same meaning as in section 338(d)(3).
    (13) Related persons. Two persons are related if stock in a 
corporation owned by one of the persons would be attributed under 
section 318(a) (other than section 318(a)(4)) to the other.
    (14) Section 338 election. A section 338 election is an election to 
apply section 338(a) to target. A section 338 election is made by filing 
a statement of section 338 election pursuant to paragraph (d) of this 
section. The form on which this statement is filed is referred to in the 
regulations under section 338 as the Form 8023, ``Elections Under 
Section 338 For Corporations Making Qualified Stock Purchases.''
    (15) Section 338(h)(10) election. A section 338(h)(10) election is 
an election to apply section 338(h)(10) to target. A section 338(h)(10) 
election is made by making a joint election for target under Sec. 
1.338(h)(10)-1 on Form 8023.
    (16) Selling group. The selling group is the affiliated group (as 
defined in section 1504) eligible to file a consolidated return that 
includes target for the taxable period in which the acquisition date 
occurs. However, a selling group is

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not an affiliated group of which target is the common parent on the 
acquisition date.
    (17) Target; old target; new target. Target is the target 
corporation as defined in section 338(d)(2). Old target refers to target 
for periods ending on or before the close of target's acquisition date. 
New target refers to target for subsequent periods.
    (18) Target affiliate. The term target affiliate has the same 
meaning as in section 338(h)(6) (applied without section 
338(h)(6)(B)(i)). Thus, a corporation described in section 
338(h)(6)(B)(i) is considered a target affiliate for all purposes of 
section 338. If a target affiliate is acquired in a qualified stock 
purchase, it is also a target.
    (19) 12-month acquisition period. The 12-month acquisition period is 
the period described in section 338(h)(1), unless extended pursuant to 
Sec. 1.338-8(j)(2).
    (d) Time and manner of making election. The purchasing corporation 
makes a section 338 election for target by filing a statement of section 
338 election on Form 8023 in accordance with the instructions to the 
form. The section 338 election must be made not later than the 15th day 
of the 9th month beginning after the month in which the acquisition date 
occurs. A section 338 election is irrevocable. See Sec. 1.338(h)(10)-
1(c)(2) for section 338(h)(10) elections.
    (e) Special rules for foreign corporations or DISCs--(1) Elections 
by certain foreign purchasing corporations--(i) General rule. A 
qualifying foreign purchasing corporation is not required to file a 
statement of section 338 election for a qualifying foreign target before 
the earlier of 3 years after the acquisition date and the 180th day 
after the close of the purchasing corporation's taxable year within 
which a triggering event occurs.
    (ii) Qualifying foreign purchasing corporation. A purchasing 
corporation is a qualifying foreign purchasing corporation only if, 
during the acquisition period of a qualifying foreign target, all the 
corporations in the purchasing corporation's affiliated group are 
foreign corporations that are not subject to United States tax.
    (iii) Qualifying foreign target. A target is a qualifying foreign 
target only if target and its target affiliates are foreign corporations 
that, during target's acquisition period, are not subject to United 
States tax (and will not become subject to United States tax during such 
period because of a section 338 election). A target affiliate is taken 
into account for purposes of the preceding sentence only if, during 
target's 12-month acquisition period, it is or becomes a member of the 
affiliated group that includes the purchasing corporation.
    (iv) Triggering event. A triggering event occurs in the taxable year 
of the qualifying foreign purchasing corporation in which either that 
corporation or any corporation in its affiliated group becomes subject 
to United States tax.
    (v) Subject to United States tax. For purposes of this paragraph 
(e)(1), a foreign corporation is considered subject to United States 
tax--
    (A) For the taxable year for which that corporation is required 
under Sec. 1.6012-2(g) (other than Sec. 1.6012-2(g)(2)(i)(B)(2)) to 
file a United States income tax return; or
    (B) For the period during which that corporation is a controlled 
foreign corporation, a passive foreign investment company for which an 
election under section 1295 is in effect, a foreign investment company, 
or a foreign corporation the stock ownership of which is described in 
section 552(a)(2).
    (2) Acquisition period. For purposes of this paragraph (e), the term 
acquisition period means the period beginning on the first day of the 
12-month acquisition period and ending on the acquisition date.
    (3) Statement of section 338 election may be filed by United States 
shareholders in certain cases. The United States shareholders (as 
defined in section 951(b)) of a foreign purchasing corporation that is a 
controlled foreign corporation (as defined in section 957 (taking into 
account section 953(c))) may file a statement of section 338 election on 
behalf of the purchasing corporation if the purchasing corporation is 
not required under Sec. 1.6012-2(g) (other than Sec. 1.6012-
2(g)(2)(i)(B)(2)) to file a United States income tax return for its 
taxable year that includes the acquisition date. Form 8023 must be filed 
as described in the form and its instructions and also must be attached 
to the Form 5471,

[[Page 149]]

``Information Returns of U.S. Persons With Respect to Certain Foreign 
Corporations,'' filed with respect to the purchasing corporation by each 
United States shareholder for the purchasing corporation's taxable year 
that includes the acquisition date (or, if paragraph (e)(1)(i) of this 
section applies to the election, for the purchasing corporation's 
taxable year within which it becomes a controlled foreign corporation). 
The provisions of Sec. 1.964-1(c) (including Sec. 1.964-1(c)(7)) do 
not apply to an election made by the United States shareholders.
    (4) Notice requirement for U.S. persons holding stock in foreign 
target--(i) General rule. If a target subject to a section 338 election 
was a controlled foreign corporation, a passive foreign investment 
company, or a foreign personal holding company at any time during the 
portion of its taxable year that ends on its acquisition date, the 
purchasing corporation must deliver written notice of the election (and 
a copy of Form 8023, its attachments and instructions) to--
    (A) Each U.S. person (other than a member of the affiliated group of 
which the purchasing corporation is a member (the purchasing group 
member)) that, on the acquisition date of the foreign target, holds 
stock in the foreign target; and
    (B) Each U.S. person (other than a purchasing group member) that 
sells stock in the foreign target to a purchasing group member during 
the foreign target's 12-month acquisition period.
    (ii) Limitation. The notice requirement of this paragraph (e)(4) 
applies only where the section 338 election for the foreign target 
affects income, gain, loss, deduction, or credit of the U.S. person 
described in paragraph (e)(4)(i) of this section under section 551, 951, 
1248, or 1293.
    (iii) Form of notice. The notice to U.S. persons must be identified 
prominently as a notice of section 338 election and must--
    (A) Contain the name, address, and employer identification number 
(if any) of, and the country (and, if relevant, the lesser political 
subdivision) under the laws of which are organized the purchasing 
corporation and the relevant target (i.e., the target the stock of which 
the particular U.S. person held or sold under the circumstances 
described in paragraph (e)(4)(i) of this section);
    (B) Identify those corporations as the purchasing corporation and 
the foreign target, respectively; and
    (C) Contain the following declaration (or a substantially similar 
declaration):

    THIS DOCUMENT SERVES AS NOTICE OF AN ELECTION UNDER SECTION 338 FOR 
THE ABOVE CITED FOREIGN TARGET THE STOCK OF WHICH YOU EITHER HELD OR 
SOLD UNDER THE CIRCUMSTANCES DESCRIBED IN TREASURY REGULATIONS SECTION 
1.338-2(e)(4). FOR POSSIBLE UNITED STATES FEDERAL INCOME TAX 
CONSEQUENCES UNDER SECTION 551, 951, 1248, OR 1293 OF THE INTERNAL 
REVENUE CODE OF 1986 THAT MAY APPLY TO YOU, SEE TREASURY REGULATIONS 
SECTION 1.338-9(b). YOU MAY BE REQUIRED TO ATTACH THE INFORMATION 
ATTACHED TO THIS NOTICE TO CERTAIN RETURNS.

    (iv) Timing of notice. The notice required by this paragraph (e)(4) 
must be delivered to the U.S. person on or before the later of the 120th 
day after the acquisition date of the particular target or the day on 
which Form 8023 is filed. The notice is considered delivered on the date 
it is mailed to the proper address (or an address similar enough to 
complete delivery), unless the date it is mailed cannot be reasonably 
determined. The date of mailing will be determined under the rules of 
section 7502. For example, the date of mailing is the date of U.S. 
postmark or the applicable date recorded or marked by a designated 
delivery service.
    (v) Consequence of failure to comply. A statement of section 338 
election is not valid if timely notice is not given to one or more U.S. 
persons described in this paragraph (e)(4). If the form of notice fails 
to comply with all requirements of this paragraph (e)(4), the section 
338 election is valid, but the waiver rule of Sec. 1.338-10(b)(1) does 
not apply.
    (vi) Good faith effort to comply. The purchasing corporation will be 
considered to have complied with this paragraph (e)(4), even though it 
failed to provide notice or provide timely notice

[[Page 150]]

to each person described in this paragraph (e)(4), if the Commissioner 
determines that the purchasing corporation made a good faith effort to 
identify and provide timely notice to those U.S. persons.

[T.D. 8940, 66 FR 9929, Feb. 13, 2001]



Sec. 1.338-3  Qualification for the section 338 election.

    (a) Scope. This section provides rules on whether certain 
acquisitions of stock are qualified stock purchases and on other 
miscellaneous issues under section 338.
    (b) Rules relating to qualified stock purchases--(1) Purchasing 
corporation requirement. An individual cannot make a qualified stock 
purchase of target. Section 338(d)(3) requires, as a condition of a 
qualified stock purchase, that a corporation purchase the stock of 
target. If an individual forms a corporation (new P) to acquire target 
stock, new P can make a qualified stock purchase of target if new P is 
considered for tax purposes to purchase the target stock. Facts that may 
indicate that new P does not purchase the target stock include new P's 
merging downstream into target, liquidating, or otherwise disposing of 
the target stock following the purported qualified stock purchase.
    (2) Purchase. The term purchase has the same meaning as in section 
338(h)(3). Stock in a target (or target affiliate) may be considered 
purchased if, under general principles of tax law, the purchasing 
corporation is considered to own stock of the target (or target 
affiliate) meeting the requirements of section 1504(a)(2), 
notwithstanding that no amount may be paid for (or allocated to) the 
stock.
    (3) Acquisitions of stock from related corporations--(i) In general. 
Stock acquired by a purchasing corporation from a related corporation 
(R) is generally not considered acquired by purchase. See section 
338(h)(3)(A)(iii).
    (ii) Time for testing relationship. For purposes of section 
338(h)(3)(A)(iii), a purchasing corporation is treated as related to 
another person if the relationship specified in section 
338(h)(3)(A)(iii) exists--
    (A) In the case of a single transaction, immediately after the 
purchase of target stock;
    (B) In the case of a series of acquisitions otherwise constituting a 
qualified stock purchase within the meaning of section 338(d)(3), 
immediately after the last acquisition in such series; and
    (C) In the case of a series of transactions effected pursuant to an 
integrated plan to dispose of target stock, immediately after the last 
transaction in such series.
    (iii) Cases where section 338(h)(3)(C) applies--acquisitions treated 
as purchases. If section 338(h)(3)(C) applies and the purchasing 
corporation is treated as acquiring stock by purchase from R, solely for 
purposes of determining when the stock is considered acquired, target 
stock acquired from R is considered to have been acquired by the 
purchasing corporation on the day on which the purchasing corporation is 
first considered to own that stock under section 318(a) (other than 
section 318(a)(4)).
    (iv) Examples. The following examples illustrate this paragraph 
(b)(3):

    Example 1. (i) S is the parent of a group of corporations that are 
engaged in various businesses. Prior to January 1, Year 1, S decided to 
discontinue its involvement in one line of business. To accomplish this, 
S forms a new corporation, Newco, with a nominal amount of cash. Shortly 
thereafter, on January 1, Year 1, S transfers all the stock of the 
subsidiary conducting the unwanted business (T) to Newco in exchange for 
100 shares of Newco common stock and a Newco promissory note. Prior to 
January 1, Year 1, S and Underwriter (U) had entered into a binding 
agreement pursuant to which U would purchase 60 shares of Newco common 
stock from S and then sell those shares in an Initial Public Offering 
(IPO). On January 6, Year 1, the IPO closes.
    (ii) Newco's acquisition of T stock is one of a series of 
transactions undertaken pursuant to one integrated plan. The series of 
transactions ends with the closing of the IPO and the transfer of all 
the shares of stock in accordance with the agreements. Immediately after 
the last transaction effected pursuant to the plan, S owns 40 percent of 
Newco, which does not give rise to a relationship described in section 
338(h)(3)(A)(iii). See Sec. 1.338-3(b)(3)(ii)(C). Accordingly, S and 
Newco are not related for purposes of section 338(h)(3)(A)(iii).
    (iii) Further, because Newco's basis in the T stock is not 
determined by reference to S's basis in the T stock and because the 
transaction is not an exchange to which section

[[Page 151]]

351, 354, 355, or 356 applies, Newco's acquisition of the T stock is a 
purchase within the meaning of section 338(h)(3).
    Example 2. (i) On January 1 of Year 1, P purchases 75 percent in 
value of the R stock. On that date, R owns 4 of the 100 shares of T 
stock. On June 1 of Year 1, R acquires an additional 16 shares of T 
stock. On December 1 of Year 1, P purchases 70 shares of T stock from an 
unrelated person and 12 of the 20 shares of T stock held by R.
    (ii) Of the 12 shares of T stock purchased by P from R on December 1 
of Year 1, 3 of those shares are deemed to have been acquired by P on 
January 1 of Year 1, the date on which 3 of the 4 shares of T stock held 
by R on that date were first considered owned by P under section 
318(a)(2)(C) (i.e., 4 x .75). The remaining 9 shares of T stock 
purchased by P from R on December 1 of Year 1 are deemed to have been 
acquired by P on June 1 of Year 1, the date on which an additional 12 of 
the 20 shares of T stock owned by R on that date were first considered 
owned by P under section 318(a)(2)(C) (i.e., (20 x .75)-3). Because 
stock acquisitions by P sufficient for a qualified stock purchase of T 
occur within a 12-month period (i.e., 3 shares constructively on January 
1 of Year 1, 9 shares constructively on June 1 of Year 1, and 70 shares 
actually on December 1 of Year 1), a qualified stock purchase is made on 
December 1 of Year 1.
    Example 3. (i) On February 1 of Year 1, P acquires 25 percent in 
value of the R stock from B (the sole shareholder of P). That R stock is 
not acquired by purchase. See section 338(h)(3)(A)(iii). On that date, R 
owns 4 of the 100 shares of T stock. On June 1 of Year 1, P purchases an 
additional 25 percent in value of the R stock, and on January 1 of Year 
2, P purchases another 25 percent in value of the R stock. On June 1 of 
Year 2, R acquires an additional 16 shares of the T stock. On December 1 
of Year 2, P purchases 68 shares of the T stock from an unrelated person 
and 12 of the 20 shares of the T stock held by R.
    (ii) Of the 12 shares of the T stock purchased by P from R on 
December 1 of Year 2, 2 of those shares are deemed to have been acquired 
by P on June 1 of Year 1, the date on which 2 of the 4 shares of the T 
stock held by R on that date were first considered owned by P under 
section 318(a)(2)(C) (i.e., 4 x .5). For purposes of this attribution, 
the R stock need not be acquired by P by purchase. See section 
338(h)(1). (By contrast, the acquisition of the T stock by P from R does 
not qualify as a purchase unless P has acquired at least 50 percent in 
value of the R stock by purchase. Section 338(h)(3)(C)(i).) Of the 
remaining 10 shares of the T stock purchased by P from R on December 1 
of Year 2, 1 of those shares is deemed to have been acquired by P on 
January 1 of Year 2, the date on which an additional 1 share of the 4 
shares of the T stock held by R on that date was first considered owned 
by P under section 318(a)(2)(C) (i.e., (4 x .75)-2). The remaining 9 
shares of the T stock purchased by P from R on December 1 of Year 2, are 
deemed to have been acquired by P on June 1 of Year 2, the date on which 
an additional 12 shares of the T stock held by R on that date were first 
considered owned by P under section 318(a)(2)(C) (i.e., (20 x .75)-3). 
Because a qualified stock purchase of T by P is made on December 1 of 
Year 2 only if all 12 shares of the T stock purchased by P from R on 
that date are considered acquired during a 12-month period ending on 
that date (so that, in conjunction with the 68 shares of the T stock P 
purchased on that date from the unrelated person, 80 of T's 100 shares 
are acquired by P during a 12-month period) and because 2 of those 12 
shares are considered to have been acquired by P more than 12 months 
before December 1 of Year 2 (i.e., on June 1 of Year 1), a qualified 
stock purchase is not made. (Under Sec. 1.338-8(j)(2), for purposes of 
applying the consistency rules, P is treated as making a qualified stock 
purchase of T if, pursuant to an arrangement, P purchases T stock 
satisfying the requirements of section 1504(a)(2) over a period of more 
than 12 months.)
    Example 4. Assume the same facts as in Example 3, except that on 
February 1 of Year 1, P acquires 25 percent in value of the R stock by 
purchase. The result is the same as in Example 3.

    (4) Acquisition date for tiered targets--(i) Stock sold in deemed 
asset sale. If an election under section 338 is made for target, old 
target is deemed to sell target's assets and new target is deemed to 
acquire those assets. Under section 338(h)(3)(B), new target's deemed 
purchase of stock of another corporation is a purchase for purposes of 
section 338(d)(3) on the acquisition date of target. If new target's 
deemed purchase causes a qualified stock purchase of the other 
corporation and if a section 338 election is made for the other 
corporation, the acquisition date for the other corporation is the same 
as the acquisition date of target. However, the deemed sale and purchase 
of the other corporation's assets is considered to take place after the 
deemed sale and purchase of target's assets.
    (ii) Example. The following example illustrates this paragraph 
(b)(4):

    Example. A owns all of the T stock. T owns 50 of the 100 shares of X 
stock. The other 50 shares of X stock are owned by corporation Y, which 
is unrelated to A, T, or P. On January 1 of Year 1, P makes a qualified 
stock purchase of T from A and makes a section

[[Page 152]]

338 election for T. On December 1 of Year 1, P purchases the 50 shares 
of X stock held by Y. A qualified stock purchase of X is made on 
December 1 of Year 1, because the deemed purchase of 50 shares of X 
stock by new T because of the section 338 election for T and the actual 
purchase of 50 shares of X stock by P are treated as purchases made by 
one corporation. Section 338(h)(8). For purposes of determining whether 
those purchases occur within a 12-month acquisition period as required 
by section 338(d)(3), T is deemed to purchase its X stock on T's 
acquisition date, i.e., January 1 of Year 1.

    (5) Effect of redemptions--(i) General rule. Except as provided in 
this paragraph (b)(5), a qualified stock purchase is made on the first 
day on which the percentage ownership requirements of section 338(d)(3) 
are satisfied by reference to target stock that is both--
    (A) Held on that day by the purchasing corporation; and
    (B) Purchased by the purchasing corporation during the 12-month 
period ending on that day.
    (ii) Redemptions from persons unrelated to the purchasing 
corporation. Target stock redemptions from persons unrelated to the 
purchasing corporation that occur during the 12-month acquisition period 
are taken into account as reductions in target's outstanding stock for 
purposes of determining whether target stock purchased by the purchasing 
corporation in the 12-month acquisition period satisfies the percentage 
ownership requirements of section 338(d)(3).
    (iii) Redemptions from the purchasing corporation or related persons 
during 12-month acquisition period--(A) General rule. For purposes of 
the percentage ownership requirements of section 338(d)(3), a redemption 
of target stock during the 12-month acquisition period from the 
purchasing corporation or from any person related to the purchasing 
corporation is not taken into account as a reduction in target's 
outstanding stock.
    (B) Exception for certain redemptions from related corporations. A 
redemption of target stock during the 12-month acquisition period from a 
corporation related to the purchasing corporation is taken into account 
as a reduction in target's outstanding stock to the extent that the 
redeemed stock would have been considered purchased by the purchasing 
corporation (because of section 338(h)(3)(C)) during the 12-month 
acquisition period if the redeemed stock had been acquired by the 
purchasing corporation from the related corporation on the day of the 
redemption. See paragraph (b)(3) of this section.
    (iv) Examples. The following examples illustrate this paragraph 
(b)(5):

    Example 1. QSP on stock purchase date; redemption from unrelated 
person during 12-month period. A owns all 100 shares of T stock. On 
January 1 of Year 1, P purchases 40 shares of the T stock from A. On 
July 1 of Year 1, T redeems 25 shares from A. On December 1 of Year 1, P 
purchases 20 shares of the T stock from A. P makes a qualified stock 
purchase of T on December 1 of Year 1, because the 60 shares of T stock 
purchased by P within the 12-month period ending on that date satisfy 
the 80-percent ownership requirements of section 338(d)(3) (i.e., 60/75 
shares), determined by taking into account the redemption of 25 shares.
    Example 2. QSP on stock redemption date; redemption from unrelated 
person during 12-month period. The facts are the same as in Example 1, 
except that P purchases 60 shares of T stock on January 1 of Year 1 and 
none on December 1 of Year 1. P makes a qualified stock purchase of T on 
July 1 of Year 1, because that is the first day on which the T stock 
purchased by P within the preceding 12-month period satisfies the 80-
percent ownership requirements of section 338(d)(3) (i.e., 60/75 
shares), determined by taking into account the redemption of 25 shares.
    Example 3. Redemption from purchasing corporation not taken into 
account. On December 15 of Year 1, T redeems 30 percent of its stock 
from P. The redeemed stock was held by P for several years and 
constituted P's total interest in T. On December 1 of Year 2, P 
purchases the remaining T stock from A. P does not make a qualified 
stock purchase of T on December 1 of Year 2. For purposes of the 80-
percent ownership requirements of section 338(d)(3), the redemption of 
P's T stock on December 15 of Year 1 is not taken into account as a 
reduction in T's outstanding stock.
    Example 4. Redemption from related person taken into account. On 
January 1 of Year 1, P purchases 60 of the 100 shares of X stock. On 
that date, X owns 40 of the 100 shares of T stock. On April 1 of Year 1, 
T redeems X's T stock and P purchases the remaining 60 shares of T stock 
from an unrelated person. For purposes of the 80-percent ownership 
requirements of section 338(d)(3), the redemption of the T stock from X 
(a person related to P) is taken into account as a reduction in T's 
outstanding stock. If P had purchased the 40 redeemed shares from X on 
April 1 of

[[Page 153]]

Year 1, all 40 of the shares would have been considered purchased 
(because of section 338(h)(3)(C)(i)) during the 12-month period ending 
on April 1 of Year 1 (24 of the 40 shares would have been considered 
purchased by P on January 1 of Year 1 and the remaining 16 shares would 
have been considered purchased by P on April 1 of Year 1). See paragraph 
(b)(3) of this section. Accordingly, P makes a qualified stock purchase 
of T on April 1 of Year 1, because the 60 shares of T stock purchased by 
P on that date satisfy the 80-percent ownership requirements of section 
338(d)(3) (i.e., 60/60 shares), determined by taking into account the 
redemption of 40 shares.

    (c) Effect of post-acquisition events on eligibility for section 338 
election--(1) Post-acquisition elimination of target. (i) The purchasing 
corporation may make an election under section 338 for target even 
though target is liquidated on or after the acquisition date. If target 
liquidates on the acquisition date, the liquidation is considered to 
occur on the following day and immediately after new target's deemed 
purchase of assets. The purchasing corporation may also make an election 
under section 338 for target even though target is merged into another 
corporation, or otherwise disposed of by the purchasing corporation 
provided that, under the facts and circumstances, the purchasing 
corporation is considered for tax purposes as the purchaser of the 
target stock. See Sec. 1.338(h)(10)-1(c)(2) for special rules 
concerning section 338(h)(10) elections in certain multi-step 
transactions.
    (ii) The following examples illustrate this paragraph (c)(1):

    Example 1. On January 1 of Year 1, P purchases 100 percent of the 
outstanding common stock of T. On June 1 of Year 1, P sells the T stock 
to an unrelated person. Assuming that P is considered for tax purposes 
as the purchaser of the T stock, P remains eligible, after June 1 of 
Year 1, to make a section 338 election for T that results in a deemed 
asset sale of T's assets on January 1 of Year 1.
    Example 2. On January 1 of Year 1, P makes a qualified stock 
purchase of T. On that date, T owns the stock of T1. On March 1 of Year 
1, T sells the T1 stock to an unrelated person. On April 1 of Year 1, P 
makes a section 338 election for T. Notwithstanding that the T1 stock 
was sold on March 1 of Year 1, the section 338 election for T on April 1 
of Year 1 results in a qualified stock purchase by T of T1 on January 1 
of Year 1. See paragraph (b)(4)(i) of this section.

    (2) Post-acquisition elimination of the purchasing corporation. An 
election under section 338 may be made for target after the acquisition 
of assets of the purchasing corporation by another corporation in a 
transaction described in section 381(a), provided that the purchasing 
corporation is considered for tax purposes as the purchaser of the 
target stock. The acquiring corporation in the section 381(a) 
transaction may make an election under section 338 for target.
    (d) Consequences of post-acquisition elimination of target where 
section 338 election not made--(1) Scope. The rules of this paragraph 
(d) apply to the transfer of target assets to the purchasing corporation 
(or another member of the same affiliated group as the purchasing 
corporation) (the transferee) following a qualified stock purchase of 
target stock, if the purchasing corporation does not make a section 338 
election for target. Notwithstanding the rules of this paragraph (d), 
section 354(a) (and so much of section 356 as relates to section 354) 
cannot apply to any person other than the purchasing corporation or 
another member of the same affiliated group as the purchasing 
corporation unless the transfer of target assets is pursuant to a 
reorganization as determined without regard to this paragraph (d).
    (2) Continuity of interest. By virtue of section 338, in determining 
whether the continuity of interest requirement of Sec. 1.368-1(b) is 
satisfied on the transfer of assets from target to the transferee, the 
purchasing corporation's target stock acquired in the qualified stock 
purchase represents an interest on the part of a person who was an owner 
of the target's business enterprise prior to the transfer that can be 
continued in a reorganization.
    (3) Control requirement. By virtue of section 338, the acquisition 
of target stock in the qualified stock purchase will not prevent the 
purchasing corporation from qualifying as a shareholder of the target 
transferor for the purpose of determining whether, immediately after the 
transfer of target assets, a shareholder of the transferor is in control 
of the corporation to which

[[Page 154]]

the assets are transferred within the meaning of section 368(a)(1)(D).
    (4) Solely for voting stock requirement. By virtue of section 338, 
the acquisition of target stock in the qualified stock purchase for 
consideration other than voting stock will not prevent the subsequent 
transfer of target assets from satisfying the solely for voting stock 
requirement for purposes of determining if the transfer of target assets 
qualifies as a reorganization under section 368(a)(1)(C).
    (5) Example. The following example illustrates this paragraph (d):

    Example. (i) Facts. P, T, and X are domestic corporations. T and X 
each operate a trade or business. A and K, individuals unrelated to P, 
own 85 and 15 percent, respectively, of the stock of T. P owns all of 
the stock of X. The total adjusted basis of T's property exceeds the sum 
of T's liabilities plus the amount of liabilities to which T's property 
is subject. P purchases all of A's T stock for cash in a qualified stock 
purchase. P does not make an election under section 338(g) with respect 
to its acquisition of T stock. Shortly after the acquisition date, and 
as part of the same plan, T merges under applicable state law into X in 
a transaction that, but for the question of continuity of interest, 
satisfies all the requirements of section 368(a)(1)(A). In the merger, 
all of T's assets are transferred to X. P and K receive X stock in 
exchange for their T stock. P intends to retain the stock of X 
indefinitely.
    (ii) Status of transfer as a reorganization. By virtue of section 
338, for the purpose of determining whether the continuity of interest 
requirement of Sec. 1.368-1(b) is satisfied, P's T stock acquired in 
the qualified stock purchase represents an interest on the part of a 
person who was an owner of T's business enterprise prior to the transfer 
that can be continued in a reorganization through P's continuing 
ownership of X. Thus, the continuity of interest requirement is 
satisfied and the merger of T into X is a reorganization within the 
meaning of section 368(a)(1)(A). Moreover, by virtue of section 338, the 
requirement of section 368(a)(1)(D) that a target shareholder control 
the transferee immediately after the transfer is satisfied because P 
controls X immediately after the transfer. In addition, all of T's 
assets are transferred to X in the merger and P and K receive the X 
stock exchanged therefor in pursuance of the plan of reorganization. 
Thus, the merger of T into X is also a reorganization within the meaning 
of section 368(a)(1)(D).
    (iii) Treatment of T and X. Under section 361(a), T recognizes no 
gain or loss in the merger. Under section 362(b), X's basis in the 
assets received in the merger is the same as the basis of the assets in 
T's hands. X succeeds to and takes into account the items of T as 
provided in section 381.
    (iv) Treatment of P. By virtue of section 338, the transfer of T 
assets to X is a reorganization. Pursuant to that reorganization, P 
exchanges its T stock solely for stock of X, a party to the 
reorganization. Because P is the purchasing corporation, section 354 
applies to P's exchange of T stock for X stock in the merger of T into 
X. Thus, P recognizes no gain or loss on the exchange. Under section 
358, P's basis in the X stock received in the exchange is the same as 
the basis of P's T stock exchanged therefor.
    (v) Treatment of K. Because K is not the purchasing corporation (or 
an affiliate thereof), section 354 cannot apply to K's exchange of T 
stock for X stock in the merger of T into X unless the transfer of T's 
assets is pursuant to a reorganization as determined without regard to 
this paragraph (d). Under general principles of tax law applicable to 
reorganizations, the continuity of interest requirement is not satisfied 
because P's stock purchase and the merger of T into X are pursuant to an 
integrated transaction in which A, the owner of 85 percent of the stock 
of T, received solely cash in exchange for A's T stock. See, e.g., Sec. 
1.368-1(e)(1)(i); Yoc Heating v. Commissioner, 61 T.C. 168 (1973); Kass 
v. Commissioner, 60 T.C. 218 (1973), aff'd, 491 F.2d 749 (3d Cir. 1974). 
Thus, the requisite continuity of interest under Sec. 1.368-1(b) is 
lacking and section 354 does not apply to K's exchange of T stock for X 
stock. K recognizes gain or loss, if any, pursuant to section 1001(c) 
with respect to its T stock.

[T.D. 8940, 66 FR 9929, Feb. 13, 2001; 66 FR 17363, Mar. 30, 2001, as 
amended by T.D. 9071, 68 FR 40768, July 9, 2003; T.D. 9271, 71 FR 38075, 
July 5, 2006]



Sec. 1.338-4  Aggregate deemed sale price; various aspects of taxation
of the deemed asset sale.

    (a) Scope. This section provides rules under section 338(a)(1) to 
determine the aggregate deemed sale price (ADSP) for target. ADSP is the 
amount for which old target is deemed to have sold all of its assets in 
the deemed asset sale. ADSP is allocated among target's assets in 
accordance with Sec. 1.338-6 to determine the amount for which each 
asset is deemed to have been sold. When a subsequent increase or 
decrease is required under general principles of tax law with respect to 
an element of ADSP, the redetermined ADSP is allocated among target's 
assets in accordance with Sec. 1.338-7. This Sec. 1.338-4 also

[[Page 155]]

provides rules regarding the recognition of gain or loss on the deemed 
sale of target affiliate stock. Notwithstanding section 
338(h)(6)(B)(ii), stock held by a target affiliate in a foreign 
corporation or in a corporation that is a DISC or that is described in 
section 1248(e) is not excluded from the operation of section 338.
    (b) Determination of ADSP--(1) General rule. ADSP is the sum of--
    (i) The grossed-up amount realized on the sale to the purchasing 
corporation of the purchasing corporation's recently purchased target 
stock (as defined in section 338(b)(6)(A)); and
    (ii) The liabilities of old target.
    (2) Time and amount of ADSP--(i) Original determination. ADSP is 
initially determined at the beginning of the day after the acquisition 
date of target. General principles of tax law apply in determining the 
timing and amount of the elements of ADSP.
    (ii) Redetermination of ADSP. ADSP is redetermined at such time and 
in such amount as an increase or decrease would be required, under 
general principles of tax law, for the elements of ADSP. For example, 
ADSP is redetermined because of an increase or decrease in the amount 
realized for recently purchased stock or because liabilities not 
originally taken into account in determining ADSP are subsequently taken 
into account. Increases or decreases with respect to the elements of 
ADSP result in the reallocation of ADSP among target's assets under 
Sec. 1.338-7.
    (iii) Example. The following example illustrates this paragraph 
(b)(2):

    Example. In Year 1, T, a manufacturer, purchases a customized 
delivery truck from X with purchase money indebtedness having a stated 
principal amount of $100,000. P acquires all of the stock of T in Year 3 
for $700,000 and makes a section 338 election for T. Assume T has no 
liabilities other than its purchase money indebtedness to X. In Year 4, 
when T is neither insolvent nor in a title 11 case, T and X agree to 
reduce the amount of the purchase money indebtedness to $80,000. Assume 
further that the reduction would be a purchase price reduction under 
section 108(e)(5). T and X's agreement to reduce the amount of the 
purchase money indebtedness would not, under general principles of tax 
law that would apply if the deemed asset sale had actually occurred, 
change the amount of liabilities of old target taken into account in 
determining its amount realized. Accordingly, ADSP is not redetermined 
at the time of the reduction. See Sec. 1.338-5(b)(2)(iii) Example 1 for 
the effect on AGUB.

    (c) Grossed-up amount realized on the sale to the purchasing 
corporation of the purchasing corporation's recently purchased target 
stock--(1) Determination of amount. The grossed-up amount realized on 
the sale to the purchasing corporation of the purchasing corporation's 
recently purchased target stock is an amount equal to--
    (i) The amount realized on the sale to the purchasing corporation of 
the purchasing corporation's recently purchased target stock determined 
as if the selling shareholder(s) were required to use old target's 
accounting methods and characteristics and the installment method were 
not available and determined without regard to the selling costs taken 
into account under paragraph (c)(1)(iii) of this section;
    (ii) Divided by the percentage of target stock (by value, determined 
on the acquisition date) attributable to that recently purchased target 
stock;
    (iii) Less the selling costs incurred by the selling shareholders in 
connection with the sale to the purchasing corporation of the purchasing 
corporation's recently purchased target stock that reduce their amount 
realized on the sale of the stock (e.g., brokerage commissions and any 
similar costs to sell the stock).
    (2) Example. The following example illustrates this paragraph (c):

    Example. T has two classes of stock outstanding, voting common stock 
and preferred stock described in section 1504(a)(4). On March 1 of Year 
1, P purchases 40 percent of the outstanding T stock from S1 for $500, 
20 percent of the outstanding T stock from S2 for $225, and 20 percent 
of the outstanding T stock from S3 for $275. On that date, the fair 
market value of all the T voting common stock is $1,250 and the 
preferred stock $750. S1, S2, and S3 incur $40, $35, and $25 
respectively of selling costs. S1 continues to own the remaining 20 
percent of the outstanding T stock. The grossed-up amount realized on 
the sale to P of P's recently purchased T stock is calculated as 
follows: The total amount realized (without regard to selling costs) is 
$1,000 (500 + 225 + 275). The percentage of T stock by value on the 
acquisition date attributable to the recently purchased T stock is 50% 
(1,000/(1,250 + 750)). The

[[Page 156]]

selling costs are $100 (40 + 35 + 25). The grossed-up amount realized is 
$1,900 (1,000/.5 - 100).

    (d) Liabilities of old target--(1) In general. In general, the 
liabilities of old target are measured as of the beginning of the day 
after the acquisition date. (But see Sec. 1.338-1(d) (regarding certain 
transactions on the acquisition date).) In order to be taken into 
account in ADSP, a liability must be a liability of target that is 
properly taken into account in amount realized under general principles 
of tax law that would apply if old target had sold its assets to an 
unrelated person for consideration that included the discharge of its 
liabilities. See Sec. 1.1001-2(a). Such liabilities may include 
liabilities for the tax consequences resulting from the deemed sale.
    (2) Time and amount of liabilities. The time for taking into account 
liabilities of old target in determining ADSP and the amount of the 
liabilities taken into account is determined as if old target had sold 
its assets to an unrelated person for consideration that included the 
discharge of the liabilities by the unrelated person. For example, if no 
amount of a target liability is properly taken into account in amount 
realized as of the beginning of the day after the acquisition date, the 
liability is not initially taken into account in determining ADSP 
(although it may be taken into account at some later date).
    (e) Deemed sale tax consequences. Gain or loss on each asset in the 
deemed sale is computed by reference to the ADSP allocated to that 
asset. ADSP is allocated under the rules of Sec. 1.338-6. Though deemed 
sale tax consequences may increase or decrease ADSP by creating or 
reducing a tax liability, the amount of the tax liability itself may be 
a function of the size of the deemed sale tax consequences. Thus, these 
determinations may require trial and error computations.
    (f) Other rules apply in determining ADSP. ADSP may not be applied 
in such a way as to contravene other applicable rules. For example, a 
capital loss cannot be applied to reduce ordinary income in calculating 
the tax liability on the deemed sale for purposes of determining ADSP.
    (g) Examples. The following examples illustrate this section. For 
purposes of the examples in this paragraph (g), unless otherwise stated, 
T is a calendar year taxpayer that files separate returns and that has 
no loss, tax credit, or other carryovers to Year 1. Depreciation for 
Year 1 is not taken into account. T has no liabilities other than the 
Federal income tax liability resulting from the deemed asset sale, and 
the T shareholders have no selling costs. Assume that T's tax rate for 
any ordinary income or net capital gain resulting from the deemed sale 
of assets is 34 percent and that any capital loss is offset by capital 
gain. On July 1 of Year 1, P purchases all of the stock of T and makes a 
section 338 election for T. The examples are as follows:

    Example 1. One class. (i) On July 1 of Year 1, T's only asset is an 
item of section 1245 property with an adjusted basis to T of $50,400, a 
recomputed basis of $80,000, and a fair market value of $100,000. P 
purchases all of the T stock for $75,000, which also equals the amount 
realized for the stock determined as if the selling shareholder(s) were 
required to use old target's accounting methods and characteristics.
    (ii) ADSP is determined as follows (for purposes of this section 
(g), G is the grossed-up amount realized on the sale to P of P's 
recently purchased T stock, L is T's liabilities other than T's tax 
liability for the deemed sale tax consequences, TR is the 
applicable tax rate, and B is the adjusted basis of the asset deemed 
sold):

ADSP = G + L + TR x (ADSP-B)
ADSP = ($75,000/1) + $0 + .34 x (ADSP - $50,400)
ADSP = $75,000 + .34ADSP - $17,136 .66ADSP = $57,864
ADSP = $87,672.72

    (iii) Because ADSP for T ($87,672.72) does not exceed the fair 
market value of T's asset ($100,000), a Class V asset, T's entire ADSP 
is allocated to that asset. Thus, T's deemed sale results in $37,272.72 
of taxable income (consisting of $29,600 of ordinary income and 
$7,672.72 of capital gain).
    (iv) The facts are the same as in paragraph (i) of this Example 1, 
except that on July 1 of Year 1, P purchases only 80 of the 100 shares 
of T stock for $60,000. The grossed-up amount realized on the sale to P 
of P's recently purchased T stock (G) is $75,000 ($60,000/.8). 
Consequently, ADSP and the deemed sale tax consequences are the same as 
in paragraphs (ii) and (iii) of this Example 1.
    (v) The facts are the same as in paragraph (i) of this Example 1, 
except that T also has

[[Page 157]]

goodwill (a Class VII asset) with an appraised value of $10,000. The 
results are the same as in paragraphs (ii) and (iii) of this Example 1. 
Because ADSP does not exceed the fair market value of the Class V asset, 
no amount is allocated to the Class VII asset (goodwill).
    Example 2. More than one class. (i) P purchases all of the T stock 
for $140,000, which also equals the amount realized for the stock 
determined as if the selling shareholder(s) were required to use old 
target's accounting methods and characteristics. On July 1 of Year 1, T 
has liabilities (not including the tax liability for the deemed sale tax 
consequences) of $50,000, cash (a Class I asset) of $10,000, actively 
traded securities (a Class II asset) with a basis of $4,000 and a fair 
market value of $10,000, goodwill (a Class VII asset) with a basis of 
$3,000, and the following Class V assets:

------------------------------------------------------------------------
                                                               Ratio of
                                                              asset FMV
              Asset                   Basis         FMV        to total
                                                             Class V FMV
------------------------------------------------------------------------
Land.............................       $5,000      $35,000          .14
Building.........................       10,000       50,000          .20
Equipment A (Recomputed basis            5,000       90,000          .36
 $80,000)........................
Equipment B (Recomputed basis           10,000       75,000          .30
 $20,000)........................
                                  --------------------------------------
    Totals.......................      $30,000     $250,000         1.00
------------------------------------------------------------------------

    (ii) ADSP exceeds $20,000. Thus, $10,000 of ADSP is allocated to the 
cash and $10,000 to the actively traded securities. The amount allocated 
to an asset (other than a Class VII asset) cannot exceed its fair market 
value (however, the fair market value of any property subject to 
nonrecourse indebtedness is treated as being not less than the amount of 
such indebtedness; see Sec. 1.338-6(a)(2)). See Sec. 1.338-6(c)(1) 
(relating to fair market value limitation).
    (iii) The portion of ADSP allocable to the Class V assets is 
preliminarily determined as follows (in the formula, the amount 
allocated to the Class I assets is referred to as I and the amount 
allocated to the Class II assets as II):

ADSPV = (G-(I + II)) + L + TR x [(II - 
          BII) + (ADSPV - BV)]
ADSPV = ($140,000 - ($10,000 + $10,000)) + $50,000 + .34 x 
          [($10,000 - $4,000) + (ADSPV - ($5,000 + $10,000 + 
          $5,000 + $10,000))]
ADSPV = $161,840 + .34ADSPV
.66 ADSPV = $161,840
ADSPV = $245,212.12

    (iv) Because, under the preliminary calculations of ADSP, the amount 
to be allocated to the Class I, II, III, IV, V, and VI assets does not 
exceed their aggregate fair market value, no ADSP amount is allocated to 
goodwill. Accordingly, the deemed sale of the goodwill results in a 
capital loss of $3,000. The portion of ADSP allocable to the Class V 
assets is finally determined by taking into account this loss as 
follows:

ADSPV = (G - (I + II)) + L + T R x [(II - 
          BII) + (ADSPV - BV) + 
          (ADSPVII - B VII)]
ADSPV = ($140,000 - ($10,000 + $10,000)) + $50,000 + .34 x 
          [($10,000 - $4,000) + (ADSPV - $30,000) + ($0 - 
          $3,000)]
ADSPV = $160,820 + .34ADSPV
.66 ADSPV = $160,820
ADSPV = $243,666.67

    (v) The allocation of ADSPV among the Class V assets is 
in proportion to their fair market values, as follows:

------------------------------------------------------------------------
             Asset                    ADSP                 Gain
------------------------------------------------------------------------
Land..........................        $34,113.33  $29,113.33 (capital
                                                   gain).
Building......................         48,733.34  38,733.34 (capital
                                                   gain).
Equipment A...................         87,720.00  82,720.00 (75,000
                                                   ordinary income 7,720
                                                   capital gain).
Equipment B...................         73,100.00  63,100.00 (10,000
                                                   ordinary income
                                                   53,100 capital gain).
                               -----------------------------------------
    Totals....................        243,666.67  213,666.67.
------------------------------------------------------------------------

    Example 3. More than one class. (i) The facts are the same as in 
Example 2, except that P purchases the T stock for $150,000, rather than 
$140,000. The amount realized for the stock determined as if the selling 
shareholder(s) were required to use old target's accounting methods and 
characteristics is also $150,000.
    (ii) As in Example 2, ADSP exceeds $20,000. Thus, $10,000 of ADSP is 
allocated to the cash and $10,000 to the actively traded securities.

[[Page 158]]

    (iii) The portion of ADSP allocable to the Class V assets as 
preliminarily determined under the formula set forth in paragraph (iii) 
of Example 2 is $260,363.64. The amount allocated to the Class V assets 
cannot exceed their aggregate fair market value ($250,000). Thus, 
preliminarily, the ADSP amount allocated to Class V assets is $250,000.
    (iv) Based on the preliminary allocation, the ADSP is determined as 
follows (in the formula, the amount allocated to the Class I assets is 
referred to as I, the amount allocated to the Class II assets as II, and 
the amount allocated to the Class V assets as V):

ADSP = G + L + TR x [(II - BII) + (V - 
          BV) + (ADSP - (I + II + V + BVII))]
ADSP = $150,000 + $50,000 + .34 x [($10,000 - $4,000) + ($250,000 - 
          $30,000) + (ADSP - ($10,000 + $10,000 + $250,000 + $3,000))]
ADSP = $200,000 + .34ADSP - $15,980
.66ADSP = $184,020
ADSP = $278,818.18

    (v) Because ADSP as determined exceeds the aggregate fair market 
value of the Class I, II, III, IV, V, and VI assets, the $250,000 amount 
preliminarily allocated to the Class V assets is appropriate. Thus, the 
amount of ADSP allocated to Class V assets equals their aggregate fair 
market value ($250,000), and the allocated ADSP amount for each Class V 
asset is its fair market value. Further, because there are no Class VI 
assets, the allocable ADSP amount for the Class VII asset (goodwill) is 
$8,818.18 (the excess of ADSP over the aggregate ADSP amounts for the 
Class I, II, III, IV, V and VI assets).
    Example 4. Amount allocated to T1 stock. (i) The facts are the same 
as in Example 2, except that T owns all of the T1 stock (instead of the 
building), and T1's only asset is the building. The T1 stock and the 
building each have a fair market value of $50,000, and the building has 
a basis of $10,000. A section 338 election is made for T1 (as well as 
T), and T1 has no liabilities other than the tax liability for the 
deemed sale tax consequences. T is the common parent of a consolidated 
group filing a final consolidated return described in Sec. 1.338-
10(a)(1).
    (ii) ADSP exceeds $20,000. Thus, $10,000 of ADSP is allocated to the 
cash and $10,000 to the actively traded securities.
    (iii) Because T does not recognize any gain on the deemed sale of 
the T1 stock under paragraph (h)(2) of this section, appropriate 
adjustments must be made to reflect accurately the fair market value of 
the T and T1 assets in determining the allocation of ADSP among T's 
Class V assets (including the T1 stock). In preliminarily calculating 
ADSPV in this case, the T1 stock can be disregarded and, 
because T owns all of the T1 stock, the T1 asset can be treated as a T 
asset. Under this assumption, ADSPV is $243,666.67. See 
paragraph (iv) of Example 2.
    (iv) Because the portion of the preliminary ADSP allocable to Class 
V assets ($243,666.67) does not exceed their fair market value 
($250,000), no amount is allocated to Class VII assets for T. Further, 
this amount ($243,666.67) is allocated among T's Class V assets in 
proportion to their fair market values. See paragraph (v) of Example 2. 
Tentatively, $48,733.34 of this amount is allocated to the T1 stock.
    (v) The amount tentatively allocated to the T1 stock, however, 
reflects the tax incurred on the deemed sale of the T1 asset equal to 
$13,169.34 (.34 x ($48,733.34-$10,000)). Thus, the ADSP allocable to the 
Class V assets of T, and the ADSP allocable to the T1 stock, as 
preliminarily calculated, each must be reduced by $13,169.34. 
Consequently, these amounts, respectively, are $230,497.33 and 
$35,564.00. In determining ADSP for T1, the grossed-up amount realized 
on the deemed sale to new T of new T's recently purchased T1 stock is 
$35,564.00.
    (vi) The facts are the same as in paragraph (i) of this Example 4, 
except that the T1 building has a $12,500 basis and a $62,500 value, all 
of the outstanding T1 stock has a $62,500 value, and T owns 80 percent 
of the T1 stock. In preliminarily calculating ADSPV, the T1 
stock can be disregarded but, because T owns only 80 percent of the T1 
stock, only 80 percent of T1 asset basis and value should be taken into 
account in calculating T's ADSP. By taking into account 80 percent of 
these amounts, the remaining calculations and results are the same as in 
paragraphs (ii), (iii), (iv), and (v) of this Example 4, except that the 
grossed-up amount realized on the sale of the recently purchased T1 
stock is $44,455.00 ($35,564.00/0.8).

    (h) Deemed sale of target affiliate stock--(1) Scope. This paragraph 
(h) prescribes rules relating to the treatment of gain or loss realized 
on the deemed sale of stock of a target affiliate when a section 338 
election (but not a section 338(h)(10) election) is made for the target 
affiliate. For purposes of this paragraph (h), the definition of 
domestic corporation in Sec. 1.338-2(c)(9) is applied without the 
exclusion therein for DISCs, corporations described in section 1248(e), 
and corporations to which an election under section 936 applies.
    (2) In general. Except as otherwise provided in this paragraph (h), 
if a section 338 election is made for target, target recognizes no gain 
or loss on the deemed sale of stock of a target affiliate having the 
same acquisition date and for which a section 338 election is made if--

[[Page 159]]

    (i) Target directly owns stock in the target affiliate satisfying 
the requirements of section 1504(a)(2);
    (ii) Target and the target affiliate are members of a consolidated 
group filing a final consolidated return described in Sec. 1.338-
10(a)(1); or
    (iii) Target and the target affiliate file a combined return under 
Sec. 1.338-10(a)(4).
    (3) Deemed sale of foreign target affiliate by a domestic target. A 
domestic target recognizes gain or loss on the deemed sale of stock of a 
foreign target affiliate. For the proper treatment of such gain or loss, 
see, e.g., sections 1246, 1248, 1291 et seq., and 338(h)(16) and Sec. 
1.338-9.
    (4) Deemed sale producing effectively connected income. A foreign 
target recognizes gain or loss on the deemed sale of stock of a foreign 
target affiliate to the extent that such gain or loss is effectively 
connected (or treated as effectively connected) with the conduct of a 
trade or business in the United States.
    (5) Deemed sale of insurance company target affiliate electing under 
section 953(d). A domestic target recognizes gain (but not loss) on the 
deemed sale of stock of a target affiliate that has in effect an 
election under section 953(d) in an amount equal to the lesser of the 
gain realized or the earnings and profits described in section 
953(d)(4)(B).
    (6) Deemed sale of DISC target affiliate. A foreign or domestic 
target recognizes gain (but not loss) on the deemed sale of stock of a 
target affiliate that is a DISC or a former DISC (as defined in section 
992(a)) in an amount equal to the lesser of the gain realized or the 
amount of accumulated DISC income determined with respect to such stock 
under section 995(c). Such gain is included in gross income as a 
dividend as provided in sections 995(c)(2) and 996(g).
    (7) Anti-stuffing rule. If an asset the adjusted basis of which 
exceeds its fair market value is contributed or transferred to a target 
affiliate as transferred basis property (within the meaning of section 
7701(a)(43)) and a purpose of such transaction is to reduce the gain (or 
increase the loss) recognized on the deemed sale of such target 
affiliate's stock, the gain or loss recognized by target on the deemed 
sale of stock of the target affiliate is determined as if such asset had 
not been contributed or transferred.
    (8) Examples. The following examples illustrate this paragraph (h):

    Example 1. (i) P makes a qualified stock purchase of T and makes a 
section 338 election for T. T's sole asset, all of the T1 stock, has a 
basis of $50 and a fair market value of $150. T's deemed purchase of the 
T1 stock results in a qualified stock purchase of T1 and a section 338 
election is made for T1. T1's assets have a basis of $50 and a fair 
market value of $150.
    (ii) T realizes $100 of gain on the deemed sale of the T1 stock, but 
the gain is not recognized because T directly owns stock in T1 
satisfying the requirements of section 1504(a)(2) and a section 338 
election is made for T1.
    (iii) T1 recognizes gain of $100 on the deemed sale of its assets.
    Example 2. The facts are the same as in Example 1, except that P 
does not make a section 338 election for T1. Because a section 338 
election is not made for T1, the $100 gain realized by T on the deemed 
sale of the T1 stock is recognized.
    Example 3. (i) P makes a qualified stock purchase of T and makes a 
section 338 election for T. T owns all of the stock of T1 and T2. T's 
deemed purchase of the T1 and T2 stock results in a qualified stock 
purchase of T1 and T2 and section 338 elections are made for T1 and T2. 
T1 and T2 each own 50 percent of the vote and value of T3 stock. The 
deemed purchases by T1 and T2 of the T3 stock result in a qualified 
stock purchase of T3 and a section 338 election is made for T3. T is the 
common parent of a consolidated group and all of the deemed asset sales 
are reported on the T group's final consolidated return. See Sec. 
1.338-10(a)(1).
    (ii) Because T, T1, T2 and T3 are members of a consolidated group 
filing a final consolidated return, no gain or loss is recognized by T, 
T1 or T2 on their respective deemed sales of target affiliate stock.
    Example 4. (i) T's sole asset, all of the FT1 stock, has a basis of 
$25 and a fair market value of $150. FT1's sole asset, all of the FT2 
stock, has a basis of $75 and a fair market value of $150. FT1 and FT2 
each have $50 of accumulated earnings and profits for purposes of 
section 1248(c) and (d). FT2's assets have a basis of $125 and a fair 
market value of $150, and their sale would not generate subpart F income 
under section 951. The sale of the FT2 stock or assets would not 
generate income effectively connected with the conduct of a trade or 
business within the United States. FT1 does not have an election in 
effect under section 953(d) and neither FT1 nor FT2 is a passive foreign 
investment company.
    (ii) P makes a qualified stock purchase of T and makes a section 338 
election for T. T's

[[Page 160]]

deemed purchase of the FT1 stock results in a qualified stock purchase 
of FT1 and a section 338 election is made for FT1. Similarly, FT1's 
deemed purchase of the FT2 stock results in a qualified stock purchase 
of FT2 and a section 338 election is made for FT2.
    (iii) T recognizes $125 of gain on the deemed sale of the FT1 stock 
under paragraph (h)(3) of this section. FT1 does not recognize $75 of 
gain on the deemed sale of the FT2 stock under paragraph (h)(2) of this 
section. FT2 recognizes $25 of gain on the deemed sale of its assets. 
The $125 gain T recognizes on the deemed sale of the FT1 stock is 
included in T's income as a dividend under section 1248, because FT1 and 
FT2 have sufficient earnings and profits for full recharacterization 
($50 of accumulated earnings and profits in FT1, $50 of accumulated 
earnings and profits in FT2, and $25 of deemed sale earnings and profits 
in FT2). Section 1.338-9(b). For purposes of sections 901 through 908, 
the source and foreign tax credit limitation basket of $25 of the 
recharacterized gain on the deemed sale of the FT1 stock is determined 
under section 338(h)(16).

[T.D. 8940, 66 FR 9929, Feb. 13, 2001; 66 FR 17466, Mar. 30, 2001]



Sec. 1.338-5  Adjusted grossed-up basis.

    (a) Scope. This section provides rules under section 338(b) to 
determine the adjusted grossed-up basis (AGUB) for target. AGUB is the 
amount for which new target is deemed to have purchased all of its 
assets in the deemed purchase under section 338(a)(2). AGUB is allocated 
among target's assets in accordance with Sec. 1.338-6 to determine the 
price at which the assets are deemed to have been purchased. When a 
subsequent increase or decrease with respect to an element of AGUB is 
required under general principles of tax law, redetermined AGUB is 
allocated among target's assets in accordance with Sec. 1.338-7.
    (b) Determination of AGUB--(1) General rule. AGUB is the sum of--
    (i) The grossed-up basis in the purchasing corporation's recently 
purchased target stock;
    (ii) The purchasing corporation's basis in nonrecently purchased 
target stock; and
    (iii) The liabilities of new target.
    (2) Time and amount of AGUB--(i) Original determination. AGUB is 
initially determined at the beginning of the day after the acquisition 
date of target. General principles of tax law apply in determining the 
timing and amount of the elements of AGUB.
    (ii) Redetermination of AGUB. AGUB is redetermined at such time and 
in such amount as an increase or decrease would be required, under 
general principles of tax law, with respect to an element of AGUB. For 
example, AGUB is redetermined because of an increase or decrease in the 
amount paid or incurred for recently purchased stock or nonrecently 
purchased stock or because liabilities not originally taken into account 
in determining AGUB are subsequently taken into account. An increase or 
decrease to one element of AGUB also may cause an increase or decrease 
to another element of AGUB. For example, if there is an increase in the 
amount paid or incurred for recently purchased stock after the 
acquisition date, any increase in the basis of nonrecently purchased 
stock because a gain recognition election was made is also taken into 
account when AGUB is redetermined. Increases or decreases with respect 
to the elements of AGUB result in the reallocation of AGUB among 
target's assets under Sec. 1.338-7.
    (iii) Examples. The following examples illustrate this paragraph 
(b)(2):

    Example 1. In Year 1, T, a manufacturer, purchases a customized 
delivery truck from X with purchase money indebtedness having a stated 
principal amount of $100,000. P acquires all of the stock of T in Year 3 
for $700,000 and makes a section 338 election for T. Assume T has no 
liabilities other than its purchase money indebtedness to X. In Year 4, 
when T is neither insolvent nor in a title 11 case, T and X agree to 
reduce the amount of the purchase money indebtedness to $80,000. Assume 
that the reduction would be a purchase price reduction under section 
108(e)(5). T and X's agreement to reduce the amount of the purchase 
money indebtedness would, under general principles of tax law that would 
apply if the deemed asset sale had actually occurred, change the amount 
of liabilities of old target taken into account in determining its 
basis. Accordingly, AGUB is redetermined at the time of the reduction. 
See paragraph (e)(2) of this section. Thus the purchase price reduction 
affects the basis of the truck only indirectly, through the mechanism of 
Sec. Sec. 1.338-6 and 1.338-7. See Sec. 1.338-4(b)(2)(iii) Example for 
the effect on ADSP.
    Example 2. T, an accrual basis taxpayer, is a chemical manufacturer. 
In Year 1, T is obligated to remediate environmental contamination at 
the site of one of its plants. Assume that all the events have occurred 
that

[[Page 161]]

establish the fact of the liability and the amount of the liability can 
be determined with reasonable accuracy but economic performance has not 
occurred with respect to the liability within the meaning of section 
461(h). P acquires all of the stock of T in Year 1 and makes a section 
338 election for T. Assume that, if a corporation unrelated to T had 
actually purchased T's assets and assumed T's obligation to remediate 
the contamination, the corporation would not satisfy the economic 
performance requirements until Year 5. Under section 461(h), the assumed 
liability would not be treated as incurred and taken into account in 
basis until that time. The incurrence of the liability in Year 5 under 
the economic performance rules is an increase in the amount of 
liabilities properly taken into account in basis and results in the 
redetermination of AGUB. (Respecting ADSP, compare Sec. 1.461-4(d)(5), 
which provides that economic performance occurs for old T as the amount 
of the liability is properly taken into account in amount realized on 
the deemed asset sale. Thus ADSP is not redetermined when new T 
satisfies the economic performance requirements.)

    (c) Grossed-up basis of recently purchased stock. The purchasing 
corporation's grossed-up basis of recently purchased target stock (as 
defined in section 338(b)(6)(A)) is an amount equal to--
    (1) The purchasing corporation's basis in recently purchased target 
stock at the beginning of the day after the acquisition date determined 
without regard to the acquisition costs taken into account in paragraph 
(c)(3) of this section;
    (2) Multiplied by a fraction, the numerator of which is 100 minus 
the number that is the percentage of target stock (by value, determined 
on the acquisition date) attributable to the purchasing corporation's 
nonrecently purchased target stock, and the denominator of which is the 
number equal to the percentage of target stock (by value, determined on 
the acquisition date) attributable to the purchasing corporation's 
recently purchased target stock;
    (3) Plus the acquisition costs the purchasing corporation incurred 
in connection with its purchase of the recently purchased stock that are 
capitalized in the basis of such stock (e.g., brokerage commissions and 
any similar costs incurred by the purchasing corporation to acquire the 
stock).
    (d) Basis of nonrecently purchased stock; gain recognition 
election--(1) No gain recognition election. In the absence of a gain 
recognition election under section 338(b)(3) and this section, the 
purchasing corporation retains its basis in the nonrecently purchased 
stock.
    (2) Procedure for making gain recognition election. A gain 
recognition election may be made for nonrecently purchased stock of 
target (or a target affiliate) only if a section 338 election is made 
for target (or the target affiliate). The gain recognition election is 
made by attaching a gain recognition statement to a timely filed Form 
8023 for target. The gain recognition statement must contain the 
information specified in the form and its instructions. The gain 
recognition election is irrevocable. If a section 338(h)(10) election is 
made for target, see Sec. 1.338(h)(10)-1(d)(1) (providing that the 
purchasing corporation is automatically deemed to have made a gain 
recognition election for its nonrecently purchased T stock).
    (3) Effect of gain recognition election--(i) In general. If the 
purchasing corporation makes a gain recognition election, then for all 
purposes of the Internal Revenue Code--
    (A) The purchasing corporation is treated as if it sold on the 
acquisition date the nonrecently purchased target stock for the basis 
amount determined under paragraph (d)(3)(ii) of this section; and
    (B) The purchasing corporation's basis on the acquisition date in 
nonrecently purchased target stock immediately following the deemed sale 
in paragraph (d)(3)(i)(A) of this section is the basis amount.
    (ii) Basis amount. The basis amount is equal to the amount in 
paragraphs (c)(1) and (2) of this section (the purchasing corporation's 
grossed-up basis in recently purchased target stock at the beginning of 
the day after the acquisition date determined without regard to the 
acquisition costs taken into account in paragraph (c)(3) of this 
section) multiplied by a fraction the numerator of which is the 
percentage of target stock (by value, determined on the acquisition 
date) attributable to

[[Page 162]]

the purchasing corporation's nonrecently purchased target stock and the 
denominator of which is 100 percent minus the numerator amount. Thus, if 
target has a single class of outstanding stock, the purchasing 
corporation's basis in each share of nonrecently purchased target stock 
after the gain recognition election is equal to the average price per 
share of the purchasing corporation's recently purchased target stock.
    (iii) Losses not recognized. Only gains (unreduced by losses) on the 
nonrecently purchased target stock are recognized.
    (iv) Stock subject to election. The gain recognition election 
applies to--
    (A) All nonrecently purchased target stock; and
    (B) Any nonrecently purchased stock in a target affiliate having the 
same acquisition date as target if such target affiliate stock is held 
by the purchasing corporation on such date.
    (e) Liabilities of new target--(1) In general. The liabilities of 
new target are the liabilities of target as of the beginning of the day 
after the acquisition date (but see Sec. 1.338-1(d) (regarding certain 
transactions on the acquisition date)). In order to be taken into 
account in AGUB, a liability must be a liability of target that is 
properly taken into account in basis under general principles of tax law 
that would apply if new target had acquired its assets from an unrelated 
person for consideration that included discharge of the liabilities of 
that unrelated person. Such liabilities may include liabilities for the 
tax consequences resulting from the deemed sale.
    (2) Time and amount of liabilities. The time for taking into account 
liabilities of old target in determining AGUB and the amount of the 
liabilities taken into account is determined as if new target had 
acquired its assets from an unrelated person for consideration that 
included the discharge of its liabilities.
    (3) Interaction with deemed sale tax consequences. In general, see 
Sec. 1.338-4(e). Although ADSP and AGUB are not necessarily linked, if 
an increase in the amount realized for recently purchased stock of 
target is taken into account after the acquisition date, and if the tax 
on the deemed sale tax consequences is a liability of target, any 
increase in that liability is also taken into account in redetermining 
AGUB.
    (f) Adjustments by the Internal Revenue Service. In connection with 
the examination of a return, the Commissioner may increase (or decrease) 
AGUB under the authority of section 338(b)(2) and allocate such amounts 
to target's assets under the authority of section 338(b)(5) so that AGUB 
and the basis of target's assets properly reflect the cost to the 
purchasing corporation of its interest in target's assets. Such items 
may include distributions from target to the purchasing corporation, 
capital contributions from the purchasing corporation to target during 
the 12-month acquisition period, or acquisitions of target stock by the 
purchasing corporation after the acquisition date from minority 
shareholders. See also Sec. 1.338-1(d) (regarding certain transactions 
on the acquisition date).
    (g) Examples. The following examples illustrate this section. For 
purposes of the examples in this paragraph (g), T has no liabilities 
other than the tax liability for the deemed sale tax consequences, T 
shareholders incur no costs in selling the T stock, and P incurs no 
costs in acquiring the T stock. The examples are as follows:

    Example 1. (i) Before July 1 of Year 1, P purchases 10 of the 100 
shares of T stock for $5,000. On July 1 of Year 2, P purchases 80 shares 
of T stock for $60,000 and makes a section 338 election for T. As of 
July 1 of Year 2, T's only asset is raw land with an adjusted basis to T 
of $50,400 and a fair market value of $100,000. T has no loss or tax 
credit carryovers to Year 2. T's marginal tax rate for any ordinary 
income or net capital gain resulting from the deemed asset sale is 34 
percent. The 10 shares purchased before July 1 of Year 1 constitute 
nonrecently purchased T stock with respect to P's qualified stock 
purchase of T stock on July 1 of Year 2.
    (ii) The ADSP formula as applied to these facts is the same as in 
Sec. 1.338-4(g) Example 1. Accordingly, the ADSP for T is $87,672.72. 
The existence of nonrecently purchased T stock is irrelevant for 
purposes of the ADSP formula, because that formula treats P's 
nonrecently purchased T stock in the same manner as T stock not held by 
P.
    (iii) The total tax liability resulting from T's deemed asset sale, 
as calculated under the ADSP formula, is $12,672.72.
    (iv) If P does not make a gain recognition election, the AGUB of new 
T's assets is

[[Page 163]]

$85,172.72, determined as follows (In the following formula below, GRP 
is the grossed-up basis in P's recently purchased T stock, BNP is P's 
basis in nonrecently purchased T stock, L is T's liabilities, and X is 
P's acquisition costs for the recently purchased T stock):

AGUB = GRP + BNP + L + X
AGUB = $60,000 x [(1 - .1)/.8] + $5,000 + $12,672.72 + 0
AGUB = $85,172.72

    (v) If P makes a gain recognition election, the AGUB of new T's 
assets is $87,672.72, determined as follows:

AGUB = $60,000 x [(1 - .1)/.8] + $60,000 x [(1 - .1)/.8] x [.1/(1 - .1)] 
          + $12,672.72
AGUB = $87,672.72

    (vi) The calculation of AGUB if P makes a gain recognition election 
may be simplified as follows:

AGUB = $60,000/.8 + $12,672.72
AGUB = $87,672.72

    (vii) As a result of the gain recognition election, P's basis in its 
nonrecently purchased T stock is increased from $5,000 to $7,500 (i.e., 
$60,000 x [(1 - .1)/.8] x [.1/(1 - .1)]). Thus, P recognizes a gain in 
Year 2 with respect to its nonrecently purchased T stock of $2,500 
(i.e., $7,500 - $5,000).
    Example 2. On January 1 of Year 1, P purchases one-third of the T 
stock. On March 1 of Year 1, T distributes a dividend to all of its 
shareholders. On April 15 of Year 1, P purchases the remaining T stock 
and makes a section 338 election for T. In appropriate circumstances, 
the Commissioner may decrease the AGUB of T to take into account the 
payment of the dividend and properly reflect the fair market value of 
T's assets deemed purchased.
    Example 3. (i) T's sole asset is a building worth $100,000. At this 
time, T has 100 shares of stock outstanding. On August 1 of Year 1, P 
purchases 10 of the 100 shares of T stock for $8,000. On June 1 of Year 
2, P purchases 50 shares of T stock for $50,000. On June 15 of Year 2, P 
contributes a tract of land to the capital of T and receives 10 
additional shares of T stock as a result of the contribution. Both the 
basis and fair market value of the land at that time are $10,800. On 
June 30 of Year 2, P purchases the remaining 40 shares of T stock for 
$40,000 and makes a section 338 election for T. The AGUB of T is 
$108,800.
    (ii) To prevent the shifting of basis from the contributed property 
to other assets of T, the Commissioner may allocate $10,800 of the AGUB 
to the land, leaving $98,000 to be allocated to the building. See 
paragraph (f) of this section. Otherwise, applying the allocation rules 
of Sec. 1.338-6 would, on these facts, result in an allocation to the 
recently contributed land of an amount less than its value of $10,800, 
with the difference being allocated to the building already held by T.
    (h) Effective/applicability date. Paragraph (d)(3)(ii) of this 
section is applicable to any qualified stock purchase or qualified stock 
disposition (as defined in Sec. 1.336-1(b)(6)) for which the 
acquisition date or disposition date (as defined in Sec. 1.336-
1(b)(8)), respectively, is on or after May 15, 2013.

[T.D. 8940, 66 FR 9929, Feb. 13, 2001, as amended by T.D. 9619, 78 FR 
28489, May 15, 2013]



Sec. 1.338-6  Allocation of ADSP and AGUB among target assets.

    (a) Scope--(1) In general. This section prescribes rules for 
allocating ADSP and AGUB among the acquisition date assets of a target 
for which a section 338 election is made.
    (2) Fair market value--(i) In general. Generally, the fair market 
value of an asset is its gross fair market value (i.e., fair market 
value determined without regard to mortgages, liens, pledges, or other 
liabilities). However, for purposes of determining the amount of old 
target's deemed sale tax consequences, the fair market value of any 
property subject to a nonrecourse indebtedness will be treated as being 
not less than the amount of such indebtedness. (For purposes of the 
preceding sentence, a liability that was incurred because of the 
acquisition of the property is disregarded to the extent that such 
liability was not taken into account in determining old target's basis 
in such property.)
    (ii) Transaction costs. Transaction costs are not taken into account 
in allocating ADSP or AGUB to assets in the deemed sale (except 
indirectly through their effect on the total ADSP or AGUB to be 
allocated).
    (iii) Internal Revenue Service authority. In connection with the 
examination of a return, the Internal Revenue Service may challenge the 
taxpayer's determination of the fair market value of any asset by any 
appropriate method and take into account all factors, including any lack 
of adverse tax interests between the parties.
    (b) General rule for allocating ADSP and AGUB--(1) Reduction in the 
amount of consideration for Class I assets. Both ADSP and AGUB, in the 
respective allocation of each, are first reduced by

[[Page 164]]

the amount of Class I assets. Class I assets are cash and general 
deposit accounts (including savings and checking accounts) other than 
certificates of deposit held in banks, savings and loan associations, 
and other depository institutions. If the amount of Class I assets 
exceeds AGUB, new target will immediately realize ordinary income in an 
amount equal to such excess. The amount of ADSP or AGUB remaining after 
the reduction is to be allocated to the remaining acquisition date 
assets.
    (2) Other assets--(i) In general. Subject to the limitations and 
other rules of paragraph (c) of this section, ADSP and AGUB (as reduced 
by the amount of Class I assets) are allocated among Class II 
acquisition date assets of target in proportion to the fair market 
values of such Class II assets at such time, then among Class III assets 
so held in such proportion, then among Class IV assets so held in such 
proportion, then among Class V assets so held in such proportion, then 
among Class VI assets so held in such proportion, and finally to Class 
VII assets. If an asset is described below as includible in more than 
one class, then it is included in such class with the lower or lowest 
class number (for instance, Class III has a lower class number than 
Class IV).
    (ii) Class II assets. Class II assets are actively traded personal 
property within the meaning of section 1092(d)(1) and Sec. 1.1092(d)-1 
(determined without regard to section 1092(d)(3)). In addition, Class II 
assets include certificates of deposit and foreign currency even if they 
are not actively traded personal property. Class II assets do not 
include stock of target affiliates, whether or not of a class that is 
actively traded, other than actively traded stock described in section 
1504(a)(4). Examples of Class II assets include U.S. government 
securities and publicly traded stock.
    (iii) Class III assets. Class III assets are assets that the 
taxpayer marks to market at least annually for Federal income tax 
purposes and debt instruments (including accounts receivable). However, 
Class III assets do not include--
    (A) Debt instruments issued by persons related at the beginning of 
the day following the acquisition date to the target under section 
267(b) or 707;
    (B) Contingent debt instruments subject to Sec. 1.1275-4, Sec. 
1.483-4, or section 988, unless the instrument is subject to the non-
contingent bond method of Sec. 1.1275-4(b) or is described in Sec. 
1.988-2(b)(2)(i)(B)(2); and
    (C) Debt instruments convertible into the stock of the issuer or 
other property.
    (iv) Class IV assets. Class IV assets are stock in trade of the 
taxpayer or other property of a kind that would properly be included in 
the inventory of taxpayer if on hand at the close of the taxable year, 
or property held by the taxpayer primarily for sale to customers in the 
ordinary course of its trade or business.
    (v) Class V assets. Class V assets are all assets other than Class 
I, II, III, IV, VI, and VII assets.
    (vi) Class VI assets. Class VI assets are all section 197 
intangibles, as defined in section 197, except goodwill and going 
concern value.
    (vii) Class VII assets. Class VII assets are goodwill and going 
concern value (whether or not the goodwill or going concern value 
qualifies as a section 197 intangible).
    (3) Other items designated by the Internal Revenue Service. Similar 
items may be added to any class described in this paragraph (b) by 
designation in the Internal Revenue Bulletin by the Internal Revenue 
Service (see Sec. 601.601(d)(2) of this chapter).
    (c) Certain limitations and other rules for allocation to an asset--
(1) Allocation not to exceed fair market value. The amount of ADSP or 
AGUB allocated to an asset (other than Class VII assets) cannot exceed 
the fair market value of that asset at the beginning of the day after 
the acquisition date.
    (2) Allocation subject to other rules. The amount of ADSP or AGUB 
allocated to an asset is subject to other provisions of the Internal 
Revenue Code or general principles of tax law in the same manner as if 
such asset were transferred to or acquired from an unrelated person in a 
sale or exchange. For example, if the deemed asset sale is a transaction 
described in section 1056(a) (relating to basis limitation for

[[Page 165]]

player contracts transferred in connection with the sale of a 
franchise), the amount of AGUB allocated to a contract for the services 
of an athlete cannot exceed the limitation imposed by that section. As 
another example, section 197(f)(5) applies in determining the amount of 
AGUB allocated to an amortizable section 197 intangible resulting from 
an assumption-reinsurance transaction.
    (3) Special rule for allocating AGUB when purchasing corporation has 
nonrecently purchased stock--(i) Scope. This paragraph (c)(3) applies if 
at the beginning of the day after the acquisition date--
    (A) The purchasing corporation holds nonrecently purchased stock for 
which a gain recognition election under section 338(b)(3) and Sec. 
1.338-5(d) is not made; and
    (B) The hypothetical purchase price determined under paragraph 
(c)(3)(ii) of this section exceeds the AGUB determined under Sec. 
1.338-5(b).
    (ii) Determination of hypothetical purchase price. Hypothetical 
purchase price is the AGUB that would result if a gain recognition 
election were made.
    (iii) Allocation of AGUB. Subject to the limitations in paragraphs 
(c)(1) and (2) of this section, the portion of AGUB (after reduction by 
the amount of Class I assets) to be allocated to each Class II, III, IV, 
V, VI, and VII asset of target held at the beginning of the day after 
the acquisition date is determined by multiplying--
    (A) The amount that would be allocated to such asset under the 
general rules of this section were AGUB equal to the hypothetical 
purchase price; by
    (B) A fraction, the numerator of which is actual AGUB (after 
reduction by the amount of Class I assets) and the denominator of which 
is the hypothetical purchase price (after reduction by the amount of 
Class I assets).
    (4) Liabilities taken into account in determining amount realized on 
subsequent disposition. In determining the amount realized on a 
subsequent sale or other disposition of property deemed purchased by new 
target, Sec. 1.1001-2(a)(3) shall not apply to any liability that was 
taken into account in AGUB.
    (5) Allocation to certain nuclear decommissioning funds--(i) General 
rule. For purposes of allocating ADSP or AGUB among the acquisition date 
assets of a target (and for no other purpose), a taxpayer may elect to 
treat a nonqualified nuclear decommissioning fund (as defined in 
paragraph (c)(5)(ii) of this section) of the target as if--
    (A) Such fund were an entity classified as a corporation;
    (B) The stock of the corporation were among the acquisition date 
assets of the target and a Class V asset;
    (C) The corporation owned the assets of the fund;
    (D) The corporation bore the responsibility for decommissioning one 
or more nuclear power plants to the extent assets of the fund are 
expected to be used for that purpose; and
    (E) A section 338(h)(10) election were made for the corporation 
(regardless of whether the requirements for a section 338(h)(10) 
election are otherwise satisfied).
    (ii) Definition of nonqualified nuclear decommissioning fund. A 
nonqualified nuclear decommissioning fund means a trust, escrow account, 
Government fund or other type of agreement--
    (A) That is established in writing by the owner or licensee of a 
nuclear generating unit for the exclusive purpose of funding the 
decommissioning of one or more nuclear power plants;
    (B) That is described to the Nuclear Regulatory Commission in a 
report described in 10 CFR 50.75(b) as providing assurance that funds 
will be available for decommissioning;
    (C) That is not a Nuclear Decommissioning Reserve Fund, as described 
in section 468A;
    (D) That is maintained at all times in the United States; and
    (E) The assets of which are to be used only as permitted by 10 CFR 
50.82(a)(8).
    (iii) Availability of election. P may make the election described in 
this paragraph (c)(5) regardless of whether the selling consolidated 
group (or the selling affiliate or the S corporation shareholders) also 
makes the election. In addition, the selling consolidated group (or the 
selling affiliate or the S corporation shareholders) may make the 
election regardless of whether P also makes the election. If T is an S 
corporation, all of the S corporation shareholders, including those that 
do

[[Page 166]]

not sell their stock, must consent to the election for the election to 
be effective as to any S corporation shareholder.
    (iv) Time and manner of making election. The election described in 
this paragraph (c)(5) is made by taking a position on an original or 
amended tax return for the taxable year of the qualified stock purchase 
that is consistent with having made the election. Such tax return must 
be filed no later than the later of 30 days after the date on which the 
section 338 election is due or the day the original tax return for the 
taxable year of the qualified stock purchase is due (with extensions).
    (v) Irrevocability of election. An election made pursuant to this 
paragraph (c)(5) is irrevocable.
    (vi) Effective/applicability date. This paragraph (c)(5) applies to 
qualified stock purchases occurring on or after September 11, 2007. For 
qualified stock purchases occurring before September 11, 2007 and on or 
after September 15, 2004, see Sec. 1.338-6T as contained in 26 CFR part 
1 in effect on April 1, 2007. For qualified stock purchases occurring 
before September 15, 2004, see Sec. 1.338-6 as contained in 26 CFR part 
1 in effect on April 1, 2004.
    (d) Examples. The following examples illustrate Sec. Sec. 1.338-4, 
1.338-5, and this section:

    Example 1. (i) T owns 90 percent of the outstanding T1 stock. P 
purchases 100 percent of the outstanding T stock for $2,000. There are 
no acquisition costs. P makes a section 338 election for T and, as a 
result, T1 is considered acquired in a qualified stock purchase. A 
section 338 election is made for T1. The grossed-up basis of the T stock 
is $2,000 (i.e., $2,000 + 1/1).
    (ii) The liabilities of T as of the beginning of the day after the 
acquisition date (including the tax liability for the deemed sale tax 
consequences) that would, under general principles of tax law, properly 
be taken into account at that time, are as follows:

Liabilities (nonrecourse mortgage plus unsecured liabilities)..     $700
Taxes Payable..................................................      300
                                                                --------
    Total......................................................    1,000
 

    (iii) The AGUB of T is determined as follows:

Grossed-up basis...............................................   $2,000
Total liabilities..............................................    1,000
                                                                --------
    AGUB.......................................................    3,000
 

    (iv) Assume that ADSP is also $3,000.
    (v) Assume that, at the beginning of the day after the acquisition 
date, T's cash and the fair market values of T's Class II, III, IV, and 
V assets are as follows:

------------------------------------------------------------------------
                                                                   Fair
         Asset class                        Asset                 market
                                                                  value
------------------------------------------------------------------------
I...........................  Cash.............................   * $200
II..........................  Portfolio of actively traded           300
                               securities.
III.........................  Accounts receivable..............      600
IV..........................  Inventory........................      300
V...........................  Building.........................      800
V...........................  Land.............................      200
V...........................  Investment in T1.................      450
                                                                --------
                               Total...........................   2,850
------------------------------------------------------------------------
*Amount.

    (vi) Under paragraph (b)(1) of this section, the amount of ADSP and 
AGUB allocable to T's Class II, III, IV, and V assets is reduced by the 
amount of cash to $2,800, i.e., $3,000--$200. $300 of ADSP and of AGUB 
is then allocated to actively traded securities. $600 of ADSP and of 
AGUB is then allocated to accounts receivable. $300 of ADSP and of AGUB 
is then allocated to the inventory. Since the remaining amount of ADSP 
and of AGUB is $1,600 (i.e., $3,000--($200 + $300 + $600 + $300)), an 
amount which exceeds the sum of the fair market values of T's Class V 
assets, the amount of ADSP and of AGUB allocated to each Class V asset 
is its fair market value:

Building.......................................................     $800
Land...........................................................      200
Investment in T1...............................................      450
                                                                --------
    Total......................................................    1,450
 

    (vii) T has no Class VI assets. The amount of ADSP and of AGUB 
allocated to T's Class VII assets (goodwill and going concern value) is 
$150, i.e., $1,600-$1,450.
    (viii) The grossed-up basis of the T1 stock is $500, i.e., $450 x 
1/.9.
    (ix) The liabilities of T1 as of the beginning of the day after the 
acquisition date (including the tax liability for the deemed sale tax 
consequences) that would, under general principles of tax law, properly 
be taken into account at that time, are as follows:

General Liabilities.............................................    $100
Taxes Payable...................................................      20
                                                                 -------
    Total.......................................................     120
 

    (x) The AGUB of T1 is determined as follows:

Grossed-up basis of T1 Stock....................................   $ 500
Liabilities.....................................................     120
                                                                 -------
    AGUB........................................................     620
 

    (xi) Assume that ADSP is also $620.
    (xii) Assume that at the beginning of the day after the acquisition 
date, T1's cash and the fair market values of its Class IV and VI assets 
are as follows:

[[Page 167]]



------------------------------------------------------------------------
                                                                   Fair
         Asset class                        Asset                 market
                                                                  value
------------------------------------------------------------------------
I...........................  Cash.............................     *$50
IV..........................  Inventory........................      200
VI..........................  Patent...........................      350
                                                                --------
                               Total...........................     600
------------------------------------------------------------------------
* Amount.

    (xiii) The amount of ADSP and of AGUB allocable to T1's Class IV and 
VI assets is first reduced by the $50 of cash.
    (xiv) Because the remaining amount of ADSP and of AGUB ($570) is an 
amount which exceeds the fair market value of T1's only Class IV asset, 
the inventory, the amount allocated to the inventory is its fair market 
value ($200). After that, the remaining amount of ADSP and of AGUB 
($370) exceeds the fair market value of T1's only Class VI asset, the 
patent. Thus, the amount of ADSP and of AGUB allocated to the patent is 
its fair market value ($350).
    (xv) The amount of ADSP and of AGUB allocated to T1's Class VII 
assets (goodwill and going concern value) is $20, i.e., $570-$550.
    Example 2. (i) Assume that the facts are the same as in Example 1 
except that P has, for five years, owned 20 percent of T's stock, which 
has a basis in P's hands at the beginning of the day after the 
acquisition date of $100, and P purchases the remaining 80 percent of 
T's stock for $1,600. P does not make a gain recognition election under 
section 338(b)(3).
    (ii) Under Sec. 1.338-5(c), the grossed-up basis of recently 
purchased T stock is $1,600, i.e., $1,600 x (1-.2)/.8.
    (iii) The AGUB of T is determined as follows:

Grossed-up basis of recently purchased stock as determined        $1,600
 under Sec. 1.338-5(c) ($1,600 x (1-.2)/.8)..................
Basis of nonrecently purchased stock...........................      100
Liabilities....................................................    1,000
                                                                --------
    AGUB.......................................................    2,700
 

    (iv) Since P holds nonrecently purchased stock, the hypothetical 
purchase price of the T stock must be computed and is determined as 
follows:

Grossed-up basis of recently purchased stock as determined        $1,600
 under Sec. 1.338-5(c) ($1,600 x (1-.2)/.8)..................
Basis of nonrecently purchased stock as if the gain recognition      400
 election under Sec. 1.338-5(d)(2) had been made ($1,600 x .2/
 (1-.2)).......................................................
Liabilities....................................................    1,000
                                                                --------
    Total......................................................    3,000
 

    (v) Since the hypothetical purchase price ($3,000) exceeds the AGUB 
($2,700) and no gain recognition election is made under section 
338(b)(3), AGUB is allocated under paragraph (c)(3) of this section.
    (vi) First, an AGUB amount equal to the hypothetical purchase price 
($3,000) is allocated among the assets under the general rules of this 
section. The allocation is set forth in the column below entitled 
Original Allocation. Next, the allocation to each asset in Class II 
through Class VII is multiplied by a fraction having a numerator equal 
to the actual AGUB reduced by the amount of Class I assets ($2,700-$200 
= $2,500) and a denominator equal to the hypothetical purchase price 
reduced by the amount of Class I assets ($3,000-$200 = $2,800), or 
2,500/2,800. This produces the Final Allocation:

------------------------------------------------------------------------
                                                   Original      Final
        Class                    Asset            allocation  allocation
------------------------------------------------------------------------
I....................  Cash.....................        $200        $200
II...................  Portfolio of actively             300        *268
                        traded securities.
III..................  Accounts receivable......         600         536
IV...................  Inventory................         300         268
V....................  Building.................         800         714
V....................  Land.....................         200         178
V....................  Investment in T1.........         450         402
VII..................  Goodwill and going                150         134
                        concern value.
                                                 -----------------------
                        Total...................       3,000      2,700
------------------------------------------------------------------------
* All numbers rounded for convenience.


[T.D. 8940, 66 FR 9929, Feb. 13, 2001; 66 FR 17363, Mar. 30, 2001; T.D. 
9158, 69 FR 55742, Sept. 16, 2004; T.D. 9358, 72 FR 51706, Sept. 11, 
2007]



Sec. 1.338-7  Allocation of redetermined ADSP and AGUB among target
assets.

    (a) Scope. ADSP and AGUB are redetermined at such time and in such 
amount as an increase or decrease would be required under general 
principles of tax law for the elements of ADSP or AGUB. This section 
provides rules for allocating redetermined ADSP or AGUB.
    (b) Allocation of redetermined ADSP and AGUB. When ADSP or AGUB is 
redetermined, a new allocation of ADSP or AGUB is made by allocating the 
redetermined ADSP or AGUB amount under the rules of Sec. 1.338-6. If 
the allocation of the redetermined ADSP or AGUB amount under Sec. 
1.338-6 to a given asset is different from the original allocation to 
it, the difference is added to or subtracted from the original 
allocation to the asset, as appropriate. (See paragraph (d) of this 
section for new target's treatment of the amount so allocated.) Amounts 
allocable to an acquisition date asset (or with respect to a disposed-of 
acquisition date asset) are subject to all the asset allocation rules 
(for example, the fair market

[[Page 168]]

value limitation in Sec. 1.338-6(c)(1)) as if the redetermined ADSP or 
AGUB were the ADSP or AGUB on the acquisition date.
    (c) Special rules for ADSP--(1) Increases or decreases in deemed 
sale tax consequences taxable notwithstanding old target ceases to 
exist. To the extent general principles of tax law would require a 
seller in an actual asset sale to account for events relating to the 
sale that occur after the sale date, target must make such an 
accounting. Target is not precluded from realizing additional deemed 
sale tax consequences because the target is treated as a new corporation 
after the acquisition date.
    (2) Procedure for transactions in which section 338(h)(10) is not 
elected--(i) Deemed sale tax consequences included in new target's 
return. If an election under section 338(h)(10) is not made, any 
additional deemed sale tax consequences of old target resulting from an 
increase or decrease in the ADSP are included in new target's income tax 
return for new target's taxable year in which the increase or decrease 
is taken into account. For example, if after the acquisition date there 
is an increase in the allocable ADSP of section 1245 property for which 
the recomputed basis (but not the adjusted basis) exceeds the portion of 
the ADSP allocable to that particular asset on the acquisition date, the 
additional gain is treated as ordinary income to the extent it does not 
exceed such excess amount. See paragraph (c)(2)(ii) of this section for 
the special treatment of old target's carryovers and carrybacks. 
Although included in new target's income tax return, the deemed sale tax 
consequences are separately accounted for as an item of old target and 
may not be offset by income, gain, deduction, loss, credit, or other 
amount of new target. The amount of tax on income of old target 
resulting from an increase or decrease in the ADSP is determined as if 
such deemed sale tax consequences had been recognized in old target's 
taxable year ending at the close of the acquisition date. However, 
because the income resulting from the increase or decrease in ADSP is 
reportable in new target's taxable year of the increase or decrease, not 
in old target's taxable year ending at the close of the acquisition 
date, there is not a resulting underpayment of tax in that past taxable 
year of old target for purposes of calculation of interest due.
    (ii) Carryovers and carrybacks--(A) Loss carryovers to new target 
taxable years. A net operating loss or net capital loss of old target 
may be carried forward to a taxable year of new target, under the 
principles of section 172 or 1212, as applicable, but is allowed as a 
deduction only to the extent of any recognized income of old target for 
such taxable year, as described in paragraph (c)(2)(i) of this section. 
For this purpose, however, taxable years of new target are not taken 
into account in applying the limitations in section 172(b)(1) or 
1212(a)(1)(B) (or other similar limitations). In applying sections 
172(b) and 1212(a)(1), only income, gain, loss, deduction, credit, and 
other amounts of old target are taken into account. Thus, if old target 
has an unexpired net operating loss at the close of its taxable year in 
which the deemed asset sale occurred that could be carried forward to a 
subsequent taxable year, such loss may be carried forward until it is 
absorbed by old target's income.
    (B) Loss carrybacks to taxable years of old target. An ordinary loss 
or capital loss accounted for as a separate item of old target under 
paragraph (c)(2)(i) of this section may be carried back to a taxable 
year of old target under the principles of section 172 or 1212, as 
applicable. For this purpose, taxable years of new target are not taken 
into account in applying the limitations in section 172(b) or 1212(a) 
(or other similar limitations).
    (C) Credit carryovers and carrybacks. The principles described in 
paragraphs (c)(2)(ii)(A) and (B) of this section apply to carryovers and 
carrybacks of amounts for purposes of determining the amount of a credit 
allowable under part IV, subchapter A, chapter 1 of the Internal Revenue 
Code. Thus, for example, credit carryovers of old target may offset only 
income tax attributable to items described in paragraph (c)(2)(i) of 
this section.
    (3) Procedure for transactions in which section 338(h)(10) is 
elected. If an election under section 338(h)(10) is made, any

[[Page 169]]

changes in the deemed sale tax consequences caused by an increase or 
decrease in the ADSP are accounted for in determining the taxable income 
(or other amount) of the member of the selling consolidated group, the 
selling affiliate, or the S corporation shareholders to which such 
income, loss, or other amount is attributable for the taxable year in 
which such increase or decrease is taken into account.
    (d) Special rules for AGUB--(1) Effect of disposition or 
depreciation of acquisition date assets. If an acquisition date asset 
has been disposed of, depreciated, amortized, or depleted by new target 
before an amount is added to the original allocation to the asset, the 
increased amount otherwise allocable to such asset is taken into account 
under general principles of tax law that apply when part of the cost of 
an asset not previously taken into account in basis is paid or incurred 
after the asset has been disposed of, depreciated, amortized, or 
depleted. A similar rule applies when an amount is subtracted from the 
original allocation to the asset. For purposes of the preceding 
sentence, an asset is considered to have been disposed of to the extent 
that its allocable portion of the decrease in AGUB would reduce its 
basis below zero.
    (2) Section 38 property. Section 1.47-2(c) applies to a reduction in 
basis of section 38 property under this section.
    (e) Examples. The following examples illustrate this section. Any 
amount described in the following examples is exclusive of interest. For 
rules characterizing deferred contingent payments as principal or 
interest, see Sec. Sec. 1.483-4, 1.1274-2(g), and 1.1275-4(c). The 
examples are as follows:

    Example 1. (i)(A) T's assets other than goodwill and going concern 
value, and their fair market values at the beginning of the day after 
the acquisition date, are as follows:

------------------------------------------------------------------------
                                                                  Fair
         Asset class                        Asset                market
                                                                  value
------------------------------------------------------------------------
V...........................  Building........................     $ 100
V...........................  Stock of X (not a target).......       200
                                                               ---------
                               Total..........................       300
------------------------------------------------------------------------

    (B) T has no liabilities other than a contingent liability that 
would not be taken into account under general principles of tax law in 
an asset sale between unrelated parties when the buyer assumed the 
liability or took property subject to it.
    (ii)(A) On September 1, 2000, P purchases all of the outstanding 
stock of T for $270 and makes a section 338 election for T. The grossed-
up basis of the T stock and T's AGUB are both $270. The AGUB is ratably 
allocated among T's Class V assets in proportion to their fair market 
values as follows:

------------------------------------------------------------------------
                              Asset                                Basis
------------------------------------------------------------------------
Building ($270 x 100/300).......................................     $90
Stock ($270 x 200/300)..........................................     180
                                                                 -------
    Total.......................................................     270
------------------------------------------------------------------------

    (B) No amount is allocated to the Class VII assets. New T is a 
calendar year taxpayer. Assume that the X stock is a capital asset in 
the hands of new T.
    (iii) On January 1, 2001, new T sells the X stock and uses the 
proceeds to purchase inventory.
    (iv) Pursuant to events on June 30, 2002, the contingent liability 
of old T is at that time properly taken into account under general 
principles of tax law. The amount of the liability is $60.
    (v) T's AGUB increases by $60 from $270 to $330. This $60 increase 
in AGUB is first allocated among T's acquisition date assets in 
accordance with the provisions of Sec. 1.338-6. Because the 
redetermined AGUB for T ($330) exceeds the sum of the fair market values 
at the beginning of the day after the acquisition date of the Class V 
acquisition date assets ($300), AGUB allocated to those assets is 
limited to those fair market values under Sec. 1.338-6(c)(1). As there 
are no Class VI assets, the remaining AGUB of $30 is allocated to 
goodwill and going concern value (Class VII assets). The amount of 
increase in AGUB allocated to each acquisition date asset is determined 
as follows:

------------------------------------------------------------------------
                                        Original  Redetermined
                 Asset                    AGUB        AGUB      Increase
------------------------------------------------------------------------
Building..............................       $90        $100         $10
X Stock...............................       180         200          20
Goodwill and going concern value......         0          30          30
                                       ---------------------------------
    Total.............................       270         330          60
------------------------------------------------------------------------

    (vi) Since the X stock was disposed of before the contingent 
liability was properly taken into account for tax purposes, no amount of 
the increase in AGUB attributable to such stock may be allocated to any 
T asset. Rather, such amount ($20) is allowed as a capital loss to T for 
the taxable year 2002 under the principles of Arrowsmith v. 
Commissioner, 344 U.S. 6 (1952). In addition, the $10 increase in AGUB 
allocated to the

[[Page 170]]

building and the $30 increase in AGUB allocated to the goodwill and 
going concern value are treated as basis redeterminations in 2002. See 
paragraph (d)(1) of this section.
    Example 2. (i) On January 1, 2002, P purchases all of the 
outstanding stock of T and makes a section 338 election for T. Assume 
that ADSP and AGUB of T are both $500 and are allocated among T's 
acquisition date assets as follows:

------------------------------------------------------------------------
         Asset Class                        Asset                 Basis
------------------------------------------------------------------------
V...........................  Machinery........................     $150
V...........................  Land.............................      250
VII.........................  Goodwill and going concern value.      100
                                                                --------
                               Total...........................      500
------------------------------------------------------------------------

    (ii) On September 30, 2004, P filed a claim against the selling 
shareholders of T in a court of appropriate jurisdiction alleging fraud 
in the sale of the T stock.
    (iii) On January 1, 2007, the former shareholders refund $140 of the 
purchase price to P in a settlement of the lawsuit. Assume that, under 
general principles of tax law, both the seller and the buyer properly 
take into account such refund when paid. Assume also that the refund has 
no effect on the tax liability for the deemed sale tax consequences. 
This refund results in a decrease of T's ADSP and AGUB of $140, from 
$500 to $360.
    (iv) The redetermined ADSP and AGUB of $360 is allocated among T's 
acquisition date assets. Because ADSP and AGUB do not exceed the fair 
market value of the Class V assets, the ADSP and AGUB amounts are 
allocated to the Class V assets in proportion to their fair market 
values at the beginning of the day after the acquisition date. Thus, 
$135 ($150 x ($360/($150 + $250))) is allocated to the machinery and 
$225 ($250 x ($360/($150 + $250))) is allocated to the land. 
Accordingly, the basis of the machinery is reduced by $15 ($150 original 
allocation--$135 redetermined allocation) and the basis of the land is 
reduced by $25 ($250 original allocation--$225 redetermined allocation). 
No amount is allocated to the Class VII assets. Accordingly, the basis 
of the goodwill and going concern value is reduced by $100 ($100 
original allocation--$0 redetermined allocation).
    (v) Assume that, as a result of deductions under section 168, the 
adjusted basis of the machinery immediately before the decrease in AGUB 
is zero. The machinery is treated as if it were disposed of before the 
decrease is taken into account. In 2007, T recognizes income of $15, the 
character of which is determined under the principles of Arrowsmith v. 
Commissioner and the tax benefit rule. No adjustment to the basis of T's 
assets is made for any tax paid on this amount. Assume also that, as a 
result of amortization deductions, the adjusted basis of the goodwill 
and going concern value immediately before the decrease in AGUB is $40. 
A similar adjustment to income is made in 2007 with respect to the $60 
of previously amortized goodwill and going concern value.
    (vi) In summary, the basis of T's acquisition date assets, as of 
January 1, 2007, is as follows:

------------------------------------------------------------------------
                             Asset                                Basis
------------------------------------------------------------------------
Machinery......................................................       $0
Land...........................................................      225
Goodwill and going concern value...............................        0
------------------------------------------------------------------------

    Example 3. (i) Assume that the facts are the same as Sec. 1.338-
6(d) Example 2 except that the recently purchased stock is acquired for 
$1,600 plus additional payments that are contingent upon T's future 
earnings. Assume that, under general principles of tax law, such later 
payments are properly taken into account when paid. Thus, T's AGUB, 
determined as of the beginning of the day after the acquisition date 
(after reduction by T's cash of $200), is $2,500 and is allocated among 
T's acquisition date assets under Sec. 1.338-6(c)(3)(iii) as follows:

------------------------------------------------------------------------
                                                                 Final
           Class                          Asset               allocation
------------------------------------------------------------------------
I..........................  Cash...........................        $200
II.........................  Portfolio of actively traded           *268
                              securities.
III........................  Accounts receivable............         536
IV.........................  Inventory......................         268
V..........................  Building.......................         714
V..........................  Land...........................         178
V..........................  Investment in T1...............         402
VII........................  Goodwill and going concern              134
                              value.
 
------------------------------------------------------------------------
* All numbers rounded for convenience.

    (ii) At a later point in time, P pays an additional $200 for its 
recently purchased T stock. Assume that the additional consideration 
paid would not increase T's tax liability for the deemed sale tax 
consequences.
    (iii) T's AGUB increases by $200, from $2,700 to $2,900. This $200 
increase in AGUB is accounted for in accordance with the provisions of 
Sec. 1.338-6(c)(3)(iii).
    (iv) The hypothetical purchase price of the T stock is redetermined 
as follows:

Grossed-up basis of recently purchased stock as determined        $1,800
 under Sec. 1.338-5(c) ($1,800 x (1- .2)/.8).................
Basis of nonrecently purchased stock as if the gain recognition      450
 election under Sec. 1.338-5(d)(2) had been made ($1,800 x .2/
 (1- .2))......................................................
Liabilities....................................................    1,000
                                                                --------
    Total......................................................    3,250
 

    (v) Since the redetermined hypothetical purchase price ($3,250) 
exceeds the redetermined AGUB ($2,900) and no gain recognition election 
was made under section 338(b)(3), the rules of Sec. 1.338-6(c)(3)(iii) 
are reapplied using the redetermined hypothetical purchase price and the 
redetermined AGUB.

[[Page 171]]

    (vi) First, an AGUB amount equal to the redetermined hypothetical 
purchase price ($3,250) is allocated among the assets under the general 
rules of Sec. 1.338-6. The allocation is set forth in the column below 
entitled Hypothetical Allocation. Next, the allocation to each asset in 
Class II through Class VII is multiplied by a fraction with a numerator 
equal to the actual redetermined AGUB reduced by the amount of Class I 
assets ($2,900 - $200 = $2,700) and a denominator equal to the 
redetermined hypothetical purchase price reduced by the amount of Class 
I assets ($3,250 - $200 = $3,050), or 2,700/3,050. This produces the 
Final Allocation:

------------------------------------------------------------------------
                                                Hypothetical     Final
        Class                   Asset            allocation   allocation
------------------------------------------------------------------------
I...................  Cash....................         $200         $200
II..................  Portfolio of actively             300         *266
                       traded securities.
III.................  Accounts receivable.....          600          531
IV..................  Inventory...............          300          266
V...................  Building................          800          708
V...................  Land....................          200          177
V...................  Investment in T1........          450          398
VII.................  Goodwill and going                400          354
                       concern value.
                                               -------------------------
                       Total..................        3,250        2900
------------------------------------------------------------------------
* All numbers rounded for convenience.

    (vii) As illustrated by this example, reapplying Sec. 1.338-6(c)(3) 
results in a basis increase for some assets and a basis decrease for 
other assets. The amount of redetermined AGUB allocated to each 
acquisition date asset is determined as follows:

------------------------------------------------------------------------
                                     Original   Redetermined
               Asset                  (c)(3)       (c)(3)      Increase
                                    allocation   allocation   (decrease)
------------------------------------------------------------------------
Portfolio of actively traded              $268         $266         $(2)
 securities.......................
Accounts receivable...............         536          531          (5)
Inventory.........................         268          266          (2)
Building..........................         714          708          (6)
Land..............................         178          177          (1)
Investment in T1..................         402          398          (4)
Goodwill and going concern value..         134          354          220
                                   -------------------------------------
    Total.........................       2,500        2,700          200
------------------------------------------------------------------------

    Example 4. (i) On January 1, 2001, P purchases all of the 
outstanding T stock and makes a section 338 election for T. P pays $700 
of cash and promises also to pay a maximum $300 of contingent 
consideration at various times in the future. Assume that, under general 
principles of tax law, such later payments are properly taken into 
account by P when paid. Assume also, however, that the current fair 
market value of the contingent payments is reasonably ascertainable. The 
fair market value of T's assets (other than goodwill and going concern 
value) as of the beginning of the following day is as follows:

------------------------------------------------------------------------
                                                                  Fair
        Asset class                       Assets                 market
                                                                 value
------------------------------------------------------------------------
V..........................  Equipment.......................       $200
V..........................  Non-actively traded securities..        100
V..........................  Building........................        500
                                                              ----------
                              Total..........................        800
------------------------------------------------------------------------

    (ii) T has no liabilities. The AGUB is $700. In calculating ADSP, 
assume that, under Sec. 1.1001-1, the current amount realized 
attributable to the contingent consideration is $200. ADSP is therefore 
$900 ($700 cash plus $200).
    (iii) (A) The AGUB of $700 is ratably allocated among T's Class V 
acquisition date assets in proportion to their fair market values as 
follows:

------------------------------------------------------------------------
                            Asset                                Basis
------------------------------------------------------------------------
Equipment ($700 x 200/800)...................................    $175.00
Non-actively traded securities ($700 x 100/800)..............      87.50
Building ($700 x 500/800)....................................     437.50
                                                              ----------
    Total....................................................     700.00
------------------------------------------------------------------------

    (B) No amount is allocated to goodwill or going concern value.
    (iv) (A) The ADSP of $900 is ratably allocated among T's Class V 
acquisition date assets in proportion to their fair market values as 
follows:

------------------------------------------------------------------------
                            Asset                                Basis
------------------------------------------------------------------------
Equipment....................................................       $200
Non-actively traded securities...............................        100
Building.....................................................        500
                                                              ----------
    Total....................................................        800
------------------------------------------------------------------------

    (B) The remaining ADSP, $100, is allocated to goodwill and going 
concern value (Class VII).

[[Page 172]]

    (v) P and T file a consolidated return for 2001 and each following 
year with P as the common parent of the affiliated group.
    (vi) In 2004, a contingent amount of $120 is paid by P. For old T, 
this payment has no effect on ADSP, because the payment is accounted for 
as a separate transaction. We have assumed that, under general 
principles of tax law, the payment is properly taken into account by P 
at the time made. Therefore, in 2004, there is an increase in new T's 
AGUB of $120. The amount of the increase allocated to each acquisition 
date asset is determined as follows:

------------------------------------------------------------------------
                                       Original  Redetermined
                Asset                    AGUB        AGUB       Increase
------------------------------------------------------------------------
Equipment...........................    $175.00      $200.00      $25.00
Land................................      87.50       100.00       12.50
Building............................     437.50       500.00       62.50
Goodwill and going concern value....       0.00        20.00       20.00
                                     -----------------------------------
    Total...........................     700.00       820.00      120.00
------------------------------------------------------------------------


[T.D. 8940, 66 FR 9929, Feb. 13, 2001]



Sec. 1.338-8  Asset and stock consistency.

    (a) Introduction--(1) Overview. This section implements the 
consistency rules of sections 338(e) and (f). Under this section, no 
election under section 338 is deemed made or required with respect to 
target or any target affiliate. Instead, the person acquiring an asset 
may have a carryover basis in the asset.
    (2) General application. The consistency rules generally apply if 
the purchasing corporation acquires an asset directly from target during 
the target consistency period and target is a subsidiary in a 
consolidated group. In such a case, gain from the sale of the asset is 
reflected under the investment adjustment provisions of the consolidated 
return regulations in the basis of target stock and may reduce gain from 
the sale of the stock. See Sec. 1.1502-32 (investment adjustment 
provisions). Under the consistency rules, the purchasing corporation 
generally takes a carryover basis in the asset, unless a section 338 
election is made for target. Similar rules apply if the purchasing 
corporation acquires an asset directly from a lower-tier target 
affiliate if gain from the sale is reflected under the investment 
adjustment provisions in the basis of target stock.
    (3) Extensions of the general rules. If an arrangement exists, 
paragraph (f) of this section generally extends the carryover basis rule 
to certain cases in which the purchasing corporation acquires assets 
indirectly from target (or a lower-tier target affiliate). To prevent 
avoidance of the consistency rules, paragraph (j) of this section also 
may extend the consistency period or the 12-month acquisition period and 
may disregard the presence of conduits.
    (4) Application where certain dividends are paid. Paragraph (g) of 
this section extends the carryover basis rule to certain cases in which 
dividends are paid to a corporation that is not a member of the same 
consolidated group as the distributing corporation. Generally, this rule 
applies where a 100 percent dividends received deduction is used in 
conjunction with asset dispositions to achieve an effect similar to that 
available under the investment adjustment provisions of the consolidated 
return regulations.
    (5) Application to foreign target affiliates. Paragraph (h) of this 
section extends the carryover basis rule to certain cases involving 
target affiliates that are controlled foreign corporations.
    (6) Stock consistency. This section limits the application of the 
stock consistency rules to cases in which the rules are necessary to 
prevent avoidance of the asset consistency rules. Following the general 
treatment of a section 338(h)(10) election, a sale of a corporation's 
stock is treated as a sale of the corporation's assets if a section 
338(h)(10) election is made. Because gain from this asset sale may be 
reflected in the basis of the stock of a higher-tier target, the 
carryover basis rule may apply to the assets.
    (b) Consistency for direct acquisitions--(1) General rule. The basis 
rules of paragraph (d) of this section apply to an asset if--
    (i) The asset is disposed of during the target consistency period;
    (ii) The basis of target stock, as of the target acquisition date, 
reflects gain from the disposition of the asset (see paragraph (c) of 
this section); and
    (iii) The asset is owned, immediately after its acquisition and on 
the target acquisition date, by a corporation that

[[Page 173]]

acquires stock of target in the qualified stock purchase (or by an 
affiliate of an acquiring corporation).
    (2) Section 338(h)(10) elections. For purposes of this section, if a 
section 338(h)(10) election is made for a corporation acquired in a 
qualified stock purchase--
    (i) The acquisition is treated as an acquisition of the 
corporation's assets (see Sec. 1.338(h)(10)-1); and
    (ii) The corporation is not treated as target.
    (c) Gain from disposition reflected in basis of target stock. For 
purposes of this section:
    (1) General rule. Gain from the disposition of an asset is reflected 
in the basis of a corporation's stock if the gain is taken into account 
under Sec. 1.1502-32, directly or indirectly, in determining the basis 
of the stock, after applying section 1503(e) and other provisions of the 
Internal Revenue Code.
    (2) Gain not reflected if section 338 election made for target. Gain 
from the disposition of an asset that is otherwise reflected in the 
basis of target stock as of the target acquisition date is not 
considered reflected in the basis of target stock if a section 338 
election is made for target.
    (3) Gain reflected by reason of distributions. Gain from the 
disposition of an asset is not considered reflected in the basis of 
target stock merely by reason of the receipt of a distribution from a 
target affiliate that is not a member of the same consolidated group as 
the distributee. See paragraph (g) of this section for the treatment of 
dividends eligible for a 100 percent dividends received deduction.
    (4) Controlled foreign corporations. For a limitation applicable to 
gain of a target affiliate that is a controlled foreign corporation, see 
paragraph (h)(2) of this section.
    (5) Gain recognized outside the consolidated group. Gain from the 
disposition of an asset by a person other than target or a target 
affiliate is not reflected in the basis of a corporation's stock unless 
the person is a conduit, as defined in paragraph (j)(4) of this section.
    (d) Basis of acquired assets--(1) Carryover basis rule. If this 
paragraph (d) applies to an asset, the asset's basis immediately after 
its acquisition is, for all purposes of the Internal Revenue Code, its 
adjusted basis immediately before its disposition.
    (2) Exceptions to carryover basis rule for certain assets. The 
carryover basis rule of paragraph (d)(1) of this section does not apply 
to the following assets--
    (i) Any asset disposed of in the ordinary course of a trade or 
business (see section 338(e)(2)(A));
    (ii) Any asset the basis of which is determined wholly by reference 
to the adjusted basis of the asset in the hands of the person that 
disposed of the asset (see section 338(e)(2)(B));
    (iii) Any debt or equity instrument issued by target or a target 
affiliate (see paragraph (h)(3) of this section for an exception 
relating to the stock of a target affiliate that is a controlled foreign 
corporation);
    (iv) Any asset the basis of which immediately after its acquisition 
would otherwise be less than its adjusted basis immediately before its 
disposition; and
    (v) Any asset identified by the Internal Revenue Service in a 
revenue ruling or revenue procedure.
    (3) Exception to carryover basis rule for de minimis assets. The 
carryover basis rules of this section do not apply to an asset if the 
asset is not disposed of as part of the same arrangement as the 
acquisition of target and the aggregate amount realized for all assets 
otherwise subject to the carryover basis rules of this section does not 
exceed $250,000.
    (4) Mitigation rule--(i) General rule. If the carryover basis rules 
of this section apply to an asset and the asset is transferred to a 
domestic corporation in a transaction to which section 351 applies or as 
a contribution to capital and no gain is recognized, the transferor's 
basis in the stock of the transferee (but not the transferee's basis in 
the asset) is determined without taking into account the carryover basis 
rules of this section.
    (ii) Time for transfer. This paragraph (d)(4) applies only if the 
asset is transferred before the due date (including extensions) for the 
transferor's income tax return for the year that includes the last date 
for which a section 338 election may be made for target.

[[Page 174]]

    (e) Examples--(1) In general. For purposes of the examples in this 
section, unless otherwise stated, the basis of each asset is the same 
for determining earnings and profits and taxable income, the exceptions 
to paragraph (d)(1) of this section do not apply, the taxable year of 
all persons is the calendar year, and the following facts apply: S is 
the common parent of a consolidated group that includes T, T1, T2, and 
T3; S owns all of the stock of T and T3; and T owns all of the stock of 
T1, which owns all of the stock of T2. B is unrelated to the S group and 
owns all of the stock of P, which owns all of the stock of P1. Y and Y1 
are partnerships that are unrelated to the S group but may be related to 
the P group. Z is a corporation that is not related to any of the other 
parties.
[GRAPHIC] [TIFF OMITTED] TC17OC91.000

    (2) Direct acquisitions. Paragraphs (b), (c), and (d) of this 
section may be illustrated by the following examples:

    Example 1. Asset acquired from target by purchasing corporation. (a) 
On February 1 of Year 1, T sells an asset to P1 and recognizes gain. T's 
gain from the disposition of the asset is taken into account under Sec. 
1.1502-32 in determining S's basis in the T stock. On January 1 of Year 
2, P1 makes a qualified stock purchase of T from S. No section 338 
election is made for T.
    (b) T disposed of the asset during its consistency period, gain from 
the asset disposition is reflected in the basis of the T stock as of T's 
acquisition date (January 1 of Year 2), and the asset is owned both 
immediately after the asset disposition (February 1 of Year 1) and on 
T's acquisition date by P1, the corporation that acquired T stock in the 
qualified stock purchase. Consequently, under paragraph (b) of this 
section, paragraph (d)(1) of this section applies to the asset and P1's 
basis in the asset is T's adjusted basis in the asset immediately before 
the sale to P1.
    Example 2. Gain from section 338(h)(10) election reflected in stock 
basis. (a) On February 1 of Year 1, P1 makes a qualified stock purchase 
of T2 from T1. A section 338(h)(10) election is made for T2 and T2 
recognizes gain on each of its assets. T2's gain is taken into account 
under Sec. 1.1502-32 in determining S's basis in the T stock. On 
January 1 of Year 2, P1 makes a qualified stock purchase of T from S. No 
section 338 election is made for T.
    (b) Under paragraph (b)(2) of this section, the acquisition of the 
T2 stock is treated as an acquisition of T2's assets on February 1 of 
Year 1, because a section 338(h)(10) election is made for T2. The gain 
recognized by T2 under section 338(h)(10) is reflected in S's basis in 
the T stock as of T's acquisition date. Because the other requirements 
of paragraph (b) of this section are satisfied,

[[Page 175]]

paragraph (d)(1) of this section applies to the assets and new T2's 
basis in its assets is old T2's adjusted basis in the assets immediately 
before the disposition.
    Example 3. Corporation owning asset ceases affiliation with 
corporation purchasing target before target acquisition date. (a) On 
February 1 of Year 1, T sells an asset to P1 and recognizes gain. On 
December 1 of Year 1, P disposes of all of the P1 stock while P1 still 
owns the asset. On January 1 of Year 2, P makes a qualified stock 
purchase of T from S. No section 338 election is made for T.
    (b) Immediately after T's disposition of the asset, the asset is 
owned by P1 which is affiliated on that date with P, the corporation 
that acquired T stock in the qualified stock purchase. However, the 
asset is owned by a corporation (P1) that is no longer affiliated with P 
on T's acquisition date. Although the other requirements of paragraph 
(b) of this section are satisfied, the requirements of paragraph 
(b)(1)(iii) of this section are not satisfied. Consequently, the basis 
rules of paragraph (d) of this section do not apply to the asset by 
reason of P1's acquisition.
    (c) If P acquires all of the Z stock and P1 transfers the asset to Z 
on or before T's acquisition date (January 1 of Year 2), the asset is 
owned by an affiliate of P both on February 1 of Year 1 (P1) and on 
January 1 of Year 2 (Z). Consequently, all of the requirements of 
paragraph (b) of this section are satisfied and paragraph (d)(1) of this 
section applies to the asset and P1's basis in the asset is T's adjusted 
basis in the asset immediately before the sale to P1.
    Example 4. Gain reflected in stock basis notwithstanding offsetting 
loss or distribution. (a) On April 1 of Year 1, T sells an asset to P1 
and recognizes gain. In Year 1, T distributes an amount equal to the 
gain. On March 1 of Year 2, P makes a qualified stock purchase of T from 
S. No section 338 election is made for T.
    (b) Although, as a result of the distribution, there is no 
adjustment with respect to the T stock under Sec. 1.1502-32 for Year 1, 
T's gain from the disposition of the asset is considered reflected in 
S's basis in the T stock. The gain is considered to have been taken into 
account under Sec. 1.1502-32 in determining the adjustments to S's 
basis in the T stock because S's basis in the T stock is different from 
what it would have been had there been no gain.
    (c) If T distributes an amount equal to the gain on February 1 of 
Year 2, rather than in Year 1, the results would be the same because S's 
basis in the T stock is different from what it would have been had there 
been no gain. If the distribution in Year 2 is by reason of an election 
under Sec. 1.1502-32(f)(2), the results would be the same.
    (d) If, in Year 1, T does not make a distribution and the S group 
does not file a consolidated return, but, in Year 2, the S group does 
file a consolidated return and makes an election under Sec. 1.1502-
32(f)(2) for T, the results would be the same. S's basis in the T stock 
is different from what it would have been had there been no gain. 
Paragraph (c)(3) of this section (gain not considered reflected by 
reason of distributions) does not apply to the deemed distribution under 
the election because S and T are members of the same consolidated group. 
If T distributes an amount equal to the gain in Year 2 and no election 
is made under Sec. 1.1502-32(f)(2), the results would be the same.
    (e) If, in Year 1, T incurs an unrelated loss in an amount equal to 
the gain, rather than distributing an amount equal to the gain, the 
results would be the same because the gain is taken into account under 
Sec. 1.1502-32 in determining S's basis in the T stock.
    Example 5. Gain of a target affiliate reflected in stock basis after 
corporate reorganization. (a) On February 1 of Year 1, T3 sells an asset 
to P1 and recognizes gain. On March 1 of Year 1, S contributes the T3 
stock to T in a transaction qualifying under section 351. On January 15 
of Year 2, P1 makes a qualified stock purchase of T from S. No section 
338 election is made for T.
    (b) T3's gain from the asset sale is taken into account under Sec. 
1.1502-32 in determining S's basis in the T3 stock. Under section 358, 
the gain that is taken into account under Sec. 1.1502-32 in determining 
S's basis in the T3 stock is also taken into account in determining S's 
basis in the T stock following S's contribution of the T3 stock to T. 
Consequently, under paragraph (b) of this section, paragraph (d)(1) of 
this section applies to the asset and P1's basis in the asset is T3's 
adjusted basis in the asset immediately before the sale to P1.
    (c) If on March 1 of Year 1, rather than S contributing the T3 stock 
to T, S causes T3 to merge into T in a transaction qualifying under 
section 368(a)(1)(D), the results would be the same.
    Example 6. Gain not reflected if election under section 338 made. 
(a) On February 1 of Year 1, T1 sells an asset to P1 and recognizes 
gain. On January 1 of Year 2, P1 makes a qualified stock purchase of T1 
from T. A section 338 election (but not a section 338(h)(10) election) 
is made for T1.
    (b) Under paragraph (c)(2) of this section, because a section 338 
election is made for T1, T's basis in the T1 stock is considered not to 
reflect gain from the disposition. Consequently, the requirement of 
paragraph (b)(1)(ii) of this section is not satisfied. Thus, P1's basis 
in the asset is not determined under paragraph (d) of this section. 
Although the section 338 election for T1 results in a qualified stock 
purchase of T2, the requirement of paragraph (b)(1)(ii) of this section 
is not satisfied with respect to T2, whether or not a section 338 
election is made for T2.

[[Page 176]]

    (c) If, on January 1 of Year 2, P1 makes a qualified stock purchase 
of T from S and a section 338 election for T, rather than T1, S's basis 
in the T stock is considered not to reflect gain from T1's disposition 
of the asset. However, the section 338 election for T results in a 
qualified stock purchase of T1. Because the gain is reflected in T's 
basis in the T1 stock, the requirements of paragraph (b) of this section 
are satisfied. Consequently, P1's basis in the asset is determined under 
paragraph (d)(1) of this section unless a section 338 election is also 
made for T1.

    (f) Extension of consistency to indirect acquisitions--(1) 
Introduction. If an arrangement exists (see paragraph (j)(5) of this 
section), this paragraph (f) generally extends the consistency rules to 
indirect acquisitions that have the same effect as direct acquisitions. 
For example, this paragraph (f) applies if, pursuant to an arrangement, 
target sells an asset to an unrelated person who then sells the asset to 
the purchasing corporation.
    (2) General rule. This paragraph (f) applies to an asset if, 
pursuant to an arrangement--
    (i) The asset is disposed of during the target consistency period;
    (ii) The basis of target stock as of, or at any time before, the 
target acquisition date reflects gain from the disposition of the asset; 
and
    (iii) The asset ownership requirements of paragraph (b)(1)(iii) of 
this section are not satisfied, but the asset is owned, at any time 
during the portion of the target consistency period following the target 
acquisition date, by--
    (A) A corporation--
    (1) The basis of whose stock, as of, or at any time before, the 
target acquisition date, reflects gain from the disposition of the 
asset; and
    (2) That is affiliated, at any time during the target consistency 
period, with a corporation that acquires stock of target in the 
qualified stock purchase; or
    (B) A corporation that at the time it owns the asset is affiliated 
with a corporation described in paragraph (f)(2)(iii)(A) of this 
section.
    (3) Basis of acquired assets. If this paragraph (f) applies to an 
asset, the principles of the basis rules of paragraph (d) of this 
section apply to the asset as of the date, following the disposition 
with respect to which gain is reflected in the basis of target's stock, 
that the asset is first owned by a corporation described in paragraph 
(f)(2)(iii) of this section. If the principles of the carryover basis 
rule of paragraph (d)(1) of this section apply to an asset, the asset's 
basis also is reduced (but not below zero) by the amount of any 
reduction in its basis occurring after the disposition with respect to 
which gain is reflected in the basis of target's stock.
    (4) Examples. This paragraph (f) may be illustrated by the following 
examples:

    Example 1. Acquisition of asset from unrelated party by purchasing 
corporation. (a) On February 1 of Year 1, T sells an asset to Z and 
recognizes gain. On February 15 of Year 1, P1 makes a qualified stock 
purchase of T from S. No section 338 election is made for T. P1 buys the 
asset from Z on March 1 of Year 1, before Z has reduced the basis of the 
asset through depreciation or otherwise.
    (b) Paragraph (b) of this section does not apply to the asset 
because the asset ownership requirements of paragraph (b)(1)(iii) of 
this section are not satisfied. However, the asset ownership 
requirements of paragraph (f)(2)(iii) of this section are satisfied 
because, during the portion of T's consistency period following T's 
acquisition date, the asset is owned by P1 while it is affiliated with 
T. Consequently, paragraph (f) of this section applies to the asset if 
there is an arrangement for T to dispose of the asset during T's 
consistency period, for the gain to be reflected in S's basis in the T 
stock as of T's acquisition date, and for P1 to own the asset during the 
portion of T's consistency period following T's acquisition date. If the 
arrangement exists, under paragraph (f)(3) of this section, P1's basis 
in the asset is determined as of March 1 of Year 1, under the principles 
of paragraph (d) of this section. Consequently, P1's basis in the asset 
is T's adjusted basis in the asset immediately before the sale to Z.
    (c) If P1 acquires the asset from Z on January 15 of Year 2 (rather 
than on March 1 of Year 1), and Z's basis in the asset has been reduced 
through depreciation at the time of the acquisition, P1's basis in the 
asset as of January 15 of Year 2 would be T's adjusted basis in the 
asset immediately before the sale to Z, reduced (but not below zero) by 
the amount of the depreciation. Z's basis and depreciation are 
determined without taking into account the basis rules of paragraph (d) 
of this section.
    (d) If P, rather than P1, acquires the asset from Z, the results 
would be the same.

[[Page 177]]

    (e) If, on March 1 of Year 1, P1 acquires the Z stock, rather than 
acquiring the asset from Z, paragraph (f) of this section would apply to 
the asset if an arrangement exists. However, under paragraph (f)(3) of 
this section, Z's basis in the asset would be determined as of February 
1 of Year 1, the date the asset is first owned by a corporation (Z) 
described in paragraph (f)(2)(iii) of this section. Consequently, Z's 
basis in the asset as of February 1 of Year 1, determined under the 
principles of paragraph (d) of this section, would be T's adjusted basis 
in the asset immediately before the sale to Z.
    Example 2. Acquisition of asset from target by target affiliate. (a) 
On February 1 of Year 1, T contributes an asset to T1 in a transaction 
qualifying under section 351 and in which T recognizes gain under 
section 351(b) that is deferred under Sec. 1.1502-13. On March 1 of 
Year 1, P1 makes a qualified stock purchase of T from S and, pursuant to 
Sec. 1.1502-13, the deferred gain is taken into account by T 
immediately before T ceases to be a member of the S group. No section 
338 election is made for T.
    (b) Paragraph (b) of this section does not apply to the asset 
because the asset ownership requirements of paragraph (b)(1)(iii) of 
this section are not satisfied.
    (c) T1 is not described in paragraph (f)(2)(iii)(A) of this section 
because the basis of the T1 stock does not reflect gain from the 
disposition of the asset. Although, under section 358(a)(1)(B)(ii), T's 
basis in the T1 stock is increased by the amount of the gain, the gain 
is not taken into account directly or indirectly under Sec. 1.1502-32 
in determining T's basis in the T1 stock.
    (d) T1 is described in paragraph (f)(2)(iii)(B) of this section 
because, during the portion of T's consistency period following T's 
acquisition date, T1 owns the asset while it is affiliated with T, a 
corporation described in paragraph (f)(2)(iii)(A) of this section. 
Consequently, paragraph (f) of this section applies to the asset if 
there is an arrangement. Under paragraph (j)(5) of this section, the 
fact that, at the time T1 acquires the asset from T, T1 is related 
(within the meaning of section 267(b)) to T indicates that an 
arrangement exists.
    Example 3. Acquisition of asset from target and indirect acquisition 
of target stock. (a) On February 1 of Year 1, T sells an asset to P1 and 
recognizes gain. On March 1 of Year 1, Z makes a qualified stock 
purchase of T from S. No section 338 election is made for T. On January 
1 of Year 2, P1 acquires the T stock from Z other than in a qualified 
stock purchase.
    (b) The asset ownership requirements of paragraph (b)(1)(iii) of 
this section are not satisfied because the asset was never owned by Z, 
the corporation that acquired T stock in the qualified stock purchase 
(or by a corporation that was affiliated with Z at the time it owned the 
asset). However, because the asset is owned by P1 while it is affiliated 
with T during the portion of T's consistency period following T's 
acquisition date, paragraph (f) of this section applies to the asset if 
there is an arrangement. If there is an arrangement, the principles of 
the carryover basis rule of paragraph (d)(1) of this section apply to 
determine P1's basis in the asset unless Z makes a section 338 election 
for T. See paragraph (c)(2) of this section.
    (c) If P1 also makes a qualified stock purchase of T from Z, the 
results would be the same. If there is an arrangement, the principles of 
the carryover basis rule of paragraph (d)(1) of this section apply to 
determine P1's basis in the asset unless Z makes a section 338 election 
for T. However, these principles apply to determine P1's basis in the 
asset if P1, but not Z, makes a section 338 election for T. The basis of 
the T stock no longer reflects, as of T's acquisition date by P1, the 
gain from the disposition of the asset.
    (d) Assume Z purchases the T stock other than in a qualified stock 
purchase and P1 makes a qualified stock purchase of T from Z. Paragraph 
(b) of this section does not apply to the asset because gain from the 
disposition of the asset is not reflected in the basis of T's stock as 
of T's acquisition date (January 1 of Year 2). However, because the gain 
is reflected in S's basis in the T stock before T's acquisition date and 
the asset is owned by P1 while it is affiliated with T during the 
portion of T's consistency period following T's acquisition date, 
paragraph (f) of this section applies to the asset if there is an 
arrangement. If there is an arrangement, the principles of the carryover 
basis rule of paragraph (d)(1) of this section apply to determine P1's 
basis in the asset even if P1 makes a section 338 election for T. The 
basis of the T stock no longer reflects, as of T's acquisition date, the 
gain from the disposition of the asset.
    Example 4. Asset acquired from target affiliate by corporation that 
becomes its affiliate. (a) On February 1 of Year 1, T1 sells an asset to 
P1 and recognizes gain. On February 15 of Year 1, Z makes a qualified 
stock purchase of T from S. No section 338 election is made for T. On 
June 1 of Year 1, P1 acquires the T1 stock from T, other than in a 
qualified stock purchase.
    (b) The asset ownership requirements of paragraph (b)(1)(iii) of 
this section are not satisfied because the asset was never owned by Z, 
the corporation that acquired T stock in the qualified stock purchase 
(or by a corporation that was affiliated with Z at the time it owned the 
asset).
    (c) P1 is not described in paragraph (f)(2)(iii)(A) of this section 
because gain from the disposition of the asset is not reflected in the 
basis of the P1 stock.

[[Page 178]]

    (d) P1 is described in paragraph (f)(2)(iii)(B) of this section 
because the asset is owned by P1 while P1 is affiliated with T1 during 
the portion of T's consistency period following T's acquisition date. T1 
becomes affiliated with Z, the corporation that acquired T stock in the 
qualified stock purchase, during T's consistency period, and, as of T's 
acquisition date, the basis of T1's stock reflects gain from the 
disposition of the asset. Consequently, paragraph (f) of this section 
applies to the asset if there is an arrangement.
    Example 5. De minimis rules. (a) On February 1 of Year 1, T sells an 
asset to P and recognizes gain. On February 15 of Year 1, T1 sells an 
asset to Z and recognizes gain. The aggregate amount realized by T and 
T1 on their respective sales of assets is not more than $250,000. On 
March 1 of Year 1, T3 sells an asset to P and recognizes gain. On April 
1 of Year 1, P makes a qualified stock purchase of T from S. No section 
338 election is made for T. On June 1 of Year 1, P1 buys from Z the 
asset sold by T1.
    (b) Under paragraph (b) of this section, the basis rules of 
paragraph (d) of this section apply to the asset sold by T. Under 
paragraph (f) of this section, the principles of the basis rules of 
paragraph (d) of this section apply to the asset sold by T1 if there is 
an arrangement. Because T3's gain is not reflected in the basis of the T 
stock, the basis rules of this section do not apply to the asset sold by 
T3.
    (c) The de minimis rule of paragraph (d)(3) of this section applies 
to an asset if the asset is not disposed of as part of the same 
arrangement as the acquisition of T and the aggregate amount realized 
for all assets otherwise subject to the carryover basis rules does not 
exceed $250,000. The aggregate amount realized by T and T1 does not 
exceed $250,000. (The asset sold by T3 is not taken into account for 
purposes of the de minimis rule.) Thus, the de minimis rule applies to 
the asset sold by T if the asset is not disposed of as part of the same 
arrangement as the acquisition of T.
    (d) If, under paragraph (f) of this section, the principles of the 
carryover basis rules of paragraph (d)(1) of this section otherwise 
apply to the asset sold by T1 because of an arrangement, the de minimis 
rules of this section do not apply to the asset because of the 
arrangement.
    (e) Assume on June 1 of Year 1, Z acquires the T1 stock from T, 
other than in a qualified stock purchase, rather than P1 buying the T1 
asset, and paragraph (f) of this section applies because there is an 
arrangement. Because the asset was disposed of and the T1 stock was 
acquired as part of the arrangement, the de minimis rules of this 
section do not apply to the asset.

    (g) Extension of consistency if dividends qualifying for 100 percent 
dividends received deduction are paid--(1) General rule for direct 
acquisitions from target. Unless a section 338 election is made for 
target, the basis rules of paragraph (d) of this section apply to an 
asset if--
    (i) Target recognizes gain (whether or not deferred) on disposition 
of the asset during the portion of the target consistency period that 
ends on the target acquisition date;
    (ii) The asset is owned, immediately after the asset disposition and 
on the target acquisition date, by a corporation that acquires stock of 
target in the qualified stock purchase (or by an affiliate of an 
acquiring corporation); and
    (iii) During the portion of the target consistency period that ends 
on the target acquisition date, the aggregate amount of dividends paid 
by target, to which section 243(a)(3) applies, exceeds the greater of--
    (A) $250,000; or
    (B) 125 percent of the yearly average amount of dividends paid by 
target, to which section 243(a)(3) applies, during the three calendar 
years immediately preceding the year in which the target consistency 
period begins (or, if shorter, the period target was in existence).
    (2) Other direct acquisitions having same effect. The basis rules of 
paragraph (d) of this section also apply to an asset if the effect of a 
transaction described in paragraph (g)(1) of this section is achieved 
through any combination of disposition of assets and payment of 
dividends to which section 243(a)(3) applies (or any other dividends 
eligible for a 100 percent dividends received deduction). See paragraph 
(h)(4) of this section for additional rules relating to target 
affiliates that are controlled foreign corporations.
    (3) Indirect acquisitions. The principles of paragraph (f) of this 
section also apply for purposes of this paragraph (g).
    (4) Examples. This paragraph (g) may be illustrated by the following 
examples:

    Example 1. Asset acquired from target paying dividends to which 
section 243(a)(3) applies. (a) The S group does not file a consolidated 
return. In Year 1, Year 2, and Year 3, T pays dividends to S to which 
section 243(a)(3) applies of $200,000, $250,000, and $300,000, 
respectively. On February 1 of Year 4, T sells an asset to P and 
recognizes gain. On January 1

[[Page 179]]

of Year 5, P makes a qualified stock purchase of T from S. No section 
338 election is made for T. During the portion of T's consistency period 
that ends on T's acquisition date, T pays S dividends to which section 
243(a)(3) applies of $1,000,000.
    (b) Under paragraph (g)(1) of this section, paragraph (d) of this 
section applies to the asset. T recognizes gain on disposition of the 
asset during the portion of T's consistency period that ends on T's 
acquisition date, the asset is owned by P immediately after the 
disposition and on T's acquisition date, and T pays dividends described 
in paragraph (g)(1)(iii) of this section. Consequently, under paragraph 
(d)(1) of this section, P's basis in the asset is T's adjusted basis in 
the asset immediately before the sale to P.
    (c) If T is a controlled foreign corporation, the results would be 
the same if T pays dividends in the amount described in paragraph 
(g)(1)(iii) of this section that qualify for a 100 percent dividends 
received deduction. See sections 243(e) and 245.
    (d) If S and T3 file a consolidated return in which T, T1, and T2 do 
not join, the results would be the same because the dividends paid by T 
are still described in paragraph (g)(1)(iii) of this section.
    (e) If T, T1, and T2 file a consolidated return in which S and T3 do 
not join, the results would be the same because the dividends paid by T 
are still described in paragraph (g)(1)(iii) of this section.
    Example 2. Asset disposition by target affiliate achieving same 
effect. (a) The S group does not file a consolidated return. On February 
1 of Year 1, T2 sells an asset to P and recognizes gain. T pays 
dividends to S described in paragraph (g)(1)(iii) of this section. On 
January 1 of Year 2, P makes a qualified stock purchase of T from S. No 
section 338 election is made for T.
    (b) Paragraph (g)(1) of this section does not apply to the asset 
because T did not recognize gain on the disposition of the asset. 
However, under paragraph (g)(2) of this section, because the asset 
disposition by T2 and the dividends paid by T achieve the effect of a 
transaction described in paragraph (g)(1) of this section, the carryover 
basis rule of paragraph (d)(1) of this section applies to the asset. The 
effect was achieved because T2 is a lower-tier affiliate of T and the 
dividends paid by T to S reduce the value to S of T and its lower-tier 
affiliates.
    (c) If T2 is a controlled foreign corporation, the results would be 
the same because T2 is a lower-tier affiliate of T and the dividends 
paid by T to S reduce the value to S of T and its lower-tier affiliates.
    (d) If P buys an asset from T3, rather than T2, the asset 
disposition and the dividends do not achieve the effect of a transaction 
described in paragraph (g)(1) of this section because T3 is not a lower-
tier affiliate of T. Thus, the basis rules of paragraph (d) of this 
section do not apply to the asset. The results would be the same whether 
or not P also acquires the T3 stock (whether or not in a qualified stock 
purchase).
    Example 3. Dividends by target affiliate achieving same effect. (a) 
The S group does not file a consolidated return. On February 1 of Year 
1, T1 sells an asset to P and recognizes gain. On January 1 of Year 2, P 
makes a qualified stock purchase of T from S. No section 338 election is 
made for T. T does not pay dividends to S described in paragraph 
(g)(1)(iii) of this section. However, T1 pays dividends to T that would 
be described in paragraph (g)(1)(iii) of this section if T1 were a 
target.
    (b) Paragraph (g)(1) of this section does not apply to the asset 
because T did not recognize gain on the disposition of the asset and did 
not pay dividends described in paragraph (g)(1)(iii) of this section. 
Further, paragraph (g)(2) of this section does not apply because the 
dividends paid by T1 to T do not reduce the value to S of T and its 
lower-tier affiliates.
    (c) If both S and T own T1 stock and T1 pays dividends to S that 
would be described in paragraph (g)(1)(iii) of this section if T1 were a 
target, paragraph (g)(2) of this section would apply because the 
dividends paid by T1 to S reduce the value to S of T and its lower-tier 
affiliates. If T, rather than T1, sold the asset to P, the results would 
be the same. Further, if T and T1 pay dividends to S that, only when 
aggregated, would be described in paragraph (g)(1)(iii) of this section 
(if they were all paid by T), the results would be the same.
    Example 4. Gain reflected by reason of dividends. (a) S and T file a 
consolidated return in which T1 and T2 do not join. On February 1 of 
Year 1, T1 sells an asset to P and recognizes gain. On January 1 of Year 
2, P makes a qualified stock purchase of T from S. No section 338 
election is made for T. T1 pays dividends to T that would be described 
in paragraph (g)(1)(iii) of this section if T1 were a target.
    (b) The requirements of paragraph (b) of this section are not 
satisfied because, under paragraph (c)(3) of this section, gain from 
T1's sale is not reflected in S's basis in the T stock by reason of the 
dividends paid by T1 to T.
    (c) Although the dividends paid by T1 to T do not reduce the value 
to S of T and its lower-tier affiliates, paragraph (g)(2) of this 
section applies because the dividends paid by T1 to T are taken into 
account under Sec. 1.1502-32 in determining S's basis in the T stock. 
Consequently, the carryover basis rule of paragraph (d)(1) of this 
section applies to the asset.

    (h) Consistency for target affiliates that are controlled foreign 
corporations--(1) In general. This paragraph (h) applies only

[[Page 180]]

if target is a domestic corporation. For additional rules that may apply 
with respect to controlled foreign corporations, see paragraph (g) of 
this section. The definitions and nomenclature of Sec. 1.338-2(b) and 
(c) and paragraph (e) of this section apply for purposes of this 
section.
    (2) Income or gain resulting from asset dispositions--(i) General 
rule. Income or gain of a target affiliate that is a controlled foreign 
corporation from the disposition of an asset is not reflected in the 
basis of target stock under paragraph (c) of this section unless the 
income or gain results in an inclusion under section 951(a)(1)(A), 
951(a)(1)(C), 1291 or 1293.
    (ii) Basis of controlled foreign corporation stock. If, by reason of 
paragraph (h)(2)(i) of this section, the carryover basis rules of this 
section apply to an asset, no increase in basis in the stock of a 
controlled foreign corporation under section 961(a) or 1293(d)(1), or 
under regulations issued pursuant to section 1297(b)(5), is allowed to 
target or a target affiliate to the extent the increase is attributable 
to income or gain described in paragraph (h)(2)(i) of this section. A 
similar rule applies to the basis of any property by reason of which the 
stock of the controlled foreign corporation is considered owned under 
section 958(a)(2) or 1297(a).
    (iii) Operating rule. For purposes of this paragraph (h)(2)--
    (A) If there is an income inclusion under section 951 (a)(1)(A) or 
(C), the shareholder's income inclusion is first attributed to the 
income or gain of the controlled foreign corporation from the 
disposition of the asset to the extent of the shareholder's pro rata 
share of such income or gain; and
    (B) Any income or gain under section 1293 is first attributed to the 
income or gain from the disposition of the asset to the extent of the 
shareholder's pro rata share of the income or gain.
    (iv) Increase in asset or stock basis--(A) If the carryover basis 
rules under paragraph (h)(2)(i) of this section apply to an asset, and 
the purchasing corporation disposes of the asset to an unrelated party 
in a taxable transaction and recognizes and includes in its U.S. gross 
income or the U.S. gross income of its shareholders the greater of the 
income or gain from the disposition of the asset by the selling 
controlled foreign corporation that was reflected in the basis of the 
target stock under paragraph (c) of this section, or the gain recognized 
on the asset by the purchasing corporation on the disposition of the 
asset, then the purchasing corporation or the target or a target 
affiliate, as appropriate, shall increase the basis of the selling 
controlled foreign corporation stock subject to paragraph (h)(2)(ii) of 
this section, as of the date of the disposition of the asset by the 
purchasing corporation, by the amount of the basis increase that was 
denied under paragraph (h)(2)(ii) of this section. The preceding 
sentence shall apply only to the extent that the controlled foreign 
corporation stock is owned (within the meaning of section 958(a)) by a 
member of the purchasing corporation's affiliated group.
    (B) If the carryover basis rules under paragraph (h)(2)(i) of this 
section apply to an asset, and the purchasing corporation or the target 
or a target affiliate, as appropriate, disposes of the stock of the 
selling controlled foreign corporation to an unrelated party in a 
taxable transaction and recognizes and includes in its U.S. gross income 
or the U.S. gross income of its shareholders the greater of the gain 
equal to the basis increase that was denied under paragraph (h)(2)(ii) 
of this section, or the gain recognized in the stock by the purchasing 
corporation or by the target or a target affiliate, as appropriate, on 
the disposition of the stock, then the purchasing corporation shall 
increase the basis of the asset, as of the date of the disposition of 
the stock of the selling controlled foreign corporation by the 
purchasing corporation or by the target or a target affiliate, as 
appropriate, by the amount of the basis increase that was denied 
pursuant to paragraph (h)(2)(i) of this section. The preceding sentence 
shall apply only to the extent that the asset is owned (within the 
meaning of section 958(a)) by a member of the purchasing corporation's 
affiliated group.
    (3) Stock issued by target affiliate that is a controlled foreign 
corporation. The exception to the carryover basis rules of this section 
provided in paragraph (d)(2)(iii) of this section does not apply

[[Page 181]]

to stock issued by a target affiliate that is a controlled foreign 
corporation. After applying the carryover basis rules of this section to 
the stock, the basis in the stock is increased by the amount treated as 
a dividend under section 1248 on the disposition of the stock (or that 
would have been so treated but for section 1291), except to the extent 
the basis increase is attributable to the disposition of an asset in 
which a carryover basis is taken under this section.
    (4) Certain distributions--(i) General rule. In the case of a target 
affiliate that is a controlled foreign corporation, paragraph (g) of 
this section applies with respect to the target affiliate by treating 
any reference to a dividend to which section 243(a)(3) applies as a 
reference to any amount taken into account under Sec. 1.1502-32 in 
determining the basis of target stock that is--
    (A) A dividend;
    (B) An amount treated as a dividend under section 1248 (or that 
would have been so treated but for section 1291); or
    (C) An amount included in income under section 951(a)(1)(B).
    (ii) Basis of controlled foreign corporation stock. If the carryover 
basis rules of this section apply to an asset, the basis in the stock of 
the controlled foreign corporation (or any property by reason of which 
the stock is considered owned under section 958(a)(2)) is reduced (but 
not below zero) by the sum of any amounts that are treated, solely by 
reason of the disposition of the asset, as a dividend, amount treated as 
a dividend under section 1248 (or that would have been so treated but 
for section 1291), or amount included in income under section 
951(a)(1)(B). For this purpose, any dividend, amount treated as a 
dividend under section 1248 (or that would have been so treated but for 
section 1291), or amount included in income under section 951(a)(1)(B) 
is considered attributable first to earnings and profits resulting from 
the disposition of the asset.
    (iii) Increase in asset or stock basis--(A) If the carryover basis 
rules under paragraphs (g) and (h)(4)(i) of this section apply to an 
asset, and the purchasing corporation disposes of the asset to an 
unrelated party in a taxable transaction and recognizes and includes in 
its U.S. gross income or the U.S. gross income of its shareholders the 
greater of the gain equal to the basis increase denied in the asset 
pursuant to paragraphs (g) and (h)(4)(i) of this section, or the gain 
recognized on the asset by the purchasing corporation on the disposition 
of the asset, then the purchasing corporation or the target or a target 
affiliate, as appropriate, shall increase the basis of the selling 
controlled foreign corporation stock subject to paragraph (h)(4)(ii) of 
this section, as of the date of the disposition of the asset by the 
purchasing corporation, by the amount of the basis reduction under 
paragraph (h)(4)(ii) of this section. The preceding sentence shall apply 
only to the extent that the controlled foreign corporation stock is 
owned (within the meaning of section 958(a)) by a member of the 
purchasing corporation's affiliated group.
    (B) If the carryover basis rules under paragraphs (g) and (h)(4)(i) 
of this section apply to an asset, and the purchasing corporation or the 
target or a target affiliate, as appropriate, disposes of the stock of 
the selling controlled foreign corporation to an unrelated party in a 
taxable transaction and recognizes and includes in its U.S. gross income 
or the U.S. gross income of its shareholders the greater of the amount 
of the basis reduction under paragraph (h)(4)(ii) of this section, or 
the gain recognized in the stock by the purchasing corporation or by the 
target or a target affiliate, as appropriate, on the disposition of the 
stock, then the purchasing corporation shall increase the basis of the 
asset, as of the date of the disposition of the stock of the selling 
controlled foreign corporation by the purchasing corporation or by the 
target or a target affiliate, as appropriate, by the amount of the basis 
increase that was denied pursuant to paragraphs (g) and (h)(4)(i) of 
this section. The preceding sentence shall apply only to the extent that 
the asset is owned (within the meaning of section 958(a)) by a member of 
the purchasing corporation's affiliated group.
    (5) Examples. This paragraph (h) may be illustrated by the following 
examples:


[[Page 182]]


    Example 1. Stock of target affiliate that is a CFC. (a) The S group 
files a consolidated return; however, T2 is a controlled foreign 
corporation. On December 1 of Year 1, T1 sells the T2 stock to P and 
recognizes gain. On January 2 of Year 2, P makes a qualified stock 
purchase of T from S. No section 338 election is made for T.
    (b) Under paragraph (b)(1) of this section, paragraph (d) of this 
section applies to the T2 stock. Under paragraph (h)(3) of this section, 
paragraph (d)(2)(iii) of this section does not apply to the T2 stock. 
Consequently, paragraph (d)(1) of this section applies to the T2 stock. 
However, after applying paragraph (d)(1) of this section, P's basis in 
the T2 stock is increased by the amount of T1's gain on the sale of the 
T2 stock that is treated as a dividend under section 1248. Because P has 
a carryover basis in the T2 stock, the T2 stock is not considered 
purchased within the meaning of section 338(h)(3) and no section 338 
election may be made for T2.
    Example 2. Stock of target affiliate CFC; inclusion under subpart F. 
(a) The S group files a consolidated return; however, T2 is a controlled 
foreign corporation. On December 1 of Year 1, T2 sells an asset to P and 
recognizes subpart F income that results in an inclusion in T1's gross 
income under section 951(a)(1)(A). On January 2 of Year 2, P makes a 
qualified stock purchase of T from S. No section 338 election is made 
for T.
    (b) Because gain from the disposition of the asset results in an 
inclusion under section 951(a)(1)(A), the gain is reflected in the basis 
of the T stock as of T's acquisition date. See paragraph (h)(2)(i) of 
this section. Consequently, under paragraph (b)(1) of this section, 
paragraph (d)(1) of this section applies to the asset. In addition, 
under paragraph (h)(2)(ii) of this section, T1's basis in the T2 stock 
is not increased under section 961(a) by the amount of the inclusion 
that is attributable to the sale of the asset.
    (c) If, in addition to making a qualified stock purchase of T, P 
acquires the T2 stock from T1 on January 1 of Year 2, the results are 
the same for the asset sold by T2. In addition, under paragraph 
(h)(2)(ii) of this section, T1's basis in the T2 stock is not increased 
by the amount of the inclusion that is attributable to the gain on the 
sale of the asset. Further, under paragraph (h)(3) of this section, 
paragraph (d)(1) of this section applies to the T2 stock. However, after 
applying paragraph (d)(1) of this section, P's basis in the T2 stock is 
increased by the amount of T1's gain on the sale of the T2 stock that is 
treated as a dividend under section 1248. Finally, because P has a 
carryover basis in the T2 stock, the T2 stock is not considered 
purchased within the meaning of section 338(h)(3) and no section 338 
election may be made for T2.
    (d) If P makes a qualified stock purchase of T2 from T1, rather than 
of T from S, and T1's gain on the sale of T2 is treated as a dividend 
under section 1248, under paragraph (h)(1) of this section, paragraphs 
(h)(2) and (3) of this section do not apply because there is no target 
that is a domestic corporation. Consequently, the carryover basis rules 
of paragraph do not apply to the asset sold by T2 or the T2 stock.
    Example 3. Gain reflected by reason of section 1248 dividend; gain 
from non-subpart F asset. (a) The S group files a consolidated return; 
however, T2 is a controlled foreign corporation. In Years 1 through 4, 
T2 does not pay any dividends to T1 and no amount is included in T1's 
income under section 951(a)(1)(B). On December 1 of Year 4, T2 sells an 
asset with a basis of $400,000 to P for $900,000. T2's gain of $500,000 
is not subpart F income. On December 15 of Year 4, T1 sells T2, in which 
it has a basis of $600,000, to P for $1,600,000. Under section 1248, 
$800,000 of T1's gain of $1,000,000 is treated as a dividend. However, 
in the absence of the sale of the asset by T2 to P, only $300,000 would 
have been treated as a dividend under section 1248. On December 30 of 
Year 4, P makes a qualified stock purchase of T1 from T. No section 338 
election is made for T1.
    (b) Under paragraph (h)(4) of this section, paragraph (g)(2) of this 
section applies by reference to the amount treated as a dividend under 
section 1248 on the disposition of the T2 stock. Because the amount 
treated as a dividend is taken into account in determining T's basis in 
the T1 stock under Sec. 1.1502-32, the sale of the T2 stock and the 
deemed dividend have the effect of a transaction described in paragraph 
(g)(1) of this section. Consequently, paragraph (d)(1) of this section 
applies to the asset sold by T2 to P and P's basis in the asset is 
$400,000 as of December 1 of Year 4.
    (c) Under paragraph (h)(3) of this section, paragraph (d)(1) of this 
section applies to the T2 stock and P's basis in the T2 stock is 
$600,000 as of December 15 of Year 4. Under paragraphs (h)(3) and 
(4)(ii) of this section, however, P's basis in the T2 stock is increased 
by $300,000 (the amount of T1's gain treated as a dividend under section 
1248 ($800,000), other than the amount treated as a dividend solely as a 
result of the sale of the asset by T2 to P ($500,000)) to $900,000.

    (i) [Reserved]
    (j) Anti-avoidance rules. For purposes of this section--
    (1) Extension of consistency period. The target consistency period 
is extended to include any continuous period that ends on, or begins on, 
any day of the consistency period during which a purchasing corporation, 
or any person related, within the meaning of section 267(b) or 
707(b)(1), to a purchasing corporation, has an arrangement--

[[Page 183]]

    (i) To purchase stock of target; or
    (ii) To own an asset to which the carryover basis rules of this 
section apply, taking into account the extension.
    (2) Qualified stock purchase and 12-month acquisition period. The 
12-month acquisition period is extended if, pursuant to an arrangement, 
a corporation acquires by purchase stock of another corporation 
satisfying the requirements of section 1504(a)(2) over a period of more 
than 12 months.
    (3) Acquisitions by conduits--(i) Asset ownership--(A) General rule. 
A corporation is treated as owning any portion of an asset attributed to 
the corporation from a conduit under section 318(a) (treating any asset 
as stock for this purpose), for purposes of--
    (1) The asset ownership requirements of this section; and
    (2) Determining whether a controlled foreign corporation is a target 
affiliate for purposes of paragraph (h) of this section.
    (B) Application of carryover basis rule. If the basis rules of this 
section apply to the asset, the basis rules of this section apply to the 
entire asset (not just the portion for which ownership is attributed).
    (ii) Stock acquisitions--(A) Purchase by conduit. A corporation is 
treated as purchasing stock of another corporation attributed to the 
corporation from a conduit under section 318(a) on the day the stock is 
purchased by the conduit. The corporation is not treated as purchasing 
the stock, however, if the conduit purchased the stock more than two 
years before the date the stock is first attributed to the corporation.
    (B) Purchase of conduit by corporation. If a corporation purchases 
an interest in a conduit (treating the interest as stock for this 
purpose), the corporation is treated as purchasing on that date any 
stock owned by a conduit on that date and attributed to the corporation 
under section 318(a) with respect to the interest in the conduit that 
was purchased.
    (C) Purchase of conduit by conduit. If a conduit (the first conduit) 
purchases an interest in a second conduit (treating the interest as 
stock for this purpose), the first conduit is treated as purchasing on 
that date any stock owned by a conduit on that date and attributed to 
the first conduit under section 318(a) with respect to the interest in 
the second conduit that was purchased.
    (4) Conduit. A person (other than a corporation) is a conduit as to 
a corporation if--
    (i) The corporation would be treated under section 318(a)(2)(A) and 
(B) (attribution from partnerships, estates, and trusts) as owning any 
stock owned by the person; and
    (ii) The corporation, together with its affiliates, would be treated 
as owning an aggregate of at least 50 percent of the stock owned by the 
person.
    (5) Existence of arrangement. The existence of an arrangement is 
determined under all the facts and circumstances. For an arrangement to 
exist, there need not be an enforceable, written, or unconditional 
agreement, and all the parties to the transaction need not have 
participated in each step of the transaction. One factor indicating the 
existence of an arrangement is the participation of a related party. For 
this purpose, persons are related if they are related within the meaning 
of section 267(b) or 707(b)(1).
    (6) Predecessor and successor--(i) Persons. A reference to a person 
(including target, target affiliate, and purchasing corporation) 
includes, as the context may require, a reference to a predecessor or 
successor. For this purpose, a predecessor is a transferor or 
distributor of assets to a person (the successor) in a transaction--
    (A) To which section 381(a) applies; or
    (B) In which the successor's basis for the assets is determined, 
directly or indirectly, in whole or in part, by reference to the basis 
of the transferor or distributor.
    (ii) Assets. A reference to an asset (the first asset) includes, as 
the context may require, a reference to any asset the basis of which is 
determined, directly or indirectly, in whole or in part, by reference to 
the first asset.
    (7) Examples. This paragraph (j) may be illustrated by the following 
examples:

    Example 1. Asset owned by conduit treated as owned by purchaser of 
target stock. (a) P owns a 60-percent interest in Y. On March 1 of Year 
1, T sells an asset to Y and recognizes gain. On January 1 of Year 2, P 
makes a

[[Page 184]]

qualified stock purchase of T from S. No section 338 election is made 
for T.
    (b) Under paragraph (j)(4) of this section, Y is a conduit with 
respect to P. Consequently, under paragraph (j)(3)(i)(A) of this 
section, P is treated as owning 60% of the asset on March 1 of Year 1 
and January 1 of Year 2. Because P is treated as owning part or all of 
the asset both immediately after the asset disposition and on T's 
acquisition date, paragraph (b) of this section applies to the asset. 
Consequently, paragraph (d)(1) of this section applies to the asset and 
Y's basis in the asset is T's adjusted basis in the asset immediately 
before the sale to Y.
    Example 2. Corporation whose stock is owned by conduit treated as 
affiliate. (a) P owns an 80-percent interest in Y. Y owns all of the 
stock of Z. On March 1 of Year 1, T sells an asset to Z and recognizes 
gain. On January 1 of Year 2, P makes a qualified stock purchase of T 
from S. No section 338 election is made for T.
    (b) Under paragraph (j)(4) of this section, Y is a conduit with 
respect to P. Consequently, under paragraph (j)(3)(i)(A) of this 
section, P is treated as owning 80% of the Z stock and Z is therefore 
treated as an affiliate of P for purposes of applying the asset 
ownership requirements of paragraph (b)(1)(iii) of this section. Because 
Z, an affiliate of P, owns the asset both immediately after the asset 
disposition and on T's acquisition date, paragraph (b) of this section 
applies to the asset, and the asset's basis is determined under 
paragraph (d) of this section.
    (c) If, instead of owning an 80-percent interest in Y, P owned a 79-
percent interest in Y, Z would not be treated as an affiliate of P and 
paragraph (b) of this section would not apply to the asset.
    Example 3. Qualified stock purchase by reason of stock purchase by 
conduit. (a) P owns a 90-percent interest in Y. Y owns a 60-percent 
interest in Y1. On February 1 of Year 2, T sells an asset to P and 
recognizes gain. On January 1 of Year 3, P purchases 70% of the T stock 
from S and Y1 purchases the remaining 30% of the T stock from S.
    (b) Under paragraph (j)(3)(ii)(A) of this section, P is treated as 
purchasing on January 1 of Year 3, the 16.2% of the T stock that is 
attributed to P from Y and Y1 under section 318(a). Thus, for purposes 
of this section, P is treated as making a qualified stock purchase of T 
on January 1 of Year 3, paragraph (b) of this section applies to the 
asset, and the asset's basis is determined under paragraph (d) of this 
section. However, because P is not treated as having made a qualified 
stock purchase of T for purposes of making an election under section 
338, no election can be made for T.
    (c) If Y1 purchases 20% of the T stock from S on December 1 of Year 
1, rather than 30% on January 1 of Year 3, P would be treated as 
purchasing 10.8% of the T stock on December 1 of Year 1. Thus, if 
paragraph (j)(2) of this section (relating to extension of the 12-month 
acquisition period) does not apply, P would not be treated as making a 
qualified stock purchase of T, because P is not treated as purchasing T 
stock satisfying the requirements of section 1504(a)(2) within a 12-
month period.
    Example 4. Successor asset. (a) On February 1 of Year 1, T sells 
stock of X to P1 and recognizes gain. On December 1 of Year 1, P1 
exchanges its X stock for stock in new X in a reorganization qualifying 
under section 368(a)(1)(F). On January 1 of Year 2, P1 makes a qualified 
stock purchase of T from S. No section 338 election is made for T.
    (b) The asset ownership requirements of paragraph (b)(1)(iii) of 
this section are satisfied because, under paragraph (j)(6)(ii) of this 
section, P1 is treated as owning the X stock on T's acquisition date. P1 
is treated as owning the X stock on that date because P1 owns the new X 
stock and P1's basis in the new X stock is determined by reference to 
P1's basis in the X stock. Consequently, under paragraph (d)(1) of this 
section, P1's basis in the X stock on February 1 of Year 1 is T's 
adjusted basis in the X stock immediately before the sale to P1.

[T.D. 8515, 59 FR 2972, Jan. 20, 1994, as amended by T.D. 8597, 60 FR 
36679, July 18, 1995; T.D. 8710, 62 FR 3459, Jan. 23, 1997. Redesignated 
by T.D. 8858, 65 FR 1246, Jan. 7, 2000, as amended by T.D. 8940, 66 FR 
9929, Feb. 13, 2001; 66 FR 17466, Mar. 30, 2001]



Sec. 1.338-9  International aspects of section 338.

    (a) Scope. This section provides guidance regarding international 
aspects of section 338. As provided in Sec. 1.338-2(c)(18), a foreign 
corporation, a DISC, or a corporation for which a section 936 election 
has been made is considered a target affiliate for all purposes of 
section 338. In addition, stock described in section 338(h)(6)(B)(ii) 
held by a target affiliate is not excluded from the operation of section 
338.
    (b) Application of section 338 to foreign targets--(1) In general. 
For purposes of subtitle A, the deemed sale tax consequences, as defined 
in Sec. 1.338-2(c)(7), of a foreign target for which a section 338 
election is made (FT), and the corresponding earnings and profits, are 
taken into account in determining the taxation of FT and FT's direct and 
indirect shareholders. See, however, section 338(h)(16). For example, 
the income and earnings and profits of FT are determined, for purposes 
of sections 551, 951, 1248, and 1293, by taking

[[Page 185]]

into account the deemed sale tax sentence consequences.
    (2) Ownership of FT stock on the acquisition date. A person who 
transfers FT stock to the purchasing corporation on FT's acquisition 
date is considered to own the transferred stock at the close of FT's 
acquisition date. See, e.g., Sec. 1.951-1(f) (relating to determination 
of holding period for purposes of sections 951 through 964). If on the 
acquisition date the purchasing corporation owns a block of FT stock 
that was acquired before FT's acquisition date, the purchasing 
corporation is considered to own such block of stock at the close of the 
acquisition date.
    (3) Carryover FT stock--(i) Definition. FT stock is carryover FT 
stock if--
    (A) FT was a controlled foreign corporation within the meaning of 
section 957 (taking into account section 953(c)) at any time during the 
portion of the 12-month acquisition period that ends on the acquisition 
date; and
    (B) Such stock is owned as of the beginning of the day after FT's 
acquisition date by a person other than a purchasing corporation, or by 
a purchasing corporation if the stock is nonrecently purchased and is 
not subject to a gain recognition election under Sec. 1.338-5(d).
    (ii) Carryover of earnings and profits. The earnings and profits of 
old FT (and associated foreign taxes) attributable to the carryover FT 
stock (adjusted to reflect deemed sale tax sentence consequences) carry 
over to new FT solely for purposes of--
    (A) Characterizing an actual distribution with respect to a share of 
carryover FT stock as a dividend;
    (B) Characterizing gain on a post-acquisition date transfer of a 
share of carryover FT stock as a dividend under section 1248 (if such 
section is otherwise applicable);
    (C) Characterizing an investment of earnings in United States 
property as income under sections 951(a)(1)(B) and 956 (if such sections 
are otherwise applicable); and
    (D) Determining foreign taxes deemed paid under sections 902 and 960 
with respect to the amount treated as a dividend or income by virtue of 
this paragraph (b)(3)(ii) (subject to the operation of section 
338(h)(16)).
    (iii) Cap on carryover of earnings and profits. The amount of 
earnings and profits of old FT taken into account with respect to a 
share of carryover FT stock is limited to the amount that would have 
been included in gross income of the owner of such stock as a dividend 
under section 1248 if--
    (A) The shareholder transferred that share to the purchasing 
corporation on FT's acquisition date for a consideration equal to the 
fair market value of that share on that date; or
    (B) In the case of nonrecently purchased FT stock treated as 
carryover FT stock, a gain recognition election under section 
338(b)(3)(A) applied to that share. For purposes of the preceding 
sentence, a shareholder that is a controlled foreign corporation is 
considered to be a United States person, and the principle of section 
1248(c)(2)(D)(ii) (concerning a United States person's indirect 
ownership of stock in a foreign corporation) applies in determining the 
correct holding period.
    (iv) Post-acquisition date distribution of old FT earnings and 
profits. A post-acquisition date distribution with respect to a share of 
carryover FT stock is considered to be derived first from earnings and 
profits derived after FT's acquisition date and then from earnings and 
profits derived on or before FT's acquisition date.
    (v) Old FT earnings and profits unaffected by post-acquisition date 
deficits. The carryover amount for a share of carryover FT stock is not 
reduced by deficits in earnings and profits incurred by new FT. This 
rule applies for purposes of determining the amount of foreign taxes 
deemed paid regardless of the fact that there are no accumulated 
earnings and profits. For example, a distribution by new FT with respect 
to a share of carryover FT stock is treated as a dividend by the 
distributee to the extent of the carryover amount for that share 
notwithstanding that new FT has no earnings and profits.
    (vi) Character of FT stock as carryover FT stock eliminated upon 
disposition. A share of FT stock is not considered carryover FT stock 
after it is disposed of provided that all gain realized on the transfer 
is recognized at the time of the transfer, or that, if less than all of

[[Page 186]]

the realized gain is recognized, the recognized amount equals or exceeds 
the remaining carryover amount for that share.
    (4) Passive foreign investment company stock. Stock that is owned as 
of the beginning of the day after FT's acquisition date by a person 
other than a purchasing corporation, or by a purchasing corporation if 
the FT stock is nonrecently purchased stock not subject to a gain 
recognition election under Sec. 1.338-5(d), is treated as passive 
foreign investment company stock to the extent provided in section 
1297(b)(1).
    (c) Dividend treatment under section 1248(e). The principles of this 
paragraph (b) apply to shareholders of a domestic corporation subject to 
section 1248(e).
    (d) Allocation of foreign taxes. If a section 338 election is made 
for target (whether foreign or domestic), and target's taxable year 
under foreign law (if any) does not close at the end of the acquisition 
date, foreign income taxes attributable to the foreign taxable income 
earned by target during such foreign taxable year are allocated to old 
target and new target. Such allocation is made under the principles of 
Sec. 1.1502-76(b).
    (e) Operation of section 338(h)(16). [Reserved]
    (f) Examples. (1) Except as otherwise provided, all corporations use 
the calendar year as the taxable year, have no earnings and profits (or 
deficit) accumulated for any taxable year, and have only one class of 
outstanding stock.
    (2) This section may be illustrated by the following examples:

    Example 1. Gain recognition election for carryover FT stock. (a) A 
has owned 90 of the 100 shares of CFCT stock since CFCT was organized on 
March 13, 1989. P has owned the remaining 10 shares of CFCT stock since 
CFCT was organized. Those 10 shares constitute nonrecently purchased 
stock in P's hands within the meaning of section 338(b)(6)(B). On 
November 1, 1994, P purchases A's 90 shares of CFCT stock for $90,000 
and makes a section 338 election for CFCT. P also makes a gain 
recognition election under section 338(b)(3)(A) and Sec. 1.338-5(d).
    (b) CFCT's earnings and profits for its short taxable year ending on 
November 1, 1994, are $50,000, determined without taking into account 
the deemed asset sale. Assume A recognizes gain of $81,000 on the sale 
of the CFCT stock. Further, assume that CFCT recognizes gain of $40,000 
by reason of its deemed sale of assets under section 338(a)(1).
    (c) A's sale of CFCT stock to P is a transfer to which section 1248 
and paragraphs (b)(1) and (2) of this section apply. For purposes of 
applying section 1248(a) to A, the earnings and profits of CFCT for its 
short taxable year ending on November 1, 1994, are $90,000 (the earnings 
and profits for that taxable year as determined under Sec. 1.1248-2(e) 
($50,000) plus earnings from the deemed sale ($40,000)). Thus, A's 
entire gain is characterized as a dividend under section 1248 (but see 
section 338(h)(16)).
    (d) Assume that P recognizes a gain of $9,000 with respect to the 10 
shares of nonrecently purchased CFCT stock by reason of the gain 
recognition election. Because P is treated as selling the nonrecently 
purchased stock for all purposes of the Internal Revenue Code, section 
1248 applies. Thus, under Sec. 1.1248-2(e), $9,000 of the $90,000 of 
earnings and profits for 1994 are attributable to the block of 10 shares 
of CFCT stock deemed sold by P at the close of November 1, 1994 ($90,000 
x 10/100). Accordingly, P's entire gain on the deemed sale of 10 shares 
of CFCT stock is included under section 1248(a) in P's gross income as a 
dividend (but see section 338(h)(16)).
    Example 2. No gain recognition election for carryover FT stock. (a) 
Assume the same facts as in Example 1, except that P does not make a 
gain recognition election.
    (b) The 10 shares of nonrecently purchased CFCT stock held by P is 
carryover FT stock under paragraph (b)(3) of this section. Accordingly, 
the earnings and profits (and attributable foreign taxes) of old CFCT 
carry over to new CFCT solely for purposes of that block of 10 shares. 
The amount of old CFCT's earnings and profits taken into account with 
respect to that block in the event, for example, of a distribution by 
new CFCT with respect to that block is the amount of the section 1248 
dividend that P would have recognized with respect to that block had it 
made a gain recognition election under section 338(b)(3)(A). Under the 
facts of Example 1, P would have recognized a gain of $9,000 with 
respect to that block, all of which would have been a section 1248 
dividend ($90,000 x 10/100). Accordingly, the carryover amount for the 
block of 10 shares of nonrecently purchased CFCT stock is $9,000.
    Example 3. Sale of controlled foreign corporation stock prior to and 
on the acquisition date. (a) X and Y, both U.S. corporations, have each 
owned 50% of the CFCT stock since 1986. Among CFCT's assets are assets 
the sale of which would generate subpart F income. On December 31, 1994, 
X sells its CFCT stock to P. On June 30, 1995, Y sells its CFCT stock to 
P. P makes a section 338 election for CFCT. In both 1994 and 1995, CFCT 
has subpart F income resulting from operations.

[[Page 187]]

    (b) For taxable year 1994, X and Y are United States shareholders on 
the last day of CFCT's taxable year, so pursuant to section 951(a)(1)(A) 
each must include in income its pro rata share of CFCT's subpart F 
income for 1994. Because P's holding period in the CFCT stock acquired 
from X does not begin until January 1, 1995, P is not a United States 
shareholder on the last day of 1994 for purposes of section 951(a)(1)(A) 
(see Sec. 1.951-1(f)). X must then determine the extent to which 
section 1248 recharacterizes its gain on the sale of CFCT stock as a 
dividend.
    (c) For the short taxable year ending June 30, 1995, Y is considered 
to own the CFCT stock sold to P at the close of CFCT's acquisition date. 
Because the acquisition date is the last day of CFCT's taxable year, Y 
and P are United States shareholders on the last day of CFCT's taxable 
year. Pursuant to section 951(a)(1)(A), each must include its pro rata 
share of CFCT's subpart F income for the short taxable year ending June 
30, 1995. This includes any income generated on the deemed sale of 
CFCT's assets. Y must then determine the extent to which section 1248 
recharacterizes its gain on the sale of the CFCT stock as a dividend, 
taking into account any increase in CFCT's earnings and profits due to 
the deemed sale of assets.
    Example 4. Acquisition of control for purposes of section 951 prior 
to the acquisition date. FS owns 100% of the FT stock. On July 1, 1994, 
P buys 60% of the FT stock. On December 31, 1994, P buys the remaining 
40% of the FT stock and makes a section 338 election for FT. For tax 
year 1994, FT has earnings and profits of $1,000 (including earnings 
resulting from the deemed sale). The section 338 election results in 
$500 of subpart F income. As a result of the section 338 election, P 
must include in gross income the following amount under section 
951(a)(1)(A) (see Sec. 1.951-(b)(2)):

FT's subpart F income for 1994................................   $500.00
Less: reduction under section 951(a)(2)(A) for period (1-1-94     249.32
 through 7-1-94) during which FT is not a controlled foreign
 corporation ($500 x 182/365).................................
                                                               ---------
Subpart F income as limited by section 951 (a)(2)(A)..........    250.68
P's pro rata share of subpart F income as determined under        150.41
 section 951(a)(2)(A) (60% x 250.68)..........................
 

    Example 5. Coordination with section 936. (a) T is a corporation for 
which a section 936 election has been made. P makes a qualified stock 
purchase of T and makes a section 338 election for T.
    (b) T's deemed sale of assets under section 338 constitutes a sale 
for purposes of subtitle A of the Internal Revenue Code, including 
section 936(a)(1)(A)(ii). To the extent that the assets deemed sold are 
used in the conduct of an active trade or business in a possession for 
purposes of section 936(a)(1)(A)(i), and assuming all the other 
conditions of section 936 are satisfied, the income from the deemed sale 
qualifies for the credit granted by section 936(a). The source of income 
from the deemed sale is determined as if the assets had actually been 
sold and is not affected for purposes of section 936 by section 
338(h)(16).
    (c) Because new T is treated a new corporation for purposes of 
subtitle A of the Internal Revenue Code, the three year testing period 
in section 936(a)(2)(A) begins again for new T on the day following T's 
acquisition date. Thus, if the character or source of old T's gross 
income disqualified it for the credit under section 936, a fresh start 
is allowed by a section 338 election.

[T.D. 8515, 59 FR 2978, Jan. 20, 1994. Redesignated by T.D. 8858, 65 FR 
1246, Jan. 7, 2000, as amended by T.D. 8940, 66 FR 9929, Feb. 13, 2001; 
66 FR 17466, Mar. 30, 2001]



Sec. 1.338-10  Filing of returns.

    (a) Returns including tax liability from deemed asset sale--(1) In 
general. Except as provided in paragraphs (a)(2) and (3) of this 
section, any deemed sale tax consequences are reported on the final 
return of old target filed for old target's taxable year that ends at 
the close of the acquisition date. Paragraphs (a)(2), (3) and (4) of 
this section do not apply to elections under section 338(h)(10). If old 
target is the common parent of an affiliated group, the final return may 
be a consolidated return (any such consolidated return must also include 
any deemed sale tax consequences of any members of the consolidated 
group that are acquired by the purchasing corporation on the same 
acquisition date as old target).
    (2) Old target's final taxable year otherwise included in 
consolidated return of selling group--(i) General rule. If the selling 
group files a consolidated return for the period that includes the 
acquisition date, old target is disaffiliated from that group 
immediately before the deemed asset sale and must file a deemed sale 
return separate from the group, which includes only the deemed sale tax 
consequences and the carryover items specified in paragraph (a)(2)(iii) 
of this section. The deemed asset sale occurs at the close of the 
acquisition date and is the last transaction of old target and the only 
transaction reported on the separate return.

[[Page 188]]

Except as provided in Sec. 1.338-1(d) (regarding certain transactions 
on the acquisition date), any transactions of old target occurring on 
the acquisition date other than the deemed asset sale are included in 
the selling group's consolidated return. A deemed sale return includes a 
combined deemed sale return as defined in paragraph (a)(4) of this 
section.
    (ii) Separate taxable year. The deemed asset sale included in the 
deemed sale return under this paragraph (a)(2) occurs in a separate 
taxable year, except that old target's taxable year of the sale and the 
consolidated year of the selling group that includes the acquisition 
date are treated as the same year for purposes of determining the number 
of years in a carryover or carryback period.
    (iii) Carryover and carryback of tax attributes. Target's attributes 
may be carried over to, and carried back from, the deemed sale return 
under the rules applicable to a corporation that ceases to be a member 
of a consolidated group.
    (iv) Old target is a component member of purchasing corporation's 
controlled group. For purposes of its deemed sale return, target is a 
component member of the controlled group of corporations including the 
purchasing corporation unless target is treated as an excluded member 
under section 1563(b)(2).
    (4) Combined deemed sale return--(i) General rule. Under section 
338(h)(15), a combined deemed sale return (combined return) may be filed 
for all targets from a single selling consolidated group (as defined in 
Sec. 1.338(h)(10)-1(b)(3)) that are acquired by the purchasing 
corporation on the same acquisition date and that otherwise would be 
required to file separate deemed sale returns. The combined return must 
include all such targets. For example, T and T1 may be included in a 
combined return if--
    (A) T and T1 are directly owned subsidiaries of S;
    (B) S is the common parent of a consolidated group; and
    (C) P makes qualified stock purchases of T and T1 on the same 
acquisition date.
    (ii) Gain and loss offsets. Gains and losses recognized on the 
deemed asset sales by targets included in a combined return are treated 
as the gains and losses of a single target. In addition, loss carryovers 
of a target that were not subject to the separate return limitation year 
restrictions (SRLY restrictions) of the consolidated return regulations 
while that target was a member of the selling consolidated group may be 
applied without limitation to the gains of other targets included in the 
combined return. If, however, a target has loss carryovers that were 
subject to the SRLY restrictions while that target was a member of the 
selling consolidated group, the use of those losses in the combined 
return continues to be subject to those restrictions, applied in the 
same manner as if the combined return were a consolidated return. A 
similar rule applies, when appropriate, to other tax attributes.
    (iii) Procedure for filing a combined return. A combined return is 
made by filing a single corporation income tax return in lieu of 
separate deemed sale returns for all targets required to be included in 
the combined return. The combined return reflects the deemed asset sales 
of all targets required to be included in the combined return. If the 
targets included in the combined return constitute a single affiliated 
group within the meaning of section 1504(a), the income tax return is 
signed by an officer of the common parent of that group. Otherwise, the 
return must be signed by an officer of each target included in the 
combined return. Rules similar to the rules in Sec. 1.1502-75(j) apply 
for purposes of preparing the combined return. The combined return must 
include a statement entitled, ``ELECTION TO FILE A COMBINED RETURN UNDER 
SECTION 338(h)(15).'' The statement must include--
    (A) The name, address, and employer identification number of each 
target required to be included in the combined return; and
    (B) The following declaration: EACH TARGET IDENTIFIED IN THIS 
ELECTION TO FILE A COMBINED RETURN CONSENTS TO THE FILING OF A COMBINED 
RETURN.
    (iv) Consequences of filing a combined return. Each target included 
in a combined return is severally liable for any

[[Page 189]]

tax associated with the combined return. See Sec. 1.338-1(b)(3).
    (5) Deemed sale excluded from purchasing corporation's consolidated 
return. Old target may not be considered a member of any affiliated 
group that includes the purchasing corporation with respect to its 
deemed asset sale.
    (6) Due date for old target's final return--(i) General rule. Old 
target's final return is generally due on the 15th day of the third 
calendar month following the month in which the acquisition date occurs. 
See section 6072 (time for filing income tax returns).
    (ii) Application of Sec. 1.1502-76(c)--(A) In general. Section 
1.1502-76(c) applies to old target's final return if old target was a 
member of a selling group that did not file consolidated returns for the 
taxable year of the common parent that precedes the year that includes 
old target's acquisition date. If the selling group has not filed a 
consolidated return that includes old target's taxable period that ends 
on the acquisition date, target may, on or before the final return due 
date (including extensions), either--
    (1) File a deemed sale return on the assumption that the selling 
group will file the consolidated return; or
    (2) File a return for so much of old target's taxable period as ends 
at the close of the acquisition date on the assumption that the 
consolidated return will not be filed.
    (B) Deemed extension. For purposes of applying Sec. 1.1502-
76(c)(2), an extension of time to file old target's final return is 
considered to be in effect until the last date for making the election 
under section 338.
    (C) Erroneous filing of deemed sale return. If, under this paragraph 
(a)(6)(ii), target files a deemed sale return but the selling group does 
not file a consolidated return, target must file a substituted return 
for old target not later than the due date (including extensions) for 
the return of the common parent with which old target would have been 
included in the consolidated return. The substituted return is for so 
much of old target's taxable year as ends at the close of the 
acquisition date. Under Sec. 1.1502-76(c)(2), the deemed sale return is 
not considered a return for purposes of section 6011 (relating to the 
general requirement of filing a return) if a substituted return must be 
filed.
    (D) Erroneous filing of return for regular tax year. If, under this 
paragraph (a)(6)(ii), target files a return for so much of old target's 
regular taxable year as ends at the close of the acquisition date but 
the selling group files a consolidated return, target must file an 
amended return for old target not later than the due date (including 
extensions) for the selling group's consolidated return. (The amended 
return is a deemed sale return.)
    (E) Last date for payment of tax. If either a substituted or amended 
final return of old target is filed under this paragraph (a)(6)(ii), the 
last date prescribed for payment of tax is the final return due date (as 
defined in paragraph (a)(6)(i) of this section).
    (7) Examples. The following examples illustrate this paragraph (a):

    Example 1. (i) S is the common parent of a consolidated group that 
includes T. The S group files calendar year consolidated returns. At the 
close of June 30 of Year 1, P makes a qualified stock purchase of T from 
S. P makes a section 338 election for T, and T's deemed asset sale 
occurs as of the close of T's acquisition date (June 30).
    (ii) T is considered disaffiliated for purposes of reporting the 
deemed sale tax consequences. Accordingly, T is included in the S 
group's consolidated return through T's acquisition date except that the 
tax liability for the deemed sale tax consequences is reported in a 
separate deemed sale return of T. Provided that T is not treated as an 
excluded member under section 1563(b)(2), T is a component member of P's 
controlled group for the taxable year of the deemed asset sale, and the 
taxable income bracket amounts available in calculating tax on the 
deemed sale return must be limited accordingly.
    (iii) If P purchased the stock of T at 10 a.m. on June 30 of Year 1, 
the results would be the same. See paragraph (a)(2)(i) of this section.
    Example 2. The facts are the same as in Example 1, except that the S 
group does not file consolidated returns. T must file a separate return 
for its taxable year ending on June 30 of Year 1, which return includes 
the deemed asset sale.

    (b) Waiver--(1) Certain additions to tax. An addition to tax or 
additional amount (addition) under subchapter A of chapter 68 of the 
Internal Revenue Code arising on or before the last day for making the 
election under section

[[Page 190]]

338 because of circumstances that would not exist but for an election 
under section 338 is waived if--
    (i) Under the particular statute the addition is excusable upon a 
showing of reasonable cause; and
    (ii) Corrective action is taken on or before the last day.
    (2) Notification. The Internal Revenue Service should be notified at 
the time of correction (e.g., by attaching a statement to a return that 
constitutes corrective action) that the waiver rule of this paragraph 
(b) is being asserted.
    (3) Elections or other actions required to be specified on a timely 
filed return--(i) In general. If paragraph (b)(1) of this section 
applies or would apply if there were an underpayment, any election or 
other action that must be specified on a timely filed return for the 
taxable period covered by the late filed return described in paragraph 
(b)(1) of this section is considered timely if specified on a late-filed 
return filed on or before the last day for making the election under 
section 338.
    (ii) New target in purchasing corporation's consolidated return. If 
new target is includible for its first taxable year in a consolidated 
return filed by the affiliated group of which the purchasing corporation 
is a member on or before the last day for making the election under 
section 338, any election or other action that must be specified in a 
timely filed return for new target's first taxable year (but which is 
not specified in the consolidated return) is considered timely if 
specified in an amended return filed on or before such last day, at the 
place where the consolidated return was filed.
    (4) Examples. The following examples illustrate this paragraph (b):

    Example 1. T is an unaffiliated corporation with a tax year ending 
March 31. At the close of September 20 of Year 1, P makes a qualified 
stock purchase of T. P does not join in filing a consolidated return. P 
makes a section 338 election for T on or before June 15 of Year 2, which 
causes T's taxable year to end as of the close of September 20 of Year 
1. An income tax return for T's taxable period ending on September 20 of 
Year 1 was due on December 15 of Year 1. Additions to tax for failure to 
file a return and to pay tax shown on a return will not be imposed if 
T's return is filed and the tax paid on or before June 15 of Year 2. 
(This waiver applies even if the acquisition date coincides with the 
last day of T's former taxable year, i.e., March 31 of Year 2.) Interest 
on any underpayment of tax for old T's short taxable year ending 
September 20 of Year 1 runs from December 15 of Year 1. A statement 
indicating that the waiver rule of this paragraph is being asserted 
should be attached to T's return.
    Example 2. Assume the same facts as in Example 1. Assume further 
that new T adopts the calendar year by filing, on or before June 15 of 
Year 2, its first return (for the period beginning on September 21 of 
Year 1 and ending on December 31 of Year 1) indicating that a calendar 
year is chosen. See Sec. 1.338-1(b)(1). Any additions to tax or amounts 
described in this paragraph (b) that arise because of the late filing of 
a return for the period ending on December 31 of Year 1 are waived, 
because they are based on circumstances that would not exist but for the 
section 338 election. Notwithstanding this waiver, however, the return 
is still considered due March 15 of Year 2, and interest on any 
underpayment runs from that date.
    Example 3. Assume the same facts as in Example 2, except that T's 
former taxable year ends on October 31. Although prior to the election 
old T had a return due on January 15 of Year 2 for its year ending 
October 31 of Year 1, that return need not be filed because a timely 
election under section 338 was made. Instead, old T must file a final 
return for the period ending on September 20 of Year 1, which is due on 
December 15 of Year 1.
    (c) Effective/applicability date. Paragraph (a)(4)(iii) of this 
section applies to any taxable year beginning on or after May 30, 2006. 
However, taxpayers may apply paragraph (a)(4)(iii) of this section to 
any original Federal income tax return (including any amended return 
filed on or before the due date (including extensions) of such original 
return) timely filed on or after May 30, 2006. For taxable years 
beginning before May 30, 2006, see Sec. 1.338-10 as contained in 26 CFR 
part 1 in effect on April 1, 2006.

[T.D. 8940, 66 FR 9948, Feb. 13, 2001, as amended by T.D. 9264, 71 FR 
30596, May 30, 2006; T.D. 9329, 72 FR 32798, June 14, 2007]



Sec. 1.338-11  Effect of section 338 election on insurance company 
targets.

    (a) In general. This section provides rules that apply when an 
election under section 338 is made for a target that is an insurance 
company. The rules in this section apply in addition to those generally 
applicable upon the making of an election under section

[[Page 191]]

338. In the case of a conflict between the provisions of this section 
and other provisions of the Internal Revenue Code or regulations, the 
rules set forth in this section determine the Federal income tax 
treatment of the parties and the transaction when a section 338 election 
is made for an insurance company target.
    (b) Computation of ADSP and AGUB--(1) Reserves taken into account as 
a liability. Old target's tax reserves are the reserves for Federal 
income tax purposes for any insurance, annuity, and reinsurance 
contracts deemed sold by old target to new target in the deemed asset 
sale. The amount of old target's tax reserves is the amount that is 
properly taken into account by old target for the contracts at the close 
of the taxable year that includes the deemed sale tax consequences 
(before giving effect to the deemed asset sale and assumption 
reinsurance transaction). Old target's tax reserves are a liability of 
old target taken into account in determining ADSP under Sec. 1.338-4 
and a liability of new target taken into account in determining AGUB 
under Sec. 1.338-5.
    (2) Allocation of ADSP and AGUB to specific insurance contracts. For 
purposes of allocating AGUB and ADSP under Sec. Sec. 1.338-6 and 1.338-
7, the fair market value of a specific insurance, reinsurance or annuity 
contract or group of insurance, reinsurance or annuity contracts 
(insurance contracts) is the amount of the ceding commission a willing 
reinsurer would pay a willing ceding company in an arm's length 
transaction for the reinsurance of the contracts if the gross 
reinsurance premium for the contracts were equal to old target's tax 
reserves for the contracts. See Sec. 1.197-2(g)(5) for rules concerning 
the treatment of the amount allocable to insurance contracts acquired in 
the deemed asset sale.
    (c) Application of assumption reinsurance principles--(1) In 
general. If a target is an insurance company, the deemed sale of 
insurance contracts is treated for Federal income tax purposes as an 
assumption reinsurance transaction between old target, as the reinsured 
or ceding company, and new target, as the reinsurer or acquiring 
company, at the close of the acquisition date. The Federal income tax 
treatment of the assumption reinsurance transaction is determined under 
the applicable provisions of subchapter L, chapter 1, subtitle A of the 
Internal Revenue Code, as modified by the rules set forth in this 
section.
    (2) Reinsurance premium. Old target is deemed to pay a gross amount 
of premium in the assumption reinsurance transaction equal to the amount 
of old target's tax reserves for the insurance contracts that are 
acquisition date assets (acquired contracts). New target is deemed to 
receive a reinsurance premium in the amount of old target's tax reserves 
for the acquired contracts. See paragraph (d) of this section for 
circumstances in which new target is deemed to receive additional 
premium. See Sec. 1.817-4(d)(2) for old target's and new target's 
treatment of the premium.
    (3) Ceding commission. Old target is deemed to receive a ceding 
commission in an amount equal to the amount of ADSP allocated to the 
acquired contracts, as determined under Sec. Sec. 1.338-6 and 1.338-7 
and paragraph (b) of this section. New target is deemed to pay a ceding 
commission in an amount equal to the amount of AGUB allocated to the 
acquired contracts, as determined under Sec. Sec. 1.338-6 and 1.338-7 
and paragraph (b) of this section. See Sec. 1.817-4(d)(2) for old 
target's and new target's treatment of the ceding commission.
    (4) Examples. The following examples illustrate this paragraph (c):

    Example 1. (i) Facts. On January 1, 2003, T, an insurance company, 
has the following assets with the following fair market values: $10 
cash, $30 of securities, $10 of equipment, a life insurance contract 
having a value, under paragraph (b)(2) of this section, of $17, and 
goodwill and going concern value. T has tax reserves of $50 and no other 
liabilities. On January 1, 2003, P purchases all of the stock of T for 
$16 and makes a section 338 election for T. For purposes of the 
capitalization requirements of section 848, assume new T has $20 of 
general deductions in its first taxable year ending on December 31, 
2003, and earns no other premiums during the year.
    (ii) Analysis. (A) For Federal income tax purposes, the section 338 
election results in a deemed sale of the assets of old T to new T. Old 
T's ADSP is $66 ($16 amount realized for the T stock plus $50 
liabilities). New T's AGUB also is $66 ($16 basis for the T stock

[[Page 192]]

plus $50 liabilities). See paragraph (b)(1) of this section. Each of the 
AGUB and ADSP is allocated under the residual method of Sec. 1.338-6 to 
determine the purchase or sale price of each asset transferred. Each of 
the AGUB and ADSP is allocated as follows: $10 to cash (Class I), $30 to 
the securities (Class II), $10 to equipment (Class V), $16 to the life 
insurance contract (Class VI), and $0 to goodwill and going concern 
value (Class VII).
    (B) Under section 1001, old T's amount realized for the securities 
is $30 and for the equipment is $10. As a result of the deemed asset 
sale, there is an assumption reinsurance transaction between old T (as 
ceding company) and new T (as reinsurer) at the close of the acquisition 
date for the life insurance contract issued by old T. See paragraph 
(c)(1) of this section. Although the assumption reinsurance transaction 
results in a $50 decrease in old T's reserves, which is taxable income 
to old T, the reinsurance premium paid by old T is deductible by old T. 
Under paragraph (c)(2) of this section, old T is deemed to pay a 
reinsurance premium equal to the reserve for the life insurance contract 
immediately before the deemed asset sale ($50) and is deemed to receive 
a ceding commission from new T. Under paragraph (c)(3) of this section, 
the portion of the ADSP allocated to the life insurance contract is $16; 
thus, the ceding commission is $16. Old T, therefore, is deemed to pay 
new T a reinsurance premium of $34 ($50 - $16 = $34). Old T also has $34 
of net negative consideration for purposes of section 848. See paragraph 
(f) of this section for rules relating to the effect of a section 338 
election on the capitalization of amounts under section 848.
    (C) New T obtains an initial basis of $30 in the securities and $10 
in the equipment. New T is deemed to receive a reinsurance premium from 
old T in an amount equal to the $50 of reserves for the life insurance 
contract and to pay old T a $16 ceding commission for the contract. See 
paragraphs (c)(2) and (3) of this section. Accordingly, new T includes 
$50 of premium in income and deducts $50 for its increase in reserves. 
For purposes of section 848, new T has $34 of net positive consideration 
for the deemed assumption reinsurance transaction. Because the only 
contract involved in the deemed assumption reinsurance transaction is a 
life insurance contract, new T must capitalize $2.62 ($34 x 7.7% = 
$2.62) under section 848. New T will amortize the $2.62 as provided 
under section 848. New T's adjusted basis in the life insurance 
contract, which is an amortizable section 197 intangible, is $13.38, the 
excess of the $16 ceding commission over the $2.62 capitalized under 
section 848. See section 197 and Sec. 1.197-2(g)(5). New T deducts the 
$2.62 of the ceding commission that is not amortizable under section 197 
because it is reflected in the amount capitalized under section 848 and 
also deducts the remaining $17.38 of its general deductions.
    Example 2. (i) Facts. Assume the same facts as in Example 1, except 
the life insurance contract has a value of $0 and the fair market value 
of T's securities are $60. Thus, to reinsure the contract in an arm's 
length transaction, T would have to pay the reinsurer a reinsurance 
premium in excess of T's $50 of tax reserves for the contract.
    (ii) Analysis. (A) For Federal income tax purposes, the section 338 
election results in a deemed sale of the assets of old T to new T. Old 
T's ADSP is $66 ($16 amount realized for the T stock plus $50 
liabilities). New T's AGUB also is $66 ($16 basis for the T stock plus 
$50 liabilities). See paragraph (b)(1) of this section. Each of the AGUB 
and ADSP is allocated under the residual method of Sec. 1.338-6 to 
determine the purchase or sale price of each asset transferred. Each of 
the AGUB and ADSP is allocated as follows: $10 to cash (Class I), $56 to 
the securities (Class II), $0 to the equipment (Class V), $0 to the life 
insurance contract (Class VI), and $0 to goodwill and going concern 
value (Class VII).
    (B) Under section 1001, old T's amount realized for the securities 
is $56 and for the equipment is $0. As a result of the deemed asset 
sale, there is an assumption reinsurance transaction between old T (as 
ceding company) and new T (as reinsurer) at the close of the acquisition 
date for the life insurance contract issued by old T. See paragraph 
(c)(1) of this section. Although the assumption reinsurance transaction 
results in a $50 decrease in old T's reserves, which is taxable income 
to old T, the reinsurance premium deemed paid by old T to new T is 
deductible by old T. Under paragraph (c)(2) of this section, old T is 
deemed to pay a reinsurance premium equal to the reserve for the life 
insurance contract immediately before the deemed asset sale ($50), and 
is deemed to receive from new T a ceding commission equal to the amount 
of AGUB allocated to the life insurance contract ($0), as provided in 
paragraph (c)(3) of this section. Old T also has $50 of net negative 
consideration for purposes of section 848. See paragraph (f) of this 
section for rules relating to the effect of a section 338 election on 
capitalization amounts under section 848.
    (C) New T obtains an initial basis of $56 in the securities (with a 
fair market value of $60) and $0 in the equipment (with a fair market 
value of $10). New T is deemed to receive a reinsurance premium from old 
T in an amount equal to the $50 of reserves for the life insurance 
contract. Accordingly, new T includes $50 of premium in income and 
deducts $50 for its increase in reserves. For purposes of section 848, 
new T has $50 of net positive consideration for the deemed assumption 
reinsurance transaction. Because the only contract involved in the 
assumption reinsurance transaction is a life insurance

[[Page 193]]

contract, new T must capitalize $3.85 ($50 x 7.7%) under section 848 
from the transaction and deducts the remaining $16.15 of its general 
deductions. Because new T allocates $0 of the AGUB to the insurance 
contract, no amount is amortizable under section 197 with respect to the 
insurance contract. See Sec. 1.338-11T(d) for rules on adjustments 
required if new T increases its reserves for, or reinsures at a loss, 
the acquired life insurance contract.

    (d) Reserve increases by new target after the deemed asset sale--(1) 
In general. If in new target's first taxable year or any subsequent 
year, new target increases its reserves for any acquired contracts, new 
target is treated as receiving an additional premium, which is computed 
under paragraph (d)(3) of this section, in the assumption reinsurance 
transaction described in paragraph (c)(1) of this section. New target 
includes the additional premium in gross income for the taxable year in 
which new target increases its reserves for acquired contracts. New 
target's increase in reserves for the insurance contracts acquired in 
the deemed asset sale is a liability of new target not originally taken 
into account in determining AGUB that is subsequently taken into 
account. Thus, AGUB is increased by the amount of the additional premium 
included in new target's gross income. See Sec. Sec. 1.338-5(b)(2)(ii) 
and 1.338-7. Old target has no deduction under this paragraph (d) and 
makes no adjustments under Sec. Sec. 1.338-4(b)(2)(ii) and 1.338-7.
    (2) Exception. New target is not treated as receiving additional 
premium under paragraph (d)(1) of this section if it is under state 
receivership as of the close of the taxable year for which the increase 
in reserves occurs.
    (3) Amount of additional premium--(i) In general. The additional 
premium taken into account under this paragraph (d) is an amount equal 
to the sum of the positive amounts described in paragraphs (d)(3)(ii) 
through (iv) of this section. However, the additional premium cannot 
exceed the limitation described in paragraph (d)(4) of this section.
    (ii) Increases in unpaid loss reserves. The positive amount with 
respect to unpaid loss reserves is computed using the formula A/B x (C-
[D + E]) where--
    (A) A equals old target's discounted unpaid losses (determined under 
section 846) included in AGUB under paragraph 11(b)(1) of this section;
    (B) B equals old target's undiscounted unpaid losses (determined 
under section 846(b)(1)) as of the close of the acquisition date;
    (C) C equals new target's undiscounted unpaid losses (determined 
under section 846(b)(1)) at the end of the taxable year that are 
attributable to losses incurred by old target on or before the 
acquisition date;
    (D) D (which may be a negative number) equals old target's 
undiscounted unpaid losses as of the close of the acquisition date, 
reduced by the cumulative amount of losses, loss adjustment expenses, 
and reinsurance premiums paid by new target through the end of the 
taxable year for losses incurred by old target on or before the 
acquisition date; and
    (E) E equals the amount obtained by dividing the cumulative amount 
of reserve increases taken into account under this paragraph (d) in 
prior taxable years by A/B.
    (iii) Increases in section 807(c) reserves. The positive amount with 
respect to the items referred to in section 807(c) other than discounted 
unpaid loss reserves is the sum of the net increases in such items that 
are required to be taken into account under section 807(f).
    (iv) Increases in other reserves. The positive amount with respect 
to reserves other than discounted unpaid loss reserves and other items 
referred to in section 807(c) is the net increase of those reserves due 
to changes in estimate, methodology, or other assumptions used to 
compute the reserves (including the adoption by new target of a 
methodology or assumptions different from those used by old target).
    (4) Limitation on additional premium. The additional premium taken 
into account by new target under paragraph (d)(1) of this section is 
limited to the excess, if any, of--
    (i) The fair market value of old target's assets acquired by new 
target in the deemed asset sale (other than Class VI and Class VII 
assets); over
    (ii) The AGUB allocated to those assets (including increases in AGUB 
allocated to those assets as the result of

[[Page 194]]

reserve increases by new target in prior taxable years).
    (5) Treatment of additional premium under section 848. If a portion 
of the positive amounts described in paragraphs (d)(3)(ii) and (iii) of 
this section are attributable to an increase in reserves for specified 
insurance contracts (as defined in section 848(e)), new target takes an 
allocable portion of the additional premium in determining its specified 
policy acquisition expenses under section 848(c) for the taxable year of 
the reserve increase.
    (6) Examples. The following examples illustrate this paragraph (d):

    Example 1. (i) Facts. On January 1, 2006, P purchases all of the 
stock of T, a non-life insurance company, for $120 and makes a section 
338 election for T. On the acquisition date, old T has total reserve 
liabilities under state law of $725, consisting of undiscounted unpaid 
losses of $625 and unearned premiums of $100. Old T's tax reserves on 
the acquisition date are $580, which consist of discounted unpaid losses 
(as defined in section 846) of $500 and unearned premiums (as computed 
under section 832(b)(4)(B)) of $80. Old T has Class I through Class V 
assets with a fair market value of $800. Old T also has a Class VI asset 
with a fair market value of $75, consisting of the future profit stream 
of certain insurance contracts. During 2006, new T makes loss and loss 
adjustment expense payments of $200 with respect to the unpaid losses 
incurred by old T before the acquisition date. As of December 31, 2006, 
new T reports undiscounted unpaid losses of $475 attributable to losses 
incurred before the acquisition date. The related amount of discounted 
unpaid losses (as defined in section 846) for those losses is $390.
    (ii) Computation and allocation of AGUB. Under Sec. 1.338-5 and 
paragraph (b)(1) of this section, as of the acquisition date, AGUB is 
$700, reflecting the sum of the amount paid for old T's stock ($120) and 
the tax reserves assumed by new T in the transaction ($580). The fair 
market value of old T's Class I through V assets is $800, whereas the 
AGUB available for such assets under Sec. 1.338-6 is $700. There is no 
AGUB available for old T's Class VI assets, even though such assets have 
a fair market value of $75 on the acquisition date.
    (iii) Adjustments for increases in reserves for unpaid losses. Under 
paragraph (d) of this section, new T must determine whether there are 
any amounts by which it increased its unpaid loss reserves that will be 
treated as an additional premium and an increase in AGUB. New T applies 
the formula of paragraph (d)(3) of this section, where A equals $500, B 
equals $625, C equals $475, D equals $425 ($625 - $200), and E equals 
$0. Under this formula, new T is treated as having increased its 
reserves for discounted unpaid losses attributable to losses incurred by 
old T by $40 ($500/$625 x ($475 - [$425 + 0]). The limitation under 
paragraph (d)(5) of this section based on the difference between the 
fair market value of old T's Class I through Class V assets and the AGUB 
allocated to such assets is $100. Accordingly, new T includes an 
additional premium of $40 in gross income for 2006, and increases the 
AGUB allocated to old T's Class I through Class V assets to reflect this 
additional premium.
    Example 2. (i) Facts. Assume the same facts as in Example 1. Further 
assume that during 2007 new T deducts total loss and loss expense 
payments of $375 with respect to losses incurred by old T before the 
acquisition date. On December 31, 2007, new T reports undiscounted 
unpaid losses of $150 with respect to losses incurred before the 
acquisition date. The related amount of discounted unpaid losses (as 
defined in section 846) for those unpaid losses is $125.
    (ii) Analysis. New T must determine whether any amounts by which it 
increased its unpaid losses during 2007 will be treated as an additional 
premium in paragraph (d)(3) of this section. New T applies the formula 
under paragraph (d)(3) of this section, where A equals $500, B equals 
$625, C equals $150, D equals $50 ($625 - $575), and E equals $50 ($40 
divided by .8). In paragraph (d)(3) of this section, new T is treated as 
increasing its reserves for discounted unpaid losses by $40 during 2007 
with respect to losses incurred by old T ($500/$625 x ($150-[$50 + 
$50]). New T determines the limitation of paragraph (d)(5) of this 
section by comparing the $800 fair market value of the Class I through V 
assets on the acquisition date to the $740 AGUB allocated to such assets 
(which includes the $40 addition to AGUB included during 2006). Thus, 
new T recognizes $40 of additional premium as a result of the increase 
in reserves during 2007, and adjusts the AGUB allocable to the Class I 
through V assets acquired from old T to reflect such additional premium.

    Example 3. (i) Facts. The facts are the same as Example 2, except 
that on January 1, 2008, new T reinsures the outstanding liability with 
respect to losses incurred by old T before the acquisition date through 
a portfolio reinsurance transaction with R, another non-life insurance 
company. R agrees to assume any remaining liability relating to losses 
incurred by old T before the acquisition date in exchange for a 
reinsurance premium of $200. Accordingly, as of December 31, 2008, new T 
reports no undiscounted unpaid losses with respect to losses incurred by 
old T before the acquisition date.

[[Page 195]]

    (ii) Analysis. New T must determine whether any amount by which it 
increased its unpaid loss reserves will be treated as an additional 
premium under paragraph (d) of this section. New T applies the formula 
of paragraph (d)(3) of this section, where A equals $500, B equals $625, 
C equals $0, and D equals -$150 ($625 - ($575 + $200), and E equals $100 
($80 divided by .8). Thus, new T is treated as having increased its 
discounted unpaid losses by $40 in 2008 with respect to losses incurred 
by old T before the acquisition date ($500/$625 x (0 -[-$150 + $100]). 
New T includes this positive amount in gross income, subject to the 
limitation of paragraph (d)(4) of this section. The limitation of 
paragraph (d)(4) of this section equals $20, which is computed by 
comparing the $800 fair market value of the Class I through V assets 
acquired from old T with the $780 AGUB allocated to such assets (which 
includes the $40 addition to AGUB in 2006 and the $40 addition to AGUB 
in 2007). Thus, New T includes $20 in additional premium, and increases 
the AGUB allocated to the Class I through V assets acquired from old T 
by $20. As a result of these adjustments, the limitation under paragraph 
(d)(4) of this section is reduced to zero.

    (7) Effective/applicability date--(i) In general. This section 
applies to increases to reserves made by new target after a deemed asset 
sale occurring on or after April 10, 2006.
    (ii) Application to pre-effective date increases to reserves. If 
either new target makes an election under Sec. 1.338(i)-1(c)(2) or old 
target makes an election under Sec. 1.338(i)-1(c)(3) to apply the rules 
of this section, in whole, to a qualified stock purchase occurring 
before April 10, 2006, then the rules contained in this section shall 
apply in whole to the qualified stock purchase.
    (iii) Application of paragraphs (d)(2) and (3) of this section. 
Paragraphs (d)(2) and (3) of this section apply to taxable years 
beginning after October 13, 2020. For taxable years beginning on or 
before such date, see paragraph (d) of this section as contained in 26 
CFR part 1 revised as of April 1, 2020.
    (e) Effect of section 338 election on section 846(e) election--(1) 
In general. New target and old target are treated as the same 
corporation for purposes of an election by old target to use its 
historical loss payment pattern under section 846(e). See Sec. 1.338-
1(b)(2)(vii). Therefore, if old target has a section 846(e) election in 
effect on the acquisition date, new target will continue to use the 
historical loss payment pattern of old target to discount unpaid losses 
incurred in accident years covered by the election, unless new target 
elects to revoke the section 846(e) election. In addition, new target 
may consider old target's historical loss payment pattern when 
determining whether to make the section 846(e) election for a 
determination year that includes or is subsequent to the acquisition 
date.
    (2) Revocation of existing section 846(e) election. New target may 
revoke old target's section 846(e) election to use its historical loss 
payment pattern to discount unpaid losses. If new target elects to 
revoke old target's section 846(e) election, new target will use the 
industry-wide patterns determined by the Secretary to discount unpaid 
losses incurred in accident years beginning on or after the acquisition 
date through the subsequent determination year. New target may revoke 
old target's section 846(e) election by attaching a statement to new 
target's original tax return for its first taxable year.
    (f) Effect of section 338 election on old target's capitalization 
amounts under section 848--(1) Determination of net consideration for 
specified insurance contracts. For purposes of applying section 848 and 
Sec. 1.848-2(f) to the deemed assumption reinsurance transaction, old 
target's net consideration (either positive or negative) for each 
category of specified insurance contracts is an amount equal to--
    (i) The allocable portion of the ceding commission (if any) relating 
to contracts in that category; less
    (ii) The amount by which old target's tax reserves for contracts in 
that category has been reduced as a result of the deemed assumption 
reinsurance transaction.
    (2) Determination of capitalization amount. Except as provided in 
Sec. 1.381(c)(22)-1(b)(13)--
    (i) If, after the deemed asset sale, old target has an amount 
otherwise required to be capitalized under section 848 for the taxable 
year or an unamortized balance of specified policy acquisition expenses 
from prior taxable years, then old target deducts such remaining amount 
or unamortized balance as an expense incurred in the taxable year that 
includes the deemed sale tax consequences; and

[[Page 196]]

    (ii) If, after the deemed asset sale, the negative capitalization 
amount resulting from the reinsurance transaction exceeds the amount 
that old target can deduct under section 848(f)(1), then old target's 
capitalization amount is treated as zero at the close of the taxable 
year that includes the deemed sale tax consequences.
    (3) Section 381 transactions. For transactions described in section 
381, see Sec. 1.381(c)(22)-1(b)(13).
    (g) Effect of section 338 election on policyholders surplus account. 
Except as specifically provided in Sec. 1.381(c)(22)-1(b)(7), the 
deemed asset sale effects a distribution of old target's policyholders 
surplus account to the extent the grossed-up amount realized on the sale 
to the purchasing corporation of the purchasing corporation's recently 
purchased target stock (as defined in Sec. 1.338-4(c)) exceeds old 
target's shareholders surplus account under section 815(c).
    (h) Effect of section 338 election on section 847 special estimated 
tax payments. If old target had elected to claim an additional deduction 
under section 847 for the taxable year that includes the deemed sale tax 
consequences or any earlier years, the amount remaining in old target's 
special loss discount account under section 847(3) must be reduced to 
the extent it relates to contracts transferred to new target and the 
amount of such reduction must be included in old target's gross income 
for the taxable year that includes the deemed sale tax consequences. Old 
target may apply the balance of its special estimated tax account as a 
credit against any tax resulting from such inclusion in gross income. 
Any special estimated tax payments remaining after this credit are 
voided and, therefore, are not available for credit or refund. Under 
section 847(1), new target is permitted to claim a section 847 deduction 
for losses incurred before the deemed asset sale, subject to the general 
requirement that new target makes timely special estimated tax payments 
equal to the tax benefit resulting from this deduction. See Sec. 
1.381(c)(22)-1(c)(14) regarding the carryover of the special loss 
discount account attributable to contracts transferred in a section 381 
transaction.

[T.D. 9257, 71 FR 18000, Apr. 10, 2006, as amended by T.D. 9377, 73 FR 
3872, Jan. 23, 2008; T.D. 9911, 85 FR 64392, Oct. 13, 2020]



Sec. 1.338(h)(10)-1  Deemed asset sale and liquidation.

    (a) Scope. This section prescribes rules for qualification for a 
section 338(h)(10) election and for making a section 338(h)(10) 
election. This section also prescribes the consequences of such 
election. The rules of this section are in addition to the rules of 
Sec. Sec. 1.338-1 through 1.338-10 and, in appropriate cases, apply 
instead of the rules of Sec. Sec. 1.338-1 through 1.338-10.
    (b) Definitions--(1) Consolidated target. A consolidated target is a 
target that is a member of a consolidated group within the meaning of 
Sec. 1.1502-1(h) on the acquisition date and is not the common parent 
of the group on that date.
    (2) Selling consolidated group. A selling consolidated group is the 
consolidated group of which the consolidated target is a member on the 
acquisition date.
    (3) Selling affiliate; affiliated target. A selling affiliate is a 
domestic corporation that owns on the acquisition date an amount of 
stock in a domestic target, which amount of stock is described in 
section 1504(a)(2), and does not join in filing a consolidated return 
with the target. In such case, the target is an affiliated target.
    (4) S corporation target. An S corporation target is a target that 
is an S corporation immediately before the acquisition date.
    (5) S corporation shareholders. S corporation shareholders are the S 
corporation target's shareholders. Unless otherwise indicated, a 
reference to S corporation shareholders refers both to S corporation 
shareholders who do and those who do not sell their target stock.
    (6) Liquidation. Any reference in this section to a liquidation is 
treated as a reference to the transfer described in paragraph (d)(4) of 
this section notwithstanding its ultimate characterization for Federal 
income tax purposes.
    (c) Section 338(h)(10) election--(1) In general. A section 
338(h)(10) election may be made for T if P acquires stock meeting the 
requirements of section

[[Page 197]]

1504(a)(2) from a selling consolidated group, a selling affiliate, or 
the S corporation shareholders in a qualified stock purchase.
    (2) Availability of section 338(h)(10) election in certain multi-
step transactions. Notwithstanding anything to the contrary in Sec. 
1.338-3(c)(1)(i), a section 338(h)(10) election may be made for T where 
P's acquisition of T stock, viewed independently, constitutes a 
qualified stock purchase and, after the stock acquisition, T merges or 
liquidates into P (or another member of the affiliated group that 
includes P), whether or not, under relevant provisions of law, including 
the step transaction doctrine, the acquisition of the T stock and the 
merger or liquidation of T qualify as a reorganization described in 
section 368(a). If a section 338(h)(10) election is made in a case where 
the acquisition of T stock followed by a merger or liquidation of T into 
P qualifies as a reorganization described in section 368(a), for all 
Federal tax purposes, P's acquisition of T stock is treated as a 
qualified stock purchase and is not treated as part of a reorganization 
described in section 368(a).
    (3) Simultaneous joint election requirement. A section 338(h)(10) 
election is made jointly by P and the selling consolidated group (or the 
selling affiliate or the S corporation shareholders) on Form 8023 in 
accordance with the instructions to the form. S corporation shareholders 
who do not sell their stock must also consent to the election. The 
section 338(h)(10) election must be made not later than the 15th day of 
the 9th month beginning after the month in which the acquisition date 
occurs.
    (4) Irrevocability. A section 338(h)(10) election is irrevocable. If 
a section 338(h)(10) election is made for T, a section 338 election is 
deemed made for T.
    (5) Effect of invalid election. If a section 338(h)(10) election for 
T is not valid, the section 338 election for T is also not valid.
    (d) Certain consequences of section 338(h)(10) election. For 
purposes of subtitle A of the Internal Revenue Code (except as provided 
in Sec. 1.338-1(b)(2)), the consequences to the parties of making a 
section 338(h)(10) election for T are as follows:
    (1) P. P is automatically deemed to have made a gain recognition 
election for its nonrecently purchased T stock, if any. The effect of a 
gain recognition election includes a taxable deemed sale by P on the 
acquisition date of any nonrecently purchased target stock. See Sec. 
1.338-5(d).
    (2) New T. The AGUB for new T's assets is determined under Sec. 
1.338-5 and is allocated among the acquisition date assets under 
Sec. Sec. 1.338-6 and 1.338-7. Notwithstanding paragraph (d)(4) of this 
section (deemed liquidation of old T), new T remains liable for the tax 
liabilities of old T (including the tax liability for the deemed sale 
tax consequences). For example, new T remains liable for the tax 
liabilities of the members of any consolidated group that are 
attributable to taxable years in which those corporations and old T 
joined in the same consolidated return. See Sec. 1.1502-6(a).
    (3) Old T--deemed sale--(i) In general. Old T is treated as 
transferring all of its assets to an unrelated person in exchange for 
consideration that includes the discharge of its liabilities in a single 
transaction at the close of the acquisition date (but before the deemed 
liquidation). See Sec. 1.338-1(a) regarding the tax characterization of 
the deemed asset sale. Except as provided in Sec. 1.338(h)(10)-1(d)(8) 
(regarding the installment method), old T recognizes all of the gain 
realized on the deemed transfer of its assets in consideration for the 
ADSP. ADSP for old T is determined under Sec. 1.338-4 and allocated 
among the acquisition date assets under Sec. Sec. 1.338-6 and 1.338-7. 
Old T realizes the deemed sale tax consequences from the deemed asset 
sale before the close of the acquisition date while old T is a member of 
the selling consolidated group (or owned by the selling affiliate or 
owned by the S corporation shareholders). If T is an affiliated target, 
or an S corporation target, the principles of Sec. Sec. 1.338-2(c)(10) 
and 1.338-10(a)(1), (5), and (6)(i) apply to the return on which the 
deemed sale tax consequences are reported. When T is an S corporation 
target, T's S election continues in effect through the close of the 
acquisition date (including the time of the deemed asset sale and the 
deemed liquidation) notwithstanding section

[[Page 198]]

1362(d)(2)(B). Also, when T is an S corporation target (but not a 
qualified subchapter S subsidiary), any direct and indirect subsidiaries 
of T which T has elected to treat as qualified subchapter S subsidiaries 
under section 1361(b)(3) remain qualified subchapter S subsidiaries 
through the close of the acquisition date.
    (ii) Tiered targets. In the case of parent-subsidiary chains of 
corporations making elections under section 338(h)(10), the deemed asset 
sale of a parent corporation is considered to precede that of its 
subsidiary. See Sec. 1.338-3(b)(4)(i).
    (4) Old T and selling consolidated group, selling affiliate, or S 
corporation shareholders--deemed liquidation; tax characterization--(i) 
In general. Old T is treated as if, before the close of the acquisition 
date, after the deemed asset sale in paragraph (d)(3) of this section, 
and while old T is a member of the selling consolidated group (or owned 
by the selling affiliate or owned by the S corporation shareholders), it 
transferred all of its assets to members of the selling consolidated 
group, the selling affiliate, or S corporation shareholders and ceased 
to exist. The transfer from old T is characterized for Federal income 
tax purposes in the same manner as if the parties had actually engaged 
in the transactions deemed to occur because of this section and taking 
into account other transactions that actually occurred or are deemed to 
occur. For example, the transfer may be treated as a distribution in 
pursuance of a plan of reorganization, a distribution in complete 
cancellation or redemption of all its stock, one of a series of 
distributions in complete cancellation or redemption of all its stock in 
accordance with a plan of liquidation, or part of a circular flow of 
cash. In most cases, the transfer will be treated as a distribution in 
complete liquidation to which section 336 or 337 applies.
    (ii) Tiered targets. In the case of parent-subsidiary chains of 
corporations making elections under section 338(h)(10), the deemed 
liquidation of a subsidiary corporation is considered to precede the 
deemed liquidation of its parent.
    (5) Selling consolidated group, selling affiliate, or S corporation 
shareholders--(i) In general. If T is an S corporation target, S 
corporation shareholders (whether or not they sell their stock) take 
their pro rata share of the deemed sale tax consequences into account 
under section 1366 and increase or decrease their basis in T stock under 
section 1367. Members of the selling consolidated group, the selling 
affiliate, or S corporation shareholders are treated as if, after the 
deemed asset sale in paragraph (d)(3) of this section and before the 
close of the acquisition date, they received the assets transferred by 
old T in the transaction described in paragraph (d)(4)(i) of this 
section. In most cases, the transfer will be treated as a distribution 
in complete liquidation to which section 331 or 332 applies.
    (ii) Basis and holding period of T stock not acquired. A member of 
the selling consolidated group (or the selling affiliate or an S 
corporation shareholder) retaining T stock is treated as acquiring the 
stock so retained on the day after the acquisition date for its fair 
market value. The holding period for the retained stock starts on the 
day after the acquisition date. For purposes of this paragraph, the fair 
market value of all of the T stock equals the grossed-up amount realized 
on the sale to P of P's recently purchased target stock. See Sec. 
1.338-4(c).
    (iii) T stock sale. Members of the selling consolidated group (or 
the selling affiliate or S corporation shareholders) recognize no gain 
or loss on the sale or exchange of T stock included in the qualified 
stock purchase (although they may recognize gain or loss on the T stock 
in the deemed liquidation).
    (6) Nonselling minority shareholders other than nonselling S 
corporation shareholders--(i) In general. This paragraph (d)(6) 
describes the treatment of shareholders of old T other than the 
following: Members of the selling consolidated group, the selling 
affiliate, S corporation shareholders (whether or not they sell their 
stock), and P. For a description of the treatment of S corporation 
shareholders, see paragraph (d)(5) of this section. A shareholder to 
which this paragraph (d)(6) applies is called a minority shareholder.

[[Page 199]]

    (ii) T stock sale. A minority shareholder recognizes gain or loss on 
the shareholder's sale or exchange of T stock included in the qualified 
stock purchase.
    (iii) T stock not acquired. A minority shareholder does not 
recognize gain or loss under this section with respect to shares of T 
stock retained by the shareholder. The shareholder's basis and holding 
period for that T stock is not affected by the section 338(h)(10) 
election.
    (7) Consolidated return of selling consolidated group. If P acquires 
T in a qualified stock purchase from a selling consolidated group--
    (i) The selling consolidated group must file a consolidated return 
for the taxable period that includes the acquisition date;
    (ii) A consolidated return for the selling consolidated group for 
that period may not be withdrawn on or after the day that a section 
338(h)(10) election is made for T; and
    (iii) Permission to discontinue filing consolidated returns cannot 
be granted for, and cannot apply to, that period or any of the 
immediately preceding taxable periods during which consolidated returns 
continuously have been filed.
    (8) Availability of the section 453 installment method. Solely for 
purposes of applying sections 453, 453A, and 453B, and the regulations 
thereunder (the installment method) to determine the consequences to old 
T in the deemed asset sale and to old T (and its shareholders, if 
relevant) in the deemed liquidation, the rules in paragraphs (d)(1) 
through (7) of this section are modified as follows:
    (i) In deemed asset sale. Old T is treated as receiving in the 
deemed asset sale new T installment obligations, the terms of which are 
identical (except as to the obligor) to P installment obligations issued 
in exchange for recently purchased stock of T. Old T is treated as 
receiving in cash all other consideration in the deemed asset sale other 
than the assumption of, or taking subject to, old T liabilities. For 
example, old T is treated as receiving in cash any amounts attributable 
to the grossing-up of amount realized under Sec. 1.338-4(c). The amount 
realized for recently purchased stock taken into account in determining 
ADSP is adjusted (and, thus, ADSP is redetermined) to reflect the 
amounts paid under an installment obligation for the stock when the 
total payments under the installment obligation are greater or less than 
the amount realized.
    (ii) In deemed liquidation. Old T is treated as distributing in the 
deemed liquidation the new T installment obligations that it is treated 
as receiving in the deemed asset sale. The members of the selling 
consolidated group, the selling affiliate, or the S corporation 
shareholders are treated as receiving in the deemed liquidation the new 
T installment obligations that correspond to the P installment 
obligations they actually received individually in exchange for their 
recently purchased stock. The new T installment obligations may be 
recharacterized under other rules. See for example Sec. 1.453-11(a)(2) 
which, in certain circumstances, treats the new T installment 
obligations deemed distributed by old T as if they were issued by new T 
in exchange for the stock in old T owned by members of the selling 
consolidated group, the selling affiliate, or the S corporation 
shareholders. The members of the selling consolidated group, the selling 
affiliate, or the S corporation shareholders are treated as receiving 
all other consideration in the deemed liquidation in cash.
    (9) Treatment consistent with an actual asset sale. No provision in 
section 338(h)(10) or this section shall produce a Federal income tax 
result under subtitle A of the Internal Revenue Code that would not 
occur if the parties had actually engaged in the transactions deemed to 
occur because of this section and taking into account other transactions 
that actually occurred or are deemed to occur. See, however, Sec. 
1.338-1(b)(2) for certain exceptions to this rule.
    (e) Examples. The following examples illustrate the provisions of 
this section:

    Example 1. (i) S1 owns all of the T stock and T owns all of the 
stock of T1 and T2. S1 is the common parent of a consolidated group that 
includes T, T1, and T2. P makes a qualified stock purchase of all of the 
T stock from S1. S1 joins with P in making a section 338(h)(10) election 
for T and for the

[[Page 200]]

deemed purchase of T1. A section 338 election is not made for T2.
    (ii) S1 does not recognize gain or loss on the sale of the T stock 
and T does not recognize gain or loss on the sale of the T1 stock 
because section 338(h)(10) elections are made for T and T1. Thus, for 
example, gain or loss realized on the sale of the T or T1 stock is not 
taken into account in earnings and profits. However, because a section 
338 election is not made for T2, T must recognize any gain or loss 
realized on the deemed sale of the T2 stock. See Sec. 1.338-4(h).
    (iii) The results would be the same if S1, T, T1, and T2 are not 
members of any consolidated group, because S1 and T are selling 
affiliates.
    Example 2. (i) S and T are solvent corporations. S owns all of the 
outstanding stock of T. S and P agree to undertake the following 
transaction: T will distribute half its assets to S, and S will assume 
half of T's liabilities. Then, P will purchase the stock of T from S. S 
and P will jointly make a section 338(h)(10) election with respect to 
the sale of T. The corporations then complete the transaction as agreed.
    (ii) Under section 338(a), the assets present in T at the close of 
the acquisition date are deemed sold by old T to new T. Under paragraph 
(d)(4) of this section, the transactions described in paragraph (d) of 
this section are treated in the same manner as if they had actually 
occurred. Because S and P had agreed that, after T's actual distribution 
to S of part of its assets, S would sell T to P pursuant to an election 
under section 338(h)(10), and because paragraph (d)(4) of this section 
deems T subsequently to have transferred all its assets to its 
shareholder, T is deemed to have adopted a plan of complete liquidation 
under section 332. T's actual transfer of assets to S is treated as a 
distribution pursuant to that plan of complete liquidation.
    Example 3. (i) S1 owns all of the outstanding stock of both T and 
S2. All three are corporations. S1 and P agree to undertake the 
following transaction. T will transfer substantially all of its assets 
and liabilities to S2, with S2 issuing no stock in exchange therefor, 
and retaining its other assets and liabilities. Then, P will purchase 
the stock of T from S1. S1 and P will jointly make a section 338(h)(10) 
election with respect to the sale of T. The corporations then complete 
the transaction as agreed.
    (ii) Under section 338(a), the remaining assets present in T at the 
close of the acquisition date are deemed sold by old T to new T. Under 
paragraph (d)(4) of this section, the transactions described in this 
section are treated in the same manner as if they had actually occurred. 
Because old T transferred substantially all of its assets to S2, and is 
deemed to have distributed all its remaining assets and gone out of 
existence, the transfer of assets to S2, taking into account the related 
transfers, deemed and actual, qualifies as a reorganization under 
section 368(a)(1)(D). Section 361(c)(1) and not section 332 applies to 
T's deemed liquidation.
    Example 4. (i) T owns two assets: an actively traded security (Class 
II) with a fair market value of $100 and an adjusted basis of $100, and 
inventory (Class IV) with a fair market value of $100 and an adjusted 
basis of $100. T has no liabilities. S is negotiating to sell all the 
stock in T to P for $100 cash and contingent consideration. Assume that 
under generally applicable tax accounting rules, P's adjusted basis in 
the T stock immediately after the purchase would be $100, because the 
contingent consideration is not taken into account. Thus, under the 
rules of Sec. 1.338-5, AGUB would be $100. Under the allocation rules 
of Sec. 1.338-6, the entire $100 would be allocated to the Class II 
asset, the actively traded security, and no amount would be allocated to 
the inventory. P, however, plans immediately to cause T to sell the 
inventory, but not the actively traded security, so it requests that, 
prior to the stock sale, S cause T to create a new subsidiary, Newco, 
and contribute the actively traded security to the capital of Newco. 
Because the stock in Newco, which would not be actively traded, is a 
Class V asset, under the rules of Sec. 1.338-6 $100 of AGUB would be 
allocated to the inventory and no amount of AGUB would be allocated to 
the Newco stock. Newco's own AGUB, $0 under the rules of Sec. 1.338-5, 
would be allocated to the actively traded security. When P subsequently 
causes T to sell the inventory, T would realize no gain or loss instead 
of realizing gain of $100.
    (ii) Assume that, if the T stock had not itself been sold but T had 
instead sold both its inventory and the Newco stock to P, T would for 
tax purposes be deemed instead to have sold both its inventory and 
actively traded security directly to P, with P deemed then to have 
created Newco and contributed the actively traded security to the 
capital of Newco. Section 338, if elected, generally recharacterizes a 
stock sale as a deemed sale of assets. However, paragraph (d)(9) of this 
section states, in general, that no provision of section 338(h)(10) or 
the regulations thereunder shall produce a Federal income tax result 
under subtitle A of the Internal Revenue Code that would not occur if 
the parties had actually engaged in the transactions deemed to occur by 
virtue of the section 338(h)(10) election, taking into account other 
transactions that actually occurred or are deemed to occur. Hence, the 
deemed sale of assets under section 338(h)(10) should be treated as one 
of the inventory and actively traded security themselves, not of the 
inventory and Newco stock. The anti-abuse rule of Sec. 1.338-1(c) does 
not apply, because the substance of the deemed sale of assets is a sale 
of the inventory and the actively traded security

[[Page 201]]

themselves, not of the inventory and the Newco stock. Otherwise, the 
anti-abuse rule might apply.
    Example 5. (i) T, a member of a selling consolidated group, has only 
one class of stock, all of which is owned by S1. On March 1 of Year 2, 
S1 sells its T stock to P for $80,000, and joins with P in making a 
section 338(h)(10) election for T. There are no selling costs or 
acquisition costs. On March 1 of Year 2, T owns land with a $50,000 
basis and $75,000 fair market value and equipment with a $30,000 
adjusted basis, $70,000 recomputed basis, and $60,000 fair market value. 
T also has a $40,000 liability. S1 pays old T's allocable share of the 
selling group's consolidated tax liability for Year 2 including the tax 
liability for the deemed sale tax consequences (a total of $13,600).
    (ii) ADSP of $120,000 ($80,000 + $40,000 + 0) is allocated to each 
asset as follows:

----------------------------------------------------------------------------------------------------------------
                 Assets                         Basis              FMV            Fraction       Allocable ADSP
----------------------------------------------------------------------------------------------------------------
Land....................................           $50,000           $75,000             \5/9\           $66,667
Equipment...............................            30,000            60,000             \4/9\            53,333
                                         -----------------------------------------------------------------------
      Total.............................            80,000           135,000                 1           120,000
----------------------------------------------------------------------------------------------------------------

    (iii) Under paragraph (d)(3) of this section, old T has gain on the 
deemed sale of $40,000 (consisting of $16,667 of capital gain and 
$23,333 of ordinary income).
    (iv) Under paragraph (d)(5)(iii) of this section, S1 recognizes no 
gain or loss upon its sale of the old T stock to P. S1 also recognizes 
no gain or loss upon the deemed liquidation of T. See paragraph (d)(4) 
of this section and section 332.
    (v) P's basis in new T stock is P's cost for the stock, $80,000. See 
section 1012.
    (vi) Under Sec. 1.338-5, the AGUB for new T is $120,000, i.e., P's 
cost for the old T stock ($80,000) plus T's liability ($40,000). This 
AGUB is allocated as basis among the new T assets under Sec. Sec. 
1.338-6 and 1.338-7.
    Example 6. (i) The facts are the same as in Example 5, except that 
S1 sells 80 percent of the old T stock to P for $64,000, rather than 100 
percent of the old T stock for $80,000.
    (ii) The consequences to P, T, and S1 are the same as in Example 5, 
except that:
    (A) P's basis for its 80-percent interest in the new T stock is P's 
$64,000 cost for the stock. See section 1012.
    (B) Under Sec. 1.338-5, the AGUB for new T is $120,000 (i.e., 
$64,000/.8 + $40,000 + $0).
    (C) Under paragraph (d)(4) of this section, S1 recognizes no gain or 
loss with respect to the retained stock in T. See section 332.
    (D) Under paragraph (d)(5)(ii) of this section, the basis of the T 
stock retained by S1 is $16,000 (i.e., $120,000 - $40,000 (the ADSP 
amount for the old T assets over the sum of new T's liabilities 
immediately after the acquisition date) `` .20 (the proportion of T 
stock retained by S1)).
    Example 7. (i) The facts are the same as in Example 6, except that 
K, a shareholder unrelated to T or P, owns the 20 percent of the T stock 
that is not acquired by P in the qualified stock purchase. K's basis in 
its T stock is $5,000.
    (ii) The consequences to P, T, and S1 are the same as in Example 6.
    (iii) Under paragraph (d)(6)(iii) of this section, K recognizes no 
gain or loss, and K's basis in its T stock remains at $5,000.
    Example 8. (i) The facts are the same as in Example 5, except that 
the equipment is held by T1, a wholly-owned subsidiary of T, and a 
section 338(h)(10) election is also made for T1. The T1 stock has a fair 
market value of $60,000. T1 has no assets other than the equipment and 
no liabilities. S1 pays old T's and old T1's allocable shares of the 
selling group's consolidated tax liability for Year 2 including the tax 
liability for T and T1's deemed sale tax consequences.
    (ii) ADSP for T is $120,000, allocated $66,667 to the land and 
$53,333 to the stock. Old T's deemed sale results in $16,667 of capital 
gain on its deemed sale of the land. Under paragraph (d)(5)(iii) of this 
section, old T does not recognize gain or loss on its deemed sale of the 
T1 stock. See section 332.
    (iii) ADSP for T1 is $53,333 (i.e., $53,333 + $0 + $0). On the 
deemed sale of the equipment, T1 recognizes ordinary income of $23,333.
    (iv) Under paragraph (d)(5)(iii) of this section, S1 does not 
recognize gain or loss upon its sale of the old T stock to P.
    Example 9. (i) The facts are the same as in Example 8, except that P 
already owns 20 percent of the T stock, which is nonrecently purchased 
stock with a basis of $6,000, and that P purchases the remaining 80 
percent of the T stock from S1 for $64,000.
    (ii) The results are the same as in Example 8, except that under 
paragraph (d)(1) of this section and Sec. 1.338-5(d), P is deemed to 
have made a gain recognition election for its nonrecently purchased T 
stock. As a result, P recognizes gain of $10,000 and its basis in the 
nonrecently purchased T stock is increased from $6,000 to $16,000. P's 
basis in all the T stock is $80,000 (i.e., $64,000 + $16,000). The 
computations are as follows:
    (A) P's grossed-up basis for the recently purchased T stock is 
$64,000 (i.e., $64,000 (the basis of the recently purchased T stock) x 
(1-.2)/(.8) (the fraction in section 338(b)(4))).

[[Page 202]]

    (B) P's basis amount for the nonrecently purchased T stock is 
$16,000 (i.e., $64,000 (the grossed-up basis in the recently purchased T 
stock) x (.2)/(1.0-.2) (the fraction in section 338(b)(3)(B))).
    (C) The gain recognized on the nonrecently purchased stock is 
$10,000 (i.e., $16,000-$6,000).
    Example 10. (i) T is an S corporation whose sole class of stock is 
owned 40 percent each by A and B and 20 percent by C. T, A, B, and C all 
use the cash method of accounting. A and B each has an adjusted basis of 
$10,000 in the stock. C has an adjusted basis of $5,000 in the stock. A, 
B, and C hold no installment obligations to which section 453A applies. 
On March 1 of Year 1, A sells its stock to P for $40,000 in cash and B 
sells its stock to P for a $25,000 note issued by P and real estate 
having a fair market value of $15,000. The $25,000 note, due in full in 
Year 7, is not publicly traded and bears adequate stated interest. A and 
B have no selling expenses. T's sole asset is real estate, which has a 
value of $110,000 and an adjusted basis of $35,000. Also, T's real 
estate is encumbered by long-outstanding purchase-money indebtedness of 
$10,000. The real estate does not have built-in gain subject to section 
1374. A, B, and C join with P in making a section 338(h)(10) election 
for T.
    (ii) Solely for purposes of application of sections 453, 453A, and 
453B, old T is considered in its deemed asset sale to receive back from 
new T the $25,000 note (considered issued by new T) and $75,000 of cash 
(total consideration of $80,000 paid for all the stock sold, which is 
then divided by .80 in the grossing-up, with the resulting figure of 
$100,000 then reduced by the amount of the installment note). Absent an 
election under section 453(d), gain is reported by old T under the 
installment method.
    (iii) In applying the installment method to old T's deemed asset 
sale, the contract price for old T's assets deemed sold is $100,000, the 
$110,000 selling price reduced by the indebtedness of $10,000 to which 
the assets are subject. (The $110,000 selling price is itself the sum of 
the $80,000 grossed-up in paragraph (ii) above to $100,000 and the 
$10,000 liability.) Gross profit is $75,000 ($110,000 selling price - 
old T's basis of $35,000). Old T's gross profit ratio is 0.75 (gross 
profit of $75,000 / $100,000 contract price). Thus, $56,250 (0.75 x the 
$75,000 cash old T is deemed to receive in Year 1) is Year 1 gain 
attributable to the sale, and $18,750 ($75,000 - $56,250) is recovery of 
basis.
    (iv) In its liquidation, old T is deemed to distribute the $25,000 
note to B, since B actually sold the stock partly for that 
consideration. To the extent of the remaining liquidating distribution 
to B, it is deemed to receive, along with A and C, the balance of old 
T's liquidating assets in the form of cash. Under section 453(h), B, 
unless it makes an election under section 453(d), is not required to 
treat the receipt of the note as a payment for the T stock; P's payment 
of the $25,000 note in Year 7 to B is a payment for the T stock. Because 
section 453(h) applies to B, old T's deemed liquidating distribution of 
the note is, under section 453B(h), not treated as a taxable disposition 
by old T.
    (v) Under section 1366, A reports 40 percent, or $22,500, of old T's 
$56,250 gain recognized in Year 1. Under section 1367, this increases 
A's $10,000 adjusted basis in the T stock to $32,500. Next, in old T's 
deemed liquidation, A is considered to receive $40,000 for its old T 
shares, causing it to recognize an additional $7,500 gain in Year 1.
    (vi) Under section 1366, B reports 40 percent, or $22,500, of old 
T's $56,250 gain recognized in Year 1. Under section 1367, this 
increases B's $10,000 adjusted basis in its T stock to $32,500. Next, in 
old T's deemed liquidation, B is considered to receive the $25,000 note 
and $15,000 of other consideration. Applying section 453, including 
section 453(h), to the deemed liquidation, B's selling price and 
contract price are both $40,000. Gross profit is $7,500 ($40,000 selling 
price - B's basis of $32,500). B's gross profit ratio is 0.1875 (gross 
profit of $7,500 / $40,000 contract price). Thus, $2,812.50 (0.1875 x 
$15,000) is Year 1 gain attributable to the deemed liquidation. In Year 
7, when the $25,000 note is paid, B has $4,687.50 (0.1875 x $25,000) of 
additional gain.
    (vii) Under section 1366, C reports 20 percent, or $11,250, of old 
T's $56,250 gain recognized in Year 1. Under section 1367, this 
increases C's $5,000 adjusted basis in its T stock to $16,250. Next, in 
old T's deemed liquidation, C is considered to receive $20,000 for its 
old T shares, causing it to recognize an additional $3,750 gain in Year 
1. Finally, under paragraph (d)(5)(ii) of this section, C is considered 
to acquire its stock in T on the day after the acquisition date for 
$20,000 (fair market value = grossed-up amount realized of $100,000 x 
20%). C's holding period in the stock deemed received in new T begins at 
that time.
    Example 11. Stock acquisition followed by upstream merger--without 
section 338(h)(10) election. (i) P owns all the stock of Y, a newly 
formed subsidiary. S owns all the stock of T. Each of P, S, T and Y is a 
domestic corporation. P acquires all of the T stock in a statutory 
merger of Y into T, with T surviving. In the merger, S receives 
consideration consisting of 50% P voting stock and 50% cash. Viewed 
independently of any other step, P's acquisition of T stock constitutes 
a qualified stock purchase. As part of the plan that includes P's 
acquisition of the T stock, T subsequently merges into P. Viewed 
independently of any other step, T's merger into P qualifies as a 
liquidation described in section 332. Absent the application of 
paragraph (c)(2) of this section, the step transaction

[[Page 203]]

doctrine would apply to treat P's acquisition of the T stock and T's 
merger into P as an acquisition by P of T's assets in a reorganization 
described in section 368(a). P and S do not make a section 338(h)(10) 
election with respect to P's purchase of the T stock.
    (ii) Because P and S do not make an election under section 
338(h)(10) for T, P's acquisition of the T stock and T's merger into P 
is treated as part of a reorganization described in section 368(a).
    Example 12. Stock acquisition followed by upstream merger--with 
section 338(h)(10) election. (i) The facts are the same as in Example 11 
except that P and S make a joint election under section 338(h)(10) for 
T.
    (ii) Pursuant to paragraph (c)(2) of this section, as a result of 
the election under section 338(h)(10), for all Federal tax purposes, P's 
acquisition of the T stock is treated as a qualified stock purchase and 
P's acquisition of the T stock is not treated as part of a 
reorganization described in section 368(a).
    Example 13. Stock acquisition followed by brother-sister merger--
with section 338(h)(10) election. (i) The facts are the same as in 
Example 12, except that, following P's acquisition of the T stock, T 
merges into X, a domestic corporation that is a wholly owned subsidiary 
of P. Viewed independently of any other step, T's merger into X 
qualifies as a reorganization described in section 368(a). Absent the 
application of paragraph (c)(2) of this section, the step transaction 
doctrine would apply to treat P's acquisition of the T stock and T's 
merger into X as an acquisition by X of T's assets in a reorganization 
described in section 368(a).
    (ii) Pursuant to paragraph (c)(2) of this section, as a result of 
the election under section 338(h)(10), for all Federal tax purposes, P's 
acquisition of T stock is treated as a qualified stock purchase and P's 
acquisition of T stock is not treated as part of a reorganization 
described in section 368(a).
    Example 14. Stock acquisition that does not qualify as a qualified 
stock purchase followed by upstream merger. (i) The facts are the same 
as in Example 11, except that, in the statutory merger of Y into T, S 
receives only P voting stock.
    (ii) Pursuant to Sec. 1.338-3(c)(1)(i) and paragraph (c)(2) of this 
section, no election under section 338(h)(10) can be made with respect 
to P's acquisition of the T stock because, pursuant to relevant 
provisions of law, including the step transaction doctrine, that 
acquisition followed by T's merger into P is treated as a reorganization 
described in section 368(a)(1)(A), and that acquisition, viewed 
independently of T's merger into P, does not constitute a qualified 
stock purchase under section 338(d)(3). Accordingly, P's acquisition of 
the T stock and T's merger into P is treated as a reorganization 
described in section 368(a).

    (f) Inapplicability of provisions. The provisions of section 6043, 
Sec. Sec. 1.331-1(d) and 1.332-6 (relating to information returns and 
recordkeeping requirements for corporate liquidations) do not apply to 
the deemed liquidation of old T under paragraph (d)(4) of this section.
    (g) Required information. The Commissioner may exercise the 
authority granted in section 338(h)(10)(C)(iii) to require provision of 
any information deemed necessary to carry out the provisions of section 
338(h)(10) by requiring submission of information on any tax reporting 
form.
    (h) Effective date. This section is applicable to stock acquisitions 
occurring on or after July 5, 2006. For stock acquisitions occurring 
before July 5, 2006, see Sec. 1.338(h)(10)-1T as contained in the 
edition of 26 CFR part 1, revised as of April 1, 2006.

[T.D. 8940, 66 FR 8950, Feb. 13, 2001, as amended by T.D. 9071, 68 FR 
40768, July 9, 2003; T.D. 9264, 71 FR 30607, May 30, 2006; T.D. 9271, 71 
FR 38075, July 5, 2006; T.D. 9329, 72 FR 32808, June 14, 2007]



Sec. 1.338(i)-1  Effective/applicability date.

    (a) In general. The provisions of Sec. Sec. 1.338-1 through 1.338-
7, 1.338-10 and 1.338(h)(10)-1 apply to any qualified stock purchase 
occurring after March 15, 2001. For rules applicable to qualified stock 
purchases on or before March 15, 2001, see Sec. Sec. 1.338-1T through 
1.338-7T, 1.338-10T, 1.338(h)(10)-1T and 1.338(i)-1T in effect prior to 
March 16, 2001 (see 26 CFR part 1 revised April 1, 2000).
    (b) Section 338(h)(10) elections for S corporation targets. The 
requirements of Sec. Sec. 1.338(h)(10)-1T(c)(2) and 1.338(h)(10)-
1(c)(2) that S corporation shareholders who do not sell their stock must 
also consent to an election under section 338(h)(10) will not invalidate 
an otherwise valid election made on the September 1997 revision of Form 
8023, ``Elections Under Section 338 For Corporations Making Qualified 
Stock Purchases,'' not signed by the nonselling shareholders, provided 
that the S corporation and all of its shareholders (including nonselling 
shareholders) report the tax consequences consistently with the results 
under section 338(h)(10).
    (c) Section 338 elections for insurance company targets--(1) In 
general. The

[[Page 204]]

rules of Sec. 1.338-11 apply to qualified stock purchases occurring on 
or after April 10, 2006.
    (2) New target election for retroactive application--(i) 
Availability of election. New target may make an irrevocable election to 
apply the rules in Sec. Sec. 1.338-11 (including the applicable 
provisions in Sec. Sec. 1.197-2(g)(5), 381(c)(22)-1, and 846) in whole, 
but not in part, to a qualified stock purchase occurring before April 
10, 2006 for which a section 338 election is made, provided that new 
target's first taxable year and all subsequent affected taxable years 
are years for which an assessment of deficiency or a refund for 
overpayment is not prevented by any law or rule of law. In the case of a 
section 338 election for which a section 338(h)(10) election is made (or 
a section 338 election for a foreign target), new target may make the 
election to apply the regulations retroactively without regard to 
whether old target makes the election. In the case of a section 338 
election for a domestic target for which no section 338(h)(10) election 
is made, new target may make the election to apply the regulations 
retroactively only if old target also makes the election. Paragraph 
(c)(2)(ii) of this section prescribes the time and manner of the 
election for new target.
    (ii) Time and manner of making the election for new target. New 
target may make an election described in paragraph (c)(2)(i) of this 
section by attaching a statement to its original or amended income tax 
return for its first taxable year. The statement must be entitled 
``Election to Retroactively Apply the Rules in Sec. Sec. 1.338-11 
(including the applicable provisions in Sec. Sec. 1.197-2(g)(5), 
1.381(c)(22)-1 and 846) in whole to a transaction completed before April 
10, 2006'' and must include the following information--
    (A) The name and E.I.N. for new target; and
    (B) The following declaration (or a substantially similar 
declaration): New target has amended its income tax returns for its 
first taxable year and for all affected subsequent years to reflect the 
rules in Sec. Sec. 1.338-11 (including the applicable provisions in 
Sec. Sec. 197-2(g)(5), 1.381(c)(22)-1 and 846). All other parties whose 
income tax liabilities are affected by new target's election have 
amended their income tax returns for all affected years to reflect the 
rules in Sec. Sec. 1.338-11 (including the applicable provisions in 
Sec. Sec. 1.197-2(g)(5), 1.381(c)(22)-1 and 846).
    (3) Old target election for retroactive application--(i) 
Availability of election. Old target may make an irrevocable election to 
apply the rules in Sec. Sec. 1.338-11 (including the applicable 
provisions in Sec. Sec. 1.197-2(g)(5), 1.381(c)(22)-1 and 846) in 
whole, but not in part, to a qualified stock purchase occurring before 
April 10, 2006 for which a section 338 election is made, provided that 
old target's taxable year that includes the deemed sale tax consequences 
and all subsequent affected taxable years are years for which an 
assessment of deficiency or a refund for overpayment is not prevented by 
any law or rule of law. In the case of a section 338 election for which 
a section 338(h)(10) election is made (or a section 338 election for a 
foreign target), old target may make the election to apply the 
regulations retroactively without regard to whether new target makes the 
election. In the case of a section 338 election for a domestic target 
for which no section 338(h)(10) election is made, old target may make 
the election to apply the regulations retroactively only if new target 
also makes the election. Paragraph (c)(3)(ii) of this section prescribes 
the time and manner of the election for old target.
    (ii) Time and manner of making the election for old target. Old 
target may make an election described in paragraph (c)(3)(i) of this 
section by attaching a statement to each affected party's original or 
amended income tax return for the taxable year that includes the deemed 
sale tax consequences. The statement must be entitled ``Election to 
Retroactively Apply the Rules in Sec. Sec. 1.338-11 (including the 
applicable provisions in Sec. Sec. 1.197-2(g)(5), 1.381(c)(22)-1 and 
846) to a transaction completed before April 10, 2006'' and must include 
the following information--
    (A) The name and E.I.N. for old target; and
    (B) The following declaration (or a substantially similar 
declaration): Old target has amended its income tax returns for the 
taxable year that includes the deemed sale tax consequences and

[[Page 205]]

for all affected subsequent years to reflect the rules in Sec. Sec. 
1.338-11 (including the applicable provisions in Sec. Sec. 1.197-
2(g)(5), 1.381(c)(22)-1 and 846). All other parties whose income tax 
liabilities are affected by old target's election have amended their 
income tax returns for all affected years to reflect the rules in 
Sec. Sec. 1.338-11 (including the applicable provisions in Sec. Sec. 
1.197-2(g)(5), 1.381(c)(22)-1 and 846).

[T.D. 8940, 66 FR 9954, Feb. 13, 2001, as amended by T.D. 9257, 71 FR 
18003, Apr. 10, 2006; T.D. 9377, 73 FR 3873, 3874, Jan. 23, 2008]

                               definition



Sec. 1.346-1  Partial liquidation.

    (a) General. This section defines a partial liquidation. If amounts 
are distributed in partial liquidation such amounts are treated under 
section 331(a)(2) as received in part or full payment in exchange for 
the stock. A distribution is treated as in partial liquidation of a 
corporation if:
    (1) The distribution is one of a series of distributions in 
redemption of all of the stock of the corporation pursuant to a plan of 
complete liquidation, or
    (2) The distribution:
    (i) Is not essentially equivalent to a dividend,
    (ii) Is in redemption of a part of the stock of the corporation 
pursuant to a plan, and
    (iii) Occurs within the taxable year in which the plan is adopted or 
within the succeeding taxable year.

An example of a distribution which will qualify as a partial liquidation 
under subparagraph (2) of this paragraph and section 346(a) is a 
distribution resulting from a genuine contraction of the corporate 
business such as the distribution of unused insurance proceeds recovered 
as a result of a fire which destroyed part of the business causing a 
cessation of a part of its activities. On the other hand, the 
distribution of funds attributable to a reserve for an expansion program 
which has been abandoned does not qualify as a partial liquidation 
within the meaning of section 346(a). A distribution to which section 
355 applies (or so much of section 356 as relates to section 355) is not 
a distribution in partial liquidation within the meaning of section 
346(a).
    (b) Special requirements on termination of business. A distribution 
which occurs within the taxable year in which the plan is adopted or 
within the succeeding taxable year and which meets the requirements of 
subsection (b) of section 346 falls within paragraph (a)(2) of this 
section and within section 346(a)(2). The requirements which a 
distribution must meet to fall within subsection (b) of section 346 are:
    (1) Such distribution is attributable to the corporation's ceasing 
to conduct, or consists of assets of, a trade or business which has been 
actively conducted throughout the five-year period immediately before 
the distribution, which trade or business was not acquired by the 
corporation within such period in a transaction in which gain or loss 
was recognized in whole or in part, and
    (2) Immediately after such distribution by the corporation it is 
actively engaged in the conduct of a trade or business, which trade or 
business was actively conducted throughout the five-year period ending 
on the date of such distribution and was not acquired by the corporation 
within such period in a transaction in which gain or loss was recognized 
in whole or in part.

A distribution shall be treated as having been made in partial 
liquidation pursuant to section 346(b) if it consists of the proceeds of 
the sale of the assets of a trade or business which has been actively 
conducted for the five-year period and has been terminated, or if it is 
a distribution in kind of the assets of such a business, or if it is a 
distribution in kind of some of the assets of such a business and of the 
proceeds of the sale of the remainder of the assets of such a business. 
In general, a distribution which will qualify under section 346(b) may 
consist of, but is not limited to:
    (i) Assets (other than inventory or property described in 
subdivision (ii) of this subparagraph) used in the trade or business 
throughout the five-year period immediately before the distribution (for 
this purpose an asset shall be considered used in the trade or business 
during the period of time the asset which it replaced was so used), or

[[Page 206]]

    (ii) Proceeds from the sale of assets described in subdivision (i) 
of this subparagraph, and, in addition,
    (iii) The inventory of such trade or business or property held 
primarily for sale to customers in the ordinary course of business, if:
    (a) The items constituting such inventory or such property were 
substantially similar to the items constituting such inventory or 
property during the five-year period immediately before the 
distribution, and
    (b) The quantity of such items on the date of distribution was not 
substantially in excess of the quantity of similar items regularly on 
hand in the conduct of such business during such five-year period, or
    (iv) Proceeds from the sale of inventory or property described in 
subdivision (iii) of this subparagraph, if such inventory or property is 
sold in bulk in the course of termination of such trade or business and 
if with respect to such inventory the conditions of subdivision (iii)(a) 
and (b) of this subparagraph would have been met had such inventory or 
property been distributed on the date of such sale.
    (c) Active conduct of a trade or business. For the purpose of 
section 346(b)(1), a corporation shall be deemed to have actively 
conducted a trade or business immediately before the distribution, if:
    (1) In the case of a business the assets of which have been 
distributed in kind, the business was operated by such corporation until 
the date of distribution, or
    (2) In the case of a business the proceeds of the sale of the assets 
of which are distributed, such business was actively conducted until the 
date of sale and the proceeds of such sale were distributed as soon 
thereafter as reasonably possible.

The term active conduct of a trade or business shall have the same 
meaning in this section as in paragraph (c) of Sec. 1.355-1.



Sec. 1.346-2  Treatment of certain redemptions.

    If a distribution in a redemption of stock qualifies as a 
distribution in part or full payment in exchange for the stock under 
both section 302(a) and this section, then only this section shall be 
applicable. None of the limitations of section 302 shall be applicable 
to such redemption.



Sec. 1.346-3  Effect of certain sales.

    The determination of whether assets sold in connection with a 
partial liquidation are sold by the distributing corporation or by the 
shareholder is a question of fact to be determined under the facts and 
circumstances of each case.

               Corporate Organizations and Reorganizations

                         corporate organizations



Sec. 1.351-1  Transfer to corporation controlled by transferor.

    (a) In general--(1) Nonrecognition of gain or loss. Section 351(a) 
provides, in general, for the nonrecognition of gain or loss upon the 
transfer by one or more persons of property to a corporation solely in 
exchange for stock of such corporation if, immediately after the 
exchange, such person or persons are in control of the corporation to 
which the property was transferred. As used in section 351, the phrase 
``one or more persons'' includes individuals, trusts, estates, 
partnerships, associations, companies, or corporations (see section 
7701(a)(1)). To be in control of the transferee corporation, such person 
or persons must own immediately after the transfer stock possessing at 
least 80 percent of the total combined voting power of all classes of 
stock entitled to vote and at least 80 percent of the total number of 
shares of all other classes of stock of such corporation (see section 
368(c)). In determining control under this section, the fact that any 
corporate transferor distributes part or all of the stock which it 
receives in the exchange to its shareholders shall not be taken into 
account. The phrase ``immediately after the exchange'' does not 
necessarily require simultaneous exchanges by two or more persons, but 
comprehends a situation where the rights of the parties have been 
previously defined and the execution of the agreement proceeds with an 
expedition consistent with orderly procedure. For purposes of this 
section, stock

[[Page 207]]

rights and stock warrants are not included in the term stock. In 
addition, for purposes of this section--
    (i) Stock will not be treated as issued for property if it is issued 
for services rendered or to be rendered to or for the benefit of the 
issuing corporation; and
    (ii) Stock will not be treated as issued for property if it is 
issued for property which is of relatively small value in comparison to 
the value of the stock already owned (or to be received for services) by 
the person who transferred such property and the primary purpose of the 
transfer is to qualify under this section the exchanges of property by 
other persons transferring property.
    (2) Application. The application of section 351(a) is illustrated by 
the following examples:

    Example 1. C owns a patent right worth $25,000 and D owns a 
manufacturing plant worth $75,000. C and D organize the R Corporation 
with an authorized capital stock of $100,000. C transfers his patent 
right to the R Corporation for $25,000 of its stock and D transfers his 
plant to the new corporation for $75,000 of its stock. No gain or loss 
to C or D is recognized.
    Example 2. B owns certain real estate which cost him $50,000 in 
1930, but which has a fair market value of $200,000 in 1955. He 
transfers the property to the N Corporation in 1955 for 78 percent of 
each class of stock of the corporation having a fair market value of 
$200,000, the remaining 22 percent of the stock of the corporation 
having been issued by the corporation in 1940 to other persons for cash. 
B realized a taxable gain of $150,000 on this transaction.
    Example 3. E, an individual, owns property with a basis of $10,000 
but which has a fair market value of $18,000. E also had rendered 
services valued at $2,000 to Corporation F. Corporation F has 
outstanding 100 shares of common stock all of which are held by G. 
Corporation F issues 400 shares of its common stock (having a fair 
market value of $20,000) to E in exchange for his property worth $18,000 
and in compensation for the services he has rendered worth $2,000. Since 
immediately after the transaction, E owns 80 percent of the outstanding 
stock of Corporation F, no gain is recognized upon the exchange of the 
property for the stock. However, E realized $2,000 of ordinary income as 
compensation for services rendered to Corporation F.

    (3) Underwritings of stock--(i) In general. For the purpose of 
section 351, if a person acquires stock of a corporation from an 
underwriter in exchange for cash in a qualified underwriting 
transaction, the person who acquires stock from the underwriter is 
treated as transferring cash directly to the corporation in exchange for 
stock of the corporation and the underwriter is disregarded. A qualified 
underwriting transaction is a transaction in which a corporation issues 
stock for cash in an underwriting in which either the underwriter is an 
agent of the corporation or the underwriter's ownership of the stock is 
transitory.
    (ii) Effective date. This paragraph (a)(3) is effective for 
qualified underwriting transactions occurring on or after May 1, 1996.

    (b) Multiple transferors--(1) Disproportionate transfers. When 
property is transferred to a corporation by two or more persons in 
exchange for stock, as described in paragraph (a) of this section, and 
the stock received is disproportionate to the transferor's prior 
interest in such property, the entire transaction will be given tax 
effect in accordance with its true nature, and the transaction may be 
treated as if the stock had first been received in proportion and then 
some of such stock had been used to make gifts (section 2501 and 
following), to pay compensation (sections 61(a)(1) and 83(a)), or to 
satisfy obligations of the transferor of any kind.
    (2) Application. The application of paragraph (b)(1) of this section 
may be illustrated as follows:

    Example 1. Individuals A and B, father and son, organize a 
corporation with 100 shares of common stock to which A transfers 
property worth $8,000 in exchange for 20 shares of stock, and B 
transfers property worth $2,000 in exchange for 80 shares of stock. No 
gain or loss will be recognized under section 351. However, if it is 
determined that A in fact made a gift to B, such gift will be subject to 
tax under section 2501 and following. Similarly, if B had rendered 
services to A (such services having no relation to the assets 
transferred or to the business of the corporation) and the disproportion 
in the amount of stock received constituted the payment of compensation 
by A to B, B will be taxable upon the fair market value of the 60 shares 
of stock received as compensation for services rendered, and A will 
realize gain or loss upon the difference between the basis to him of the 
60 shares and their fair market value at the time of the exchange.

[[Page 208]]

    Example 2. Individuals C and D each transferred, to a newly 
organized corporation, property having a fair market value of $4,500 in 
exchange for the issuance by the corporation of 45 shares of its capital 
stock to each transferor. At the same time, the corporation issued to E, 
an individual, 10 shares of its capital stock in payment for 
organizational and promotional services rendered by E for the benefit of 
the corporation. E transferred no property to the corporation. C and D 
were under no obligation to pay for E's services. No gain or loss is 
recognized to C or D. E received compensation taxable as ordinary income 
to the extent of the fair market value of the 10 shares of stock 
received by him.

    (c)(1) The general rule of section 351 does not apply, and 
consequently gain or loss will be recognized, where property is 
transferred to an investment company after June 30, 1967. A transfer of 
property after June 30, 1967, will be considered to be a transfer to an 
investment company if--
    (i) The transfer results, directly or indirectly, in diversification 
of the transferors' interests, and
    (ii) The transferee is (a) a regulated investment company, (b) a 
real estate investment trust, or (c) a corporation more than 80 percent 
of the value of whose assets (excluding cash and nonconvertible debt 
obligations from consideration) are held for investment and are readily 
marketable stocks or securities, or interests in regulated investment 
companies or real estate investment trusts.
    (2) The determination of whether a corporation is an investment 
company shall ordinarily be made by reference to the circumstances in 
existence immediately after the transfer in question. However, where 
circumstances change thereafter pursuant to a plan in existence at the 
time of the transfer, this determination shall be made by reference to 
the later circumstances.
    (3) Stocks and securities will be considered readily marketable if 
(and only if) they are part of a class of stock or securities which is 
traded on a securities exchange or traded or quoted regularly in the 
over-the-counter market. For purposes of subparagraph (1)(ii)(c) of this 
paragraph, the term ``readily marketable stocks or securities'' includes 
convertible debentures, convertible preferred stock, warrants, and other 
stock rights if the stock for which they may be converted or exchanged 
is readily marketable. Stocks and securities will be considered to be 
held for investment unless they are (i) held primarily for sale to 
customers in the ordinary course of business, or (ii) used in the trade 
or business of banking, insurance, brokerage, or a similar trade or 
business.
    (4) In making the determination required under subparagraph 
(1)(ii)(c) of this paragraph, stock and securities in subsidiary 
corporations shall be disregarded and the parent corporation shall be 
deemed to own its ratable share of its subsidiaries' assets. A 
corporation shall be considered a subsidiary if the parent owns 50 
percent or more of (i) the combined voting power of all classes of stock 
entitled to vote, or (ii) the total value of shares of all classes of 
stock outstanding.
    (5) A transfer ordinarily results in the diversification of the 
transferors' interests if two or more persons transfer nonidentical 
assets to a corporation in the exchange. For this purpose, if any 
transaction involves one or more transfers of nonidentical assets which, 
taken in the aggregate, constitute an insignificant portion of the total 
value of assets transfered, such transfers shall be disregarded in 
determining whether diversification has occurred. If there is only one 
transferor (or two or more transferors of identical assets) to a newly 
organized corporation, the transfer will generally be treated as not 
resulting in diversification. If a transfer is part of a plan to achieve 
diversification without recognition of gain, such as a plan which 
contemplates a subsequent transfer, however delayed, of the corporate 
assets (or of the stock or securities received in the earlier exchange) 
to an investment company in a transaction purporting to qualify for 
nonrecognition treatment, the original transfer will be treated as 
resulting in diversification.
    (6)(i) For purposes of paragraph (c)(5) of this section, a transfer 
of stocks and securities will not be treated as resulting in a 
diversification of the transferors' interests if each transferor 
transfers a diversified portfolio of stocks and securities. For purposes 
of this paragraph (c)(6), a portfolio of stocks and securities is 
diversified if it

[[Page 209]]

satisfies the 25 and 50-percent tests of section 368(a)(2)(F)(ii), 
applying the relevant provisions of section 368(a)(2)(F). However, 
Government securities are included in total assets for purposes of the 
denominator of the 25 and 50-percent tests (unless the Government 
securities are acquired to meet the 25 and 50-percent tests), but are 
not treated as securities of an issuer for purposes of the numerator of 
the 25 and 50-percent tests.
    (ii) Paragraph (c)(6)(i) of this section is effective for transfers 
completed on or after May 2, 1996. Transfers of diversified (within the 
meaning of paragraph (c)(6)(i) of this section), but nonidentical, 
portfolios of stocks and securities completed before May 2, 1996, may be 
treated either--
    (A) Consistent with paragraph (c)(6)(i) of this section; or
    (B) As resulting in diversification of the transferors' interests.
    (7) The application of subparagraph (5) of this paragraph may be 
illustrated as follows:

    Example 1. Individuals A, B, and C organize a corporation with 101 
shares of common stock. A and B each transfers to it $10,000 worth of 
the only class of stock of corporation X, listed on the New York Stock 
Exchange, in exchange for 50 shares of stock. C transfers $200 worth of 
readily marketable securities in corporation Y for one share of stock. 
In determining whether or not diversification has occurred, C's 
participation in the transaction will be disregarded. There is, 
therefore, no diversification, and gain or loss will not be recognized.
    Example 2. A, together with 50 other transferors, organizes a 
corporation with 100 shares of stock. A transfers $10,000 worth of stock 
in corporation X, listed on the New York Stock Exchange, in exchange for 
50 shares of stock. Each of the other 50 transferors transfers $200 
worth of readily marketable securities in corporations other than X in 
exchange for one share of stock. In determining whether or not 
diversification has occurred, all transfers will be taken into account. 
Therefore, diversification is present, and gain or loss will be 
recognized.
    (d) Applicability date. Paragraphs (a)(1) and (b)(1) of this section 
apply to transfers after October 2, 1989, for tax years ending after 
such date, except as specified in section 7203(c)(2) and (3) of Public 
Law 101-239.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6942, 32 FR 
20977, Dec. 29, 1967; T.D. 8665, 61 FR 19189, May 1, 1996; T.D. 8663, 61 
FR 19545, May 2, 1996; T.D. 9759, 81 FR 17074, Mar. 28, 2016]



Sec. 1.351-2  Receipt of property.

    (a) If an exchange would be within the provisions of section 351(a) 
if it were not for the fact that the property received in exchange 
consists not only of property permitted by such subsection to be 
received without the recognition of gain, but also of other property or 
money, then the gain, if any, to the recipient shall be recognized, but 
in an amount not in excess of the sum of such money and the fair market 
value of such other property. No loss to the recipient shall be 
recognized.
    (b) See section 357 and the regulations pertaining to that section 
for applicable rules as to the treatment of liabilities as ``other 
property'' in cases subject to section 351, where another party to the 
exchange assumes a liability, or acquires property subject to a 
liability.
    (c) See sections 358 and 362 and the regulations pertaining to those 
sections for applicable rules with respect to the determination of the 
basis of stock, securities, or other property received in exchanges 
subject to section 351.
    (d) See part I (section 301 and following), subchapter C, chapter 1 
of the Code, and the regulations thereunder for applicable rules with 
respect to the taxation of dividends where a distribution by a 
corporation of its stock or securities in connection with an exchange 
subject to section 351(a) has the effect of the distribution of a 
taxable dividend.
    (e) See Sec. 1.356-7(a) for the applicability of the definition of 
nonqualified preferred stock in section 351(g)(2) for stock issued prior 
to June 9, 1997, and for stock issued in transactions occurring after 
June 8, 1997, that are described in section 1014(f)(2) of the Taxpayer 
Relief Act of 1997, Public Law 105-34 (111 Stat. 788, 921). See Sec. 
1.356-7(c)

[[Page 210]]

for the treatment of preferred stock received in certain exchanges for 
common or preferred stock described in section 351(g)(2)(C)(i)(II).

[T.D. 6500, 25 FR 11607, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8904, 65 FR 58650, Oct. 2, 2000]



Sec. 1.351-3  Records to be kept and information to be filed.

    (a) Significant transferor. Every significant transferor must 
include a statement entitled, ``STATEMENT PURSUANT TO Sec. 1.351-3(a) 
BY [INSERT NAME AND TAXPAYER IDENTIFICATION NUMBER (IF ANY) OF 
TAXPAYER], A SIGNIFICANT TRANSFEROR,'' on or with such transferor's 
income tax return for the taxable year of the section 351 exchange. If a 
significant transferor is a controlled foreign corporation (within the 
meaning of section 957), each United States shareholder (within the 
meaning of section 951(b)) with respect thereto must include this 
statement on or with its return. The statement must include--
    (1) The name and employer identification number (if any) of the 
transferee corporation;
    (2) The date(s) of the transfer(s) of assets;
    (3) The fair market value and basis of the property transferred by 
such transferor in the exchange, determined immediately before the 
transfer and aggregated as follows:
    (i) Importation property transferred in a loss importation 
transaction, as defined in Sec. 1.362-3(c)(2) and (3), respectively;
    (ii) Loss duplication property as defined in Sec. 1.362-4(g)(1);
    (iii) Property with respect to which any gain or loss was recognized 
on the transfer (without regard to whether such property is also 
identified in paragraph (a)(3)(i) or (ii) of this section); and
    (iv) Property not described in paragraph (a)(3)(i), (ii), or (iii) 
of this section.
    (4) The date and control number of any private letter ruling(s) 
issued by the Internal Revenue Service in connection with the section 
351 exchange.
    (b) Transferee corporation. Except as provided in paragraph (c) of 
this section, every transferee corporation must include a statement 
entitled, ``STATEMENT PURSUANT TO Sec. 1.351-3(b) BY [INSERT NAME AND 
EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A TRANSFEREE 
CORPORATION,'' on or with its income tax return for the taxable year of 
the exchange. If the transferee corporation is a controlled foreign 
corporation (within the meaning of section 957), each United States 
shareholder (within the meaning of section 951(b)) with respect thereto 
must include this statement on or with its return. The statement must 
include--
    (1) The name and taxpayer identification number (if any) of every 
significant transferor;
    (2) The date(s) of the transfer(s) of assets;
    (3) The fair market value and basis of property received in the 
exchange, determined immediately before the transfer and aggregated as 
follows:
    (i) Importation property transferred in a loss importation 
transaction, as defined in Sec. 1.362-3(c)(2) and (3), respectively;
    (ii) Loss duplication property as defined in Sec. 1.362-4(g)(1);
    (iii) Property with respect to which any gain or loss was recognized 
on the transfer (without regard to whether such property is also 
identified in paragraph (b)(3)(ii) of this section);
    (iv) Property not described in paragraph (b)(3)(i), (ii), or (iii) 
of this section; and
    (4) The date and control number of any private letter ruling(s) 
issued by the Internal Revenue Service in connection with the section 
351 exchange.
    (c) Exception for certain transferee corporations. The transferee 
corporation is not required to file a statement under paragraph (b) of 
this section if all of the information that would be included in the 
statement described in paragraph (b) of this section is included in any 
statement(s) described in paragraph (a) of this section that is attached 
to the same return for the same section 351 exchange.
    (d) Definitions. For purposes of this section:
    (1) Significant transferor means a person that transferred property 
to a corporation and received stock of the

[[Page 211]]

transferee corporation in an exchange described in section 351 if, 
immediately after the exchange, such person--
    (i) Owned at least five percent (by vote or value) of the total 
outstanding stock of the transferee corporation if the stock owned by 
such person is publicly traded, or
    (ii) Owned at least one percent (by vote or value) of the total 
outstanding stock of the transferee corporation if the stock owned by 
such person is not publicly traded.
    (2) Publicly traded stock means stock that is listed on--
    (i) A national securities exchange registered under section 6 of the 
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
    (ii) An interdealer quotation system sponsored by a national 
securities association registered under section 15A of the Securities 
Exchange Act of 1934 (15 U.S.C. 78o-3).
    (e) Substantiation information. Under Sec. 1.6001-1(e), taxpayers 
are required to retain their permanent records and make such records 
available to any authorized Internal Revenue Service officers and 
employees. In connection with the exchange described in this section, 
these records should specifically include information regarding the 
amount, basis, and fair market value of all transferred property, and 
relevant facts regarding any liabilities assumed or extinguished as part 
of such exchange.
    (f) Effective/applicability date. * * * Paragraphs (a)(3) and (b)(3) 
of this section apply with respect to exchanges under section 351 
occurring on or after March 28, 2016, and also with respect to exchanges 
under section 351 occurring before such date as a result of an entity 
classification election under Sec. 301.7701-3 of this chapter filed on 
or after March 28, 2016, unless such exchange is pursuant to a binding 
agreement that was in effect prior to March 28, 2016 and at all times 
thereafter.

[T.D. 9329, 72 FR 32798, June 14, 2007, as amended by T.D. 9759, 81 FR 
17074, Mar. 28, 2016]

              effects on shareholders and security holders



Sec. 1.354-1  Exchanges of stock and securities in certain 
reorganizations.

    (a) Section 354 provides that under certain circumstances no gain or 
loss is recognized to a shareholder who surrenders his stock in exchange 
for other stock or to a security holder who surrenders his securities in 
exchange for stock. Section 354 also provides that under certain 
circumstances a security holder may surrender securities and receive 
securities in the same principal amount or in a lesser principal amount 
without the recognition of gain or loss to him. The exchanges to which 
section 354 applies must be pursuant to a plan of reorganization as 
provided in section 368(a) and the stock and securities surrendered as 
well as the stock and securities received must be those of a corporation 
which is a party to the reorganization. Section 354 does not apply to 
exchanges pursuant to a reorganization described in section 368(a)(1)(D) 
unless the transferor corporation--
    (1) Transfers all or substantially all of its assets to a single 
corporation, and
    (2) Distributes all of its remaining properties (if any) and the 
stock, securities and other properties received in the exchange to its 
shareholders or security holders in pursuance of the plan of 
reorganization. The fact that properties retained by the transferor 
corporation, or received in exchange for the properties transferred in 
the reorganization, are used to satisfy existing liabilities not 
represented by securities and which were incurred in the ordinary course 
of business before the reorganization does not prevent the application 
of section 354 to an exchange pursuant to a plan of reorganization 
defined in section 368(a)(1)(D).
    (b) Except as provided in section 354 (c) and (d), section 354 is 
not applicable to an exchange of stock or securities if a greater 
principal amount of securities is received than the principal amount of 
securities the recipient surrenders, or if securities are received and 
the recipient surrenders no securities. See, however, section 356 and 
regulations pertaining to such section. See also section 306 with 
respect to the

[[Page 212]]

receipt of preferred stock in a transaction to which section 354 is 
applicable.
    (c) An exchange of stock or securities shall be subject to section 
354(a)(1) even though--
    (1) Such exchange is not pursuant to a plan of reorganization 
described in section 368(a), and
    (2) The principal amount of the securities received exceeds the 
principal amount of the securities surrendered or if securities are 
received and no securities are surrendered--

if such exchange is pursuant to a plan of reorganization for a railroad 
corporation as defined in section 77(m) of the Bankruptcy Act (11 U.S.C. 
205(m)) and is approved by the Interstate Commerce Commission under 
section 77 of such act or under section 20b of the Interstate Commerce 
Act (49 U.S.C. 20b) as being in the public interest. Section 354 is not 
applicable to such exchanges if there is received property other than 
stock or securities. See, however, section 356 and regulations 
pertaining to such section.
    (d) The rules of section 354 may be illustrated by the following 
examples:

    Example 1. Pursuant to a reorganization under section 368(a) to 
which Corporations T and W are parties, A, a shareholder in Corporation 
T, surrenders all his common stock in Corporation T in exchange for 
common stock of Corporation W. No gain or loss is recognized to A.
    Example 2. Pursuant to a reorganization under section 368(a) to 
which Corporations X and Y (which are not railroad corporations) are 
parties, B, a shareholder in Corporation X, surrenders all his stock in 
X for stock and securities in Y. Section 354 does not apply to this 
exchange. See, however, section 356.
    Example 3. C, a shareholder in Corporation Z (which is not a 
railroad corporation), surrenders all his stock in Corporation Z in 
exchange for securities in Corporation Z. Whether or not this exchange 
is in connection with a recapitalization under section 368(a)(1)(E), 
section 354 does not apply. See, however, section 302.
    Example 4. The facts are the same as in Example 3 of this paragraph 
(d), except that C receivies solely rights to acquire stock in 
Corporation Z. Section 354 does not apply.

    (e) Except as provided in Sec. 1.356-6, for purposes of section 
354, the term securities includes rights issued by a party to the 
reorganization to acquire its stock. For purposes of this section and 
section 356(d)(2)(B), a right to acquire stock has no principal amount. 
For this purpose, rights to acquire stock has the same meaning as it 
does under sections 305 and 317(a). Other Internal Revenue Code 
provisions governing the treatment of rights to acquire stock may also 
apply to certain exchanges occurring in connection with a 
reorganization. See, for example, sections 83 and 421 through 424 and 
the regulations thereunder. This paragraph (e) applies to exchanges 
occurring on or after March 9, 1998.
    (f) See Sec. 1.356-7(a) and (b) for the treatment of nonqualified 
preferred stock (as defined in section 351(g)(2)) received in certain 
exchanges for nonqualified preferred stock or preferred stock. See Sec. 
1.356-7(c) for the treatment of preferred stock received in certain 
exchanges for common or preferred stock described in section 
351(g)(2)(C)(i)(II).

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7616, 44 FR 
26869, May 8, 1979; T.D. 8752, 63 FR 410, Jan. 6, 1998; T.D. 8882, 65 FR 
31078, May 16, 2000; T.D. 8904, 65 FR 58651, Oct. 2, 2000]



Sec. 1.355-0  Outline of sections.

    In order to facilitate the use of Sec. Sec. 1.355-1 through 1.355-
8, this section lists the major paragraphs in those sections as follows:

   Sec. 1.355-1 Distribution of stock and securities of a controlled 
                              corporation.

    (a) Effective date of certain sections.
    (b) Application of section.

                       Sec. 1.355-2 Limitations.

    (a) Property distributed.
    (b) Independent business purpose.
    (1) Independent business purpose requirement.
    (2) Corporate business purpose.
    (3) Business purpose for distribution.
    (4) Business purpose as evidence of nondevice.
    (5) Examples.
    (c) Continuity of interest requirement.
    (1) Requirement.
    (2) Examples.
    (d) Device for distribution of earnings and profits.
    (1) In general.
    (2) Device factors.
    (i) In general.
    (ii) Pro rata distribution.
    (iii) Subsequent sale or exchange of stock.
    (A) In general.

[[Page 213]]

    (B) Sale or exchange negotiated or agreed upon before the 
distribution.
    (C) Sale or exchange not negotiated or agreed upon before the 
distribution.
    (D) Negotiated or agreed upon before the distribution.
    (E) Exchange in pursuance of a plan of reorganization.
    (iv) Nature and use of assets.
    (A) In general.
    (B) Assets not used in a trade or business meeting the requirement 
of section 355(b).
    (C) Related function.
    (3) Nondevice factors.
    (i) In general.
    (ii) Corporate business purpose.
    (iii) Distributing corporation publicly traded and widely held.
    (iv) Distribution to domestic corporate shareholders.
    (4) Examples.
    (5) Transactions ordinarily not considered as a device.
    (i) In general.
    (ii) Absence of earnings and profits.
    (iii) Section 303(a) transactions.
    (iv) Section 302(a) transactions.
    (v) Examples.
    (e) Stock and securities distributed.
    (1) In general.
    (2) Additional rules.
    (f) Principal amount of securities.
    (1) Securities received.
    (2) Only stock received.
    (g) Recently acquired controlled stock under section 355(a)(3)(B).
    (1) Other property.
    (2) Exceptions.
    (3) DSAG.
    (4) Taxable transaction.
    (5) Examples.
    (h) Active conduct of a trade or business.
    (i) Effective/applicability date.

          Sec. 1.355-3 Active conduct of a trade or business.

    (a) General requirements.
    (1) Application of section 355.
    (2) Examples.
    (b) Active conduct of a trade or business defined.
    (1) In general.
    (2) Active conduct or a trade or business immediately after 
distribution.
    (i) In general.
    (ii) Trade or business.
    (iii) Active conduct.
    (iv) Limitations.
    (3) Active conduct for five-year period preceding distribution.
    (4) Special rules for acquisition of a trade or business (Prior to 
the Revenue Act of 1987 and Technical and Miscellaneous Revenue Act of 
1988).
    (i) In general.
    (ii) Example.
    (iii) Gain or loss recognized in certain transactions.
    (iv) Affiliated group.
    (5) Special rules for acquisition of a trade or business (After the 
Revenue Act of 1987 and Technical and Miscellaneous Revenue Act of 
1988).
    (c) Examples.

             Sec. 1.355-4 Non pro rata distributions, etc.

      Sec. 1.355-5 Records to be kept and information to be filed.

    (a) Distributing corporation.
    (1) In general.
    (2) Special rule when an asset transfer precedes a stock 
distribution.
    (b) Significant distributee.
    (c) Definitions.
    (1) Significant distributee.
    (2) Publicly traded stock.
    (d) Substantiation information.
    (e) Effective/applicability date.

 Sec. 1.355-6 Recognition of gain on certain distributions of stock or 
                  securities in controlled corporation.

    (a) Conventions.
    (1) Examples.
    (2) Five-year period.
    (3) Distributing securities.
    (4) Marketable securities.
    (b) General rules and purposes of section 355(d).
    (1) Disqualified distributions in general.
    (2) Disqualified stock.
    (i) In general.
    (ii) Purchase.
    (iii) Exceptions.
    (A) Purchase eliminated.
    (B) Deemed purchase eliminated.
    (C) Elimination of basis.
    (1) General rule.
    (2) Special rule for transferred and exchanged basis property.
    (3) Special rule for Split-offs and Split-ups.
    (D) Special rule if basis allocated between two corporations.
    (3) Certain distributions not disqualified distributions because 
purposes of section 355(d) not violated.
    (i) In general.
    (ii) Disqualified person.
    (iii) Purchased basis.
    (iv) Increase in interest because payment of cash in lieu of 
fractional shares.
    (v) Other exceptions.
    (vi) Examples.
    (4) Anti-avoidance rule.
    (i) In general.
    (ii) Example.
    (c) Whether a person holds a 50 percent or greater interest.
    (1) In general.
    (2) Valuation.
    (3) Effect of options, warrants, convertible obligations, and other 
similar interests.

[[Page 214]]

    (i) Application.
    (ii) General rule.
    (iii) Options deemed newly issued and substituted options.
    (A) Exchange, adjustment, or alteration of existing option.
    (B) Certain compensatory options.
    (C) Substituted options.
    (iv) Effect of treating an option as exercised.
    (A) In general.
    (B) Stock purchase agreement or similar arrangement.
    (v) Instruments treated as options.
    (vi) Instruments generally not treated as options.
    (A) Escrow, pledge, or other security agreements.
    (B) Compensatory options.
    (1) General rule.
    (2) Exception.
    (C) Certain stock conversion features.
    (D) Options exercisable only upon death, disability, mental 
imcompetency, or separation from service.
    (E) Rights of first refusal.
    (F) Other enumerated instruments.
    (vii) Reasonably certain that the option will be exercised.
    (A) In general.
    (B) Stock purchase agreement or similar arrangement.
    (viii) Examples.
    (4) Plan or arrangement.
    (i) In general.
    (ii) Understanding.
    (iii) Examples.
    (iv) Exception.
    (A) Subsequent disposition.
    (B) Example.
    (d) Purchase.
    (1) In general.
    (i) Definition of purchase under section 355(d)(5)(A).
    (ii) Section 355 distributions.
    (iii) Example.
    (2) Exceptions to definition of purchase under section 355(d)(5)(A).
    (i) Acquisition of stock in a transaction which includes other 
property or money.
    (A) Transferors and shareholders of transferor or distributing 
corporations.
    (1) In general.
    (2) Exception.
    (B) Transferee corporations.
    (1) In general.
    (2) Exception.
    (C) Examples.
    (ii) Acquisition of stock in a distribution to which section 305(a) 
applies.
    (iii) Section 1036(a) exchange.
    (iv) Section 338 elections.
    (A) In general.
    (B) Example.
    (v) Partnership distributions.
    (A) Section 732(b).
    (B) Section 734(b).
    (3) Certain section 351 exchanges treated as purchases.
    (i) In general.
    (A) Treatment of stock received by transferor.
    (B) Multiple classes of stock.
    (ii) Cash item, marketable stock.
    (iii) Exception for certain acquisitions.
    (A) In general.
    (B) Example.
    (iv) Exception for assets transferred as part of an active trade or 
business.
    (A) In general.
    (B) Active conduct of a trade or business.
    (C) Reasonable needs of the trade or business.
    (D) Consideration of all facts and circumstances.
    (E) Successive transfers.
    (v) Exception for transfer between members of the same affiliated 
group.
    (A) In general.
    (B) Examples.
    (4) Triangular asset reorganizations.
    (i) Definition.
    (ii) Treatment.
    (iii) Example.
    (5) Reverse triangular reorganizations other than triangular asset 
reorganizations.
    (i) In general.
    (ii) Letter ruling and closing agreement.
    (iii) Example.
    (6) Treatment of group structure changes.
    (i) In general.
    (ii) Adjustments to basis of higher-tier members.
    (iii) Example.
    (7) Special rules for triangular asset reorganizations, other 
reverse triangular reorganizations, and group structure changes.
    (e) Deemed purchase and timing rules.
    (1) Attribution and aggregation.
    (i) In general.
    (ii) Purchase of additional interest.
    (iii) Purchase between persons treated as one person.
    (iv) Purchase by a person already treated as holding stock under 
section 355(d)(8)(A).
    (v) Examples.
    (2) Transferred basis rule.
    (3) Exchanged basis rule.
    (i) In general.
    (ii) Example.
    (4) Certain section 355 or section 305 distributions.
    (i) Section 355.
    (ii) Section 305.
    (5) Substantial diminution of risk.
    (i) In general.
    (ii) Property to which suspension applies.
    (iii) Risk of loss substantially diminished.
    (iv) Special class of stock.
    (f) Duty to determine stockholders.
    (1) In general.
    (2) Deemed knowledge of contents of securities filings.
    (3) Presumptions as to securities filings.

[[Page 215]]

    (4) Presumption as to less-than-five-percent shareholders.
    (5) Examples.
    (g) Effective date.

 Sec. 1.355-7 Recognition of gain on certain distributions of stock or 
              securities in connection with an acquisition.

    (a) In general.
    (b) Plan.
    (1) In general.
    (2) Certain post-distribution acquisitions.
    (3) Plan factors.
    (4) Non-plan factors.
    (c) Operating rules.
    (1) Internal discussions and discussions with outside advisors 
evidence of business purpose.
    (2) Takeover defense.
    (3) Effect of distribution on trading in stock.
    (4) Consequences of section 355(e) disregarded for certain purposes.
    (5) Multiple acquisitions.
    (d) Safe harbors.
    (1) Safe Harbor I.
    (2) Safe Harbor II.
    (i) In general.
    (ii) Special rule.
    (3) Safe Harbor III.
    (4) Safe Harbor IV.
    (i) In general.
    (ii) Special rules.
    (5) Safe Harbor V.
    (i) In general.
    (ii) Special rules.
    (6) Safe Harbor VI.
    (7) Safe Harbor VII.
    (i) In general.
    (ii) Special rules.
    (8) Safe Harbor VIII.
    (i) In general.
    (ii) Special rule.
    (9) Safe Harbor IX.
    (i) In general.
    (ii) Special rule.
    (e) Options, warrants, convertible obligations, and other similar 
interests.
    (1) Treatment of options.
    (i) General rule.
    (ii) Agreement, understanding, or arrangement to write, transfer, or 
modify an option.
    (iii) Substantial negotiations related to options.
    (2) Stock acquired pursuant to options.
    (3) Instruments treated as options.
    (4) Instruments generally not treated as options.
    (i) Escrow, pledge, or other security agreements.
    (ii) Options exercisable only upon death, disability, mental 
incompetency, or separation from service.
    (iii) Rights of first refusal.
    (iv) Other enumerated instruments.
    (f) Multiple controlled corporations.
    (g) Valuation.
    (h) Definitions.
    (1) Agreement, understanding, arrangement, or substantial 
negotiations.
    (2) Controlled corporation.
    (3) Controlling shareholder.
    (4) Coordinating group.
    (5) Disclosure event.
    (6) Discussions.
    (7) Established market.
    (8) Five-percent shareholder.
    (9) Implicit permission.
    (10) Public announcement.
    (11) Public offering.
    (12) Similar acquisition (not involving a public offering).
    (13) Similar acquisition involving a public offering.
    (i) One public offering.
    (ii) More than one public offering.
    (iii) Potential acquisition involving a public offering.
    (14) Ten-percent shareholder.
    (i) [Reserved]
    (j) Examples.
    (k) Effective dates.

Sec. 1.355-8 Definition of predecessor and successor and limitations on 
        gain recognition under section 355(e) and section 355(f).

    (a) In general.
    (1) Scope.
    (2) Overview.
    (i) Purposes and conceptual overview.
    (ii) References to and definitions of terms used in this section.
    (iii) Special rules and examples.
    (3) Purposes of section; Predecessor of Distributing overview.
    (i) Purposes.
    (ii) Predecessor of Distributing overview.
    (A) Relevant Property transferred to Controlled.
    (B) Relevant Property includes Controlled Stock.
    (4) References.
    (i) References to Distributing or Controlled.
    (ii) References to Plan or Distribution.
    (iii) Plan Period.
    (5) List of definitions.
    (b) Predecessor of Distributing.
    (1) Definition.
    (i) In general.
    (ii) Pre-Distribution requirements.
    (A) Relevant Property requirement.
    (B) Reflection of basis requirement.
    (iii) Post-Distribution requirement.
    (2) Additional definitions and rules related to paragraph (b)(1) of 
this section.
    (i) References to Distributing and Controlled.
    (ii) Potential Predecessor.
    (A) Potential Predecessor definition.
    (B) Expanded Affiliated Group definition.
    (iii) Successors of Potential Predecessors.
    (iv) Relevant Property; Relevant Equity.

[[Page 216]]

    (A) In general.
    (B) Property held by Distributing.
    (C) F reorganizations.
    (v) Stock of Distributing as Relevant Property.
    (A) In general.
    (B) Certain reorganizations.
    (vi) Substitute Asset.
    (A) In general.
    (B) Controlled stock received by Distributing.
    (1) In general.
    (2) Exception.
    (C) Treatment as Relevant Property.
    (vii) Separated Property.
    (viii) Underlying Property.
    (ix) Multiple Predecessors of Distributing.
    (x) Deemed exchanges.
    (c) Additional definitions.
    (1) Predecessor of Controlled.
    (2) Successors.
    (i) In general.
    (ii) Determination of Successor status.
    (3) Section 381 Transaction.
    (d) Special acquisition rules.
    (1) Deemed acquisitions of stock in Section 381 Transactions.
    (i) Rule.
    (ii) Example.
    (2) Deemed acquisitions of stock after Section 381 Transactions.
    (3) Separate counting for Distributing and each Predecessor of 
Distributing.
    (e) Special rules for limiting gain recognition.
    (1) Overview.
    (i) Gain limitation.
    (ii) Multiple Planned 50-percent Acquisitions.
    (iii) Statutory Recognition Amount limit; Section 336(e).
    (2) Planned 50-percent Acquisition of a Predecessor of Distributing.
    (i) In general.
    (ii) Operating rules.
    (A) Separated Property other than Controlled stock.
    (B) Controlled stock that is Separated Property.
    (C) Anti-duplication rule.
    (3) Planned 50-percent Acquisition of Distributing.
    (4) Gain recognition limited to Statutory Recognition Amount.
    (5) Section 336(e) election.
    (f) Predecessor or Successor as a member of the affiliated group.
    (g) Inapplicability of section 355(f) to certain intra-group 
Distributions.
    (1) In general.
    (2) Alternative application of section 355(f).
    (h) Examples.
    (i) Applicability date.

[T.D. 8238, 54 FR 289, Jan. 5, 1989, as amended by T.D. 8913, 65 FR 
79722, Dec. 20, 2000; T.D. 8960, 66 FR 40591, Aug. 3, 2001; T.D. 8988, 
67 FR 20636, Apr. 26, 2002; 67 FR 38200, June 3, 2002; T.D. 9198, 70 FR 
20283, Apr. 19, 2005; T.D. 9264, 71 FR 30597, May 30, 2006; T.D. 9329, 
72 FR 32799, June 14, 2007; T.D. 9435, 73 FR 75950, Dec. 15, 2008; T.D. 
9548, 76 FR 65111, Oct. 20, 2011; T.D. 9805, 81 FR 91747, Dec. 19, 2016; 
T.D. 9888, 84 FR 69316, Dec. 18, 2019]



Sec. 1.355-1  Distribution of stock and securities of a controlled
corporation.

    (a) Effective/applicability date of certain sections. Except as 
otherwise provided, this section and Sec. Sec. 1.355-2 through 1.355-4 
apply to transactions occurring after February 6, 1989. For transactions 
occurring on or before that date, see 26 CFR 1.355-1 through 1.355-4 
(revised as of April 1, 1987). This section and Sec. Sec. 1.355-2 
through 1.355-4, other than Sec. 1.355-2(g) and (i), do not reflect the 
amendments to section 355 made by the Revenue Act of 1987, the Technical 
and Miscellaneous Revenue Act of 1988, and the Tax Technical Corrections 
Act of 2007. For the applicability date of Sec. Sec. 1.355-2(g), 1.355-
5, 1.355-6, and 1.355-7, see Sec. Sec. 1.355-2(i), 1.355-5(e), 1.355-
6(g), and 1.355-7(k), respectively.
    (b) Application of section. Section 355 provides for the separation, 
without recognition of gain or loss to (or the inclusion in income of) 
the shareholders and security holders, of one or more existing 
businesses formerly operated, directly or indirectly, by a single 
corporation (the ``distributing corporation''). It applies only to the 
separation of existing businesses that have been in active operation for 
at least five years (or a business that has been in active operation for 
at least five years into separate businesses), and which, in general, 
have been owned, directly or indirectly, for at least five years by the 
distributing corporation. A separation is achieved through the 
distribution by the distributing corporation of stock, or stock and 
securities, of one or more subsidiaries (the ``controlled 
corporations'') to its shareholders with respect to its stock or to its 
security holders in exchange for its securities. The controlled 
corporations may be preexisting or newly created subsidiaries. 
Throughout the regulations under section 355, the term distribution 
refers to

[[Page 217]]

a distribution by the distributing corporation of stock, or stock and 
securities, of one or more controlled corporations, unless the context 
indicates otherwise. Section 355 contemplates the continued operation of 
the business or businesses existing prior to the separation. See Sec. 
1.355-4 for types of distributions that may qualify under section 355, 
including pro rata distributions and non pro rata distributions.
    (c) Stock rights. Except as provided in Sec. 1.356-6, for purposes 
of section 355, the term securities includes rights issued by the 
distributing corporation or the controlled corporation to acquire the 
stock of that corporation. For purposes of this section and section 
356(d)(2)(B), a right to acquire stock has no principal amount. For this 
purpose, rights to acquire stock has the same meaning as it does under 
sections 305 and 317(a). Other Internal Revenue Code provisions 
governing the treatment of rights to acquire stock may also apply to 
certain distributions occurring in connection with a transaction 
described in section 355. See, for example, sections 83 and 421 through 
424 and the regulations thereunder. This paragraph (c) applies to 
distributions occurring on or after March 9, 1998.
    (d) Nonqualified preferred stock. See Sec. 1.356-7(a) and (b) for 
the treatment of nonqualified preferred stock (as defined in section 
351(g)(2)) received in certain exchanges for (or in certain 
distributions with respect to) nonqualified preferred stock or preferred 
stock. See Sec. 1.356-7(c) for the treatment of the receipt of 
preferred stock in certain exchanges for (or in certain distributions 
with respect to) common or preferred stock described in section 
351(g)(2)(C)(i)(II).

[T.D. 8238, 54 FR 289, Jan. 5, 1989, as amended by T.D. 8752, 63 FR 410, 
Jan. 6, 1998; T.D. 8882, 65 FR 31078, May 16, 2000; T.D. 8904, 65 FR 
58651, Oct. 2, 2000; T.D. 9435, 73 FR 75950, Dec. 15, 2008; 74 FR 3420, 
Jan. 21, 2009; T.D. 9548, 76 FR 65111, Oct. 20, 2011]



Sec. 1.355-2  Limitations.

    (a) Property distributed. Section 355 applies to a distribution only 
if the property distributed consists solely of stock, or stock and 
securities, of a controlled corporation. If additional property 
(including an excess principal amount of securities received over 
securities surrendered) is received, see section 356.
    (b) Independent business purpose--(1) Independent business purpose 
requirement. Section 355 applies to a transaction only if it is carried 
out for one or more corporate business purposes. A transaction is 
carried out for a corporate business purpose if it is motivated, in 
whole or substantial part, by one or more corporate business purposes. 
The potential for the avoidance of Federal taxes by the distributing or 
controlled corporations (or a corporation controlled by either) is 
relevant in determining the extent to which an existing corporate 
business purpose motivated the distribution. The principal reason for 
this business purpose requirement is to provide nonrecognition treatment 
only to distributions that are incident to readjustments of corporate 
structures required by business exigencies and that effect only 
readjustments of continuing interests in property under modified 
corporate forms. This business purpose requirement is independent of the 
other requirements under section 355.
    (2) Corporate business purpose. A corporate business purpose is a 
real and substantial non Federal tax purpose germane to the business of 
the distributing corporation, the controlled corporation, or the 
affiliated group (as defined in Sec. 1.355-3(b)(4)(iv)) to which the 
distributing corporation belongs. A purpose of reducing non Federal 
taxes is not a corporate business purpose if (i) the transaction will 
effect a reduction in both Federal and non Federal taxes because of 
similarities between Federal tax law and the tax law of the other 
jurisdiction and (ii) the reduction of Federal taxes is greater than or 
substantially coextensive with the reduction of non Federal taxes. See 
Examples (7) and (8) of paragraph (b)(5) of this section. A shareholder 
purpose (for example, the personal planning purposes of a shareholder) 
is not a corporate business purpose. Depending upon the facts of a 
particular case, however, a shareholder purpose for a transaction may be 
so nearly coextensive with a corporate business purpose as to preclude 
any distinction between them. In such a case, the transaction is carried

[[Page 218]]

out for one or more corporate business purposes. See Example (2) of 
paragraph (b)(5) of this section.
    (3) Business purpose for distribution. The distribution must be 
carried out for one or more corporate business purposes. See Example (3) 
of paragraph (b)(5) of this section. If a corporate business purpose can 
be achieved through a nontaxable transaction that does not involve the 
distribution of stock of a controlled corporation and which is neither 
impractical nor unduly expensive, then, for purposes of paragraph (b)(1) 
of this section, the separation is not carried out for that corporate 
business purpose. See Examples (3) and (4) of paragraph (b)(5) of this 
section. For rules with respect to the requirement of a business purpose 
for a transfer of assets to a controlled corporation in connection with 
a reorganization described in section 368(a)(1)(D), See Sec. 1.368-
1(b).
    (4) Business purpose as evidence of nondevice. The corporate 
business purpose or purposes for a transaction are evidence that the 
transaction was not used principally as a device for the distribution of 
earnings and profits within the meaning of section 355(a)(1)(B). See 
paragraph (d)(3)(ii) of this section.
    (5) Examples. The provisions of this paragraph (b) may be 
illustrated by the following examples:

    Example 1. Corporation X is engaged in the production, 
transportation, and refining of petroleum products. In 1985, X acquires 
all of the properties of corporation Z, which is also engaged in the 
production, transportation, and refining of petroleum products. In 1991, 
as a result of antitrust litigation, X is ordered to divest itself of 
all of the properties acquired from Z. X transfers those properties to 
new corporation Y and distributes the stock of Y pro rata to X's 
shareholders. In view of the divestiture order, the distribution is 
carried out for a corporate business purpose. See paragraph (b)(1) of 
this section.
    Example 2. Corporation X is engaged in two businesses: The 
manufacture and sale of furniture and the sale of jewelry. The 
businesses are of equal value. The outstanding stock of X is owned 
equally by unrelated individuals A and B. A is more interested in the 
furniture business, while B is more interested in the jewelry business. 
A and B decide to split up the businesses and go their separate ways. A 
and B anticipate that the operations of each business will be enhanced 
by the separation because each shareholder will be able to devote his 
undivided attention to the business in which he is more interested and 
more proficient. Accordingly, X transfers the jewelry business to new 
corporation Y and distributes the stock of Y to B in exchange for all of 
B's stock in X. The distribution is carried out for a corporate business 
purpose, notwithstanding that it is also carried out in part for 
shareholder purposes. See paragraph (b)(2) of this section.
    Example 3. Corporation X is engaged in the manufacture and sale of 
toys and the manufacture and sale of candy. The shareholders of X wish 
to protect the candy business from the risks and vicissitudes of the toy 
business. Accordingly, X transfers the toy business to new corporation Y 
and distributes the stock of Y to X's shareholders. Under applicable 
law, the purpose of protecting the candy business from the risks and 
vicissitudes of the toy business is achieved as soon as X transfers the 
toy business to Y. Therefore, the distribution is not carried out for a 
corporate business purpose. See paragraph (b)(3) of this section.
    Example 4. Corporation X is engaged in a regulated business in State 
T. X owns all of the stock of corporation Y, a profitable corporation 
that is not engaged in a regulated business. Commission C sets the rates 
that X may charge its customers, based on its total income. C has 
recently adopted rules according to which the total income of a 
corporation includes the income of a business if, and only if, the 
business is operated, directly or indirectly, by the corporation. Total 
income, for this purpose, includes the income of a wholly owned 
subsidiary corporation but does not include the income of a parent or 
``brother/sister'' corporation. Under C's new rule, X's total income 
includes the income of Y, with the result that X has suffered a 
reduction of the rates that it may charge its customers. It would not be 
impractical or unduly expensive to create in a nontaxable transaction 
(such as a transaction qualifying under section 351) a holding company 
to hold the stock of X and Y. X distributes the stock of Y to X's 
shareholders. The distribution is not carried out for the purpose of 
increasing the rates that X may charge its customers because that 
purpose could be achieved through a nontaxable transaction, the creation 
of a holding company, that does not involve the distribution of stock of 
a controlled corporation and which is neither impractical nor unduly 
expensive. See paragraph (b)(3) of this section.
    Example 5. The facts are the same as in Example (4), except that C 
has recently adopted rules according to which the total income of a 
corporation includes not only the income included in Example (3), but 
also the income of any member of the affiliated group to which the 
corporation belongs. In order to avoid a reduction in the rates that it 
may charge its customers, X distributes the stock of Y to X's 
shareholders. The distribution is

[[Page 219]]

carried out for a corporate business purpose. See paragraph (b)(3) of 
this section.
    Example 6. (i) Corporation X owns all of the one class of stock of 
corporation Y. X distributes the stock of Y pro rata to its five 
shareholders, all of whom are individuals, for the sole purpose of 
enabling X and/or Y to elect to become an S corporation. The 
distribution does not meet the corporate business purpose requirement. 
See paragraph (b)(1) and (2) of this section.
    (ii) The facts are the same as in Example 6(i), except that the 
business of Y is operated as a division of X. X transfers this division 
to new corporation Y and distributes the stock of Y pro rata to its 
shareholders, all of whom are individuals, for the sole purpose of 
enabling X and/or Y to elect to become an S corporation. The 
distribution does not meet the corporate business purpose requirement. 
See paragraph (b)(1) and (2) of this section.
    Example 7. The facts are the same as in Example (6)(i), except that 
the distribution is made to enable X to elect to become an S corporation 
both for Federal tax purposes and for purposes of the income tax imposed 
by State M. State M has tax law provisions similar to subchapter S of 
the Internal Revenue Code of 1986. An election to be an S corporation 
for Federal tax purposes will effect a substantial reduction in Federal 
taxes that is greater than the reduction of State M taxes pursuant to an 
election to be an S corporation for State M purposes. The purpose of 
reducing State M taxes is not a corporate business purpose. The 
distribution does not meet the corporate business purpose requirements. 
See paragraph (b)(1) and (2) of this section.
    Example 8. The facts are the same as Example (7), except that the 
distribution also is made to enable A, a key employee of Y, to acquire 
stock of Y without investing in X. A is considered to be critical to the 
success of Y and he has indicated that he will seriously consider 
leaving the company if he is not given the opportunity to purchase a 
significant amount of stock of Y. As a matter of state law, Y could not 
issue stock to the employee while it was a subsidiary of X. As in 
Example (7), the purpose of reducing State M taxes is not a corporate 
business purpose. In order to determine whether the issuance of stock to 
the key employee, in fact, motivated the distribution of the Y stock, 
the potential avoidance of Federal taxes is a relevant factor to take 
into account. If the facts and circumstances establish that the 
distribution was substantially motivated by the need to issue stock to 
the employee, the distribution will meet the corporate business purpose 
requirement.

    (c) Continuity of interest requirement--(1) Requirement. Section 355 
applies to a separation that effects only a readjustment of continuing 
interests in the property of the distributing and controlled 
corporations. In this regard section 355 requires that one or more 
persons who, directly or indirectly, were the owners of the enterprise 
prior to the distribution or exchange own, in the aggregate, an amount 
of stock establishing a continuity of interest in each of the modified 
corporate forms in which the enterprise is conducted after the 
separation. This continuity of interest requirement is independent of 
the other requirements under section 355.
    (2) Examples.

    Example 1. For more than five years, corporation X has been engaged 
directly in one business, and indirectly in a different business through 
its wholly owned subsidiary, S. The businesses are equal in value. At 
all times, the outstanding stock of X has been owned equally by 
unrelated individuals A and B. For valid business reasons, A and B cause 
X to distribute all of the stock of S to B in exchange for all of B's 
stock in X. After the transaction, A owns all the stock of X and B owns 
all the stock of S. The continuity of interest requirement is met 
because one or more persons who were the owners of X prior to the 
distribution (A and B) own, in the aggregate, an amount of stock 
establishing a continuity of interest in each of X and S after the 
distribution.
    Example 2. Assume the same facts as in Example (1), except that 
pursuant to a plan to acquire a stock interest in X without acquiring, 
directly or indirectly, an interest in S, C purchased one-half of the X 
stock owned by A and immediately thereafter X distributed all of the S 
stock to B in exchange for all of B's stock in X. After the 
transactions, A owns 50 percent of X and B owns 100 percent of S. The 
distribution by X of all of the stock of S to B in exchange for all of 
B's stock in X will satisfy the continuity of interest requirement for 
section 355 because one or more persons who were the owners of X prior 
to the distribution (A and B) own, in the aggregate, an amount of stock 
establishing a continuity of interest in each of X and S after the 
distribution.
    Example 3. Assume the same facts as in Examples (1) and (2), except 
that C purchased all of the X stock owned by A. After the transactions, 
neither A nor B own any of the stock of X, and B owns all the stock of 
S. The continuity of interest requirement is not met because the owners 
of X prior to the distribution (A and B) do not, in the aggregate, own 
an amount of stock establishing a continuity of interest in each of X 
and S after the distribution, i.e., although A and B collectively have 
retained 50 percent of their

[[Page 220]]

equity interest in the former combined enterprise, they have failed to 
continue to own the minimum stock interest in the distributing 
corporation, X, that would be required in order to meet the continuity 
of interest requirement.
    Example 4. Assume the same facts as in Examples (1) and (2), except 
that C purchased 80 percent of the X stock owned by A. After the 
transactions, A owns 20 percent of the stock of X, B owns no X stock, 
and B owns 100 percent of the S stock. The continuity of interest 
requirement is not met because the owners of X prior to the distribution 
(A and B) do not, in the aggregate, have a continuity of interest in 
each of X and S after the distribution, i.e., although A and B 
collectively have retained 60 percent of their equity interest in the 
former combined enterprise, the 20 percent interest of A in X is less 
than the minimum equity interest in the distributing corporation, X, 
that would be required in order to meet the continuity of interest 
requirement.

    (d) Device for distribution of earnings and profits--(1) In general. 
Section 355 does not apply to a transaction used principally as a device 
for the distribution of the earnings and profits of the distributing 
corporation, the controlled corporation, or both (a ``device''). Section 
355 recognizes that a tax-free distribution of the stock of a controlled 
corporation presents a potential for tax avoidance by facilitating the 
avoidance of the dividend provisions of the Code through the subsequent 
sale or exchange of stock of one corporation and the retention of the 
stock of another corporation. A device can include a transaction that 
effects a recovery of basis. In this paragraph (d), ``exchange'' 
includes transactions, such as redemptions, treated as exchanges under 
the Code. Generally, the determination of whether a transaction was used 
principally as a device will be made from all of the facts and 
circumstances, including, but not limited to, the presence of the device 
factors specified in paragraph (d)(2) of this section (``evidence of 
device''), and the presence of the nondevice factors specified in 
paragraph (d)(3) of this section (``evidence of nondevice''). However, 
if a transaction is specified in paragraph (d)(5) of this section, then 
it is ordinarily considered not to have been used principally as a 
device.
    (2) Device factors--(i) In general. The presence of any of the 
device factors specified in this subparagraph (2) is evidence of device. 
The strength of this evidence depends on the facts and circumstances.
    (ii) Pro rata distribution. A distribution that is pro rata or 
substantially pro rata among the shareholders of the distributing 
corporation presents the greatest potential for the avoidance of the 
dividend provisions of the Code and, in contrast to other types of 
distributions, is more likely to be used principally as a device. 
Accordingly, the fact that a distribution is pro rata or substantially 
pro rata is evidence of device.
    (iii) Subsequent sale or exchange of stock--(A) In general. A sale 
or exchange of stock of the distributing or the controlled corporation 
after the distribution (a ``subsequent sale or exchange'') is evidence 
of device. Generally, the greater the percentage of the stock sold or 
exchanged after the distribution, the stronger the evidence of device. 
In addition, the shorter the period of time between the distribution and 
the sale or exchange, the stronger the evidence of device.
    (B) Sale or exchange negotiated or agreed upon before the 
distribution. A subsequent sale or exchange pursuant to an arrangement 
negotiated or agreed upon before the distribution is substantial 
evidence of device.
    (C) Sale or exchange not negotiated or agreed upon before the 
distribution. A subsequent sale or exchange not pursuant to an 
arrangement negotiated or agreed upon before the distribution is 
evidence of device.
    (D) Negotiated or agreed upon before the distribution. For purposes 
of this subparagraph (2), a sale or exchange is always pursuant to an 
arrangement negotiated or agreed upon before the distribution if 
enforceable rights to buy or sell existed before the distribution. If a 
sale or exchange was discussed by the buyer and the seller before the 
distribution and was reasonably to be anticipated by both parties, then 
the sale or exchange will ordinarily be considered to be pursuant to an 
arrangement negotiated or agreed upon before the distribution.

[[Page 221]]

    (E) Exchange in pursuance of a plan of reorganization. For purposes 
of this subparagraph (2), if stock is exchanged for stock in pursuance 
of a plan of reorganization, and either no gain or loss or only an 
insubstantial amount of gain is recognized on the exchange, then the 
exchange is not treated as a subsequent sale or exchange, but the stock 
received in the exchange is treated as the stock surrendered in the 
exchange. For this purpose, gain treated as a dividend pursuant to 
sections 356(a)(2) and 316 shall be disregarded.
    (iv) Nature and use of assets--(A) In general. The determination of 
whether a transaction was used principally as a device will take into 
account the nature, kind, amount, and use of the assets of the 
distributing and the controlled corporations (and corporations 
controlled by them) immediately after the transaction.
    (B) Assets not used in a trade or business meeting the requirement 
of section 355(b). The existence of assets that are not used in a trade 
or business that satisfies the requirements of section 355(b) is 
evidence of device. For this purpose, assets that are not used in a 
trade or business that satisfies the requirements of section 355(b) 
include, but are not limited to, cash and other liquid assets that are 
not related to the reasonable needs of a business satisfying such 
section. The strength of the evidence of device depends on all the facts 
and circumstances, including, but not limited to, the ratio for each 
corporation of the value of assets not used in a trade or business that 
satisfies the requirements of section 355(b) to the value of its 
business that satisfies such requirements. A difference in the ratio 
described in the preceding sentence for the distributing and controlled 
corporation is ordinarily not evidence of device if the distribution is 
not pro rata among the shareholders of the distributing corporation and 
such difference is attributable to a need to equalize the value of the 
stock distributed and the value of the stock or securities exchanged by 
the distributees.
    (C) Related function. There is evidence of device if a business of 
either the distributing or controlled corporation (or a corporation 
controlled by it) is (1) a ``secondary business'' that continues as a 
secondary business for a significant period after the separation, and 
(2) can be sold without adversely affecting the business of the other 
corporation (or a corporation controlled by it). A secondary business is 
a business of either the distributing or controlled corporation, if its 
principal function is to serve the business of the other corporation (or 
a corporation controlled by it). A secondary business can include a 
business transferred to a newly-created subsidiary or a business which 
serves a business transferred to a newly-created subsidiary. The 
activities of the secondary business may consist of providing property 
or performing services. Thus, in Example (11) of Sec. 1.355-3(c), 
evidence of device would be presented if the principal function of the 
coal mine (satisfying the requirements of the steel business) continued 
after the separation and the coal mine could be sold without adversely 
affecting the steel business. Similarly, in Example (10) of Sec. 1.355-
3(c), evidence of device would be presented if the principal function of 
the sales operation after the separation is to sell the output from the 
manufacturing operation and the sales operation could be sold without 
adversely affecting the manufacturing operation.
    (3) Nondevice factors--(i) In general. The presence of any of the 
nondevice factors specified in this subparagraph (3) is evidence of 
nondevice. The strength of this evidence depends on all of the facts and 
circumstances.
    (ii) Corporate business purpose. The corporate business purpose for 
the transaction is evidence of nondevice. The stronger the evidence of 
device (such as the presence of the device factors specified in 
paragraph (d)(2) of this section), the stronger the corporate business 
purpose required to prevent the determination that the transaction was 
used principally as a device. Evidence of device presented by the 
transfer or retention of assets not used in a trade or business that 
satisfies the requirements of section 355(b) can be outweighed by the 
existence of a corporate business purpose for those transfers or 
retentions. The assessment of the strength of a corporate business 
purpose will be based on all of the facts and circumstances, including, 
but not limited to, the following factors:

[[Page 222]]

    (A) The importance of achieving the purpose to the success of the 
business;
    (B) The extent to which the transaction is prompted by a person not 
having a proprietary interest in either corporation, or by other outside 
factors beyond the control of the distributing corporation; and
    (C) The immediacy of the conditions prompting the transaction.
    (iii) Distributing corporation publicly traded and widely held. The 
fact that the distributing corporation is publicly traded and has no 
shareholder who is directly or indirectly the beneficial owner of more 
than five percent of any class of stock is evidence of nondevice.
    (iv) Distribution to domestic corporate shareholders. The fact that 
the stock of the controlled corporation is distributed to one or more 
domestic corporations that, if section 355 did not apply, would be 
entitled to a deduction under section 243(a)(1) available to 
corporations meeting the stock ownership requirements of section 243(c), 
or a deduction under section 243(a)(2) or (3) or 245(b) is evidence of 
nondevice.
    (4) Examples. The provisions of paragraph (d)(1) through (3) of this 
section may be illustrated by the following examples:

    Example 1. Individual A owns all of the stock of corporation X, 
which is engaged in the warehousing business. X owns all of the stock of 
corporation Y, which is engaged in the transportation business. X 
employs individual B, who is extremely knowledgeable of the warehousing 
business in general and the operations of X in particular. B has 
informed A that he will seriously consider leaving the company if he is 
not given the opportunity to purchase a significant amount of stock of 
X. Because of his knowledge and experience, the loss of B would 
seriously damage the business of X. B cannot afford to purchase any 
significant amount of stock of X as long as X owns Y. Accordingly, X 
distributes the stock of Y to A and A subsequently sells a portion of 
his X stock to B. However, X could have issued additional shares to B 
sufficient to give B an equivalent ownership interest in X. There is no 
other evidence of device or evidence of nondevice. In light of the fact 
that X could have issued additional shares to B, the sale of X stock by 
A is substantial evidence of device. The transaction is considered to 
have been used principally as a device. See paragraph (d)(1), (2)(ii), 
(iii)(A), (B) and (D), and (3)(i) and (ii) of this section.
    Example 2. Corporation X owns and operates a fast food restaurant in 
State M and owns all of the stock of corporation Y, which owns and 
operates a fast food restaurant in State N. X and Y operate their 
businesses under franchises granted by D and E, respectively. X owns 
cash and marketable securities that exceed the reasonable needs of its 
business but whose value is small relative to the value of its business. 
E has recently changed its franchise policy and will no longer grant or 
renew franchises to subsidiaries (or other members of the same 
affiliated group) of corporations operating businesses under franchises 
granted by its competitors. Thus, Y will lose its franchise if it 
remains a subsidiary of X. The franchise is about to expire. 
Accordingly, X distributes the stock of Y pro rata among X's 
shareholders. X retains its business and transfers cash and marketable 
securities to Y in an amount proportional to the value of Y's business. 
There is no other evidence of device or evidence of nondevice. The 
transfer by X to Y and the retention by X of cash and marketable 
securities is relatively weak evidence of device because after the 
transfer X and Y hold cash and marketable securities in amounts 
proportional to the values of their businesses. The fact that the 
distribution is pro rata is evidence of device. A strong corporate 
business purpose is relatively strong evidence of nondevice. 
Accordingly, the transaction is considered not to have been used 
principally as a device. See paragraph (d)(1), (2)(ii), (iv)(A), and (B) 
and (3)(i) and (ii)(A), (B) and (C) of this section.
    Example 3. Corporation X is engaged in a regulated business in State 
M and owns all of the stock of corporation Y, which is not engaged in a 
regulated business in State M. State M has recently amended its laws to 
provide that affiliated corporations operating in M may not conduct both 
regulated and unregulated businesses. X transfers cash not related to 
the reasonable needs of the business of X or Y to Y and then distributes 
the stock of Y pro rata among X's shareholders. As a result of the 
transfer of cash, the ratio of the value of its assets not used in a 
trade or business that satisfies the requirements of section 355(b) to 
the value of its business is substantially greater for Y than for X. 
There is no other evidence of device or evidence of nondevice. The 
transfer of cash by X to Y is relatively strong evidence of device 
because after the transfer Y holds disproportionately many assets that 
are not used in a trade or business that satisfies the requirements of 
section 355(b). The fact that the distribution is pro rata is evidence 
of device. The strong business purpose is relatively strong evidence of 
nondevice, but it does not pertain to the transfer. Accordingly, the 
transaction is considered to have been used principally as a device. See 
paragraph (d)(1), (2)(ii), (iv)(A) and (B), and (3) and (i) and (ii) of 
this section.

[[Page 223]]

    Example 4. The facts are the same as in Example (3), except that, 
instead of transferring cash to Y, X purchases operating assets 
unrelated to the business of Y and transfers them to Y prior to the 
distribution. There is no other evidence of device or evidence of 
nondevice. The transaction is considered to have been used principally 
as a device. See paragraph (d)(1), (2)(ii), (iv)(A) and (B), and (3)(i) 
and (ii) of this section.

    (5) Transactions ordinarily not considered as a device--(i) In 
general. This subparagraph (5) specifies three distributions that 
ordinarily do not present the potential for tax avoidance described in 
paragraph (d)(1) of this section. Accordingly, such distributions are 
ordinarily considered not to have been used principally as a device, 
notwithstanding the presence of any of the device factors described in 
paragraph (d)(2) of this section. A transaction described in paragraph 
(d)(5)(iii) or (iv) of this section is not protected by this 
subparagraph (5) from a determination that it was used principally as a 
device if it involves the distribution of the stock of more than one 
controlled corporation and facilitates the avoidance of the dividend 
provisions of the Code through the subsequent sale or exchange of stock 
of one corporation and the retention of the stock of another 
corporation.
    (ii) Absence of earnings and profits. A distribution is ordinarily 
considered not to have been used principally as a device if--
    (A) The distributing and controlled corporations have no accumulated 
earnings and profits at the beginning of their respective taxable years,
    (B) The distributing and controlled corporations have no current 
earnings and profits as of the date of the distribution, and
    (C) No distribution of property by the distributing corporation 
immediately before the separation would require recognition of gain 
resulting in current earnings and profits for the taxable year of the 
distribution.
    (iii) Section 303(a) transactions. A distribution is ordinarily 
considered not to have been used principally as a device if, in the 
absence of section 355, with respect to each shareholder distributee, 
the distribution would be a redemption to which section 303(a) applied.
    (iv) Section 302(a) transactions. A distribution is ordinarily 
considered not to have been used principally as a device if, in the 
absence of section 355, with respect to each shareholder distributee, 
the distribution would be a redemption to which section 302(a) applied. 
For purposes of the preceding sentence, section 302(c)(2)(A)(ii) and 
(iii) shall not apply.
    (v) Examples. The provisions of this subparagraph (5) may be 
illustrated by the following examples:

    Example 1. The facts are the same as in Example (3) of paragraph 
(d)(4) of this section, except that X and Y had no accumulated earnings 
and profits at the beginning of its taxable year, X and Y have no 
current earnings and profits as of the date of the distribution, and no 
distribution of property by X immediately before the separation would 
require recognition of gain that would result in earnings and profits 
for the taxable year of the distribution. The transaction is considered 
not to have been used principally as a device. See paragraph (d)(5)(i) 
and (ii) of this section.
    Example 2. Corporation X is engaged in three businesses: a hotel 
business, a restaurant business, and a rental real estate business. 
Individuals A, B, and C own all of the stock of X. X transfers the 
restaurant business to new corporation Y and transfers the rental real 
estate business to new corporation Z. X then distributes the stock of Y 
and Z pro rata between B and C in exchange for all of their stock in X. 
In the absence of section 355, the distribution would be a redemption to 
which section 302(a) applied. Since this distribution involves the stock 
of more than one controlled corporation and facilitates the avoidance of 
the dividend provisions of the Code through the subsequent sale or 
exchange of stock in one corporation and the retention of the stock of 
another corporation, it is not protected by paragraph (d)(5)(i) and (iv) 
of this section from a determination that it was used principally as a 
device. Thus, the determination of whether the transaction was used 
principally as a device must be made from all the facts and 
circumstances, including the presence of the device factors and 
nondevice factors specified in paragraph (d)(2) and (3) of this section.

    (e) Stock and securities distributed--(1) In general. Section 355 
applies to a distribution only if the distributing corporation 
distributes--
    (i) All of the stock and securities of the controlled corporation 
that it owns, or

[[Page 224]]

    (ii) At least an amount of the stock of the controlled corporation 
that constitutes control as defined in section 368(c). In such a case, 
all, or any part, of the securities of the controlled corporation may be 
distributed, and paragraph (e)(2) of this section shall apply.
    (2) Additional rules. Where a part of either the stock or the 
securities of the controlled corporation is retained under paragraph 
(e)(1)(ii) of this section, it must be established to the satisfaction 
of the Commissioner that the retention by the distributing corporation 
was not in pursuance of a plan having as one of its principal purposes 
the avoidance of Federal income tax. Ordinarily, the corporate business 
purpose or purposes for the distribution will require the distribution 
of all of the stock and securities of the controlled corporation. If the 
distribution of all of the stock and securities of a controlled 
corporation would be treated to any extent as a distribution of ``other 
property'' under section 356, this fact tends to establish that the 
retention of stock or securities is in pursuance of a plan having as one 
of its principal purposes the avoidance of Federal income tax.
    (f) Principal amount of securities--(1) Securities received. Section 
355 does not apply to a distribution if, with respect to any shareholder 
or security holder, the principal amount of securities received exceeds 
the principal amount of securities surrendered, or securities are 
received but no securities are surrendered. In such cases, see section 
356.
    (2) Only stock received. If only stock is received in a distribution 
to which section 355(a)(1)(A) applies, the principal amount of the 
securities surrendered, if any, and the par value or stated value of the 
stock surrendered, if any, are not relevant to the application of that 
section.
    (g) Recently acquired controlled stock under section 355(a)(3)(B)--
(1) Other property. Except as provided in paragraph (g)(2) of this 
section, for purposes of section 355(a)(1)(A), section 355(c), and so 
much of section 356 as relates to section 355, stock of a controlled 
corporation acquired by the DSAG in a taxable transaction (as defined in 
paragraph (g)(4) of this section) within the five-year period ending on 
the date of the distribution (pre-distribution period) shall not be 
treated as stock of the controlled corporation but shall be treated as 
``other property.'' Transfers of controlled corporation stock that is 
owned by the DSAG immediately before and immediately after the transfer 
are disregarded and are not acquisitions for purposes of this paragraph 
(g)(1).
    (2) Exceptions. Paragraph (g)(1) of this section does not apply to 
an acquisition of stock of the controlled corporation--
    (i) If the controlled corporation is a DSAG member at any time after 
the acquisition (but prior to the distribution); or
    (ii) Described in Sec. 1.355-3(b)(4)(iii).
    (3) DSAG. For purposes of this paragraph (g), a DSAG is the 
distributing corporation's separate affiliated group (the affiliated 
group which would be determined under section 1504(a) if such 
corporation were the common parent and section 1504(b) did not apply) 
that consists of the distributing corporation as the common parent and 
all corporations affiliated with the distributing corporation through 
stock ownership described in section 1504(a)(1)(B) (regardless of 
whether the corporations are includible corporations under section 
1504(b)). For purposes of paragraph (g)(1) of this section, any 
reference to the DSAG is a reference to the distributing corporation if 
it is not the common parent of a separate affiliated group.
    (4) Taxable transaction--(i) Generally. For purposes of this 
paragraph (g), a taxable transaction is a transaction in which gain or 
loss was recognized in whole or in part.
    (ii) Dunn Trust and predecessor issues. [Reserved]
    (5) Examples. The following examples illustrate this paragraph (g). 
Assume that C, D, P, and S are corporations, X is an unrelated 
individual, each of the transactions is unrelated to any other 
transaction and, but for the issue of whether C stock is treated as 
``other property'' under section 355(a)(3)(B), the distributions satisfy 
all of the requirements of section 355. No inference should be drawn 
from any of these examples as to whether any requirements of section 355 
other than section

[[Page 225]]

355(a)(3)(B), as specified, are satisfied. Furthermore, the following 
definitions apply:
    (i) Purchase is an acquisition that is a taxable transaction.
    (ii) Section 368(c) stock is stock constituting control within the 
meaning of section 368(c).
    (iii) Section 1504(a)(2) stock is stock meeting the requirements of 
section 1504(a)(2).

    Example 1. Hot stock. For more than five years, D has owned section 
368(c) stock but not section 1504(a)(2) stock of C. In year 6, D 
purchases additional C stock from X. However, D does not own section 
1504(a)(2) stock of C after the year 6 purchase. If D distributes all of 
its C stock within five years after the year 6 purchase, for purposes of 
section 355(a)(1)(A), section 355(c), and so much of section 356 as 
relates to section 355, the C stock purchased in year 6 would be treated 
as ``other property.'' See paragraph (g)(1) of this section.
    Example 2. C becomes a DSAG member. For more than five years, D has 
owned section 368(c) stock but not section 1504(a)(2) stock of C. In 
year 6, D purchases additional C stock from X such that D's total 
ownership of C is section 1504(a)(2) stock. If D distributes all of its 
C stock within five years after the year 6 purchase, the distribution of 
the C stock purchased in year 6 would not be treated as ``other 
property'' because C becomes a DSAG member. See paragraph (g)(2)(i) of 
this section. The result would be the same if D did not own any C stock 
prior to year 6 and D purchased all of the C stock in year 6. See 
paragraph (g)(2)(i) of this section. Similarly, if D did not own any C 
stock prior to year 6, D purchased 20 percent of the C stock in year 6, 
and then acquired all of the remaining C stock in year 7, the C stock 
purchased in year 6 and the C stock acquired in year 7 (even if 
purchased) would not be treated as ``other property'' because C becomes 
a DSAG member. See paragraph (g)(2)(i) of this section.
    Example 3. Intra-SAG transaction. For more than five years, D has 
owned all of the stock of S. D and S, in the aggregate, have owned 
section 368(c) stock but not section 1504(a)(2) stock of C. Therefore, D 
and S are DSAG members, but C is not. In year 6, D purchases S's C 
stock. If D distributes all of its C stock within five years after the 
year 6 purchase, the distribution of the C stock purchased in year 6 
would not be treated as ``other property.'' D's purchase of the C stock 
from S is disregarded for purposes of paragraph (g)(1) of this section 
because that C stock was owned by the DSAG immediately before and 
immediately after the purchase. See paragraph (g)(1) of this section.
    Example 4. Affiliate exception. For more than five years, P has 
owned 90 percent of the sole outstanding class of the stock of D and a 
portion of the stock of C, and X has owned the remaining 10 percent of 
the D stock. Throughout this period, D has owned section 368(c) stock 
but not section 1504(a)(2) stock of C. In year 6, D purchases P's C 
stock. However, D does not own section 1504(a)(2) stock of C after the 
year 6 purchase. If D distributes all of its C stock to X in exchange 
for X's D stock within five years after the year 6 purchase, the 
distribution of the C stock purchased in year 6 would not be treated as 
``other property'' because the C stock was purchased from a member (P) 
of the affiliated group (as defined in Sec. 1.355-3(b)(4)(iv)) of which 
D is a member, and P did not purchase that C stock within the pre-
distribution period. See paragraph (g)(2)(ii) of this section.

    (h) Active conduct of a trade or business. Section 355 applies to a 
distribution only if the requirements of Sec. 1.355-3 (relating to the 
active conduct of a trade or business) are satisfied.
    (i) Effective/applicability date. Paragraphs (g)(1) through (g)(5) 
of this section apply to distributions occurring after October 20, 2011. 
For rules regarding distributions occurring on or before October 20, 
2011, see Sec. 1.355-2T(i), as contained in 26 CFR part 1, revised as 
of April 1, 2011.

[T.D. 8238, 54 FR 290, Jan. 5, 1989; 54 FR 5577, Feb. 3, 1989; 57 FR 
28463, June 25, 1992; T.D. 9435, 73 FR 75950, Dec. 15, 2008; T.D. 9548, 
76 FR 65111, Oct. 20, 2011]



Sec. 1.355-3  Active conduct of a trade or business.

    (a) General requirements--(1) Application of section 355. Under 
section 355(b)(1), a distribution of stock, or stock and securities, of 
a controlled corporation qualifies under section 355 only if--
    (i) The distributing and the controlled corporations are each 
engaged in the active conduct of a trade or business immediately after 
the distribution (section 355(b)(1)(A)), or
    (ii) Immediately before the distribution, the distributing 
corporation had no assets other than stock or securities of the 
controlled corporations, and each of the controlled corporations is 
engaged in the active conduct of a trade or business immediately after 
the distribution (section 355(b)(1)(B)). A de minimis amount of assets 
held by the

[[Page 226]]

distributing corporation shall be disregarded for purposes of this 
paragraph (a)(1)(ii).
    (2) Examples. Paragraph (a)(1) of this section may be illustrated by 
the following examples:

    Example 1. Prior to the distribution, corporation X is engaged in 
the active conduct of a trade or business and owns all of the stock of 
corporation Y, which also is engaged in the active conduct of a trade or 
business. X distributes all of the stock of Y to X's shareholders, and 
each corporation continues the active conduct of its trade or business. 
The active business requirement of section 355(b)(1)(A) is satisfied.
    Example 2. The facts are the same as in Example (1), except that X 
transfers all of its assets other than the stock of Y to a new 
corporation in exchange for all of the stock of the new corporation and 
then distributes the stock of both controlled corporations to X's 
shareholders. The active business requirement of section 355(b)(1)(B) is 
satisfied.

    (b) Active conduct of a trade or business defined--(1) In general. 
Section 355(b)(2) provides rules for determining whether a corporation 
is treated as engaged in the active conduct of a trade or business for 
purposes of section 355(b)(1). Under section 355(b)(2)(A), a corporation 
is treated as engaged in the active conduct of a trade or business if it 
is itself engaged in the active conduct of a trade or business or if 
substantially all of its assets consist of the stock, or stock and 
securities, of a corporation or corporations controlled by it 
(immediately after the distribution) each of which is engaged in the 
active conduct of a trade or business.
    (2) Active conduct of a trade or business immediately after 
distribution--(i) In general. For purposes of section 355(b), a 
corporation shall be treated as engaged in the ``active conduct of a 
trade or business'' immediately after the distribution if the assets and 
activities of the corporation satisfy the requirements and limitations 
described in paragraph (b)(2)(ii), (iii), and (iv) of this section.
    (ii) Trade or business. A corporation shall be treated as engaged in 
a trade or business immediately after the distribution if a specific 
group of activities are being carried on by the corporation for the 
purpose of earning income or profit, and the activities included in such 
group include every operation that forms a part of, or a step in, the 
process of earning income or profit. Such group of activities ordinarily 
must include the collection of income and the payment of expenses.
    (iii) Active conduct. For purposes of section 355(b), the 
determination whether a trade or business is actively conducted will be 
made from all of the facts and circumstances. Generally, the corporation 
is required itself to perform active and substantial management and 
operational functions. Generally, activities performed by the 
corporation itself do not include activities performed by persons 
outside the corporation, including independent contractors. A 
corporation may satisfy the requirements of this subdivision (iii) 
through the activities that it performs itself, even though some of its 
activities are performed by others. Separations of real property all or 
substantially all of which is occupied prior to the distribution by the 
distributing or the controlled corporation (or by any corporation 
controlled directly or indirectly by either of those corporations) will 
be carefully scrutinized with respect to the requirements of section 
355(b) and this Sec. 1.355-3.
    (iv) Limitations. The active conduct of a trade or business does not 
include--
    (A) The holding for investment purposes of stock, securities, land, 
or other property, or
    (B) The ownership and operation (including leasing) of real or 
personal property used in a trade or business, unless the owner performs 
significant services with respect to the operation and management of the 
property.
    (3) Active conduct for five-year period preceding distribution. 
Under section 355(b)(2)(B), a trade or business that is relied upon to 
meet the requirements of section 355(b) must have been actively 
conducted throughout the five-year period ending on the date of the 
distribution. For purposes of this subparagraph (3)--
    (i) Activities which constitute a trade or business under the tests 
described in paragraph (b)(2) of this section shall be treated as 
meeting the requirement of the preceding sentence if such activities 
were actively conducted throughout the 5-year period ending on the date 
of distribution, and

[[Page 227]]

    (ii) The fact that a trade or business underwent change during the 
five-year period preceding the distribution (for example, by the 
addition of new or the dropping of old products, changes in production 
capacity, and the like) shall be disregarded, provided that the changes 
are not of such a character as to constitute the acquisition of a new or 
different business. In particular, if a corporation engaged in the 
active conduct of one trade or business during that five-year period 
purchased, created, or otherwise acquired another trade or business in 
the same line of business, then the acquisition of that other business 
is ordinarily treated as an expansion of the original business, all of 
which is treated as having been actively conducted during that five-year 
period, unless that purchase, creation, or other acquisition effects a 
change of such a character as to constitute the acquisition of a new or 
different business.
    (4) Special rules for acquisition of a trade or business (Prior to 
the Revenue Act of 1987 and Technical and Miscellaneous Revenue Act of 
1988)--(i) In general. Under section 355(b)(2)(C), a trade or business 
relied upon to meet the requirements of section 355(b) must not have 
been acquired by the distributing corporation, the controlled 
corporation, or another member of the affiliated group during the five-
year period ending on the date of the distribution unless it was 
acquired in a transaction in which no gain or loss was recognized. 
Similarly, under section 355(b)(2)(D), the trade or business must not 
have been indirectly acquired by any of those corporations (or a 
predecessor in interest of any of those corporations) during that five-
year period in a transaction in which gain or loss was recognized in 
whole or in part and which consisted of the acquisition of control of 
the corporation directly engaged in the trade or business, or the 
indirect acquisition of control of that corporation through the direct 
or indirect acquisition of control of one or more other corporations. A 
trade or business acquired, directly or indirectly, within the five-year 
period ending on the date of the distribution in a transaction in which 
the basis of the assets acquired was not determined in whole or in part 
by reference to the transferor's basis does not qualify under section 
355(b)(2), even though no gain or loss was recognized by the 
transferror.
    (ii) Example. Paragraph (b)(4)(i) of this section may be illustrated 
by the following example:

    Example. In 1985, corporation X, which operates a business and has 
cash and other liquid assets, purchases all of the stock of corporation 
Y, which is engaged in the active conduct of a trade or business. Later 
in the same year, X merges into Y in a ``downstream'' statutory merger. 
In 1986, Y transfers the business assets formerly owned by X to a new 
subsidiary, corporation Z, and then distributes the stock of Z to Y's 
shareholders. Section 355 does not apply to the distribution of the 
stock of Z because the trade or business of Y was indirectly acquired by 
X, a predecessor in interest of Y, during the five-year period preceding 
the distribution.

    (iii) Gain or loss recognized in certain transactions. The 
requirements of section 355(b)(2)(C) and (D) are intended to prevent the 
direct or indirect acquisition of a trade or business by a corporation 
in anticipation of a distribution by the corporation of that trade of 
business in a distribution to which section 355 would otherwise apply. A 
direct or indirect acquisition of a trade or business by one member of 
an affiliated group from another member of the group is not the type of 
transaction to which section 355(b)(2)(C) and (D) is intended to apply. 
Therefore, in applying section 355(b)(2)(C) or (D), such an acquisition, 
even though taxable, shall be disregarded.
    (iv) Affiliated group. For purposes of this subparagraph (4), the 
term affiliated group means an affiliated group as defined in section 
1504(a) (without regard to section 1504(b)), except that the term stock 
includes nonvoting stock described in section 1504(a)(4).
    (5) Special rules for acquisition of a trade or business (After the 
Revenue Act of 1987 and Technical and Miscellaneous Revenue Act of 
1988). [Reserved]
    (c) Examples. The following examples illustrate section 355(b)(2)(A) 
and (B) and paragraph (b)(1), (2), and (3) of this section. However, a 
transaction that satisfies these active business requirements will 
qualify under section 355

[[Page 228]]

only if it satisfies the other requirements of section 355 (a) and (b).

    Example 1. Corporation X is engaged in the manufacture and sale of 
soap and detergents and also owns investment securities. X transfers the 
investment securities to new subsidiary Y and distributes the stocks of 
Y to X's shareholders. Y does not satisfy the requirements of section 
355(b) because the holding of investment securities does not constitute 
the active conduct of a trade or business. See paragraph (b)(2)(iv)(A) 
of this section.
    Example 2. Corporation X owns, manages, and derives rental income 
from an office building and also owns vacant land. X transfers the land 
to new subsidiary Y and distributes the stock of Y to X's shareholders. 
Y will subdivide the land, install streets and utilities, and sell the 
developed lots to various homebuilders. Y does not satisfy the 
requirements of section 355(b) because no significant development 
activities were conducted with respect to the land during the five-year 
period ending on the date of the distribution. See paragraph (b)(3) of 
this section.
    Example 3. Corporation X owns land on which it conducts a ranching 
business. Oil has been discovered in the area, and it is apparent that 
oil may be found under the land on which the ranching business is 
conducted. X has engaged in no significant activities in connection with 
its mineral rights. X transfers its mineral rights to new subsidiary Y 
and distributes the stock of Y to X's shareholders. Y will actively 
pursue the development of the oil producing potential of the property. Y 
does not satisfy the requirements of section 355(b) because X engaged in 
no significant exploitation activities with respect to the mineral 
rights during the five-year period ending on the date of the 
distribution. See paragraph (b)(3) of this section.
    Example 4. For more than five years, corporation X has conducted a 
single business of constructing sewage disposal plants and other 
facilities. X transfers one-half of its assets to new subsidiary Y. 
These assets include a contract for the construction of a sewage 
disposal plant in State M, construction equipment, cash, and other 
tangible assets. X retains a contract for the construction of a sewage 
disposal plant in State N, construction equipment, cash, and other 
intangible assets. X then distributes the stock of Y to one of X's 
shareholders in exchange for all of his stock of X. X and Y both satisfy 
the requirements of section 355(b). See paragraph (b)(3)(i) of this 
section.
    Example 5. For the past six years, corporation X has owned and 
operated two factories devoted to the production of edible pork skins. 
The entire output of one factory is sold to one customer, C, while the 
output of the second factory is sold to C and a number of other 
customers. To eliminate errors in packaging, X opens a new factory. 
Thereafter, orders from C are processed and packaged at the two original 
factories, while the new factory handles only orders from other 
customers. Eight months after opening the new factory, X transfers it 
and related business assets to new subsidiary Y and distributes the 
stock of Y to X's shareholders. X and Y both satisfy the requirements of 
section 355(b). See paragraph (b)(3)(i) and (ii) of this section.
    Example 6. Corporation X has owned and operated a men's retail 
clothing store in the downtown area of the City of G for nine years and 
has owned and operated another men's retail clothing store in a suburban 
area of G for seven years. X transfers the store building, fixtures, 
inventory, and other assets related to the operations of the suburban 
store to new subsidiary Y. X also transfers to Y the delivery trucks and 
delivery personnel that formerly served both stores. Henceforth, X will 
contract with a local public delivery service to make its deliveries. X 
retains the warehouses that formerly served both stores. Henceforth, Y 
will lease warehouse space from an unrelated public warehouse company. X 
then distributes the stock of Y to X's shareholders. X and Y both 
satisfy the requirements of section 355(b). See paragraph (b)(3)(i) of 
this section.
    Example 7. For the past nine years, corporation X has owned and 
operated a department store in the downtown area of the City of G. Three 
years ago, X acquired a parcel of land in a suburban area of G and 
constructed a new department store on it. X transfers the suburban store 
and related business assets to new subsidiary Y and distributes the 
stock of Y to X's shareholders. After the distribution, each store has 
its own manager and is operated independently of the other store. X and 
Y both satisfy the requirements of section 355(b). See paragraph 
(b)(3)(i) and (ii) of this section.
    Example 8. For the past six years, corporation X has owned and 
operated hardware stores in several states. Two years ago, X purchased 
all of the assets of a hardware store in State M, where X had not 
previously conducted business. X transfers the State M store and related 
business assets to new subsidiary Y and distributes the stock of Y to 
X's shareholders. After the distribution, the State M store has its own 
manager and is operated independently of the other stores. X and Y both 
satisfy the requirements of section 355(b). See paragraph (b)(3)(i) and 
(ii) of this section.
    Example 9. For the past eight years, corporation X has engaged in 
the manufacture and sale of household products. Throughout

[[Page 229]]

this period, X has maintained a research department for use in 
connection with its manufacturing activities. The research department 
has 30 employees actively engaged in the development of new products. X 
transfers the research department to new subsidiary Y and distributes 
the stock of Y to X's shareholders. After the distribution, Y continues 
its research operations on a contractual basis with several 
corporations, including X. X and Y both satisfy the requirements of 
section 355(b). See paragraph (b)(3)(i) of this section. The result in 
this example is the same if, after the distribution, Y continues its 
research operations but furnishes its services only to X. See paragraph 
(b)(3)(i) of this section. However, see Sec. 1.355-2 (d)(2)(iv)(C) 
(related function device factor) for possible evidence of device.
    Example 10. For the past six years, corporation X has processed and 
sold meat products. X derives income from no other source. X separates 
the sales function from the processing function by transferring the 
business assets related to the sales function and cash for working 
capital to new subsidiary Y. X then distributes the stock of Y to X's 
shareholders. After the distribution, Y purchases for resale the meat 
products processed by X. X and Y both satisfy the requirements of 
section 355(b). See paragraph (b)(3)(i) of this section. However, see 
Sec. 1.355-2(d)(2)(iv)(C) (related function device factor) for possible 
evidence of device.
    Example 11. For the past eight years, corporation X has been engaged 
in the manufacture and sale of steel and steel products. X owns all of 
the stock of corporation Y, which, for the past six years, has owned and 
operated a coal mine for the sole purpose of supplying X's coal 
requirements in the manufacture of steel. X distributes the stock of Y 
to X's shareholders. X and Y both satisfy the requirements of section 
355 (b). See paragraph (b)(3)(i) of this section. However, see Sec. 
1.355-2 (d)(2)(iv)(C) (related function device factor) for possible 
evidence of device.
    Example 12. For the past seven years, corporation X, a bank, has 
owned an eleven-story office building, the ground floor of which X has 
occupied in the conduct of its banking business. The remaining ten 
floors are rented to various tenants. Throughout this seven-year period, 
the building has been managed and maintained by employees of the bank. X 
transfers the building to new subsidiary Y and distributes the stock of 
Y to X's shareholders. Henceforth, Y will manage the building, negotiate 
leases, seek new tenants, and repair and maintain the building. X and Y 
both satisfy the requirements of section 355 (b). See paragraph (b)(3) 
of this section.
    Example 13. For the past nine years, corporation X, a bank, has 
owned a two-story building, the ground floor and one half of the second 
floor of which X has occupied in the conduct of its banking business. 
The other half of the second floor has been rented as storage space to a 
neighboring retail merchant. X transfers the building to new subsidiary 
Y and distributes the stock of Y to X's shareholders. After the 
distribution, X leases from Y the space in the building that it formerly 
occupied. Under the lease, X will repair and maintain its portion of the 
building and pay property taxes and insurance. Y does not satisfy the 
requirements of section 355 (b) because it is not engaged in the active 
conduct of a trade or business immediately after the distribution. See 
paragraph (b)(2)(iv)(A) of this section. This example does not address 
the question of whether the activities of X with respect to the building 
prior to the separation would constitute the active conduct of a trade 
or business.

[T.D. 8238, 54 FR 294, Jan. 5, 1989]



Sec. 1.355-4  Non pro rata distributions, etc.

    Section 355 provides for nonrecognition of gain or loss with respect 
to a distribution whether or not (a) the distribution is pro rata with 
respect to all of the shareholders of the distributing corporation, (b) 
the distribution is pursuant to a plan of reorganization within the 
meaning of section 368 (a) (1)(D), or (c) the shareholder surrenders 
stock in the distributing corporation. Under section 355, the stock of a 
controlled corporation may consist of common stock or preferred stock. 
(See, however, section 306 and the regulations thereunder.) Section 355 
does not apply, however, if the substance of a transaction is merely an 
exchange between shareholders or security holders of stock or securities 
in one corporation for stock or securities in another corporation. For 
example, if two individuals, A and B, each own directly 50 percent of 
the stock of corporation X and 50 percent of the stock of corporation Y, 
section 355 would not apply to a transaction in which A and B transfer 
all of their stock of X and Y to a new corporation Z, for all of the 
stock of Z, and Z then distributes the stock of X to A and the stock of 
Y to B.

[T.D. 8238, 54 FR 296, Jan. 5, 1989]



Sec. 1.355-5  Records to be kept and information to be filed.

    (a) Distributing corporation--(1) In general. Every corporation that 
makes a

[[Page 230]]

distribution (the distributing corporation) of stock or securities of a 
controlled corporation, as described in section 355 (or so much of 
section 356 as relates to section 355), must include a statement 
entitled, ``STATEMENT PURSUANT TO Sec. 1.355-5(a) BY [INSERT NAME AND 
EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A DISTRIBUTING 
CORPORATION,'' on or with its return for the year of the distribution. 
If the distributing corporation is a controlled foreign corporation 
(within the meaning of section 957), each United States shareholder 
(within the meaning of section 951(b)) with respect thereto must include 
this statement on or with its return. The statement must include--
    (i) The name and employer identification number (if any) of the 
controlled corporation;
    (ii) The name and taxpayer identification number (if any) of every 
significant distributee;
    (iii) The date of the distribution of the stock or securities of the 
controlled corporation;
    (iv) The aggregate fair market value and basis, determined 
immediately before the distribution or exchange, of the stock, 
securities, or other property (including money) distributed by the 
distributing corporation in the transaction; and
    (v) The date and control number of any private letter ruling(s) 
issued by the Internal Revenue Service in connection with the 
transaction.
    (2) Special rule when an asset transfer precedes a stock 
distribution. If the distributing corporation transferred property to 
the controlled corporation in a transaction described in section 351 or 
368, as part of a plan to then distribute the stock or securities of the 
controlled corporation in a transaction described in section 355 (or so 
much of section 356 as relates to section 355), then, unless paragraph 
(a)(1)(v) of this section applies, the distributing corporation must 
also include on or with its return for the year of the distribution the 
statement required by Sec. 1.351-3(a) or 1.368-3(a). If the 
distributing corporation is a controlled foreign corporation (within the 
meaning of section 957), each United States shareholder (within the 
meaning of section 951(b)) with respect thereto must include the 
statement required by Sec. 1.351-3(a) or 1.368-3(a) on or with its 
return.
    (b) Significant distributee. Every significant distributee must 
include a statement entitled, ``STATEMENT PURSUANT TO Sec. 1.355-5(b) 
BY [INSERT NAME AND TAXPAYER IDENTIFICATION NUMBER (IF ANY) OF 
TAXPAYER], A SIGNIFICANT DISTRIBUTEE,'' on or with such distributee's 
return for the year in which such distribution is received. If a 
significant distributee is a controlled foreign corporation (within the 
meaning of section 957), each United States shareholder (within the 
meaning of section 951(b)) with respect thereto must include this 
statement on or with its return. The statement must include--
    (1) The names and employer identification numbers (if any) of the 
distributing and controlled corporations;
    (2) The date of the distribution of the stock or securities of the 
controlled corporation; and
    (3) The aggregate basis, determined immediately before the exchange, 
of any stock or securities transferred by the significant distributee in 
the exchange, and the aggregate fair market value, determined 
immediately before the distribution or exchange, of the stock, 
securities or other property (including money) received by the 
significant distributee in the distribution or exchange.
    (c) Definitions. For purposes of this section:
    (1) Significant distributee means--
    (i) A holder of stock of a distributing corporation that receives, 
in a transaction described in section 355 (or so much of section 356 as 
relates to section 355), stock of a corporation controlled by the 
distributing corporation if, immediately before the distribution or 
exchange, such holder--
    (A) Owned at least five percent (by vote or value) of the total 
outstanding stock of the distributing corporation if the stock owned by 
such holder is publicly traded; or
    (B) Owned at least one percent (by vote or value) of the stock of 
the distributing corporation if the stock owned by such holder is not 
publicly traded; or

[[Page 231]]

    (ii) A holder of securities of a distributing corporation that 
receives, in a transaction described in section 355 (or so much of 
section 356 as relates to section 355), stock or securities of a 
corporation controlled by the distributing corporation if, immediately 
before the distribution or exchange, such holder owned securities in 
such distributing corporation with a basis of $1,000,000 or more.
    (2) Publicly traded stock means stock that is listed on--
    (i) A national securities exchange registered under section 6 of the 
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
    (ii) An interdealer quotation system sponsored by a national 
securities association registered under section 15A of the Securities 
Exchange Act of 1934 (15 U.S.C. 78o-3).
    (d) Substantiation information. Under Sec. 1.6001-1(e), taxpayers 
are required to retain their permanent records and make such records 
available to any authorized Internal Revenue Service officers and 
employees. In connection with the distribution or exchange described in 
this section, these records should specifically include information 
regarding the amount, basis, and fair market value of all property 
distributed or exchanged, and relevant facts regarding any liabilities 
assumed or extinguished as part of such distribution or exchange.
    (e) Effective/applicability date. This section applies to any 
taxable year beginning on or after May 30, 2006. However, taxpayers may 
apply this section to any original Federal income tax return (including 
any amended return filed on or before the due date (including 
extensions) of such original return) timely filed on or after May 30, 
2006. For taxable years beginning before May 30, 2006, see Sec. 1.355-5 
as contained in 26 CFR part 1 in effect on April 1, 2006.

[T.D. 9329, 72 FR 32799, June 14, 2007]



Sec. 1.355-6  Recognition of gain on certain distributions of stock
or securities in controlled corporation.

    (a) Conventions--(1) Examples. For purposes of the examples in this 
section, unless otherwise stated, assume that P, S, T, X, Y, N, HC, D, 
D1, D2, D3, and C are corporations, A and B are individuals, 
shareholders are not treated as one person under section 355(d)(7), 
stock has been owned for more than five years and section 355(d)(6) and 
paragraph (e)(4) of this section do not apply, no election under section 
338 (if available) is made, and all transactions described are respected 
under general tax principles, including the step transaction doctrine. 
No inference should be drawn from any example as to whether any 
requirements of section 355 other than those of section 355(d), as 
specified, are satisfied.
    (2) Five-year period. For purposes of this section, the term five-
year period means the five-year period (determined after applying 
section 355(d)(6) and paragraph (e)(4) of this section) ending on the 
date of the distribution, but in no event beginning earlier than October 
10, 1990.
    (3) Distributing securities. For purposes of determining if stock of 
any controlled corporation received in the distribution is disqualified 
stock described in section 355(d)(3)(B)(ii)(II) (relating to a 
distribution of controlled corporation stock on any securities in the 
distributing corporation acquired by purchase during the five-year 
period), references in this section to stock of a corporation that is or 
becomes a distributing corporation includes securities of the 
corporation. Similarly, a reference to stock in paragraph (c)(4) of this 
section (relating to a plan or arrangement) includes securities.
    (4) Marketable securities. Unless otherwise stated, any reference in 
this section to marketable stock includes marketable securities.
    (b) General rules and purposes of section 355(d)--(1) Disqualified 
distributions in general. In the case of a disqualified distribution, 
any stock or securities in the controlled corporation shall not be 
treated as qualified property for purposes of section 355(c)(2) or 
361(c)(2). In general, a disqualified distribution is any distribution 
to which section 355 (or so much of section 356 as relates thereto) 
applies if, immediately after the distribution--
    (i) Any person holds disqualified stock in the distributing 
corporation

[[Page 232]]

that constitutes a 50 percent or greater interest in such corporation; 
or
    (ii) Any person holds disqualified stock in the controlled 
corporation (or, if stock of more than one controlled corporation is 
distributed, in any controlled corporation) that constitutes a 50 
percent or greater interest in such corporation.
    (2) Disqualified stock--(i) In general. Disqualified stock is--
    (A) Any stock in the distributing corporation acquired by purchase 
during the five-year period; and
    (B) Any stock in any controlled corporation--
    (1) Acquired by purchase during the five-year period; or
    (2) Received in the distribution to the extent attributable to 
distributions on any stock in the distributing corporation acquired by 
purchase during the five-year period.
    (ii) Purchase. For the definition of a purchase for purposes of 
section 355(d) and this section, see section 355(d)(5) and paragraph (d) 
of this section.
    (iii) Exceptions--(A) Purchase eliminated. Stock (or an interest in 
another entity) that is acquired by purchase (including stock (or 
another interest) that is treated as acquired by purchase under 
paragraph (e)(2), (3), or (4) of this section) ceases to be acquired by 
that purchase if (and when) the basis resulting from the purchase is 
eliminated. For purposes of this paragraph (b)(2)(iii), basis resulting 
from the purchase is basis in the stock (or in an interest in another 
entity) that is directly purchased during the five-year period or that 
is treated as acquired by purchase during such period under paragraph 
(e)(2), (3), or (4) of this section.
    (B) Deemed purchase eliminated. Stock (or an interest in another 
entity) that is deemed purchased under section 355(d)(8) or paragraph 
(e)(1) of this section shall cease to be treated as purchased if (and 
when) the basis resulting from the purchase that effects the deemed 
purchase is eliminated.
    (C) Elimination of basis--(1) General rule. Basis in the stock of a 
corporation (or in an interest in another entity) is eliminated if (and 
when) it would no longer be taken into account by any person in 
determining gain or loss on a sale or exchange of any stock of such 
corporation (or an interest in the other entity). Basis is not 
eliminated, however, if it is allocated between stock of two 
corporations under Sec. 1.358-2(a).
    (2) Special rule for transferred and exchanged basis property. Basis 
of stock (or an interest in another entity) resulting from a purchase 
(the first purchase) is eliminated if (and when) such stock (or other 
interest) is subsequently transferred to another person in an exchange 
or other transfer to which paragraph (e)(2) or (3) of this section 
applies (the second purchase). The elimination of basis in stock (or in 
another interest) resulting from the first purchase, however, does not 
eliminate the basis resulting from the second purchase in the stock (or 
other interest) that is treated as acquired by purchase by the acquirer 
in a transaction to which paragraph (e)(2) of this section applies or by 
the person making the exchange in a transaction to which paragraph 
(e)(3) of this section applies.
    (3) Special rule for Split-offs and Split-ups. Under section 
355(d)(3)(B)(ii) and paragraph (b)(2)(i)(B)(2) of this section, 
disqualified stock includes controlled corporation stock received in 
exchange for distributing corporation stock acquired by purchase. Solely 
for purposes of determining whether controlled corporation stock 
received in a distribution in exchange for distributing corporation 
stock is disqualified stock described in that section and paragraph 
immediately after the distribution, paragraph (b)(2)(iii)(C)(2) of this 
section does not apply to the exchange to eliminate basis resulting from 
a purchase of that distributing corporation stock (notwithstanding that 
paragraph (e)(3) of this section applies to the exchange).
    (D) Special rule if basis allocated between two corporations. If the 
shareholder of a distributing corporation, pursuant to Sec. 1.358-2, 
allocates basis resulting from a purchase between the stock of two or 
more corporations then, following such allocation, the determination of 
whether such basis has been eliminated shall be made separately with 
respect to the stock of each such corporation.
    (3) Certain distributions not disqualified distributions because 
purposes of section

[[Page 233]]

355(d) not violated--(i) In general. Notwithstanding the provisions of 
section 355(d)(2) and this paragraph (b), a distribution is not a 
disqualified distribution if the distribution does not violate the 
purposes of section 355(d) as provided in this paragraph (b)(3). A 
distribution does not violate the purposes of section 355(d) if the 
effect of the distribution is neither--
    (A) To increase ownership (combined direct and indirect) in the 
distributing corporation or any controlled corporation by a disqualified 
person; nor
    (B) To provide a disqualified person with a purchased basis in the 
stock of any controlled corporation.
    (ii) Disqualified person. A disqualified person is any person 
(taking into account section 355(d)(7) and paragraph (c)(4) of this 
section) that, immediately after a distribution, holds (directly or 
indirectly under section 355(d)(8) and paragraph (e)(1) of this section) 
disqualified stock in the distributing corporation or controlled 
corporation that--
    (A) The person--
    (1) Acquired by purchase under section 355(d)(5) or (8) and 
paragraphs (d) and (e) of this section during the five-year period, or
    (2) Received in the distribution to the extent attributable to 
distributions on any stock in the distributing corporation acquired by 
purchase under section 355(d)(5) or (8) and paragraphs (d) and (e) of 
this section by that person during the five-year period; and
    (B) Constitutes a 50 percent or greater interest in such corporation 
(under section 355(d)(4) and paragraph (c) of this section).
    (iii) Purchased basis. In general, a purchased basis is basis in 
controlled corporation stock that is disqualified stock. However, basis 
in controlled corporation stock that is disqualified stock will not be 
treated as purchased basis if the controlled corporation stock and any 
distributing corporation stock with respect to which the controlled 
corporation stock is distributed are treated as acquired by purchase 
solely under the attribution rules of section 355(d)(8) and paragraph 
(e)(1) of this section. The prior sentence will not apply, however, if 
the distributing corporation stock is treated as acquired by purchase 
under the attribution rules as a result of the acquisition of an 
interest in a partnership (the purchased partnership), and following the 
distribution, the controlled corporation stock is directly held by the 
purchased partnership (or a chain of partnerships that includes the 
purchased partnership).
    (iv) Increase in interest because of payment of cash in lieu of 
fractional shares. Any increase in direct or indirect ownership in the 
distributing corporation or any controlled corporation by a disqualified 
person because of a payment of cash in lieu of issuing fractional shares 
will be disregarded for purposes of paragraph (b)(3)(i)(A) of this 
section if the payment of the cash is solely to avoid the expense and 
inconvenience of issuing fractional share interests, and does not 
represent separately bargained for consideration.
    (v) Other exceptions. The Commissioner may provide by guidance 
published in the Internal Revenue Bulletin that other distributions are 
not disqualified distributions because they do not violate the purposes 
of section 355(d).
    (vi) Examples. The following examples illustrate this paragraph 
(b)(3):

    Example 1. Stock distributed in spin-off; no purchased basis. D owns 
all of the stock of D1, and D1 owns all the stock of C. A purchases 60 
percent of the D stock for cash. Within five years of A's purchase, D1 
distributes the C stock to D. A is treated as having purchased 60 
percent of the stock of both D1 and C on the date A purchases 60 percent 
of the D stock under the attribution rules of section 355(d)(8) and 
paragraph (e)(1) of this section. The C stock received by D is 
attributable to a distribution on purchased D1 stock under section 
355(d)(3)(B)(ii). Accordingly, the D1 and C stock each is disqualified 
stock under section 355(d)(3) and paragraph (b)(2) of this section, and 
A is a disqualified person under paragraph (b)(3)(ii) of this section. 
However, the purposes of section 355(d) under paragraph (b)(3)(i) of 
this section are not violated. A did not increase direct or indirect 
ownership in D1 or C. In addition, D's basis in the C stock is not a 
purchased basis under paragraph (b)(3)(iii) of this section because both 
the D1 and the C stock are treated as acquired by purchase solely under 
the attribution rules of section 355(d)(8) and paragraph (e)(1) of this 
section. Accordingly, D1's distribution of the C stock to D is not a 
disqualified distribution under section 355(d)(2) and paragraph (b)(1) 
of this section.

[[Page 234]]

    Example 2. Stock distributed in spin-off; purchased basis. The facts 
are the same as Example 1, except that D immediately further distributes 
the C stock to its shareholders (including A) pro rata. The D and C 
stock each is disqualified stock under section 355(d)(3) and paragraph 
(b)(2) of this section, and A is a disqualified person under paragraph 
(b)(3)(ii) of this section. The purposes of section 355(d) under 
paragraph (b)(3)(i) of this section are violated. A did not increase 
direct or indirect ownership in D or C. However, A's basis in the C 
stock is a purchased basis under paragraph (b)(3)(iii) of this section 
because the D stock is not treated as acquired by purchase solely under 
the attribution rules of section 355(d)(8) and paragraph (e)(1) of this 
section. Accordingly, the further distribution is a disqualified 
distribution under section 355(d)(2) and paragraph (b)(1) of this 
section.
    Example 3. Stock distributed in split-off with ownership increase; 
purchased basis. The facts are the same as Example 1, except that D 
immediately further distributes the C stock to A in exchange for A's 
purchased stock in D. The C stock received by A is attributable to a 
distribution on purchased D stock under section 355(d)(3)(B)(ii), and 
A's basis in the C stock is determined by reference to the adjusted 
basis of A's purchased D stock under paragraph (e)(3) of this section. 
(Under paragraph (b)(2)(iii)(B)(3) of this section, the basis resulting 
from A's purchase of D stock is not eliminated solely for purposes of 
determining if the C stock acquired by A is disqualified stock 
immediately after the distribution, notwithstanding that paragraph 
(e)(3) of this section applies to the exchange.) Accordingly, the D 
stock and the C stock each is disqualified stock under section 355(d)(3) 
and paragraph (b)(2) of this section, and A is a disqualified person 
under paragraph (b)(3)(ii) of this section. The purposes of section 
355(d) under paragraph (b)(3)(i) of this section are violated because A 
increased its ownership in C from a 60 percent indirect interest to a 
100 percent direct interest, and because A's basis in the C stock is a 
purchased basis under paragraph (b)(3)(iii) of this section. 
Accordingly, the further distribution is a disqualified distribution 
under section 355(d)(2) and paragraph (b)(1) of this section.
    Example 4. Stock distributed in spin-off; purchased basis. D1 owns 
all the stock of C. D purchases all of the stock of D1 for cash. Within 
five years of D's purchase of D1, P acquires all of the stock of D1 from 
D in a section 368(a)(1)(B) reorganization that is not a reorganization 
under section 368(a)(1)(A) by reason of section 368(a)(2)(E), and D1 
distributes all of its C stock to P. P is treated as having acquired the 
D1 stock by purchase on the date D acquired it under the transferred 
basis rule of section 355(d)(5)(C) and paragraph (e)(2) of this section. 
P is treated as having purchased all of the C stock on the date D 
purchased the D1 stock under the attribution rules of section 355(d)(8) 
and paragraph (e)(1) of this section, and the C stock received by P is 
attributable to a distribution on purchased D1 stock under section 
355(d)(3)(B)(ii). Accordingly, the D1 and C stock each is disqualified 
stock under section 355(d)(3) and paragraph (b)(2) of this section, and 
P is a disqualified person under paragraph (b)(3)(ii) of this section. 
The purposes of section 355(d) under paragraph (b)(3)(i) of this section 
are violated. P did not increase direct or indirect ownership in D1 or 
C. However, P's basis in the C stock is a purchased basis under 
paragraph (b)(3)(iii) of this section because the D1 stock is not 
treated as acquired by purchase solely under the attribution rules of 
section 355(d)(8) and paragraph (e)(1) of this section. Accordingly, 
D1's distribution of the C stock to P is a disqualified distribution 
under section 355(d)(2) and paragraph (b)(1) of this section.
    Example 5. Stock distributed in split-off with ownership increase; 
no purchased basis. P owns 50 percent of the stock of D, the remaining D 
stock is owned by unrelated persons, D owns all the stock of C, and A 
purchases all of the P stock from the P shareholders. Within five years 
of A's purchase, D distributes all of the C stock to P in exchange for 
P's D stock. A is treated as having purchased 50 percent of the stock of 
both D and C on the date A purchases the P stock under the attribution 
rules of section 355(d)(8) and paragraph (e)(1) of this section. The C 
stock received by P is attributable to a distribution on purchased D 
stock under section 355(d)(3)(B)(ii). Accordingly, the D stock and the C 
stock each is disqualified stock under section 355(d)(3) and paragraph 
(b)(2) of this section, and A is a disqualified person under paragraph 
(b)(3)(ii) of this section. The purposes of section 355(d) under 
paragraph (b)(3)(i) of this section are violated because, even though 
P's basis in the C stock is not a purchased basis under paragraph 
(b)(3)(iii) of this section, A increased its direct or indirect 
ownership in C from a 50 percent indirect interest to a 100 percent 
indirect interest. Accordingly, D's distribution of the C stock to P is 
a disqualified distribution under section 355(d)(2) and paragraph (b)(1) 
of this section.
    Example 6. Stock distributed in split-off with no ownership 
increase; no purchased basis. A purchases all of the stock of T. T later 
merges into D in a section 368(a)(1)(A) reorganization and A exchanges 
its purchased T stock for 60 percent of the stock of D. D owns all of 
the stock of D1 and D2, D1 and D2 each owns 50 percent of the stock of 
D3, and D3 owns all of the stock of C. Within five years of A's purchase 
of the T stock, D3 distributes the C stock to D1 in exchange for all of 
D1's D3 stock. A is treated as having acquired 60 percent of the D stock 
by purchase on the

[[Page 235]]

date A purchases the T stock under paragraph (e)(3) of this section. A 
is treated as having purchased 60 percent of the stock of D1, D2, D3, 
and C on the date A purchases the T stock under the attribution rules of 
section 355(d)(8) and paragraph (e)(1) of this section. The C stock 
received by D1 is attributable to a distribution on purchased D3 stock 
under section 355(d)(3)(B)(ii). Accordingly, the D3 stock and the C 
stock each is disqualified stock under section 355(d)(3) and paragraph 
(b)(2) of this section, and A is a disqualified person under paragraph 
(b)(3)(ii) of this section. However, the purposes of section 355(d) 
under paragraph (b)(3)(i) of this section are not violated. A did not 
increase direct or indirect ownership in D3 or C, and D1's basis in the 
C stock is not a purchased basis under paragraph (b)(3)(iii) of this 
section because the D3 stock is treated as acquired by purchase solely 
under the attribution rules of section 355(d)(8) and paragraph (e)(1) of 
this section. Accordingly, D3's distribution of the C stock to D1 is not 
a disqualified distribution under section 355(d)(2) and paragraph (b)(1) 
of this section.
    Example 7. Purchased basis eliminated by liquidation; stock 
distributed in spin-off. P owns 30 percent of the stock of D, D owns all 
of the stock of D1, and D1 owns all of the stock of C. P purchases the 
remaining 70 percent of the D stock for cash. Within five years of P's 
purchase, P liquidates D in a transaction qualifying under sections 332 
and 337(a), and D1 then distributes the stock of C to P. Prior to the 
liquidation, P is treated as having purchased 70 percent of the stock of 
D1 and C on the date P purchases the D stock under the attribution rules 
of section 355(d)(8)(B) and paragraph (e)(1) of this section. After the 
liquidation, however, under paragraph (b)(2)(iii) of this section, P is 
not treated as having acquired by purchase the D1 or the C stock under 
section 355(d)(8)(B) and paragraph (e)(1) of this section because P's 
basis in the D stock is eliminated in the liquidation of D. Under 
section 334(b)(1), P's basis in the D1 stock is determined by reference 
to D's basis in the D1 stock and not by reference to P's basis in D. 
Paragraph (d)(2)(i)(B) of this section does not treat the D1 stock as 
newly purchased in P's hands because no gain or loss was recognized by D 
in the liquidation. Accordingly, neither the D1 stock nor the C stock is 
disqualified stock under section 355(d)(3) and paragraph (b)(2) of this 
section in P's hands, and the distribution is not a disqualified 
distribution under section 355(d)(2) and paragraph (b)(1) of this 
section.
    Example 8. Purchased basis eliminated by upstream merger; stock 
distributed in spin-off. D owns all of the stock of D1, and D1 owns all 
of the stock of C. P purchases 60 percent of the D stock for cash. 
Within five years of P's purchase, D merges into P in a section 
368(a)(1)(A) reorganization, with the D shareholders other than P 
receiving solely P stock in exchange for their D stock, and D1 then 
distributes the stock of C to P. Prior to the merger, P is treated as 
having purchased 60 percent of the stock of D1 and C on the date P 
purchases the D stock under the attribution rules of section 355(d)(8) 
and paragraph (e)(1) of this section. After the merger, however, under 
paragraph (b)(2)(iii) of this section, P is not treated as having 
acquired by purchase the D1 or the C stock under section 355(d)(8)(B) 
and paragraph (e)(1) of this section because P's basis in the D stock is 
eliminated in the merger. Under section 362(b), P's basis in the D1 
stock is determined by reference to D's basis in the D1 stock and not by 
reference to P's basis in D. Paragraph (d)(2)(i)(B) of this section does 
not treat the D1 stock as newly purchased in P's hands because no gain 
or loss was recognized by D in the merger. Accordingly, neither the D1 
stock nor the C stock is disqualified stock under section 355(d)(3) and 
paragraph (b)(2) of this section in P's hands, and the distribution is 
not a disqualified distribution under section 355(d)(2) and paragraph 
(b)(1) of this section.
    Example 9. Purchased basis eliminated by distribution; stock 
distributed in spin-off. A purchases all the stock of C for cash on Date 
1. D acquires all of the stock of C from A in a section 368(a)(1)(B) 
reorganization that is not a reorganization under section 368(a)(1)(A) 
by reason of section 368(A)(1)(E). A receives ten percent of the D stock 
in the transaction. The remaining D stock is owned by B. Within five 
years of A's purchase of the C stock, D distributes all the stock of C 
pro rata to A and B. Under the transferred basis rule of paragraph 
(e)(2) of this section, D is treated as having purchased all of the C 
stock on the date A acquired it. Under the exchanged basis rule of 
paragraph (e)(3) of this section, A is treated as having purchased its D 
stock on Date 1 and A is treated as having purchased ten percent of the 
C stock on Date 1 under the attribution rules of section 355(d)(8) and 
paragraph (e)(3) of this section. Moreover, under paragraph 
(b)(2)(iii)(C) of this section, A's basis in the C stock resulting from 
A's Date 1 purchase of C stock is eliminated. After the distribution, 
A's and B's bases in their C stock are determined by reference to the 
bases of their D stock under Sec. 1.358-2(a)(2) (and not by reference 
to D's basis in the C stock). D's basis in the stock of C resulting from 
its deemed purchase of that stock under paragraph (e)(2) of this section 
is eliminated by the distribution of the C stock because it would no 
longer be taken into account by any person in determining gain or loss 
on the sale of C stock. Therefore, the C stock distributed to A and B is 
not disqualified stock as a result of D's purchase of C. However, A's 
basis in its D stock resulting from its deemed purchase of that stock 
under paragraph (e)(3) of this section is not

[[Page 236]]

eliminated. Therefore, A's ten percent interest in the stock of D is 
disqualified stock. Furthermore, A's ten percent interest in the stock 
of C is disqualified stock because the distribution of the C stock is 
attributable to A's D stock that was acquired by purchase. However, 
there has not been a disqualified distribution because no person, 
immediately after the distribution, holds disqualified stock in either D 
or C that constitutes a 50 percent or greater interest in such 
corporation.
    Example 10. Allocation of purchased basis analyzed separately. --(i) 
P owns all the stock of D. D purchases all the stock of D1 for cash on 
Date 1. D1 owns all the stock of C (which owns all the stock of C1) and 
S. Within five years of Date 1, D1 distributes all the stock of C to D. 
The D1 and C stock each is disqualified stock under section 355(d)(3) 
and paragraph (b)(2) of this section, and D is a disqualified person 
under paragraph (b)(3)(ii) of this section. The purposes of section 
355(d) under paragraph (b)(3)(i) of this section are violated. D did not 
increase direct or indirect ownership in D1 or C. However, D's basis in 
the C stock is a purchased basis under paragraph (b)(3)(iii) of this 
section because the D1 stock is not treated as acquired by purchase 
solely under the attribution rules of section 355(d)(8) and paragraph 
(e)(1) of this section. Accordingly, the distribution is a disqualified 
distribution under section 355(d) and paragraph (b)(1) of this section. 
D's basis in the D1 stock is allocated pursuant to Sec. 1.358-2 between 
the D1 stock and the C stock. Therefore, under paragraph (e)(4) of this 
section, the C stock is deemed to be acquired by purchase on Date 1, the 
date D purchased all the stock of D1. If thereafter, and within five 
years of Date 1, C were to distribute all the stock of C1 to D, that 
distribution would also be a disqualified distribution because of D's 
deemed purchase of the stock of C.
    (ii) Following the distribution of the stock of C by D1, and within 
five years of Date 1, D distributes all the stock of D1 to P. Under 
paragraph (b)(2)(iii)(D) of this section, the determination of whether 
D's basis in D1 has been eliminated shall be made without regard to D's 
allocated basis in C. After the distribution, P's basis in the D1 stock 
is determined by reference to its basis in its D stock under Sec. 
1.358-2(a)(2) (and not by reference to D's basis in the D1 stock). D's 
basis in the D1 stock resulting from the purchase of that stock is 
eliminated by the distribution of the D1 stock because it would no 
longer be taken into account by any person in determining gain or loss 
on the sale of D1 stock. Therefore, the D1 stock distributed to P is not 
disqualified stock as a result of D's purchase of D1. Moreover, a 
subsequent distribution of the S stock by D1 to P would not be a 
disqualified distribution because both the D1 and S stock would cease to 
be treated as purchased when D's basis in D1 has been eliminated.

    (4) Anti-avoidance rule--(i) In general. Notwithstanding any 
provision of section 355(d) or this section, the Commissioner may treat 
any distribution as a disqualified distribution under section 355(d)(2) 
and paragraph (b)(1) of this section if the distribution or another 
transaction or transactions are engaged in or structured with a 
principal purpose to avoid the purposes of section 355(d) or this 
section with respect to the distribution. Without limiting the preceding 
sentence, the Commissioner may determine that the existence of a related 
person, intermediary, pass-through entity, or similar person (an 
intermediary) should be disregarded, in whole or in part, if the 
intermediary is formed or availed of with a principal purpose to avoid 
the purposes of section 355(d) or this section.
    (ii) Example. The following example illustrates this paragraph 
(b)(4):

    Example. Post-distribution redemption. B wholly owns D, which wholly 
owns C. With a principal purpose to avoid the purposes of section 
355(d), A, B, D, and C engage in the following transactions. A purchases 
45 of 100 shares of the only class of D stock. Within five years after 
A's purchase, D distributes all of its 100 shares in C to A and B pro 
rata. D then redeems 20 shares of B's D stock, and C redeems 20 shares 
of B's C stock. After the redemption, A owns 45 shares and B owns 35 
shares in each of D and C. Under paragraph (b)(4)(i) of this section, 
the Commissioner may treat A as owning disqualified stock in D and C 
that constitutes a 50 percent or greater interest in D and C immediately 
after the distribution. Under that treatment, the distribution is a 
disqualified distribution under section 355(d)(2) and paragraph (b)(1) 
of this section.

    (c) Whether a person holds a 50 percent or greater interest--(1) In 
general. Under section 355(d)(4), 50 percent or greater interest means 
stock possessing at least 50 percent of the total combined voting power 
of all classes of stock entitled to vote or at least 50 percent of the 
total value of shares of all classes of stock.
    (2) Valuation. For purposes of section 355(d)(4) and this section, 
all shares of stock within a single class are considered to have the 
same value. But see paragraph (c)(3)(vii)(A) of this section

[[Page 237]]

(determination of whether it is reasonably certain that an option will 
be exercised).
    (3) Effect of options, warrants, convertible obligations, and other 
similar interests--(i) Application. This paragraph (c)(3) provides rules 
to determine when an option is treated as exercised for purposes of 
section 355(d) (other than section 355(d)(6)). Except as provided in 
this paragraph (c)(3), an option is not treated as exercised for 
purposes of section 355(d). This paragraph (c)(3) does not affect the 
determination of whether an instrument is an option or stock under 
general principles of tax law (such as substance over form).
    (ii) General rule. In determining whether a person has acquired by 
purchase a 50 percent or greater interest under section 355(d)(4), an 
option to acquire stock (as described in paragraphs (c)(3)(v) and (vi) 
of this section) that has not been exercised when a distribution occurs 
is treated as exercised on the date it was issued or most recently 
transferred if--
    (A) Its exercise (whether by itself or in conjunction with the 
deemed exercise of one or more other options) would cause a person to 
become a disqualified person; and
    (B) Immediately after the distribution, it is reasonably certain (as 
described in paragraph (c)(3)(vii) of this section) that the option will 
be exercised.
    (iii) Options deemed newly issued and substituted options--(A) 
Exchange, adjustment, or alteration of existing option. For purposes of 
this paragraph (c)(3), each of the following is treated as a new 
issuance or transfer of an existing option only if it materially 
increases the likelihood that an option will be exercised--
    (1) An exchange of an option for another option or options;
    (2) An adjustment to the terms of an option (including an adjustment 
pursuant to the terms of the option);
    (3) An adjustment to the terms of the underlying stock (including an 
adjustment pursuant to the terms of the stock);
    (4) A change to the capital structure of the issuing corporation; 
and
    (5) An alteration to the fair market value of issuing corporation 
stock through an asset transfer (other than regular, ordinary dividends) 
or through any other means.
    (B) Certain compensatory options. An option described in paragraph 
(c)(3)(vi)(B)(2) of this section is treated as issued on the date it 
becomes transferable.
    (C) Substituted options. If an option (existing option) is exchanged 
for another option or options (substituted option or options) and 
paragraph (c)(3)(iii)(A) of this section does not apply to treat such 
exchange as a new issuance or transfer of the existing option, the 
substituted option or options will be treated as issued or most recently 
transferred on the date that the existing option was issued or most 
recently transferred.
    (iv) Effect of treating an option as exercised--(A) In general. For 
purposes of section 355(d), an option that is treated as exercised under 
this paragraph (c)(3) is treated as exercised both for purposes of 
determining the percentage of the voting power of stock owned by the 
holder and for purposes of determining the percentage of the value of 
stock owned by the holder.
    (B) Stock purchase agreement or similar arrangement. If a stock 
purchase agreement or similar arrangement is deemed exercised, the 
purchaser is treated as having purchased the stock under the terms of 
the agreement or arrangement as though all covenants had been satisfied 
and all contingencies met. The agreement or arrangement is deemed to 
have been exercised as of the date it is entered into or most recently 
assigned.
    (v) Instruments treated as options. For purposes of this paragraph 
(c)(3), except to the extent provided in paragraph (c)(3)(vi) of this 
section, the following are treated as options: A call option, warrant, 
convertible obligation, the conversion feature of convertible stock, put 
option, redemption agreement (including a right to cause the redemption 
of stock), notional principal contract (as defined in Sec. 1.446-3(c)) 
that provides for the payment of amounts in stock, stock purchase 
agreement or similar arrangement, or any other instrument that provides 
for the right to purchase, issue, redeem, or

[[Page 238]]

transfer stock (including an option on an option).
    (vi) Instruments generally not treated as options. For purposes of 
this paragraph (c)(3), the following are not treated as options, unless 
issued, transferred, or listed with a principal purpose to avoid the 
application of section 355(d) or this section:
    (A) Escrow, pledge, or other security agreements. An option that is 
part of a security arrangement in a typical lending transaction 
(including a purchase money loan), if the arrangement is subject to 
customary commercial conditions. For this purpose, a security 
arrangement includes, for example, an agreement for holding stock in 
escrow or under a pledge or other security agreement, or an option to 
acquire stock contingent upon a default under a loan.
    (B) Compensatory options--(1) General rule. An option to acquire 
stock in a corporation with customary terms and conditions, provided to 
an employee, director, or independent contractor in connection with the 
performance of services for the corporation or a person related to it 
under section 355(d)(7)(A) (and that is not excessive by reference to 
the services performed) and that--
    (i) Is nontransferable within the meaning of Sec. 1.83-3(d); and
    (ii) Does not have a readily ascertainable fair market value as 
defined in Sec. 1.83-7(b).
    (2) Exception. Paragraph (c)(3)(vi)(B)(1) of this section ceases to 
apply to an option that becomes transferable.
    (C) Certain stock conversion features. The conversion feature of 
convertible stock, provided that--
    (1) The stock is not convertible for at least five years after 
issuance or transfer; and
    (2) The terms of the conversion feature do not require the tender of 
any consideration other than the stock being converted.
    (D) Options exercisable only upon death, disability, mental 
incompetency, or separation from service. Any option entered into 
between stockholders of a corporation (or a stockholder and the 
corporation) with respect to the stock of either stockholder that is 
exercisable only upon the death, disability, mental incompetency of the 
stockholder, or, in the case of stock acquired in connection with the 
performance of services for the corporation or a person related to it 
under section 355(d)(7)(A) (and that is not excessive by reference to 
the services performed), the stockholder's separation from service.
    (E) Rights of first refusal. A bona fide right of first refusal 
regarding the corporation's stock with customary terms, entered into 
between stockholders of a corporation (or between the corporation and a 
stockholder).
    (F) Other enumerated instruments. Any other instruments specified in 
regulations, a revenue ruling, or a revenue procedure. See Sec. 
601.601(d)(2) of this chapter.
    (vii) Reasonably certain that the option will be exercised--(A) In 
general. The determination of whether, immediately after the 
distribution, an option is reasonably certain to be exercised is based 
on all the facts and circumstances. In applying the previous sentence, 
the fair market value of stock underlying an option is determined by 
taking into account control premiums and minority and blockage 
discounts.
    (B) Stock purchase agreement or similar arrangement. A stock 
purchase agreement or similar arrangement is treated as reasonably 
certain to be exercised if the parties' obligations to complete the 
transaction are subject only to reasonable closing conditions.
    (viii) Examples. The following examples illustrate this paragraph 
(c)(3):

    Example 1. D owns all of the stock of C. A purchases 40 percent of 
D's only class of stock and an option to purchase D stock from D, that 
if deemed exercised, would result in A owning a total of 60 percent of 
the stock of D. Assume that no control premium or minority or blockage 
discount applies to the D stock underlying the option. The option 
permits A to acquire the D stock at $30 per share, and D's stock has a 
fair market value of $27 per share on the date the option is issued. The 
option is subject to no contingencies or restrictive covenants, may be 
exercised within five years after its issuance, and is not described in 
paragraph (c)(3)(vi) of this section (regarding instruments generally 
not treated as options). Within five years of A's purchase of the D 
stock and option, D distributes the stock of its subsidiary C pro rata 
and A receives 40 percent of the C stock in the distribution. 
Immediately after the distribution, D's stock has a fair market

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value of $30 per share and C's stock has a fair market value of $15 per 
share. At the time of the distribution, A exchanges A's option for an 
option to purchase 20 percent of the D stock at $20 per share and an 
option to purchase 20 percent of the C stock at $10 per share. The 
exchange of the options in D for options in D and C did not materially 
increase the likelihood that the options would be exercised. 
Nonetheless, based on all the facts and circumstances, it is reasonably 
certain, immediately after the distribution, that A will exercise its 
options. Under paragraph (c)(3)(iii)(C) of this section, the substituted 
options are treated as issued on the date the original option was 
issued. Accordingly, the options are treated as exercised by A on the 
date that A purchased the original option. A is treated as owning 60 
percent of the D stock and 60 percent of the C stock that is 
disqualified stock, and the distribution is a disqualified distribution 
under section 355(d)(2) and paragraph (b)(1) of this section.
    Example 2. D owns all of the stock of C. A purchases 37 percent of 
D's only class of stock. B owns 38 percent of the D stock, and the 
remaining 25 percent is owned by 20 individuals, each of whom owns less 
than five percent of D's stock. A purchases an option to purchase an 
additional 14 percent of the D stock from shareholders other than B for 
$50 per share. The option is subject to no contingencies or restrictive 
covenants, may be exercised within five years after its issuance, and is 
not described in paragraph (c)(3)(vi) of this section. Within five years 
of A's purchase of the option and 37 percent interest in D, D 
distributes the stock of its subsidiary C pro rata and A receives 37 
percent of the C stock in the distribution. At the time of the 
distribution, A exchanges its option for an option to purchase 14 
percent of the D stock at $25 per share and an option to purchase 14 
percent of the C stock at $25 per share. Assume that, although a 
shareholder that owned no D or C stock would pay only $20 per share for 
D or C stock immediately after the distribution, a shareholder in A's 
position would pay $30 per share for 14 percent of the stock of D or C 
because of the control premium which attaches to the shares. The control 
premium is taken into account under paragraph (c)(3)(vii)(A) of this 
section to determine whether A is reasonably certain to exercise the 
options. The exchange of the options in D for options in D and C did not 
materially increase the likelihood that the options would be exercised. 
Nonetheless, based on all the facts and circumstances, it is reasonably 
certain, immediately after the distribution, that A will exercise its 
options. Under paragraph (c)(3)(iii)(C) of this section, the substituted 
options are treated as issued on the date the original option was 
issued. Accordingly, the options are treated as exercised by A on the 
date that A purchased the original option. Under paragraph (c)(2) of 
this section, all shares of D and C are considered to have the same 
value to determine the amount of stock A is treated as purchasing under 
the options. A is treated as owning 51 percent of the D stock and 51 
percent of the C stock that is disqualified stock, and the distribution 
is a disqualified distribution under section 355(d)(2).

    (4) Plan or arrangement--(i) In general. Under section 355(d)(7)(B), 
if two or more persons act pursuant to a plan or arrangement with 
respect to acquisitions of stock in the distributing corporation or 
controlled corporation, those persons are treated as one person for 
purposes of section 355(d).
    (ii) Understanding. For purposes of section 355(d)(7)(B), two or 
more persons who are (or will after an acquisition become) shareholders 
(or are treated as shareholders under paragraph (c)(3)(ii) of this 
section) act pursuant to a plan or arrangement with respect to an 
acquisition of stock only if they have a formal or informal 
understanding among themselves to make a coordinated acquisition of 
stock. A principal element in determining if such an understanding 
exists is whether the investment decision of each person is based on the 
investment decision of one or more other existing or prospective 
shareholders. However, the participation by creditors in formulating a 
plan for an insolvency workout or a reorganization in a title 11 or 
similar case (whether as members of a creditors' committee or otherwise) 
and the receipt of stock by creditors in satisfaction of indebtedness 
pursuant to the workout or reorganization do not cause the creditors to 
be considered as acting pursuant to a plan or arrangement.
    (iii) Examples. The following examples illustrate paragraph 
(c)(4)(ii) of this section:

    Example 1. D has 1,000 shares of common stock outstanding. A group 
of 20 unrelated individuals who previously owned no D stock (the Group) 
agree among themselves to acquire 50 percent or more of D's stock. The 
Group is not a person under section 7701(a)(1). Subsequently, pursuant 
to their understanding, the members of the Group purchase 600 shares of 
D common stock from the existing D shareholders (a total of 60 percent 
of the D stock), with each member purchasing 30 shares. Under paragraph 
(c)(4)(ii) of this section, the members of the Group

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have a formal or informal understanding among themselves to make a 
coordinated acquisition of stock. Their interests are therefore 
aggregated under section 355(d)(7)(B), and they are treated as one 
person that purchased 600 shares of D's stock for purposes of section 
355(d).
    Example 2. D has 1,000 shares of outstanding stock owned by 
unrelated individuals. D's management is concerned that D may become 
subject to a takeover bid. In separate meetings, D's management meets 
with potential investors who own no stock and are friendly to management 
to convince them to acquire D's stock based on an understanding that D 
will assemble a group that in the aggregate will acquire more than 50 
percent of D's stock. Subsequently, 15 of these investors each purchases 
four percent of D's outstanding stock. Under paragraph (c)(4)(ii) of 
this section, the 15 investors have a formal or informal understanding 
among themselves to make a coordinated acquisition of stock. Their 
interests are therefore aggregated under section 355(d)(7)(B), and they 
are treated as one person that purchased 600 shares of D stock for 
purposes of section 355(d).
    Example 3. (i) D has 1,000 shares of outstanding stock owned by 
unrelated individuals. An investment advisor advises its clients that it 
believes D's stock is undervalued and recommends that they acquire D 
stock. Acting on the investment advisor's recommendation, 20 unrelated 
individuals each purchases 30 shares of the outstanding D stock. Each 
client's decision was not based on the investment decisions made by one 
or more other clients. Because there is no formal or informal 
understanding among the clients to make a coordinated acquisition of D 
stock, their interests are not aggregated under section 355(d)(7)(B) and 
they are treated as making separate purchases.
    (ii) The facts are the same as in paragraph (i) of this Example 3, 
except that the investment advisor is also the underwriter (without 
regard to whether it is a firm commitment or best efforts underwriting) 
for a primary or secondary offering of D stock. The result is the same.
    (iii) The facts are the same as in paragraph (i) of this Example 3, 
except that, instead of an investment advisor recommending that clients 
purchase D stock, the trustee of several trusts qualified under section 
401(a) sponsored by unrelated corporations causes each trust to purchase 
the D stock. The result is the same, provided that the trustee's 
investment decision made on behalf of each trust was not based on the 
investment decision made on behalf of one or more of the other trusts.

    (iv) Exception--(A) Subsequent disposition. If two or more persons 
do not act pursuant to a plan or arrangement within the meaning of this 
paragraph (c)(4) with respect to an acquisition of stock in a 
corporation (the first corporation), a subsequent acquisition in which 
such persons exchange their stock in the first corporation for stock in 
another corporation (the second corporation) in a transaction in which 
the basis of the second corporation's stock in the hands of such persons 
is determined in whole or in part by reference to the basis of their 
stock in the first corporation, will not result in such persons being 
treated as one person, even if the acquisition of the second 
corporation's stock is pursuant to a plan or arrangement.
    (B) Example. The following example illustrates this paragraph 
(c)(4)(iv):

    Example. In an initial public offering of D stock on Date 1, 100 
investors independently purchase one percent each of the D stock. Two 
years later, D merges into P (in a reorganization described in section 
368(a)(1)(A)) and, pursuant to the plan of reorganization, the D 
shareholders exchange their D stock for 50 percent of the stock of P. 
The D shareholders approve the plan by a two-thirds vote, as required by 
state law. Under section 358(a), each shareholder's basis in its P stock 
is determined by reference to the basis of the D stock it purchased. 
Under paragraph (e)(3) of this section, the former D shareholders are 
treated as purchasing their P stock on Date 1. The investors do not 
become a single person under paragraph (c)(4) of this section with 
respect to the deemed purchase of the P stock on Date 1 by virtue of 
their acquisition of the P stock pursuant to the merger on Date 2.

    (d) Purchase--(1) In general--(i) Definition of purchase under 
section 355(d)(5)(A). Under section 355(d)(5)(A), except as otherwise 
provided in section 355(d)(5)(B) and (C), a purchase means any 
acquisition, but only if--
    (A) The basis of the property acquired in the hands of the acquirer 
is not determined--
    (1) In whole or in part by reference to the adjusted basis of such 
property in the hands of the person from whom acquired; or
    (2) Under section 1014(a) or 1022; and
    (B) The property is not acquired in an exchange to which section 
351, 354, 355, or 356 applies.
    (ii) Section 355 distributions. Paragraph (d)(1)(i)(B) of this 
section includes all section 355 distributions,

[[Page 241]]

whether in exchange (in whole or in part) for stock or pro rata.
    (iii) Example. The following example illustrates this paragraph 
(d)(1):

    Example. Section 304(a)(1) acquisition. A, who owns all of the stock 
of P and T, sells the T stock to P for cash. The T stock is not 
marketable stock under section 355(d)(5)(B)(ii) and paragraph (d)(3)(ii) 
of this section. A is treated under section 304(a)(1) as receiving a 
distribution in redemption of the P stock. Under section 302(d), the 
deemed redemption is treated as a section 301 distribution. Assume that 
under sections 304(b)(2) and 301(c)(1), all of the distribution is a 
dividend. A and P are treated in the same manner as if A had transferred 
the T stock to P in exchange for stock of P in a transaction to which 
section 351(a) applies, and P had then redeemed the stock P was treated 
as issuing in the transaction. Under section 362(a), P's basis in the T 
stock is determined by reference to A's adjusted basis in the T stock, 
and there is no basis increase in the T stock because A recognizes no 
gain on the deemed transfer. Accordingly, P's acquisition of the T stock 
from A is not a purchase by P under section 355(d)(5)(A)(i)(I) and 
paragraphs (d)(1)(i)(A)(1) and (d)(2)(i)(B) of this section.

    (2) Exceptions to definition of purchase under section 355(d)(5)(A). 
The following acquisitions are not treated as purchases under section 
355(d)(5)(A):
    (i) Acquisition of stock in a transaction which includes other 
property or money--(A) Transferors and shareholders of transferor or 
distributing corporations--(1) In general. An acquisition of stock 
permitted to be received by a transferor of property without the 
recognition of gain under section 351(a), or permitted to be received 
without the recognition of gain under section 354, 355, or 356 is not a 
purchase to the extent section 358(a)(1) applies to determine the 
recipient's basis in the stock received, whether or not the recipient 
recognizes gain under section 351(b) or 356. But see paragraph (e)(3) of 
this section (interest received in exchange for purchased interest in 
exchanged basis transaction treated as purchased).
    (2) Exception. To the extent there is received in the exchange or 
distribution, in addition to stock described in paragraph 
(d)(2)(i)(A)(1) of this section, stock that is other property under 
section 351(b) or 356(a)(1), the stock is treated as purchased on the 
date of the exchange or distribution for purposes of section 355(d).
    (B) Transferee corporations--(1) In general. An acquisition of stock 
by a corporation is not a purchase to the extent section 334(b) or 
362(a) or (b) applies to determine the corporation's basis in the stock 
received. But see section 355(d)(5)(C) and paragraph (e)(2) of this 
section (purchased property transferred in transferred basis transaction 
is treated as purchased by transferee).
    (2) Exception. If a corporation acquires stock, the stock is treated 
as purchased on the date of the stock acquisition for purposes of 
section 355(d)--
    (i) If the liquidating corporation recognizes gain or loss with 
respect to the transferred stock as described in section 334(b)(1); or
    (ii) To the extent the basis of the transferred stock is increased 
through the recognition of gain by the transferor under section 362(a) 
or (b).
    (C) Examples. The following examples illustrate this paragraph 
(d)(2)(i):

    Example 1. (i) A owns all the stock of T. T merges into D in a 
transaction qualifying under section 368(a)(1)(A), with A exchanging all 
of the T stock for D stock and $100 cash. Under section 356(a)(1), A 
recognizes $100 of the realized gain on the transaction. Under section 
358(a)(1), A's basis in the D stock equals A's basis in the T stock, 
decreased by the $100 received and increased by the gain recognized, 
also $100. Under paragraph (d)(2)(i)(A) of this section, A is not 
treated as having purchased the D stock for purposes of section 
355(d)(5).
    (ii) The facts are the same as in paragraph (i) of this Example 1, 
except that rather than D stock and $100 cash, A receives D stock and 
stock in C, a corporation not a party to the reorganization, with a fair 
market value of $100. Under section 358(a)(2), A's basis in the C stock 
is its fair market value, or $100. Under paragraph (d)(2)(i)(A)(2) of 
this section, A is treated as having purchased the C stock, but not the 
D stock, for purposes of section 355(d)(5).
    Example 2. A purchases all of the stock of D, which is not 
marketable stock, on Date 1 for $90. Within five years of A's purchase, 
on Date 2, A contributes the D stock to P in exchange for P stock worth 
$90 and $10 cash in a transaction qualifying under section 351. A 
recognizes a gain of $10 as a result of the transfer. Under section 
362(a), P's basis in D is $100. P is treated as having purchased 90 
percent ($90 worth) of the D stock on Date 1 under section 355(d)(5)(C) 
and paragraph (e)(2) of this section and as having purchased 10 percent 
($10 worth) of the D stock on Date

[[Page 242]]

2 under paragraph (d)(2)(i)(B)(2)(ii) of this section.

    (ii) Acquisition of stock in a distribution to which section 305(a) 
applies. An acquisition of stock in a distribution qualifying under 
section 305(a) is not a purchase to the extent section 307(a) applies to 
determine the recipient's basis. However, to the extent the distribution 
is of rights to acquire stock, see paragraph (c)(3) of this section for 
rules regarding options, warrants, convertible obligations, and other 
similar interests.
    (iii) Section 1036(a) exchange. An exchange of stock qualifying 
under section 1036(a) is not a purchase by either party to the exchange 
to the extent the basis of the property acquired equals that of the 
property exchanged under section 1031(d).
    (iv) Section 338 elections--(A) In general. Stock acquired in a 
qualified stock purchase with respect to which a section 338 election 
(or a section 338(h)(10) election) is made is not treated as a purchase 
for purposes of section 355(d)(5)(A). However, any stock (or an interest 
in another entity) held by old target that is treated as purchased by 
new target is treated as acquired by purchase for purposes of section 
355(d)(5)(A) unless a section 338 election or section 338(h)(10) 
election also is made for that stock. See Sec. 1.338-2T(c) for the 
definitions of section 338 election, section 338(h)(10) election, old 
target, and new target.
    (B) Example. The following example illustrates this paragraph 
(d)(2)(iv):

    Example. T owns all of the stock of S and no other assets. X 
acquires all of the T stock from the T shareholders for cash and makes 
an election under section 338. Under section 338(a) and (b), T, as Old 
T, is treated as having sold all of its assets at fair market value and 
purchased the assets as a new corporation, New T, as of the beginning of 
the day after the acquisition date. Under paragraph (d)(2)(iv)(A) of 
this section, X is not treated as having purchased the T stock. Absent a 
section 338 election or a section 338(h)(10) election with respect to S, 
New T is treated as having purchased all of the S stock under section 
355(d)(5)(A).

    (v) Partnership distributions--(A) Section 732(b). An acquisition of 
stock (or an interest in another entity) in a liquidation of a partner's 
interest in a partnership in which basis is determined pursuant to 
section 732(b) is a purchase at the time of the liquidation.
    (B) Section 734(b). If the adjusted basis of stock (or an interest 
in another entity) held by a partnership is increased under section 
734(b), a proportionate amount of the stock (or other interest) will be 
treated as purchased at the time of the basis adjustment, determined by 
reference to the amount of the basis adjustment (but not in excess of 
the fair market value of the stock (or other interest) at the time of 
the adjustment) over the fair market value of the stock (or other 
interest) at the time of the adjustment.
    (3) Certain section 351 exchanges treated as purchases--(i) In 
general--(A) Treatment of stock received by transferor. Under section 
355(d)(5)(B), a purchase includes any acquisition of property in an 
exchange to which section 351 applies to the extent the property is 
acquired in exchange for any cash or cash item, any marketable stock, or 
any debt of the transferor. The property treated as acquired by purchase 
is the property received by the transferor in the exchange.
    (B) Multiple classes of stock. If the transferor in a transaction 
described in section 355(d)(5)(B) receives stock or securities of more 
than one class, or receives both stock and securities, then the amount 
of stock or securities purchased is determined in a manner that 
corresponds to the allocation of basis to the stock or securities under 
section 358. See Sec. 1.358-2(b).
    (ii) Cash item, marketable stock. For purposes of section 
355(d)(5)(B) and this paragraph (d)(3), either or both of the terms cash 
item and marketable stock include personal property within the meaning 
of section 1092(d)(1) and Sec. 1.1092(d)-1, without giving effect to 
section 1092(d)(3).
    (iii) Exception for certain acquisitions--(A) In general. Except to 
the extent provided in paragraph (e)(3) of this section (interest 
received in exchange for purchased interest in exchanged basis 
transaction treated as purchased), an acquisition of stock in a 
corporation in a section 351 transaction by one or more persons in 
exchange for an amount of stock in another corporation (the transferred 
corporation) that meets the requirements of section

[[Page 243]]

1504(a)(2) is not a purchase by the transferor or transferors, 
regardless of whether the stock of the transferred corporation is 
marketable stock under section 355(d)(5)(B)(ii) and paragraph (d)(3)(ii) 
of this section.
    (B) Example. The following example illustrates this paragraph 
(d)(3)(iii):

    Example. D's two classes of stock, voting common and nonvoting 
preferred, are both widely held and publicly traded. The nonvoting 
preferred stock is stock described in section 1504(a)(4). Assume that 
all of the D stock is marketable stock under section 355(d)(5)(B)(ii) 
and paragraph (d)(3)(ii) of this section. D's board of directors 
proposes that, for valid business purposes, D's common stock should be 
held by a holding company, HC, but its preferred stock should not be 
transferred to HC. As proposed, the D common shareholders exchange their 
D stock solely for HC common stock in a section 351(a) transaction. The 
D preferred shareholders retain their stock. HC acquires an amount of D 
stock that meets the requirements of section 1504(a)(2). Although the D 
common stock was marketable stock in the hands of the D shareholders 
immediately before the transfer, and the D nonvoting preferred stock is 
marketable stock after the transfer, the D shareholders are not treated 
as having acquired the HC stock by purchase (except to the extent the 
exchanged basis rule of paragraph (e)(3) of this section may apply to 
treat HC stock as purchased on the date the exchanged D stock was 
purchased).

    (iv) Exception for assets transferred as part of an active trade or 
business--(A) In general. Except to the extent provided in paragraph 
(e)(3) of this section, an acquisition not described in paragraph 
(d)(3)(iii) of this section of stock in exchange for any cash or cash 
item, any marketable stock, or any debt of the transferor in a section 
351 transaction is not a purchase if--
    (1) The transferor is engaged in the active conduct of a trade or 
business under paragraph (d)(3)(iv)(B) of this section and the 
transferred items (including debt incurred in the ordinary course of the 
trade or business) are used in the trade or business;
    (2) The transferred items do not exceed the reasonable needs of the 
trade or business under paragraph (d)(3)(iv)(C) of this section;
    (3) The transferor transfers the items as part of the trade or 
business; and
    (4) The transferee continues the active conduct of the trade or 
business.
    (B) Active conduct of a trade or business. For purposes of this 
paragraph (d)(3)(iv), whether, with respect to the trade or business at 
issue, the transferor and transferee are engaged in the active conduct 
of a trade or business is determined under Sec. 1.355-3(b)(2) and (3), 
except that--
    (1) Conduct is tested before the transfer (with respect to the 
transferor) and after the transfer (with respect to the transferee) 
rather than immediately after a distribution; and
    (2) The trade or business need not have been conducted for five 
years before its transfer, but it must have been conducted for a 
sufficient period of time to establish that it is a viable and ongoing 
trade or business.
    (C) Reasonable needs of the trade or business. For purposes of this 
paragraph (d)(3)(iv), the reasonable needs of the trade or business 
include only the amount of cash or cash items, marketable stock, or debt 
of the transferor that a prudent business person apprised of all 
relevant facts would consider necessary for the present and reasonably 
anticipated future needs of the business. Transferred items may be 
considered necessary for reasonably anticipated future needs only if the 
transferor and transferee have specific, definite, and feasible plans 
for their use. Those plans must require that items intended for 
anticipated future needs rather than present needs be used as 
expeditiously as possible consistent with the business purpose for 
retention of the items. Future needs are not reasonably anticipated if 
they are uncertain or vague or where the execution of the plan for their 
use is substantially postponed. The reasonable needs of a trade or 
business are generally its needs at the time of the transfer of the 
business including the items. However, for purposes of applying section 
355(d) to a distribution, events and conditions after the transfer and 
through the date immediately after the distribution (including whether 
plans for the use of transferred items have been consummated or 
substantially postponed) may be considered to determine whether at the 
time of the transfer the items were necessary for the present and 
reasonably anticipated future needs of the business.

[[Page 244]]

    (D) Consideration of all facts and circumstances. All facts and 
circumstances are considered in determining whether this paragraph 
(d)(3)(iv) applies.
    (E) Successive transfers. A transfer of assets does not fail to meet 
the requirements of paragraph (d)(3)(iv)(A)(4) of this section solely 
because the transferee transfers the assets directly (or indirectly 
through other members) to another member of the transferee's affiliated 
group, as defined in Sec. 1.355-3(b)(4)(iv) (the final transferee), if 
the requirements of paragraphs (d)(3)(iv)(A)(1), (2), (3) and (4) of 
this section would be met if the transferor had transferred the assets 
directly to the final transferee.
    (v) Exception for transfer between members of the same affiliated 
group--(A) In general. Except to the extent provided in paragraph (e)(3) 
of this section, an acquisition of stock (whether actual or 
constructive) not described in paragraphs (d)(3)(iii) and (iv) of this 
section in exchange for any cash or cash item, marketable stock, or debt 
of the transferor in a section 351 transaction is not a purchase if--
    (1) The transferor corporation or corporations and the transferee 
corporation (whether formed in the transaction or already existing) are 
members of the same affiliated group as defined in section 1504(a) 
before the section 351 transaction (if the transferee corporation is in 
existence before the transaction);
    (2) The cash or cash item, marketable stock or debt of the 
transferor are not included in assets that are acquired (or treated as 
acquired) by the transferor (or another member of the transferor's 
affiliated group) from a nonmember in a related transaction in which 
section 362(a) or (b) applies to determine the basis in the acquired 
assets; and
    (3) The transferor corporation or corporations, the transferee 
corporation, and any distributed controlled corporation of the 
transferee corporation do not cease to be members of such affiliated 
group in any transaction pursuant to a plan that includes the section 
351 transaction (including any distribution of a controlled corporation 
by the transferee corporation). But see paragraph (b)(4) of this section 
where the transfer is made for a principal purpose to avoid the purposes 
of section 355(d).
    (B) Examples. The following examples illustrate this paragraph 
(d)(3)(v):

    Example 1. Publicly traded P has wholly owned S since 1990. S is 
engaged in the telecommunications business and the business of computer 
software development. S is developing new software for use in the 
managed health care industry. Over a period of four years beginning on 
January 31, 2000, P contributes a substantial amount of cash to S solely 
for the purpose of funding the software development. On completion of 
the software in January of 2004, 60 percent of the value of the S stock 
is attributable to the cash contributions made within the last four 
years. The P group's primary lender requires that S separately 
incorporate the software and related assets and distribute the new 
subsidiary to P as a condition of providing required funding to market 
the software. Accordingly, on February 1, 2004, S forms N, contributes 
the software and related assets to N, and distributes all of the N stock 
to P in a transaction intended to qualify under section 355(a). P, S, 
and N will not leave the affiliated group in any transaction related to 
the cash contributions. Under paragraph (d)(3)(v)(A) of this section, 
P's cash contributions to S are not treated as purchases of additional S 
stock, and the distribution of N from S to P is not a disqualified 
distribution under section 355(d)(2) and paragraph (b)(1) of this 
section.
    Example 2. On Date 1, P contributes cash to its subsidiary S with a 
principal purpose to increase its stock basis in S. Sixty percent of the 
value of P's S stock is attributable to the cash contribution. Under 
paragraph (b)(4) of this section (anti-avoidance rule), 60 percent of 
the S stock is treated as purchased under section 355(d)(5)(B), 
notwithstanding paragraph (d)(3)(v)(A) of this section. Accordingly, any 
distribution of a subsidiary of S to P within the five-year period after 
Date 1 will be a disqualified distribution, regardless of whether P, S, 
and any distributed S subsidiary remain affiliated after the 
distribution and any transactions related to the cash contribution.

    (4) Triangular asset reorganizations--(i) Definition. A triangular 
asset reorganization is a reorganization that qualifies under--
    (A) Section 368(a)(1)(A) or (G) by reason of section 368(a)(2)(D);
    (B) Section 368(a)(1)(A) by reason of section 368(a)(2)(E) 
(regardless of whether section 368(a)(3)(E) applies), unless the 
transaction also qualifies as either a section 351 transfer or a 
reorganization under section 368(a)(1)(B); or

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    (C) Section 368(a)(1)(C), and stock of the controlling corporation 
rather than the acquiring corporation is exchanged for the acquired 
corporation's properties.
    (ii) Treatment. Notwithstanding section 355(d)(5)(A), for purposes 
of section 355(d), the controlling corporation in a triangular asset 
reorganization is treated as having--
    (A) Acquired the assets of the acquired corporation (and as having 
assumed any liabilities assumed by the controlling corporation's 
subsidiary corporation or to which the acquired corporation's assets 
were subject (the acquired liabilities)) in a transaction in which the 
controlling corporation's basis in the acquired corporation's assets was 
determined under section 362(b); and
    (B) Transferred the acquired assets and acquired liabilities to its 
subsidiary corporation in a section 351 transfer.
    (iii) Example. The following example illustrates this paragraph 
(d)(4):

    Example. Forward triangular reorganization. P forms S with $25 of 
cash and T merges into S in a reorganization qualifying under section 
368(a)(1)(A) by reason of section 368(a)(2)(D) in which the T 
shareholders receive $70 of P stock and $15 of cash in exchange for 
their T stock. T is not a common parent of a consolidated group of 
corporations. The remaining $10 of cash with which P formed S will not 
be used in the acquired business. T's assets consist only of assets part 
of and used in its business with a value of $80, and $5 of cash that is 
not part of or used in T's business. T has no liabilities. S will use 
T's business assets in T's business (which will become S's business), 
but will invest the $5 of cash in an unrelated passive investment. Under 
paragraph (d)(4)(ii) of this section, P is treated as acquiring the T 
assets in a transaction in which P's basis in the T assets was 
determined under section 362(b) and contributing them to S in a section 
351 transfer. Under paragraph (d)(3)(v) of this section, $10 (of the 
total $25) of cash contributed by P to S upon S's formation is not 
treated as a purchase of S stock. The $15 (of the total $25) of cash 
contributed by P to S upon S's formation that is paid to T's 
shareholders is not treated as a purchase of S stock. The exception in 
paragraph (d)(3)(v) of this section does not apply to the $5 of cash 
from T's business because P is treated as having acquired T's assets in 
a related transaction in which section 362(b) applies to determine P's 
basis in such assets. Accordingly, P is treated under section 
355(d)(5)(B) and paragraph (d)(3)(iv) of this section as having 
purchased $5 of the S stock, but is not deemed to have purchased the 
remaining $80 of the S stock.

    (5) Reverse triangular reorganizations other than triangular asset 
reorganizations--(i) In general. Except as provided in paragraph 
(d)(5)(ii) of this section, if a transaction qualifies as a 
reorganization under section 368(a)(1)(A) by reason of section 
368(a)(2)(E) and also as either a reorganization under section 
368(a)(1)(B) or a section 351 transfer, then either section 355(d)(5)(B) 
(and paragraphs (d)(3)(i) through (iv) of this section) or 355(d)(5)(C) 
(and paragraph (e)(2) of this section) applies. Regardless of which 
method the controlling corporation employs to determine its basis in the 
surviving corporation stock under Sec. 1.358-6(c)(2)(ii) or Sec. 
1.1502-30(b), the total amount of surviving corporation stock treated as 
purchased by the controlling corporation will equal the higher of--
    (A) The amount of surviving corporation stock that would be treated 
as purchased (on the date of the deemed section 351 transfer) by the 
controlling corporation if the controlling corporation acquired the 
surviving corporation's assets and assumed its liabilities in a 
transaction in which the controlling corporation's basis in the 
surviving corporation assets was determined under section 362(b), and 
then transferred the acquired assets and liabilities to the surviving 
corporation in a section 351 transfer (see Sec. Sec. 1.358-6(c)(1) and 
(2)(ii)(A), and 1.1502-30(b)); or
    (B) The amount of surviving corporation stock that would be treated 
as purchased (on the date the surviving corporation shareholders 
purchased their surviving corporation stock) if the controlling 
corporation acquired the stock of the surviving corporation in a 
transaction in which the basis in the surviving corporation's stock was 
determined under section 362(b) (see Sec. Sec. 1.358-6(c)(2)(ii)(B) and 
1.1502-30(b)).
    (ii) Letter ruling and closing agreement. If a controlling 
corporation obtains a letter ruling and enters into a closing agreement 
under section 7121 in which it agrees to determine its basis in 
surviving corporation stock under Sec. 1.358-6(c)(2)(ii)(A), or under 
Sec. 1.1502-30(b) by applying Sec. 1.358-6(c)(2)(ii)(A) (deemed

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asset acquisition and transfer by controlling corporation), then section 
355(d)(5)(B) and paragraphs (d)(3)(i) through (iv) of this section 
apply, and section 355(d)(5)(C) and paragraph (e)(2) of this section do 
not apply. If a controlling corporation obtains a letter ruling and 
enters into a closing agreement under section 7121 under which it agrees 
to determine its basis in surviving corporation stock under Sec. 1.358-
6(c)(2)(ii)(B), or under Sec. 1.1502-30(b) by applying Sec. 1.358-
6(c)(2)(ii)(B) (deemed stock acquisition), then section 355(d)(5)(C) and 
paragraph (e)(2) of this section apply, and section 355(d)(5)(B) and 
paragraphs (d)(3)(i) through (iv) of this section do not apply.
    (iii) Example. The following example illustrates this paragraph 
(d)(5):

    Example. Reverse triangular reorganization; purchase. (i) A 
purchases 60 percent of the stock of D on Date 1. D owns no cash items, 
marketable stock, or transferor debt, but holds cash that is not part of 
or used in D's trade or business under paragraph (d)(3)(iv) of this 
section and that represents 20 percent of D's value. On Date 2, P forms 
S, and S merges into D in a reorganization qualifying under section 
368(a)(1)(B) and under section 368(a)(1)(A) by reason of section 
368(a)(2)(E). In the reorganization, P acquires all of the D stock in 
exchange solely for P stock. After Date 2, and within five years after 
Date 1, D distributes its wholly owned subsidiary C to P. P does not 
obtain a letter ruling and enter into a closing agreement under 
paragraph (d)(5)(ii) of this section. P would acquire 20 percent of the 
D stock by purchase on Date 2 under paragraph (d)(5)(i)(A) of this 
section by operation of section 355(d)(5)(B) and paragraph (d)(3)(iv) of 
this section. The exception in paragraph (d)(3)(v) of this section does 
not apply because D was not affiliated with P before the transaction in 
which the section 351 transfer is deemed to occur and D's assets are 
treated as acquired by P in a related transaction in which section 
362(b) applies to determine P's basis in the D assets. P would acquire 
60 percent of the D stock by purchase on Date 1 under paragraph 
(d)(5)(i)(B) of this section because, under the transferred basis rule 
of section 355(d)(5)(C) and paragraph (e)(2) of this section, P is 
treated as though P purchased the D stock on the date A purchased it. 
Accordingly, under paragraph (d)(5)(i) of this section, P is treated as 
acquiring the higher amount (60 percent) by purchase on Date 1. D's 
distribution of C to P is a disqualified distribution under section 
355(d)(2) and paragraph (b)(1) of this section. In addition, A is 
treated as acquiring the P stock by purchase on Date 1 under paragraph 
(e)(3) of this section because A's basis in the P stock is determined by 
reference to A's basis in the D stock.
    (ii) The facts are the same as in paragraph (i) of this Example, 
except that P obtains a letter ruling and enters into a closing 
agreement under which it agrees to determine its basis in the D stock 
under Sec. 1.358-6(c)(2)(ii)(A). Under paragraph (d)(5)(ii) of this 
section, section 355(d)(5)(B) (and paragraphs (d)(3)(i) through (iv) of 
this section) applies, and section 355(d)(5)(C) (and paragraph (e)(2) of 
this section) does not apply. Accordingly, P is treated as acquiring 
only 20 percent of the D stock by purchase on Date 2. D's distribution 
of C to P is not a disqualified distribution under section 355(d)(2) and 
paragraph (b)(1) of this section.

    (6) Treatment of group structure changes--(i) In general. 
Notwithstanding section 355(d)(5)(A), for purposes of section 355(d), if 
a corporation succeeds another corporation as the common parent of a 
consolidated group in a group structure change to which Sec. 1.1502-31 
applies, the new common parent is treated as having acquired the assets 
and assumed the liabilities of the former common parent in a transaction 
in which the new common parent's basis in the former common parent's 
assets was determined under section 362(b), and then transferred the 
acquired assets and liabilities to the former common parent (or, if the 
former common parent does not survive, to the new common parent's 
subsidiary) in a section 351 transfer, with the new common parent and 
former common parent being treated as not in the same affiliated group 
at the time of the transfer for purposes of applying paragraph (d)(3)(v) 
of this section (notwithstanding Sec. 1.1502-31(c)(2)).
    (ii) Adjustments to basis of higher-tier members. A higher-tier 
member that indirectly owns all or part of the former common parent's 
stock after a group structure change is treated as having purchased the 
stock of an immediate subsidiary to the extent that the higher-tier 
member's basis in the subsidiary is increased under Sec. 1.1502-
31(d)(4).
    (iii) Example. The following example illustrates this paragraph 
(d)(6):

    Example. P is the common parent of a consolidated group, and T is 
the common parent of another group. P has owned S for more than five 
years, and the fair market value of the S stock is $50. T's assets 
consist only of non-marketable stock of direct and indirect

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wholly owned subsidiaries with a value of $50, assets used in its 
business with a value of $50, and $50 of marketable stock that is not 
part of or used in T's business. T has no liabilities. T merges into S 
with the T shareholders receiving solely P stock with a value of $150 in 
exchange for their T stock in a section 368(a)(2)(D) reorganization. S 
will use T's business assets in T's business (which will become S's 
business), but will hold the $50 of marketable stock for investment 
purposes. Assume that the transaction is a reverse acquisition under 
Sec. 1.1502-75(d)(3) because the T shareholders, as a result of owning 
T stock, own more than 50 percent of the value of P's stock immediately 
after the transaction. Thus, the transaction is a group structure change 
under Sec. 1.1502-33(f)(1). Under paragraph (d)(6) of this section, P 
is treated as having acquired the assets of T in a transaction in which 
P's basis in the T assets was determined under section 362(b), and then 
transferred the acquired assets to S in a section 351 transfer, with P 
and T being treated as not in the same affiliated group at the time of 
the transfer solely for purposes of paragraph (d)(3)(v) of this section. 
The exception in paragraph (d)(3)(v) of this section (transfers within 
an affiliated group) does not apply. Accordingly, P is treated under 
section 355(d)(5)(B) and paragraph (d)(3)(iv) of this section as having 
purchased $50 of the S stock (attributable to the marketable stock), but 
is not deemed to have purchased the remaining $150 of the S stock.

    (7) Special rules for triangular asset reorganizations, other 
reverse triangular reorganizations, and group structure changes. The 
amount of acquiring subsidiary, surviving corporation, or former common 
parent stock that is treated as purchased under paragraph (c)(4), 
(5)(i)(A), or (6) of this section (by operation of section 355(d)(5)(B) 
and paragraphs (d)(3)(i) through (iv) of this section) is adjusted to 
reflect any basis adjustment under--
    (i) Section 1.358-6(c)(2)(i)(B) and (C) (reduction of basis 
adjustment in reverse triangular reorganization where controlling 
corporation acquires less than all of the surviving corporation stock), 
Sec. 1.1502-30(b) (applying Sec. 1.358-6(c)(2)(i)(B) and (C) to a 
consolidated group), and Sec. 1.1502-31(d)(2)(ii) (reduction of basis 
adjustment in group structure change where new common parent acquires 
less than all of the former common parent stock); or
    (ii) Section 1.358-6(d) (reduction of basis adjustment in any 
triangular reorganization to the extent controlling corporation does not 
provide consideration), Sec. 1.1502-30(b) (applying Sec. 1.358-6(d) 
(except Sec. 1.358-6(d)(2)) to a consolidated group), and Sec. 1.1502-
31(d)(1) (reduction of basis adjustment in group structure change to the 
extent new common parent does not provide consideration).
    (e) Deemed purchase and timing rules--(1) Attribution and 
aggregation--(i) In general. Under section 355(d)(8)(B), if any person 
acquires by purchase an interest in any entity, and the person is 
treated under section 355(d)(8)(A) as holding any stock by reason of 
holding the interest, the stock shall be treated as acquired by purchase 
on the later of the date of the purchase of the interest in the entity 
or the date the stock is acquired by purchase by such entity.
    (ii) Purchase of additional interest. If a person and an entity are 
treated as a single person under section 355(d)(7), and the person later 
purchases an additional interest in the entity, the person is treated as 
purchasing on the date of the later purchase the amount of stock 
attributed from the entity to the person under section 355(d)(8)(A) as a 
result of the additional interest.
    (iii) Purchase between persons treated as one person. If two persons 
are treated as one person under section 355(d)(7), and one later 
purchases stock from the other, the date of the later purchase is used 
for purposes of determining when the five-year period commences.
    (iv) Purchase by a person already treated as holding stock under 
section 355(d)(8)(A). If a person who is already treated as holding 
stock under section 355(d)(8)(A) later directly purchases such stock, 
the date of the later direct purchase is used for purposes of 
determining when the five-year period commences.
    (v) Examples. The following examples illustrate this paragraph 
(e)(1):

    Example 1. On Date 1, A purchases 10 percent of the stock of P, 
which has held 100 percent of the stock of T for more than five years at 
the time of A's purchase. A is deemed to have purchased 10 percent of 
P's T stock on Date 1. If A later purchases an additional 41 percent of 
the stock of P on Date 2, A is deemed to have purchased an additional 41 
percent of P's T stock on Date 2. Because A and P are now related 
persons under section 267(b), they are treated as one person under 
section 355(d)(7)(A), and A is treated as

[[Page 248]]

owning all of P's T stock. A is treated as acquiring 51 percent of the T 
stock by purchase at the times of A's respective purchases of P stock on 
Date 1 and Date 2. The remaining 49 percent of T stock is treated as 
acquired when P acquired the T stock, more than five years before Date 
1. If P distributes T after Date 2 and within five years after Date 1, 
the distribution will be a disqualified distribution under section 
355(d)(2) and paragraph (b)(1) of this section.
    Example 2. A has owned 60 percent of the stock of P for more than 
five years, and P has owned 40 percent of the stock of T for more than 
five years. A and P are treated as one person, and A is treated as 
owning 40 percent of the stock of T for more than five years. If P later 
purchases an additional 20 percent of the stock of T on Date 1, A is 
treated as acquiring by purchase the additional 20 percent of T stock on 
Date 1. If A then purchases an additional 10 percent of the stock of P 
on Date 2, under paragraph (e)(1)(i) of this section, A is deemed to 
have purchased on Date 2 an additional four percent of the T stock (10 
percent of the 40 percent that P originally owned). In addition, even 
though A and P were already treated as one person under section 
355(d)(7)(A), A also is deemed to have purchased two percent of the T 
stock on Date 2 (10 percent of the 20 percent of the T stock that it was 
treated as purchasing on Date 1). A is still treated as owning all 60 
percent of the T stock owned by P. However, of the 60 percent, A is 
treated as having purchased 18 percent of the T stock on Date 1 and 6 
percent of the T stock on Date 2, for a total of 24 percent purchased 
stock.
    Example 3. A purchases a 20 percent interest in partnership M on 
Date 1. M has owned 30 percent of the stock and 25 percent of the 
securities of P for more than five years. P has owned 40 percent of the 
stock and 100 percent of the securities of T for more than five years. 
Under section 318(a)(2)(C) as modified by section 355(d)(8)(A), M is 
deemed to own 12 percent of the stock (30 percent of the 40 percent P 
owns) and 30 percent of the securities (30 percent of the 100 percent P 
owns) of T. Under sections 318(a)(2)(A) and 355(d)(8)(B), A is deemed to 
have purchased 2.4 percent of the stock (20 percent of the 12 percent M 
is deemed to own) and 6 percent of the securities (20 percent of the 30 
percent M is deemed to own) of T on Date 1. Similarly, A is deemed to 
have purchased 6 percent of the stock (20 percent of the 30 percent M 
owns) and five percent of the securities (20 percent of the 25 percent M 
owns) of P on Date 1. If M later purchases an additional 10 percent of P 
stock on Date 2, M is deemed to have purchased four percent of the stock 
(10 percent of the 40 percent P owns) and 10 percent of the securities 
(10 percent of the 100 percent P owns) of T on Date 2. A is deemed to 
have purchased two percent of the stock of P on Date 2 (20 percent of 
the 10 percent M purchased). A is also deemed to have purchased 0.8 
percent of the stock (20 percent of the four percent M is deemed to have 
purchased) and two percent of the securities (20 percent of the 10 
percent M is deemed to have purchased) of T on Date 2.
    Example 4. A and B are brother and sister. For more than five years, 
A has owned 75 percent of the stock of P, and B has owned 25 percent of 
the stock of P. A and B are treated as one person under section 267(b), 
and the stock of each is treated as purchased on the date it was 
purchased by A and B, respectively. If B later purchases 50 percent of 
the P stock from A on Date 1, A and B are still treated as one person. 
However, under paragraph (e)(3)(iii) of this section, the 50 percent of 
P stock that B purchased from A is treated as purchased on Date 1.

    (2) Transferred basis rule. If any person acquires property from 
another person who acquired the property by purchase (determined with 
regard to section 355(d)(5) and paragraphs (d) and (e)(2), (3) and (4) 
of this section, but without regard to section 355(d)(8) and paragraph 
(e)(1) of this section), and the adjusted basis of the property in the 
hands of the acquirer is determined in whole or in part by reference to 
the adjusted basis of the property in the hands of the other person, the 
acquirer is treated as having acquired the property by purchase on the 
date it was so acquired by the other person. The rule in this paragraph 
(e)(2) applies, for example, where stock of a corporation acquired by 
purchase is subsequently acquired in a section 351 transfer or a 
reorganization qualifying under section 368(a)(1)(B), but does not apply 
if the stock of a former common parent is acquired in a group structure 
change to which Sec. 1.1502-31 applies. But see paragraph 
(d)(2)(i)(B)(2) of this section for situations where the stock is 
treated as purchased on the date of a transfer.
    (3) Exchanged basis rule--(i) In general. If any person acquires an 
interest in an entity (the first interest) by purchase (determined with 
regard to section 355(d)(5) and paragraphs (d) and (e)(2), (3) and (4) 
of this section, but without regard to section 355(d)(8) and paragraph 
(e)(1) of this section), and the first interest is exchanged for an 
interest in the same or another entity (the second interest) where the 
adjusted basis of the second interest is determined in whole or in part 
by reference

[[Page 249]]

to the adjusted basis of the first interest, then the second interest is 
treated as having been purchased on the date the first interest was 
purchased. The rule in this paragraph (e)(3) applies only to exchanges 
that are not otherwise treated as purchases under section 355(d)(5) and 
paragraph (d) of this section. The rule in this paragraph (e)(3) 
applies, for example, where stock of a corporation acquired by purchase 
is subsequently exchanged for other stock in a section 351, 354, or 
1036(a) exchange. But see paragraph (d)(2)(i)(A)(2) of this section for 
situations where the stock is treated as purchased on the date of an 
exchange or distribution.
    (ii) Example. The following example illustrates this paragraph 
(e)(3):

    Example. A purchases 50 percent of the stock of T on Date 1. On Date 
2, T merges into D in a section 368(a)(1)(A) reorganization, with A 
exchanging all of the T stock solely for stock of D. Under section 
358(a), A's basis in the D stock is determined by reference to the basis 
of the T stock it purchased. Accordingly, A is treated as having 
purchased the D stock on Date 1, and has a purchased basis in the D 
stock under paragraph (b)(3)(iii) of this section.

    (4) Certain section 355 or section 305 distributions--(i) Section 
355. If a distributing corporation distributes any stock of a controlled 
corporation with respect to recently purchased distributing stock in a 
distribution that qualifies under section 355 (or so much of section 356 
as relates to section 355), such controlled corporation stock is deemed 
to be acquired by purchase by the distributee on the date the 
distributee acquired the recently purchased distributing stock. Recently 
purchased distributing stock is stock in the distributing corporation 
acquired by purchase (determined with regard to section 355(d)(5) and 
paragraphs (d) and (e)(2), (3), and (4) of this section, but without 
regard to section 355(d)(8) and paragraph (e)(1) of this section) by the 
distributee during the five-year period with respect to that 
distribution.
    (ii) Section 305. If a corporation distributes its stock in a 
distribution that qualifies under section 305(a), the stock received in 
the distribution (to the extent section 307(a) applies to determine the 
recipient's basis) is deemed to be acquired by purchase by the recipient 
on the date (if any) that the recipient acquired by purchase (determined 
with regard to section 355(d)(5) and paragraphs (d) and (e)(2), (3), and 
(4) of this section), the stock with respect to which the distribution 
is made.
    (5) Substantial diminution of risk--(i) In general. If section 
355(d)(6) applies to any stock for any period, the running of any five-
year period set forth in section 355(d)(3) is suspended during such 
period.
    (ii) Property to which suspension applies. Section 355(d)(6) applies 
to any stock for any period during which the holder's risk of loss with 
respect to such stock, or with respect to any portion of the activities 
of the corporation, is (directly or indirectly) substantially diminished 
by an option, a short sale, any special class of stock, or any other 
device or transaction.
    (iii) Risk of loss substantially diminished. Whether a holder's risk 
of loss is substantially diminished under section 355(d)(6) and 
paragraph (e)(5)(ii) of this section will be determined based on all 
facts and circumstances relating to the stock, the corporate activities, 
and arrangements for holding the stock.
    (iv) Special class of stock. For purposes of section 355(d)(6) and 
paragraph (e)(5)(ii) of this section, the term special class of stock 
includes a class of stock that grants particular rights to, or bears 
particular risks for, the holder or the issuer with respect to the 
earnings, assets, or attributes of less than all the assets or 
activities of a corporation or any of its subsidiaries. The term 
includes, for example, tracking stock and stock (or any related 
instruments or arrangements) the terms of which provide for the 
distribution (whether or not at the option of any party or in the event 
of any contingency) of any controlled corporation or other specified 
assets to the holder or to one or more persons other than the holder.
    (f) Duty to determine stockholders--(1) In general. In determining 
whether section 355(d) applies to a distribution of controlled 
corporation stock, a distributing corporation must determine whether a 
disqualified person holds its stock or the stock of any distributed

[[Page 250]]

controlled corporation. This paragraph (f) provides rules regarding this 
determination and the extent to which a distributing corporation must 
investigate whether a disqualified person holds stock.
    (2) Deemed knowledge of contents of securities filings. A 
distributing corporation is deemed to have knowledge of the existence 
and contents of all schedules, forms, and other documents filed with or 
under the rules of the Securities and Exchange Commission, including 
without limitation any Schedule 13D or 13G (or any similar schedules) 
and amendments, with respect to any relevant corporation.
    (3) Presumption as to securities filings. Absent actual knowledge to 
the contrary, in determining whether section 355(d) applies to a 
distribution, a distributing corporation may presume, with respect to 
stock that is reporting stock (while such stock is reporting stock), 
that every shareholder or other person required to file a schedule, 
form, or other document with or under the rules of the Securities and 
Exchange Commission as of a given date has filed the schedule, form, or 
other document as of that date and that the contents of filed schedules, 
forms, or other documents are accurate and complete. Reporting stock is 
stock that is described in Rule 13d-1(i) of Regulation 13D (17 CFR 
240.13d-1(i)) (or any rule or regulation to generally the same effect) 
promulgated by the Securities and Exchange Commission under the 
Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.).
    (4) Presumption as to less-than-five-percent shareholders. Absent 
actual knowledge (or deemed knowledge under paragraph (f)(2) of this 
section) immediately after the distribution to the contrary with regard 
to a particular shareholder, a distributing corporation may presume that 
no less-than-five-percent shareholder of a corporation acquired stock or 
securities by purchase under section 355(d)(5) or (8) and paragraphs (d) 
and (e) of this section during the five-year period. For purposes of 
this paragraph (f), a less-than-five-percent shareholder is a person 
that, at no time during the five-year period, holds directly (or by 
application of paragraph (c)(3)(ii) of this section, but not by 
application of section 355(d)(7) or (8)) stock possessing five percent 
or more of the total combined voting power of all classes of stock 
entitled to vote or the total value of shares of all classes of stock of 
a corporation. However, this presumption does not apply to any less-
than-five-percent shareholder that, at any time during the five-year 
period--
    (i) Is related under section 355(d)(7)(A) to a shareholder in the 
corporation that is, at any time during the five-year period, not a 
less-than-five-percent shareholder;
    (ii) Acted pursuant to a plan or arrangement, with respect to 
acquisitions of the corporation's stock or securities under section 
355(d)(7)(B) and paragraph (c)(4) of this section, with a shareholder in 
the corporation that is, at any time during the five-year period, not a 
less-than-five-percent shareholder; or
    (iii) Holds stock or securities that is attributed under section 
355(d)(8)(A) to a shareholder in the corporation that is, at any time 
during the five-year period, not a less-than-five-percent shareholder.
    (5) Examples. The following examples illustrate this paragraph (f):

    Example 1. Publicly traded corporation; no schedules filed. D is a 
widely held and publicly traded corporation with a single class of 
reporting stock and no other class of stock. Assume that applicable 
federal law requires any person that directly holds five percent or more 
of the D stock to file a schedule with the Securities and Exchange 
Commission within 10 days after an acquisition. D distributes its wholly 
owned subsidiary C pro rata. D determines that no schedule, form, or 
other document has been filed with respect to its stock or the stock of 
any other relevant corporation during the five-year period or within 10 
days after the distribution. Immediately after the distribution, D has 
no knowledge that any of its shareholders are (or were at any time 
during the five-year period) not less-than-five-percent shareholders, or 
that any particular shareholder acquired D stock by purchase under 
section 355(d)(5) or (8) and paragraphs (d) and (e) of this section 
during the five-year period. Under paragraph (f)(3) of this section, D 
may presume it has no shareholder that is or was not a less-than-five-
percent shareholder during the five-year period due to the absence of 
any filed schedules, forms, or other documents. Under paragraph (f)(4) 
of this section, D may presume that

[[Page 251]]

none of its less-than-five-percent shareholders acquired D's stock by 
purchase during the five-year period. Accordingly, D may presume that 
section 355(d) does not apply to the distribution of C.
    Example 2. Publicly traded corporation; schedule filed. The facts 
are the same as those in Example 1, except that D determines that, as of 
10 days after the distribution, only one schedule has been filed with 
respect to its stock. That schedule discloses that X acquired 15 percent 
of the D stock one year before the distribution. Absent contrary 
knowledge, D may rely on the presumptions in paragraph (f)(3) of this 
section and so may presume that X is its only shareholder that is or was 
not a less-than-five-percent shareholder during the five-year period. D 
may not rely on the presumption in paragraph (f)(4) of this section with 
respect to X. In addition, D may not rely on the presumption in 
paragraph (f)(4) of this section with respect to any less-than-five-
percent shareholder that, at any time during the five-year period, is 
related to X under section 355(d)(7)(A), acted pursuant to a plan or 
arrangement with X under section 355(d)(7)(B) and paragraph (c)(4) of 
this section with respect to acquisitions of D stock, or holds stock 
that is attributed to X under section 355(d)(8)(A). Accordingly, under 
paragraph (f)(1) of this section, to determine whether section 355(d) 
applies, D must determine: whether X acquired its directly held D stock 
by purchase under section 355(d)(5) and paragraphs (d) and (e)(2) and 
(3) of this section during the five-year period; whether X is treated as 
having purchased any additional D stock under section 355(d)(8) and 
paragraph (e)(1) of this section during the five-year period; and 
whether X is related to, or acquired its D stock pursuant to a plan or 
arrangement with, one or more of D's other shareholders during the five-
year period under section 355(d)(7)(A) or (B) and paragraph (c)(4) of 
this section, and if so, whether those shareholders acquired their D 
stock by purchase under section 355(d)(5) or (8) and paragraphs (d) and 
(e) of this section during the five-year period.
    Example 3. Acquisition of publicly traded corporation. The facts are 
the same as those in Example 1, except that P acquires all of the D 
stock in a section 368(a)(1)(B) reorganization that is not also a 
reorganization under section 368(a)(1)(A) by reason of section 
368(a)(2)(E), and D distributes C to P one year later. Because D was 
widely held, P applies statistical sampling procedures that involve less 
than 50% of D's outstanding shares, to estimate the basis of all shares 
acquired, instead of surveying each shareholder. Under the deemed 
purchase rule of section 355(d)(5)(C) and paragraph (e)(2) of this 
section, P is treated as having acquired the D stock by purchase on the 
date the D shareholders acquired the D stock by purchase. Even though D 
has no less-than-five-percent shareholder immediately after the 
distribution, D may rely on the presumptions in paragraphs (f)(3) and 
(4) of this section to determine whether and to what extent the D stock 
is treated as purchased during the five-year period in P's hands under 
the deemed purchase rule of section 355(d)(5)(C) and paragraph (e)(2) of 
this section. Accordingly, D may presume that section 355(d) does not 
apply to the distribution of C to P. This result would not change even 
if the statistical sampling that involves less than 50 percent of D's 
outstanding shares indicated that more than 50% of D's shares were 
acquired by purchase during the five-year period.
    Example 4. Non-publicly traded corporation. D is owned by 20 
shareholders and has a single class of stock that is not reporting 
stock. D knows that A owns 40 percent of the D stock, and D does not 
know that any other shareholder has owned as much as five percent of the 
D stock at any time during the five-year period. D may not rely on the 
presumption in paragraph (f)(3) of this section because its stock is not 
reporting stock. D may not rely on the presumption in paragraph (f)(4) 
of this section with respect to A. In addition, D may not rely on the 
presumption in paragraph (f)(4) of this section for any less-than-five-
percent shareholder that, at any time during the five-year period, is 
related to A under section 355(d)(7)(A), acted pursuant to a plan or 
arrangement with A under section 355(d)(7)(B) and paragraph (c)(4) of 
this section with respect to acquisitions of D stock, or holds stock 
that is attributed to A under section 355(d)(8)(A). D may rely on the 
presumption in paragraph (f)(4) of this section for less-than-five-
percent shareholders that during the five-year period are not related to 
A, did not act pursuant to a plan or arrangement with A, and do not hold 
stock attributed to A. Accordingly, under paragraph (f)(1) of this 
section, to determine whether section 355(d) applies, D must determine: 
that A is its only shareholder that is (or was at any time during the 
five-year period) not a less-than-five-percent shareholder; whether A 
acquired its directly held D stock by purchase under section 355(d)(5) 
and paragraphs (d) and (e)(2) and (3) of this section during the five-
year period; whether A is treated as having purchased any additional D 
stock under section 355(d)(8) and paragraph (e)(1) of this section 
during the five-year period; and whether A is related to, or acquired 
its D stock pursuant to a plan or arrangement with, one or more of D's 
other shareholders during the five-year period under section 
355(d)(7)(A) or (B) and paragraph (c)(4) of this section, and if so, 
whether those shareholders acquired their D stock by purchase under 
section 355(d)(5) or (8) and paragraphs (d) and (e) of this section 
during the five-year period.


[[Page 252]]


    (g) Effective/applicability dates. This section applies to 
distributions occurring after December 20, 2000, except that they do not 
apply to any distributions occurring pursuant to a written agreement 
that is (subject to customary conditions) binding on December 20, 2000, 
and at all later times. The provisions of paragraph (d)(1)(i)(A)(2) of 
this section relating to section 1022 are effective on and after January 
19, 2017.

[T.D. 8913, 65 FR 79723, Dec. 20, 2000; 66 FR 9034, Feb. 6, 2001, as 
amended by T.D. 9811, 82 FR 6237, Jan. 19, 2017]



Sec. 1.355-7  Recognition of gain on certain distributions of stock 
or securities in connection with an acquisition.

    (a) In general. Except as provided in section 355(e) and in this 
section, section 355(e) applies to any distribution--
    (1) To which section 355 (or so much of section 356 as relates to 
section 355) applies; and
    (2) That is part of a plan (or series of related transactions) 
(hereinafter, plan) pursuant to which 1 or more persons acquire directly 
or indirectly stock representing a 50-percent or greater interest in the 
distributing corporation (Distributing) or any controlled corporation 
(Controlled).
    (b) Plan--(1) In general. Whether a distribution and an acquisition 
are part of a plan is determined based on all the facts and 
circumstances. The facts and circumstances to be considered in 
demonstrating whether a distribution and an acquisition are part of a 
plan include, but are not limited to, the facts and circumstances set 
forth in paragraphs (b)(3) and (4) of this section. In general, the 
weight to be given each of the facts and circumstances depends on the 
particular case. Whether a distribution and an acquisition are part of a 
plan does not depend on the relative number of facts and circumstances 
set forth in paragraph (b)(3) that evidence that a distribution and an 
acquisition are part of a plan as compared to the relative number of 
facts and circumstances set forth in paragraph (b)(4) that evidence that 
a distribution and an acquisition are not part of a plan.
    (2) Certain post-distribution acquisitions. In the case of an 
acquisition (other than involving a public offering) after a 
distribution, the distribution and the acquisition can be part of a plan 
only if there was an agreement, understanding, arrangement, or 
substantial negotiations regarding the acquisition or a similar 
acquisition at some time during the two-year period ending on the date 
of the distribution. In the case of an acquisition (other than involving 
a public offering) after a distribution, the existence of an agreement, 
understanding, arrangement, or substantial negotiations regarding the 
acquisition or a similar acquisition at some time during the two-year 
period ending on the date of the distribution tends to show that the 
distribution and the acquisition are part of a plan. See paragraph 
(b)(3)(i) of this section. However, all facts and circumstances must be 
considered to determine whether the distribution and the acquisition are 
part of a plan. For example, in the case of an acquisition (other than 
involving a public offering) after a distribution, if the distribution 
was motivated in whole or substantial part by a corporate business 
purpose (within the meaning of Sec. 1.355-2(b)) other than a business 
purpose to facilitate the acquisition or a similar acquisition of 
Distributing or Controlled (see paragraph (b)(4)(v) of this section) and 
would have occurred at approximately the same time and in similar form 
regardless of whether the acquisition or a similar acquisition was 
effected (see paragraph (b)(4)(vi) of this section), the taxpayer may be 
able to establish that the distribution and the acquisition are not part 
of a plan.
    (3) Plan factors. Among the facts and circumstances tending to show 
that a distribution and an acquisition are part of a plan are the 
following:
    (i) In the case of an acquisition (other than involving a public 
offering) after a distribution, at some time during the two-year period 
ending on the date of the distribution, there was an agreement, 
understanding, arrangement, or substantial negotiations regarding the 
acquisition or a similar acquisition. The weight to be accorded this 
fact depends on the nature, extent, and timing of the agreement, 
understanding, arrangement, or substantial negotiations. The existence 
of an

[[Page 253]]

agreement, understanding, or arrangement at the time of the distribution 
is given substantial weight.
    (ii) In the case of an acquisition involving a public offering after 
a distribution, at some time during the two-year period ending on the 
date of the distribution, there were discussions by Distributing or 
Controlled with an investment banker regarding the acquisition or a 
similar acquisition. The weight to be accorded this fact depends on the 
nature, extent, and timing of the discussions.
    (iii) In the case of an acquisition (other than involving a public 
offering) before a distribution, at some time during the two-year period 
ending on the date of the acquisition, there were discussions by 
Distributing or Controlled with the acquirer regarding a distribution. 
The weight to be accorded this fact depends on the nature, extent, and 
timing of the discussions. In addition, in the case of an acquisition 
(other than involving a public offering) before a distribution, the 
acquirer intends to cause a distribution and, immediately after the 
acquisition, can meaningfully participate in the decision regarding 
whether to make a distribution.
    (iv) In the case of an acquisition involving a public offering 
before a distribution, at some time during the two-year period ending on 
the date of the acquisition, there were discussions by Distributing or 
Controlled with an investment banker regarding a distribution. The 
weight to be accorded this fact depends on the nature, extent, and 
timing of the discussions.
    (v) In the case of an acquisition either before or after a 
distribution, the distribution was motivated by a business purpose to 
facilitate the acquisition or a similar acquisition.
    (4) Non-plan factors. Among the facts and circumstances tending to 
show that a distribution and an acquisition are not part of a plan are 
the following:
    (i) In the case of an acquisition involving a public offering after 
a distribution, during the two-year period ending on the date of the 
distribution, there were no discussions by Distributing or Controlled 
with an investment banker regarding the acquisition or a similar 
acquisition.
    (ii) In the case of an acquisition after a distribution, there was 
an identifiable, unexpected change in market or business conditions 
occurring after the distribution that resulted in the acquisition that 
was otherwise unexpected at the time of the distribution.
    (iii) In the case of an acquisition (other than involving a public 
offering) before a distribution, during the two-year period ending on 
the date of the earlier to occur of the acquisition or the first public 
announcement regarding the distribution, there were no discussions by 
Distributing or Controlled with the acquirer regarding a distribution. 
Paragraph (b)(4)(iii) of this section does not apply to an acquisition 
where the acquirer intends to cause a distribution and, immediately 
after the acquisition, can meaningfully participate in the decision 
regarding whether to make a distribution.
    (iv) In the case of an acquisition before a distribution, there was 
an identifiable, unexpected change in market or business conditions 
occurring after the acquisition that resulted in a distribution that was 
otherwise unexpected.
    (v) In the case of an acquisition either before or after a 
distribution, the distribution was motivated in whole or substantial 
part by a corporate business purpose (within the meaning of Sec. 1.355-
2(b)) other than a business purpose to facilitate the acquisition or a 
similar acquisition.
    (vi) In the case of an acquisition either before or after a 
distribution, the distribution would have occurred at approximately the 
same time and in similar form regardless of the acquisition or a similar 
acquisition.
    (c) Operating rules. The operating rules contained in this paragraph 
(c) apply for all purposes of this section.
    (1) Internal discussions and discussions with outside advisors 
evidence of business purpose. Discussions by Distributing or Controlled 
with outside advisors and internal discussions may be indicative of one 
or more business purposes for the distribution and the relative 
importance of such purposes.
    (2) Takeover defense. If Distributing engages in discussions with a 
potential acquirer regarding an acquisition of Distributing or 
Controlled and distributes Controlled stock intending, in

[[Page 254]]

whole or substantial part, to decrease the likelihood of the acquisition 
of Distributing or Controlled by separating it from another corporation 
that is likely to be acquired, Distributing will be treated as having a 
business purpose to facilitate the acquisition of the corporation that 
was likely to be acquired.
    (3) Effect of distribution on trading in stock. The fact that the 
distribution made all or a part of the stock of Controlled available for 
trading or made Distributing's or Controlled's stock trade more actively 
is not taken into account in determining whether the distribution and an 
acquisition of Distributing or Controlled stock were part of a plan.
    (4) Consequences of section 355(e) disregarded for certain purposes. 
For purposes of determining the intentions of the relevant parties under 
this section, the consequences of the application of section 355(e), and 
the existence of any contractual indemnity by Controlled for tax 
resulting from the application of section 355(e) caused by an 
acquisition of Controlled, are disregarded.
    (5) Multiple acquisitions. All acquisitions of stock of Distributing 
or Controlled that are considered to be part of a plan with a 
distribution pursuant to paragraph (b) of this section will be 
aggregated for purposes of the 50-percent test of paragraph (a)(2) of 
this section.
    (d) Safe harbors--(1) Safe Harbor I. A distribution and an 
acquisition occurring after the distribution will not be considered part 
of a plan if--
    (i) The distribution was motivated in whole or substantial part by a 
corporate business purpose (within the meaning of Sec. 1.355-2(b)), 
other than a business purpose to facilitate an acquisition of the 
acquired corporation (Distributing or Controlled); and
    (ii) The acquisition occurred more than six months after the 
distribution and there was no agreement, understanding, arrangement, or 
substantial negotiations concerning the acquisition or a similar 
acquisition during the period that begins one year before the 
distribution and ends six months thereafter.
    (2) Safe Harbor II--(i) In general. A distribution and an 
acquisition occurring after the distribution will not be considered part 
of a plan if--
    (A) The distribution was not motivated by a business purpose to 
facilitate the acquisition or a similar acquisition;
    (B) The acquisition occurred more than six months after the 
distribution and there was no agreement, understanding, arrangement, or 
substantial negotiations concerning the acquisition or a similar 
acquisition during the period that begins one year before the 
distribution and ends six months thereafter; and
    (C) No more than 25 percent of the stock of the acquired corporation 
(Distributing or Controlled) was either acquired or the subject of an 
agreement, understanding, arrangement, or substantial negotiations 
during the period that begins one year before the distribution and ends 
six months thereafter.
    (ii) Special rule. For purposes of paragraph (d)(2)(i)(C) of this 
section, acquisitions of stock that are treated as not part of a plan 
pursuant to Safe Harbor VII, Safe Harbor VIII, or Safe Harbor IX are 
disregarded.
    (3) Safe Harbor III. If an acquisition occurs after a distribution, 
there was no agreement, understanding, or arrangement concerning the 
acquisition or a similar acquisition at the time of the distribution, 
and there was no agreement, understanding, arrangement, or substantial 
negotiations concerning the acquisition or a similar acquisition within 
one year after the distribution, the acquisition and the distribution 
will not be considered part of a plan.
    (4) Safe Harbor IV--(i) In general. A distribution and an 
acquisition (other than involving a public offering) occurring before 
the distribution will not be considered part of a plan if the 
acquisition occurs before the date of the first disclosure event 
regarding the distribution.
    (ii) Special rules. (A) Paragraph (d)(4)(i) of this section does not 
apply to a stock acquisition if the acquirer or a coordinating group of 
which the acquirer is a member is a controlling shareholder or a ten-
percent shareholder of the acquired corporation (Distributing or 
Controlled) at any time

[[Page 255]]

during the period beginning immediately after the acquisition and ending 
on the date of the distribution.
    (B) Paragraph (d)(4)(i) of this section does not apply to an 
acquisition that occurs in connection with a transaction in which the 
aggregate acquisitions are of stock possessing 20 percent or more of the 
total voting power of the stock of the acquired corporation 
(Distributing or Controlled) or stock having a value of 20 percent or 
more of the total value of the stock of the acquired corporation 
(Distributing or Controlled).
    (5) Safe Harbor V--(i) In general. A distribution that is pro rata 
among the Distributing shareholders and an acquisition (other than 
involving a public offering) of Distributing stock occurring before the 
distribution will not be considered part of a plan if--
    (A) The acquisition occurs after the date of a public announcement 
regarding the distribution; and
    (B) There were no discussions by Distributing or Controlled with the 
acquirer regarding a distribution on or before the date of the first 
public announcement regarding the distribution.
    (ii) Special rules. (A) Paragraph (d)(5)(i) of this section does not 
apply to a stock acquisition if the acquirer or a coordinating group of 
which the acquirer is a member is a controlling shareholder or a ten-
percent shareholder of Distributing at any time during the period 
beginning immediately after the acquisition and ending on the date of 
the distribution.
    (B) Paragraph (d)(5)(i) of this section does not apply to an 
acquisition that occurs in connection with a transaction in which the 
aggregate acquisitions are of stock possessing 20 percent or more of the 
total voting power of the stock of Distributing or stock having a value 
of 20 percent or more of the total value of the stock of Distributing.
    (6) Safe Harbor VI. A distribution and an acquisition involving a 
public offering occurring before the distribution will not be considered 
part of a plan if the acquisition occurs before the date of the first 
disclosure event regarding the distribution in the case of an 
acquisition of stock that is not listed on an established market 
immediately after the acquisition, or before the date of the first 
public announcement regarding the distribution in the case of an 
acquisition of stock that is listed on an established market immediately 
after the acquisition.
    (7) Safe Harbor VII--(i) In general. An acquisition (other than 
involving a public offering) of Distributing or Controlled stock that is 
listed on an established market is not part of a plan if, immediately 
before or immediately after the transfer, none of the transferor, the 
transferee, and any coordinating group of which either the transferor or 
the transferee is a member is--
    (A) The acquired corporation (Distributing or Controlled);
    (B) A corporation that the acquired corporation (Distributing or 
Controlled) controls within the meaning of section 368(c);
    (C) A member of a controlled group of corporations within the 
meaning of section 1563 of which the acquired corporation (Distributing 
or Controlled) is a member;
    (D) A controlling shareholder of the acquired corporation 
(Distributing or Controlled); or
    (E) A ten-percent shareholder of the acquired corporation 
(Distributing or Controlled).
    (ii) Special rules. (A) Paragraph (d)(7)(i) of this section does not 
apply to a transfer of stock by or to a person if the corporation the 
stock of which is being transferred knows, or has reason to know, that 
the person or a coordinating group of which such person is a member 
intends to become a controlling shareholder or a ten-percent shareholder 
of the acquired corporation (Distributing or Controlled) at any time 
after the acquisition and before the date that is two years after the 
distribution.
    (B) If a transfer of stock to which paragraph (d)(7)(i) of this 
section applies results immediately, or upon a subsequent event or the 
passage of time, in an indirect acquisition of voting power by a person 
other than the transferee, paragraph (d)(7)(i) of this section does not 
prevent an acquisition of stock (with the voting power such stock 
represents after the transfer to which paragraph (d)(7)(i) of this 
section

[[Page 256]]

applies) by such other person from being treated as part of a plan.
    (8) Safe Harbor VIII--(i) In general. If, in a transaction to which 
section 83 or section 421(a) or (b) applies, stock of Distributing or 
Controlled is acquired by a person in connection with such person's 
performance of services as an employee, director, or independent 
contractor for Distributing, Controlled, a related person, a corporation 
the assets of which Distributing, Controlled, or a related person 
acquires in a reorganization under section 368(a), or a corporation that 
acquires the assets of Distributing or Controlled in such a 
reorganization (and the stock acquired is not excessive by reference to 
the services performed), the acquisition and the distribution will not 
be considered part of a plan. For purposes of this paragraph (d)(8)(i), 
a related person is a person related to Distributing or Controlled under 
section 355(d)(7)(A).
    (ii) Special rule. Paragraph (d)(8)(i) of this section does not 
apply to a stock acquisition if the acquirer or a coordinating group of 
which the acquirer is a member is a controlling shareholder or a ten-
percent shareholder of the acquired corporation (Distributing or 
Controlled) immediately after the acquisition.
    (9) Safe Harbor IX--(i) In general. If stock of Distributing or 
Controlled is acquired by a retirement plan of Distributing or 
Controlled (or a retirement plan of any other person that is treated as 
the same employer as Distributing or Controlled under section 414(b), 
(c), (m), or (o)) that qualifies under section 401(a) or 403(a), the 
acquisition and the distribution will not be considered part of a plan.
    (ii) Special rule. Paragraph (d)(9)(i) of this section does not 
apply to the extent that the stock acquired pursuant to acquisitions by 
all of the qualified plans of the persons described in paragraph 
(d)(9)(i) of this section during the four-year period beginning two 
years before the distribution, in the aggregate, represents more than 
ten percent of the total combined voting power of all classes of stock 
entitled to vote, or more than ten percent of the total value of shares 
of all classes of stock, of the acquired corporation (Distributing or 
Controlled).
    (e) Options, warrants, convertible obligations, and other similar 
interests--(1) Treatment of options--(i) General rule. For purposes of 
this section, if stock of Distributing or Controlled is acquired 
pursuant to an option that is written by Distributing, Controlled, or a 
person that is a controlling shareholder of Distributing or Controlled 
at the time the option is written, or that is acquired by a person that 
is a controlling shareholder of Distributing or Controlled immediately 
after the option is written, the option will be treated as an agreement, 
understanding, or arrangement to acquire the stock on the earliest of 
the following dates: the date that the option is written, if the option 
was more likely than not to be exercised as of such date; the date that 
the option is transferred if, immediately before or immediately after 
the transfer, the transferor or transferee was Distributing, Controlled, 
a corporation that Distributing or Controlled controls within the 
meaning of section 368(c), a member of a controlled group of 
corporations within the meaning of section 1563 of which Distributing or 
Controlled is a member, or a controlling shareholder or a ten-percent 
shareholder of Distributing or Controlled and the option was more likely 
than not to be exercised as of such date; and the date that the option 
is modified in a manner that materially increases the likelihood of 
exercise, if the option was more likely than not to be exercised as of 
such date; provided, however, if the writing, transfer, or modification 
had a principal purpose of avoiding section 355(e), the option will be 
treated as an agreement, understanding, arrangement, or substantial 
negotiations to acquire the stock on the date of the distribution. The 
determination of whether an option was more likely than not to be 
exercised is based on all the facts and circumstances, taking control 
premiums and minority and blockage discounts into account in determining 
the fair market value of stock underlying an option.
    (ii) Agreement, understanding, or arrangement to write, transfer, or 
modify an option. If there is an agreement, understanding, or 
arrangement to write an option, the option will be treated as written on 
the date of the agreement,

[[Page 257]]

understanding, or arrangement. If there is an agreement, understanding, 
or arrangement to transfer an option, the option will be treated as 
transferred on the date of the agreement, understanding, or arrangement. 
If there is an agreement, understanding, or arrangement to modify an 
option in a manner that materially increases the likelihood of exercise, 
the option will be treated as so modified on the date of the agreement, 
understanding, or arrangement.
    (iii) Substantial negotiations related to options. If an option is 
treated as an agreement, understanding, or arrangement to acquire the 
stock on the date that the option is written, substantial negotiations 
to acquire the option will be treated as substantial negotiations to 
acquire the stock subject to such option. If an option is treated as an 
agreement, understanding, or arrangement to acquire the stock on the 
date that the option is transferred, substantial negotiations regarding 
the transfer of the option will be treated as substantial negotiations 
to acquire the stock subject to such option. If an option is treated as 
an agreement, understanding, or arrangement to acquire the stock on the 
date that the option is modified in a manner that materially increases 
the likelihood of exercise, substantial negotiations regarding such 
modifications to the option will be treated as substantial negotiations 
to acquire the stock subject to such option.
    (2) Stock acquired pursuant to options. For purposes of this 
section, if an option is issued for cash, the terms of the acquisition 
of the option and the terms of the option are established by the 
corporation the stock of which is subject to the option (Distributing or 
Controlled) or the writer with the involvement of one or more investment 
bankers, and the potential acquirers of the option have no opportunity 
to negotiate the terms of the acquisition of the option or the terms of 
the option, then an acquisition pursuant to such option shall be treated 
as an acquisition involving a public offering occurring after the 
distribution if the option is exercised after the distribution or an 
acquisition involving a public offering before a distribution if the 
option is exercised before the distribution. Otherwise, an acquisition 
pursuant to an option shall be treated as an acquisition not involving a 
public offering.
    (3) Instruments treated as options. For purposes of this section, 
except to the extent provided in paragraph (e)(4) of this section, call 
options, warrants, convertible obligations, the conversion feature of 
convertible stock, put options, redemption agreements (including rights 
to cause the redemption of stock), any other instruments that provide 
for the right or possibility to issue, redeem, or transfer stock 
(including an option on an option), or any other similar interests are 
treated as options.
    (4) Instruments generally not treated as options. For purposes of 
this section, the following are not treated as options unless (in the 
case of paragraphs (e)(4)(i), (ii), and (iii) of this section) written, 
transferred (directly or indirectly), modified, or listed with a 
principal purpose of avoiding the application of section 355(e) or this 
section.
    (i) Escrow, pledge, or other security agreements. An option that is 
part of a security arrangement in a typical lending transaction 
(including a purchase money loan), if the arrangement is subject to 
customary commercial conditions. For this purpose, a security 
arrangement includes, for example, an agreement for holding stock in 
escrow or under a pledge or other security agreement, or an option to 
acquire stock contingent upon a default under a loan.
    (ii) Options exercisable only upon death, disability, mental 
incompetency, or separation from service. Any option entered into 
between shareholders of a corporation (or a shareholder and the 
corporation) that is exercisable only upon the death, disability, or 
mental incompetency of the shareholder, or, in the case of stock 
acquired in connection with the performance of services for the 
corporation or a person related to it under section 355(d)(7)(A) (and 
that is not excessive by reference to the services performed), the 
shareholder's separation from service.
    (iii) Rights of first refusal. A bona fide right of first refusal 
regarding the corporation's stock with customary

[[Page 258]]

terms, entered into between shareholders of a corporation (or between 
the corporation and a shareholder).
    (iv) Other enumerated instruments. Any other instrument the 
Commissioner may designate in revenue procedures, notices, or other 
guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2) of this chapter).
    (f) Multiple controlled corporations. Only the stock or securities 
of a controlled corporation in which one or more persons acquire 
directly or indirectly stock representing a 50-percent or greater 
interest as part of a plan involving the distribution of that 
corporation will be treated as not qualified property under section 
355(e)(1) if--
    (1) The stock or securities of more than one controlled corporation 
are distributed in distributions to which section 355 (or so much of 
section 356 as relates to section 355) applies; and
    (2) One or more persons do not acquire, directly or indirectly, 
stock representing a 50-percent or greater interest in Distributing 
pursuant to a plan involving any of those distributions.
    (g) Valuation. Except as provided in paragraph (e)(1)(i) of this 
section, for purposes of section 355(e) and this section, all shares of 
stock within a single class are considered to have the same value. Thus, 
control premiums and minority and blockage discounts within a single 
class are not taken into account.
    (h) Definitions. For purposes of this section, the following 
definitions shall apply:
    (1) Agreement, understanding, arrangement, or substantial 
negotiations. (i) An agreement, understanding, or arrangement generally 
requires either--
    (A) An agreement, understanding, or arrangement by one or more 
officers or directors acting on behalf of Distributing or Controlled, by 
controlling shareholders of Distributing or Controlled, or by another 
person or persons with the implicit or explicit permission of one or 
more of such officers, directors, or controlling shareholders, with the 
acquirer or with a person or persons with the implicit or explicit 
permission of the acquirer; or
    (B) An agreement, understanding, or arrangement by an acquirer that 
is a controlling shareholder of Distributing or Controlled immediately 
after the acquisition that is the subject of the agreement, 
understanding, or arrangement, or by a person or persons with the 
implicit or explicit permission of such acquirer, with the transferor or 
with a person or persons with the implicit or explicit permission of the 
transferor.
    (ii) In the case of an acquisition by a corporation, an agreement, 
understanding, or arrangement with the acquiring corporation generally 
requires an agreement, understanding, or arrangement with one or more 
officers or directors acting on behalf of the acquiring corporation, 
with controlling shareholders of the acquiring corporation, or with 
another person or persons with the implicit or explicit permission of 
one or more of such officers, directors, or controlling shareholders.
    (iii) Whether an agreement, understanding, or arrangement exists 
depends on the facts and circumstances. The parties do not necessarily 
have to have entered into a binding contract or have reached agreement 
on all significant economic terms to have an agreement, understanding, 
or arrangement. However, an agreement, understanding, or arrangement 
clearly exists if a binding contract to acquire stock exists.
    (iv) Substantial negotiations in the case of an acquisition (other 
than involving a public offering) generally require discussions of 
significant economic terms, e.g., the exchange ratio in a 
reorganization, either--
    (A) By one or more officers or directors acting on behalf of 
Distributing or Controlled, by controlling shareholders of Distributing 
or Controlled, or by another person or persons with the implicit or 
explicit permission of one or more of such officers, directors, or 
controlling shareholders, with the acquirer or with a person or persons 
with the implicit or explicit permission of the acquirer; or
    (B) If the acquirer is a controlling shareholder of Distributing or 
Controlled immediately after the acquisition that is the subject of 
substantial negotiations, by the acquirer or by a person or persons with 
the implicit or explicit permission of the acquirer, with the transferor 
or with a person or persons with the implicit or explicit permission of 
the transferor.

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    (v) In the case of an acquisition (other than involving a public 
offering) by a corporation, substantial negotiations generally require 
discussions of significant economic terms with one or more officers or 
directors acting on behalf of the acquiring corporation, with 
controlling shareholders of the acquiring corporation, or with another 
person or persons with the implicit or explicit permission of one or 
more of such officers, directors, or controlling shareholders.
    (vi) In the case of an acquisition involving a public offering, the 
existence of an agreement, understanding, arrangement, or substantial 
negotiations will be based on discussions by one or more officers or 
directors acting on behalf of Distributing or Controlled, by controlling 
shareholders of Distributing or Controlled, or by another person or 
persons with the implicit or explicit permission of one or more of such 
officers, directors, or controlling shareholders, with an investment 
banker.
    (2) Controlled corporation. A controlled corporation is a 
corporation the stock of which is distributed in a distribution to which 
section 355 (or so much of section 356 as relates to section 355) 
applies.
    (3) Controlling shareholder. (i) A controlling shareholder of a 
corporation the stock of which is listed on an established market is a 
five-percent shareholder who actively participates in the management or 
operation of the corporation. For purposes of this paragraph (h)(3)(i), 
a corporate director will be treated as actively participating in the 
management of the corporation.
    (ii) A controlling shareholder of a corporation the stock of which 
is not listed on an established market is any person that owns stock 
possessing voting power representing a meaningful voice in the 
governance of the corporation. For purposes of determining whether a 
person owns stock possessing voting power representing a meaningful 
voice in the governance of the corporation, the person shall be treated 
as owning the stock that such person owns actually and constructively 
under the rules of section 318 (without regard to section 318(a)(4)). In 
addition, if the exercise of an option (whether by itself or in 
conjunction with the deemed exercise of one or more other options) would 
cause the holder to own stock possessing voting power representing a 
meaningful voice in the governance of the corporation, then the option 
will be treated as exercised.
    (iii) If a distribution precedes an acquisition, Controlled's 
controlling shareholders immediately after the distribution and 
Distributing are included among Controlled's controlling shareholders at 
the time of the distribution.
    (4) Coordinating group. A coordinating group includes two or more 
persons that, pursuant to a formal or informal understanding, join in 
one or more coordinated acquisitions or dispositions of stock of 
Distributing or Controlled. A principal element in determining if such 
an understanding exists is whether the investment decision of each 
person is based on the investment decision of one or more other existing 
or prospective shareholders. A coordinating group is treated as a single 
shareholder for purposes of determining whether the coordinating group 
is treated as a controlling shareholder, a five-percent shareholder, or 
a ten-percent shareholder.
    (5) Disclosure event. A disclosure event regarding the distribution 
means any communication by an officer, director, controlling 
shareholder, or employee of Distributing, Controlled, or a corporation 
related to Distributing or Controlled, or an outside advisor of any of 
those persons (where such advisor makes the communication on behalf of 
such person), regarding the distribution, or the possibility thereof, to 
the acquirer or any other person (other than an officer, director, 
controlling shareholder, or employee of Distributing, Controlled, or a 
corporation related to Distributing or Controlled, or an outside advisor 
of any of those persons). For purposes of this paragraph (h)(5), a 
corporation is related to Distributing or Controlled if it is a member 
of an affiliated group (as defined in section 1504(a) without regard to 
section 1504(b)) that includes either Distributing or Controlled or it 
is a member of a qualified group (as defined in Sec. 1.368-1(d)(4)(ii)) 
that includes either Distributing or Controlled.

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    (6) Discussions. Discussions by Distributing or Controlled generally 
require discussions by one or more officers or directors acting on 
behalf of Distributing or Controlled, by controlling shareholders of 
Distributing or Controlled, or by another person or persons with the 
implicit or explicit permission of one or more of such officers, 
directors, or controlling shareholders. Discussions with the acquirer 
generally require discussions with the acquirer or with a person or 
persons with the implicit or explicit permission of the acquirer. In the 
case of an acquisition by a corporation, discussions with the acquiring 
corporation generally require discussions with one or more officers or 
directors acting on behalf of the acquiring corporation, with 
controlling shareholders of the acquiring corporation, or with another 
person or persons with the implicit or explicit permission of one or 
more of such officers, directors, or controlling shareholders.
    (7) Established market. An established market is--
    (i) A national securities exchange registered under section 6 of the 
Securities Exchange Act of 1934 (15 U.S.C. 78f);
    (ii) An interdealer quotation system sponsored by a national 
securities association registered under section 15A of the Securities 
Act of 1934 (15 U.S.C. 78o-3); or
    (iii) Any additional market that the Commissioner may designate in 
revenue procedures, notices, or other guidance published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter).
    (8) Five-percent shareholder. A person will be considered a five-
percent shareholder of a corporation the stock of which is listed on an 
established market if the person owns five percent or more of any class 
of stock of the corporation whose stock is transferred. For purposes of 
determining whether a person owns five percent or more of any class of 
stock of the corporation whose stock is transferred, the person shall be 
treated as owning the stock that such person owns actually and 
constructively under the rules of section 318 (without regard to section 
318(a)(4)). In addition, if the exercise of an option (whether by itself 
or in conjunction with the deemed exercise of one or more other options) 
would cause the holder to become a five-percent shareholder, then the 
option will be treated as exercised. Absent actual knowledge that a 
person is a five-percent shareholder, a corporation can rely on 
Schedules 13D and 13G (or any similar schedules) filed with the 
Securities and Exchange Commission to identify its five-percent 
shareholders.
    (9) Implicit permission. A corporation is treated as having the 
implicit permission of its shareholders when it engages in discussions 
or negotiations, or enters into an agreement, understanding, or 
arrangement.
    (10) Public announcement. A public announcement regarding the 
distribution means any communication by Distributing or Controlled 
regarding Distributing's intention to effect the distribution where the 
communication is generally available to the public.
    (11) Public offering. An acquisition involving a public offering 
means an acquisition of stock for cash where the terms of the 
acquisition are established by the acquired corporation (Distributing or 
Controlled) or the seller with the involvement of one or more investment 
bankers and the potential acquirers have no opportunity to negotiate the 
terms of the acquisition. For example, a public offering includes an 
underwritten offering of registered stock for cash.
    (12) Similar acquisition (not involving a public offering). In 
general, an actual acquisition (other than involving a public offering) 
is similar to another potential acquisition if the actual acquisition 
effects a direct or indirect combination of all or a significant portion 
of the same business operations as the combination that would have been 
effected by such other potential acquisition. Thus, an actual 
acquisition may be similar to another acquisition even if the timing or 
terms of the actual acquisition are different from the timing or terms 
of the other acquisition. For example, an actual acquisition of 
Distributing by shareholders of another corporation in connection with a 
merger of such other corporation with and into Distributing is similar 
to another acquisition of Distributing by merger

[[Page 261]]

into such other corporation or into a subsidiary of such other 
corporation. However, in general, an actual acquisition (other than 
involving a public offering) is not similar to another acquisition if 
the ultimate owners of the business operations with which Distributing 
or Controlled is combined in the actual acquisition are substantially 
different from the ultimate owners of the business operations with which 
Distributing or Controlled was to be combined in such other acquisition.
    (13) Similar acquisition involving a public offering--(i) One public 
offering. In general, an actual acquisition involving a public offering 
may be similar to a potential acquisition involving a public offering, 
even though there are changes in the terms of the stock, the class of 
stock being offered, the size of the offering, the timing of the 
offering, the price of the stock, or the participants in the offering.
    (ii) More than one public offering. More than one actual acquisition 
involving a public offering may be similar to a potential acquisition 
involving a public offering. If there is an actual acquisition involving 
a public offering (the first public offering) that is the same as, or 
similar to, a potential acquisition involving a public offering, then 
another actual acquisition involving a public offering (the second 
public offering) cannot be similar to the potential acquisition unless 
the purpose of the second public offering is similar to that of the 
potential acquisition and occurs close in time to the first public 
offering.
    (iii) Potential acquisition involving a public offering. For 
purposes of paragraph (h)(13)(i) and (ii) of this section, as the 
context may require, a potential acquisition involving a public offering 
means a potential acquisition involving a public offering that was 
discussed by Distributing or Controlled with an investment banker, that 
motivated the distribution, or that was the subject of an agreement, 
understanding, arrangement, or substantial negotiations.
    (14) Ten-percent shareholder. A person will be considered a ten-
percent shareholder of a corporation the stock of which is listed on an 
established market if the person owns, actually or constructively under 
the rules of section 318 (without regard to section 318(a)(4)), ten 
percent or more of any class of stock of the corporation whose stock is 
transferred. A person will be considered a ten-percent shareholder of a 
corporation the stock of which is not listed on an established market if 
the person owns stock possessing ten percent or more of the total voting 
power of the stock of the corporation whose stock is transferred or 
stock having a value equal to ten percent or more of the total value of 
the stock of the corporation whose stock is transferred. For purposes of 
determining whether a person owns ten percent or more of the total 
voting power or value of the stock of the corporation whose stock is 
transferred, the person shall be treated as owning the stock that such 
person owns actually and constructively under the rules of section 318 
(without regard to section 318(a)(4)). In addition, if the exercise of 
an option (whether by itself or in conjunction with the deemed exercise 
of one or more other options) would cause the holder to become a ten-
percent shareholder, then the option will be treated as exercised. 
Absent actual knowledge that a person is a ten-percent shareholder, a 
corporation the stock of which is listed on an established market can 
rely on Schedules 13D and 13G (or any similar schedules) filed with the 
Securities and Exchange Commission to identify its ten-percent 
shareholders.
    (i) [Reserved]
    (j) Examples. The following examples illustrate paragraphs (a) 
through (h) of this section. Throughout these examples, assume that 
Distributing (D) owns all of the stock of Controlled (C). Assume further 
that D distributes the stock of C in a distribution to which section 355 
applies and to which section 355(d) does not apply. Unless otherwise 
stated, assume the corporations do not have controlling shareholders. No 
inference should be drawn from any example concerning whether any 
requirements of section 355 other than those of section 355(e) are 
satisfied. The examples are as follows:

    Example 1. Unwanted assets. (i) D is in business 1. C is in business 
2. D is relatively small in its industry. D wants to combine with X, a 
larger corporation also engaged in business 1. X and D begin negotiating 
for X

[[Page 262]]

to acquire D, but X does not want to acquire C. To facilitate the 
acquisition of D by X, D agrees to distribute all the stock of C pro 
rata before the acquisition. Prior to the distribution, D and X enter 
into a contract for D to merge into X subject to several conditions. One 
month after D and X enter into the contract, D distributes C and, on the 
day after the distribution, D merges into X. As a result of the merger, 
D's former shareholders own less than 50 percent of the stock of X.
    (ii) The issue is whether the distribution of C and the merger of D 
into X are part of a plan. No Safe Harbor applies to this acquisition. 
To determine whether the distribution of C and the merger of D into X 
are part of a plan, D must consider all the facts and circumstances, 
including those described in paragraph (b) of this section.
    (iii) The following tends to show that the distribution of C and the 
merger of D into X are part of a plan: X and D had an agreement 
regarding the acquisition during the two-year period ending on the date 
of the distribution (paragraph (b)(3)(i) of this section), and the 
distribution was motivated by a business purpose to facilitate the 
merger (paragraph (b)(3)(v) of this section). Because the merger was 
agreed to at the time of the distribution, the fact described in 
paragraph (b)(3)(i) of this section is given substantial weight.
    (iv) None of the facts and circumstances listed in paragraph (b)(4) 
of this section, tending to show that a distribution and an acquisition 
are not part of a plan, exist in this case.
    (v) The distribution of C and the merger of D into X are part of a 
plan under paragraph (b) of this section.
    Example 2. Public offering. (i) D's managers, directors, and 
investment banker discuss the possibility of offering D stock to the 
public. They decide a public offering of 20 percent of D's stock with D 
as a stand-alone corporation would be in D's best interest. One month 
later, to facilitate a stock offering by D of 20 percent of its stock, D 
distributes all the stock of C pro rata to D's shareholders. D issues 
new shares amounting to 20 percent of its stock to the public in a 
public offering seven months after the distribution.
    (ii) The issue is whether the distribution of C and the public 
offering by D are part of a plan. No Safe Harbor applies to this 
acquisition. Safe Harbor VII, relating to public trading, does not apply 
to public offerings (see paragraph (d)(7)(i) of this section). To 
determine whether the distribution of C and the public offering by D are 
part of a plan, D must consider all the facts and circumstances, 
including those described in paragraph (b) of this section.
    (iii) The following tends to show that the distribution of C and the 
public offering by D are part of a plan: D discussed the public offering 
with its investment banker during the two-year period ending on the date 
of the distribution (paragraph (b)(3)(ii) of this section), and the 
distribution was motivated by a business purpose to facilitate the 
public offering (paragraph (b)(3)(v) of this section).
    (iv) None of the facts and circumstances listed in paragraph (b)(4) 
of this section, tending to show that a distribution and an acquisition 
are not part of a plan, exist in this case.
    (v) The distribution of C and the public offering by D are part of a 
plan under paragraph (b) of this section.
    Example 3. Hot market. (i) D is a widely-held corporation the stock 
of which is listed on an established market. D announces a distribution 
of C and distributes C pro rata to D's shareholders. By contract, C 
agrees to indemnify D for any imposition of tax under section 355(e) 
caused by the acts of C. The distribution is motivated by a desire to 
improve D's access to financing at preferred customer interest rates, 
which will be more readily available if D separates from C. At the time 
of the distribution, although neither D nor C has been approached by any 
potential acquirer of C, it is reasonably certain that soon after the 
distribution either an acquisition of C will occur or there will be an 
agreement, understanding, arrangement, or substantial negotiations 
regarding an acquisition of C. Corporation Y acquires C in a merger 
described in section 368(a)(1)(A) by reason of section 368(a)(2)(E) 
within six months after the distribution. The C shareholders receive 
less than 50 percent of the stock of Y in the exchange.
    (ii) The issue is whether the distribution of C and the acquisition 
of C by Y are part of a plan. No Safe Harbor applies to this 
acquisition. Under paragraph (b)(2) of this section, because prior to 
the distribution neither D nor C and Y had an agreement, understanding, 
arrangement, or substantial negotiations regarding the acquisition or a 
similar acquisition, the distribution of C by D and the acquisition of C 
by Y are not part of a plan under paragraph (b) of this section.
    Example 4. Unexpected opportunity. (i) D, the stock of which is 
listed on an established market, makes a public announcement that it 
will distribute all the stock of C pro rata to D's shareholders. After 
the public announcement but before the distribution, widely-held X 
becomes available as an acquisition target. There were no discussions by 
D or C with X before the date of the public announcement. D negotiates 
with X and X merges into D before the distribution. In the merger, X's 
shareholders receive ten percent of D's stock. D distributes the stock 
of C pro rata within six months after the acquisition of X. No 
shareholder of X was a controlling shareholder or a ten-percent 
shareholder of D at any time during the period beginning immediately 
after the merger and ending on the date of the distribution

[[Page 263]]

    (ii) The issue is whether the acquisition of X by D and the 
distribution of C are part of a plan. Safe Harbor V applies to this 
acquisition because the distribution is pro rata among D's shareholders, 
the acquisition occurs after the date of a public announcement regarding 
the distribution, there were no discussions by D or C with X on or 
before the date of the public announcement, no acquirer was a 
controlling shareholder or a ten-percent shareholder of D during the 
period beginning immediately after the merger and ending on the date of 
the distribution, and not more than 20 percent of D's stock was acquired 
by the X shareholders in the merger.
    Example 5. Vote shifting transaction. (i) D is in business 1. C is 
in business 2. D wants to combine with X, which is also engaged in 
business 1. The stock of X is closely held. X and D begin negotiating 
for D to acquire X, but the X shareholders do not want to acquire an 
indirect interest in C. To facilitate the acquisition of X by D, D 
agrees to distribute all the stock of C pro rata before the acquisition 
of X. D and X enter into a contract for X to merge into D subject to 
several conditions. Among those conditions is that D will amend its 
corporate charter to provide for two classes of stock: Class A and Class 
B. Under all circumstances, each share of Class A stock will be entitled 
to ten votes in the election of each director on D's board of directors. 
Upon issuance, each share of Class B stock will be entitled to ten votes 
in the election of each director on D's board of directors; however, a 
disposition of such share by its original holder will result in such 
share being entitled to only one vote, rather than ten votes, in the 
election of each director. Immediately after the merger, the Class B 
shares will be listed on an established market. One month after D and X 
enter into the contract, D distributes C. Immediately after the 
distribution, the shareholders of D exchange their D stock for the new 
Class B shares. On the day after the distribution, X merges into D. In 
the merger, the former shareholders of X exchange their X stock for 
Class A shares of D. Immediately after the merger, D's historic 
shareholders own stock of D representing 51 percent of the total 
combined voting power of all classes of stock of D entitled to vote and 
more than 50 percent of the total value of all classes of stock of D. 
During the 30-day period following the merger, none of the Class A 
shares are transferred, but a number of D's historic shareholders sell 
their Class B stock of D in public trading with the result that, at the 
end of that 30-day period, the Class A shares owned by the former X 
shareholders represent 52 percent of the total combined voting power of 
all classes of stock of D entitled to vote.
    (ii) X acquisition. (A) The issue is whether the distribution of C 
and the merger of X into D are part of a plan. No Safe Harbor applies to 
this acquisition. To determine whether the distribution of C and the 
merger of X into D are part of a plan, D must consider all the facts and 
circumstances, including those described in paragraph (b) of this 
section.
    (B) The following tends to show that the distribution of C and the 
merger of X into D are part of a plan: X and D had an agreement 
regarding the acquisition during the two-year period ending on the date 
of the distribution (paragraph (b)(3)(i) of this section), and the 
distribution was motivated by a business purpose to facilitate the 
merger (paragraph (b)(3)(v) of this section). Because the merger was 
agreed to at the time of the distribution, the fact described in 
paragraph (b)(3)(i) of this section is given substantial weight.
    (C) None of the facts and circumstances listed in paragraph (b)(4) 
of this section, tending to show that a distribution and an acquisition 
are not part of a plan, exist in this case.
    (D) The distribution of C and the merger of X into D are part of a 
plan under paragraph (b) of this section.
    (iii) Public trading of Class B shares. (A) Assuming that each of 
the transferors and the transferees of the Class B stock of D in public 
trading is not one of the prohibited transferors or transferees listed 
in paragraph (d)(7)(i), Safe Harbor VII will apply to the acquisitions 
of the Class B stock during the 30-day period following the merger such 
that the distribution and those acquisitions will not be treated as part 
of a plan. However, to the extent that those acquisitions result in an 
indirect acquisition of voting power by a person other than the acquirer 
of the transferred stock, Safe Harbor VII does not prevent the 
acquisition of the D stock (with the voting power such stock represents 
after those acquisitions) by the former X shareholders from being 
treated as part of a plan.
    (B) To the extent that the transfer of the Class B shares causes the 
voting power of D to shift to the Class A stock acquired by the former X 
shareholders, such shifted voting power will be treated as attributable 
to the stock acquired by the former X shareholders as part of a plan 
that includes the distribution and the X acquisition.
    Example 6. Acquisition not involving a public offering that is not 
similar. (i) D, X, and Y are each corporations the stock of which is 
publicly traded and widely held. Each of D, X, and Y is engaged in the 
manufacture and sale of trucks. C is engaged in the manufacture and sale 
of buses. D and X engage in substantial negotiations concerning X's 
acquisition of the stock of D from the D shareholders in exchange for 
stock of X. D and X do not reach an agreement regarding that 
acquisition. Three months after D and X

[[Page 264]]

first began negotiations regarding that acquisition, D distributes the 
stock of C pro rata to its shareholders. Three months after the 
distribution, Y acquires the stock of D from the D shareholders in 
exchange for stock of Y. The ultimate owners of Y are substantially 
different from the ultimate owners of X.
    (ii) Although both X and Y engage in the manufacture and sale of 
trucks, X's truck business and Y's truck business are not the same 
business operations. Therefore, because Y's acquisition of D does not 
effect a combination of the same business operations as X's acquisition 
of D would have effected, and because the ultimate owners of Y are 
substantially different from the ultimate owners of X, Y's acquisition 
of D is not similar to X's potential acquisition of D that was the 
subject of earlier negotiations.
    Example 7. Acquisition not involving a public offering that is 
similar. (i) D is engaged in the business of writing custom software for 
several industries (industries 1 through 6). The software business of D 
related to industries 4, 5, and 6 is significant relative to the 
software business of D related to industries 3, 4, 5, and 6. X, an 
unrelated corporation, is engaged in the business of writing software 
and the business of manufacturing and selling hardware devices. X's 
business of writing software is significant relative to its total 
businesses. X and D engage in substantial negotiations regarding X's 
acquisition of D stock from the D shareholders in exchange for stock of 
X. Because X does not want to acquire the software businesses related to 
industries 1 and 2, these negotiations relate to an acquisition of D 
stock where D owns the software businesses related only to industries 3, 
4, 5, and 6. Thereafter, D concludes that the intellectual property 
licenses central to the software business related to industries 1 and 2 
are not transferable and that a separation of the software business 
related to industry 3 from the software business related to industry 2 
is not desirable. One month after D begins negotiating with X, D 
contributes the software businesses related to industries 4, 5, and 6 to 
C, and distributes the stock of C pro rata to its shareholders. In 
addition, X sells its hardware businesses for cash. After the 
distribution, C and X negotiate for X's acquisition of the C stock from 
the C shareholders in exchange for X stock, and X acquires the stock of 
C.
    (ii) Although D and C are different corporations, C does not own the 
custom software business related to industry 3, and X sold its hardware 
business prior to the acquisition of C, because X's acquisition of C 
involves a combination of a significant portion of the same business 
operations as the combination that would have been effected by the 
acquisition of D that was the subject of negotiations between D and X, 
X's acquisition of C is the same as, or similar to, X's potential 
acquisition of D that was the subject of earlier negotiations.
    Example 8. Acquisitions involving public offerings with different 
purposes. (i) D's managers, directors, and investment banker discuss the 
possibility of offering D stock to the public for the purpose of funding 
the acquisition of the assets of X. They decide a public offering of 20 
percent of D's stock with D as a stand-alone corporation would allow D 
to raise the capital needed to effect the acquisition of X's assets. One 
month later, to facilitate a stock offering by D of 20 percent of its 
stock, D distributes all the stock of C pro rata to D's shareholders. 
Two months after the distribution, D issues new shares amounting to 20 
percent of its stock to the public in a public offering (the first 
public offering). Four months after the distribution, D acquires the 
assets of X. Seven months after the distribution, D's managers, 
directors, and investment banker discuss the possibility of offering D 
stock to the public solely for the purpose of funding the acquisition of 
the assets of Y, a corporation unrelated to X. One year after the 
distribution, D issues new shares amounting to 40 percent of its stock 
to the public in a public offering (the second public offering). One 
month after the second public offering, D acquires the assets of Y.
    (ii) The first public offering is the same as the potential 
acquisition that D's managers, directors, and investment banker 
discussed prior to the distribution. The purpose of the second public 
offering (funding the acquisition of the assets of Y) is not similar to 
that of the potential acquisition (funding the acquisition of the assets 
of X). Therefore, the second public offering is not similar to the 
potential acquisition.
    Example 9. Acquisitions involving public offerings that are close in 
time. (i) D's managers, directors, and investment banker discuss the 
possibility of offering D stock to the public for the purpose of raising 
funds for general corporate purposes. They decide a public offering of 
20 percent of D's stock with D as a stand-alone corporation would allow 
D to raise such funds. One month later, to facilitate a stock offering 
by D of 20 percent of its stock, D distributes all the stock of C pro 
rata to D's shareholders. Two months after the distribution, D issues 
new shares amounting to 20 percent of its stock to the public in a 
public offering (the first public offering). After the first public 
offering, D's managers, directors, and investment banker discuss the 
possibility of another offering of D stock to the public for the purpose 
of raising additional funds for general corporate purposes. Eight months 
after the distribution, D issues new shares amounting to ten percent of 
its stock to the public in a public offering (the second public 
offering).
    (ii) The first public offering is the same as the potential 
acquisition that D's managers, directors, and investment banker 
discussed

[[Page 265]]

prior to the distribution. The purpose of the second public offering 
(raising funds for general corporate purposes) is the same as that of 
the potential acquisition. In addition, the second public offering is 
close in time to the first public offering. Therefore, the second public 
offering is similar to the potential acquisition.
    Example 10. Acquisitions involving public offerings that are not 
close in time. The facts are the same as those in Example 9, except that 
the second public offering occurs fourteen months after the 
distribution. Although the purpose of the second public offering is the 
same as that of the potential acquisition, the second public offering is 
not close in time to the first public offering. Therefore, the second 
public offering is not similar to the potential acquisition.

    (k) Effective dates. This section applies to distributions occurring 
after April 19, 2005. For distributions occurring on or before April 19, 
2005, and after April 26, 2002, see Sec. 1.355-7T as contained in 26 
CFR part 1 revised as of April 1, 2003; however, taxpayers may apply 
these regulations, in whole, but not in part, to such distributions. For 
distributions occurring on or before April 26, 2002, and after August 3, 
2001, see Sec. 1.355-7T as contained in 26 CFR part 1 revised as of 
April 1, 2002; however, taxpayers may apply, in whole, but not in part, 
either these regulations or Sec. 1.355-7T as contained in 26 CFR part 1 
revised as of April 1, 2003, to such distributions. For distributions 
occurring on or before August 3, 2001, and after April 16, 1997, 
taxpayers may apply, in whole, but not in part, either these regulations 
or Sec. 1.355-7T as contained in 26 CFR part 1 revised as of April 1, 
2003, to such distributions.

[T.D. 9198, 70 FR 20283, Apr. 19, 2005]



Sec. 1.355-8  Definition of predecessor and successor and limitations 
on gain recognition under section 355(e) and section 355(f).

    (a) In general--(1) Scope. For purposes of section 355(e), this 
section provides rules under section 355(e)(4)(D) to determine whether a 
corporation is treated as a predecessor or successor of a distributing 
corporation (Distributing) or a controlled corporation (Controlled) with 
respect to a distribution by Distributing of stock (or stock and 
securities) of Controlled that qualifies under section 355(a) (or so 
much of section 356 as relates to section 355) (Distribution). This 
section also provides rules limiting the amount of Distributing's gain 
recognized under section 355(e) on a Distribution if section 355(e) 
applies to an acquisition by one or more persons, as part of a Plan, of 
stock that in the aggregate represents a 50-percent or greater interest 
(Planned 50-percent Acquisition) of a Predecessor of Distributing, or a 
Planned 50-percent Acquisition of Distributing. In addition, this 
section provides rules regarding the application of section 336(e) to a 
Distribution to which this section applies. This section also provides 
rules regarding the application of section 355(f) to a Distribution in 
certain cases.
    (2) Overview--(i) Purposes and conceptual overview. Paragraph (a)(3) 
of this section summarizes the two principal purposes of this section 
and sets forth a brief conceptual overview of the scenarios in which a 
corporation may be a Predecessor of Distributing.
    (ii) References to and definitions of terms used in this section. 
Paragraph (a)(4) of this section provides rules regarding references to 
the terms Distributing, Controlled, Distribution, Plan, and Plan Period 
for purposes of section 355(e), Sec. 1.355-7, and this section. 
Paragraph (a)(5) of this section lists the terms used in this section 
and indicates where each term is defined. Paragraph (b) of this section 
defines the term Predecessor of Distributing and several related terms. 
Paragraph (c) of this section defines the terms Predecessor of 
Controlled, Successor (of Distributing or Controlled), and Section 381 
Transaction.
    (iii) Special rules and examples. Paragraph (d) of this section 
provides guidance with regard to acquisitions and deemed acquisitions of 
stock if there is a Predecessor of Distributing or a Successor of either 
Distributing or Controlled. Paragraph (e) of this section provides two 
rules that may limit the amount of Distributing's gain on a Distribution 
if there is a Predecessor of Distributing, as well as an overall gain 
limitation. Paragraph (e) of this section also provides guidance with 
respect to the application of section 336(e). Regardless of whether 
there is a

[[Page 266]]

Predecessor of Distributing, Predecessor of Controlled, or Successor of 
either Distributing or Controlled, paragraph (f) of this section 
provides a special rule relating to section 355(e)(2)(C), which provides 
that section 355(e) does not apply to certain transactions within an 
Expanded Affiliated Group. Paragraph (g) of this section provides rules 
coordinating the application of section 355(f) with the rules of this 
section. Paragraph (h) of this section contains examples that illustrate 
the rules of this section.
    (3) Purposes of section; Predecessor of Distributing overview--(i) 
Purposes. The rules in this section have two principal purposes. The 
first is to ensure that section 355(e) applies to a Distribution if, as 
part of a Plan, some of the assets of a Predecessor of Distributing are 
transferred directly or indirectly to Controlled without full 
recognition of gain, and the Distribution accomplishes a division of the 
assets of the Predecessor of Distributing. The second is to ensure that 
section 355(e) applies when there is a Planned 50-percent Acquisition of 
a Successor of Distributing or Successor of Controlled. The rules of 
this section must be interpreted and applied in a manner that is 
consistent with and reasonably carries out the purposes of this section.
    (ii) Predecessor of Distributing overview. The term Predecessor of 
Distributing is defined in paragraph (b) of this section. Only a 
Potential Predecessor can be a Predecessor of Distributing. See 
paragraph (b)(1)(i) of this section. A Potential Predecessor can be a 
Predecessor of Distributing only if, as part of a Plan, the Distribution 
accomplishes a division of the assets of the Potential Predecessor. See 
paragraph (b)(1)(iii) of this section. Accordingly, in the absence of 
that Plan, a Predecessor of Distributing cannot exist for purposes of 
section 355(e). The detailed rules set forth in paragraph (b) of this 
section provide that a Potential Predecessor the assets of which are 
divided as part of a Plan may be a Predecessor of Distributing in either 
of the following two scenarios:
    (A) Relevant Property transferred to Controlled. As part of the 
Plan, one or more of the Potential Predecessor's assets were transferred 
to Controlled in one or more tax-deferred transactions prior to the 
Distribution.
    (B) Relevant Property includes Controlled Stock. The Potential 
Predecessor's assets included Controlled stock that, as part of the 
Plan, was transferred to Distributing in one or more tax-deferred 
transactions prior to the Distribution.
    (4) References--(i) References to Distributing or Controlled. For 
purposes of section 355(e), except as otherwise provided in this 
section, any reference to Distributing or Controlled includes, as the 
context may require, a reference to any Predecessor of Distributing or 
any Predecessor of Controlled, respectively, or any Successor of 
Distributing or Controlled, respectively. However, except as otherwise 
provided in this section, a reference to a Predecessor of Distributing 
or to a Successor of Distributing does not include a reference to 
Distributing, and a reference to a Predecessor of Controlled or to a 
Successor of Controlled does not include a reference to Controlled.
    (ii) References to Plan or Distribution. Except as otherwise 
provided in this section, references to a Plan in this section are 
references to a plan within the meaning of Sec. 1.355-7. References to 
a distribution in Sec. 1.355-7 include a reference to a Distribution 
and other related pre-Distribution transactions that together effect a 
division of the assets of a Predecessor of Distributing. In determining 
whether a Distribution and a Planned 50-percent Acquisition of a 
Predecessor of Distributing, Distributing (including any Successor 
thereof), or Controlled (including any Successor thereof) are part of a 
Plan, the rules of Sec. 1.355-7 apply. In applying those rules, 
references to Distributing or Controlled in Sec. 1.355-7 generally 
include references to any Predecessor of Distributing and any Successor 
of Distributing, or any Successor of Controlled, as appropriate. 
However, with regard to any possible Planned 50-percent Acquisition of a 
Predecessor of Distributing, any agreement, understanding, arrangement, 
or substantial negotiations with regard to the acquisition of the stock 
of the Predecessor of Distributing is analyzed under Sec. 1.355-7 with 
regard to the actions of officers or directors of Distributing or

[[Page 267]]

Controlled, controlling shareholders (as defined in Sec. 1.355-7(h)(3)) 
of Distributing or Controlled, or a person acting with permission of one 
of those parties. For purposes of the preceding sentence, references in 
Sec. 1.355-7 to Distributing do not include references to a Predecessor 
of Distributing. Therefore, the actions of officers, directors, or 
controlling shareholders of a Predecessor of Distributing, or of a 
person acting with the implicit or explicit permission of one of those 
parties, are not considered unless those parties otherwise would be 
treated as acting on behalf of Distributing or Controlled under Sec. 
1.355-7 (for example, if a Predecessor of Distributing is a controlling 
shareholder of Distributing).
    (iii) Plan Period. For purposes of this section, the term Plan 
Period means the period that ends immediately after the Distribution and 
begins on the earliest date on which any pre-Distribution step that is 
part of the Plan is agreed to or understood, arranged, or substantially 
negotiated by one or more officers or directors acting on behalf of 
Distributing or Controlled, by controlling shareholders of Distributing 
or Controlled, or by another person or persons with the implicit or 
explicit permission of one or more of such officers, directors, or 
controlling shareholders. For purposes of the preceding sentence, 
references to Distributing and Controlled do not include references to 
any Predecessor of Distributing, Predecessor of Controlled, or Successor 
of Distributing or Controlled.
    (5) List of definitions. This section uses the following terms, 
which are defined where indicated--
    (i) Acquiring Owner. Paragraph (d)(1)(i) of this section.
    (ii) Controlled. Paragraph (a)(1) of this section.
    (iii) Distributing. Paragraph (a)(1) of this section.
    (iv) Distributing Gain Limitation Rule. Paragraph (e)(1)(ii) of this 
section.
    (v) Distribution. Paragraph (a)(1) of this section.
    (vi) Division of Relevant Property Requirement. Paragraph 
(b)(1)(iii) of this section.
    (vii) Expanded Affiliated Group. Paragraph (b)(2)(ii)(B) of this 
section.
    (viii) Hypothetical Controlled. Paragraph (e)(2)(i) of this section.
    (ix) Hypothetical D/355(e) Reorganization. Paragraph (e)(2)(i) of 
this section.
    (x) Plan. Paragraph (a)(4)(ii) of this section.
    (xi) Plan Period. Paragraph (a)(4)(iii) of this section.
    (xii) Planned 50-percent Acquisition. Paragraph (a)(1) of this 
section.
    (xiii) POD Gain Limitation Rule. Paragraph (e)(1)(ii) of this 
section.
    (xiv) Potential Predecessor. Paragraph (b)(2)(ii)(A) of this 
section.
    (xv) Predecessor of Controlled. Paragraph (c)(1) of this section.
    (xvi) Predecessor of Distributing. Paragraph (b)(1) of this section.
    (xvii) Reflection of Basis Requirement. Paragraph (b)(1)(ii)(B) of 
this section.
    (xviii) Relevant Equity. Paragraph (b)(2)(iv)(A) of this section.
    (xix) Relevant Property. Paragraph (b)(2)(iv)(A) of this section.
    (xx) Relevant Property Requirement. Paragraph (b)(1)(ii)(A) of this 
section.
    (xxi) Section 381 Transaction. Paragraph (c)(3) of this section.
    (xxii) Separated Property. Paragraph (b)(2)(vii) of this section.
    (xxiii) Statutory Recognition Amount. Paragraph (e)(1)(i) of this 
section.
    (xxiv) Substitute Asset. Paragraph (b)(2)(vi)(A) of this section.
    (xxv) Successor. Paragraph (c)(2)(i) of this section.
    (xxvi) Successor Transaction. Paragraph (c)(2)(i) of this section.
    (xxvii) Underlying Property. Paragraph (b)(2)(viii) of this section.
    (b) Predecessor of Distributing--(1) Definition--(i) In general. For 
purposes of section 355(e), a Potential Predecessor is a predecessor of 
Distributing (Predecessor of Distributing) if, taking into account the 
special rules of paragraph (b)(2) of this section--
    (A) Both pre-Distribution requirements of paragraph (b)(1)(ii) of 
this section are satisfied; and
    (B) The post-Distribution requirement of paragraph (b)(1)(iii) of 
this section is satisfied.
    (ii) Pre-Distribution requirements--(A) Relevant Property 
requirement. The requirement set forth in this paragraph (b)(1)(ii)(A) 
(Relevant Property Requirement) is satisfied if, before the

[[Page 268]]

Distribution, and as part of a Plan, either--
    (1) Any Controlled stock distributed in the Distribution was 
directly or indirectly acquired (or deemed acquired under the rules set 
forth in paragraph (b)(2)(x) of this section) by Distributing in 
exchange for any direct or indirect interest in Relevant Property--
    (i) That is held directly or indirectly by Controlled immediately 
before the Distribution; and
    (ii) The gain on which (if any) was not recognized in full at any 
point during the Plan Period; or
    (2) Any Controlled stock that is distributed in the Distribution is 
Relevant Property of the Potential Predecessor.
    (B) Reflection of basis requirement. The requirement set forth in 
this paragraph (b)(1)(ii)(B) (Reflection of Basis Requirement) is 
satisfied if any Controlled stock that satisfies the Relevant Property 
Requirement--
    (1) Either--
    (i) Had a basis prior to the Distribution that was determined in 
whole or in part by reference to the basis of any Separated Property; or
    (ii) Is Relevant Property of the Potential Predecessor; and
    (2) During the Plan Period prior to the Distribution, was neither 
distributed in a distribution to which section 355(e) applied nor 
transferred in a transaction in which the gain (if any) on that 
Controlled stock was recognized in full.
    (iii) Post-Distribution requirement. The requirement set forth in 
this paragraph (b)(1)(iii) (Division of Relevant Property Requirement) 
is satisfied if, immediately after the Distribution, and as part of a 
Plan, direct or indirect ownership of the Potential Predecessor's 
Relevant Property has been divided between Controlled on the one hand, 
and Distributing or the Potential Predecessor (or a successor to the 
Potential Predecessor) on the other hand. For purposes of this paragraph 
(b)(1)(iii), if Controlled stock that is distributed in the Distribution 
is Relevant Property of a Potential Predecessor, then Controlled is 
deemed to have received Relevant Property of the Potential Predecessor.
    (2) Additional definitions and rules related to paragraph (b)(1) of 
this section--(i) References to Distributing and Controlled. For 
purposes of the Relevant Property Requirement, the Reflection of Basis 
Requirement, and the Division of Relevant Property Requirement, 
references to Distributing and Controlled do not include references to 
any Predecessor of Distributing, Predecessor of Controlled, or Successor 
of Distributing or Controlled.
    (ii) Potential Predecessor--(A) Potential Predecessor definition. 
The term Potential Predecessor means a corporation, other than 
Distributing or Controlled, if--
    (1) As part of a Plan, the corporation transfers property to a 
Potential Predecessor, Distributing, or a member of the same Expanded 
Affiliated Group as Distributing in a Section 381 Transaction; or
    (2) Immediately after completion of the Plan, the corporation is a 
member of the same Expanded Affiliated Group as Distributing.
    (B) Expanded Affiliated Group definition. The term Expanded 
Affiliated Group means an affiliated group (as defined in section 1504 
without regard to section 1504(b)).
    (iii) Successors of Potential Predecessors. For purposes of the 
Division of Relevant Property Requirement, if a Potential Predecessor 
transfers property in a Section 381 Transaction to a corporation (other 
than Distributing or Controlled) during the Plan Period, the corporation 
is a successor to the Potential Predecessor.
    (iv) Relevant Property; Relevant Equity--(A) In general. Except as 
otherwise provided in this paragraph (b)(2)(iv) or in paragraph 
(b)(2)(v) of this section, the term Relevant Property means any property 
that was held, directly or indirectly, by the Potential Predecessor 
during the Plan Period. The term Relevant Equity means Relevant Property 
that is an equity interest in a corporation or a partnership.
    (B) Property held by Distributing. Except as provided in paragraph 
(b)(2)(iv)(C) of this section, property held directly or indirectly by 
Distributing (including Controlled stock) is Relevant Property of a 
Potential Predecessor only to the extent that the

[[Page 269]]

property was transferred directly or indirectly to Distributing during 
the Plan Period, and it was Relevant Property of the Potential 
Predecessor before the direct or indirect transfer(s). For example, if 
during the Plan Period a subsidiary corporation of a Potential 
Predecessor merges into Controlled in a reorganization under section 
368(a)(1)(A) and (2)(D), and, as a result, the Potential Predecessor 
directly or indirectly owns Distributing stock received in the merger, 
the subsidiary's assets held by Controlled are Relevant Property of that 
Potential Predecessor.
    (C) F reorganizations. For purposes of paragraph (b)(2)(iv)(B) of 
this section, the transferor and transferee in any reorganization 
described in section 368(a)(1)(F) (F reorganization) are treated as a 
single corporation. Therefore, for example, Relevant Property acquired 
during the Plan Period by a corporation that is a transferor (as to a 
later F reorganization) is treated as having been acquired directly (and 
from the same source) by the transferee (as to the later F 
reorganization) during the Plan Period. In addition, any transfer (or 
deemed transfer) of assets to Distributing in an F reorganization will 
not cause the transferred assets to be treated as Relevant Property.
    (v) Stock of Distributing as Relevant Property--(A) In general. For 
purposes of the Division of Relevant Property Requirement, except as 
provided in paragraph (b)(2)(v)(B) of this section, stock of 
Distributing is not Relevant Property (and thus is not Relevant Equity) 
to the extent that the Potential Predecessor becomes, as part of a Plan, 
the direct or indirect owner of that stock as the result of the transfer 
to Distributing of direct or indirect interests in the Potential 
Predecessor's Relevant Property. For example, stock of Distributing is 
not Relevant Property if it is acquired by a Potential Predecessor as 
part of a Plan in an exchange to which section 351(a) applies.
    (B) Certain reorganizations. For purposes of the Division of 
Relevant Property Requirement, stock of Distributing is Relevant 
Property (and thus Relevant Equity) to the extent that the Potential 
Predecessor becomes, as part of the Plan, the direct or indirect owner 
of that stock as the result of a transaction described in section 
368(a)(1)(E).
    (vi) Substitute Asset--(A) In general. Subject to paragraph 
(b)(2)(vi)(B) of this section, the term Substitute Asset means any 
property that is held directly or indirectly by Distributing during the 
Plan Period and was received, during the Plan Period, in exchange for 
Relevant Property that was acquired directly or indirectly by 
Distributing if all gain on the transferred Relevant Property is not 
recognized on the exchange. For example, property received by Controlled 
in exchange for Relevant Property in a transaction qualifying under 
section 1031 is a Substitute Asset. In addition, stock received by 
Distributing in a distribution qualifying under section 305(a) or 
section 355(a) on Relevant Equity is a Substitute Asset.
    (B) Controlled stock received by Distributing--(1) In general. 
Except as provided in paragraph (b)(2)(vi)(B)(2) of this section, stock 
of Controlled received in exchange for a direct or indirect transfer of 
Relevant Property by Distributing is not a Substitute Asset.
    (2) Exception. If the basis in Controlled stock received or deemed 
received in an exchange described in paragraph (b)(2)(vi)(B)(1) of this 
section is determined in whole or in part by reference to the basis of 
Relevant Equity the issuer of which ceases to exist for Federal income 
tax purposes under the Plan, that Controlled stock constitutes a 
Substitute Asset. See paragraph (b)(2)(x) of this section.
    (C) Treatment as Relevant Property. For purposes of this section, a 
Substitute Asset is treated as Relevant Property with the same ownership 
and transfer history as the Relevant Property for which (or with respect 
to which) it was received.
    (vii) Separated Property. The term Separated Property means each 
item of Relevant Property that is described in the Relevant Property 
Requirement (regardless of whether the fair market value of the Relevant 
Property exceeds its adjusted basis). However, if Relevant Equity is 
Separated Property, Underlying Property associated with that Relevant 
Equity is not treated as

[[Page 270]]

Separated Property. In addition, if Distributing directly or indirectly 
acquires Relevant Equity in a transaction in which gain is recognized in 
full, Underlying Property associated with that Relevant Equity is not 
treated as Separated Property.
    (viii) Underlying Property. The term Underlying Property means 
property directly or indirectly held by a corporation or partnership any 
equity interest in which is Relevant Equity.
    (ix) Multiple Predecessors of Distributing. If there are multiple 
Potential Predecessors that satisfy the pre-Distribution requirements 
and post-Distribution requirement of paragraph (b)(1) of this section, 
each of those Potential Predecessors is a Predecessor of Distributing. 
For example, a Potential Predecessor that transfers property to a 
Predecessor of Distributing without full recognition of gain (and that 
otherwise meets the requirements of paragraph (b)(1) of this section) is 
also a Predecessor of Distributing if the applicable transfer occurred 
as part of a Plan that existed at the time of such transfer.
    (x) Deemed exchanges. For purposes of paragraph (b)(1)(ii) of this 
section (regarding the Relevant Property Requirement and the Reflection 
of Basis Requirement) and paragraph (b)(2)(vi) of this section 
(regarding Substitute Assets), Distributing is treated as acquiring 
Controlled stock in exchange for a direct or indirect interest in 
Relevant Property if the basis of Distributing in that Controlled stock, 
immediately after a transfer of the Relevant Property, is determined in 
whole or in part by reference to the basis of that Relevant Property 
immediately before the transfer. For example, if a corporation transfers 
Relevant Property to Controlled in exchange for Distributing stock in a 
transaction that qualifies as a reorganization under section 
368(a)(1)(C), then, for purposes of paragraphs (b)(1)(ii) and (b)(2)(vi) 
of this section, Distributing is treated as acquiring Controlled stock 
in exchange for a direct or indirect interest in Relevant Property. See 
Sec. 1.358-6(c)(1).
    (c) Additional definitions--(1) Predecessor of Controlled. Solely 
for purposes of applying paragraph (f) of this section, a corporation is 
a predecessor of Controlled (Predecessor of Controlled) if, before the 
Distribution, it transfers property to Controlled in a Section 381 
Transaction as part of a Plan. Other than for the purpose described in 
the preceding sentence, no corporation can be a Predecessor of 
Controlled. If multiple corporations satisfy the requirements of this 
paragraph (c)(1), each of those corporations is a Predecessor of 
Controlled. For example, a corporation that transfers property to a 
Predecessor of Controlled in a Section 381 Transaction is also a 
Predecessor of Controlled if the Section 381 Transaction occurred as 
part of a Plan that existed at the time of such transaction.
    (2) Successors--(i) In general. For purposes of section 355(e), a 
successor (Successor) of Distributing or of Controlled is a corporation 
to which Distributing or Controlled, respectively, transfers property in 
a Section 381 Transaction after the Distribution (Successor 
Transaction).
    (ii) Determination of Successor status. More than one corporation 
may be a Successor of Distributing or Controlled. For example, if 
Distributing transfers property to another corporation (X) in a Section 
381 Transaction, and X transfers property to another corporation (Y) in 
a Section 381 Transaction, then each of X and Y is a Successor of 
Distributing. In this case, the determination of whether Y is a 
Successor of Distributing is made after the determination of whether X 
is a Successor of Distributing.
    (3) Section 381 Transaction. The term Section 381 Transaction means 
a transaction to which section 381 applies.
    (d) Special acquisition rules--(1) Deemed acquisitions of stock in 
Section 381 Transactions--(i) Rule. This paragraph (d)(1)(i) applies to 
each shareholder of the acquiring corporation immediately before a 
Section 381 Transaction (Acquiring Owner). Each Acquiring Owner is 
treated for purposes of this section as acquiring, in the Section 381 
Transaction, stock representing an interest in the distributor or 
transferor corporation, to the extent that the Acquiring Owner's 
interest in the acquiring corporation immediately after the Section 381 
Transaction exceeds the Acquiring Owner's direct or indirect interest in 
the distributor or

[[Page 271]]

transferor corporation immediately before the Section 381 Transaction.
    (ii) Example. The example set forth in this paragraph (d)(1)(ii) 
illustrates the application of the deemed acquisition rule in paragraph 
(d)(1)(i) of this section. Assume that A held all of the stock of 
Distributing, Distributing held a 25-percent interest in a Predecessor 
of Distributing, and A held no direct interest, or other indirect 
interest, in the Predecessor of Distributing immediately before a 
Section 381 Transaction in which the Predecessor of Distributing 
transfers its assets to Distributing. In the Section 381 Transaction, 
the Predecessor of Distributing's shareholders (other than Distributing) 
collectively receive a 10-percent interest in Distributing (reducing A's 
interest in Distributing to 90 percent). Under paragraph (d)(1)(i) of 
this section, A is treated as acquiring in the Section 381 Transaction 
stock representing a 65-percent interest in the Predecessor of 
Distributing. This is because A's 90-percent interest in Distributing 
(the acquiring corporation in the Section 381 Transaction) immediately 
after the Section 381 Transaction exceeds A's 25-percent interest (held 
indirectly through Distributing) in the Predecessor of Distributing (the 
transferor corporation in the Section 381 Transaction) immediately 
before the Section 381 Transaction by 65 percent. Similarly, each 
Acquiring Owner of a Successor of Distributing is treated as acquiring, 
in the Successor Transaction, stock of Distributing, to the extent that 
the Acquiring Owner's interest in the Successor of Distributing 
immediately after the Successor Transaction exceeds the Acquiring 
Owner's direct or indirect interest in Distributing immediately before 
the Successor Transaction.
    (2) Deemed acquisitions of stock after Section 381 Transactions. For 
purposes of this section, after a Section 381 Transaction (including a 
Successor Transaction), an acquisition of stock of an acquiring 
corporation (including a deemed stock acquisition under paragraph 
(d)(1)(i) of this section) is treated also as an acquisition of an 
interest in the stock of the distributor or transferor corporation. For 
example, an acquisition of the stock of Distributing that occurs after a 
Section 381 Transaction is treated not only as an acquisition of the 
stock of Distributing, but also as an acquisition of the stock of any 
Predecessor of Distributing whose assets were acquired by Distributing 
in the prior Section 381 Transaction. Similarly, an acquisition of the 
stock of a Successor of Distributing that occurs after the Successor 
Transaction is treated not only as an acquisition of the stock of the 
Successor of Distributing, but also as an acquisition of the stock of 
Distributing.
    (3) Separate counting for Distributing and each Predecessor of 
Distributing. The measurement of whether one or more persons have 
acquired stock of any specific corporation in a Planned 50-percent 
Acquisition is made separately from the measurement of any potential 
Planned 50-percent Acquisition of any other corporation. Therefore, 
there may be a Planned 50-percent Acquisition of a Predecessor of 
Distributing even if there is no Planned 50-percent Acquisition of 
Distributing. Similarly, there may be a Planned 50-percent Acquisition 
of Distributing even if there is no Planned 50-percent Acquisition of a 
Predecessor of Distributing.
    (e) Special rules for limiting gain recognition--(1) Overview--(i) 
Gain limitation. This paragraph (e) provides rules that limit the amount 
of gain that must be recognized by Distributing by reason of section 
355(e) to an amount that is less than the amount that Distributing 
otherwise would be required to recognize under section 355(c)(2) or 
section 361(c)(2) (Statutory Recognition Amount) in certain cases 
involving one or more Predecessors of Distributing.
    (ii) Multiple Planned 50-percent Acquisitions. If there are Planned 
50-percent Acquisitions of multiple corporations (for example, two 
Predecessors of Distributing), Distributing must recognize the Statutory 
Recognition Amount with respect to each such corporation, subject to the 
limitations in paragraph (e)(2) of this section relating to a Planned 
50-percent Acquisition of a Predecessor of Distributing (POD Gain 
Limitation Rule) and paragraph (e)(3) of this section relating to a 
Planned 50-percent Acquisition of Distributing (Distributing Gain 
Limitation Rule), if

[[Page 272]]

applicable. The POD Gain Limitation Rule and the Distributing Gain 
Limitation Rule are applied separately to the Planned 50-percent 
Acquisition of each such corporation to determine the amount of gain 
required to be recognized.
    (iii) Statutory Recognition Amount limit; Section 336(e). Paragraph 
(e)(4) of this section sets forth an overall gain limitation based on 
the Statutory Recognition Amount. Paragraph (e)(5) of this section 
clarifies the availability of an election under section 336(e) with 
regard to certain Distributions.
    (2) Planned 50-percent Acquisition of a Predecessor of 
Distributing--(i) In general. If there is a Planned 50-percent 
Acquisition of a Predecessor of Distributing, the amount of gain 
recognized by Distributing by reason of section 355(e) as a result of 
the Planned 50-percent Acquisition is limited to the amount of gain, if 
any, that Distributing would have recognized if, immediately before the 
Distribution, Distributing had engaged in the following transaction: 
Distributing transferred all Separated Property received from the 
Predecessor of Distributing to a newly formed corporation (Hypothetical 
Controlled) in exchange solely for stock of Hypothetical Controlled in a 
reorganization under section 368(a)(1)(D) and then distributed the stock 
of Hypothetical Controlled to the shareholders of Distributing in a 
transaction to which section 355(e) applied (Hypothetical D/355(e) 
Reorganization). The computation in this paragraph (e)(2)(i) is applied 
regardless of whether Distributing actually directly held the Separated 
Property.
    (ii) Operating rules. For purposes of applying paragraph (e)(2)(i) 
of this section, the following rules apply:
    (A) Separated Property other than Controlled stock. Each of the 
basis and the fair market value of Separated Property other than stock 
of Controlled treated as transferred by Distributing to a Hypothetical 
Controlled in a Hypothetical D/355(e) Reorganization equals the basis 
and the fair market value, respectively, of such property in the hands 
of Controlled immediately before the Distribution.
    (B) Controlled stock that is Separated Property. Each of the basis 
and the fair market value of the stock of Controlled that is Separated 
Property treated as transferred by Distributing to a Hypothetical 
Controlled in a Hypothetical D/355(e) Reorganization equals the basis 
and the fair market value, respectively, of such stock in the hands of 
Distributing immediately before the Distribution.
    (C) Anti-duplication rule. A Predecessor of Distributing's Separated 
Property is taken into account for purposes of applying this paragraph 
(e)(2) only to the extent such property was not taken into account by 
Distributing in a Hypothetical D/355(e) Reorganization with respect to 
another Predecessor of Distributing. Further, appropriate adjustments 
must be made to prevent other duplicative inclusions of section 355(e) 
gain under this paragraph (e) reflecting the same economic gain.
    (3) Planned 50-percent Acquisition of Distributing. This paragraph 
(e)(3) applies if there is a Planned 50-percent Acquisition of 
Distributing. In that case, the amount of gain recognized by 
Distributing by reason of section 355(e) as a result of the Planned 50-
percent Acquisition is limited to the excess, if any, of the Statutory 
Recognition Amount over the amount of gain, if any, that Distributing 
would have been required to recognize under paragraphs (e)(1)(ii) and 
(e)(2) of this section if there had been a Planned 50-percent 
Acquisition of every Predecessor of Distributing, but not of 
Distributing or Controlled. For purposes of this paragraph (e)(3), 
references to Distributing are not references to a Predecessor of 
Distributing.
    (4) Gain recognition limited to Statutory Recognition Amount. The 
sum of the amounts required to be recognized by Distributing under 
section 355(e) (taking into account the POD Gain Limitation Rule and the 
Distributing Gain Limitation Rule) with regard to a single Distribution 
cannot exceed the Statutory Recognition Amount. In addition, 
Distributing may choose not to apply the POD Gain Limitation Rule or the 
Distributing Gain Limitation Rule to a Distribution, and instead may 
recognize the Statutory Recognition Amount. Distributing indicates its 
choice to apply the preceding sentence

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by reporting the Statutory Recognition Amount on its original or amended 
Federal income tax return for the year of the Distribution.
    (5) Section 336(e) election. Distributing is not eligible to make a 
section 336(e) election (as defined in Sec. 1.336-1(b)(11)) with 
respect to a Distribution to which this section applies unless 
Distributing would, absent the making of a section 336(e) election, 
recognize the Statutory Recognition Amount with respect to the 
Distribution (taking into account the POD Gain Limitation Rule and the 
Distributing Gain Limitation Rule) without regard to the final two 
sentences of paragraph (e)(4) of this section. See Sec. Sec. 1.336-1 
through 1.336-5 for additional requirements with regard to a section 
336(e) election.
    (f) Predecessor or Successor as a member of the affiliated group. 
For purposes of section 355(e)(2)(C), if a corporation transfers its 
assets to a member of the same Expanded Affiliated Group in a Section 
381 Transaction, the transferor will be treated as continuing in 
existence within the same Expanded Affiliated Group.
    (g) Inapplicability of section 355(f) to certain intra-group 
Distributions--(1) In general. Section 355(f) does not apply to a 
Distribution if there is a Planned 50-percent Acquisition of a 
Predecessor of Distributing (but not of Distributing, Controlled, or 
their Successors), except as provided in paragraph (g)(2) of this 
section. Therefore, except as provided in paragraph (g)(2) of this 
section, section 355 (or so much of section 356 as relates to section 
355) and the regulations under sections 355 and 356, including the POD 
Gain Limitation Rule, apply, without regard to section 355(f), to a 
Distribution within an affiliated group (as defined in section 1504(a)) 
if the Distribution and the Planned 50-percent Acquisition of the 
Predecessor of Distributing are part of a Plan. For purposes of this 
paragraph (g)(1), references to a Distribution (and Distributing and 
Controlled) include references to a distribution (and Distributing and 
Controlled) to which section 355 would apply but for the application of 
section 355(f).
    (2) Alternative application of section 355(f). Distributing may 
choose not to apply paragraph (g)(1) of this section to each 
Distribution (that occurs under a Plan) to which section 355(f) would 
otherwise apply absent paragraph (g)(1) of this section. Instead, 
Distributing may apply section 355(f) to all such Distributions 
according to its terms, but only if all members of the same Expanded 
Affiliated Group report consistently the Federal income tax consequences 
of the Distributions that are part of the Plan (determined without 
regard to section 355(f)). In such a case, neither the POD Gain 
Limitation Rule nor the Distributing Gain Limitation Rule is available 
with regard to any applicable Distribution. Distributing indicates its 
choice to apply section 355(f) consistently to all applicable 
Distributions by reporting the Federal income tax consequences of each 
Distribution in accordance with section 355(f) on its Federal income tax 
return for the year of the Distribution.
    (h) Examples. The following examples illustrate the principles of 
this section. Unless the facts indicate otherwise, assume throughout 
these examples that: Distributing (D) owns all the stock of Controlled 
(C), and none of the shares of C held by D has a built-in loss; D 
distributes the stock of C in a Distribution to which section 355(d) 
does not apply; X, Y, and Z are individuals; each of D, D1, C, P, P1, 
P2, and R is a corporation having one class of stock outstanding, and 
none is a member of a consolidated group; and each transaction that is 
part of a Plan defined in this section is respected as a separate 
transaction under general Federal income tax principles. No inference 
should be drawn from any example concerning whether any requirements of 
section 355 are satisfied other than those of section 355(e) or whether 
any general Federal income tax principles (including the step 
transaction doctrine) are implicated by the example:
    (1) Example 1: Predecessor of D and Planned 50-Percent Acquisition 
of P--(i) Facts. X owns 100% of the stock of P, which holds multiple 
assets. Y owns 100% of the stock of D. The following steps occur as part 
of a Plan: P merges into D in a reorganization under section 
368(a)(1)(A). Immediately after the merger, X and Y own 10% and 90%, 
respectively, of the stock of D. D then contributes to C one of the 
assets

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(Asset 1) acquired from P in the merger. At the time of the 
contribution, Asset 1 has a basis of $40x and a fair market value of 
$110x. In exchange for Asset 1, D receives additional C stock and $10x. 
D distributes the stock of C (but not the cash) to X and Y, pro rata. 
The contribution and Distribution constitute a reorganization under 
section 368(a)(1)(D), and D recognizes $10x of gain under section 361(b) 
on the contribution. Immediately before the Distribution, taking into 
account the $10x of gain recognized by D on the contribution, Asset 1 
has an adjusted basis of $50x under section 362(b) and a fair market 
value of $110x, and the stock of C held by D has a basis of $100x and a 
fair market value of $200x.
    (ii) Analysis--(A) P is a Predecessor of D. Under paragraph (b)(1) 
of this section, P is a Predecessor of D. First, P is a Potential 
Predecessor because, as part of a Plan, P transferred property to D in a 
Section 381 Transaction. See paragraph (b)(2)(ii)(A)(1) of this section. 
Second, both of the pre-Distribution requirements and the post-
Distribution requirement are satisfied. The Relevant Property 
Requirement is satisfied because, immediately before the Distribution 
and as part of a Plan, C holds P Relevant Property (Asset 1) the gain on 
which was not recognized in full at any point during the Plan Period, 
and some of the C stock distributed in the Distribution was acquired by 
D in exchange for Asset 1. See paragraph (b)(1)(ii)(A)(1) of this 
section. The Reflection of Basis Requirement is satisfied because that C 
stock had a basis prior to the Distribution that was determined in whole 
or in part by reference to the basis of Separated Property (Asset 1), 
and was neither distributed in a distribution to which section 355(e) 
applied nor transferred in a transaction in which the gain on that C 
stock was recognized in full during the Plan Period prior to the 
Distribution. See paragraph (b)(1)(ii)(B) of this section. The Division 
of Relevant Property Requirement is satisfied because immediately after 
the Distribution, D continues to hold Relevant Property of P, and 
therefore, as part of a Plan, P's Relevant Property has been divided 
between C and D. See paragraph (b)(1)(iii) of this section.
    (B) Planned 50-percent Acquisition of P. Under paragraph (d)(1)(i) 
of this section, Y is treated as acquiring stock representing 90% of the 
voting power and value of P as a result of the merger of P into D. 
Accordingly, there has been a Planned 50-percent Acquisition of P.
    (C) Gain limited. Without regard to the limitations in paragraph (e) 
of this section, D would be required to recognize $100x of gain ($200x 
of aggregate fair market value minus $100x of aggregate basis of the C 
stock held by D), the Statutory Recognition Amount described in section 
361(c)(2). However, under the POD Gain Limitation Rule, D's gain 
recognized by reason of the Planned 50-percent Acquisition of P will not 
exceed $60x, an amount equal to the amount of gain D would have 
recognized had D transferred Asset 1 (Separated Property) to a newly 
formed corporation (C1) solely for C1 stock and distributed the C1 stock 
to D's shareholders in a Hypothetical D/355(e) Reorganization. See 
paragraph (e)(2)(i) of this section. For purposes of the computation in 
this paragraph (h)(1)(ii)(C), the basis and fair market value of Asset 1 
equal the basis and fair market value of Asset 1 in the hands of C 
immediately before the Distribution. See paragraph (e)(2)(ii)(A) of this 
section. Under section 361(c)(2), D would recognize $60x of gain, an 
amount equal to the gain in the hypothetical C1 stock (excess of the 
$110x fair market value over the $50x basis). Therefore, D recognizes 
$60x of gain (in addition to the $10x of gain recognized under section 
361(b)).
    (iii) Plan not in existence at time of acquisition of Potential 
Predecessor's property. The facts are the same as in paragraph (h)(1)(i) 
of this section (Example 1) except that the merger of P into D occurred 
before the existence of a Plan. Even though D transferred P property 
(Asset 1) to C, Asset 1 was not Relevant Property of P because P did not 
hold Asset 1 during the Plan Period. See paragraphs (b)(2)(iv) and 
(a)(4)(iii) of this section. Because Asset 1 is not Relevant Property, D 
did not receive C stock distributed in the Distribution in exchange for 
Relevant Property when it contributed Asset 1 to C, none of the 
distributed C stock had a basis prior to

[[Page 275]]

the Distribution that was determined in whole or in part by reference to 
the basis of Separated Property, and C did not hold Relevant Property 
immediately before the Distribution. Further, Relevant Property of P has 
not been divided. Therefore, P is not a Predecessor of D.
    (2) Example 2: Planned 50-percent Acquisition of D, but not 
Predecessor of D--(i) Facts. X owns 100% of the stock of P, which holds 
multiple assets. Y owns 100% of the stock of D. The following steps 
occur as part of a Plan: P merges into D in a reorganization under 
section 368(a)(1)(A). Immediately after the merger, X and Y own 90% and 
10%, respectively, of the stock of D. D then contributes to C one of the 
assets (Asset 1) acquired from P in the merger. In exchange for Asset 1, 
D receives additional C stock. D distributes the stock of C to X and Y, 
pro rata. The contribution and Distribution constitute a reorganization 
under section 368(a)(1)(D). Immediately before the Distribution, Asset 1 
has a basis of $50x and a fair market value of $110x, and the stock of C 
held by D has a basis of $120x and a fair market value of $200x.
    (ii) Analysis--(A) P is a Predecessor of D. Under paragraph (b)(1) 
of this section, P is a Predecessor of D. First, P is a Potential 
Predecessor because, as part of a Plan, P transferred property to D in a 
Section 381 Transaction. See paragraph (b)(2)(ii)(A)(1) of this section. 
Second, both of the pre-Distribution requirements and the post-
Distribution requirement are satisfied. The Relevant Property 
Requirement is satisfied because, immediately before the Distribution 
and as part of a Plan, C holds P Relevant Property (Asset 1) the gain on 
which was not recognized in full at any point during the Plan Period, 
and some of the C stock distributed in the Distribution was acquired by 
D in exchange for Asset 1. See paragraph (b)(1)(ii)(A)(1) of this 
section. The Reflection of Basis Requirement is satisfied because that C 
stock had a basis prior to the Distribution that was determined in whole 
or in part by reference to the basis of Separated Property (Asset 1), 
and was neither distributed in a distribution to which section 355(e) 
applied nor transferred in a transaction in which the gain on that C 
stock was recognized in full during the Plan Period prior to the 
Distribution. See paragraph (b)(1)(ii)(B) of this section. The Division 
of Relevant Property Requirement is satisfied because immediately after 
the Distribution, D continues to hold Relevant Property of P, and 
therefore, as part of a Plan, P's Relevant Property has been divided 
between C and D. See paragraph (b)(1)(iii) of this section.
    (B) Planned 50-percent Acquisition of D. Under paragraph (d)(1)(i) 
of this section, Y is treated as acquiring stock representing 10% of the 
voting power and value of P as a result of the merger of P into D. The 
10% acquisition of P stock does not cause section 355(e) gain 
recognition or cause application of the POD Gain Limitation Rule because 
there has not been a Planned 50-percent Acquisition of P. X acquires 90% 
of the voting power and value of D as a result of the merger of P into 
D. Accordingly, there has been a Planned 50-percent Acquisition of D. 
This Planned 50-percent Acquisition implicates section 355(e) and 
results in gain recognition, subject to the rules of paragraph (e) of 
this section.
    (C) Gain limited. Without regard to the limitations in paragraph (e) 
of this section, D would be required to recognize $80x of gain ($200x of 
fair market value minus $120x of basis of the C stock held by D), the 
Statutory Recognition Amount described in section 361(c)(2). However, 
under the Distributing Gain Limitation Rule, D's gain recognized by 
reason of the Planned 50-percent Acquisition of D will not exceed $20x, 
the excess of the Statutory Recognition Amount ($80x) over the amount of 
gain that D would have been required to recognize under the POD Gain 
Limitation Rule if there had been a Planned 50-percent Acquisition of P 
but not D or C ($60x). See paragraph (e)(3) of this section. The 
hypothetical gain limitation under the POD Gain Limitation Rule equals 
the amount D would have recognized had it transferred Asset 1 (Separated 
Property) to a newly formed corporation (C1) solely for stock and 
distributed the C1 stock in a Hypothetical D/355(e) Reorganization. See 
paragraph (e)(2)(i) of this section. Under section 361(c)(2), D would 
recognize $60x of gain, an amount equal

[[Page 276]]

to the gain in the hypothetical C1 stock (excess of the $110x fair 
market value over the $50x basis). Therefore, D recognizes $20x of gain 
($80x-$60x).
    (3) Example 3: Predecessor of D owns C stock--(i) Facts. X owns 100% 
of the stock of P, which holds multiple assets, including Asset 2. Y 
owns 100% of the stock of D. P owns 35% of the stock of C (Block 1), and 
D owns the remaining 65% of the C stock (Block 2). The following steps 
occur as part of a Plan: P merges into D in a reorganization under 
section 368(a)(1)(A), and D immediately thereafter distributes all of 
the C stock to X and Y pro rata. Immediately after the merger, X and Y 
own 10% and 90%, respectively, of the D stock, and, prior to the 
Distribution, D owns Block 1 with a basis of $30x and a fair market 
value of $35x, and Block 2 with a basis of $10x and a fair market value 
of $65x. D continues to hold Asset 2.
    (ii) Analysis--(A) P is a Predecessor of D. Under paragraph (b)(1) 
of this section, P is a Predecessor of D. First, P is a Potential 
Predecessor because, as part of a Plan, P transferred property to D in a 
Section 381 Transaction. See paragraph (b)(2)(ii)(A)(1) of this section. 
Second, both of the pre-Distribution requirements and the post-
Distribution requirement are satisfied. The Relevant Property 
Requirement is satisfied because some of the C stock distributed in the 
Distribution (Block 1) was Relevant Property of P. See paragraph 
(b)(1)(ii)(A)(2) of this section. The Reflection of Basis Requirement is 
satisfied because Block 1 of the C stock is Relevant Property of P, and 
was neither distributed in a distribution to which section 355(e) 
applied nor transferred in a transaction in which the gain on that C 
stock was recognized in full during the Plan Period prior to the 
Distribution. See paragraph (b)(1)(ii)(B) of this section. The Division 
of Relevant Property Requirement is satisfied because some of the C 
stock distributed in the Distribution was Relevant Property of P, and 
therefore C is deemed to have received Relevant Property of P, and D 
continues to hold Relevant Property of P immediately after the 
Distribution. See paragraph (b)(1)(iii) of this section. Therefore, as 
part of a Plan, P's Relevant Property has been divided between C and D.
    (B) Planned 50-percent Acquisition of P. Under paragraph (d)(1)(i) 
of this section, Y is treated as acquiring stock representing 90% of the 
voting power and value of P as a result of the merger of P into D. 
Accordingly, there has been a Planned 50-percent Acquisition of P.
    (C) Gain limited. Without regard to the limitations in paragraph (e) 
of this section, D would be required to recognize $60x of gain ($100x of 
fair market value minus $40x of basis of the C stock held by D), the 
Statutory Recognition Amount under section 355(c)(2). However, under the 
POD Gain Limitation Rule, D's gain recognized by reason of the Planned 
50-percent Acquisition of P will not exceed $5x, an amount equal to the 
amount D would have recognized had it transferred Block 1 of the C stock 
(Separated Property) to a newly formed corporation (C1) solely for stock 
and distributed the C1 stock to D shareholders in a Hypothetical D/
355(e) Reorganization. See paragraph (e)(2)(i) of this section. Because 
Relevant Equity (Block 1 of the C stock) is Separated Property, 
Underlying Property associated with that Relevant Equity is not treated 
as Separated Property. See paragraph (b)(2)(vii) of this section. For 
purposes of the computation in this paragraph (h)(3)(ii)(C), the basis 
and fair market value of the Block 1 C stock equal its basis and fair 
market value in the hands of D immediately before the Distribution. See 
paragraph (e)(2)(ii)(A) of this section. Under section 361(c)(2), D 
would recognize $5x of gain, an amount equal to the gain in the 
hypothetical C1 stock ($35x fair market value-$30x basis). Therefore, D 
recognizes $5x of gain.
    (4) Example 4: C stock as Substitute Asset--(i) Facts. X owns 100% 
of the stock of P, which owns multiple assets, including 100% of the 
stock of R and Asset 2. Y owns 100% of the stock of D. The following 
steps occur as part of a Plan: P merges into D in a reorganization under 
section 368(a)(1)(A) (P-D reorganization). Immediately after the merger, 
X and Y own 10% and 90%, respectively, of the stock of D. D then causes 
R to transfer all of its assets to C and liquidate in a reorganization

[[Page 277]]

under section 368(a)(1) (R-C reorganization). At the time of the P-D 
reorganization, the R stock has a basis of $40x and a fair market value 
of $110x. D distributes the stock of C to X and Y, pro rata. D continues 
to directly hold Asset 2. Immediately before the Distribution, the C 
stock held by D that was deemed received in the R-C reorganization 
(Block 1) has a basis of $40x and a fair market value of $110x, and all 
of the stock of C held by D has a basis of $100x and a fair market value 
of $200x.
    (ii) Analysis--(A) P is a Predecessor of D. Under paragraph (b)(1) 
of this section, P is a Predecessor of D. First, P is a Potential 
Predecessor because, as part of a Plan, P transferred property to D in a 
Section 381 Transaction. See paragraph (b)(2)(ii)(A)(1) of this section. 
Second, both pre-Distribution requirements and the post-Distribution 
requirement are satisfied. The Relevant Property Requirement is 
satisfied because, for the following two reasons, some of the C stock 
distributed in the Distribution (Block 1) was Relevant Property of P. D 
is treated as acquiring Block 1 of the C stock in exchange for a direct 
or indirect interest in R stock (that is, Relevant Property) in the R-C 
reorganization because the basis of D in that C stock immediately after 
a transfer of the R stock (in the liquidation of R) is determined in 
whole or in part by reference to the basis of the R stock immediately 
before the transfer. See paragraph (b)(2)(x) of this section. Further, 
because the basis in Block 1 of the C stock is determined in whole or in 
part by reference to the basis of Relevant Equity (the R stock) the 
issuer of which ceases to exist for Federal income tax purposes under 
the Plan, Block 1 of the C stock is a Substitute Asset, and is therefore 
treated as Relevant Property with the same ownership and transfer 
history as the R stock. See paragraph (b)(2)(vi)(B)(2) of this section. 
The Reflection of Basis Requirement is satisfied because Block 1 of the 
C stock is Relevant Property of P, and was neither distributed in a 
distribution to which section 355(e) applied nor transferred in a 
transaction in which the gain on that C stock was recognized in full 
during the Plan Period prior to the Distribution. See paragraph 
(b)(1)(ii)(B) of this section. The Division of Relevant Property 
Requirement is satisfied because some of the C stock distributed in the 
Distribution was Relevant Property of P, and therefore C is deemed to 
have received Relevant Property of P, and immediately after the 
Distribution, D continues to hold Asset 2, which is Relevant Property of 
P. See paragraph (b)(1)(iii) of this section. Therefore, as part of a 
Plan, P's Relevant Property has been divided between C and D.
    (B) Planned 50-percent Acquisition of P. Under paragraph (d)(1)(i) 
of this section, Y is treated as acquiring stock representing 90% of the 
voting power and value of P as a result of the P-D reorganization. 
Accordingly, there has been a Planned 50-percent Acquisition of P.
    (C) Gain limited. Without regard to the limitations in paragraph (e) 
of this section, D would be required to recognize $100x of gain ($200x 
of fair market value minus $100x of basis of all C stock held by D), the 
Statutory Recognition Amount described in section 355(c)(2). However, 
under the POD Gain Limitation Rule, D's gain recognized by reason of the 
Planned 50-percent Acquisition of P will not exceed $70x, an amount 
equal to the amount D would have recognized had it transferred Block 1 
of the C stock (Separated Property) to a newly formed corporation (C1) 
solely for stock and distributed the C1 stock to D shareholders in a 
Hypothetical D/355(e) Reorganization. See paragraph (e)(2)(i) of this 
section. Because Relevant Equity (Block 1 of the C stock) is Separated 
Property, Underlying Property associated with that Relevant Equity is 
not treated as Separated Property. See paragraph (b)(2)(vii) of this 
section. Under section 361(c)(2), D would recognize $70x of gain, an 
amount equal to the gain in the hypothetical C1 stock (excess of the 
$110x fair market value over the $40x basis). Therefore, D recognizes 
$70x of gain.
    (5) Example 5: Section 351 transaction--(i) Facts. X owns 100% of 
the stock of P, which holds multiple assets, including Asset 1, Asset 2, 
and Asset 3. Y owns 100% of the stock of D. The following

[[Page 278]]

steps occur as part of a Plan: P transfers Asset 1 and Asset 2 to D and 
Y transfers property to D in an exchange qualifying under section 351. 
Immediately after the exchange, P and Y own 10% and 90%, respectively, 
of the stock of D. D then contributes Asset 1 to C in exchange for 
additional C stock. D distributes all of the stock of C to P and Y, pro 
rata. D continues to directly hold Asset 2, and P continues to directly 
hold Asset 3. The contribution and Distribution constitute a 
reorganization under section 368(a)(1)(D). Immediately before the 
Distribution, Asset 1 has a basis of $40x and a fair market value of 
$110x, and the stock of C held by D has a basis of $100x and a fair 
market value of $200x. Following the Distribution, and as part of the 
same Plan, Z acquires 51% of the P stock.
    (ii) Analysis--P is not a Predecessor of D. Under paragraph (b)(1) 
of this section, P is not a Predecessor of D. P is not a Potential 
Predecessor because P did not transfer property to a Potential 
Predecessor, D, or a member of the same Expanded Affiliated Group as D 
in a Section 381 Transaction and P is not a member of the same Expanded 
Affiliated Group as D immediately after completion of the Plan. See 
paragraph (b)(2)(ii) of this section. Thus, P cannot be a Predecessor of 
D. See paragraph (b)(1)(i) of this section.
    (6) Example 6: Section 351 transaction after an acquisition of P--
(i) Facts. X owns 100% of the stock of P, which holds multiple assets, 
including Asset 1 and Asset 2. Y owns 100% of the stock of D, D owns 
100% of the stock of D1, and D1 owns 100% of the stock of C. D files a 
consolidated return for the affiliated group of which it is the common 
parent. The following steps occur as part of a Plan: D acquires 100% of 
the stock of P from X. P transfers Asset 1 and Asset 2 to D1 for D1 
stock in an exchange qualifying under section 351. See Sec. 1.1502-34. 
D1 contributes Asset 1 to C in exchange for additional C stock. D1 
distributes all of the stock of C to D in exchange for D1 stock (First 
Distribution). D then distributes all of the stock of C to Y (Second 
Distribution). D1 continues to directly hold Asset 2. Immediately before 
the First Distribution, Asset 1 has a basis of $10x and a fair market 
value of $60x, and the stock of C held by D1 has a basis of $100x and a 
fair market value of $200x.
    (ii) Analysis--(A) P is a Predecessor of D1. Under paragraph (b)(1) 
of this section, P is a Predecessor of D1. First, P is a Potential 
Predecessor of D1 because P is a member of the same Expanded Affiliated 
Group as D1 immediately after completion of the Plan. See paragraph 
(b)(2)(ii)(A)(2) of this section. The Relevant Property Requirement is 
satisfied because, immediately before the First Distribution and as part 
of a Plan, C holds P Relevant Property (Asset 1) the gain on which was 
not recognized in full at any point during the Plan Period, and some of 
the C stock distributed in the First Distribution was acquired by D1 in 
exchange for Asset 1. See paragraph (b)(1)(ii)(A)(1) of this section. 
The Reflection of Basis Requirement is satisfied because that C stock 
had a basis prior to the First Distribution that was determined in whole 
or in part by reference to the basis of Separated Property (Asset 1), 
and was neither distributed in a distribution to which section 355(e) 
applied nor transferred in a transaction in which the gain on that C 
stock was recognized in full prior to the First Distribution. See 
paragraph (b)(1)(ii)(B) of this section. The Division of Relevant 
Property Requirement is satisfied because immediately after the First 
Distribution, each of C, on the one hand, and P or D1, on the other 
hand, continues to hold Relevant Property of P, and therefore, as part 
of a Plan, P's Relevant Property has been divided between C and D1. See 
paragraph (b)(1)(iii) of this section.
    (B) Planned 50-percent Acquisition of P. D has acquired stock 
representing 100% of the voting power and value of P. Accordingly, there 
has been a Planned 50-percent Acquisition of P.
    (C) Gain on First Distribution. Because there is a Planned 50-
percent Acquisition of a Predecessor of Distributing (but not of 
Distributing, Controlled, or their Successors), section 355(f) will not 
apply to the First Distribution unless D and D1 choose to have section 
355(f) apply. See paragraph (g) of this section. As a result, section 
355, including the POD Gain Limitation Rule, will

[[Page 279]]

apply to the First Distribution. Under the POD Gain Limitation Rule, 
D1's gain recognized by reason of the Planned 50-percent Acquisition of 
P will not exceed $50x, an amount equal to the amount D1 would have 
recognized had it transferred Asset 1 (Separated Property) to a newly 
formed corporation (C1) solely for stock and distributed the C1 stock to 
D1 shareholders in a Hypothetical D/355(e) Reorganization. See paragraph 
(e)(2)(i) of this section. Under section 361(c)(2), D1 would recognize 
$50x of gain, an amount equal to the gain in the hypothetical C1 stock 
(excess of the $60x fair market value over the $10x basis). Therefore, 
D1 recognizes $50x of gain. Under paragraph (g)(2) of this section, 
however, D and D1 may choose to apply section 355(f) to the First 
Distribution as an exception to the general application of paragraph 
(g)(1) of this section. By application of section 355(f), section 355 
(including the POD Gain Limitation Rule) would not apply to the First 
Distribution. Therefore, D1 would be required to recognize $100x of gain 
(excess of the $200x fair market value over the $100x basis of C stock 
held by D1) under section 311(b), and D would be treated under section 
302(d) as receiving a distribution of $200x to which section 301 
applies.
    (D) P is not a Predecessor of D. Under paragraph (b)(1) of this 
section, P is not a Predecessor of D. First, P is a Potential 
Predecessor of D because P is a member of the same Expanded Affiliated 
Group as D immediately after completion of the Plan. See paragraph 
(b)(2)(ii)(A)(2) of this section. However, although the Relevant 
Property Requirement is satisfied, the Reflection of Basis Requirement 
is not satisfied. The Relevant Property Requirement is satisfied 
because, immediately before the Second Distribution and as part of a 
Plan, C holds P Relevant Property (Asset 1) the gain on which was not 
recognized in full at any point during the Plan Period, and some of the 
C stock distributed in the Second Distribution was indirectly acquired 
by D in exchange for Asset 1. See paragraph (b)(1)(ii)(A)(1) of this 
section. However, regardless of whether D and D1 choose under paragraph 
(g)(2) of this section to have section 355(f) apply to the First 
Distribution, the Reflection of Basis Requirement cannot be satisfied. 
If section 355(f) applies to the First Distribution, then all of the C 
stock will have been transferred in a transaction in which the gain on 
the C stock was recognized in full during the Plan Period prior to the 
Second Distribution. If section 355(f) does not apply to the First 
Distribution, then all of the C stock will have been transferred in a 
distribution to which section 355(e) applied during the Plan Period 
prior to the Second Distribution. Because not all of the pre-
Distribution and post-Distribution requirements are satisfied, P cannot 
be a Predecessor of D.
    (7) Example 7: Sequential Predecessors--(i) Facts. X owns 100% of 
P1, which holds multiple assets, including Asset 1 and Asset 2. Y owns 
100% of P2, which holds Asset 3, and Z owns 100% of D. The following 
steps occur as part of a Plan: P1 merges into P2 in a reorganization 
under 368(a)(1)(A) (P1-P2 reorganization). Immediately after the merger, 
X and Y own 10% and 90%, respectively, of the stock of P2. P2 then 
merges into D in a reorganization under 368(a)(1)(A) (P2-D 
reorganization). Immediately after the merger, X, Y, and Z own 1%, 9%, 
and 90%, respectively, of the stock of D. D then contributes Asset 1 to 
C in exchange for additional C stock, and retains Asset 2 and Asset 3. D 
distributes all of the stock of C to X, Y, and Z, pro rata. Immediately 
before the Distribution, Asset 1 has a basis of $40x and a fair market 
value of $100x, and the stock of C held by D has a basis of $100x and a 
fair market value of $200x.
    (ii) Analysis--(A) P2 is a Predecessor of D. Under paragraph (b)(1) 
of this section, P2 is a Predecessor of D. First, P2 is a Potential 
Predecessor because, as part of a Plan, P2 transferred property to D in 
a Section 381 Transaction. See paragraph (b)(2)(ii)(A)(1) of this 
section. Second, both pre-Distribution requirements and the post-
Distribution requirement are satisfied. The Relevant Property 
Requirement is satisfied because, immediately before the Distribution 
and as part of a Plan, C holds P2 Relevant Property (Asset 1) the gain 
on which was not recognized

[[Page 280]]

in full at any point during the Plan Period, and some of the C stock 
distributed in the Distribution was acquired by D in exchange for Asset 
1. See paragraph (b)(1)(ii)(A)(1) of this section. The Reflection of 
Basis Requirement is satisfied because that C stock had a basis prior to 
the Distribution that was determined in whole or in part by reference to 
the basis of Separated Property (Asset 1), and was neither distributed 
in a distribution to which section 355(e) applied nor transferred in a 
transaction in which the gain on that C stock was recognized in full 
during the Plan Period prior to the Distribution. See paragraph 
(b)(1)(ii)(B) of this section. The Division of Relevant Property 
Requirement is satisfied because immediately after the Distribution, D 
continues to hold P2 Relevant Property (Asset 2 and Asset 3), and 
therefore, as part of a Plan, P2's Relevant Property has been divided 
between C and D. See paragraph (b)(1)(iii) of this section.
    (B) P1 is a Predecessor of D. Under paragraph (b)(1) of this 
section, P1 is a Predecessor of D. First, P1 is a Potential Predecessor 
because, as part of a Plan, P1 transferred property to a Potential 
Predecessor (P2) in a Section 381 Transaction. See paragraph 
(b)(2)(ii)(A)(1) of this section. Second, both pre-Distribution 
requirements and the post-Distribution requirement are satisfied. The 
Relevant Property Requirement is satisfied because, immediately before 
the Distribution and as part of a Plan, C holds P1 Relevant Property 
(Asset 1) the gain on which was not recognized in full at any point 
during the Plan Period, and some of the C stock distributed in the 
Distribution was acquired by D in exchange for Asset 1. See paragraph 
(b)(1)(ii)(A)(1) of this section. The Reflection of Basis Requirement is 
satisfied because that C stock had a basis prior to the Distribution 
that was determined in whole or in part by reference to the basis of 
Separated Property (Asset 1), and was neither distributed in a 
distribution to which section 355(e) applied nor transferred in a 
transaction in which the gain on that C stock was recognized in full 
during the Plan Period prior to the Distribution. See paragraph 
(b)(1)(ii)(B) of this section. The Division of Relevant Property 
Requirement is satisfied because immediately after the Distribution, D 
continues to hold Relevant Property of P1 (Asset 2), and therefore, as 
part of a Plan, P1's Relevant Property has been divided between C and D. 
See paragraph (b)(1)(iii) of this section.
    (C) Planned 50-percent Acquisitions of P1 and P2. Under paragraph 
(d)(1)(i) of this section, Y is treated as acquiring stock representing 
90% of the voting power and value of P1 as a result of the P1-P2 merger. 
In addition, under paragraph (d)(1)(i) of this section, Z is treated as 
acquiring stock representing 90% of the voting power and value of P2 in 
the P2-D merger. Accordingly, there have been Planned 50-percent 
Acquisitions of P1 and P2.
    (D) Gain limited. Without regard to the limitations in paragraph (e) 
of this section, D would be required to recognize $100x of gain ($200x 
of aggregate fair market value minus $100x of aggregate basis of the C 
stock held by D), the Statutory Recognition Amount described in section 
361(c)(2), because there have been Planned 50-percent Acquisitions of P1 
and P2, both Predecessors of D. However, under paragraph (e) of this 
section, D's gain recognized by reason of the Planned 50-percent 
Acquisitions of P1 and P2 will not exceed $60x, an amount equal to the 
amount D would have recognized had it transferred Asset 1 (Separated 
Property) to a newly formed corporation (C1) solely for stock and 
distributed the C1 stock to D shareholders in a Hypothetical D/355(e) 
Reorganization. Under section 361(c)(2), D would recognize $60x, an 
amount equal to the gain in the hypothetical C1 stock (excess of the 
$100x fair market value over the $40x basis). Paragraph (e)(1)(ii) of 
this section provides that if there are Planned 50-percent Acquisitions 
of multiple corporations, Distributing must recognize the Statutory 
Recognition Amount with respect to each such corporation, subject to the 
POD Gain Limitation Rule and the Distributing Gain Limitation Rule, if 
applicable. In this case, the POD Gain Limitation Rule limits the amount 
of gain required to be recognized by D with respect to each of the 
Planned 50-percent Acquisitions of P1 and P2 to $60x. See paragraph 
(e)(2)(i) of this section. Ordinarily, each $60x limitation would be 
added together,

[[Page 281]]

and the total gain limitation provided by paragraph (e) of this section 
would be $120x. However, the anti-duplication rule set forth in 
paragraph (e)(2)(ii)(C) of this section provides that, for purposes of 
applying the POD Gain Limitation Rule, a Predecessor of Distributing's 
Separated Property is taken into account only to the extent such 
property was not taken into account with respect to another Predecessor 
of Distributing. Thus, Asset 1 may not be taken into account more than 
once in determining the total gain limitation. Therefore, D recognizes 
$60x of gain.
    (8) Example 8: Multiple Predecessors of D--(i) Facts. X owns 100% of 
the stock of P1, which holds multiple assets, including Asset 1 and 
Asset 3. Y owns 100% of the stock of P2, which holds multiple assets, 
including Asset 2 and Asset 4. Z owns 100% of the stock of D. The 
following steps occur as part of a Plan: Each of P1 and P2 merges into D 
in a reorganization under section 368(a)(1)(A). Immediately after the 
mergers, each of X and Y owns 10%, and Z owns 80%, of the stock of D. D 
then contributes to C Asset 1 (acquired from P1), and Asset 2 (acquired 
from P2). In exchange for Asset 1 and Asset 2, D receives additional C 
stock. D distributes the stock of C to X, Y, and Z, pro rata. D's 
contribution of Asset 1 and Asset 2 and the Distribution constitute a 
reorganization under section 368(a)(1)(D). D continues to hold Asset 3 
and Asset 4. Immediately before the Distribution, Asset 1 has a basis of 
$50x and a fair market value of $110x, Asset 2 has a basis of $70x and a 
fair market value of $90x, and the stock of C held by D has a basis of 
$130x and a fair market value of $220x.
    (ii) Analysis--(A) P1 and P2 are Predecessors of D. Under paragraph 
(b)(1) of this section, each of P1 and P2 is a Predecessor of D. First, 
each of P1 and P2 is a Potential Predecessor because, as part of a Plan, 
each of P1 and P2 transferred property to D in a Section 381 
Transaction. See paragraph (b)(2)(ii)(A)(1) of this section. Second, 
both pre-Distribution requirements and the post-Distribution requirement 
are satisfied. The Relevant Property Requirement is satisfied because, 
immediately before the Distribution and as part of a Plan, C holds P1 
Relevant Property (Asset 1) and P2 Relevant Property (Asset 2), the gain 
on each of which was not recognized in full at any point during the Plan 
Period, and some of the C stock distributed in the Distribution was 
acquired by D in exchange for each of Asset 1 and Asset 2. See paragraph 
(b)(1)(ii)(A)(1) of this section. The Reflection of Basis Requirement is 
satisfied because that C stock had a basis prior to the Distribution 
that was determined in whole or in part by reference to the basis of 
Separated Property (Asset 1 and Asset 2, respectively), and was neither 
distributed in a distribution to which section 355(e) applied nor 
transferred in a transaction in which the gain on that C stock was 
recognized in full during the Plan Period prior to the Distribution. See 
paragraph (b)(1)(ii)(B) of this section. The Division of Relevant 
Property Requirement is satisfied because immediately after the 
Distribution, D continues to hold Relevant Property of P1 and P2, and 
therefore, as part of a Plan, each of P1's and P2's Relevant Property 
has been divided between C and D. See paragraph (b)(1)(iii) of this 
section.
    (B) Planned 50-percent Acquisitions of P1 and P2. Under paragraph 
(d)(1)(i) of this section, Z is treated as acquiring stock representing 
80% of the voting power and value of each of P1 and P2 as a result of 
the mergers of P1 and P2 into D. Accordingly, there have been Planned 
50-percent Acquisitions of P1 and P2.
    (C) Gain limited. Without regard to the limitations in paragraph (e) 
of this section, D would be required to recognize $90x of gain ($220x of 
fair market value minus $130x of basis of the C stock held by D), the 
Statutory Recognition Amount under section 361(c)(2). However, under the 
POD Gain Limitation Rule, D's gain recognized by reason of the Planned 
50-percent Acquisition of P1 will not exceed $60x ($110x fair market 
value minus $50x basis), an amount equal to the amount D would have 
recognized had it transferred Asset 1 (Separated Property) to a newly 
formed corporation (C1) solely for stock and distributed the C1 stock to 
D shareholders in a Hypothetical D/355(e) Reorganization. See paragraph

[[Page 282]]

(e)(2)(i) of this section. In addition, under the POD Gain Limitation 
Rule, D's gain recognized by reason of the deemed acquisition of P2 
stock will not exceed $20x ($90x fair market value minus $70x basis), an 
amount equal to the amount D would have recognized had it transferred 
Asset 2 (Separated Property) to a second newly formed corporation (C2) 
solely for stock and distributed the C2 stock to D shareholders in a 
Hypothetical D/355(e) Reorganization. See paragraph (e)(2)(i) of this 
section. Therefore, D recognizes $80x of gain ($60x + $20x). See 
paragraph (e)(1)(ii) of this section.
    (9) Example 9: Successor of C--(i) Facts. X owns 100% of the stock 
of each of D and R. The following steps occur as part of a Plan: D 
distributes all of its C stock to X. Immediately before the 
Distribution, D's C stock has a basis of $10x and a fair market value of 
$30x. C then merges into R in a reorganization under section 
368(a)(1)(D). Immediately after the merger, X owns all of the R stock. 
As part of the same Plan, Z acquires 51% of the stock of R from X.
    (ii) Analysis--(A) R is a Successor of C. Under paragraph (c)(2)(i) 
of this section, R is a Successor of C because, after the Distribution, 
C transfers property to R in a Section 381 Transaction.
    (B) Planned 50-percent Acquisition of C. Under paragraph (d)(2) of 
this section, Z's acquisition of stock of R is treated as an acquisition 
of stock of C. Therefore, Z is treated as acquiring 51% of the stock of 
C. Accordingly, there has been a Planned 50-percent Acquisition of C.
    (C) Gain not limited. Section 355(e) applies to the Distribution 
because there has been a Planned 50-percent Acquisition of C. Neither 
the POD Gain Limitation Rule nor the Distributing Gain Limitation Rule 
applies because there has been no Planned 50-percent Acquisition of a 
Predecessor of D, and no Planned 50-percent Acquisition of D. Therefore, 
D recognizes $20x of gain ($30x fair market value minus $10x basis of 
the C stock held by D) under section 355(c)(2).
    (10) Example 10: Multiple Successors--(i) Facts. X owns 100% of the 
stock of both D and R. Y owns 100% of the stock of S. The following 
steps occur as part of a Plan: D distributes all of the C stock to X. 
Immediately after the Distribution, D merges into R in a reorganization 
under section 368(a)(1)(A) (D-R merger). Following the D-R merger, R 
merges into S in a reorganization under section 368(a)(1)(A) (R-S 
merger). Immediately after the R-S merger, X and Y own 10% and 90%, 
respectively, of the S stock. Immediately before the Distribution, D's C 
stock has a basis of $10x and a fair market value of $30x.
    (ii) Analysis--(A) R and S are Successors of D. Under paragraph 
(c)(2)(i) of this section, R is a Successor of D because, after the 
Distribution, D transfers property to R in a Section 381 Transaction. 
Under paragraph (c)(2)(ii) of this section, S is also a Successor of D 
because R (a Successor of D) transfers property to S in a Section 381 
Transaction.
    (B) Planned 50-percent Acquisition of D. Under paragraph (d)(1)(i) 
of this section, there is no deemed acquisition of D stock as a result 
of the D-R merger because X wholly owns the stock of D before the merger 
and wholly owns the stock of R after the merger. Under paragraph 
(d)(1)(i) of this section, Y is treated as acquiring stock representing 
90% of the voting power and value of R (a Successor of D) as a result of 
the R-S merger. Under paragraph (d)(2) of this section, an acquisition 
of R stock is also treated as an acquisition of D stock. Accordingly, 
there has been a Planned 50-percent Acquisition of D.
    (C) Gain not limited. Section 355(e) applies to the Distribution 
because there has been a Planned 50-percent Acquisition of D. The POD 
Gain Limitation Rule does not apply because there has been no Planned 
50-percent Acquisition of a Predecessor of D. The Distributing Gain 
Limitation Rule applies because there has been a Planned 50-percent 
Acquisition of D. However, the gain limitation under the Distributing 
Gain Limitation Rule equals the Statutory Recognition Amount, because 
there is no Predecessor of D (and thus no Separated Property). 
Therefore, D recognizes $20x of gain ($30x fair market value minus $10x 
basis of the C stock held by D) under section 355(c)(2).
    (i) Applicability date. This section applies to Distributions 
occurring after December 15, 2019. For Distributions

[[Page 283]]

occurring on or before December 15, 2019, see Sec. 1.355-8T as 
contained in 26 CFR part 1 revised as of April 1, 2019.

[T.D. 9888, 84 FR 69317, Dec. 18, 2019; 85 FR 15060, Mar. 17, 2020]



Sec. 1.356-1  Receipt of additional consideration in connection with
an exchange.

    (a) If in any exchange to which the provisions of section 354 or 
section 355 would apply except for the fact that there is received by 
the shareholders or security holders other property (in addition to 
property permitted to be received without recognition of gain by such 
sections) or money, then--
    (1) The gain, if any, to the taxpayer shall be recognized in an 
amount not in excess of the sum of the money and the fair market value 
of the other property, but,
    (2) The loss, if any, to the taxpayer from the exchange or 
distribution shall not be recognized to any extent.
    (b) For purposes of computing the gain, if any, recognized pursuant 
to section 356 and paragraph (a)(1) of this section, to the extent the 
terms of the exchange specify the other property or money that is 
received in exchange for a particular share of stock or security 
surrendered or a particular class of stock or securities surrendered, 
such terms shall control provided that such terms are economically 
reasonable. To the extent the terms of the exchange do not specify the 
other property or money that is received in exchange for a particular 
share of stock or security surrendered or a particular class of stock or 
securities surrendered, a pro rata portion of the other property and 
money received shall be treated as received in exchange for each share 
of stock and security surrendered, based on the fair market value of 
such surrendered share of stock or security.
    (c) If the distribution of such other property or money by or on 
behalf of a corporation has the effect of the distribution of a 
dividend, then there shall be chargeable to each distributee (either an 
individual or a corporation)--
    (1) As a dividend, such an amount of the gain recognized as is not 
in excess of the distributee's ratable share of the undistributed 
earnings and profits of the corporation accumulated after February 28, 
1913, and
    (2) As a gain from the exchange of property, the remainder of the 
gain so recognized.
    (d) The rules of this section may be illustrated by the following 
examples:

    Example 1. In an exchange to which the provisions of section 356 
apply and to which section 354 would apply but for the receipt of 
property not permitted to be received without the recognition of gain or 
loss, A (either an individual or a corporation), received the following 
in exchange for a share of stock having an adjusted basis to A of $85:

------------------------------------------------------------------------
 
------------------------------------------------------------------------
One share of stock worth...................................         $100
Cash.......................................................           25
Other property (basis $25) fair market value...............           50
 
    Total fair market value of consideration received......          175
    Adjusted basis of stock surrendered in exchange........           85
        Total gain.........................................           90
 
Gain to be recognized, limited to cash and other property             75
 received..................................................
A's pro rata share of earnings and profits accumulated                30
 after February 28, 1913 (taxable dividend)................
 
    Remainder to be treated as a gain from the exchange of            45
     property..............................................
------------------------------------------------------------------------

    Example 2. If, in Example 1, A's stock had an adjusted basis to A of 
$200, A would have realized a loss of $25 on the exchange, which loss 
would not be recognized.
    Example 3. (i) Facts. J, an individual, acquired 10 shares of Class 
A stock of Corporation X on Date 1 for $3 each and 10 shares of Class B 
stock of Corporation X on Date 2 for $9 each. On Date 3, Corporation Y 
acquires the assets of Corporation X in a reorganization under section 
368(a)(1)(A). Pursuant to the terms of the plan of reorganization, J 
surrenders all of J's shares of Corporation X stock for 10 shares of 
Corporation Y stock and $100 of cash. On the date of the exchange, the 
fair market value of each share of Class A stock of Corporation X is 
$10, the fair market value of each share of Class B stock of Corporation 
X is $10, and the fair market value of each share of Corporation Y stock 
is

[[Page 284]]

$10. The terms of the exchange do not specify that shares of Corporation 
Y stock or cash are received in exchange for particular shares of Class 
A stock or Class B stock of Corporation X.
    (ii) Analysis. Under paragraph (b) of this section, because the 
terms of the exchange do not specify that the cash is received in 
exchange for shares of Class A or Class B stock of Corporation X, a pro 
rata portion of the cash received is treated as received in exchange for 
each share of Class A stock of Corporation X and each share of Class B 
stock of Corporation X based on the fair market value of the surrendered 
shares. Therefore, J is treated as receiving shares of Corporation Y 
stock with a fair market value of $50 and $50 of cash in exchange for 
its shares of Class A stock of Corporation X and shares of Corporation Y 
stock with a fair market value of $50 and $50 of cash in exchange for 
its shares of Class B stock of Corporation X. J realizes a gain of $70 
on the exchange of shares of Class A stock, $50 of which is recognized 
under section 356 and paragraph (a) of this section, and J realizes a 
gain of $10 on the exchange of shares of Class B stock of Corporation X, 
all of which is recognized under section 356 and paragraph (a) of this 
section. Assuming that J's gain recognized is not treated as a dividend 
under section 356(a)(2), such gain shall be treated as gain from the 
exchange of property.
    Example 4. (i) Facts. The facts are the same as in Example 3, except 
that the terms of the plan of reorganization specify that J receives 10 
shares of stock of Corporation Y in exchange for J's shares of Class A 
stock of Corporation X and $100 of cash in exchange for J's shares of 
Class B stock of Corporation X.
    (ii) Analysis. Under paragraph (b) of this section, because the 
terms of the exchange specify that J receives 10 shares of stock of 
Corporation Y in exchange for J's shares of Class A stock of Corporation 
X and $100 of cash in exchange for J's shares of Class B stock of 
Corporation X and such terms are economically reasonable, such terms 
control. J realizes a gain of $70 on the exchange of shares of Class A 
stock, none of which is recognized under section 356 and paragraph (a) 
of this section, and J realizes a gain of $10 on the exchange of shares 
of Class B stock of Corporation X, all of which is recognized under 
section 356 and paragraph (a) of this section.

    (e) Section 301(b)(1)(B) and section 301(d)(2) do not apply to a 
distribution of ``other property'' to a corporate shareholder if such 
distribution is within the provisions of section 356.
    (f) See paragraph (l) of Sec. 1.301-1 for certain transactions 
which are not within the scope of section 356.
    (g) This section applies to exchanges and distributions of stock and 
securities occurring on or after January 23, 2006.

[T.D. 9244, 71 FR 4268, Jan. 26, 2006]



Sec. 1.356-2  Receipt of additional consideration not in connection 
with an exchange.

    (a) If, in a transaction to which section 355 would apply except for 
the fact that a shareholder (individual or corporate) receives property 
permitted by section 355 to be received without the recognition of gain, 
together with other property or money, without the surrender of any 
stock or securities of the distributing corporation, then the sum of the 
money and the fair market value of the other property as of the date of 
the distribution shall be treated as a distribution of property to which 
the rules of section 301 (other than section 301(b) and section 301(d)) 
apply. See section 358 for determination of basis of such other 
property.
    (b) Paragraph (a) of this section may be illustrated by the 
following examples:

    Example 1. Individuals A and B each own 50 of the 100 outstanding 
shares of common stock of Corporation X. Corporation X owns all of the 
stock of Corporation Y, 100 shares. Corporation X distributes to each 
shareholder 50 shares of the stock of Corporation Y plus $100 cash 
without requiring the surrender of any shares of its own stock. The $100 
cash received by each is treated as a distribution of property to which 
the rules of section 301 apply.
    Example 2. If, in the above example, Corporation X distributes 50 
shares of stock of Corporation Y to A and 30 shares of such stock plus 
$100 cash to B without requiring the surrender of any of its own stock, 
the amount of cash received by B is treated as a distribution of 
property to which the rules of section 301 apply.



Sec. 1.356-3  Rules for treatment of securities as ``other property''.

    (a) As a general rule, for purposes of section 356, the term other 
property includes securities. However, it does not include securities 
permitted under section 354 or section 355 to be received tax free. 
Thus, when securities are surrendered in a transaction to which section 
354 or section 355 is applicable, the

[[Page 285]]

characterization of the securities received as ``other property'' does 
not include securities received where the principal amount of such 
securities does not exceed the principal amount of securities 
surrendered in the transaction. If a greater principal amount of 
securities is received in an exchange described in section 354 (other 
than subsection (c) or (d) thereof) or section 355 over the principal 
amount of securities surrendered, the term other property includes the 
fair market value of such excess principal amount as of the date of the 
exchange. If no securities are surrendered in exchange, the term other 
property includes the fair market value, as of the date of receipt, of 
the entire principal amount of the securities received.
    (b) Except as provided in Sec. 1.356-6, for purposes of this 
section, a right to acquire stock that is treated as a security for 
purposes of section 354 or 355 has no principal amount. Thus, such right 
is not other property when received in a transaction to which section 
356 applies (regardless of whether securities are surrendered in the 
exchange). This paragraph (b) applies to transactions occurring on or 
after March 9, 1998.
    (c) In the examples in this paragraph (c), stock means common stock 
and warrants means rights to acquire common stock. The following 
examples illustrate the rules of paragraph (a) of this section:

    Example 1. A, an individual, exchanged 100 shares of stock for 100 
shares of stock and a security in the principal amount of $1,000 with a 
fair market value of $990. The amount of $990 is treated as ``other 
property.''
    Example 2. B, an individual, exchanged 100 shares of stock and a 
security in the principal amount of $1,000 for 300 shares of stock and a 
security in the principal amount of $1,500. The security had a fair 
market value on the date of receipt of $1,575. The fair market value of 
the excess principal amount, or $525, is treated as ``other property.''
    Example 3. C, an individual, exchanged a security in the principal 
amount of $1,000 for 100 shares of stock and a security in the principal 
amount of $900. No part of the security received is treated as ``other 
property.''
    Example 4. D, an individual, exchanged a security in the principal 
amount of $1,000 for 100 shares of stock and a security in the principal 
amount of $1,200 with a fair market value of $1,100. The fair market 
value of the excess principal amount, or $183.33, is treated as ``other 
property.''
    Example 5. E, an individual, exchanged a security in the principal 
amount of $1,000 for another security in the principal amount of $1,200 
with a fair market value of $1,080. The fair market value of the excess 
principal amount, or $180, is treated as ``other property.''
    Example 6. F, an individual, exchanged a security in the principal 
amount of $1,000 for two different securities each in the principal 
amount of $750. One of the securities had a fair market value of $750, 
the other had a fair market value of $600. One-third of the fair market 
value of each security ($250 and $200) is treated as ``other property.''
    Example 7. G, an individual, exchanged stock for stock and a 
warrant. The warrant had no principal amount. Thus, G received no excess 
principal amount within the meaning of section 356(d).
    Example 8. H, an individual, exchanged a warrant for stock and a 
warrant. The warrants had no principal amount. Thus, H received no 
excess principal amount within the meaning of section 356(d).
    Example 9. I, an individual, exchanged a warrant for stock and a 
debt security. The warrant had no principal amount. The debt security 
had a $100 principal amount. I received $100 of excess principal amount 
within the meaning of section 356(d).

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7616, 44 FR 
26869, May 8, 1979; T.D. 8752, 63 FR 410, Jan. 6, 1998; T.D. 8882, 65 FR 
31078, May 16, 2000]



Sec. 1.356-4  Exchanges for section 306 stock.

    If, in a transaction to which section 356 is applicable, other 
property or money is received in exchange for section 306 stock, an 
amount equal to the fair market value of the property plus the money, if 
any, shall be treated as a distribution of property to which section 301 
is applicable. The determination of whether section 306 stock is 
surrendered for other property (including money) is a question of fact 
to be decided under all of the circumstances of each case. Ordinarily, 
the other property (including money) received will first be treated as 
received in exchange for any section 306 stock owned by a shareholder 
prior to such transaction. For example, if a shareholder who owns a 
share of common stock (having a basis to him of $100) and a share of 
preferred stock which is section 306 stock (having a basis to him of 
$100) surrenders both shares in a transaction to

[[Page 286]]

which section 356 is applicable for one share of common stock having a 
fair market value of $80 and one $100 bond having a fair market value of 
$100, the bond will be deemed received in exchange for the section 306 
stock and it will be treated as a distribution to which section 301 is 
applicable to the extent of its entire fair market value ($100).



Sec. 1.356-5  Transactions involving gift or compensation.

    With respect to transactions described in sections 354, 355, or 356, 
but which--
    (a) Result in a gift, see section 2501 and following, and the 
regulations pertaining thereto, or
    (b) Have the effect of the payment of compensation, see section 
61(a)(1), and the regulations pertaining thereto.



Sec. 1.356-6  Rules for treatment of nonqualified preferred stock
as other property.

    (a) In general. For purposes of Sec. Sec. 1.354-1(e), 1.355-1(c), 
and 1.356-3(b), the terms stock and securities do not include--
    (1) Nonqualified preferred stock, as defined in section 351(g)(2), 
received in exchange for (or in a distribution with respect to) stock, 
or a right to acquire stock, other than nonqualified preferred stock; or
    (2) A right to acquire such nonqualified preferred stock, received 
in exchange for (or in a distribution with respect to) stock, or a right 
to acquire stock, other than nonqualified preferred stock.
    (b) Exceptions. The following exceptions apply:
    (1) Certain recapitalizations. Paragraph (a) of this section does 
not apply in the case of a recapitalization under section 368(a)(1)(E) 
of a family-owned corporation as described in section 
354(a)(2)(C)(ii)(II).
    (2) Transition rule. Paragraph (a) of this section does not apply to 
a transaction described in section 1014(f)(2) of the Taxpayer Relief Act 
of 1997 (111 Stat. 921).
    (c) Effective date. This section applies to nonqualified preferred 
stock, or a right to acquire such stock, received in connection with a 
transaction occurring on or after March 9, 1998.

[T.D. 8753, 63 FR 411, Jan. 6, 1998. Redesignated by T.D. 8882, 65 FR 
31078, May 16, 2000]



Sec. 1.356-7  Rules for treatment of nonqualified preferred stock 
and other preferred stock received in certain transactions.

    (a) Stock issued prior to effective date. Stock described in section 
351(g)(2) is nonqualified preferred stock (NQPS) regardless of the date 
on which the stock is issued. However, sections 351(g), 354(a)(2)(C), 
355(a)(3)(D), 356(e), and 1036(b) do not apply to any transaction 
occurring prior to June 9, 1997, or to any transaction occurring after 
June 8, 1997, that is described in section 1014(f)(2) of the Taxpayer 
Relief Act of 1997, Public Law 105-34 (111 Stat. 788, 921). For purposes 
of this section, preferred stock that is not NQPS is referred to as 
Qualified Preferred Stock (QPS).
    (b) Receipt of preferred stock in exchange for (or distribution on) 
substantially identical preferred stock--(1) General rule. For purposes 
of sections 354(a)(2)(C)(i), 355(a)(3)(D), and 356(e)(2), preferred 
stock is QPS, even though it is described in section 351(g)(2), if it is 
received in exchange for (or in a distribution with respect to) 
preferred stock (the original preferred stock) that is QPS, provided--
    (i) The original preferred stock is QPS solely because, on its issue 
date, either a right or obligation described in clause (i), (ii), or 
(iii) of section 351(g)(2)(A) was not exercisable until after a 20-year 
period beginning on the issue date, or the right or obligation was 
exercisable within the 20-year period beginning on the issue date but 
was subject to a contingency which made remote the likelihood of the 
redemption or purchase, or the issuer's (or a related party's) right to 
redeem or purchase the stock was not more likely than not to be 
exercised within a 20-year period beginning on the issue date, or 
because of any combination of these reasons; and
    (ii) The stock received is substantially identical to the original 
preferred stock.

[[Page 287]]

    (2) Substantially identical. The stock received is substantially 
identical to the original preferred stock if--
    (i) The stock received does not contain any term or terms that, in 
relation to any term or terms of the original preferred stock, either 
decrease the period in which a right or obligation described in clause 
(i), (ii), or (iii) of section 351(g)(2)(A) can be exercised, or 
increase the likelihood that such a right or obligation will be 
exercised, or accelerate the timing of the returns from the stock 
instrument, including the timing of actual or deemed dividends or other 
distributions received on the stock; and
    (ii) As a result of the exchange or distribution, exercise of the 
right or obligation does not become more likely than not to occur within 
a 20-year period beginning on the issue date of the original preferred 
stock.
    (3) Treatment of stock received. The stock received will continue to 
be treated as QPS in subsequent transactions involving such stock, and 
the principles of this paragraph (b) apply to such transactions as 
though the stock received is the original preferred stock issued on the 
same date as the original preferred stock.
    (c) Stock transferred for services. For purposes of sections 
351(g)(1), 354(a)(2)(C)(i), 355(a)(3)(D), and 356(e)(2), preferred stock 
containing a right or obligation described in clause (i), (ii) or (iii) 
of section 351(g)(2)(A) that is exercisable only upon the holder's 
separation from service from the issuer or a related person (as 
described in section 351(g)(3)(B)) will be treated as transferred in 
connection with the performance of services (and representing reasonable 
compensation) within the meaning of section 351(g)(2)(C)(i)(II), if such 
preferred stock is received in exchange for (or in a distribution with 
respect to) existing stock containing a similar right or obligation 
(exercisable only upon separation from service) and the existing stock 
was transferred in connection with the performance of services for the 
issuer or a related person (and represented reasonable compensation when 
transferred). In applying the rules relating to NQPS, the preferred 
stock received will continue to be treated as transferred in connection 
with the performance of services (and representing reasonable 
compensation) in subsequent transactions involving such stock, and the 
principles of this paragraph (c) apply to such transactions.
    (d) Rights to acquire stock. For purposes of Sec. 1.356-6, the 
principles of paragraphs (a), (b), and (c) of this section apply.
    (e) Examples. In the examples in this paragraph (e), T and P are 
corporations, A is a shareholder of T, and A surrenders and receives (in 
addition to the stock exchanged in the examples) common stock in the 
reorganizations described. The following examples illustrate paragraphs 
(a), (b), and (c) of this section:

    Example 1. In 1995, A transfers property to T and receives T 
preferred stock that is described in section 351(g)(2) in a transaction 
under section 351. In 2002, pursuant to a reorganization under section 
368(a)(1)(B), A surrenders the T preferred stock in exchange for P NQPS. 
Under paragraph (a) of this section, the T preferred stock issued to A 
in 1995 is NQPS. However, because section 351(g) does not apply to 
transactions occurring before June 9, 1997, the T NQPS was not ``other 
property'' within the meaning of section 351(b) when issued in 1995. 
Under sections 354(a)(2)(C) and 356(e)(2), the P NQPS received by A in 
2002 is not ``other property'' within the meaning of section 
356(a)(1)(B) because it is received in exchange for NQPS.
    Example 2. T issues QPS to A on January 1, 2000 that is not NQPS 
solely because the holder cannot require T to redeem the stock until 
January 1, 2022. In 2007, pursuant to a reorganization under section 
368(a)(1)(A) in which T merges into P, A surrenders the T preferred 
stock in exchange for P preferred stock with terms that are identical to 
the terms of the T preferred stock, including the term that the holder 
cannot require the redemption of the stock until January 1, 2022. 
Because the P stock and the T stock have identical terms, and because 
the redemption did not become more likely than not to occur within the 
20-year period that begins on January 1, 2000 (which is the issue date 
of the T preferred stock) as a result of the exchange, under paragraph 
(b) of this section, the P preferred stock received by A is treated as 
QPS. Thus, the P preferred stock received is not ``other property'' 
within the meaning of section 356(a)(1)(B).
    Example 3. The facts are the same as in Example 2, except that, in 
addition, in 2010, pursuant to a recapitalization of P under section 
368(a)(1)(E), A exchanges the P preferred stock above for P NQPS that 
permits the holder to require P to redeem the stock in

[[Page 288]]

2020. Under paragraph (b) of this section, the P preferred stock 
surrendered by A is treated as QPS. Because the P preferred stock 
received by A in the recapitalization is not substantially identical to 
the P preferred stock surrendered, the P preferred stock received by A 
is not treated as QPS. Thus, the P preferred stock received is ``other 
property'' within the meaning of section 356(a)(1)(B).
    Example 4. T issues preferred stock to A on January 1, 2000 that 
permits the holder to require T to redeem the stock on January 1, 2018, 
or at any time thereafter, but which is not NQPS solely because, as of 
the issue date, the holder's right to redeem is subject to a contingency 
that makes remote the likelihood of redemption on or before January 1, 
2020. In 2007, pursuant to a reorganization under section 368(a)(1)(A) 
in which T merges into P, A surrenders the T preferred stock in exchange 
for P preferred stock with terms that are identical to the terms of the 
T preferred stock. Immediately before the exchange, the contingency to 
which the holder's right to cause redemption of the T stock is subject 
makes remote the likelihood of redemption before January 1, 2020, but 
the P stock, although subject to the same contingency, is more likely 
than not to be redeemed before January 1, 2020. Because, as a result of 
the exchange of T stock for P stock, the exercise of the redemption 
right became more likely than not to occur within the 20-year period 
beginning on the issue date of the T preferred stock, the P preferred 
stock received by A is not substantially identical to the T stock 
surrendered, and is not treated as QPS. Thus, the P preferred stock 
received is ``other property'' within the meaning of section 
356(a)(1)(B).
    Example 5. The facts are the same as in Example 4, except that, 
immediately before the merger of T into P in 2007, the contingency to 
which the holder's right to cause redemption of the T stock is subject 
makes it more likely than not that the T stock will be redeemed before 
January 1, 2020. Because exercise of the redemption right did not become 
more likely than not to occur within the 20-year period beginning on the 
issue date of the T preferred stock as a result of the exchange, the P 
preferred stock received by A is substantially identical to the T stock 
surrendered, and is treated as QPS. Thus, the P preferred stock received 
is not ``other property'' within the meaning of section 356(a)(1)(B).
    Example 6. A is an employee of T. In connection with A's performance 
of services for T, T transfers to A in 2000 an amount of T common stock 
that represents reasonable compensation. The T common stock contains a 
term granting A the right to require T to redeem the common stock, but 
only upon A's separation from service from T. In 2005, pursuant to a 
reorganization under section 368(a)(1)(A) in which T merges into P, A 
receives, in exchange for A's T common stock, P preferred stock granting 
a similar redemption right upon A's separation from P's service. Under 
paragraph (c) of this section, the P preferred stock received by A is 
treated as transferred in connection with the performance of services 
(and representing reasonable compensation) within the meaning of section 
351(g)(2)(C)(i)(II). Thus, the P preferred stock received by A is QPS.

    (f) Effective dates. This section applies to transactions occurring 
on or after October 2, 2000.

[T.D. 8904, 65 FR 58651, Oct. 2, 2000]



Sec. 1.357-1  Assumption of liability.

    (a) General rule. Section 357(a) does not affect the rule that 
liabilities assumed are to be taken into account for the purpose of 
computing the amount of gain or loss realized under section 1001 upon an 
exchange. Section 357(a) provides, subject to the exceptions and 
limitations specified in section 357 (b) and (c), that--
    (1) Liabilities assumed are not to be treated as ``other property or 
money'' for the purpose of determining the amount of realized gain which 
is to be recognized under section 351, 361, 371, or 374, if the 
transactions would, but for the receipt of ``other property or money'' 
have been exchanges of the type described in any one of such sections; 
and
    (2) If the only type of consideration received by the transferor in 
addition to that permitted to be received by section 351, 361, 371, or 
374, consists of an assumption of liabilities, the transaction, if 
otherwise qualified, will be deemed to be within the provisions of 
section 351, 361, 371, or 374.
    (b) Application of general rule. The application of paragraph (a) of 
this section may be illustrated by the following example:

    Example. A, an individual, transfers to a controlled corporation 
property with an adjusted basis of $10,000 in exchange for stock of the 
corporation with a fair market value of $8,000, $3,000 cash, and the 
assumption by the corporation of indebtedness of A amounting to $4,000. 
A's gain is $5,000, computed as follows:

Stock received, fair market value.............................    $8,000
Cash received.................................................     3,000
Liability assumed by transferee...............................     4,000
                                                               ---------
 Total consideration received.................................    15,000

[[Page 289]]

 
Less: Adjusted basis of property transferred..................    10,000
                                                               ---------
 Gain realized................................................     5,000
 


Assuming that the exchange falls within section 351 as a transaction in 
which the gain to be recognized is limited to ``other property or 
money'' received, the gain recognized to A will be limited to the $3,000 
cash received, since, under the general rule of section 357(a), the 
assumption of the $4,000 liability does not constitute ``other 
property.''

    (c) Tax avoidance purpose. The benefits of section 357(a) do not 
extend to any exchange involving an assumption of liabilities where it 
appears that the principal purpose of the taxpayer with respect to such 
assumption was to avoid Federal income tax on the exchange, or, if not 
such purpose, was not a bona fide business purpose. In such cases, the 
total amount of liabilities assumed or acquired pursuant to such 
exchange (and not merely a particular liability with respect to which 
the tax avoidance purpose existed) shall, for the purpose of determining 
the amount of gain to be recognized upon the exchange in which the 
liabilities are assumed or acquired, be treated as money received by the 
taxpayer upon the exchange. Thus, if in the example set forth in 
paragraph (b) of this section, the principal purpose of the assumption 
of the $4,000 liability was to avoid tax on the exchange, or was not a 
bona fide business purpose, then the amount of gain recognized would be 
$5,000. In any suit or proceeding where the burden is on the taxpayer to 
prove that an assumption of liabilities is not to be treated as ``other 
property or money'' under section 357, which is the case if the 
Commissioner determines that the taxpayer's purpose with respect thereto 
was a purpose to avoid Federal income tax on the exchange or was not a 
bona fide business purpose, and the taxpayer contests such determination 
by litigation, the taxpayer must sustain such burden by the clear 
preponderance of the evidence. Thus, the taxpayer must prove his case by 
such a clear preponderance of all the evidence that the absence of a 
purpose to avoid Federal income tax on the exchange, or the presence of 
a bona fide business purpose, is unmistakable.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6528, 26 FR 
399, Jan. 19, 1961]



Sec. 1.357-2  Liabilities in excess of basis.

    (a) Section 357(c) provides in general that in an exchange to which 
section 351 (relating to a transfer to a corporation controlled by the 
transferor) is applicable, or to which section 361 (relating to the 
nonrecognition of gain or loss to corporations) is applicable by reason 
of a section 368(a)(1)(D) reorganization, if the sum of the amount of 
liabilities assumed plus the amount of liabilities to which the property 
is subject exceeds the total of the adjusted basis of the property 
transferred pursuant to such exchange, then such excess shall be 
considered as a gain from the sale or exchange of a capital asset or of 
property which is not a capital asset as the case may be. Thus, if an 
individual transfers, under section 351, properties having a total basis 
in his hands of $20,000, one of which has a basis of $10,000 but is 
subject to a mortgage of $30,000, to a corporation controlled by him, 
such individual will be subject to tax with respect to $10,000, the 
excess of the amount of the liability over the total adjusted basis of 
all the properties in his hands. The same result will follow whether or 
not the liability is assumed by the transferee. The determination of 
whether a gain resulting from the transfer of capital assets is long-
term or short-term capital gain shall be made by reference to the 
holding period to the transferor of the assets transferred. An exception 
to the general rule of section 357(c) is made (1) for any exchange as to 
which under section 357(b) (relating to assumption of liabilities for 
tax-avoidance purposes) the entire amount of the liabilities is treated 
as money received and (2) for an exchange to which section 371 (relating 
to reorganizations in certain receivership and bankruptcy proceedings) 
or section 374 (relating to gain or loss not recognized in certain 
railroad reorganizations) is applicable.
    (b) The application of paragraph (a) of this section may be 
illustrated by the following examples:

    Example 1. If all such assets transferred are capital assets and if 
half the assets (ascertained by reference to their fair market value at 
the time of the transfer) have been held for less than 1 year (6 months 
for taxable years beginning before 1977; 9 months for taxable years 
beginning in 1977), and the

[[Page 290]]

remaining half for more than 1 year (6 months for taxable years 
beginning before 1977; 9 months for taxable years beginning in 1977), 
half the excess of the amount of the liability over the total of the 
adjusted basis of the property transferred pursuant to the exchange 
shall be treated as short-term capital gain, and the remaining half 
shall be treated as long-term capital gain.
    Example 2. If half of the assets (ascertained by reference to their 
fair market value at the time of the transfer) transferred are capital 
assets and half are assets other than capital assets, then half of the 
excess of the amount of the liability over the total of the adjusted 
basis of the property transferred pursuant to the exchange shall be 
treated as capital gain, and the remaining half shall be treated as gain 
from the sale or exchange of assets other than capital assets.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6528, 26 FR 
399, Jan. 19, 1961; T.D. 7728, 45 FR 72650, Nov. 3, 1980]



Sec. 1.358-1  Basis to distributees.

    (a) In the case of an exchange to which section 354 or 355 applies 
in which, under the law applicable to the year in which the exchange is 
made, only nonrecognition property is received, immediately after the 
transaction, the sum of the basis of all of the stock and securities 
received in the transaction shall be the same as the basis of all the 
stock and securities in such corporation surrendered in the transaction, 
allocated in the manner described in Sec. 1.358-2. In the case of a 
distribution to which section 355 applies in which, under the law 
applicable to the year in which the distribution is made, only 
nonrecognition property is received, immediately after the transaction, 
the sum of the basis of all of the stock and securities with respect to 
which the distribution is made plus the basis of all stock and 
securities received in the distribution with respect to such stock and 
securities shall be the same as the basis of the stock and securities 
with respect to which the distribution is made immediately before the 
transaction, allocated in the manner described in Sec. 1.358-2. In the 
case of an exchange to which section 351 or 361 applies in which, under 
the law applicable to the year in which the exchange was made, only 
nonrecognition property is received, the basis of all the stock and 
securities received in the exchange shall be the same as the basis of 
all property exchanged therefor. If in an exchange or distribution to 
which section 351, 356, or 361 applies both nonrecognition property and 
``other property'' are received, the basis of all the property except 
``other property'' held after the transaction shall be determined as 
described in the preceding three sentences decreased by the sum of the 
money and the fair market value of the ``other property'' (as of the 
date of the transaction) and increased by the sum of the amount treated 
as a dividend (if any) and the amount of the gain recognized on the 
exchange, but the term gain as here used does not include any portion of 
the recognized gain that was treated as a dividend. In any case in which 
a taxpayer transfers property with respect to which loss is recognized, 
such loss shall be reflected in determining the basis of the property 
received in the exchange. The basis of the ``other property'' is its 
fair market value as of the date of the transaction. See Sec. 1.460-
4(k)(3)(iv)(A) for rules relating to stock basis adjustments required 
where a contract accounted for using a long-term contract method of 
accounting is transferred in a transaction described in section 351 or a 
reorganization described in section 368(a)(1)(D) with respect to which 
the requirements of section 355 (or so much of section 356 as relates to 
section 355) are met.
    (b) The application of paragraph (a) of this section may be 
illustrated by the following example:

    Example. A purchased a share of stock in Corporation X in 1935 for 
$150. Since that date A has received distributions out of other than 
earnings and profits (as defined in section 316) totaling $60, so that 
A's adjusted basis for the stock is $90. In a transaction qualifying 
under section 356, A exchanged this share for one share in Corporation 
Y, worth $100, cash in the amount of $10, and other property with a fair 
market value of $30. The exchange had the effect of the distribution of 
a dividend. A's ratable share of the earnings and profits of Corporation 
X accumulated after February 28, 1913, was $5. A realized a gain of $50 
on the exchange, but the amount recognized is limited to $40, the sum of 
the cash received and the fair market value of the other property. Of 
the gain recognized, $5 is taxable as a dividend, and $35 is taxable as 
a gain from the exchange of property. The basis to A of the one share of

[[Page 291]]

stock of Corporation Y is $90, that is, the adjusted basis of the one 
share of stock of Corporation X ($90), decreased by the sum of the cash 
received ($10) and the fair market value of the other property received 
($30) and increased by the sum of the amount treated as a dividend ($5) 
and the amount treated as a gain from the exchange of property ($35). 
The basis of the other property received is $30.

    (c) This section applies to exchanges and distributions of stock and 
securities occurring on or after January 23, 2006.

[T.D. 9244, 71 FR 4269, Jan. 26, 2006; 71 FR 19118, Apr. 13, 2006; 71 FR 
62556, Oct. 26, 2006]



Sec. 1.358-2  Allocation of basis among nonrecognition property.

    (a) Allocation of basis in exchanges or distributions to which 
section 354, 355, or 356 applies. (1) As used in this paragraph the term 
stock means stock which is not ``other property'' under section 356. The 
term securities means securities (including, where appropriate, 
fractional parts of securities) which are not ``other property'' under 
section 356. Stock, or securities, as the case may be, which differ 
either because they are in different corporations or because the rights 
attributable to them differ (although they are in the same corporation) 
are considered different classes of stock or securities, as the case may 
be, for purposes of this section.
    (2)(i) If a shareholder or security holder surrenders a share of 
stock or a security in an exchange under the terms of section 354, 355, 
or 356, the basis of each share of stock or security received in the 
exchange shall be the same as the basis of the share or shares of stock 
or security or securities (or allocable portions thereof) exchanged 
therefor (as adjusted under Sec. 1.358-1). If more than one share of 
stock or security is received in exchange for one share of stock or one 
security, the basis of the share of stock or security surrendered shall 
be allocated to the shares of stock or securities received in the 
exchange in proportion to the fair market value of the shares of stock 
or securities received. If one share of stock or security is received in 
exchange for more than one share of stock or security or if a fraction 
of a share of stock or security is received, then the basis of the 
shares of stock or securities surrendered must be allocated to the 
shares of stock or securities (or allocable portions thereof) received 
in a manner that reflects, to the greatest extent possible, that a share 
of stock or security received is received in respect of shares of stock 
or securities that were acquired on the same date and at the same price. 
To the extent it is not possible to allocate basis in this manner, the 
basis of the shares of stock or securities surrendered must be allocated 
to the shares of stock or securities (or allocable portions thereof) 
received in a manner that minimizes the disparity in the holding periods 
of the surrendered shares of stock or securities whose basis is 
allocated to any particular share of stock or security received.
    (ii) If a shareholder or security holder surrenders a share of stock 
or a security in an exchange under the terms of section 354, 355, or 
356, and receives shares of stock or securities of more than one class, 
or receives ``other property'' or money in addition to shares of stock 
or securities, then, to the extent the terms of the exchange specify 
that shares of stock or securities of a particular class or ``other 
property'' or money is received in exchange for a particular share of 
stock or security or a particular class of stock or securities, for 
purposes of applying the rules of this section, such terms shall control 
provided such terms are economically reasonable. To the extent the terms 
of the exchange do not specify that shares of stock or securities of a 
particular class or ``other property'' or money is received in exchange 
for a particular share of stock or security or a particular class of 
stock or securities, then, for purposes of applying the rules of 
paragraph (a)(2)(i) of this section, a pro rata portion of the shares of 
stock and securities of each class received and a pro rata portion of 
the ``other property'' and money received shall be treated as received 
in exchange for each share of stock and security surrendered, based on 
the fair market value of the stock and securities surrendered.
    (iii)(A) For purposes of this section, if a shareholder or security 
holder surrenders a share of stock or a security

[[Page 292]]

in a transaction under the terms of section 354 (or so much of section 
356 as relates to section 354) in which the shareholder or security 
holder receives no property or property (including property permitted by 
section 354 to be received without the recognition of gain or ``other 
property'' or money) with a fair market value less than that of the 
stock or securities surrendered in the transaction:
    (1) Such shareholder or security holder shall be treated as 
receiving the stock, securities, other property, and money actually 
received by the shareholder or security holder in the transaction and an 
amount of stock of the issuing corporation (as defined in Sec. 1.368-
1(b)) that has a value equal to the excess of the value of the stock or 
securities the shareholder or security holder surrendered in the 
transaction over the value of the stock, securities, other property, and 
money the shareholder or security holder actually received in the 
transaction. If the shareholder owns only one class of stock of the 
issuing corporation the receipt of which would be consistent with the 
economic rights associated with each class of stock of the issuing 
corporation, the stock deemed received by the shareholder pursuant to 
the previous sentence shall be stock of such class. If the shareholder 
owns multiple classes of stock of the issuing corporation the receipt of 
which would be consistent with the economic rights associated with each 
class of stock of the issuing corporation, the stock deemed received by 
the shareholder shall be stock of each such class owned by the 
shareholder immediately prior to the transaction, in proportion to the 
value of the stock of each such class owned by the shareholder at that 
time. The basis of each share of stock or security of the issuing 
corporation deemed received and actually received shall be determined 
under the rules of this section. If and to the extent necessary to 
reflect the actual ownership of the issuing corporation immediately 
after the exchange to which section 354 (or so much of section 356 as 
relates to section 354) applies, an appropriate amount of the stock of 
the issuing corporation treated as issued to the shareholder or security 
holder in the exchange is deemed further transferred in accordance with 
Sec. 1.368-2(l) to reflect the actual ownership of the issuing 
corporation. Paragraph (a)(2)(iii)(A)(2) of this section is only applied 
to any shareholder of the issuing corporation after all of the deemed 
transfers pursuant to Sec. 1.368-2(l) are completed. The transferred 
shares' basis shall be adjusted for all deemed transfers required by 
Sec. 1.368-2(l).
    (2) A direct shareholder of the issuing corporation that receives 
the shares deemed issued as part of the transaction, as described in 
paragraph (a)(2)(iii)(A)(1) of this section, shall then be treated as 
surrendering all of its shares of stock and securities in the issuing 
corporation, including those shares of stock or securities held 
immediately prior to the transaction, those shares of stock or 
securities actually received in the transaction, and those shares of 
stock deemed received as described in paragraph (a)(2)(iii)(A)(1) of 
this section, in a reorganization under section 368(a)(1)(E) in exchange 
for the shares of stock and securities of the issuing corporation that 
the shareholder or security holder actually holds immediately after the 
transaction. The basis of each share of stock and security deemed 
received in the reorganization under section 368(a)(1)(E) shall be 
determined under the rules of this section.
    (B) For purposes of this section, if an actual shareholder of the 
issuing corporation is deemed to receive a nominal share of stock of the 
issuing corporation as provided in Sec. 1.368-2(l), then that 
shareholder must, after allocating and adjusting the basis of the 
nominal share in accordance with the rules of this section and Sec. 
1.358-1, designate the share of stock of the issuing corporation that it 
owns to which the basis, if any, of the nominal share will attach. If 
the shareholder does not actually own any shares of stock in the issuing 
corporation immediately after the exchange to which section 354 (or so 
much of section 356 as relates to section 354) applies, the nominal 
share of stock of the issuing corporation received by the shareholder in 
the exchange is deemed further transferred in accordance with Sec. 
1.368-2(l) without applying the designation rule set forth in

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the first sentence of this paragraph until it is transferred to a person 
that actually owns stock in the issuing corporation. The transferred 
share's basis shall be adjusted for all deemed transfers required by 
Sec. 1.368-2(l).
    (iv) If a shareholder or security holder receives one or more shares 
of stock or one or more securities in a distribution under the terms of 
section 355 (or so much of section 356 as relates to section 355), the 
basis of each share of stock or security of the distributing corporation 
(as defined in Sec. 1.355-1(b)), as adjusted under Sec. 1.358-1, shall 
be allocated between the share of stock or security of the distributing 
corporation with respect to which the distribution is made and the share 
or shares of stock or security or securities (or allocable portions 
thereof) received with respect to the share of stock or security of the 
distributing corporation in proportion to their fair market values. If 
one share of stock or security is received with respect to more than one 
share of stock or security or if a fraction of a share of stock or 
security is received, then the basis of each share of stock or security 
of the distributing corporation must be allocated to the shares of stock 
or securities (or allocable portions thereof) received in a manner that 
reflects that, to the greatest extent possible, a share of stock or 
security received is received with respect to shares of stock or 
securities acquired on the same date and at the same price. To the 
extent it is not possible to allocate basis in this manner, the basis of 
each share of stock or security of the distributing corporation must be 
allocated to the shares of stock or securities (or allocable portions 
thereof) received in a manner that minimizes the disparity in the 
holding periods of the shares of stock or securities with respect to 
which such shares of stock or securities are received.
    (v) If a shareholder or security holder receives shares of stock or 
securities of more than one class, or receives ``other property'' or 
money in addition to stock or securities in a distribution under the 
terms of section 355 (or so much of section 356 as relates to section 
355), then, to the extent the terms of the distribution specify that 
shares of stock or securities of a particular class or ``other 
property'' or money is received with respect to a particular share of 
stock or security of the distributing corporation or a particular class 
of stock or securities of the distributing corporation, for purposes of 
applying the rules of this section, such terms shall control provided 
that such terms are economically reasonable. To the extent the terms of 
the distribution do not specify that shares of stock or securities of a 
particular class or ``other property'' or money is received with respect 
to a particular share of stock or security of the distributing 
corporation or a particular class of stock or securities of the 
distributing corporation, then, for purposes of applying the rules of 
this section, a pro rata portion of the shares of stock and securities 
of each class received and a pro rata portion of the ``other property'' 
and money received shall be treated as received with respect to each 
share of stock and security of the distributing corporation with respect 
to which the distribution is made, based on the fair market value of 
each such share of stock or security.
    (vi) If a share of stock or a security is received in exchange for, 
or with respect to, more than one share of stock or security and such 
shares or securities were acquired on different dates or at different 
prices, the share of stock or security received shall be divided into 
segments based on the relative fair market values of the shares of stock 
or securities surrendered in exchange for such share or security or the 
relative fair market values of the shares of stock or securities with 
respect to which the share of stock or security is received in a 
distribution under the terms of section 355 (or so much of section 356 
as relates to section 355)). Each segment shall have a basis determined 
under the rules of paragraph (a)(2) of this section and a corresponding 
holding period.
    (vii) If a shareholder or security holder that purchased or acquired 
shares of stock or securities in a corporation on different dates or at 
different prices exchanges such shares of stock or securities under the 
terms of section 354, 355, or 356, or receives a distribution of shares 
of stock or securities under the

[[Page 294]]

terms of section 355 (or so much of section 356 as relates to section 
355), and the shareholder or security holder is not able to identify 
which particular share of stock or security (or allocable portion of a 
share of stock or security) is received (or deemed received) in exchange 
for, or with respect to, a particular share of stock or security, the 
shareholder or security holder may designate which share of stock or 
security is received in exchange for, or with respect to, a particular 
share of stock or security, provided that such designation is consistent 
with the terms of the exchange or distribution (or an exchange deemed to 
have occurred pursuant to paragraph (a)(2)(iii) of this section), and 
the other rules of this section. In the case of an exchange under the 
terms of section 354 or 356 (including a deemed exchange as a result of 
the application of paragraph (a)(2)(iii) of this section), the 
designation must be made on or before the first date on which the basis 
of a share of stock or a security received (or deemed received in the 
reorganization under section 368(a)(1)(E) in the case of a transaction 
to which paragraph (a)(2)(iii) of this section applies) is relevant. In 
the case of an exchange or distribution under the terms of section 355 
(or so much of section 356 as relates to section 355), the designation 
must be made on or before the first date on which the basis of a share 
of stock or a security of the distributing corporation or the controlled 
corporation (as defined in Sec. 1.355-1(b)) is relevant. The basis of 
the shares or securities received in an exchange under the terms of 
section 354 or section 356, for example, is relevant when such shares or 
securities are sold or otherwise transferred. The designation will be 
binding for purposes of determining the Federal tax consequences of any 
sale or transfer of, or distribution with respect to, the shares or 
securities received. If the shareholder fails to make a designation in a 
case in which the shareholder is not able to identify which share of 
stock is received in exchange for, or with respect to, a particular 
share of stock, then the shareholder will not be able to identify which 
shares are sold or transferred for purposes of determining the basis of 
property sold or transferred under section 1012 and Sec. 1.1012-1(c) 
and, instead, will be treated as selling or transferring the share 
received in respect of the earliest share purchased or acquired.
    (viii) This paragraph (a)(2) shall not apply to determine the basis 
of a share of stock or security received by a shareholder or security 
holder in an exchange described in both section 351 and either section 
354 or 356, if, in connection with the exchange--
    (A) The shareholder or security holder exchanges property for stock 
or securities in an exchange to which neither section 354 nor section 
356 applies;
    (B) The shareholder or security holder exchanges property for stock 
or securities in a transaction for which an election to apply section 
362(e)(2)(C) is in effect; or
    (C) Liabilities of the shareholder or security holder are assumed.
    (ix) This paragraph (a)(2) shall apply to determine the basis of a 
share of stock or security received by a shareholder or security holder 
in an exchange described in both section 1036 and section 354 or section 
356.
    (b) Allocation of basis in exchanges to which section 351 or 361 
applies. (1) As used in this paragraph (b), the term stock refers only 
to stock which is not ``other property'' under section 351 or 361 and 
the term securities refers only to securities which are not ``other 
property'' under section 351 or 361.
    (2) If in an exchange to which section 351 or 361 applies property 
is transferred to a corporation and the transferor receives stock or 
securities of more than one class or receives both stock and securities, 
then the basis of the property transferred (as adjusted under Sec. 
1.358-1) shall be allocated among all of the stock and securities 
received in proportion to the fair market values of the stock of each 
class and the securities of each class.
    (c) Examples. The application of paragraphs (a) and (b) of this 
section is illustrated by the following examples:

    Example 1. (i) Facts. J, an individual, acquired 20 shares of 
Corporation X stock on Date 1 for $3 each and 10 shares of Corporation X 
stock on Date 2 for $6 each. On Date 3, Corporation Y acquires the 
assets of Corporation X in a reorganization under section 368(a)(1)(A). 
Pursuant to the terms of the plan of reorganization, J receives 2 shares 
of

[[Page 295]]

Corporation Y stock in exchange for each share of Corporation X stock. 
Therefore, J receives 60 shares of Corporation Y stock. Pursuant to 
section 354, J recognizes no gain or loss on the exchange. J is not able 
to identify which shares of Corporation Y stock are received in exchange 
for each share of Corporation X stock.
    (ii) Analysis. Under paragraph (a)(2)(i) of this section, J has 40 
shares of Corporation Y stock each of which has a basis of $1.50 and is 
treated as having been acquired on Date 1 and 20 shares of Corporation Y 
stock each of which has a basis of $3 and is treated as having been 
acquired on Date 2. Under paragraph (a)(2)(vii) of this section, on or 
before the date on which the basis of a share of Corporation Y stock 
received becomes relevant, J may designate which of the shares of 
Corporation Y stock have a basis of $1.50 and which have a basis of $3.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that instead of receiving 2 shares of Corporation Y stock in exchange 
for each share of Corporation X stock, J receives 1\1/2\ shares of 
Corporation Y stock in exchange for each share of Corporation X stock. 
Therefore, J receives 45 shares of Corporation Y stock. Again, J is not 
able to identify which shares (or portions of shares) of Corporation Y 
stock are received in exchange for each share of Corporation X stock.
    (ii) Analysis. Under paragraph (a)(2)(i) of this section, J has 30 
shares of Corporation Y stock each of which has a basis of $2 and is 
treated as having been acquired on Date 1 and 15 shares of Corporation Y 
stock each of which has a basis of $4 and is treated as having been 
acquired on Date 2. Under paragraph (a)(2)(vii) of this section, on or 
before the date on which the basis of a share of Corporation Y stock 
received becomes relevant, J may designate which of the shares of 
Corporation Y stock received have a basis of $2 and which have a basis 
of $4.
    Example 3. (i) Facts. J, an individual, acquired 10 shares of Class 
A stock of Corporation X on Date 1 for $3 each, 10 shares of Class A 
stock of Corporation X on Date 2 for $9 each, and 10 shares of Class B 
stock of Corporation X on Date 3 for $3 each. On Date 4, J surrenders 
all of J's shares of Class A stock in exchange for 20 shares of new 
Class C stock and 20 shares of new Class D stock in a reorganization 
under section 368(a)(1)(E). Pursuant to section 354, J recognizes no 
gain or loss on the exchange. On the date of the exchange, the fair 
market value of each share of Class A stock is $6, the fair market value 
of each share of Class C stock is $2, and the fair market value of each 
share of Class D stock is $4. The terms of the exchange do not specify 
that shares of Class C stock or shares of Class D stock of Corporation X 
are received in exchange for particular shares of Class A stock of 
Corporation X.
    (ii) Analysis. Under paragraph (a)(2)(ii) of this section, because 
the terms of the exchange do not specify that shares of Class C stock or 
shares of Class D stock of Corporation X are received in exchange for 
particular shares of Class A stock of Corporation X, a pro rata portion 
of the shares of Class C stock and shares of Class D stock received will 
be treated as received in exchange for each share of Class A stock based 
on the fair market value of the surrendered shares of Class A stock. 
Therefore, J is treated as receiving one share of Class C stock and one 
share of Class D stock in exchange for each share of Class A stock. 
Under paragraph (a)(2)(i) of this section, J has 10 shares of Class C 
stock, each of which has a basis of $1 and is treated as having been 
acquired on Date 1 and 10 shares of Class C stock, each of which has a 
basis of $3 and is treated as having been acquired on Date 2. In 
addition, J has 10 shares of Class D stock, each of which has a basis of 
$2 and is treated as having been acquired on Date 1 and 10 shares of 
Class D stock, each of which has a basis of $6 and is treated as having 
been acquired on Date 2. J's basis in each share of Class B stock 
remains $3. Under paragraph (a)(2)(vii) of this section, on or before 
the date on which the basis of a share of Class C stock or Class D stock 
received becomes relevant, J may designate which of the shares of Class 
C stock have a basis of $1 and which have a basis of $3, and which of 
the shares of Class D stock have a basis of $2 and which have a basis of 
$6.
    Example 4. (i) Facts. J, an individual, acquired 10 shares of Class 
A stock of Corporation X on Date 1 for $2 each, 10 shares of Class A 
stock of Corporation X on Date 2 for $4 each, and 20 shares of Class B 
stock of Corporation X on Date 3 for $6 each. On Date 4, Corporation Y 
acquires the assets of Corporation X in a reorganization under section 
368(a)(1)(A). Pursuant to the terms of the plan of reorganization, J 
surrenders all of J's shares of Corporation X stock for 40 shares of 
Corporation Y stock and $200 of cash. On the date of the exchange, the 
fair market value of each share of Class A stock of Corporation X is 
$10, the fair market value of each share of Class B stock of Corporation 
X is $10, and the fair market value of each share of Corporation Y stock 
is $5. The terms of the exchange do not specify that shares of 
Corporation Y stock or cash are received in exchange for particular 
shares of Class A stock or Class B stock of Corporation X.
    (ii) Analysis. Under paragraph (a)(2)(ii) of this section and under 
Sec. 1.356-1(b), because the terms of the exchange do not specify that 
shares of Corporation Y stock or cash are received in exchange for 
particular shares of Class A stock or Class B stock of Corporation X, a 
pro rata portion of the

[[Page 296]]

shares of Corporation Y stock and cash received will be treated as 
received in exchange for each share of Class A stock and Class B stock 
of Corporation X surrendered based on the fair market value of such 
stock. Therefore, J is treated as receiving one share of Corporation Y 
stock and $5 of cash in exchange for each share of Class A stock of 
Corporation X and one share of Corporation Y stock and $5 of cash in 
exchange for each share of Class B stock of Corporation X. J realizes a 
gain of $140 on the exchange of shares of Class A stock of Corporation 
X, $100 of which is recognized under Sec. 1.356-1(a). J realizes a gain 
of $80 on the exchange of Class B stock of Corporation X, all of which 
is recognized under Sec. 1.356-1(a). Under paragraph (a)(2)(i) of this 
section, J has 10 shares of Corporation Y stock, each of which has a 
basis of $2 and is treated as having been acquired on Date 1, 10 shares 
of Corporation Y stock, each of which has a basis of $4 and is treated 
as having been acquired on Date 2, and 20 shares of Corporation Y stock, 
each of which has a basis of $5 and is treated as having been acquired 
on Date 3. Under paragraph (a)(2)(vii) of this section, on or before the 
date on which the basis of a share of Corporation Y stock received 
becomes relevant, J may designate which of the shares of Corporation Y 
stock received have a basis of $2, which have a basis of $4, and which 
have a basis of $5.
    Example 5. (i) Facts. The facts are the same as in Example 4, except 
that the terms of the plan of reorganization specify that J receives 40 
shares of stock of Corporation Y in exchange for J's shares of Class A 
stock of Corporation X and $200 of cash in exchange for J's shares of 
Class B stock of Corporation X.
    (ii) Analysis. Under paragraph (a)(2)(ii) of this section and under 
Sec. 1.356-1(b), because the terms of the exchange specify that J 
receives 40 shares of stock of Corporation Y in exchange for J's shares 
of Class A stock of Corporation X and $200 of cash in exchange for J's 
shares of Class B stock of Corporation X and such terms are economically 
reasonable, such terms control. J realizes a gain of $140 on the 
exchange of shares of Class A stock of Corporation X, none of which is 
recognized under Sec. 1.356-1(a). J realizes a gain of $80 on the 
exchange of shares of Class B stock of Corporation X, all of which is 
recognized under Sec. 1.356-1(a). Under paragraph (a)(2)(i) of this 
section, J has 20 shares of Corporation Y stock, each of which has a 
basis of $1 and is treated as having been acquired on Date 1, and 20 
shares of Corporation Y stock, each of which has a basis of $2 and is 
treated as having been acquired on Date 2. Under paragraph (a)(2)(vii) 
of this section, on or before the date on which the basis of a share of 
Corporation Y stock received becomes relevant, J may designate which of 
the shares of Corporation Y stock received have a basis of $1 and which 
have a basis of $2.
    Example 6. (i) Facts. J, an individual, acquired 10 shares of stock 
of Corporation X on Date 1 for $2 each, and a security issued by 
Corporation X to J on Date 2 with a principal amount of $100 and a basis 
of $100. On Date 3, Corporation Y acquires the assets of Corporation X 
in a reorganization under section 368(a)(1)(A). Pursuant to the terms of 
the plan of reorganization, J surrenders all of J's shares of 
Corporation X stock in exchange for 10 shares of Corporation Y stock and 
surrenders J's Corporation X security in exchange for a Corporation Y 
security. On the date of the exchange, the fair market value of each 
share of stock of Corporation X is $10, the fair market value of J's 
Corporation X security is $100, the fair market value of each share of 
Corporation Y stock is $10, and the fair market value and principal 
amount of the Corporation Y security received by J is $100.
    (ii) Analysis. Under paragraph (a)(2)(ii) of this section and under 
Sec. 1.354-1(a), because the terms of the exchange specify that J 
receives 10 shares of stock of Corporation Y in exchange for J's shares 
of Class A stock of Corporation X and a Corporation Y security in 
exchange for its Corporation X security and such terms are economically 
reasonable, such terms control. Pursuant to section 354, J recognizes no 
gain on either exchange. Under paragraph (a)(2)(i) of this section, J 
has 10 shares of Corporation Y stock, each of which has a basis of $2 
and is treated as having been acquired on Date 1, and a security that 
has a basis of $100 and is treated as having been acquired on Date 2.
    Example 7. (i) Facts. J, an individual, acquired 10 shares of 
Corporation X stock on Date 1 for $2 each and 10 shares of Corporation X 
stock on Date 2 for $5 each. On Date 3, Corporation Y acquires the stock 
of Corporation X in a reorganization under section 368(a)(1)(B). 
Pursuant to the terms of the plan of reorganization, J receives one 
share of Corporation Y stock in exchange for every 2 shares of 
Corporation X stock. Pursuant to section 354, J recognizes no gain or 
loss on the exchange. J is not able to identify which portion of each 
share of Corporation Y stock is received in exchange for each share of 
Corporation X stock.
    (ii) Analysis. Under paragraph (a)(2)(i) of this section, J has 5 
shares of Corporation Y stock each of which has a basis of $4 and is 
treated as having been acquired on Date 1 and 5 shares of Corporation Y 
stock each of which has a basis of $10 and is treated as having been 
acquired on Date 2. Under paragraph (a)(2)(vii) of this section, on or 
before the date on which the basis of a share of Corporation Y stock 
received becomes relevant, J may designate which of the shares of 
Corporation Y stock received have a basis of $4 and which have a basis 
of $10.

[[Page 297]]

    Example 8. (i) Facts. The facts are the same as in Example 7, except 
that, in addition to transferring the stock of Corporation X to 
Corporation Y, J transfers land to Corporation Y. In addition, after the 
transaction, J owns stock of Corporation Y satisfying the requirements 
of section 368(c). J's transfer of the Corporation X stock to 
Corporation Y is an exchange described in sections 351 and 354. J's 
transfer of land to Corporation Y is an exchange described in section 
351.
    (ii) Analysis. Under paragraph (a)(2)(viii) of this section, because 
neither section 354 nor section 356 applies to the transfer of land to 
Corporation Y, the rules of paragraph (a)(2) of this section do not 
apply to determine J's basis in the Corporation Y stock received in the 
transaction.
    Example 9. (i) Facts. J, an individual, acquired 10 shares of 
Corporation X stock on Date 1 for $3 each and 10 shares of Corporation X 
stock on Date 2 for $6 each. On Date 3, Corporation Z, a newly formed, 
wholly owned subsidiary of Corporation Y, merges with and into 
Corporation X with Corporation X surviving. As part of the plan of 
merger, J receives one share of Corporation Y stock in exchange for each 
share of Corporation X stock. In connection with the transaction, 
Corporation Y assumes a liability of J. In addition, after the 
transaction, J owns stock of Corporation Y satisfying the requirements 
of section 368(c). J's transfer of the Corporation X stock to 
Corporation Y is an exchange described in sections 351 and 354.
    (ii) Analysis. Under paragraph (a)(2)(viii) of this section, 
because, in connection with the transfer of the Corporation X stock to 
Corporation Y, Corporation Y assumed a liability of J, the rules of 
paragraph (a)(2) of this section do not apply to determine J's basis in 
the Corporation Y stock received in the transaction.
    Example 10. (i) Facts. Each of Corporation X and Corporation Y has a 
single class of stock outstanding, all of which is owned by J, an 
individual. J acquired 100 shares of Corporation X stock on Date 1 for 
$1 each and 100 shares of Corporation Y stock on Date 2 for $2 each. On 
Date 3, Corporation Y acquires the assets of Corporation X in a 
reorganization under section 368(a)(1)(D). Pursuant to the terms of the 
plan of reorganization, J surrenders J's 100 shares of Corporation X 
stock but does not receive any additional Corporation Y stock. 
Immediately before the effective time of the reorganization, the fair 
market value of each share of Corporation X stock and each share of 
Corporation Y stock is $1. Pursuant to section 354, J recognizes no gain 
or loss.
    (ii) Analysis. Under paragraph (a)(2)(iii) of this section, J is 
deemed to have received shares of Corporation Y stock with an aggregate 
fair market value of $100 in exchange for J's Corporation X shares. 
Given the number of outstanding shares of stock of Corporation Y and 
their value immediately before the effective time of the reorganization, 
J is deemed to have received 100 shares of stock of Corporation Y in the 
reorganization. Under paragraph (a)(2)(i) of this section, each of those 
shares has a basis of $1 and is treated as having been acquired on Date 
1. Then, the stock of Corporation Y is deemed to be recapitalized in a 
reorganization under section 368(a)(1)(E) in which J receives 100 shares 
of Corporation Y stock in exchange for those shares of Corporation Y 
stock that J held immediately prior to the reorganization and those 
shares J is deemed to have received in the reorganization. Under 
paragraph (a)(2)(i), immediately after the reorganization, J holds 50 
shares of Corporation Y stock each of which has a basis of $2 and is 
treated as having been acquired on Date 1 and 50 shares of Corporation Y 
stock each of which has a basis of $4 and is treated as having been 
acquired on Date 2. Under paragraph (a)(2)(vii) of this section, on or 
before the date on which the basis of any share of J's Corporation Y 
stock becomes relevant, J may designate which of the shares of 
Corporation Y have a basis of $2 and which have a basis of $4.
    Example 11. (i) Facts. Corporation X has a single class of stock 
outstanding, all of which is owned by J, an individual. J acquired 100 
shares of Corporation X stock on Date 1 for $1 each. Corporation Y has 
two classes of stock outstanding, common stock and nonvoting preferred 
stock. On Date 2, J acquired 100 shares of Corporation Y common stock 
for $2 each and 100 shares of Corporation Y preferred stock for $4 each. 
On Date 3, Corporation Y acquires the assets of Corporation X in a 
reorganization under section 368(a)(1)(D). Pursuant to the terms of the 
plan of reorganization, J surrenders J's 100 shares of Corporation X 
stock but does not receive any additional Corporation Y stock. 
Immediately before the effective time of the reorganization, the fair 
market value of each share of Corporation X stock is $10, the fair 
market value of each share of Corporation Y common stock is $10, and the 
fair market value of each share of Corporation Y preferred stock is $20. 
Pursuant to section 354, J recognizes no gain or loss.
    (ii) Analysis. Under paragraph (a)(2)(iii) of this section, J is 
deemed to have received shares of Corporation Y stock with an aggregate 
fair market value of $1,000 in exchange for J's Corporation X shares. 
Consistent with the economics of the transaction and the rights 
associated with each class of stock of Corporation Y owned by J, J is 
deemed to receive additional shares of Corporation Y common stock. 
Because the value of the common stock indicates that the liquidation 
preference associated with the Corporation Y preferred stock could be 
satisfied even if the reorganization did not occur, it is not 
appropriate to deem the issuance of additional

[[Page 298]]

Corporation Y preferred stock. Given the number of outstanding shares of 
common stock of Corporation Y and their value immediately before the 
effective time of the reorganization, J is deemed to have received 100 
shares of common stock of Corporation Y in the reorganization. Under 
paragraph (a)(2)(i) of this section, each of those shares has a basis of 
$1 and is treated as having been acquired on Date 1. Then, the common 
stock of Corporation Y is deemed to be recapitalized in a reorganization 
under section 368(a)(1)(E) in which J receives 100 shares of Corporation 
Y common stock in exchange for those shares of Corporation Y common 
stock that J held immediately prior to the reorganization and those 
shares of Corporation Y common stock that J is deemed to have received 
in the reorganization. Under paragraph (a)(2)(i), immediately after the 
reorganization, J holds 50 shares of Corporation Y common stock, each of 
which has a basis of $2 and is treated as having been acquired on Date 
1, and 50 shares of Corporation Y common stock, each of which has a 
basis of $4 and is treated as having been acquired on Date 2. Under 
paragraph (a)(2)(vii) of this section, on or before the date on which 
the basis of any share of J's Corporation Y common stock becomes 
relevant, J may designate which of those shares have a basis of $2 and 
which have a basis of $4.
    Example 12. (i) Facts. J, an individual, acquired 5 shares of 
Corporation X stock on Date 1 for $4 each and 5 shares of Corporation X 
stock on Date 2 for $8 each. Corporation X owns all of the outstanding 
stock of Corporation Y. The fair market value of the stock of 
Corporation X is $1800. The fair market value of the stock of 
Corporation Y is $900. In a distribution to which section 355 applies, 
Corporation X distributes all of the stock of Corporation Y pro rata to 
its shareholders. No stock of Corporation X is surrendered in connection 
with the distribution. In the distribution, J receives 2 shares of 
Corporation Y stock with respect to each share of Corporation X stock. 
Pursuant to section 355, J recognizes no gain or loss on the receipt of 
the shares of Corporation Y stock. J is not able to identify which share 
of Corporation Y stock is received in respect of each share of 
Corporation X stock.
    (ii) Analysis. Under paragraph (a)(2)(iv) of this section, because J 
receives 2 shares of Corporation Y stock with respect to each share of 
Corporation X stock, the basis of each share of Corporation X stock is 
allocated between such share of Corporation X stock and two shares of 
Corporation Y stock in proportion to the fair market value of those 
shares. Therefore, each of the 5 shares of Corporation X stock acquired 
on Date 1 will have a basis of $2 and each of the 10 shares of 
Corporation Y stock received with respect to those shares will have a 
basis of $1. In addition, each of the 5 shares of Corporation X stock 
acquired on Date 2 will have a basis of $4 and each of the 10 shares of 
Corporation Y stock received with respect to those shares will have a 
basis of $2. Under paragraph (a)(2)(vii) of this section, on or before 
the date on which the basis of a share of Corporation Y stock received 
becomes relevant, J may designate which of the shares of Corporation Y 
stock have a basis of $1 and which have a basis of $2.
    Example 13. (i) Facts. J, an individual, acquired 20 shares of 
Corporation X stock on Date 1 for $2 each and 20 shares of Corporation X 
stock on Date 2 for $4 each. Corporation X has 80 shares of stock 
outstanding. Corporation X owns 40 shares of stock of Corporation Y, 
which represents all of the outstanding stock of Corporation Y. The fair 
market value of the stock of Corporation X is $80. The fair market value 
of the stock of Corporation Y is $40. Corporation X distributes all of 
the stock of Corporation Y in a transaction to which section 355 
applies. In the transaction, J surrenders 20 shares of stock of 
Corporation X in exchange for 20 shares of stock of Corporation Y. J 
retains 20 shares of Corporation X stock. Pursuant to section 355, J 
recognizes no gain or loss on the receipt of the shares of Corporation Y 
stock. J is not able to identify which shares of Corporation X stock are 
surrendered. In addition, J is not able to identify which shares of 
Corporation Y stock are received in exchange for each surrendered share 
of Corporation X stock.
    (ii) Analysis. Under paragraph (a)(2)(i) of this section, J has 20 
shares of Corporation Y stock each of which is treated as received in 
exchange for one share of Corporation X stock. The basis of the 20 
shares of Corporation X stock that are retained by J will remain 
unchanged. Under paragraph (a)(2)(vii) of this section, on or before the 
date on which the basis of a share of Corporation X or Corporation Y 
stock becomes relevant, J may designate which shares of Corporation X 
stock J surrendered in the exchange and which share of the Corporation Y 
stock received is received for each share of Corporation X stock 
surrendered. Therefore, it is possible that a share of Corporation Y 
stock would have a basis of $2 and be treated as having been acquired on 
Date 1, or would have a basis of $4 and be treated as having been 
acquired on Date 2.
    Example 14. (i) Facts. J, an individual, acquired 10 shares of 
Corporation X stock on Date 1 for $3 each, 10 shares of Corporation X 
stock on Date 2 for $18 each, 10 shares of Corporation X stock on Date 3 
for $6 each, and 10 shares of Corporation X stock on Date 4 for $9 each. 
On Date 5, Corporation Y acquires the assets of Corporation X in a 
reorganization under section 368(a)(1)(A). Pursuant to the terms of the 
plan of reorganization, J receives a \3/4\ share of Corporation Y

[[Page 299]]

stock in exchange for each share of Corporation X stock. Therefore, J 
receives 30 shares of Corporation X stock. Pursuant to section 354, J 
recognizes no gain or loss on the exchange. J is not able to identify 
which shares of Corporation Y stock are received in exchange for each 
share (or portions of shares) of Corporation X stock.
    (ii) Analysis. Under paragraph (a)(2)(i) of this section, J has 7 
shares of Corporation Y stock each of which has a basis of $4 and is 
treated as having been acquired on Date 1, 7 shares of Corporation Y 
stock each of which has a basis of $24 and is treated as having been 
acquired on Date 2, 7 shares of Corporation Y stock each of which has a 
basis of $8 and is treated as having been acquired on Date 3, and 7 
shares of Corporation Y stock each of which has a basis of $12 and is 
treated as having been acquired on Date 4. In addition, J has two shares 
of Corporation Y stock, each of which is divided into two equal segments 
under paragraph (a)(2)(vi) of this section. The first of those two 
shares has one segment with a basis of $2 that is treated as having been 
acquired on Date 1 and a second segment with a basis of $12 that is 
treated as having been acquired on Date 2. The second of those two 
shares has one segment with a basis of $4 that is treated as having been 
acquired on Date 3 and a second segment with a basis of $6 that is 
treated as having been acquired on Date 4. Under paragraph (a)(2)(vii), 
on or before the date on which a share of Corporation Y stock received 
becomes relevant, J may designate which of the shares of Corporation Y 
stock have a basis of $4, which have a basis of $24, which have a basis 
of $8, which have a basis of $12, and which share has a split basis of 
$2 and $12, and which share has a split basis of $4 and $6.
    Example 15. (i) Facts. Each of Corporation X and Corporation Y has a 
single class of stock outstanding, all of which is owned by J, an 
individual. J purchased 100 shares of Corporation X stock on Date 1 for 
$1.50 each, resulting in J having an aggregate basis in the stock of 
Corporation X of $150. On Date 2, Corporation Y acquires the assets of 
Corporation X for $100 of cash, their fair market value, in a 
transaction described in Sec. 1.368-2(l). Pursuant to the terms of the 
exchange, Corporation X does not receive any Corporation Y stock. 
Corporation X distributes the $100 of cash to J and retains no assets.
    (ii) Analysis. Pursuant to Sec. 1.368-2(l), Corporation Y will be 
deemed to issue a nominal share of Corporation Y stock to Corporation X 
in addition to the $100 of cash actually exchanged for the Corporation X 
assets. Corporation X will then be deemed to distribute the nominal 
share of Corporation Y stock to J in addition to the $100 of cash 
actually distributed to J. Pursuant to Sec. 1.368-2(l), J, the actual 
shareholder of Corporation Y, the issuing corporation, is deemed to 
receive the nominal share of Corporation Y stock described in Sec. 
1.368-2(l). J will have a basis of $50 in the nominal share of 
Corporation Y stock under section 358(a)(1). Therefore, under paragraph 
(a)(2)(iii)(B) of this section, J must designate a share of Corporation 
Y stock to which J's basis of $50 in the nominal share of Corporation Y 
stock will attach.
    Example 16. (i) Facts. Each of Corporation X and Corporation Y has a 
single class of stock outstanding, all of which is owned by Corporation 
P. Corporation T has a single class of stock outstanding, all of which 
is owned by Corporation X. The corporations do not join in the filing of 
a consolidated return. Corporation X purchased 100 shares of Corporation 
T stock on Date 1 for $1.50 each, resulting in Corporation X having an 
aggregate basis in the stock of Corporation T of $150. On Date 2, 
Corporation Y acquires the assets of Corporation T for $100 of cash, 
their fair market value, in a transaction described in Sec. 1.368-2(l). 
Pursuant to the terms of the exchange, Corporation T does not receive 
any Corporation Y stock. Corporation T distributes the $100 of cash to 
Corporation X and retains no assets.
    (ii) Analysis. Pursuant to Sec. 1.368-2(l), Corporation Y will be 
deemed to issue a nominal share of Corporation Y stock to Corporation T 
in addition to the $100 of cash actually exchanged for the Corporation T 
assets. Corporation T will be deemed to distribute the nominal share of 
Corporation Y stock to Corporation X in addition to the $100 of cash 
actually distributed. Corporation X will have a basis of $50 in the 
nominal share of Corporation Y stock under section 358(a). However, 
Corporation X is not an actual shareholder of Corporation Y, the issuing 
corporation. Therefore, Corporation X cannot designate any share of 
Corporation Y stock under paragraph (a)(2)(iii)(B) of this section to 
which the basis of the nominal share of Corporation Y stock will attach 
and Corporation X will be deemed to distribute the nominal share of 
Corporation Y stock to Corporation P as required by Sec. 1.368-2(l). 
Corporation X does not recognize the loss on the deemed distribution of 
the nominal share to Corporation P under section 311(a). Corporation P's 
basis in the nominal share it receives is zero, its fair market value, 
under section 301(d). Under paragraph (a)(2)(iii)(B) of this section, 
Corporation P must designate a share of Corporation Y stock to which the 
nominal share's zero basis will attach.

    (d) Effective/applicability date. This section generally applies to 
exchanges and distributions of stock and securities occurring on or 
after January 23, 2006. However, paragraph (a)(2)(iii) and Examples 15 
and 16 of paragraph (c) of this section apply to exchanges and 
distributions of stock and securities

[[Page 300]]

occurring on or after November 12, 2014. See Sec. 1.358-2T(a)(2)(iii) 
and Sec. 1.358-2T(c), Examples 15 and 16, as contained in 26 CFR part 
1, revised April 1, 2014, for exchanges and distributions of stock and 
securities occurring on or after November 21, 2011 and before November 
12, 2014; see Sec. 1.358-2(a)(2)(iii), as contained in 26 CFR part 1, 
revised as of April 1, 2011, for exchanges and distributions of stock 
and securities occurring on or after January 23, 2006 and before 
November 21, 2011.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7616, 44 FR 
26869, May 8, 1979; T.D. 8648, 60 FR 66079, Dec. 21, 1995; T.D. 9244, 71 
FR 4270, Jan. 26, 2006; 71 FR 19118, Apr. 13, 2006; 71 FR 62556, Oct. 
26, 2006; T.D. 9475, 74 FR 67057, Dec. 18, 2009; T.D. 9558, 76 FR 71879, 
Nov. 21, 2011; T.D. 9633, 78 FR 54160, Sept. 3, 2013; T.D. 9702, 79 FR 
67062, Nov. 12, 2014]



Sec. 1.358-3  Treatment of assumption of liabilities.

    (a) For purposes of section 358, where a party to the exchange 
assumes a liability of a distributee or acquires from him property 
subject to a liability, the amount of such liability is to be treated as 
money received by the distributee upon the exchange, whether or not the 
assumption of liabilities resulted in a recognition of gain or loss to 
the taxpayer under the law applicable to the year in which the exchange 
was made.
    (b) The application of paragraph (a) of this section may be 
illustrated by the following examples:

    Example 1. A, an individual, owns property with an adjusted basis of 
$100,000 on which there is a purchase money mortgage of $25,000. On 
December 1, 1945, A organizes Corporation X to which he transfers the 
property in exchange for all the stock of Corporation X and the 
assumption by Corporation X of the mortgage. The capital stock of the 
Corporation X has a fair market value of $150,000. Under sections 351 
and 357, no gain or loss is recognized to A. The basis in A's hands of 
the stock of Corporation X is $75,000, computed as follows:

Adjusted basis of property transferred......................    $100,000
Less: Amount of money received (amount of liabilities           --25,000
 assumed)...................................................
                                                             -----------
 Basis of Corporation X stock to A..........................      75,000
 

    Example 2. A, an individual, owns property with an adjusted basis of 
$25,000 on which there is a mortgage of $50,000. On December 1, 1954, A 
organizes Corporation X to which he transfers the property in exchange 
for all the stock of Corporation X and the assumption by Corporation X 
of the mortgage. The stock of Corporation X has a fair market value of 
$50,000. Under sections 351 and 357, gain is recognized to A in the 
amount of $25,000. The basis in A's hands of the stock of Corporation X 
is zero, computed as follows:

Adjusted basis of property transferred......................     $25,000
Less: Amount of money received (amount of liabilities)......    --50,000
Plus: Amount of gain recognized to taxpayer.................      25,000
                                                             -----------
 Basis of Corporation X stock to A..........................           0
 



Sec. 1.358-4  Exceptions.

    (a) Plan of reorganization adopted after October 22, 1968. In the 
case of a plan of reorganization adopted after October 22, 1968, section 
358 does not apply in determining the basis of property acquired by a 
corporation in connection with such reorganization by the exchange of 
its stock or securities (or by the exchange of stock or securities of a 
corporation which is in control of the acquiring corporation) as the 
consideration in whole or in part for the transfer of the property to 
it. See section 362 and the regulations pertaining to that section for 
rules relating to basis to corporations of property acquired in such 
cases.
    (b) Plan of reorganization adopted before October 23, 1968. In the 
case of a plan of reorganization adopted before October 23, 1968, 
section 358 does not apply in determining the basis of property acquired 
by a corporation in connection with such reorganization by the issuance 
of stock or securities of such corporation (or by the issuance of stock 
or securities of another corporation which is in control of such 
corporation) as the consideration in whole or in part for the transfer 
of the property to it. The term issuance of stock or securities includes 
any transfer of stock or securities, including stock or securities which 
were purchased or were acquired as a contribution to capital. See 
section 362 and the regulations pertaining to that section for rules 
relating to basis to corporations of property acquired in such cases.

[T.D. 7422, 41 FR 26569, June 28, 1976]

[[Page 301]]



Sec. 1.358-5  Special rules for assumption of liabilities.

    (a) In general. Section 358(h)(2)(B) does not apply to an exchange 
occurring on or after May 9, 2008.
    (b) Effective/Applicability date. For exchanges occurring on or 
after June 24, 2003, and before May 9, 2008, see Sec. 1.358-5T as 
contained in 26 CFR part 1 in effect on April 1, 2007.

[T.D. 9397, 73 FR 26322, May 9, 2008]



Sec. 1.358-6  Stock basis in certain triangular reorganizations.

    (a) Scope. This section provides rules for computing the basis of a 
controlling corporation in the stock of a controlled corporation as the 
result of certain reorganizations involving the stock of the controlling 
corporation as described in paragraph (b) of this section. The rules of 
this section are in addition to rules under other provisions of the 
Internal Revenue Code and principles of law. See, e.g., section 1001 for 
the recognition of gain or loss by the controlled corporation on the 
exchange of property for the assets or stock of a target corporation in 
a reorganization described in section 368. See also sections 362(e)(1) 
and 362(e)(2) for further adjustments to basis that may be necessary 
under either or both of those sections.
    (b) Triangular reorganizations--(1) Nomenclature. For purposes of 
this section--
    (i) P is a corporation--
    (A) That is a party to a reorganization,
    (B) That is in control (within the meaning of section 368(c)) of 
another party to the reorganization, and
    (C) Whose stock is transferred pursuant to the reorganization.
    (ii) S is a corporation--
    (A) That is a party to the reorganization, and
    (B) That is controlled by P.
    (iii) T is a corporation that is another party to the 
reorganization.
    (2) Definitions of triangular reorganizations. This section applies 
to the following reorganizations (which are referred to collectively as 
triangular reorganizations):
    (i) Forward triangular merger. A forward triangular merger is a 
statutory merger of T and S, with S surviving, that qualifies as a 
reorganization under section 368(a)(1)(A) or (G) by reason of the 
application of section 368(a)(2)(D).
    (ii) Triangular C reorganization. A triangular C reorganization is 
an acquisition by S of substantially all of T's assets in exchange for P 
stock in a transaction that qualifies as a reorganization under section 
368(a)(1)(C).
    (iii) Reverse triangular merger. A reverse triangular merger is a 
statutory merger of S and T, with T surviving, that qualifies as a 
reorganization under section 368(a)(1)(A) by reason of the application 
of section 368(a)(2)(E).
    (iv) Triangular B reorganization. A triangular B reorganization is 
an acquisition by S of T stock in exchange for P stock in a transaction 
that qualifies as a reorganization under section 368(a)(1)(B).
    (v) Triangular G reorganization. A triangular G reorganization is an 
acquisition by S (other than by statutory merger) of substantially all 
of T's assets in a title 11 or similar case in exchange for P stock in a 
transaction that qualifies as a reorganization under section 
368(a)(1)(G) by reason of the application of section 368(a)(2)(D).
    (c) General rules. Subject to the special rule provided in paragraph 
(d) of this section, P's basis in the stock of S or T, as applicable, as 
a result of a triangular reorganization, is adjusted under the following 
rules--
    (1) Forward triangular merger or triangular C reorganization--(i) In 
general. In a forward triangular merger or a triangular C 
reorganization, P's basis in its S stock is adjusted as if--
    (A) P acquired the T assets acquired by S in the reorganization (and 
P assumed any liabilities which S assumed or to which the T assets 
acquired by S were subject) directly from T in a transaction in which 
P's basis in the T assets was determined under section 362(b); and
    (B) P transferred the T assets (and liabilities which S assumed or 
to which the T assets acquired by S were subject) to S in a transaction 
in which P's basis in S stock was determined under section 358.
    (ii) Limitation. If, in applying section 358, the amount of T 
liabilities assumed by S or to which the T assets acquired by S are 
subject equals or exceeds T's

[[Page 302]]

aggregate adjusted basis in its assets, the amount of the adjustment 
under paragraph (c)(1)(i) of this section is zero. P recognizes no gain 
under section 357(c) as a result of a triangular reorganization.
    (2) Reverse triangular merger--(i) In general--(A) Treated as a 
forward triangular merger. Except as otherwise provided in this 
paragraph (c)(2), P's basis in its T stock acquired in a reverse 
triangular merger equals its basis in its S stock immediately before the 
transaction adjusted as if T had merged into S in a forward triangular 
merger to which paragraph (c)(1) of this section applies.
    (B) Allocable share. If P acquires less than all of the T stock in 
the transaction, the basis adjustment described in paragraph 
(c)(2)(i)(A) of this section is reduced in proportion to the percentage 
of T stock not acquired in the transaction. The percentage of T stock 
not acquired in the transaction is determined by taking into account the 
fair market value of all classes of T stock.
    (C) Special rule if P owns T stock before the transaction. Solely 
for purposes of paragraphs (c)(2)(i)(A) and (B) of this section, if P 
owns T stock before the transaction, P may treat that stock as acquired 
in the transaction or not, without regard to the form of the 
transaction.
    (ii) Reverse triangular merger that qualifies as a section 351 
transfer or section 368(a)(1)(B) reorganization. Notwithstanding 
paragraph (c)(2)(i) of this section, if a reorganization qualifies as 
both a reverse triangular merger and as a section 351 transfer or as 
both a reverse triangular merger and a reorganization under section 
368(a)(1)(B), P can--
    (A) Determine the basis in its T stock as if paragraph (c)(2)(i) of 
this section applies; or
    (B) Determine the basis in the T stock acquired as if P acquired 
such stock from the former T shareholders in a transaction in which P's 
basis in the T stock was determined under section 362(b).
    (3) Triangular B reorganization. In a triangular B reorganization, 
P's basis in its S stock is adjusted as if--
    (i) P acquired the T stock acquired by S in the reorganization 
directly from the T shareholders in a transaction in which P's basis in 
the T stock was determined under section 362(b); and
    (ii) P transferred the T stock to S in a transaction in which P's 
basis in its S stock was determined under section 358.
    (4) Examples. The rules of this paragraph (c) are illustrated by the 
following examples. For purposes of these examples, P, S, and T are 
domestic corporations, the property transferred is not importation 
property within the meaning of Sec. 1.362-3(c)(2) or loss duplication 
property within the meaning of Sec. 1.362-4(g)(1), P and S do not file 
consolidated returns, P owns all of the shares of the only class of S 
stock, the P stock exchanged in the transaction satisfies the 
requirements of the applicable triangular reorganization provisions, and 
the facts set forth the only corporate activity.

    Example 1. Forward triangular merger. (a) Facts. T has assets with 
an aggregate basis of $60 and fair market value of $100 and no 
liabilities. Pursuant to a plan, P forms S with $5 cash (which S 
retains), and T merges into S. In the merger, the T shareholders receive 
P stock worth $100 in exchange for their T stock. The transaction is a 
reorganization to which sections 368(a)(1)(A) and (a)(2)(D) apply.
    (b) Basis adjustment. Under Sec. 1.358-6(c)(1), P's $5 basis in its 
S stock is adjusted as if P acquired the T assets acquired by S in the 
reorganization directly from T in a transaction in which P's basis in 
the T assets was determined under section 362(b). Under section 362(b), 
P would have an aggregate basis of $60 in the T assets. P is then 
treated as if it transferred the T assets to S in a transaction in which 
P's basis in the S stock was determined under section 358. Under section 
358, P's $5 basis in its S stock would be increased by the $60 basis in 
the T assets deemed transferred. Consequently, P has a $65 basis in its 
S stock as a result of the reorganization.
    (c) Use of pre-existing S. The facts are the same as paragraph (a) 
of this Example 1, except that S is an operating company with 
substantial assets that has been in existence for several years. P has a 
$110 basis in the S stock. Under Sec. 1.358-6(c)(1), P's $110 basis in 
its S stock is increased by the $60 basis in the T assets deemed 
transferred. Consequently, P has a $170 basis in its S stock as a result 
of the reorganization.
    (d) Mixed consideration. The facts are the same as paragraph (a) of 
this Example 1, except that the T shareholders receive P stock

[[Page 303]]

worth $80 and $20 cash from P. Under section 358, P's $5 basis in its S 
stock is increased by the $60 basis in the T assets deemed transferred. 
Consequently, P has a $65 basis in its S stock as a result of the 
reorganization.
    (e) Liabilities. The facts are the same as paragraph (a) of this 
Example 1, except that T's assets are subject to $50 of liabilities, and 
the T shareholders receive $50 of P stock in exchange for their T stock. 
Under section 358, P's basis in its S stock is increased by the $60 
basis in the T assets deemed transferred and decreased by the $50 of 
liabilities to which the T assets acquired by S are subject. 
Consequently, P has a net basis adjustment of $10, and a $15 basis in 
its S stock as a result of the reorganization. For certain triangular 
reorganizations where the surviving corporation (S or T) is foreign, see 
Sec. 1.367(b)-13.
    (f) Liabilities in excess of basis. The facts are the same as in 
paragraph (a) of this Example 1, except that T's assets are subject to 
liabilities of $90, and the T shareholders receive $10 of P stock in 
exchange for their T stock in the reorganization. Under Sec. 1.358-
6(c)(1)(ii), the adjustment under Sec. 1.358-6(c) is zero if the amount 
of the liabilities which S assumed or to which the T assets acquired by 
S are subject exceeds the aggregate adjusted basis in T's assets. 
Consequently, P has no adjustment in its S stock, and P has a $5 basis 
in its S stock as a result of the reorganization.
    Example 2. Reverse triangular merger. (a) Facts. T has assets with 
an aggregate basis of $60 and a fair market value of $100 and no 
liabilities. P has a $110 basis in its S stock. Pursuant to a plan, S 
merges into T with T surviving. In the merger, the T shareholders 
receive $10 cash from P and P stock worth $90 in exchange for their T 
stock. The transaction is a reorganization to which sections 
368(a)(1)(A) and (a)(2)(E) apply.
    (b) Basis adjustment. Under Sec. 1.358-6(c)(2)(i)(A), P's basis in 
the T stock acquired is P's $110 basis in its S stock before the 
transaction, adjusted as if T had merged into S in a forward triangular 
merger to which Sec. 1.358-6(c)(1) applies. In such a case, P's $110 
basis in its S stock before the transaction would have been increased by 
the $60 basis of the T assets deemed transferred. Consequently, P has a 
$170 basis in its T stock immediately after the transaction.
    (c) Reverse triangular merger that also qualifies under section 
368(a)(1)(B). The facts relating to T are the same as in paragraph (a) 
of this Example 2. P, however, forms S pursuant to the plan of 
reorganization. The T shareholders receive $100 worth of P stock (and no 
cash) in exchange for their T stock. The T shareholders have an 
aggregate basis in their T stock of $85 immediately before the 
reorganization. The reorganization qualifies as both a reverse 
triangular merger and a reorganization under section 368(a)(1)(B). Under 
Sec. 1.358-6(c)(2)(ii), P may determine its basis in its T stock either 
as if Sec. 1.358-6(c)(2)(i) applied to the T stock acquired, or as if P 
acquired the T stock from the former T shareholders in a transaction in 
which P's basis in the T stock was determined under section 362(b). 
Accordingly, P may determine a basis in its T stock of $60 (T's net 
asset basis) or $85 (the T shareholders' aggregate basis in the T stock 
immediately before the reorganization).
    (d) Allocable share in a reverse triangular merger. The facts are 
the same as in paragraph (a) of this Example 2, except that X, a 10% 
shareholder of T, does not participate in the transaction. The remaining 
T shareholders receive $10 cash from P and P stock worth $80 for their T 
stock. P owns 90% of the T stock after the transaction. Under Sec. 
1.358-6(c)(2)(i)(A), P's basis in its T stock is P's $110 basis in its S 
stock before the reorganization, adjusted as if T had merged into S in a 
forward triangular merger. In such a case, P's basis would have been 
adjusted by the $60 basis in the T assets deemed transferred. Under 
Sec. 1.358-6(c)(2)(i)(B), however, the basis adjustment determined 
under Sec. 1.358-6(c)(2)(i)(A) is reduced in proportion to the 
percentage of T stock not acquired by P in the transaction. The 
percentage of T stock not acquired in the transaction is 10%. Therefore, 
P reduces its $60 basis adjustment by 10%, resulting in a net basis 
adjustment of $54. Consequently, P has a $164 basis in its T stock as a 
result of the transaction.
    (e) P's ownership of T stock. The facts are the same as in paragraph 
(a) of this Example 2, except that P owns 10% of the T stock before the 
transaction. P's basis in that T stock is $8. All the T shareholders 
other than P surrender their T stock for $10 cash from P and P stock 
worth $80. P does not surrender the stock in the transaction. Under 
Sec. 1.358-6(c)(2)(i)(C), P may treat its T stock owned before the 
transaction as acquired in the transaction or not. If P treats that T 
stock as acquired in the transaction, P's basis in that T stock and the 
T stock actually acquired in the transaction equals P's $110 basis in 
its S stock before the transaction, adjusted by the $60 basis of the T 
assets deemed transferred, for a total basis of $170. If P treats its T 
stock as not acquired, P retains its $8 pre-transaction basis in that 
stock. P's basis in its other T shares equals P's $110 basis in its S 
stock before the transaction, adjusted by $54 (the $60 basis in the T 
assets deemed transferred, reduced by 10%), for a total basis of $164 in 
those shares. See Sec. 1.358-6(c)(2)(i)(A) and (B). Consequently, if P 
treats its T shares as not acquired, P's total basis in all of its T 
shares is $172.
    Example 3. Triangular B reorganization. (a) Facts. T has assets with 
a fair market value of $100 and no liabilities. The T shareholders have 
an aggregate basis in their T stock of $85 immediately before the 
reorganization. Pursuant to a plan, P forms S with $5 cash

[[Page 304]]

and S acquires all of the T stock in exchange for $100 of P stock. The 
transaction is a reorganization to which section 368(a)(1)(B) applies.
    (b) Basis adjustment. Under Sec. 1.358-6(c)(3), P adjusts its $5 
basis in its S stock by treating P as if it acquired the T stock 
acquired by S in the reorganization directly from the T shareholders in 
exchange for the P stock in a transaction in which P's basis in the T 
stock was determined under section 362(b). Under section 362(b), P would 
have an aggregate basis of $85 in the T stock received by S in the 
reorganization. P is then treated as if it transferred the T stock to S 
in a transaction in which P's basis in the S stock was determined under 
section 358. Under section 358, P's basis in its S stock would be 
increased by the $85 basis in the T stock deemed transferred. 
Consequently, P has a $90 basis in its S stock as a result of the 
reorganization.

    (d) Special rule for consideration not provided by P--(1) In 
general. The amount of P's adjustment to basis in its S or T stock, as 
applicable, described in paragraph (c) of this section is decreased by 
the fair market value of any consideration (including P stock in which 
gain or loss is recognized, see Sec. 1.1032-2(c)) that is exchanged in 
the reorganization and that is not provided by P pursuant to the plan of 
reorganization. This paragraph (d) does not apply to the amount of T 
liabilities assumed by S or to which the T assets acquired by S are 
subject under paragraph (c)(1) of this section (or deemed assumed or 
taken subject to by S under paragraph (c)(2)(i) of this section).
    (2) Limitation. P makes no adjustment to basis under this section if 
the decrease required under paragraph (d)(1) of this section equals or 
exceeds the amount of the adjustment described in paragraph (c) of this 
section.
    (3) Example. The rules of this paragraph (d) are illustrated by the 
following example. For purposes of this example, P, S, and T are 
domestic corporations, P and S do not file consolidated returns, P owns 
all of the only class of S stock, the P stock exchanged in the 
transaction satisfies the requirements of the applicable triangular 
reorganization provisions, and the facts set forth the only corporate 
activity.

    Example. (a) Facts. T has assets with an aggregate basis of $60 and 
fair market value of $100 and no liabilities. S is an operating company 
with substantial assets that has been in existence for several years. P 
has a $100 basis in its S stock. Pursuant to a plan, T merges into S and 
the T shareholders receive $70 of P stock provided by P pursuant to the 
plan and $30 of cash provided by S in exchange for their T stock. The 
transaction is a reorganization to which sections 368(a)(1)(A) and 
(a)(2)(D) apply.
    (b) Basis adjustment. Under Sec. 1.358-6(c)(1), P's $100 basis in 
its S stock is increased by the $60 basis in the T assets deemed 
transferred. Under Sec. 1.358-6(d)(1), the $60 adjustment is decreased 
by the $30 of cash provided by S in the reorganization. Consequently, P 
has a net adjustment of $30 in its S stock, and P has a $130 basis in 
its S stock as a result of the reorganization.
    (c) Appreciated asset. The facts are the same as in paragraph (a) of 
this Example, except that in the reorganization S provides an asset with 
a $20 adjusted basis and $30 fair market value instead of $30 of cash. 
The basis results are the same as in paragraph (b) of this Example. In 
addition, S recognizes $10 of gain under section 1001 on its disposition 
of the asset in the reorganization.
    (d) Depreciated asset. The facts are the same as in paragraph (c) of 
this Example, except that S has a $60 adjusted basis in the asset. The 
basis results are the same as in paragraph (b) of this Example. In 
addition, S recognizes $30 of loss under section 1001 on its disposition 
of the asset in the reorganization.
    (e) P stock. The facts are the same as in paragraph (a) of this 
Example, except that in the reorganization S provides P stock with a 
fair market value of $30 instead of $30 of cash. S acquired the P stock 
in an unrelated transaction several years before the reorganization. S 
has a $20 adjusted basis in the P stock. The basis results are the same 
as in paragraph (b) of this Example. In addition, S recognizes $10 of 
gain on its disposition of the P stock in the reorganization. See Sec. 
1.1032-2(c).

    (e) Cross-references--(1) Triangular reorganizations involving 
members of a consolidated group. For rules relating to stock basis 
adjustments made as a result of a triangular reorganization in which P 
and S, or P and T, as applicable, are, or become, members of a 
consolidated group, see Sec. 1.1502-30. However, if a transaction is a 
group structure change, stock basis adjustments are determined under 
Sec. 1.1502-31 and not under Sec. 1.1502-30, even if the transaction 
also qualifies as a reorganization otherwise subject to Sec. 1.1502-30.
    (2) Triangular reorganizations involving certain foreign 
corporations. For rules relating to stock basis adjustments

[[Page 305]]

made as a result of triangular reorganizations involving certain foreign 
corporations, see Sec. Sec. 1.367(b)-4(b), 1.367(b)-10, and 1.367(b)-
13.
    (f) Effective/applicability dates--(1) General rule. Paragraph 
(e)(1) of this section shall apply to triangular reorganizations 
occurring on or after September 17, 2008.
    (2) Special rule for reverse triangular mergers. For a reverse 
triangular merger occurring before December 23, 1994, P may--
    (i) Determine the basis in its T stock as if paragraph (c)(2)(i) of 
this section applied; or
    (ii) Determine the basis in its T stock acquired as if P acquired 
such stock from the former T shareholders in a transaction in which P's 
basis in the T stock was determined under section 362(b).
    (3) Triangular G reorganization and special rule for triangular 
reorganizations involving members of a consolidated group. Paragraphs 
(b)(2)(v) and (e) of this section shall apply to triangular 
reorganizations occurring on or after September 17, 2008. However, 
taxpayers may apply paragraph (b)(2)(v) of this section to triangular 
reorganizations occurring before September 17, 2008 and on or after 
December 23, 1994.
    (4) Triangular reorganizations involving importation property 
acquired in loss importation transaction or loss duplication 
transaction; triangular reorganizations involving certain foreign 
corporations. Paragraphs (a) and (e)(2) of this section apply to 
triangular reorganizations occurring after October 22, 2004 unless 
effected to a binding agreement that was in effect prior to that date 
and at all times thereafter.

[T.D. 8648, 60 FR 66079, Dec. 21, 1995; 61 FR 11547, Mar. 21, 1996; T.D. 
9243, 71 FR 4282, Jan. 26, 2006; T.D. 9424, Sept. 17, 2008; 73 FR 62204, 
Oct. 20, 2008; T.D. 9759, 81 FR 17074, Mar. 28, 2016]



Sec. 1.358-7  Transfers by partners and partnerships to corporations.

    (a) Transfers by partners of partnership interests. For purposes of 
section 358(h), a transfer of a partnership interest to a corporation is 
treated as a transfer of the partner's share of each of the 
partnership's assets and an assumption by the corporation of the 
partner's share of partnership liabilities (including section 358(h) 
liabilities, as defined in paragraph (d) of this section). See paragraph 
(e) Example 2 of this section.
    (b) Transfers by partnerships. If a corporation assumes a section 
358(h) liability from a partnership in an exchange to which section 
358(a) applies, then, for purposes of applying section 705 
(determination of basis of partner's interest) and Sec. 1.704-1(b), any 
reduction, under section 358(h)(1), in the partnership's basis in 
corporate stock received in the transaction is treated as an expenditure 
of the partnership described in section 705(a)(2)(B). See paragraph (e) 
Example 1 of this section. This expenditure must be allocated among the 
partners in accordance with section 704(b) and (c) and Sec. 1.752-7(c). 
If a partner's share of the reduction, under section 358(h)(1), in the 
partnership's basis in corporate stock exceeds the partner's basis in 
the partnership interest, then the partner recognizes gain equal to the 
excess, which is treated as gain from the sale or exchange of a 
partnership interest. This paragraph does not apply to the extent that 
Sec. 1.752-7(j)(4) applies to the assumption of the Sec. 1.752-7 
liability by the corporation.
    (c) Assumption of section 358(h) liability by partnership followed 
by transfer of partnership interest or partnership property to a 
corporation--trade or business exception. Where a partnership assumes a 
section 358(h) liability from a partner and, subsequently, the partner 
transfers all or part of the partner's partnership interest to a 
corporation in an exchange to which section 358(a) applies, then, for 
purposes of applying section 358(h)(2), the section 358(h) liability is 
treated as associated only with the contribution made to the partnership 
by that partner. See paragraph (e) Example 2 of this section. Similar 
rules apply where a partnership assumes a section 358(h) liability of a 
partner and a corporation subsequently assumes that section 358(h) 
liability from the partnership in an exchange to which section 358(a) 
applies.
    (d) Section 358(h) liabilities defined. For purposes of this 
section, section 358(h) liabilities are liabilities described in section 
358(h)(3).

[[Page 306]]

    (e) Examples. The following examples illustrate the provisions of 
this section. Assume, for purposes of these examples, that the 
obligation assumed by the corporation does not reduce the shareholder's 
basis in the corporate stock under section 358(d). The examples are as 
follows:

    Example 1. Transfer of partnership property to corporation. In 2004, 
in an exchange to which section 351(a) applies, PRS, a cash basis 
taxpayer, transfers $2,000,000 cash to Corporation X, also a cash basis 
taxpayer, in exchange for Corporation X shares and the assumption by 
Corporation X of $1,000,000 of accounts payable incurred by PRS. At the 
time of the exchange, PRS has two partners, A, a 90% partner, who has a 
$2,000,000 basis in the PRS interest, and B, a 10% partner, who has a 
$50,000 basis in the PRS interest. Assume that, under section 358(h)(1), 
PRS's basis in the Corporation X stock is reduced by the accounts 
payable assumed by Corporation X ($1,000,000). Under paragraph (b) of 
this section, A's and B's bases in PRS must be reduced, but not below 
zero, by their respective shares of the section 358(h)(1) basis 
reduction. If either partner's share of the section 358(h)(1) basis 
reduction exceeds the partner's basis in the partnership interest, then 
the partner recognizes gain equal to the excess. A's share of the 
section 358(h) basis reduction is $900,000 (90% of $1,000,000). 
Therefore, A's basis in the PRS interest is reduced to $1,100,000 
($2,000,000 - $900,000). B's share of the section 358(h) basis reduction 
is $100,000 (10% of $1,000,000). Because B's share of the section 358(h) 
basis reduction ($100,000) exceeds B's basis in the PRS interest 
($50,000), B's basis in the PRS interest is reduced to $0 and B 
recognizes $50,000 of gain. This gain is treated as gain from the sale 
of the PRS interest.
    Example 2. Transfer of partnership interest to corporation. In 2004, 
A contributes undeveloped land with a value and basis of $4,000,000 in 
exchange for a 50% interest in PRS and an assumption by PRS of 
$2,000,000 of pension liabilities from a separate business that A 
conducts. A's basis in the PRS interest immediately after the 
contribution is A's basis in the land, $4,000,000, unreduced by the 
amount of the pension liabilities. PRS develops the land as a landfill. 
Before PRS has economically performed with respect to the pension 
liabilities, A transfers A's interest in PRS to Corporation X, in an 
exchange to which section 351 applies. At the time of the exchange, the 
value of A's PRS interest is $2,000,000, A's basis in PRS is $4,000,000, 
and A has no share of partnership liabilities other than the pension 
liabilities. For purposes of applying section 358(h), the transfer of 
the PRS interest to Corporation X is treated as a transfer to 
Corporation X of A's share of PRS assets and an assumption by 
Corporation X of A's share of the pension liabilities of PRS 
($2,000,000). Because the pension liabilities were not assumed by PRS 
from A in an exchange in which the trade or business associated with the 
liability was transferred to PRS, the transfer of the PRS interest to 
Corporation X is not excepted from section 358(h) under section 
358(h)(2). See paragraph (c) of this section. Under section 358(h), A's 
basis in the Corporation X stock is reduced by the $2,000,000 of pension 
liabilities.

    (f) Effective date. This section applies to assumptions of 
liabilities by a corporation occurring on or after June 24, 2003.

[T.D. 9207, 70 FR 30341, May 26, 2005]

                         effects on corporation



Sec. 1.361-1  Nonrecognition of gain or loss to corporations.

    Section 361 provides the general rule that no gain or loss shall be 
recognized if a corporation, a party to a reorganization, exchanges 
property in pursuance of the plan of reorganization solely for stock or 
securities in another corporation, a party to the reorganization. This 
provision includes only stock and securities received in connection with 
a reorganization defined in section 368(a). It also includes nonvoting 
stock and securities in a corporation, a party to a reorganization, 
received in a transaction to which section 368(a)(1)(C) is applicable 
only by reason of section 368(a)(2)(B).



Sec. 1.362-1  Basis to corporations.

    (a) In general. Section 362 provides, as a general rule, that if 
property was acquired on or after June 22, 1954, by a corporation (1) in 
connection with a transaction to which section 351 (relating to transfer 
of property to corporation controlled by transferor) applies, (2) as 
paid-in surplus or as a contribution to capital, or (3) in connection 
with a reorganization to which part III, subchapter C, chapter 1 of the 
Code applies, then the basis shall be the same as it would be in the 
hands of the transferor, increased in the amount of gain recognized to 
the transferor on such transfer. (See also Sec. 1.362-2.) See Sec. 
1.460-4(k)(3)(iv)(B)(2) for rules relating to adjustments to the basis 
of certain contracts accounted for using a long-term contract method of 
accounting

[[Page 307]]

that are acquired in certain transfers described in section 351 and 
certain reorganizations described in section 368(a).
    (b) Exceptions. (1) In the case of a plan of reorganization adopted 
after October 22, 1968, section 362 does not apply if the property 
acquired in connection with such reorganization consists of stock or 
securities in a corporation a party to the reorganization, unless 
acquired by the exchange of stock or securities of the transferee (or of 
a corporation which is in control of the transferee) as the 
consideration in whole or in part for the transfer.
    (2) In the case of a plan of reorganization adopted before October 
23, 1968, section 362 does not apply if the property acquired in 
connection with such reorganization consists of stock or securities in a 
corporation a party to the reorganization, unless acquired by the 
issuance of stock or securities of the transferee (or, in the case of 
transactions occurring after December 31, 1963, of a corporation which 
is in control of the transferee) as the consideration in whole or in 
part for the transfer. The term issuance of stock or securities includes 
any transfer of stock or securities, including stock or securities which 
were purchased or were acquired as a contribution to capital.

[T.D. 7422, 41 FR 26569, June 28, 1976, as amended by T.D. 8995, 67 FR 
34605, May 15, 2002]



Sec. 1.362-2  Certain contributions to capital.

    The following regulations shall be used in the application of 
section 362(c):
    (a) Property deemed to be acquired with contributed money shall be 
that property, if any, the acquisition of which was the purpose 
motivating the contribution;
    (b) In the case of an excess of the amount of money contributed over 
the cost of the property deemed to be acquired with such money (as 
defined in paragraph (a) of this section) such excess shall be applied 
to the reduction of the basis (but not below zero) of other properties 
held by the corporation, on the last day of the 12-month period 
beginning on the day the contribution is received, in the following 
order--
    (1) All property of a character subject to an allowance for 
depreciation (not including any properties as to which a deduction for 
amortization is allowable),
    (2) Property with respect to which a deduction for amortization is 
allowable,
    (3) Property with respect to which a deduction for depletion is 
allowable under section 611 but not under section 613, and
    (4) All other remaining properties.

The reduction of the basis of each of the properties within each of the 
above categories shall be made in proportion to the relative bases of 
such properties.
    (c) With the consent of the Commissioner, the taxpayer may, however, 
have the basis of the various units of property within a particular 
category adjusted in a manner different from the general rule set forth 
in paragraph (b) of this section. Variations from such rule may, for 
example, involve adjusting the basis of only certain units of the 
taxpayer's property within a given category. A request for variations 
from the general rule should be filed by the taxpayer with its return 
for the taxable year for which the transfer of the property has 
occurred.



Sec. 1.362-3  Basis of importation property acquired in loss 
importation transaction.

    (a) Purpose. The purpose of section 362(e)(1) and this section is to 
modify the application of section 362(a) (section 351 transfers, 
contributions to capital, or paid-in surplus) and section 362(b) 
(reorganizations) to prevent a corporation (Acquiring) from importing a 
net built-in loss in a transaction described in either section. See 
paragraph (c) of this section for definitions of terms used in this 
section.
    (b) Basis determinations under this section--(1) Basis of 
importation property received in loss importation transaction. 
Notwithstanding the general rules of section 362(a) and (b), Acquiring's 
basis in importation property (as defined in paragraph (c)(2) of this 
section) acquired in a loss importation transaction (as defined in 
paragraph (c)(3) of this section) is equal to the value of the property 
immediately after the transaction.

[[Page 308]]

    (2) Adjustment to basis of subsidiary stock in triangular 
reorganizations. If a corporation (P) computes its basis in stock of a 
subsidiary (whether S or T) under Sec. 1.358-6 (stock basis in certain 
triangular reorganizations), P's basis in property treated as acquired 
by P in Sec. 1.358-6(c) is determined under section 362(e)(1) and this 
section to the extent such property, if actually acquired by P, would be 
importation property acquired in a loss importation transaction. See 
Sec. 1.358-6(c)(1)(i)(A), (c)(2)(ii)(B), and (c)(3)(i). The 
subsidiary's basis in the property actually acquired in the transaction 
is determined under applicable law (including this section), without 
regard to the amount of any adjustment to P's basis in the subsidiary's 
stock. Thus, the basis of the property in S's or T's hands may differ 
from the amount of the adjustment to P's basis in its stock of S or T.
    (3) Acquiring's basis in other property transferred. In general, 
Acquiring's basis in property received in a section 362 transaction (as 
defined in paragraph (c)(1) of this section) that is not determined 
under section 362(e)(1) and this section is determined under section 
362(a) or section 362(b). However, if the transaction is described in 
section 362(a) (without regard to whether it is also described in any 
other section), further adjustment may be required under section 
362(e)(2). See Sec. 1.362-4.
    (4) Other effects of basis determination under this section--(i) 
Determination by reference to transferor's basis. A determination of 
basis under this section is a determination by reference to the 
transferor's basis, including for purposes of sections 1223(2) and 
7701(a)(43). However, solely for purposes of applying section 755, a 
determination of basis under this section is treated as a determination 
not by reference to the transferor's basis.
    (ii) Not tax-exempt income or noncapital, nondeductible expense. The 
application of this section does not give rise to an item treated as 
tax-exempt income under Sec. 1.1502-32(b)(2)(ii) or as a noncapital, 
nondeductible expense under Sec. 1.1502-32(b)(2)(iii).
    (iii) No effect on earnings and profits. Any determination of basis 
under this section does not reduce or otherwise affect the calculation 
of the all earnings and profits amount provided in Sec. 1.367(b)-2(d).
    (c) Definitions. For purposes of this section, the following 
definitions apply:
    (1) Section 362 transaction. The term section 362 transaction means 
any transaction described in section 362(a) or in section 362(b).
    (2) Importation property--(i) General rule. The term importation 
property means any property (including separate portions determined 
under paragraph (d)(4) of this section and separate portions of property 
tentatively divided under paragraph (e)(2) of this section) with respect 
to which--
    (A) Any gain or loss that would be recognized on its sale by the 
transferor immediately before the transaction (the transferor's 
hypothetical sale) would not be subject to tax imposed under any 
provision of subtitle A of the Internal Revenue Code (federal income 
tax) (taking into account the provisions of paragraph (d) of this 
section); and
    (B) Any gain or loss that would be recognized on its sale by 
Acquiring immediately after the transaction (Acquiring's hypothetical 
sale) would be subject to federal income tax (taking into account the 
provisions of paragraph (d) of this section).
    (ii) Special rules for applying this paragraph (c)(2). See paragraph 
(d) of this section for rules for determining whether gain or loss on a 
hypothetical sale would be taken into account in determining a federal 
income tax liability and paragraph (e) of this section for rules 
applicable when more than one person would take such gain or loss into 
account.
    (3) Loss importation transaction. The term loss importation 
transaction means any section 362 transaction in which Acquiring's 
aggregate basis in all importation property received from all 
transferors in the transaction would exceed the aggregate value of such 
property immediately after the transaction. For this purpose, 
Acquiring's basis in property received is determined without regard to 
this section or section 362(e)(2).
    (4) Value--(i) General rule. The term value means fair market value.

[[Page 309]]

    (ii) Special rule for transfers of partnership interests. 
Notwithstanding the general rule in paragraph (c)(4)(i) of this section, 
when referring to a partnership interest, for purposes of this section, 
the term value means the sum of the cash that Acquiring would receive 
for the interest, assuming an exchange between a willing buyer and a 
willing seller (neither being under any compulsion to buy or sell and 
both having reasonable knowledge of relevant facts), increased by any 
Sec. 1.752-1 liabilities (as defined in Sec. 1.752-1(a)(4)) of the 
partnership allocated to Acquiring with regard to such transferred 
interest under section 752 immediately after the transfer to Acquiring. 
If a partnership has elected under section 754, or if section 743(b) 
would require a downward basis adjustment to the partnership property, 
the partnership must apply the rules of Sec. 1.743-1 to determine the 
amount of the basis adjustment to the partnership property.
    (d) Rules for determining whether gain or loss would be taken into 
account in determining a federal income tax liability--(1) General rule. 
In general, any gain or loss that would be recognized on a hypothetical 
sale described in paragraph (c)(2) of this section is considered to be 
subject to federal income tax if, taking into account all relevant facts 
and circumstances, such gain or loss would affect or be taken into 
account in determining the federal income tax liability of the 
transferor or Acquiring, respectively. This determination is made 
without regard to whether such person has or would have any actual 
federal income tax liability for the taxable year of the transaction.
    (2) Look-through rule in the case of certain pass-through entities. 
Notwithstanding the general rule in paragraph (d)(1) of this section, 
the determination of whether any gain or loss on a hypothetical sale 
would be treated as subject to federal income tax is made by reference 
to the person that would be required to include such gain or loss in its 
taxable income if the hypothetical seller is--
    (i) A trust treated as owned by its grantors or others (see section 
671);
    (ii) A partnership (see section 701); or
    (iii) An S corporation (see sections 1363 and 1366).
    (3) Controlled foreign corporation (CFC), passive foreign investment 
company (PFIC). For purposes of this section, gain or loss that would be 
recognized by a CFC (as defined in section 957(a)) or a PFIC (as defined 
in section 1297(a)) is not deemed taken into account in determining a 
federal income tax liability solely because it could affect an inclusion 
under section 951(a) or section 1293(a).
    (4) Special rule for debt-financed property subject to section 512. 
If property is debt-financed property (as defined in section 514(b)) 
owned by an organization subject to the unrelated business income tax 
described in section 511(a)(2) and, as a result, a portion of any gain 
or loss on a sale of the property would be included in unrelated taxable 
business income (UBTI) under section 512, such property is treated as 
divided into separate portions in proportion to the amount of such gain 
or loss that would be includible in UBTI. The rules of paragraph (e) of 
this section apply to determine the characterization of such portions 
(as includible in the determination of a federal income tax liability or 
not), and the tax treatment and consequences of the transaction in which 
such portions are transferred.
    (5) Look-through treatment in the case of certain avoidance 
transactions--(i) Application of this paragraph (d)(5). This paragraph 
(d)(5) applies if--
    (A) The transferor is a domestic entity that is a trust (other than 
a trust described in paragraph (d)(2)(i) of this section), estate, 
regulated investment company (as defined in section 851(a)), a real 
estate investment trust (as defined in section 856(a)), or a cooperative 
(as described in section 1381); and
    (B) The transferor transfers, directly or indirectly, property that 
was transferred to or acquired by it as part of a plan (whether of 
transferor, Acquiring, or any other person) to avoid the application of 
section 362(e)(1) and this section to a section 362 transaction.
    (ii) Effect of application of this paragraph (d)(5). Notwithstanding 
paragraph (d)(1) of this section, if a transferor is described in both 
paragraphs (d)(5)(i)(A) and (B) of this section--
    (A) The transferor is treated as though it distributes the proceeds 
of

[[Page 310]]

the hypothetical sale (which, for this purpose, are presumed to be an 
amount greater than zero);
    (B) To the fullest extent possible under the transferor's organizing 
instrument, the deemed distribution is treated as made to a distributee 
or distributees that would not take distributions from the transferor 
into account in determining a federal income tax liability; and
    (C) The determination of whether the gain or loss on the 
hypothetical sale is treated as subject to federal income tax is made by 
reference to the deemed distributee or distributees.
    (iii) Tiered entities. If a deemed distributee is an entity 
described in paragraph (d)(5)(i)(A) of this section, the determination 
of whether gain or loss on the hypothetical sale is taken into account 
in determining a federal income tax liability is made by treating the 
deemed distributee, and any successive such deemed distributees, as a 
transferor and applying the rules in paragraphs (d)(5)(i) and (ii) of 
this section to its deemed distribution (and to all successive deemed 
distributions), until no deemed distributee or successive deemed 
distributee is an entity described in paragraph (d)(5)(i)(A) of this 
section.
    (e) Special rules for gain or loss that would be taken into account 
by multiple persons--(1) In general. If gain or loss from a disposition 
of property would be includible in income by more than one person, the 
property is treated as tentatively divided into separate portions in 
proportion to the amount of gain or loss recognized with respect to the 
property that would be allocated to each such person. If an entity's 
organizing instrument specially allocates gain and loss, the tentative 
division of property under this paragraph (e) must reflect the manner in 
which gain or loss on the disposition of such property would be 
allocated under the terms of the organizing instrument and any 
applicable rules of law, taking into account the net gain or loss 
actually recognized by the entity in that tax year.
    (2) Application of section. The rules of this section apply 
independently to each tentatively divided portion to determine if the 
portion is importation property. Each tentatively divided portion that 
is determined to be importation property is included with all other 
importation property in the determination of whether the transaction is 
a loss importation transaction.
    (3) Acquiring's basis in property tentatively divided into separate 
portions. Immediately after the application of section 362(e)(1) and 
this section and before the application of section 362(e)(2), each 
property treated as tentatively divided into separate portions for 
purposes of applying section 362(e)(1) and this section ceases to be 
treated as tentatively divided and Acquiring has a single, undivided 
basis in such property that is equal to the sum of--
    (i) The value of each tentatively divided portion that is 
importation property, if the transaction is a loss importation 
transaction; and
    (ii) Acquiring's basis in each tentatively divided portion that is 
not importation property received in a loss importation transaction, as 
determined under section 362(a) or section 362(b), as applicable, and 
without regard to any potential application of section 362(e)(2).
    (f) Examples. The examples in this paragraph (f) illustrate the 
application of section 362(e)(1) and the provisions of this section. 
Unless otherwise indicated, the examples use the following nomenclature 
and assumptions: A and B are U.S. citizens. DC, DC1, and P are domestic 
corporations that have not elected to be S corporations within the 
meaning of section 1361(a)(1) and that are not members of a consolidated 
group. F is a foreign individual. FP is a foreign partnership. FC, FC1, 
and FC2 are foreign corporations. Unless the facts indicate otherwise, 
the foreign individuals, corporations, and partnerships are not engaged 
in a U.S. trade or business, have no U.S. real property interests, and 
have no other relationships, activities, or interests that would cause 
them, their shareholders, their partners, or their property to be 
subject to federal income tax. There is no applicable income tax treaty, 
all persons' tax years are calendar years, and all persons and 
transactions are unrelated unless the facts indicate otherwise.


[[Page 311]]


    Example 1. Basic application of section. (i) Section 351 transfer of 
importation property in a loss importation transaction. (A) Facts. FC 
owns three assets, A1 (basis $40, value $150), A2 (basis $120, value 
$30), and A3 (basis $140, value $20). On Date 1, FC transfers A1, A2, 
and A3 to DC in a transaction to which section 351 applies.
    (B) Importation property. If FC had sold A1, A2, or A3 immediately 
before the transaction, no gain or loss recognized on the sale would 
have been taken into account in determining a federal income tax 
liability. Further, if DC had sold A1, A2, or A3 immediately after the 
transaction, DC would take into account any gain or loss recognized on 
the sale in determining its federal income tax liability. Therefore, A1, 
A2, and A3 are all importation properties. See paragraph (c)(2) of this 
section.
    (C) Loss importation transaction. FC's transfer of A1, A2, and A3 is 
a section 362 transaction. Furthermore, but for section 362(e)(1) and 
this section and section 362(e)(2), DC's aggregate basis in the 
importation properties, A1, A2, and A3, would be $300 ($40 + $120 + 
$140) under section 362(a) and the properties' aggregate value would be 
$200 ($150 + $30 + $20). Therefore, the importation properties' 
aggregate basis would exceed their aggregate value and the transaction 
is a loss importation transaction. See paragraph (c)(3) of this section.
    (D) Application of section 362(e)(1) and this section to importation 
property received in loss importation transaction. Because the 
importation properties, A1, A2, and A3, were transferred in a loss 
importation transaction, paragraph (b)(1) of this section applies and 
DC's basis in A1, A2, and A3 will each be equal to the property's value 
($150, $30, and $20, respectively) immediately after the transfer.
    (E) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. Taking into account the application of 
section 362(e)(1) and this section, DC's aggregate basis in the 
transferred properties would not exceed their aggregate value 
immediately after the transfer. Therefore, FC does not have a net built-
in loss, FC's transfer is not a loss duplication transaction, and 
section 362(e)(2) does not apply to this transaction. DC's bases in A1, 
A2, and A3, as determined under paragraph (i)(D) of this Example 1, are 
$150, $30, and $20, respectively. Under section 358(a), FC receives the 
DC stock with a basis of $300 (the sum of FC's bases in A1, A2, and A3 
immediately before the exchange).
    (ii) Reorganization. The facts are the same as in paragraph (i)(A) 
of this Example 1 except that, instead of transferring property to DC in 
a section 351 exchange, FC merges with and into DC in a transaction 
described in section 368(a)(1)(A). The analysis and results are the same 
as set forth in paragraphs (i)(B), (C), and (D) of this Example 1. 
However, the analysis in paragraph (i)(E) of this Example 1 does not 
apply to these facts because the transaction is not subject to 362(e)(2) 
and Sec. 1.362-4. Under section 358(a), FC's shareholders will take the 
DC stock with a basis determined by reference to their FC stock basis.
    (iii) FC's property used in U.S. trade or business. (A) Facts. The 
facts are the same as in paragraph (i)(A) of this Example 1, except that 
FC is engaged in a U.S. trade or business and uses all the properties in 
that U.S. trade or business. In this case, none of the properties would 
be importation property because FC would take any gain or loss on the 
disposition of the properties into account in determining its federal 
income tax liability. Accordingly, this section does not apply to the 
transaction.
    (B) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. Taking into account the application of 
section 362(e)(1) and this section but without taking into account the 
provisions of section 362(e)(2), DC's aggregate basis in the transferred 
properties would be $300 ($40 + $120 + $140) under section 362(a) and 
the properties' aggregate value immediately after the transfer would be 
$200 ($150 + $30 + $20). Therefore, FC has a net built-in loss and FC's 
transfer of A1, A2, and A3 is a loss duplication transaction. 
Accordingly, under the general rule of section 362(e)(2), FC's $100 net 
built-in loss ($300 aggregate basis over $200 aggregate value) would be 
allocated proportionately (by the amount of built-in loss in each 
property) to reduce DC's basis in the loss properties, A2 and A3. See 
Sec. 1.362-4. As a result, DC's basis in A2 would be $77.14 ($120 basis 
under section 362(a) reduced by $42.86, A2's proportionate share of FC's 
net built-in loss, computed as $90/$210 x $100) and DC's basis in A3 
would be $82.86 ($140 basis under section 362(a) reduced by $57.14, A3's 
proportionate share of FC's net built-in loss, computed as $120/$210 x 
$100). However, if FC and DC were to elect under section 362(e)(2)(C) to 
apply the $100 basis reduction to FC's basis in the DC stock received in 
the transaction, DC's bases in A2 and A3 would remain their section 
362(a) bases of $120 and $140, respectively. Under section 362(a), DC's 
basis in A1 is $40 (irrespective of whether the section 362(e)(2)(C) 
election is made). If FC and DC do not make a section 362(e)(2)(C) 
election, FC's basis in the DC stock received in the exchange will be 
$300; if FC and DC do make the election, FC's basis in the DC stock will 
be $200 ($300-$100 net built-in loss). See Sec. 1.362-4(b).

[[Page 312]]

    Example 2. Multiple transferors. (i) Facts. The facts are the same 
as in paragraph (i)(A) of Example 1 of this paragraph (f), except that 
FC only owns A1 (basis $40, value $150) and A2 (basis $120, value $30) 
and F owns A3 (basis $140, value $20). On Date 1, FC transfers A1 and 
A2, and F transfers A3, to DC in a single transaction described in 
section 351.
    (ii) Importation property. A1 and A2 are importation properties for 
the reasons set forth in paragraph (i)(B) of Example 1 of this paragraph 
(f). A3 is also an importation property because, if F had sold A3 
immediately before the transaction, no gain or loss recognized on the 
sale would have been taken into account in determining a federal income 
tax liability, and, further, if DC had sold A3 immediately after the 
transaction, DC would take into account any gain or loss recognized on 
the sale in determining its federal income tax liability.
    (iii) Loss importation transaction. The transfers by FC and F are a 
section 362 transaction. The transaction is a loss importation 
transaction for the reasons set forth in paragraph (i)(C) of Example 1 
of this paragraph (f) (notwithstanding that one of the transferors, FC, 
did not transfer a net built-in loss). See paragraph (c)(3) of this 
section.
    (iv) Application of section 362(e)(1) and this section to 
importation property received in loss importation transaction. Because 
the importation properties, A1, A2, and A3, were transferred in a loss 
importation transaction, paragraph (b)(1) of this section applies and 
DC's basis in A1, A2, and A3 will each be equal to the property's value 
($150, $30, and $20, respectively) immediately after the transfer.
    (v) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. The application of section 362(e)(2) is 
determined separately for each transferor. See Sec. 1.362-4(b). Taking 
into account the application of section 362(e)(1) and this section, 
neither DC's aggregate basis in FC's properties nor DC's basis in F's 
property would exceed the properties' respective values immediately 
after the transaction. Therefore neither FC nor F has a net built-in 
loss, neither transfer is a loss duplication transaction, and section 
362(e)(2) does not apply to either transfer. DC's bases in A1, A2, and 
A3, as determined under paragraph (iv) of this Example 2, are $150, $30, 
and $20, respectively. Under section 358(a), FC's basis in the DC stock 
received is $160 ($40 + $120) and F's basis in the DC stock received in 
the exchange is $140.
    Example 3. Transfer of importation and non-importation property. (i) 
Facts. As in paragraph (i) of Example 2, FC owns A1 (basis $40, value 
$150) and A2 (basis $120, value $30), and F owns A3 (basis $140, value 
$20). In addition, A2 is a U.S. real property interest as defined in 
section 897(c)(1). On Date 1, FC transfers A1 and A2, and F transfers 
A3, to DC in a single transaction described in section 351.
    (ii) Importation property. A1 and A3 are importation properties for 
the reasons set forth in paragraph (i)(B) of Example 1 and paragraph 
(ii) of Example 2 of this paragraph (f), respectively. However, A2 is 
not importation property because, if FC had sold A2 immediately before 
the transaction, FC would take into account any gain or loss recognized 
on the sale in determining its federal income tax liability.
    (iii) Loss importation transaction. FC's and F's transfer is a 
section 362 transaction. Furthermore, but for section 362(e)(1) and this 
section and section 362(e)(2), DC's aggregate basis in the importation 
properties, A1 and A3, would be $180 ($40 + $140) and the properties' 
aggregate value would be $170 ($150 + $20) immediately after the 
transaction. Therefore, the importation properties' aggregate basis 
would exceed their aggregate value immediately after the transaction, 
and the transfer is a loss importation transaction.
    (iv) Application of section 362(e)(1) and this section to 
importation property received in loss importation transaction. Because 
the importation properties, A1 and A3, were transferred in a loss 
importation transaction, paragraph (b)(1) of this section applies and 
DC's basis in A1 and in A3 will each be equal to the property's value 
($150 and $20, respectively) immediately after the transfer.
    (v) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. The application of section 362(e)(2) is 
determined separately for each transferor. See Sec. 1.362-4(b).
    (A) FC's transfer. Taking into account the application of section 
362(e)(1) and this section but without taking into account the 
provisions of section 362(e)(2), DC would have an aggregate basis of 
$270 in the transferred properties ($150 in A1, as determined under 
paragraph (iv) of this Example 3, plus $120 in A2, determined under 
section 362(a)), and the properties would have an aggregate value of 
$180 ($150 + $30) immediately after the transfer. Therefore, FC has a 
net built-in loss and FC's transfer of A1 and A2 is a loss duplication 
transaction. Accordingly, under the general rule of section 362(e)(2), 
FC's $90 net built-in loss ($270 aggregate basis to DC over $180 
aggregate value) would be allocated proportionately to reduce DC's basis 
in the loss property transferred by FC. As a result, FC's entire net 
built-in loss would be allocated to A2, the only loss property 
transferred by FC, and DC's basis in A2 would be $30 ($120 basis under 
section 362(a) reduced by $90 net built-in loss). However, if FC and DC 
were to elect

[[Page 313]]

under section 362(e)(2)(C) to apply the $90 basis reduction to FC's 
basis in the DC stock received in the transaction, DC's basis in A2 
would remain its section 362(a) basis of $120. DC's basis in A1 is $150 
as determined under paragraph (iv) of this Example 3 (irrespective of 
whether the section 362(e)(2)(C) election is made). If FC and DC do not 
make a section 362(e)(2)(C) election, FC's basis in the DC stock 
received in the exchange will be $160; if FC and DC do make the 
election, FC's basis in the DC stock will be $70 ($160-$90 net built-in 
loss). See Sec. 1.362-4.
    (B) F's transfer of A3. Taking into account the application of 
section 362(e)(1) and this section, DC's basis in A3, the property 
transferred by F, would not exceed its value immediately after the 
transfer. Therefore, F does not have a built-in loss, F's transfer is 
not a loss duplication transaction, and section 362(e)(2) does not apply 
to F's transfer. DC's basis in A3, as determined under paragraph (iv) of 
this Example 3, is $20. Under section 358(a), F receives the DC stock 
with a basis of $140.
    Example 4. Multiple transferors of non-importation properties. (i) 
Facts. DC1 owns A1 (basis $40, value $150). In addition, as in Example 3 
of this paragraph (f), FC owns A2 (basis $120, value $30), a U.S. real 
property interest as defined in section 897(c)(1), and F owns A3 (basis 
$140, value $20). On Date 1, DC1 transfers A1, FC transfers A2, and F 
transfers A3, to DC in a single transaction described in section 351.
    (ii) Importation property. A2 is not importation property and A3 is 
importation property for the reasons set forth in paragraph (ii) of 
Example 3 and paragraph (i)(B) of Example 1 of this paragraph (f), 
respectively. A1 is not importation property because, if DC1 had sold A2 
immediately before the transaction, DC1 would take into account any gain 
or loss recognized on the sale in determining its federal income tax 
liability.
    (iii) Loss importation transaction. The transfer of A1, A2, and A3 
is a section 362 transaction. Furthermore, but for section 362(e)(1) and 
this section and section 362(e)(2), DC's basis in importation property, 
A3, would be $140 and the value of the property would be $20 immediately 
after the transaction. Therefore, the importation property's basis would 
exceed value and the transfer is a loss importation transaction.
    (iv) Application of section 362(e)(1) and this section to 
importation property received in loss importation transaction. Because 
the importation property, A3, was transferred in a loss importation 
transaction, section 362(e)(1) and paragraph (b)(1) of this section 
apply and DC's basis in A3 will be equal to A3's $20 value immediately 
after the transfer.
    (v) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. The application of section 362(e)(2) is 
determined separately for each transferor. See Sec. 1.362-4.
    (A) DC1's transfer. Taking into account the application of section 
362(e)(1) and this section, DC's basis in A1 ($40 under section 362(a)) 
would not exceed its value immediately after the transfer. Therefore, 
DC1 does not have a net built-in loss, DC1's transfer is not a loss 
duplication transaction, and section 362(e)(2) does not apply to DC1's 
transfer. DC's basis in A1, determined under section 362(a), is $40. 
Under section 358(a), DC1 receives the DC stock with a basis of $40.
    (B) FC's transfer. Taking into account the application of section 
362(e)(1) and this section, but without taking into account the 
provisions of section 362(e)(2), DC would have a section 362(a) basis of 
$120 in A2, which would exceed A2's $30 value immediately after the 
transfer. Therefore, FC has a net built-in loss and FC's transfer of A2 
is a loss duplication transaction. Accordingly, under the general rule 
of section 362(e)(2), FC's $90 net built-in loss (DC's $120 basis in A2 
over A2's $30 value) would be applied to reduce DC's basis in A2, the 
only loss property transferred by FC. As a result, DC's basis in A2 
would be $30 ($120 basis under section 362(a), reduced by the $90 net 
built-in loss). However, if FC and DC were to elect under section 
362(e)(2)(C) to apply the $90 basis reduction to FC's basis in the DC 
stock received in the transaction, DC's basis in A2 would be its $120 
basis determined under section 362(a). If FC and DC do not make a 
section 362(e)(2)(C) election, FC's basis in the DC stock received in 
the exchange will be $120; if FC and DC do make the election, FC's basis 
in the DC stock will be $30 ($120-$90). See Sec. 1.362-4.
    (C) F's transfer. F's transfer of A3 is a transaction described in 
section 362(a). However, taking into account the application of section 
362(e)(1) and this section, DC's basis in A3 ($20) would not exceed its 
value immediately after the transfer. Therefore, F does not have a 
built-in loss, F's transfer is not a loss duplication transaction, and 
section 362(e)(2) does not apply to F's transfer. DC's basis in A3, as 
determined under paragraph (iv) of this Example 4, is $20. Under section 
358(a), F receives the DC stock with a basis of $140.
    Example 5. Partnership transactions. (i) Transfer by foreign 
partnership, foreign and domestic partners. (A) Facts. A and F are equal 
partners in FP. FP owns A1 (basis $100, value $70). Under the terms of 
the FP partnership agreement, FP's items of income, gain, deduction, and 
loss are allocated equally between A and F. Section 704(c) does not 
apply with respect to the partnership property. FP transfers A1 to DC in 
a transfer to which section 351 applies. No election is made under 
section 362(e)(2)(C).

[[Page 314]]

    (B) Importation property. If FP had sold A1 immediately before the 
transaction, any gain or loss recognized on the sale would be allocated 
to and includible by A and F equally under the partnership agreement. 
Thus, under paragraph (d)(2) of this section, A1 is treated as 
tentatively divided into two equal portions, one treated as owned by A 
and one treated as owned by F. If FP had sold A1 immediately before the 
transaction, any gain or loss recognized on the portion treated as owned 
by A would have been taken into account in determining a federal income 
tax liability (A's); thus A's tentatively divided portion of A1 is not 
importation property. However, no gain or loss recognized on the 
tentatively divided portion treated as owned by F would have been taken 
into account in determining a federal income tax liability. Further, if 
DC had sold A1 immediately after the transaction, any gain or loss 
recognized on the sale would have been taken into account in determining 
a federal income tax liability (DC's); thus, F's tentatively divided 
portion of A1 is importation property.
    (C) Loss importation transaction. FP's transfer of A1 is a section 
362 transaction. Furthermore, but for section 362(e)(1) and this section 
and section 362(e)(2), DC's basis in the importation property, F's 
portion of A1, would be $50 under section 362(a) and the property's 
value would be $35 immediately after the transaction. Therefore, the 
importation property's basis would exceed its value and the transfer is 
a loss importation transaction.
    (D) Application of section 362(e)(1) and this section to importation 
property received in loss importation transaction. Because the 
importation property, F's tentatively divided portion of A1, was 
transferred in a loss importation transaction, section 362(e)(1) and 
paragraph (b)(1) of this section apply and DC's basis in F's portion of 
A1 will be equal to its $35 value.
    (E) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. Taking into account the application of 
section 362(e)(1) and this section but without taking into account the 
provisions of section 362(e)(2), DC's aggregate basis in A1 would be $85 
(the sum of the $35 basis in F's tentatively divided portion of A1, as 
determined under paragraph (i)(D) of this Example 5, and the $50 basis 
in A's tentatively divided portion of A1, determined under section 
362(a), see paragraphs (d)(2) and (e)(3) of this section) and A1's value 
immediately after the transfer would be $70. Therefore, FP has a net 
built-in loss and FP's transfer of A1 is a loss duplication transaction. 
Accordingly, under the general rule of section 362(e)(2), FP's $15 net 
built-in loss ($85 basis over $70 value) would be allocated to reduce 
DC's basis in the loss asset, A1, the only loss property transferred by 
FP. As a result, DC's basis in A1 would be $70 ($85 basis under section 
362(a) and this section, reduced by the $15 net built-in loss). Under 
section 358, FP's basis in the DC stock received in the exchange will be 
$100. See Sec. 1.362-4.
    (ii) Transfer with election to apply section 362(e)(2)(C). The facts 
are the same as in paragraph (i)(A) of this Example 5, except that FP 
and DC elect to apply section 362(e)(2)(C) to reduce FP's basis in the 
DC stock received in the exchange. The analysis and results are the same 
as in paragraphs (i)(B), (C), (D), and (E) of this Example 5, except 
that the $15 reduction to DC's basis in A1 is not made and, as a result, 
DC's basis in A1 remains $85, and FP's basis in the DC stock received in 
the exchange is reduced from $100 to $85. The $15 reduction to FP's 
basis in DC stock reduces A's basis in its FP interest under section 
705(a)(2)(B). See Sec. 1.362-4(e)(1).
    (iii) Transfer by domestic partnership. The facts are the same as in 
paragraph (i)(A) of this Example 5 except that FP is a domestic 
partnership. The analysis and results are the same as in paragraphs 
(i)(B), (C), (D), and (E) of this Example 5.
    (iv) Transfer of interest in partnership with liability. (A) Facts. 
F and two other individuals are equal partners in FP. F's basis in its 
partnership interest is $247. F's share of FP's Sec. 1.752-1 
liabilities (as defined in Sec. 1.752-1(a)(4)) is $150. F transfers his 
partnership interest to DC in a transaction to which section 351 
applies. If DC were to sell the FP interest immediately after the 
transfer, DC would receive $100 in cash or other property. In addition, 
taking into account the rules under Sec. 1.752-4, DC's share of FP's 
Sec. 1.752-1 liabilities (as defined in Sec. 1.752-1(a)(4)) is $145 
immediately after the transfer.
    (B) Importation property. If F had sold his partnership interest 
immediately before the transaction, no gain or loss recognized on the 
sale would have been taken into account in determining a federal income 
tax liability. Further, if DC had sold the partnership interest 
immediately after the transaction, any gain or loss recognized on the 
sale would have been taken into account in determining a federal income 
tax liability. Therefore, F's partnership interest is importation 
property.
    (C) Loss importation transaction. F's transfer is a section 362 
transaction. However, but for section 362(e)(1) and this section and 
section 362(e)(2), DC's basis in the importation property, the 
partnership interest, determined under section 362(a) and taking into 
account the rules under section 752, would be $242 (F's $247 basis 
reduced by F's $150 share of FP liabilities and increased by DC's $145 
share of FP liabilities) and, under paragraph (c)(4)(ii) of this 
section, the value of the FP interest would be $245 (the sum of $100, 
the cash DC would receive if DC immediately sold the

[[Page 315]]

partnership interest, and $145, DC's share of the Sec. 1.752-1 
liabilities (as defined in Sec. 1.752-1(a)(4)) under section 752 
immediately after the transfer to DC). Therefore, the importation 
property's basis ($242) would not exceed its value ($245), and the 
transfer is not a loss importation transaction.
    (D) Basis in property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. As described in paragraph (iv)(C) of this 
Example 5, taking into account the application of section 362(e)(1) and 
this section, DC's basis in the partnership interest would not exceed 
its value. Therefore, under Sec. 1.362-4, F does not have a net built-
in loss, the transfer is not a loss duplication transaction, and section 
362(e)(2) does not apply to the transfer. DC's basis in F's partnership 
interest is $242, determined under sections 362(a) and 752. Under 
section 358, taking into account the rules under section 752, F's basis 
in the DC stock received in the exchange is $97 ($247 reduced by F's 
$150 share of FP liabilities). If FP had elected under section 754, or 
if section 743(b) required a downward basis adjustment to the 
partnership property, FP would apply the rules of Sec. 1.743-1 to 
determine the amount of the basis adjustment to the partnership 
property.
    Example 6. Transactions involving tax-exempt entities. (i) Exempt 
transferor. (A) Facts. InsCo is a benevolent life insurance association 
of a purely local character exempt from federal income tax under section 
501(a) because it is described in section 501(c)(12). InsCo owns shares 
of stock of DC1 (basis $100, value $70) for investment purposes, which 
are not debt-financed property (as defined in section 514). On December 
31, Year 1, InsCo transfers the DC1 stock to DC in exchange for DC stock 
in a transaction to which section 351 applies. No election is made under 
section 362(e)(2)(C).
    (B) Importation property. If InsCo had sold the DC1 stock 
immediately before the transaction, any gain or loss realized would be 
excluded from UBTI under section 512(b)(5), and thus no gain or loss 
recognized on the sale would have been taken into account in determining 
federal income tax liability. Further, if DC had sold the DC1 stock 
immediately after the transaction, any gain or loss recognized on the 
sale would have been taken into account in determining federal income 
tax liability. Therefore, the DC1 stock is importation property.
    (C) Loss importation transaction. InsCo's transfer is a section 362 
transaction. Furthermore, but for section 362(e)(1) and this section and 
section 362(e)(2), DC's basis in importation property, the DC1 stock, 
would be $100, and the stock's value would be $70 immediately after the 
transaction. Therefore, the importation property's basis would exceed 
its value and the transfer is a loss importation transaction.
    (D) Application of section 362(e)(1) and this section to importation 
property received in loss importation transaction. Because the 
importation property, the DC1 stock, was transferred in a loss 
importation transaction, paragraph (b)(1) of this section applies and 
DC's basis in the stock will be equal to its $70 value.
    (E) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. Taking into account the application of 
section 362(e)(1) and this section, DC's basis in the DC1 stock does not 
exceed its value immediately after the transaction. Therefore, InsCo 
does not have a net built-in loss, InsCo's transfer is not a loss 
duplication transaction, and section 362(e)(2) has no application to the 
transaction. DC's basis in the DC1 stock, as determined under paragraph 
(i)(D) of this Example 6, is $70. Under section 358, InsCo's basis in 
the DC stock received in the exchange will be $100.
    (ii) Transferor loses tax-exempt status. (A) Facts. The facts are 
the same as in paragraph (i)(A) of this Example 6 except that InsCo 
fails to be described in section 501(c)(12) in Year 1.
    (B) Importation property. If InsCo had sold the DC1 stock 
immediately before the transaction, any gain or loss recognized on the 
sale would have been taken into account in determining a federal income 
tax liability. Therefore, the DC1 stock is not importation property and 
this section does not apply to the transaction.
    (C) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. Taking into account the application of 
section 362(e)(1) and this section but without taking into account the 
provisions of section 362(e)(2), DC would have a section 362(a) basis of 
$100 in the stock, which would exceed its value of $70 immediately after 
the transfer. Therefore, InsCo has a net built-in loss and InsCo's 
transfer of the DC1 stock is a loss duplication transaction. 
Accordingly, under the general rule of section 362(e)(2), InsCo's $30 
net built-in loss ($100 basis over $70 value) would be allocated to 
reduce DC's basis in the loss asset, the DC1 stock, the only loss 
property transferred by InsCo. As a result, DC's basis in the DC1 stock 
would be $70 ($100 basis under section 362(a), reduced by the $30 net 
built-in loss). Under section 358, InsCo's basis in the DC stock 
received in the exchange will be $100.
    (iii) Transfer of property that is subject to unrelated business 
tax. (A) Facts. The facts are

[[Page 316]]

the same as in paragraph (i)(A) of this Example 6 except that, on 
December 31, Year 1, instead of the DC1 stock, InsCo transfers A1 (basis 
$200, value $150) to DC. A1 is real property that InsCo owned from 
January 1 to December 31 of Year 1. During the entirety of this period, 
A1's basis was $200, and in the twelve months prior to December 31, Year 
1, the highest amount of outstanding principal indebtedness on A1 was 
$40. For purposes of the UBTI rules under section 512, A1 is debt-
financed property within the meaning of section 514(b).
    (B) Importation property. If InsCo had sold A1 immediately before 
the transaction, 20 percent of any gain or loss recognized on that sale 
(that is, $40 of acquisition indebtedness on A1 divided by A1's $200 
basis in Year 1) would, under sections 512 and 514, be includible in 
UBTI at the end of Year 1, and 80 percent would not. Thus, under 
paragraph (d)(4) of this section, A1 is treated as tentatively divided 
into two portions, one reflecting the gain or loss that would be taken 
into account in determining a federal income tax liability in InsCo's 
hands immediately before the transfer (the 20 percent portion) and one 
that would not (the 80 percent portion). Further, if DC sold A1 
immediately after the transfer, any gain or loss on both portions would 
be taken into account in determining a federal income tax liability. 
Accordingly, the 20 percent portion is not importation property, but the 
80 percent portion is.
    (C) Loss importation transaction. InsCo's transfer of A1 is a 
section 362 transaction. Furthermore, but for section 362(e)(1) and this 
section and section 362(e)(2), DC's basis in the importation property, 
the 80 percent portion of A1, would be $160 (80 percent of InsCo's $200 
basis) under section 362(a) and the property's value would be $120 (80% 
of A1's $120 value) immediately after the transaction. Therefore, the 
importation property's basis would exceed its value and the transfer is 
a loss importation transaction.
    (D) Application of section 362(e)(1) and this section to importation 
property received in loss importation transaction. Because the 
importation property, the 80 percent portion of A1, was transferred in a 
loss importation transaction, section 362(e)(1) and paragraph (b)(1) of 
this section apply and DC's basis in that portion of A1 will be equal to 
its $120 value.
    (E) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. Taking into account the application of 
section 362(e)(1) and this section but without taking into account the 
provisions of section 362(e)(2), DC's aggregate basis in A1 would be 
$160 (the sum of the $120 basis in the 80 percent importation portion of 
A1, as determined under paragraph (iii)(D) of this Example 6, and the 
$40 basis in the 20 percent portion of A1 that is not importation 
property, determined under section 362(a). See paragraph (e)(3) of this 
section). Further, A1's value immediately after the transfer would be 
$150. Therefore, InsCo has a net built-in loss in A1, and InsCo's 
transfer of A1 is a loss duplication transaction. Accordingly, under the 
general rule of section 362(e)(2), InsCo's $10 net built-in loss ($160 
basis over $150 value) would be allocated to reduce DC's basis in the 
loss asset, A1, the only loss property transferred by InsCo. As a 
result, DC's basis in A1 would be $150 ($160 basis under section 362(a) 
and this section, reduced by the $10 net built-in loss). Under section 
358, InsCo's basis in the DC stock received in the exchange will be 
$200. See Sec. 1.362-4.
    (iv) Transfer with election to apply section 362(e)(2)(C). The facts 
are the same as in paragraph (iii)(A) of this Example 6, except that 
InsCo and DC elect to apply section 362(e)(2)(C) to reduce InsCo's basis 
in the DC stock received in the exchange. The analysis and results are 
the same as in paragraphs (iii)(B), (C), (D), and (E) of this Example 6, 
except that the $10 reduction to DC's basis in A1 is not made and, as a 
result, DC's basis in A1 remains $160; however, InsCo's basis in the DC 
stock received in the exchange is reduced from $200 to $190.
    Example 7. Transactions involving CFCs. (i) Transfer by CFC. (A) 
Facts. FC is a CFC with 100 shares of stock outstanding. A owns 60 of 
the shares and F owns the remaining 40 shares. FC owns two assets, A1 
(basis $70, value $100), which is used in the conduct of a U.S. trade or 
business, and A2 (basis $100, value $75), which is not used in the 
conduct of a U.S. trade or business. FC transfers both assets to DC in a 
transaction to which section 351 applies.
    (B) Importation property. If FC had sold A1 immediately before the 
transaction, any gain or loss recognized on the sale would have been 
taken into account in determining a federal income tax liability (FC's). 
See section 882(a). Therefore, A1 is not importation property. If FC had 
sold A2 immediately before the transaction, FC would not take the gain 
or loss recognized into account in determining its federal income tax 
liability, but the gain or loss could be taken into account in 
determining a section 951 inclusion to FC's U.S. shareholders. However, 
under paragraph (d)(3) of this section, gain or loss is not deemed taken 
into account in determining a federal income tax liability solely 
because it could affect an inclusion under section 951(a). Further, if 
DC had sold A2 immediately after the transaction, any gain or loss 
recognized on the sale would have been taken into account in determining 
a federal income tax liability. Therefore, A2 is importation property.
    (C) Loss importation transaction. FC's transfer is a section 362 
transaction. Furthermore,

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but for section 362(e)(1) and this section and section 362(e)(2), DC's 
basis in the importation property, A2, would be $100 and the property's 
value would be $75 immediately after the transaction. Therefore, the 
importation property's basis would exceed its value and the transfer is 
a loss importation transaction.
    (D) Application of section 362(e)(1) and this section to importation 
property received in loss importation transaction. Because the 
importation property, A2, was transferred in a loss importation 
transaction, paragraph (b)(1) of this section applies and DC's basis in 
A2 will be equal to A2's $75 value immediately after the transfer.
    (E) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. Taking into account the application of 
section 362(e)(1) and this section but without taking into account the 
provisions of section 362(e)(2), DC would have an aggregate basis of 
$145 in the transferred properties ($70 in A1, determined under section 
362(a), plus $75 in A2, determined under this section) and the 
properties would have an aggregate value of $175 ($100 + $75) 
immediately after the transfer. Therefore, FC does not have a net built-
in loss, FC's transfer is not a loss duplication transaction, and 
section 362(e)(2) does not apply to the transaction. DC's basis in A1 
will be $70, determined under section 362(a), and DC's basis in A2 will 
be $75, as determined under paragraph (i)(D) of this Example 7. Under 
the general rule in section 358(a), FC receives the DC stock with a 
basis of $170 ($70 attributable to A1 plus $100 attributable to A2).
    (ii) Transfer of CFC stock. (A) Facts. The facts are the same as in 
paragraph (i)(A) of this Example 7, except that A transfers its 60 
shares of FC stock (basis $80, value $105) and F transfers its 40 shares 
of FC stock (basis $100, value $70) to DC in an exchange that qualifies 
under section 351.
    (B) Importation property. If A had sold its FC shares immediately 
before the transaction, any gain or loss recognized on the sale would 
have been taken into account in determining a federal income tax 
liability (A's). Therefore, A's FC shares are not importation property. 
However, if F had sold its FC shares immediately before the transaction, 
no gain or loss recognized on the sale would have been taken into 
account in determining a federal income tax liability. Further, if DC 
had sold F's FC shares immediately after the transaction, any gain or 
loss recognized on the sale would have been taken into account in 
determining a federal income tax liability. Therefore, F's FC shares are 
importation property.
    (C) Loss importation transaction. The transfer of the FC shares is a 
section 362 transaction. Furthermore, but for section 362(e)(1) and this 
section and section 362(e)(2), DC's aggregate basis in the importation 
property, F's shares of FC stock, would be $100 under section 362(a) and 
the shares' aggregate value would be $70. Therefore, the importation 
property's aggregate basis would exceed its aggregate value, and the 
transfer is a loss importation transaction.
    (D) Application of section 362(e)(1) and this section to importation 
property received in loss importation transaction. Because the 
importation property, F's shares of FC stock, was transferred in a loss 
importation transaction, paragraph (b)(1) of this section applies and 
DC's aggregate basis in the shares will be equal to their $70 aggregate 
value immediately after the transfer.
    (E) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. The application of section 362(e)(2) is 
determined separately for each transferor. See Sec. 1.362-4(b).
    (1) A's transfer. Taking into account the application of section 
362(e)(1) and this section, DC's aggregate basis in the shares ($80 
under section 362(a)) would not exceed the shares' value ($105) 
immediately after the transaction. Therefore A does not have a built-in 
loss, A's transfer is not a loss duplication transaction, and section 
362(e)(2) does not apply to A's transfer. DC's aggregate basis in A's 
shares, determined under section 362(a), is $80. Under section 358(a), A 
receives the DC stock with a basis of $80.
    (2) F's transfer. Taking into account the application of section 
362(e)(1) and this section, DC's aggregate basis in the shares would not 
exceed their value immediately after the transaction. Therefore, F does 
not have a built-in loss, F's transfer is not a loss duplication 
transaction, and section 362(e)(2) does not apply to F's transfer. DC's 
aggregate basis in F's shares, as determined under paragraph (ii)(D) of 
this Example 7, is $70. Under section 358(a), F receives the DC stock 
with a basis of $100.
    Example 8. Property subject to withholding tax. (i) Facts. FC owns a 
share of DC1 stock (basis $100, value $70) as an investment. FC receives 
dividends on the share that are subject to federal withholding tax of 30 
percent of the amount received under section 881(a); under section 
1442(a), DC1 must withhold tax on the dividends paid. FC transfers the 
DC1 share to DC in a transaction to which section 351 applies.
    (ii) Importation property. Although any dividends received with 
respect to the DC1 stock were subject to withholding tax, if FC had sold 
the share of stock of DC1, no gain or loss recognized on the sale would 
have been taken into account in determining a federal income tax 
liability. See section 865(a)(2).

[[Page 318]]

Further, if DC had sold the share of DC1 stock immediately after the 
transaction, any gain or loss recognized on the sale would be taken into 
account in determining federal income tax liability. Therefore, the 
share of DC1 stock is importation property.
    (iii) Loss importation transaction. FC's transfer is a section 362 
transaction. Furthermore, but for section 362(e)(1) and this section and 
section 362(e)(2), DC's basis in the importation property, the share of 
DC1 stock, would be $100 and the share's value would be $70 immediately 
after the transaction. Therefore, the share's basis would exceed its 
value and the transfer is a loss importation transaction.
    (iv) Application of section 362(e)(1) and this section to 
importation property received in loss importation transaction. Because 
the importation property, the DC1 share, was transferred in a loss 
importation transaction, paragraph (b)(1) of this section applies and 
DC's basis in the share will be equal to the share's $70 value.
    (v) Basis of property received in transaction. Following the 
application of section 362(e)(1) and this section, the provisions of 
section 362(e)(2) must be taken into account because the transfer is a 
section 362(a) transaction. Taking into account the application of 
section 362(e)(1) and this section, DC's basis in the DC1 share would 
not exceed the share's value immediately after the transaction. 
Therefore, FC does not have a net built-in loss, FC's transfer is not a 
loss duplication transaction, and section 362(e)(2) does not apply to 
the transaction. DC's basis in the DC1 share, as determined under 
paragraph (iv) of this Example 8, is $70. Under section 358, FC's basis 
in the DC stock received in the exchange will be $100.
    Example 9. Property transferred in triangular reorganization. (i) 
Foreign subsidiary. (A) Facts. P owns the sole outstanding share of 
stock of FC (basis $1), FC1 owns the sole outstanding share of FC2 
(basis $100), and FC2 owns one asset, A1 (basis $100, value $20). In a 
forward triangular merger described in Sec. 1.358-6(b)(2)(i), FC2 
merges with and into FC, and FC1 receives shares of P stock in exchange 
for its FC2 stock. The forward triangular merger is a transaction 
described in section 368(a)(2)(D) and, therefore, in section 362(b).
    (B) Determining P's basis in its FC share. Pursuant to Sec. 1.358-
6, for purposes of determining the adjustment to P's basis in its FC 
shares, P is treated as though it first received A1 in a transaction in 
which its basis in A1 would be determined under section 362(b) and then 
it transferred A1 to FC in a transaction in which P's basis in its FC 
stock would be determined under section 358.
    (1) P's deemed acquisition and transfer of A1. If FC2 had sold A1 
for its value immediately before the deemed transaction, no gain or loss 
recognized on the sale would have been taken into account in determining 
a federal income tax liability. If P had sold A1 immediately after the 
deemed transaction, any gain or loss recognized on the sale would have 
been taken into account in determining a federal income tax liability 
(P's). Therefore, with respect to P's deemed acquisition, A1 is 
importation property. Furthermore, immediately after the deemed 
transaction, P's basis in A1, but for section 362(e)(1) and this section 
and section 362(e)(2), would be $100 and A1's value is $20. Therefore, 
the importation property's basis would exceed its value and the transfer 
is a loss importation transaction. Accordingly, P's deemed basis in A1 
will be equal to A1's $20 value.
    (2) P's FC stock basis. As a result of P's deemed transfer of A1 to 
FC (and applying the principles of Sec. 1.367(b)-13), P's basis in its 
FC stock is increased by its $20 deemed basis in A1. Accordingly, 
following the transaction, P's basis in its share of FC stock will be 
$21 (the sum of its original $1 basis and the $20 adjustment for the 
deemed transfer of A1).
    (C) FC's basis in A1. FC's basis in A1 is determined under the rules 
of this section without regard to the determination of P's adjustment to 
its basis in FC stock. If FC2 had sold A1 for its value immediately 
before the transaction, no gain or loss recognized on the sale would 
have been taken into account in determining a federal income tax 
liability. However, if FC had sold A1 immediately after the transaction, 
no gain or loss recognized on the sale would have been taken into 
account in determining a federal income tax liability, so A1 is not 
importation property. Accordingly, this section will not apply to the 
transaction. Although there is a net built-in loss in A1, the 
transaction is not described in section 362(a), and so section 362(e)(2) 
and Sec. 1.362-4 will not apply to the transaction. Thus, under section 
362(b), FC's basis in A1 will be $100.
    (D) FC1's basis in P stock. Under section 358, FC1's basis in the P 
stock it receives in the exchange will be $100.
    (ii) Property transferred to U.S. subsidiary in triangular 
reorganization. (A) Facts. The facts are the same as in paragraph (i)(A) 
of this Example 9, except that P also owns the sole outstanding share of 
DC (basis $1) and, instead of merging into FC, FC2 merged into DC.
    (B) Determining P's basis in its DC share. As determined under 
paragraph (i)(B)(2) of this Example 9, P's basis in its DC share is $21, 
the sum of its original $1 basis plus the $20 adjustment for the deemed 
transfer of A1.
    (C) DC's basis in A1. If FC2 had sold A1 for its value immediately 
before the transaction, no gain or loss recognized on the sale would 
have been taken into account in determining a federal income tax 
liability. However, if DC had sold A1 immediately after the transaction, 
any gain or loss recognized on

[[Page 319]]

the sale would have been taken into account in determining a federal 
income tax liability, so A1 is importation property with respect to DC. 
Furthermore, immediately after the transaction, DC's basis in A1, but 
for section 362(e)(1) and this section and section 362(e)(2), would be 
$100 and A1's value is $20. Therefore, the importation property's basis 
would exceed its value and the transfer is a loss importation 
transaction. Accordingly, DC's basis in A1 will be $20, A1's value 
immediately after the transaction.

    (D) FC1's basis in P stock. Under section 358, FC1's basis in the P 
stock it receives in the exchange is $100.
    (g) Applicability date. This section applies with respect to any 
transaction occurring on or after March 28, 2016, and also with respect 
to any transaction occurring before such date as a result of an entity 
classification election under Sec. 301.7701-3 of this chapter filed on 
or after March 28, 2016, unless such transaction is pursuant to a 
binding agreement that was in effect prior to March 28, 2016 and at all 
times thereafter. In addition, taxpayers may apply this section to any 
transaction occurring after October 22, 2004.

[T.D. 9759, 81 FR 17075, Mar. 28, 2016]



Sec. 1.362-4  Basis of loss duplication property.

    (a) Purpose and scope--(1) In general. The purpose of section 
362(e)(2) and this section is to prevent the duplication of net loss in 
transfers to which section 351 applies, capital contributions, and paid-
in surplus (each, a section 362(a) transaction). See paragraph (g) of 
this section for definitions of terms used in this section.
    (2) Intercompany transactions. For rules relating to the application 
of section 362(e)(2) to transfers between members of a consolidated 
group on or after October 22, 2004, see Sec. 1.1502-80(h).
    (b) Basis determinations under section 362(e)(2) and this section. 
Notwithstanding section 362(a), if a corporation (Acquiring) receives 
loss duplication property (as defined in paragraph (g)(1) of this 
section) from a person (Transferor) in a loss duplication transaction 
(as defined in paragraph (g)(2) of this section), Acquiring's basis in 
such property is equal to the basis of the property determined without 
regard to section 362(e)(2) and this section (as described in paragraph 
(g)(1)(ii) of this section), reduced by the property's allocable portion 
of Transferor's net built-in loss (as defined in paragraph (g)(3) of 
this section). If more than one Transferor transfers property to a 
corporation in a section 362(a) transaction, whether and the extent to 
which section 362(e)(2) and this section apply is determined separately 
for each Transferor.
    (c) Exceptions and special rules.--(1) Transactions in which net 
built-in loss is eliminated without recognition. Section 362(e)(2) does 
not apply to a transaction to the extent that--
    (i) Without recognizing gain or loss, Transferor distributes the 
Acquiring stock received in the transaction; and
    (ii) Upon completion of the transaction, no person holds Acquiring 
stock or any other asset with a basis determined, in whole or in part, 
by reference to Transferor's basis in the distributed Acquiring stock.
    (2) Certain transactions outside of the United States. Section 
362(e)(2) does not apply to a transaction if--
    (i) Neither Transferor nor Acquiring is a U.S. person (as defined in 
section 7701(a)(30)), a person otherwise required to file a U.S. return 
for the year of the transaction, a controlled foreign corporation (CFC, 
as defined in paragraph (g)(7) of this section), or a controlled foreign 
partnership (CFP, as defined in paragraph (g)(9) of this section) on the 
date of the transaction;
    (ii) The transfer occurs more than two years prior to the date of 
any event described in paragraph (d)(3)(ii)(E), (F), or (G) of this 
section; and
    (iii) The original transaction and the event or events described in 
paragraph (d)(3)(ii)(E), (F), or (G) of this section were not entered 
into with a view to reducing or avoiding the Federal income tax 
liability of any person by avoiding the application of section 362(e)(2) 
and this section to the original transaction.
    (3) Other effects of basis determination under this section--(i) 
Determination by reference to transferor's basis. A determination of 
basis under this section is a determination by reference to the 
transferor's basis, including for purposes of sections 755, 1223(2), and 
7701(a)(43).

[[Page 320]]

    (ii) Treatment as tax-exempt income or noncapital, nondeductible 
expense. A determination of basis under paragraph (b) of this section 
does not give rise to an item treated as a noncapital, nondeductible 
expense under Sec. 1.1502-32(b)(2)(iii). However, a determination of 
basis under paragraph (d) of this section does give rise to an item 
treated as a noncapital, nondeductible expense under Sec. 1.1502-
32(b)(2)(iii).
    (d) Election to reduce Transferor's stock basis instead of 
Acquiring's asset basis--(1) In general. In lieu of making the basis 
reductions otherwise required under paragraph (b) of this section, 
Transferor and Acquiring may elect to reduce Transferor's basis in 
Acquiring stock that is received in the transaction without the 
recognition of gain or loss (the section 362(e)(2)(C) election). The 
section 362(e)(2)(C) election may be made protectively and will have no 
effect to the extent that property transferred in the transaction is 
determined not to be subject to section 362(e)(2) and this section. 
However, the election is irrevocable once it is made. A section 
362(e)(2)(C) election is made and effective if--
    (i) Prior to the filing of a Section 362(e)(2)(C) Statement 
(described in paragraph (d)(3)(i) of this section), Transferor and 
Acquiring enter into a written, binding agreement to elect to apply 
section 362(e)(2)(C); and
    (ii) The Section 362(e)(2)(C) Statement is filed in accordance with 
the provisions of paragraph (d)(3) of this section.
    (2) Effect of section 362(e)(2)(C) election. If a section 
362(e)(2)(C) election is made and in effect--
    (i) An amount equal to the portion of Transferor's net built-in loss 
(as defined in paragraph (g)(3) of this section) that would otherwise be 
applied to reduce asset basis under paragraph (b) of this section is 
allocated among the Acquiring shares received or deemed received in the 
exchange (in proportion to the value of such shares) and applied to 
reduce Transferor's basis (determined without regard to section 
362(e)(2) and this section) in each such share; and
    (ii) Acquiring's basis in loss duplication property received from 
Transferor in the transaction is not determined under section 362(e)(2) 
and this section.
    (3) Section 362(e)(2)(C) Statement--(i) Form and contents of 
statement. The Section 362(e)(2)(C) Statement is to be titled ``Section 
362(e)(2)(C) Statement.'' The Section 362(e)(2)(C) Statement must--
    (A) Identify (by name and tax identification number, if any) 
Transferor and Acquiring;
    (B) State that Transferor and Acquiring have entered into a written, 
binding agreement to elect to apply section 362(e)(2)(C) as required in 
paragraph (d)(1)(i) of this section; and
    (C) State the date of the transaction (or, if the transaction 
includes transfers on more than one date, then the dates of all 
transfers) to which the election applies.
    (ii) Filing the Section 362(e)(2)(C) Statement. In general, the 
Section 362(e)(2)(C) Statement is filed by the person or entity 
described in the applicable paragraph of this paragraph (d)(3)(ii). 
Thus, if Transferor is a partnership, S corporation, trust (including a 
subpart E trust), or other pass-through entity, or Acquiring is an S 
corporation, the entity (and not the partners, shareholders, or other 
persons having an interest in the entity or its property) is the person 
that must file the Section 362(e)(2)(C) Statement, without regard to 
whether such entity is foreign or domestic. However, in the case of a 
CFC or CFP, the controlling U.S. shareholders of the CFC or the 
reporting U.S. partners of the CFP, respectively, file the Section 
362(e)(2)(C) Statement.
    (A) Transferor is a person required to file a U.S. return. If 
Transferor is a person required to file a U.S. return for the year of 
the transfer, Transferor must include the Section 362(e)(2)(C) Statement 
on or with its timely filed (including extensions) original U.S. return 
for the taxable year in which the transfer occurred.
    (B) Transferor is a CFC or CFP and not required to file a U.S. 
return. If paragraph (d)(3)(ii)(A) of this section does not apply and 
Transferor is either a CFC or a CFP on the date of the transfer, all of 
Transferor's controlling U.S. shareholders (in the case of a CFC) or

[[Page 321]]

all of Transferor's reporting U.S. partners (in the case of a CFP) must 
include the Section 362(e)(2)(C) Statement on or with their timely filed 
(including extensions) original U.S. returns for their taxable years in 
which the transfer occurred.
    (C) Transferor is not a person required to file a U.S. return, a 
CFC, or a CFP, but Acquiring is required to file U.S. return. If 
paragraphs (d)(3)(ii)(A) and (B) of this section do not apply and 
Acquiring is a person required to file a U.S. return for the year of the 
transfer, Acquiring must include the Section 362(e)(2)(C) Statement on 
or with its timely filed (including extensions) original U.S. return for 
the taxable year in which the transfer occurred.
    (D) Transferor is not a person required to file a U.S. return, a 
CFC, or a CFP, Acquiring is not required to file a U.S. return, but 
Acquiring is a CFC. If paragraphs (d)(3)(ii)(A) through (C) of this 
section do not apply and Acquiring is a CFC on the date of the transfer, 
all of Acquiring's controlling U.S. shareholders must include the 
Section 362(e)(2)(C) Statement on or with their timely filed (including 
extensions) original U.S. returns for their taxable years in which the 
transfer occurred.
    (E) Neither Transferor nor Acquiring is a person required to file a 
U.S. return, a CFC, or a CFP, but Transferor later becomes a person 
required to file a U.S. return, a CFC, or a CFP. If paragraphs 
(d)(3)(ii)(A) through (D) of this section do not apply and Transferor 
becomes a person required to file a U.S. return, a CFC, or a CFP, 
Transferor (if required to file a U.S. return), all of Transferor's 
controlling U.S. shareholders (if Transferor becomes a CFC not otherwise 
required to file a U.S. return), or all of Transferor's reporting U.S. 
partners (if Transferor becomes a CFP not otherwise required to file a 
U.S. return) must include the Section 362(e)(2)(C) Statement on or with 
their timely filed (including extensions) original U.S. returns for 
their taxable years in which an event described in this paragraph 
(d)(3)(ii)(E) first occurs. For purposes of this paragraph 
(d)(3)(ii)(E), the term Transferor includes any person holding property 
with a basis determined directly or indirectly by reference to 
Transferor's basis in the Acquiring stock received in the transaction.
    (F) Transferor is not and does not become a person required to file 
a U.S. return, a CFC, or a CFP, Acquiring is not, but later becomes 
either a person required to file a U.S. return, a CFC, or a CFP. If 
paragraphs (d)(3)(ii)(A) through (E) of this section do not apply and 
Acquiring becomes a person required to file a U.S. return, a CFC, or a 
CFP, Acquiring (if required to file a U.S. return), all of Acquiring's 
controlling U.S. shareholders (if Acquiring becomes a CFC not otherwise 
required to file a U.S. return), or all of Acquiring's reporting U.S. 
partners (if Acquiring becomes a CFP not otherwise required to file a 
U.S. return) must include the Section 362(e)(2)(C) Statement on or with 
their timely filed (including extensions) original U.S. returns for 
their taxable years in which an event described in this paragraph 
(d)(3)(ii)(F) first occurs. For purposes of this paragraph 
(d)(3)(ii)(F), the term Acquiring includes any person holding property 
with a basis determined directly or indirectly by reference to 
Acquiring's basis in loss duplication property received in the 
transaction.
    (G) Transferor and Acquiring are not and do not become a person 
required to file a U.S. return, a CFC, or a CFP, but the basis of the 
loss duplication property or Acquiring stock later becomes relevant for 
Federal tax purposes. If paragraphs (d)(3)(ii)(A) through (F) of this 
section do not apply and, in a transferred basis transaction, a person 
required to file a U.S. return, a CFC, or a CFP acquires either loss 
duplication property or Acquiring stock that was received in the loss 
duplication transaction, or any property the basis of which is 
determined in whole or in part by reference to any such property or 
stock, all such persons (or, in the case of a CFC or CFP not required to 
file a U.S. return, all the controlling U.S. shareholders or all the 
reporting U.S. partners, as applicable) must include the Section 
362(e)(2)(C) Statement on or with their timely filed (including 
extensions) original U.S. returns for their first taxable year(s) in 
which there occurs an event or events described in this paragraph 
(d)(3)(ii)(G).

[[Page 322]]

    (e) Transfers by partnerships and S corporations--(1) Transfers by 
partnerships. If a partnership transfers property in a loss duplication 
transaction with respect to which a section 362(e)(2)(C) election is 
made, the resulting reduction to the partnership's basis in the 
Acquiring stock received in exchange for the loss duplication property 
is treated as an expenditure of the partnership described in section 
705(a)(2)(B).
    (2) Transfers by S corporations. If an S corporation transfers 
property in a loss duplication transaction with respect to which a 
section 362(e)(2)(C) election is made, the resulting reduction to the S 
corporation's basis in the Acquiring stock received in exchange for the 
loss duplication property is treated as an expense of the S corporation 
described in section 1367(a)(2)(D).
    (f) Transfers to S corporations. If a person transfers property to 
an S corporation in a loss duplication transaction, any resulting 
reduction under section 362(e)(2) and this section to the S 
corporation's basis in the property received is not treated as an 
expense of the S corporation described in section 1367(a)(2)(D).
    (g) Definitions. For purposes of section 362(e)(2) and this 
section--
    (1) Loss duplication property is any property--
    (i) That is transferred by Transferor to Acquiring in a loss 
duplication transaction (as defined in paragraph (g)(2) of this 
section); and
    (ii) That Acquiring would take with a basis in excess of value 
immediately after the transaction; for this purpose, the basis Acquiring 
would take in the property is determined immediately after the 
transaction and without regard to section 362(e)(2) and this section, 
but otherwise taking into account all applicable provisions of law, 
including, without limitation, section 362(e)(1).
    (2) A loss duplication transaction is a section 362(a) transaction 
in which Acquiring's aggregate basis in the property received from 
Transferor would, but for section 362(e)(2) and this section, exceed the 
aggregate value of such property immediately after the transaction. For 
this purpose--
    (i) A transaction is a section 362(a) transaction if it is described 
in section 362(a) without regard to whether it is also described in any 
other provision of the Internal Revenue Code (Code), including, without 
limitation, section 362(b); and
    (ii) Acquiring's aggregate basis in the property received from 
Transferor is determined immediately after the transaction and without 
regard to section 362(e)(2) and this section, but otherwise taking into 
account all applicable provisions of law, including, without limitation, 
section 362(e)(1).
    (3) Transferor's net built-in loss is the excess of--
    (i) Acquiring's aggregate basis (determined under paragraph 
(g)(2)(ii) of this section) in all property received from Transferor in 
a loss duplication transaction, over
    (ii) The aggregate value of such property immediately after the 
transaction.
    (4) A property's built-in loss is the excess of Acquiring's basis in 
the property (determined as described in paragraph (g)(1)(ii) of this 
section) over the property's value (determined immediately after the 
transaction).
    (5) A property's allocable portion of Transferor's net built-in loss 
is the portion of Transferor's net built-in loss that bears the same 
ratio to Transferor's net built-in loss that the property's built-in 
loss bears to the aggregate built-in losses reflected in the bases of 
loss duplication property transferred by Transferor in the transaction.
    (6) A U.S. return is a return of income under section 6012 or an 
information return under Subtitle F, Chapter 61, Subchapter A, Part III 
of the Code (sections 6031 and following) or the regulations thereunder, 
that the taxpayer is unconditionally required to file. Thus, the term 
does not include elective forms or statements that are required to be 
filed only to obtain a particular tax treatment, including forms filed 
to make an election or to reduce or avoid withholding by a person not 
otherwise required to file a U.S. return (as described in this paragraph 
(g)(6)) (for example, a notice of nonrecognition under Sec. 1.1445-
2(d)).

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    (7) A controlled foreign corporation (CFC) is any corporation 
described in section 957 or section 953(c).
    (8) A controlling U.S. shareholder is any person that is treated as 
a controlling U.S. shareholder under Sec. 1.964-1(c)(5) because such 
person either owns a direct interest in the CFC or is treated as owning 
an interest in the CFC by reason of section 318(a)(2) (attribution from 
partnerships, estates, trusts, and corporations).
    (9) A controlled foreign partnership (CFP) is any partnership 
treated as a controlled foreign partnership for purposes of section 
6038.
    (10) A reporting U.S. partner is any partner of a CFP that is 
required to file an information return with respect to the CFP pursuant 
to section 6038 or the regulations thereunder, without regard to Sec. 
1.6038-3(c) or (j). In addition, in applying the constructive ownership 
rules of Sec. 1.6038-3(b)(4), the term ``nonresident alien'' is 
replaced by the term ``individual.''
    (11) The term stock means both Acquiring stock and Acquiring 
securities received by Transferor in the transaction if gain or loss on 
the receipt of the stock or securities is not recognized in whole or in 
part.
    (12) Value--(i) General rule. The term value means fair market 
value.
    (ii) Special rule for transfers of partnership interests. 
Notwithstanding the general rule in paragraph (g)(12)(i) of this 
section, when referring to a partnership interest, for purposes of 
section 362(e)(2) and this section, the term value means the sum of the 
cash that Acquiring would receive for the interest, assuming an exchange 
between a willing buyer and a willing seller (neither being under any 
compulsion to buy or sell and both having reasonable knowledge of 
relevant facts), increased by any Sec. 1.752-1 liabilities (as defined 
in Sec. 1.752-1(a)(4)) of the partnership allocated to Acquiring with 
regard to such transferred interest under section 752 immediately after 
the transfer to Acquiring. See Sec. 1.743-1 regarding the application 
of section 743(b) following a section 362(e) basis reduction.
    (h) Examples. The examples in this paragraph (h) illustrate the 
application of section 362(e)(2) and the provisions of this section. 
Unless the facts otherwise indicate, the examples use the following 
nomenclature and assumptions: X, Y, P, S, S1, and S2 are domestic 
corporations; A and B are U.S. individuals; FC1 and FC2 are foreign 
corporations and are not engaged in a U.S. trade or business, have no 
U.S. real property interests, and have no other relationships, 
activities, or interests that would cause them, their shareholders, or 
their property to be subject to tax imposed under any provision of 
subtitle A of the Internal Revenue Code (federal income tax); there is 
no applicable income tax treaty; PRS is a domestic partnership; no 
election is made under section 362(e)(2)(C); and the transferred 
property is not importation property (as defined in Sec. 1.362-3(c)(2)) 
and the transfers are not loss importation transactions (as defined in 
Sec. 1.362-3(c)(3)), so that the basis of no property is determined 
under section 362(e)(1). All persons and transactions are unrelated 
unless the facts indicate otherwise, all taxpayers are on a calendar tax 
year, and all other relevant facts are set forth in the examples. See 
Sec. 1.362-3(f) for additional examples illustrating the application of 
section 362(e)(2) and this section, including to transactions that are 
subject to section 362(e)(2), and section 362(e)(1).

    Example 1. Transfer described in section 351. (i) Basic application 
of section. (A) Facts. A owns Asset 1 (basis $90, value $60) and Asset 2 
(basis $110, value $120). In a transaction to which section 351 applies, 
A transfers Asset 1 and Asset 2 to X in exchange for a single 
outstanding share of X stock representing all the outstanding X stock 
immediately after the transaction.
    (B) Analysis--(1) Loss duplication transaction. A's transfer of 
Asset 1 and Asset 2 is a section 362(a) transaction. But for section 
362(e)(2) and this section, X's aggregate basis in those assets would be 
$200 ($90 + $110), which would exceed the aggregate value of the assets 
$180 ($60 + $120) immediately after the transaction. Accordingly, the 
transfer is a loss duplication transaction and A has a net built-in loss 
of $20 ($200-$180).
    (2) Identifying loss duplication property. But for section 362(e)(2) 
and this section, X's basis in Asset 1 would be $90, which would exceed 
Asset 1's $60 value immediately after the transaction. Accordingly, 
Asset 1 is loss duplication property. But for section 362(e)(2) and this 
section, X's basis in Asset 2 would be $110, which would not exceed 
Asset 2's $120

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value immediately after the transaction. Accordingly, Asset 2 is not 
loss duplication property.
    (C) Basis in loss duplication property. X's basis in Asset 1 is $70, 
computed as its $90 basis under section 362(a) reduced by A's $20 net 
built-in loss.
    (D) Basis in other property. Under section 362(a), X has a 
transferred basis of $110 in Asset 2. Under section 358(a), A has an 
exchanged basis of $200 in the X stock it receives in the transaction.
    (ii) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A) of this Example 1, except that A and X make an election 
under section 362(e)(2)(C). Under paragraph (d)(2)(i) of this section, A 
reduces its basis in the X stock, as determined without regard to 
section 362(e)(2) and this section, by the amount of A's net built-in 
loss that would have been applied to reduce X's basis in Asset 1 had the 
section 362(e)(2)(C) election not been made. In addition, no reduction 
is made to X's basis in Asset 1, as determined without regard to section 
362(e)(2) and this section. As a result, A's basis in the X stock is 
$180 ($200-$20), X's basis in Asset 1 is $90, and X's basis in Asset 2 
is $110.
    Example 2. Transfer described in both section 351 and section 
368(a)(1)(B). (i) Basic application of section--(A) Facts. P owns the 
sole outstanding share of S1 stock and the ten outstanding shares of S2 
stock. In a transaction to which section 351 applies and that is 
described in section 368(a)(1)(B), P transfers its ten S2 shares to S1 
in exchange for an additional ten shares of S1 voting stock. At the time 
of the transfer, P has a basis of $10 each in five of its S2 shares 
(Shares 1-5) and a basis of $5 each in its other five S2 shares (Shares 
6-10), and the value of each share is $7.
    (B) Analysis--(1) Loss duplication transaction. P's transfer of the 
S2 shares is a section 362(a) transaction notwithstanding that it is 
also a transaction described in section 368(a)(1)(B) and therefore 
section 362(b). But for section 362(e)(2) and this section, S1's 
aggregate basis in the S2 shares would be $75 ($10 x 5, or $50, for 
Shares 1-5 + $5 x 5, or $25, for Shares 6-10). Thus, S1's $75 aggregate 
basis in the shares would exceed the aggregate value of the shares, $70 
($7 x 10 shares), immediately after the transaction. Accordingly, the 
transfer is a loss duplication transaction and P has a net built-in loss 
of $5 ($75-$70).
    (2) Identifying loss duplication property. But for section 362(e)(2) 
and this section, S1's basis in each of Shares 1-5 would be $10, which 
would exceed each share's $7 value immediately after the transaction. 
Accordingly, Shares 1-5 are each loss duplication property. But for 
section 362(e)(2) and this section, S1's basis in each of Shares 6-10 
would be $5, which would not exceed each share's $7 value immediately 
after the transaction. Accordingly, Shares 6-10 are not loss duplication 
property.
    (C) Basis in loss duplication property. S1's basis in each of Shares 
1-5 is $9, computed as its $10 basis (determined without regard to 
section 362(e)(2) and this section) reduced by $1, the share's allocable 
portion (1/5) of P's net built-in loss ($5).
    (D) Basis in other property. Under section 362(a), S1 has a 
transferred basis of $5 in each of Shares 6-10. Under section 358(a), P 
has an exchanged basis in the ten S1 shares it receives in the exchange 
($10 in each of the five S1 shares received in exchange for Shares 1-5 
and $5 in each of the five S1 shares received in exchange for Shares 5-
10).
    (ii) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A) of this Example 2, except that an election under 
section 362(e)(2)(C) is made to reduce P's basis in the shares of S1 
stock received in the exchange. Under paragraph (d)(2)(i) of this 
section, P reduces its basis in the S1 stock by $5, the amount of P's 
net built-in loss that S1's basis in the S2 shares would have been 
reduced under section 362(e)(2) and this section had the section 
362(e)(2)(C) election not been made, and no reduction is made to S1's 
basis in the S2 stock (as determined without regard to section 362(e)(2) 
and this section). Because an election is being made under section 
362(e)(2)(C), P's basis in the new S1 shares is not determined under the 
general rule of Sec. 1.358-2(a)(2)(i) (under which P's basis in each 
new S1 share would be equal to the basis of the S2 share transferred in 
exchange for the S1 share). Section 1.358-2(a)(2)(viii)(B). Accordingly, 
P's basis in each new S1 share will be $7, the share's allocable portion 
of P's $75 aggregate basis in the S2 shares transferred in the 
transaction (or, $7.50 per share), reduced under paragraph (d)(2)(i) of 
this section by the $5 that would have been applied to reduce S1's basis 
in the S2 shares had the section 362(e)(2)(C) election not been made (or 
$.50 per share). Under paragraph (d)(2)(ii) of this section and section 
362(a), S1 receives five shares of the S2 stock with a basis of $10 each 
and five shares of the S2 stock with a basis of $5 each.
    Example 3. Transfer described in both section 351 and section 
368(a)(1)(A), multiple transferors, elimination of duplicated loss. (i) 
Facts. A owns Asset 1 (basis $120, value $130) and all the outstanding 
shares of X stock. B owns all the outstanding shares of Y stock (basis 
$150). Y owns Asset 2 (basis $250, value $210). Pursuant to a single 
plan, A transfers Asset 1 to X in exchange for additional X shares and, 
in a transaction qualifying as a reorganization described in section 
368(a)(1)(A), Y merges with and into X. In the merger, B receives X 
stock with a basis equal to B's basis in its Y stock immediately before 
the merger. A's transfer of Asset 1 to X in exchange for X stock and Y's 
transfer of Asset 2 to X in the merger are both transactions to which

[[Page 325]]

section 351 applies. Notwithstanding that the transfers by A and Y are 
pursuant to a single plan forming one transaction, section 362(e)(2) and 
this section apply to each transferor separately.
    (ii) Application of section to A's transfer of Asset 1. A's transfer 
of Asset 1 is a section 362(a) transaction. But for section 362(e)(2) 
and this section, X's basis in Asset 1 would be $120, which would not 
exceed Asset 1's $130 value immediately after the transaction. 
Accordingly, A's transfer of Asset 1 is not a loss duplication 
transaction notwithstanding that, taking both A's transfer and Y's 
transfer into account, X has an aggregate net loss in Asset 1 and Asset 
2. Because Asset 1 is not received in a loss duplication transaction, it 
is not loss duplication property and section 362(e)(2) and this section 
do not apply to A's transfer of Asset 1.
    (iii) Application of section to Y's transfer of Asset 2--(A) 
Analysis--(1) Loss duplication transaction. Y's transfer of Asset 2 to X 
is a section 362(a) transaction, notwithstanding that it is also a 
transaction described in section 368(a)(1)(A) and therefore section 
362(b). But for section 362(e)(2) and this section, X's basis in Asset 2 
would be $250, which would exceed Asset 2's $210 value immediately after 
the transaction. Accordingly, Y's transfer is a loss duplication 
transaction and Y has a net built-in loss of $40.
    (2) Identifying loss duplication property. But for section 362(e)(2) 
and this section, X's basis in Asset 2 would be $250, which would exceed 
Asset 2's $210 value immediately after the transaction. Accordingly, 
Asset 2 is loss duplication property.
    (B) Basis in loss duplication property. Although Asset 2 is loss 
duplication property, section 362(e)(2) does not apply to Y's transfer 
of Asset 2 to X because Y distributes all of the X stock received in the 
exchange without recognizing gain or loss, and, upon completion of the 
transaction, no person will hold the X stock or any other asset with a 
basis determined in whole or in part by reference to Y's basis in such 
stock. Accordingly, under paragraph (c)(1) of this section, X's basis in 
Asset 2 is not determined under section 362(e)(2) and this section. 
Thus, under section 362(a), X's basis in Asset 2 is $250.
    (iv) Basis in other property. Under section 358, A's basis in the X 
stock received in exchange for Asset 1 is $120 and B's basis in the X 
stock received in the merger is $150. Under section 362(a), X's basis in 
Asset 1 is $120.

    Example 4. Transfer described in both section 351 and section 
368(a)(1)(D), followed by a distribution qualifying under section 355. 
(i) Basic transaction--(A) Facts. A and B each own one of the two 
outstanding shares of X common stock. X's assets include Asset 1 (basis 
$120, value $70), Asset 2 (basis $160, value $110), and Asset 3 (basis 
$220, value $240). In a transaction to which section 351 applies and 
that is described in section 368(a)(1)(D), X transfers Asset 1, Asset 2, 
and Asset 3 to Y in exchange for all the Y stock; then, in a 
distribution that qualifies under section 355, X distributes all the Y 
stock received in the exchange to A in exchange for all of A's X stock. 
Under section 361(c)(1), X does not recognize gain or loss as a result 
of the distribution of all the Y stock.
    (B) Analysis--(1) Loss duplication transaction. X's transfer of 
Asset 1, Asset 2, and Asset 3 is a section 362(a) transaction. But for 
section 362(e)(2) and this section, Y's aggregate basis in those assets 
would be $500 ($120 + $160 + $220). The aggregate value of the assets 
immediately after the transaction is $420 ($70 + $110 + $240). Thus, Y's 
aggregate basis in the assets would exceed the aggregate value of the 
assets immediately after the transaction. Accordingly, the transfer is a 
loss duplication transaction and X has a net built-in loss of $80 ($500 
- $420).
    (2) Identifying loss duplication property. But for section 362(e)(2) 
and this section, Y's basis in Asset 1 would be $120, which would exceed 
Asset 1's $70 value immediately after the transaction. Accordingly, 
Asset 1 is loss duplication property. But for section 362(e)(2) and this 
section, Y's basis in Asset 2 would be $160, which would exceed Asset 
2's $110 value immediately after the transaction. Accordingly, Asset 2 
is also loss duplication property. But for section 362(e)(2) and this 
section, Y's basis in Asset 3 would be $220 and would therefore not 
exceed Asset 3's $240 value immediately after the transaction. 
Accordingly, Asset 3 is not loss duplication property.
    (C) Basis in loss duplication property. Although Asset 1 and Asset 2 
are each loss duplication property, X will distribute the Y stock 
received in exchange for Asset 1 and Asset 2 without recognition of gain 
or loss, and, upon completion of the transaction, no person will hold 
the Y stock received by X or any other asset with a basis determined in 
whole or in part by reference to X's basis in the Y stock received in 
the exchange. (A's basis in the Y stock will be determined by reference 
to his basis in his X stock.) Accordingly, under paragraph (c)(1) of 
this section, Y's bases in Asset 1 and Asset 2 are determined under 
section 362(a) and not under section 362(e)(2) and this section. Thus, 
Y's basis in Asset 1 is $120 and Y's basis in Asset 2 is $160.
    (D) Basis in other property. Under section 358, A's basis in the Y 
stock received in exchange for his X stock is determined by reference to 
his basis in his X stock surrendered. Under section 362(a), Y's basis in 
Asset 3 is $220.
    (ii) Section 355(e)--(A) Facts. The facts are the same as in 
paragraph (i)(A) of this Example 4, except that, after the section 355 
distribution, Y is acquired pursuant to a plan (within the meaning of 
Sec. 1.355-7), resulting in

[[Page 326]]

the application of section 355(e) to the transactions.
    (B) Analysis. Because section 361(c)(2), and not section 361(c)(1), 
will apply to X's distribution of Y stock, X will not qualify for 
nonrecognition treatment on the distribution of the Y stock. As a 
result, paragraph (c)(1) of this section does not apply to the 
transaction, and Y's bases in Asset 1 and Asset 2, the loss duplication 
property, are determined under section 362(e)(2) and this section. Asset 
1 has a built-in loss of $50 ($120 - $70), and Asset 2 has a built-in 
loss of $50 ($160 - $110). Thus, Asset 1's allocable portion of X's net 
built-in loss is $40 ($50/$100 x $80), and Asset 2's allocable portion 
of X's net built-in loss is $40 ($50/$100 x $80). Accordingly, Y 
receives Asset 1 with a basis of $80 ($120 - $40) and Asset 2 with a 
basis of $120 ($160 - $40).
    (iii) Retained stock and securities--(A) Facts. The facts are the 
same as in paragraph (i)(A) of this Example 4, except that X transfers 
Asset 1, Asset 2, and Asset 3 to Y in exchange for Y stock and Y 
securities, each constituting half of the consideration. In addition, 
for a valid business purpose, X retains Y stock and Y securities each 
worth 1 percent of the total consideration.
    (B) Analysis. Paragraph (c)(1) of this section applies only to the 
extent that stock received in a transaction is distributed without 
recognition of gain or loss. Thus, section 362(e)(2) and this section 
apply to the extent that property was exchanged for the retained Y stock 
and Y securities (2 percent of the total). Accordingly, Y reduces its 
basis in Asset 1 and in Asset 2, the loss duplication property, by $1.60 
(two percent of X's $80 net built-in loss). Asset 1 has a built-in loss 
of $50 ($120 - $70), and Asset 2 has a built-in loss of $50 ($160 - 
$110). Thus, Asset 1's allocable portion of X's net built-in loss is 
$.80 ($50/$100 x $1.60), and Asset 2's allocable portion of X's net 
built-in loss is $.80 ($50/$100 x $1.60). As a result, Y receives Asset 
1 with a basis of $119.20 ($120 - $.80) and Asset 2 with a basis of 
$159.20 ($160 - $.80).
    (iv) Retained stock and securities with a section 362(e)(2)(C) 
election--(A) Facts. The facts are the same as in paragraph (iii)(A) of 
this Example 4, except that an election under section 362(e)(2)(C) is 
made to reduce X's bases in its retained Y stock and retained Y 
securities.
    (B) Analysis. Under paragraph (d)(2)(i) of this section, X reduces 
its basis in the retained Y stock and the retained Y securities 
(determined without regard to section 362(e)(2) and this section) by 
$1.60, the portion of X's $80 net built-in loss that would have been 
applied to reduce Y's basis in the transferred assets had the election 
to apply section 362(e)(2)(C) not been made. (Because the value of the Y 
stock and the value of the Y securities are equal, X's $500 basis in the 
transferred property would be allocated equally between the Y stock and 
the Y securities, $250 to each, under Sec. 1.358-2(b)(2), and the 
retained Y stock and Y securities have a basis of $2.50 each (one 
percent of $250).) For the reasons set forth in paragraph (iii)(B) of 
this Example 4, Y would have been required to reduce its basis in the 
transferred assets by $1.60. Accordingly, X must reduce its aggregate 
basis in the retained Y stock and Y securities by $1.60. Under paragraph 
(d)(2)(i) of this section, the $1.60 basis reduction is allocated and 
applied to reduce X's bases in the retained Y stock and Y securities in 
proportion to the value of each. Because X retained Y stock and Y 
securities with equal values, X holds each of the retained Y stock and 
securities with an adjusted basis of $1.70 ($2.50 - $.80). Under 
paragraph (d)(2)(ii) of this section, Y receives Asset 1 with a basis of 
$120, Asset 2 with a basis of $160, and Asset 3 with a basis of $220.
    Example 5. Transfer of liabilities. (i) Liabilities described in 
section 358(d)(1)--(A) Basic application of section, no section 
362(e)(2)(C) election--(1) Facts. A owns Asset 1 (basis $800, value 
$700). A also has a $200 liability that has been taken into account for 
tax purposes and is thus described in section 358(d)(1), and not in 
sections 357(c)(3), 358(d)(2), and 358(h)(1). A transfers Asset 1 to X 
in exchange for a single outstanding share of X stock representing all 
the outstanding X stock immediately after the transaction and X's 
assumption of the liability. The transfer is a transaction to which 
section 351 applies.
    (2) Analysis--(i) Loss duplication transaction. A's transfer of 
Asset 1 is a section 362(a) transaction. But for section 362(e)(2) and 
this section, X's basis in Asset 1 would be $800, which would exceed 
Asset 1's $700 value immediately after the transaction. Accordingly, the 
transfer is a loss duplication transaction and A has a net built-in loss 
of $100 ($800 - $700).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in Asset 1 would be $800, which 
would exceed the $700 value of Asset 1 immediately after the 
transaction. Accordingly, Asset 1 is loss duplication property.
    (3) Basis in loss duplication property. X's basis in Asset 1 is 
$700, computed as its $800 basis determined under section 362(a) reduced 
by A's $100 net built-in loss.
    (4) Basis in other property. Under sections 358(a) and (d)(1), A's 
basis in the X stock is $600 ($800 basis in property transferred--$200 
liability assumed).
    (B) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A)(1) of this Example 5, except that A and X make an 
election under section 362(e)(2)(C). In this case, A's $100 net built-in 
loss that would have been applied to reduce X's basis in Asset 1 is 
applied to reduce A's basis in the X stock received. As a result, A's 
basis in the X stock is $500 ($600, as determined in paragraph

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(i)(A)(4) of this Example 5, reduced by $100) and X's basis in Asset 1 
is $800.
    (ii) Contingent liabilities described in section 358(h)(1), section 
358(h)(2)(A) exception applies--(A) Facts. The facts are the same as in 
paragraph (i)(A)(1) of this Example 5, except that A's liability (valued 
at $200) has not been taken into account for tax purposes and is 
described in sections 358(d)(2) and 358(h)(1). However, Asset 1 is a 
trade or business and the liability is associated with the trade or 
business; as a result, the liability is described in section 
358(h)(2)(A) and is excepted from the general rule of section 358(h)(1).
    (B) Analysis. For the reasons set forth in paragraph (i)(A)(2) of 
this Example 5, A's transfer of Asset 1 is a loss duplication 
transaction, A has a net built-in loss of $100, and Asset 1 is loss 
duplication property.
    (C) Basis in loss duplication property. For the reasons set forth in 
paragraph (i)(A)(3) of this Example 5, X's basis in Asset 1 is $700.
    (D) Basis in other property. A's basis in the X stock is $800 under 
sections 358(a), 358(d)(2), and 358(h)(2)(A).
    (E) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (ii)(A) of this Example 5, except that A and X make an 
election under section 362(e)(2)(C). In this case, A's $100 net built-in 
loss that would have applied to reduce X's basis in Asset 1 is applied 
to reduce A's basis in the X stock received. As a result, A's basis in 
the X stock is $700 ($800, as determined in paragraph (ii)(D) of this 
Example 5, reduced by $100). X's basis in Asset 1 is $800.
    Example 6. Section 351 transfer with boot. (i) Basic transaction-(A) 
Facts. A owns Asset 1 (basis $80, value $100) and Asset 2 (basis $30, 
value $25). In a transaction to which section 351 applies, A transfers 
Asset 1 and Asset 2 to X in exchange for 10 shares of X stock and $25.
    (B) Analysis--(1) Loss duplication transaction. A's transfer of 
Asset 1 and Asset 2 is a section 362(a) transaction. But for section 
362(e)(2) and this section, X's aggregate basis in those assets would be 
$130, computed as follows. Under section 362(a), a corporation's basis 
in property acquired in a transaction to which section 351 applies is 
the same as the property's basis in the hands of the transferor, 
increased by any gain recognized to the transferor on such transfer. 
Under section 351(b), gain (but not loss) is recognized to the extent a 
transferor in a section 351 exchange receives other property or money in 
addition to the stock permitted to be received without the recognition 
of gain. To determine the amount of gain recognized under section 
351(b), the consideration is allocated proportionately (by value) among 
the transferred properties. A's gain on the transfer is therefore 
computed as follows: Asset 1 reflects 80 percent of the value 
transferred ($100/$125) and Asset 2 reflects 20 percent of the value 
transferred ($25/$125). Thus, 80 percent of the stock (eight shares) and 
the cash ($20) are treated as being received in exchange for Asset 1 and 
20 percent of the stock (two shares) and the cash ($5) are treated as 
being received in exchange for Asset 2. Thus, under section 351(b), A 
recognizes $20 of gain for the cash received in exchange for Asset 1, 
but A recognizes no loss for the amount received for Asset 2. As a 
result, under section 362(a), X would have a basis of $100 in Asset 1 
and $30 in Asset 2. Thus, X's aggregate basis in the assets would be 
$130, which exceeds the $125 aggregate value of the assets ($100 + 
$25)). The transfer is a loss duplication transaction and A has a net 
built-in loss of $5 ($130-$125).
    (2) Identifying loss duplication property. But for section 362(e)(2) 
and this section, X's basis in Asset 1 would be $100 (A's $80 basis 
increased by A's $20 gain recognized), which would not exceed Asset 1's 
$100 value immediately after the transaction. Accordingly, Asset 1 is 
not loss duplication property. But for section 362(e)(2) and this 
section, X's basis in Asset 2 would be $30, which would exceed Asset 2's 
$25 value immediately after the transaction. Accordingly, Asset 2 is 
loss duplication property.
    (C) Basis in loss duplication property. X's basis in Asset 2 is $25, 
computed as its $30 basis under section 362(a) reduced by A's $5 net 
built-in loss.
    (D) Basis in other property. Under section 362(a), X's basis in 
Asset 1 is $100 (A's $80 basis increased by the $20 gain recognized). 
Under section 358, A's basis in the X stock is $105 (the sum of its $80 
basis in Asset 1, its $30 basis in Asset 2, and its $20 gain recognized, 
reduced by the $25 cash received in the exchange).
    (ii) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A) of this Example 6, except that A and X elect to reduce 
A's stock basis under section 362(e)(2)(C). Under paragraph (d)(2)(i) of 
this section, A reduces its $105 basis in the X stock by $5, the amount 
of A's net built-in loss of that would have been applied to reduce X's 
basis in Asset 2 had the section 362(e)(2)(C) election not been made. As 
a result, A's basis in the X stock is $100, and X's basis in Asset 2 is 
$30.
    Example 7. Section 304 sale of built-in loss stock. (i) Basic 
transaction--(A) Facts. A owns all the stock of X (basis $90, value $60) 
and all the stock of Y. A sells all his X stock to Y for $60. Under 
section 304, A is treated as though he transferred the X stock to Y in 
exchange for Y stock in a transaction to which section 351 applies. 
Then, Y is treated as redeeming the Y stock it was treated as having 
issued to A in the deemed section 351 transaction.
    (B) Analysis--(1) Loss duplication transaction. A's deemed transfer 
of X stock to Y is a section 362(a) transaction. But for section 
362(e)(2) and this section, Y's aggregate basis

[[Page 328]]

in the X stock would be $90, which would exceed the X stock's value of 
$60 immediately after the transaction. Accordingly, the transfer is a 
loss duplication transaction and A has a net built-in loss of $30.
    (2) Identifying loss duplication property. But for section 362(e)(2) 
and this section, Y's basis in the X stock would be $90, which would 
exceed the X stock's $60 value immediately after the transaction. 
Accordingly, the X stock is loss duplication property.
    (C) Basis in loss duplication property. Y's basis in the X stock is 
$60, its $90 basis determined without regard to section 362(e)(2) and 
this section, reduced by A's $30 net built-in loss.
    (D) Basis in other property. Under section 358(a), A has an 
exchanged basis of $90 in the Y stock he is deemed to receive in the 
exchange; the effect of the deemed redemption of that stock is then 
determined under section 302.
    (ii) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A) of this Example 7, except that the parties elect to 
reduce A's stock basis under section 362(e)(2)(C). For the reasons set 
forth in paragraphs (i)(B) and (C) of this Example 7, Y's basis in the X 
stock would be reduced by $30. Accordingly, A's basis in the deemed-
issued Y stock is $60, his $90 basis otherwise determined under section 
358(a) reduced by the $30 that would have been applied to reduce Y's 
basis in the X stock under section 362(e)(2) and this section; the 
effect of the deemed redemption of that stock is then determined under 
section 302. Y's basis in the X stock is $90.
    Example 8. Transactions involving partnerships. (i) Transfer by a 
partnership--(A) Basic application of section--(1) Facts. PRS owns Asset 
1 (basis $100, value $70). PRS contributes Asset 1 to X in a transaction 
to which section 351 applies.
    (2) Analysis--(i) Loss duplication transaction. PRS's transfer of 
Asset 1 is a section 362(a) transaction. But for section 362(e)(2) and 
this section, X's basis in Asset 1 would be $100, which would exceed 
Asset 1's $70 value immediately after the transaction. Accordingly, the 
transfer is a loss duplication transaction and PRS has a net built-in 
loss of $30 ($100-$70).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in Asset 1 would be $100, which 
would exceed Asset 1's $70 value immediately after the transaction. 
Accordingly, Asset 1 is loss duplication property.
    (3) Basis in loss duplication property. X's basis in Asset 1 is $70, 
computed as its $100 basis under section 362(a) reduced by PRS's $30 net 
built-in loss.
    (4) Basis in other property. Under section 358(a), PRS has an 
exchanged basis of $100 in the X stock it receives in the exchange.
    (B) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A)(1) of this Example 8, except that PRS and X elect to 
reduce PRS's stock basis under section 362(e)(2)(C). In this case, PRS's 
$30 net built-in loss (as determined in paragraph (i)(A)(2)(i) of this 
Example 8) that would have been applied to reduce X's basis in Asset 1 
is applied to reduce PRS's basis in the X stock received. As a result, 
PRS's basis in the X stock is $70 ($100-$30) and X's basis in Asset 1 is 
$100. The $30 reduction to PRS's basis in the X stock is treated as an 
expenditure of PRS under section 705(a)(2)(B) and paragraph (e)(1) of 
this section. As a result, the partners of PRS must reduce their bases 
in their PRS interests.
    (ii) Transfer of interest in partnership with liability--(A) Basic 
application of section--(1) Facts. A and two other individuals are equal 
partners in PRS. A's basis in its partnership interest is $247. A's 
share of PRS's Sec. 1.752-1 liabilities (as defined in Sec. 1.752-
1(a)(4)) is $145. A transfers his partnership interest to X in a 
transaction to which section 351 applies. PRS has no election in effect 
under section 754. If X were to sell the PRS interest immediately after 
the transfer, X would receive $100 in cash or other property. In 
addition, assume that, taking into account the rules under Sec. 1.752-
4, X's share of PRS's Sec. 1.752-1 liabilities (as defined in Sec. 
1.752-1(a)(4)) is $150 immediately after the transfer.
    (2) Analysis--(i) Loss duplication transaction. A's transfer of its 
PRS interest is a section 362(a) transaction. But for section 362(e)(2) 
and this section, X's basis in the PRS interest, would be $252 (A's 
basis of $247, reduced by A's $145 share of PRS liabilities, increased 
by X's $150 share of PRS liabilities) and, under paragraph (g)(12)(ii) 
of this section, the value of the PRS interest would be $250 (the sum of 
$100, the cash X would receive if X immediately sold the interest, and 
$150, X's share of the Sec. 1.752-1 liabilities (as defined in Sec. 
1.752-1(a)(4)) under section 752 immediately after the transfer to X). 
Therefore, the transfer is a loss duplication transaction and A has a 
net built-in loss of $2 ($252-$250).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in the PRS interest would be $252, 
which would exceed the PRS interest's $250 value immediately after the 
transaction. Accordingly, the PRS interest is loss duplication property.
    (3) Basis in loss duplication property. X's basis in the PRS 
interest is $250, computed as its $252 basis under section 362(a), 
taking into account the rules under section 752, reduced by A's $2 net 
built-in loss.
    (4) Basis in other property. Under section 358, taking into account 
the rules under section 752, A has a basis of $102 ($247 reduced by A's 
$145 share of PRS liabilities) in the X stock he receives in the 
transaction.

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    (B) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A) of this Example 8, except that A and X make an election 
under section 362(e)(2)(C). Under paragraph (d)(2)(i) of this section, A 
reduces his basis in the X stock, as determined without regard to 
section 362(e)(2) and this section, by the amount of A's net built-in 
loss that would have been applied to reduce X's basis in the PRS 
interest had the section 362(e)(2)(C) election not been made. In 
addition, no reduction is made to X's basis in the PRS interest, as 
determined without regard to section 362(e)(2) and this section. As a 
result, A's basis in the X stock is $100 ($102-$2) and X's basis in the 
PRS interest is $252.
    (C) Transfer of partnership interest with liability, not loss 
duplication transaction. The facts are the same as in paragraph 
(ii)(A)(1) of this Example 8, except that A's share of PRS's Sec. 
1.752-1 liabilities (as defined in Sec. 1.752-1(a)(4)) is $155. But for 
section 362(e)(2) and this section, X's basis in the PRS interest would 
be $242 (A's basis of $247, reduced by A's $155 share of PRS 
liabilities, increased by X's $150 share of PRS liabilities), which 
would not exceed the PRS interest's $250 value immediately after the 
transaction. Accordingly, A's transfer of the PRS interest is not a loss 
duplication transaction and section 362(e)(2) and this section have no 
application to the transaction. Under section 362(a), X's basis in the 
PRS interest is $242 and, under section 358, taking into account the 
rules under section 752, A has a basis of $92 ($247 reduced by A's $155 
share of PRS liabilities) in the X stock he receives in the transaction.
    Example 9. Transactions involving S Corporations. (i) Transfer by S 
Corporation--(A) No section 362(e)(2)(C) election--(1) Facts. S, an S 
corporation as defined in section 1361(a)(1), owns Asset 1 (basis $100, 
value $70). S transfers Asset 1 to X in exchange for a single 
outstanding share of X stock representing all the outstanding X stock 
immediately after the transaction. S does not elect to treat X as a 
qualified subchapter S subsidiary. The transaction is one to which 
section 351 applies.
    (2) Analysis--(i) Loss duplication transaction. S's transfer of 
Asset 1 is a section 362(a) transaction. But for section 362(e)(2) and 
this section, X's basis in Asset 1 would be $100, which would exceed 
Asset 1's $70 value immediately after the transaction. Accordingly, the 
transfer is a loss duplication transaction and S has a net built-in loss 
of $30 ($100-$70).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in Asset 1 would be $100, which 
would exceed Asset 1's $70 value immediately after the transaction. 
Accordingly, Asset 1 is loss duplication property.
    (iii) Basis in loss duplication property. X's basis in Asset 1 is 
$70, computed as its $100 basis under section 362(a) reduced by S's $30 
net built-in loss.
    (iv) Basis in other property. Under section 358(a), S has an 
exchanged basis of $100 in the X stock it receives in the exchange.
    (B) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A)(1) of this Example 9, except that S and X elect to 
reduce S's stock basis under section 362(e)(2). In this case, S's $30 
built-in loss (as determined in paragraph (i)(A)(2)(i) of this Example 
9) that would have been applied to reduce X's basis in Asset 1 is 
applied to reduce S's basis in the X stock received. As a result, S's 
basis in the X stock is $70 ($100 - $30) and X's basis in Asset 1 is 
$100. The $30 reduction to S's basis in the X stock is treated as an 
expense of S under section 1367(a)(2)(D) and paragraph (e)(2) of this 
section. As a result, the shareholders of S must reduce their bases in 
their S stock.
    (ii) Transfer to S Corporation--(A) Basic application of section. 
(1) Facts. A owns Asset 1 (basis $90, value $60) and Asset 2 (basis 
$110, value $120). In a transaction to which section 351 applies, A 
transfers Asset 1 and Asset 2 to S, an S corporation as defined in 
section 1361(a)(1), in exchange for a single share of S stock 
representing all the outstanding S stock immediately after the 
transaction.
    (2) Analysis--(i) Loss duplication transaction. A's transfer of 
Asset 1 and Asset 2 is a section 362(a) transaction. But for section 
362(e)(2) and this section, S's aggregate basis in those assets would be 
$200 ($90 + $110), which would exceed the aggregate value of the assets 
$180 ($60 + $120) immediately after the transaction. Accordingly, the 
transfer is a loss duplication transaction and A has a net built-in loss 
of $20 ($200 - $180).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, S's basis in Asset 1 would be $90, which 
would exceed Asset 1's $60 value immediately after the transaction. As a 
result, Asset 1 is loss duplication property. But for section 362(e)(2) 
and this section, S's basis in Asset 2 would be $110, which would not 
exceed Asset 2's $120 value immediately after the transaction. As a 
result, Asset 2 is not loss duplication property.
    (3) Basis in loss duplication property. S's basis in Asset 1 is $70, 
computed as its $90 basis under section 362(a) reduced by S's $20 net 
built-in loss. The $20 reduction to S's basis in Asset 1 does not 
require a reduction to A's basis in its S stock under section 
1367(a)(2)(D). See paragraph (f) of this section.
    (4) Basis in other property. Under section 362(a), S has a 
transferred basis of $110 in Asset 2. Under section 358(a), A has a 
basis of $200 in the S stock it receives in the exchange.
    (B) Section 362(e)(2)(C) election--(1) Application of section to 
transaction. The facts are the

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same as in paragraph (ii)(A)(1) of this Example 9, except that A and S 
elect to reduce A's stock basis under section 362(e)(2)(C). In this 
case, A's $20 built-in loss (as determined in paragraph (ii)(A)(2) of 
this Example 9) that would have been applied to reduce S's basis in 
Asset 1 is applied to reduce A's basis in the S stock received. As a 
result, A's basis in the S stock is $180 ($200 - $20), S's basis in 
Asset 1 is $90, and S's basis in Asset 2 is $110.
    (2) Tax consequences of subsequent disposition of transferred 
assets. The facts are the same as in paragraph (ii)(B)(1) of this 
Example 9 except that, in addition, the year after the transaction, S 
sells Asset 1 (basis $90, value $60) and Asset 2 (basis $110, value 
$120) for $180, recognizing the $20 net built-in loss. The loss is 
allocated to A and reduces A's basis in the S stock from $180 to $160 
under section 1367(a)(2)(B). If A then sells its S stock for its $180 
value, A will recognize a gain of $20.
    Example 10. Triangular reorganizations. (i) Facts. P owns all the 
stock of S1 and X owns all the stock of S2. In a merger described in 
section 368(a)(2)(D), S2 merges with and into S1, and X receives stock 
of P in exchange for its S2 stock. S2 has a net built-in loss in its 
assets acquired by S1 in the transaction.
    (ii) Analysis. The reorganization is not a section 362(a) 
transaction, notwithstanding that, under Sec. 1.358-6(c), P is treated 
as acquiring and then transferring S2's assets to S1 for purposes of 
determining P's adjustment to its basis in its S1 stock. Accordingly, 
S1's basis in the property acquired in the transaction is not determined 
under section 362(e)(2) and this section; it is determined under section 
362(b).
    Example 11. Transfers of importation property with non-importation 
property. (i) Single transferor, loss importation transaction. (A) 
Facts. FC1 transfers Asset 1 (basis $80, value $50), Asset 2 (basis 
$120, value $110), and Asset 3 (basis $32, value $40) to DC in a 
transaction to which section 351 applies. Asset 1 is not importation 
property within the meaning of Sec. 1.362-3(c)(2). Asset 2 and Asset 3 
are importation property within the meaning of Sec. 1.362-3(c)(2).
    (B) Application of section 362(e)(1). Immediately after the 
transfer, and without regard to section 362(e)(1) or section 362(e)(2) 
and this section, DC's aggregate basis in importation property (Asset 2 
and Asset 3) would be $152. The aggregate value of the importation 
property immediately after the transfer is $150. Accordingly, the 
transaction is a loss importation transaction within the meaning of 
Sec. 1.362-3(c)(3) and, under section 362(e)(1), DC's bases in Asset 2 
and Asset 3 would equal the value of each, $110 and $40, respectively.
    (C) Application of section 362(e)(2) and this section. (1) Analysis. 
(i) Loss duplication transaction. FC1's transfer of Asset 1, Asset 2, 
and Asset 3 is a transaction described in section 362(a). But for 
section 362(e)(2) and this section, DC's aggregate basis in those assets 
would be $230 ($80 under section 362(a) + $110 + $40 under section 
362(e)(1)), which would exceed the aggregate value of the assets $200 
($50 + $110 + 40) immediately after the transaction. Accordingly, the 
transfer is a loss duplication transaction and FC1 has a net built-in 
loss of $30 ($230 - $200).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, DC's basis in Asset 1 would be $80, which 
would exceed Asset 1's $50 value immediately after the transaction. 
Accordingly, Asset 1 is loss duplication property. But for section 
362(e)(2) and this section, DC's basis in Asset 2 would be $110, which 
would not exceed Asset 2's $110 value immediately after the transaction. 
Accordingly, Asset 2 is not loss duplication property. But for section 
362(e)(2) and this section, DC's basis in Asset 3 would be $40, which 
would not exceed Asset 3's $40 value immediately after the transaction. 
Accordingly, Asset 3 is not loss duplication property.
    (D) Basis in loss duplication property. DC's basis in Asset 1 is 
$50, computed as its $80 basis under section 362(a) reduced by FC1's $30 
net built-in loss.
    (E) Basis in other property. Under section 362(e)(1), DC's basis in 
Asset 2 is $110 and DC's basis in Asset 3 is $40. Under section 358(a), 
FC1 has an exchanged basis of $232 in the DC stock it receives in the 
transaction.
    (ii) Multiple transferors, no importation of loss. (A) Facts. The 
facts are the same as paragraph (i)(A) of this Example 11, except that, 
in addition, FC2 transfers Asset 4 (basis $100, value $150) to DC as 
part of the same transaction. Asset 4 is importation property within the 
meaning of Sec. 1.362-3(c)(2).
    (B) Application of section 362(e)(1). Immediately after the 
transfer, and without regard to section 362(e)(1) or section 362(e)(2) 
and this section, DC's aggregate basis in importation property (Asset 2, 
Asset 3, and Asset 4) would be $252 ($120 + $32 + $100). The aggregate 
value of the importation property immediately after the transfer is $300 
($110 + $40 + $150). Accordingly, the transaction is not a loss 
importation transaction within the meaning of Sec. 1.362-3(c)(3) and 
DC's bases in the importation property is not determined under section 
362(e)(1).
    (C) Application of section 362(e)(2) and this section. 
Notwithstanding that the transfers by FC1 and FC2 are pursuant to a 
single plan forming one transaction, section 362(e)(2) and this section 
apply to each transferor separately.
    (1) Application of section to FC1. (i) Loss duplication transaction. 
FC1's transfer of Asset 1, Asset 2, and Asset 3 is a transaction 
described in section 362(a). But for section 362(e)(2) and this section, 
DC's aggregate basis in those assets would be $232 ($80 + $120 + $32), 
which would exceed the aggregate

[[Page 331]]

value of the assets $200 ($50 + $110 + $40) immediately after the 
transaction. Accordingly, the transfer is a loss duplication transaction 
and FC1 has a net built-in loss of $32 ($232 - $200).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, DC's basis in Asset 1 would be $80, which 
would exceed Asset 1's $50 value immediately after the transaction. 
Accordingly, Asset 1 is loss duplication property. But for section 
362(e)(2) and this section, DC's basis in Asset 2 would be $120, which 
would exceed Asset 2's $110 value immediately after the transaction. 
Accordingly, Asset 2 is also loss duplication property. But for section 
362(e)(2) and this section, DC's basis in Asset 3 would be $32, which 
would not exceed Asset 3's $40 value immediately after the transaction. 
Accordingly, Asset 3 is not loss duplication property.
    (iii) Basis in loss duplication property. DC's basis in Asset 1 is 
$56, computed as its $80 basis under section 362(a) reduced by $24, its 
allocable portion of FC1's $32 net built-in loss ($30/40 x $32). DC's 
basis in Asset 2 is $112, computed as its $120 basis under section 
362(a) reduced by $8, its allocable portion of FC1's $40 net built-in 
loss ($10/$40 x $32).
    (iv) Basis in other property. Under section 358(a), FC1 has an 
exchanged basis of $232 in the DC stock it receives in the transaction.
    (2) Application of section to FC2. FC2's transfer of Asset 3 is not 
a loss duplication transaction because Asset 3's value exceeds its basis 
immediately after the transaction. Accordingly, under section 362(a), 
DC's basis in Asset 3 is $100.
    Example 12. Section 362(e)(2)(C) elections with respect to transfers 
between persons that are not required to file a U.S. return and that are 
not CFCs or CFPs--(i) Basic application of section. On June 30, Year 1, 
FC1 transfers Asset 1 to FC2 in a transaction to which section 351 
applies (the original transfer) and that is therefore a section 362(a) 
transaction. But for section 362(e)(2) and this section, FC2's basis in 
Asset 1 (determined immediately after the transfer, taking into account 
all applicable law, including section 362(e)(1)) exceeds the value of 
Asset 1 immediately after the transaction. Accordingly, the transaction 
is a loss duplication transaction and Asset 1 is loss duplication 
property. FC1 and FC2 executed a written, binding agreement to apply 
section 362(e)(2)(C) at some point before any Section 362(e)(2)(C) 
Statement is filed. However, the transfer was not entered into with a 
view to reducing or avoiding the Federal income tax liability of any 
person by avoiding the application of section 362(e)(2) and this 
section; further, no event described in paragraph (d)(3)(ii)(E), (F), or 
(G) of this section occurs prior to June 30, Year 3. As a result, under 
paragraph (c)(2) of this section, section 362(e)(2) and this section do 
not apply to the transfer. Accordingly, FC2's basis in Asset 1 is 
determined under section 362(a), no section 362(e)(2)(C) election can be 
made, and any protective filing of a Section 362(e)(2)(C) Statement will 
have no effect.
    (ii) Loss duplication property later acquired by a person required 
to file U.S. return. The facts are the same as in paragraph (i) of this 
Example 12, except that, in addition, on January 1, Year 2, FC2 
transfers Asset 1 to DC in an exchange to which section 351 applies. 
FC2's transfer is an event described in paragraph (d)(3)(ii)(G) of this 
section. As a result, paragraph (c)(2) does not except the original 
transfer from the application of section 362(e)(2) and this section. 
Under paragraph (d)(3)(ii)(G) of this section, DC must include the 
Section 362(e)(2)(C) Statement for the original transfer on or with its 
Year 2 U.S. return in order for that election to be effective. The 
result would be the same if, instead of FC2 transferring Asset 1 to DC, 
FC1 transferred its FC2 stock to DC in an exchange to which section 351 
applies. (Further, if an asset transferred by FC1 or FC2 to DC is a loss 
asset immediately after its transfer to DC, DC's basis in that asset may 
be subject to section 362(e)(1).)
    (iii) Party to exchange later becomes a person required to file U.S. 
return. The facts are the same as in paragraph (i) of this Example 12, 
except that, in addition, on January 1, Year 2, FC2 becomes engaged in a 
U.S. business. FC2's becoming engaged in a U.S. business is an event 
described in paragraph (d)(3)(ii)(F) of this section because it will 
cause FC2 to become a person required to file a U.S. return. As a 
result, paragraph (c)(2) of this section does not except the transfer 
from the application of section 362(e)(2) and this section. Under 
paragraph (d)(3)(ii)(F) of this section, FC2 must include the Section 
362(e)(2)(C) Statement for the original transfer on or with its Year 2 
U.S. return in order for the section 362(e)(2)(C) election for the 
original transfer to be effective.
    (iv) Statement not filed with respect to designated event. The facts 
are the same as in paragraph (iii) of this Example 12, except that, in 
addition, FC1 became engaged in a U.S. trade or business on October 31, 
Year 1 and as a result became a person required to file a U.S. return, 
an event described in paragraph (d)(3)(ii)(E) of this section. As a 
result, paragraph (c)(2) of this section does not except the transfer 
from the application of section 362(e)(2) and this section. Further, in 
order for the election to be effective, FC1 must file the Section 
362(e)(2)(C) Statement on or with its Year 1 U.S. return. See paragraph 
(d)(3)(ii)(E) of this section. A statement filed by FC2 on or with its 
Year 2 U.S. return has no effect. Thus, if FC1 does not file the 
statement, the election does not become effective and basis is 
determined under the general rule of section 362(e)(2).
    (v) Nonrecognition transfer of loss duplication property outside 
United States, transferee later

[[Page 332]]

becomes engaged in U.S. trade or business. The facts are the same as in 
paragraph (i) of this Example 12, except that, in addition, on December 
31, Year 1, FC2 transfers Asset 1 to FC3 in a transferred basis 
transaction. In Year 2, FC3 becomes engaged in a U.S. trade or business 
and as a result becomes a person required to file a U.S. return; Asset 1 
is not used in or connected with the U.S. trade or business or otherwise 
subject to Federal income tax. FC3's becoming engaged in a U.S. trade or 
business is an event described in paragraph (d)(3)(ii)(F) of this 
section because FC3, a person who holds loss duplication property with a 
basis determined by FC2's basis in the property, will be required to 
file a U.S. return as a result of its becoming engaged in a U.S. 
business. As a result, paragraph (c)(2) of this section does not except 
the transfer from the application of section 362(e)(2) and this section. 
Under paragraph (d)(3)(ii)(F) of this section, FC3 must include the 
Section 362(e)(2)(C) Statement for the original transfer on or with its 
Year 2 U.S. return in order for the section 362(e)(2)(C) election for 
the original transfer to be effective.

    (i) [Reserved]
    (j) Effective/applicability date. * * * The introductory text and 
Example 11 of paragraph (h) of this section apply with respect to 
transactions occurring on or after March 28, 2016, and also with respect 
to transactions occurring before such date as a result of an entity 
classification election under Sec. 301.7701-3 of this chapter filed on 
or after March 28, 2016, unless such transaction is pursuant to a 
binding agreement that was in effect prior to March 28, 2016 and at all 
times thereafter. In addition, taxpayers may apply such provisions to 
any transaction occurring after October 22, 2004.

[T.D. 9424, 73 FR 53948, Sept. 17, 2008, as amended by T.D. 9633, 78 FR 
54160, Sept. 3, 2013; T.D. 9759, 81 FR 17082, Mar. 28, 2016]



Sec. 1.367(a)-0  Table of contents.

    This section lists the paragraphs contained in Sec. Sec. 1.367(a)-1 
through 1.367(a)-8.

 Sec. 1.367(a)-1 Transfers to foreign corporations subject to section 
                           367(a): In general.

    (a) Scope.
    (b) General rules.
    (1) Foreign corporation not considered a corporation for purposes of 
certain transfers.
    (2) Cases in which foreign corporate status is not disregarded.
    (3) Determination of value.
    (4) In general.
    (5) Treatment of certain property as subject to section 367(d).
    (c) [Reserved]
    (d) Definitions.
    (1) United States person.
    (2) Foreign corporation.
    (3) Transfer.
    (4) Property.
    (5) Intangible property.
    (6) Operating intangibles.
    (e) Close of taxable year in certain section 368(a)(1)(F) 
reorganizations.
    (f) Exchanges under sections 354(a) and 361(a) in certain section 
368(a)(1)(F) reorganizations.
    (1) Rule.
    (2) Rule applies regardless of whether a continuance under 
applicable law.
    (g) Effective/applicability dates.

  Sec. 1.367(a)-2 Exceptions for transfers of property for use in the 
                 active conduct of a trade or business.

    (a) Scope and general rule.
    (1) Scope.
    (2) General rule.
    (b) Eligible property.
    (c) Exception for certain property.
    (1) Inventory.
    (2) Installment obligations, etc.
    (3) Nonfunctional currency, etc.
    (4) Certain leased tangible property.
    (d) Active conduct of a trade or business outside the United States.
    (1) In general.
    (2) Trade or business.
    (3) Active conduct.
    (4) Outside of the United States.
    (5) Use in the trade or business.
    (6) Active leasing and licensing.
    (e) Special rules for certain property to be leased.
    (1) Leasing business of the foreign corporation.
    (2) De minimis leasing by the foreign corporation.
    (3) Aircraft and vessels leased in foreign commerce.
    (f) Special rules for oil and gas working interests.
    (1) In general.
    (2) Active use of working interest.
    (3) Start-up operations.
    (4) Other applicable rules.
    (g) Property retransferred by the foreign corporation.
    (1) General rule.
    (2) Exception.
    (h) Compulsory transfers of property.
    (i) [Reserved]
    (j) Failure to comply with reporting requirements of section 6038B.
    (1) Failure to comply.
    (2) Relief for certain failures to comply that are not willful.
    (k) Effective/applicability dates.
    (1) In general.

[[Page 333]]

    (2) Foreign currency exception.

   Sec. 1.367(a)-3 Treatment of transfers of stock or securities to 
                          foreign corporations.

    (a) In general.
    (1) Overview.
    (2) Exceptions for certain exchanges of stock or securities.
    (3) Cross-references.
    (b) Transfers of stock or securities of foreign corporations.
    (1) General rule.
    (2) Certain transfers subject to sections 367(a) and (b).
    (c) Transfers of stock or securities of domestic corporations.
    (1) General rule.
    (2) Ownership presumption.
    (3) Active trade or business test.
    (4) Special rules.
    (5) Definitions.
    (6) Reporting requirements of U.S. target company.
    (7) Ownership statements.
    (8) Certain transfers in connection with performance of services.
    (9) Private letter ruling option.
    (10) Examples.
    (11) Effective date.
    (d) Indirect stock transfers in certain nonrecognition transfers.
    (1) In general.
    (2) Special rules for indirect transfers.
    (3) Examples.
    (e) [Reserved]
    (f) Failure to file statements.
    (1) Failure to file.
    (2) Relief for certain failures to file that are not willful.
    (g) Effective/applicability dates.
    (1) Rules of applicability.
    (2) Election.
    (h) Former 10-year gain recognition agreements.
    (i) [Reserved]
    (j) Transition rules regarding certain transfers of domestic or 
foreign stock or securities after December 16, 1987, and prior to July 
20, 1998.
    (1) Scope.
    (2) Transfers of domestic or foreign stock or securities: Additional 
substantive rules.
    (k) [Reserved]

 Sec. 1.367(a)-4 Special rule applicable to U.S. depreciated property.

    (a) Depreciated property used in the United States.
    (1) In general.
    (2) U.S. depreciated property.
    (3) Property used within and without the United States.
    (b) Effective/applicability dates.

                      Sec. 1.367(a)-5 [Reserved].

  Sec. 1.367(a)-6 Transfer of foreign branch with previously deducted 
                                 losses.

    (a) through (b)(1) [Reserved]
    (2) No active conduct exception.
    (c)(1) [Reserved]
    (2) Gain limitation.
    (3) [Reserved]
    (4) Transfers of certain intangible property.
    (d) through (i) [Reserved].
    (j) Effective/applicability dates.

  Sec. 1.367(a)-7 Outbound transfers of property described in section 
                             361(a) or (b).

    (a) Scope and purpose.
    (b) General rule.
    (1) Nonrecognition exchanges enumerated in section 367(a)(1).
    (2) Nonrecognition exchanges not enumerated in section 367(a)(1).
    (c) Elective exception.
    (1) Control.
    (2) Gain recognition.
    (3) Basis adjustments required for control group members.
    (4) Agreement to amend or file a U.S. income tax return.
    (5) Election and reporting requirements.
    (d) Section 361 exchange followed by successive distributions to 
which section 355 applies.
    (e) Other rules.
    (1) Section 367(a) property with respect to which gain is 
recognized.
    (2) Relief for certain failures to comply that are not willful.
    (3) Anti-abuse rule.
    (4) Certain income inclusions under Sec. 1.367(b)-4.
    (5) Certain gain under Sec. 1.367(a)-6.
    (f) Definitions.
    (g) Examples.
    (h) Applicable cross-references.
    (i) [Reserved]
    (j) Effective/applicability dates.
    (1) In general.
    (2) Section 367(d) property.

        Sec. 1.367(a)-8 Gain recognition agreement requirements.

    (a) Scope.
    (b) Definitions and special rules.
    (1) Definitions.
    (2) Special rules.
    (c) Gain recognition agreement.
    (1) Terms of agreement.
    (2) Content of gain recognition agreement.
    (3) Description of transferred stock or securities and other 
information.
    (4) Basis adjustments for gain recognized.
    (5) Terms and conditions of a new gain recognition agreement.
    (6) Cross-reference.
    (d) Filing requirements.

[[Page 334]]

    (1) General rule.
    (2) Special requirements.
    (3) Common parent as agent for U.S. transferor.
    (e) Signatory.
    (1) General rule.
    (2) Signature requirement.
    (f) Extension of period of limitations on assessments of tax.
    (1) General rule.
    (2) New gain recognition agreement.
    (g) Annual certification.
    (h) Use of security.
    (i) [Reserved]
    (j) Triggering events.
    (1) Disposition of transferred stock or securities.
    (2) Disposition of substantially all of the assets of the 
transferred corporation.
    (3) Disposition of certain partnership interests.
    (4) Disposition of stock of the transferee foreign corporation.
    (5) Deconsolidation.
    (6) Consolidation.
    (7) Death of an individual; trust or estate ceases to exist.
    (8) Failure to comply.
    (9) Gain recognition agreement filed in connection with indirect 
stock transfers and certain triangular asset reorganizations.
    (10) Gain recognition agreement filed pursuant to paragraph (k)(14) 
of this section.
    (k) Triggering event exceptions.
    (1) Transfers of stock of the transferee foreign corporation to a 
corporation or partnership.
    (2) Complete liquidation of U.S. transferor under sections 332 and 
337.
    (3) Transfers of transferred stock or securities to a corporation or 
partnership.
    (4) Transfers of substantially all of the assets of the transferred 
corporation.
    (5) Recapitalizations and section 1036 exchanges.
    (6) Certain asset reorganizations.
    (7) Certain triangular reorganizations.
    (8) Complete liquidation of transferred corporation.
    (9) Death of U.S. transferor.
    (10) Deconsolidation.
    (11) Consolidation.
    (12) Intercompany transactions.
    (13) Deemed asset sales pursuant to section 338(g) elections.
    (14) Other dispositions or events.
    (l) [Reserved]
    (m) Receipt of boot in nonrecognition transactions.
    (1) Dispositions of transferred stock or securities.
    (2) Dispositions of assets of transferred corporation.
    (n) Special rules for distributions with respect to stock.
    (1) Certain dividend equivalent redemptions treated as dispositions.
    (2) Gain recognized under section 301(c)(3).
    (o) Dispositions or other events that terminate or reduce the amount 
of gain subject to the gain recognition agreement.
    (1) Taxable disposition of stock of the transferee foreign 
corporation.
    (2) Gain recognized in connection with certain nonrecognition 
transactions.
    (3) Gain recognized under section 301(c)(3).
    (4) Dispositions of substantially all of the assets of a domestic 
transferred corporation.
    (5) Certain distributions or transfers of transferred stock or 
securities to U.S. persons.
    (6) Dispositions or other event following certain intercompany 
transactions.
    (7) Expropriations under foreign law.
    (p) Relief for certain failures to file or failures to comply that 
are not willful.
    (1) In general.
    (2) Procedures for establishing that a failure to file or failure to 
comply was not willful.
    (3) Examples.
    (q) Examples.
    (1) Presumed facts and references.
    (2) Examples.
    (r) Effective/applicability date.
    (1) General rule.
    (2) Applicability to transfers occurring before March 13, 2009.
    (3) Applicability to requests for relief submitted before November 
19, 2014.

[T.D. 9803, 81 FR 91021, Dec. 16, 2016]



Sec. 1.367(a)-1  Transfers to foreign corporations subject to section 
367(a): In general.

    (a) Scope. Section 367(a)(1) provides the general rule concerning 
certain transfers of property by a United States person (referred to at 
times in this section as the ``U.S. person'' or ``U.S. transferor'') to 
a foreign corporation. Paragraph (b) of this section provides general 
rules explaining the effect of section 367(a)(1). Paragraph (c) of this 
section describes transfers of property that are described in section 
367(a)(1). Paragraph (d) of this section provides definitions that apply 
for purposes of sections 367(a) and (d) and the regulations thereunder. 
Paragraphs (e) and (f) of this section provide rules that apply to 
certain reorganizations described in section 368(a)(1)(F). Paragraph (g) 
of this section provides dates of applicability. For rules concerning 
the reporting requirements under section 6038B for certain transfers of 
property to a foreign corporation, see Sec. 1.6038B-1.

[[Page 335]]

    (b) General rules--(1) Foreign corporation not considered a 
corporation for purposes of certain transfers. If a U.S. person 
transfers property to a foreign corporation in connection with an 
exchange described in section 351, 354, 356, or 361, then, pursuant to 
section 367(a)(1), the foreign corporation will not be considered to be 
a corporation for purposes of determining the extent to which gain is 
recognized on the transfer. Section 367(a)(1) denies nonrecognition 
treatment only to transfers of items of property on which gain is 
realized. Thus, the amount of gain recognized because of section 
367(a)(1) is unaffected by the transfer of items of property on which 
loss is realized (but not recognized).
    (2) Cases in which foreign corporate status is not disregarded. For 
circumstances in which section 367(a)(1) does not apply to a U.S. 
transferor's transfer of property to a foreign corporation, and thus the 
foreign corporation is considered to be a corporation, see Sec. Sec. 
1.367(a)-2, 1.367(a)-3, and 1.367(a)-7.
    (3) Determination of value. In cases in which a U.S. transferor's 
transfer of property to a foreign corporation constitutes a controlled 
transaction as defined in Sec. 1.482-1(i)(8), the value of the property 
transferred is determined in accordance with section 482 and the 
regulations thereunder.
    (4) Character, source, and adjustments--(i) In general. If a U.S. 
person is required to recognize gain under section 367 upon a transfer 
of property to a foreign corporation, then--
    (A) The character and source of such gain are determined as if the 
property had been disposed of in a taxable exchange with the transferee 
foreign corporation (unless otherwise provided by regulation); and
    (B) Appropriate adjustments to earnings and profits, basis, and 
other affected items will be made according to otherwise applicable 
rules, taking into account the gain recognized under section 367(a)(1). 
For purposes of applying section 362, the foreign corporation's basis in 
the property received is increased by the amount of gain recognized by 
the U.S. transferor under section 367(a) and the regulations issued 
pursuant to that section. To the extent the regulations provide that the 
U.S. transferor recognizes gain with respect to a particular item of 
property, the foreign corporation increases its basis in that item of 
property by the amount of such gain recognized. For example, Sec. Sec. 
1.367(a)-2, 1.367(a)-3, and 1.367(a)-4 provide that gain is recognized 
with respect to particular items of property. To the extent the 
regulations do not provide that gain recognized by the U.S. transferor 
is with respect to a particular item of property, such gain is treated 
as recognized with respect to items of property subject to section 
367(a) in proportion to the U.S. transferor's gain realized in such 
property, after taking into account gain recognized with respect to 
particular items of property transferred under any other provision of 
section 367(a). For example, Sec. 1.367(a)-6 provides that branch 
losses must be recaptured by the recognition of gain realized on the 
transfer but does not associate the gain with particular items of 
property. See also Sec. 1.367(a)-1(c)(3) for rules concerning transfers 
by partnerships or of partnership interests.
    (C) The transfer will not be recharacterized for U.S. Federal tax 
purposes solely because the U.S. person recognizes gain in connection 
with the transfer under section 367(a)(1). For example, if a U.S. person 
transfers appreciated stock or securities to a foreign corporation in an 
exchange described in section 351, the transfer is not recharacterized 
as other than an exchange described in section 351 solely because the 
U.S. person recognizes gain in the transfer under section 367(a)(1).
    (ii) Example. The rules of this paragraph (b)(4) are illustrated by 
the following example.

    Example. Domestic corporation DC transfers inventory with a fair 
market value of $1 million and adjusted basis of $800,000 to foreign 
corporation FC in exchange for stock of FC that is described in section 
351(a). Title passes within the United States. Pursuant to section 
367(a), DC is required to recognize gain of $200,000 upon the transfer. 
Under the rule of this paragraph (b)(4), the gain is treated as ordinary 
income (sections 1201 and 1221) from sources within the United States 
(section 861) arising from a taxable exchange with FC. Appropriate 
adjustments to earnings and profits, basis, etc., will be made as if the 
transfer were subject to section 351.

[[Page 336]]

Thus, for example, DC's basis in the FC stock received, and FC's basis 
in the transferred inventory, will each be increased by the $200,000 
gain recognized by DC, pursuant to sections 358(a)(1) and 362(a), 
respectively.

    (5) Treatment of certain property as subject to section 367(d). A 
U.S. transferor may apply section 367(d) and Sec. 1.367(d)-1, rather 
than section 367(a) and the regulations thereunder, to a transfer of 
property to a foreign corporation that otherwise would be subject to 
section 367(a), provided that the property is not eligible property, as 
defined in Sec. 1.367(a)-2(b) but determined without regard to Sec. 
1.367(a)-2(c). A U.S. transferor and any other U.S. transferor that is 
related (within the meaning of section 267(b) or 707(b)(1)) to the U.S. 
transferor must consistently apply this paragraph (b)(5) to all property 
described in this paragraph (b)(5) that is transferred to one or more 
foreign corporations pursuant to a plan. A U.S. transferor applies the 
provisions of this paragraph (b)(5) in the form and manner set forth in 
Sec. 1.6038B-1(d)(1)(iv) and (v).
    (c)(1) through (c)(3)(i) [Reserved]. For further guidance, see Sec. 
1.367(a)-1T(c)(1) through (c)(3)(i).
    (ii) Transfer of partnership interest treated as transfer of 
proportionate share of assets--(A) In general. If a U.S. person 
transfers an interest as a partner in a partnership (whether foreign or 
domestic) in an exchange described in section 367(a)(1), then that 
person is treated as having transferred a proportionate share of the 
property of the partnership in an exchange described in section 
367(a)(1). Accordingly, the applicability of the exception to section 
367(a)(1) provided in Sec. 1.367(a)-2 is determined with reference to 
the property of the partnership rather than the partnership interest 
itself. A U.S. person's proportionate share of partnership property is 
determined under the rules and principles of sections 701 through 761 
and the regulations thereunder.
    (c)(3)(i)(A) Example through (7) [Reserved]. For further guidance, 
see Sec. 1.367(a)-1T(c)(3)(i)(A) Example through (7).
    (d) Definitions. The following definitions apply for purposes of 
sections 367(a) and (d) and the regulations thereunder.
    (1) United States person. The term ``United States person'' includes 
those persons described in section 7701(a)(30). The term includes a 
citizen or resident of the United States, a domestic partnership, a 
domestic corporation, and any estate or trust other than a foreign 
estate or trust. (For definitions of these terms, see section 7701 and 
the regulations thereunder.) For purposes of this section, an individual 
with respect to whom an election has been made under section 6013(g) or 
(h) is considered to be a resident of the United States while such 
election is in effect. A nonresident alien or a foreign corporation will 
not be considered a United States person because of its actual or deemed 
conduct of a trade or business within the United States during a taxable 
year.
    (2) Foreign corporation. The term ``foreign corporation'' has the 
meaning set forth in section 7701(a)(3) and (5) and Sec. 301.7701-5.
    (3) Transfer. For purposes of section 367 and regulations 
thereunder, the term ``transfer'' means any transaction that constitutes 
a transfer for purposes of section 332, 351, 354, 355, 356, or 361, as 
applicable. A person's entering into a cost sharing arrangement under 
Sec. 1.482-7 or acquiring rights to intangible property under such an 
arrangement shall not be considered a transfer of property described in 
section 367(a)(1). See Sec. 1.6038B-1T(b)(4) for the date on which the 
transfer is considered to be made.
    (4) Property. For purposes of section 367 and the regulations 
thereunder, the term ``property'' means any item that constitutes 
property for purposes of section 351, 354, 355, 356, or 361, as 
applicable.
    (5) Intangible property. The term ``intangible property'' means 
either property described in section 936(h)(3)(B) or property to which a 
U.S. person applies section 367(d) pursuant to paragraph (b)(5) of this 
section, but does not include property described in section 1221(a)(3) 
or a working interest in oil and gas property.
    (6) Operating intangibles. An operating intangible is any property 
described in section 936(h)(3)(B) of a type not ordinarily licensed or 
otherwise transferred

[[Page 337]]

in transactions between unrelated parties for consideration contingent 
upon the licensee's or transferee's use of the property. Examples of 
operating intangibles may include long-term purchase or supply 
contracts, surveys, studies, and customer lists.
    (e) Close of taxable year in certain section 368(a)(1)(F) 
reorganizations. If a domestic corporation is the transferor corporation 
in a reorganization described in section 368(a)(1)(F) after March 30, 
1987, in which the acquiring corporation is a foreign corporation, then 
the taxable year of the transferor corporation shall end with the close 
of the date of the transfer and the taxable year of the acquiring 
corporation shall end with the close of the date on which the 
transferor's taxable year would have ended but for the occurrence of the 
transfer. With regard to the consequences of the closing of the taxable 
year, see section 381 and the regulations thereunder.
    (f) Exchanges under sections 354(a) and 361(a) in certain section 
368(a)(1)(F) reorganizations--(1) Rule. In every reorganization under 
section 368(a)(1)(F), where the transferor corporation is a domestic 
corporation, and the acquiring corporation is a foreign corporation, 
there is considered to exist--
    (i) A transfer of assets by the transferor corporation to the 
acquiring corporation under section 361(a) in exchange for stock (or 
stock and securities) of the acquiring corporation and the assumption by 
the acquiring corporation of the transferor corporation's liabilities;
    (ii) A distribution of the stock (or stock and securities) of the 
acquiring corporation by the transferor corporation to the shareholders 
(or shareholders and security holders) of the transferor corporation; 
and
    (iii) An exchange by the transferor corporation's shareholders (or 
shareholders and security holders) of their stock (or stock and 
securities) of the transferor corporation for stock (or stock and 
securities) of the acquiring corporation under section 354(a).
    (2) Rule applies regardless of whether a continuance under 
applicable law. For purposes of paragraph (f)(1) of this section, it 
shall be immaterial that the applicable foreign or domestic law treats 
the acquiring corporation as a continuance of the transferor 
corporation.
    (g) Effective/applicability dates. (1) through (3) [Reserved]. For 
further guidance, see Sec. 1.367(a)-1T(g)(1) through (3).
    (4) The rules in paragraphs (b)(4)(i)(B) and (b)(4)(i)(C) of this 
section apply to transfers occurring on or after April 18, 2013. For 
guidance with respect to paragraph (b)(4)(i)(B) of this section before 
April 18, 2013, see 26 CFR part 1 revised as of April 1, 2012. The rules 
in paragraph (e) of this section apply to transactions occurring on or 
after March 31, 1987. The rules in paragraph (f) of this section apply 
to transactions occurring on or after January 1, 1985.
    (5) Paragraphs (a), (b)(1) through (b)(4)(i)(B), (b)(4)(ii) through 
(b)(5), (c)(3)(ii)(A), (d) introductory text through (d)(2), (d)(4) 
through (d)(6) of this section apply to transfers occurring on or after 
September 14, 2015, and to transfers occurring before September 14, 
2015, resulting from entity classification elections made under Sec. 
301.7701-3 that are filed on or after September 14, 2015. For transfers 
occurring before this section is applicable, see Sec. Sec. 1.367(a)-1 
and 1.367(a)-1T as contained in 26 CFR part 1 revised as of April 1, 
2016.

[T.D. 9803, 81 FR 91022, Dec. 16, 2016, as amended at 82 FR 52848, Nov. 
15, 2017]



Sec. 1.367(a)-1T  Transfers to foreign corporations subject to section
367(a): In general (temporary).

    (a) [Reserved]
    (b) General rules--
    (b)(1) through (3) [Reserved]
    (4) Character, source, and adjustments--(i) In general. If a U.S. 
person is required to recognize gain under section 367 upon a transfer 
of property to a foreign corporation, then--
    (A) [Reserved]
    (B) [Reserved] For further guidance see Sec. 1.367(a)-
1(b)(4)(i)(B).
    (C) [Reserved] For further guidance see Sec. 1.367(a)-
1(b)(4)(i)(C).
    (b)(4)(ii) through (5) [Reserved]
    (c) Transfers described in section 367(a)(1)--(1) In general. A 
transfer described in section 367(a)(1) is any transfer of property by a 
U.S. person to a

[[Page 338]]

foreign corporation pursuant to an exchange described in section 332, 
351, 354, 355, 356, or 361. Section 367(a)(1) applies to such a transfer 
whether it is made directly, indirectly, or constructively. Indirect or 
constructive transfers that are described in section 367(a)(1) include 
the transfers described in subparagraphs (2) through (7) of this 
paragraph (c).
    (2) Indirect transfers in certain reorganizations. [Reserved]. For 
further guidance, see Sec. 1.367(a)-3(d).
    (3) Indirect transfers involving partnerships and interests 
therein--(i) Transfer by partnership treated as transfer by partners--
(A) In general. If a partnership (whether foreign or domestic) transfers 
property to a foreign corporation in an exchange described in section 
367(a)(1), then a U.S. person that is a partner in the partnership shall 
be treated as having transferred a proportionate share of the property 
in an exchange described in section 367(a)(1). A U.S. person's 
proportionate share of partnership property shall be determined under 
the rules and principles of sections 701 through 761 and the regulations 
thereunder. The rule of this paragraph (c)(3)(i)(A) is illustrated by 
the following example.

    Example. P is a partnership having five equal general partners, two 
of whom are United States persons. P transfers property to F, a foreign 
corporation, in connection with an exchange described in section 351. 
The exchange includes an indirect transfer of property by the partners 
to F. The transfers of property attributable to those partners who are 
United States persons, that is, 40 percent of each asset transferred to 
F, are transfers described in section 367(a)(1). The gain (if any) 
recognized on the transfer of 40 percent of each asset to F is 
attributable to the two partners who are United States persons.

    (B) Special adjustments to basis. If a U.S. person is treated under 
the rule of this paragraph (c)(3)(i) as having transferred a 
proportionate share of the property of a partnership in an exchange 
described in section 367(a), and is therefore required to recognize gain 
upon the transfer, then--
    (1) The U.S. person's basis in the partnership shall be increased by 
the amount of gain recognized by him;
    (2) Solely for purposes of determining the basis of the partnership 
in the stock of the transferee foreign corporation, the U.S. person 
shall be treated as having newly acquired an interest in the partnership 
(for an amount equal to the gain recognized), permitting the partnership 
to make an optional adjustment to basis pursuant to sections 743 and 
754; and
    (3) The transferee foreign corporation's basis in the property 
acquired from the partnership shall be increased by the amount of gain 
recognized by U.S. persons under this paragraph (c)(3)(i).
    (ii) Transfer of partnership interest treated as transfer of 
proportionate share of assets--
    (A) [Reserved]
    (B) Special adjustments to basis. If a U.S. person is treated under 
the rule of paragraph (c)(3)(ii)(A) of this section as having 
transferred a proportionate share of the property of a partnership in an 
exchange described in section 367(a), and is therefore required to 
recognize gain upon the transfer, then--
    (1) The U.S. person's basis in the stock of the transferee foreign 
corporation shall be increased by the amount of gain so recognized by 
that person;
    (2) The transferee foreign corporation's basis in the transferred 
partnership interest shall be increased by the amount of gain recognized 
by the U.S. person; and
    (3) Solely for purposes of determining the partnership's basis in 
the property held by it, the U.S. person shall be treated as having 
newly acquired an interest in the partnership (for an amount equal to 
the gain recognized), permitting the partnership to make an optional 
adjustment to basis pursuant to sections 743 and 754.
    (C) Limited partnership interest. The transfer by a U.S. person of 
an interest in a partnership shall not be subject to the rules of 
paragraph (c)(3)(ii)(A) and (B) if--
    (1) The interest transferred is a limited partnership interest; and
    (2) Such interest is regularly traded on an established securities 
market.

Instead, the transfer of such an interest shall be treated in the same 
manner as a transfer of stock or securities. Thus, the consequences of 
such a transfer shall be determined under the rules

[[Page 339]]

of Sec. 1.367(a)-3. For purposes of this section, a limited partnership 
interest is an interest as a limited partner in a partnership that is 
organized under the laws of any State of the United States or the 
District of Columbia. Whether such an interest is regularly traded on an 
established securities market shall be determined under the provisions 
of paragraph (c)(3)(ii)(D) of this section.
    (D) Regularly traded on an established securities market--(1) 
Established securities market. For purposes of this paragraph 
(c)(3)(ii), an established securities market is--
    (i) A national securities exchange which is registered under section 
6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f);
    (ii) A foreign national securities exchange which is officially 
recognized, sanctioned, or supervised by governmental authority; and
    (iii) An over-the-counter market. An over-the-counter market is any 
market reflected by the existence of an inter-dealer quotation system. 
An inter-dealer quotation system is any system of general circulation to 
brokers and dealers which regularly disseminates quotations of stock and 
securities by identified brokers or dealers, other than by quotation 
sheets which are prepared and distributed by a broker or dealer in the 
regular course of business and which contain only quotations of such 
broker or dealer.
    (2) Regularly traded. A class of interests that is traded on an 
established securities market is considered to be regularly traded if it 
is regularly quoted by brokers or dealers making a market in such 
interests. A class of interests shall be presumed to be regularly traded 
if the entity has a total of 500 or more interest-holders.
    (4) Transfers by trusts and estates--(i) In general. For purposes of 
section 367(a), a transfer of property by an estate or trust shall be 
treated as a transfer by the entity itself and not as an indirect 
transfer by its beneficiaries. Thus, a transfer of property by a foreign 
trust or estate (as defined in section 7701(a)(31)) is not described in 
section 367(a)(1), regardless of whether the beneficiaries of the trust 
or estate are U.S. persons. Similarly, a transfer of property by a 
domestic trust or estate may be described in section 367(a)(1), 
regardless of whether the beneficiaries of the trust or estate are 
foreign persons.
    (ii) Grantor trusts. A transfer of a portion or all of the assets of 
a foreign or domestic trust to a foreign corporation in an exchange 
described in section 367(a)(1) is considered a transfer by any U.S. 
person who is treated as the owner of any such portion or all of the 
assets of the trust under sections 671 through 679.
    (5) Termination of election under section 1504(d). Section 367(A) 
applies to the constructive reorganization and transfer of property from 
a domestic corporation to a foreign corporation that occurs upon the 
termination of an election under section 1504(d), which permits the 
treatment of certain contiguous country corporations as domestic 
corporations. The rule of this paragraph (c)(5) is illustrated by the 
following example.

    Example. Domestic corporation Y previously made a valid election 
under section 1504(d) to have its wholly owned Canadian subsidiary, C, 
treated as a domestic corporation. On July, 1, 1986, C fails to continue 
to qualify for the election under section 1504 (d). A constructive 
reorganization described in section 368(a)(1)(D) occurs. The resulting 
constructive transfer of assets by ``domestic'' corporation C to 
Canadian corporation C upon the termination of the election is a 
transfer of property described in section 367(a)(1).

    (6) Changes in classification of an entity. If a foreign entity is 
classified as an entity other than an association taxable as a 
corporation for United States tax purposes, and subsequently a change is 
made in the governing documents, articles, or agreements of the entity 
so that the entity is thereafter classified as an association taxable as 
a corporation, the change in classification is considered a transfer of 
property to a foreign corporation in connection with an exchange 
described in section 351. For purposes of section 367(a)(1), the 
transfer of property is considered as made by the persons determined 
under the rules set forth in paragraph (c)(3) of this section with 
respect to partnerships, and paragraph (c)(4)(i) or (ii), with respect 
to trusts and estates, and the rules of such paragraphs apply 
determining whether a

[[Page 340]]

transfer described in section 367(a)(1) has been made.
    (7) Contributions to capital. For rules with respect to the 
treatment of a contribution to the capital of a foreign corporation as a 
transfer described in section 367(a)(1), see section 367(c)(2) and the 
regulations thereunder.
    (d) introductory text through (d)(2) [Reserved]
    (3) [Reserved] For further guidance, see Sec. 1.367(a)-1(d)(3).
    (4) through (6) [Reserved]
    (e) [Reserved]. For further guidance, see Sec. 1.367(a)-1(e).
    (f) [Reserved]. For further guidance, see Sec. 1.367(a)-1(f).
    (g) Effective date of certain section--
    (1) In general. Except as specifically provided to the contrary 
elsewhere in these sections, Sec. Sec. 1.367(a)-1T through 1.367(a)-6T 
apply to transfers occurring after December 31, 1984.
    (2) Private rulings. The taxpayer may rely on a private ruling under 
section 367(a) received by him before June 16, 1986.
    (3) Certain indirect transfers. Sections 1.367(a)-1T(c)(2)(i) and 
(iii) and 1.367(a)-1T(c)(3) apply to transfers made after June 16, 1986. 
For transfers made before that date, see 26 CFR 1.367(a)-1(b) (revised 
as of April 1, 1986).
    (4) [Reserved] For further guidance see Sec. 1.367(a)-1(g)(4).

[T.D. 8087, 51 FR 17938, May 16, 1986, as amended by T.D. 8280, 55 FR 
1408, Jan. 16, 1990; T.D. 8770, 63 FR 33555, June 19, 1998; T.D. 9441, 
74 FR 348, Jan. 5, 2009; T.D. 9568, 76 FR 80087, Dec. 22, 2011; T.D. 
9614, 78 FR 17031, Mar. 19, 2013; T.D. 9739, 80 FR 56912, Sept. 21, 
2015; T.D. 9803, 81 FR 91024, Dec. 16, 2016]



Sec. 1.367(a)-2  Exceptions for transfers of property for use in the 
active conduct of a trade or business.

    (a) Scope and general rule--(1) Scope. Paragraph (a)(2) of this 
section provides the general exception to section 367(a)(1) for certain 
property transferred for use in the active conduct of a trade or 
business. Paragraph (b) of this section describes property that is 
eligible for the exception provided in paragraph (a)(2) of this section. 
Paragraph (c) of this section describes property that is not eligible 
for the exception provided in paragraph (a)(2) of this section. 
Paragraph (d) of this section provides general rules, and paragraphs (e) 
through (h) of this section provide special rules, for determining 
whether property is used in the active conduct of a trade or business 
outside of the United States. Paragraph (i) of this section is reserved. 
Paragraph (j) of this section provides relief for certain failures to 
comply with the reporting requirements under paragraph (a)(2)(iii) of 
this section that are not willful. Paragraph (k) of this section 
provides dates of applicability. The rules of this section do not apply 
to a transfer of stock or securities in an exchange subject to Sec. 
1.367(a)-3.
    (2) General rule. Except as otherwise provided in Sec. Sec. 
1.367(a)-4, 1.367(a)-6, and 1.367(a)-7, section 367(a)(1) does not apply 
to property transferred by a United States person (U.S. transferor) to a 
foreign corporation if--
    (i) The property constitutes eligible property;
    (ii) The property is transferred for use by the foreign corporation 
in the active conduct of a trade or business outside of the United 
States, as determined under paragraph (d), (e), (f), (g), or (h) of this 
section, as applicable; and
    (iii) The U.S. transferor complies with the reporting requirements 
of section 6038B and the regulations thereunder.
    (b) Eligible property. Except as provided in paragraph (c) of this 
section, eligible property means--
    (1) Tangible property;
    (2) A working interest in oil and gas property; and
    (3) A financial asset. For purposes of this section, a financial 
asset is--
    (i) A cash equivalent;
    (ii) A security within the meaning of section 475(c)(2), without 
regard to the last sentence of section 475(c)(2) (referencing section 
1256) and without regard to section 475(c)(4), but excluding an interest 
in a partnership;
    (iii) A commodities position described in section 475(e)(2)(B), 
475(e)(2)(C), or 475(e)(2)(D); and
    (iv) A notional principal contract described in Sec. 1.446-3(c)(1).
    (c) Exception for certain property. Notwithstanding paragraph (b) of 
this section, property described in paragraph (c)(1), (2), (3), or (4) 
of this section does not constitute eligible property.

[[Page 341]]

    (1) Inventory. Stock in trade of the taxpayer or other property of a 
kind which would properly be included in the inventory of the taxpayer 
if on hand at the close of the taxable year, or property held by the 
taxpayer primarily for sale to customers in the ordinary course of its 
trade or business (including raw materials and supplies, partially 
completed goods, and finished products).
    (2) Installment obligations, etc. Installment obligations, accounts 
receivable, or similar property, but only to the extent that the 
principal amount of any such obligation has not previously been included 
by the taxpayer in its taxable income.
    (3) Nonfunctional currency, etc.--(i) In general. Property that 
gives rise to a section 988 transaction of the taxpayer described in 
section 988(c)(1)(A) through (C), without regard to section 988(c)(1)(D) 
and (E), or that would give rise to such a section 988 transaction if it 
were acquired, accrued, entered into, or disposed of directly by the 
taxpayer.
    (ii) Limitation of gain required to be recognized. If section 
367(a)(1) applies to a transfer of property described in paragraph 
(c)(3)(i) of this section, then the gain required to be recognized is 
limited to the gain realized as part of the same transaction upon the 
transfer of property described in paragraph (c)(3)(i) of this section, 
less any loss realized as part of the same transaction upon the transfer 
of property described in paragraph (c)(3)(i) of this section. This 
limitation applies in lieu of the rule in Sec. 1.367(a)-1(b)(1). No 
loss is recognized with respect to property described in this paragraph 
(c)(3).
    (4) Certain leased tangible property. Tangible property with respect 
to which the transferor is a lessor at the time of the transfer, unless 
either the foreign corporation is the lessee at the time of the transfer 
or the foreign corporation will lease the property to third persons.
    (d) Active conduct of a trade or business outside the United 
States--(1) In general. Except as provided in paragraphs (e), (f), (g), 
and (h) of this section, to determine whether property is transferred 
for use by the foreign corporation in the active conduct of a trade or 
business outside of the United States, four factual determinations must 
be made:
    (i) What is the trade or business of the foreign corporation (see 
paragraph (d)(2) of this section);
    (ii) Do the activities of the foreign corporation constitute the 
active conduct of that trade or business (see paragraph (d)(3) of this 
section);
    (iii) Is the trade or business conducted outside of the United 
States (see paragraph (d)(4) of this section); and
    (iv) Is the transferred property used or held for use in the trade 
or business (see paragraph (d)(5) of this section)?
    (2) Trade or business. Whether the activities of the foreign 
corporation constitute a trade or business is determined based on all 
the facts and circumstances. In general, a trade or business is a 
specific unified group of activities that constitute (or could 
constitute) an independent economic enterprise carried on for profit. 
For example, the activities of a foreign selling subsidiary could 
constitute a trade or business if they could be independently carried on 
for profit, even though the subsidiary acts exclusively on behalf of, 
and has operations fully integrated with, its parent corporation. To 
constitute a trade or business, a group of activities must ordinarily 
include every operation which forms a part of, or a step in, a process 
by which an enterprise may earn income or profit. In this regard, one or 
more of such activities may be carried on by independent contractors 
under the direct control of the foreign corporation. (However, see 
paragraph (d)(3) of this section.) The group of activities must 
ordinarily include the collection of income and the payment of expenses. 
If the activities of the foreign corporation do not constitute a trade 
or business, then the exception provided by this section does not apply, 
regardless of the level of activities carried on by the corporation. The 
following activities are not considered to constitute by themselves a 
trade or business for purposes of this section:
    (i) Any activity giving rise to expenses that would be deductible 
only under section 212 if the activities were carried on by an 
individual; or

[[Page 342]]

    (ii) The holding for one's own account of investments in stock, 
securities, land, or other property, including casual sales thereof.
    (3) Active conduct. Whether a trade or business is actively 
conducted by the foreign corporation is determined based on all the 
facts and circumstances. In general, a corporation actively conducts a 
trade or business only if the officers and employees of the corporation 
carry out substantial managerial and operational activities. A 
corporation may be engaged in the active conduct of a trade or business 
even though incidental activities of the trade or business are carried 
out on behalf of the corporation by independent contractors. In 
determining whether the officers and employees of the corporation carry 
out substantial managerial and operational activities, however, the 
activities of independent contractors are disregarded. On the other 
hand, the officers and employees of the corporation are considered to 
include the officers and employees of related entities who are made 
available to and supervised on a day-to-day basis by, and whose salaries 
are paid by (or reimbursed to the lending related entity by), the 
foreign corporation. See paragraph (d)(6) of this section for the 
standard that applies to determine whether a trade or business that 
produces rents or royalties is actively conducted. The rule of this 
paragraph (d)(3) is illustrated by the following example.

    Example. X, a domestic corporation, and Y, a foreign corporation not 
related to X, transfer property to Z, a newly formed foreign corporation 
organized for the purpose of combining the research activities of X and 
Y. Z contracts all of its operational and research activities to Y for 
an arm's-length fee. Z's activities do not constitute the active conduct 
of a trade or business.

    (4) Outside of the United States. Whether the foreign corporation 
conducts a trade or business outside of the United States is determined 
based on all the facts and circumstances. Generally, the primary 
managerial and operational activities of the trade or business must be 
conducted outside the United States and immediately after the transfer 
the transferred assets must be located outside the United States. Thus, 
the exception provided by this section would not apply to the transfer 
of the assets of a domestic business to a foreign corporation if the 
domestic business continued to operate in the United States after the 
transfer. In such a case, the primary operational activities of the 
business would continue to be conducted in the United States. Moreover, 
the transferred assets would be located in the United States. However, 
it is not necessary that every item of property transferred be used 
outside of the United States. As long as the primary managerial and 
operational activities of the trade or business are conducted outside of 
the United States and substantially all of the transferred assets are 
located outside the United States, incidental items of transferred 
property located in the United States may be considered to have been 
transferred for use in the active conduct of a trade or business outside 
of the United States.
    (5) Use in the trade or business. Whether property is used or held 
for use by the foreign corporation in a trade or business is determined 
based on all the facts and circumstances. In general, property is used 
or held for use in the foreign corporation's trade or business if it 
is--
    (i) Held for the principal purpose of promoting the present conduct 
of the trade or business;
    (ii) Acquired and held in the ordinary course of the trade or 
business; or
    (iii) Otherwise held in a direct relationship to the trade or 
business. Property is considered held in a direct relationship to a 
trade or business if it is held to meet the present needs of that trade 
or business and not its anticipated future needs. Thus, property will 
not be considered to be held in a direct relationship to a trade or 
business if it is held for the purpose of providing for future 
diversification into a new trade or business, future expansion of trade 
or business activities, future plant replacement, or future business 
contingencies.
    (6) Active leasing and licensing. For purposes of paragraph (d)(3) 
of this section, whether a trade or business that produces rents or 
royalties is actively conducted is determined under the principles of 
section 954(c)(2)(A) and

[[Page 343]]

the regulations thereunder, but without regard to whether the rents or 
royalties are received from an unrelated party. See Sec. Sec. 1.954-
2(c) and (d).
    (e) Special rules for certain property to be leased--(1) Leasing 
business of the foreign corporation. Except as otherwise provided in 
this paragraph (e), tangible property that will be leased to another 
person by the foreign corporation will be considered to be transferred 
for use by the foreign corporation in an active trade or business 
outside the United States only if--
    (i) The foreign corporation's leasing of the property constitutes 
the active conduct of a leasing business, as determined under paragraph 
(d)(6) of this section;
    (ii) The lessee of the property is not expected to, and does not, 
use the property in the United States; and
    (iii) The foreign corporation has a need for substantial investment 
in assets of the type transferred.
    (2) De minimis leasing by the foreign corporation. Tangible property 
that will be leased to another person by the foreign corporation but 
that does not satisfy the conditions of paragraph (e)(1) of this section 
will, nevertheless, be considered to be transferred for use in the 
active conduct of a trade or business if either--
    (i) The property transferred will be used by the foreign corporation 
in the active conduct of a trade or business but will be leased during 
occasional brief periods when the property would otherwise be idle, such 
as an airplane leased during periods of excess capacity; or
    (ii) The property transferred is real property located outside the 
United States and--
    (A) The property will be used primarily in the active conduct of a 
trade or business of the foreign corporation; and
    (B) Not more than ten percent of the square footage of the property 
will be leased to others.
    (3) Aircraft and vessels leased in foreign commerce. For purposes of 
satisfying paragraph (e)(1) of this section, an aircraft or vessel, 
including component parts such as an engine leased separately from the 
aircraft or vessel, that will be leased to another person by the foreign 
corporation will be considered to be transferred for use in the active 
conduct of a trade or business if--
    (i) The employees of the foreign corporation perform substantial 
managerial and operational activities of leasing aircraft or vessels 
outside the United States; and
    (ii) The leased property is predominantly used outside the United 
States, as determined under Sec. 1.954-2(c)(2)(v).
    (f) Special rules for oil and gas working interests--(1) In general. 
A working interest in oil and gas property will be considered to be 
transferred for use in the active conduct of a trade or business if--
    (i) The transfer satisfies the conditions of paragraph (f)(2) or 
(f)(3) of this section;
    (ii) At the time of the transfer, the foreign corporation has no 
intention to farm out or otherwise transfer any part of the transferred 
working interest; and
    (iii) During the first three years after the transfer there are no 
farmouts or other transfers of any part of the transferred working 
interest as a result of which the foreign corporation retains less than 
a 50-percent share of the transferred working interest.
    (2) Active use of working interest. A working interest in oil and 
gas property that satisfies the conditions in paragraphs (f)(1)(ii) and 
(iii) of this section will be considered to be transferred for use in 
the active conduct of a trade or business if--
    (i) The U.S. transferor is regularly and substantially engaged in 
exploration for and extraction of minerals, either directly or through 
working interests in joint ventures, other than by reason of the 
property that is transferred;
    (ii) The terms of the working interest transferred were actively 
negotiated among the joint venturers;
    (iii) The working interest transferred constitutes at least a five 
percent working interest;
    (iv) Before and at the time of the transfer, through its own 
employees or officers, the U.S. transferor was regularly and actively 
engaged in--
    (A) Operating the working interest, or

[[Page 344]]

    (B) Analyzing technical data relating to the activities of the 
venture;
    (v) Before and at the time of the transfer, through its own 
employees or officers, the U.S. transferor was regularly and actively 
involved in decision making with respect to the operations of the 
venture, including decisions relating to exploration, development, 
production, and marketing; and
    (vi) After the transfer, the foreign corporation will for the 
foreseeable future satisfy the requirements of subparagraphs (iv) and 
(v) of this paragraph (f)(2).
    (3) Start-up operations. A working interest in oil and gas property 
that satisfies the conditions in paragraphs (f)(1)(ii) and (iii) of this 
section but that does not satisfy all the requirements of paragraph 
(f)(2) of this section will, nevertheless, be considered to be 
transferred for use in the active conduct of a trade or business if--
    (i) The working interest was acquired by the U.S. transferor 
immediately before the transfer and for the specific purpose of 
transferring it to the foreign corporation;
    (ii) The requirements of paragraphs (f)(2)(ii) and (iii) of this 
section are satisfied; and
    (iii) The foreign corporation will for the foreseeable future 
satisfy the requirements of paragraph (f)(2)(iv) and (v) of this 
section.
    (4) Other applicable rules. A working interest in oil and gas 
property that is not described in paragraph (f)(1) of this section may 
nonetheless qualify for the exception to section 367(a)(1) contained in 
this section depending upon the facts and circumstances.
    (g) Property retransferred by the foreign corporation--(1) General 
rule. Property will not be considered to be transferred for use in the 
active conduct of a trade or business outside of the United States if--
    (i) At the time of the transfer, it is reasonable to believe that, 
in the reasonably foreseeable future, the foreign corporation will sell 
or otherwise dispose of any material portion of the property other than 
in the ordinary course of business; or
    (ii) Except as provided in paragraph (g)(2) of this section, the 
foreign corporation receives the property in an exchange described in 
section 367(a)(1), and, as part of the same transaction, transfers the 
property to another person. For purposes of the preceding sentence, a 
subsequent transfer within six months of the initial transfer will be 
considered to be part of the same transaction, and a subsequent transfer 
more than six months after the initial transfer may be considered to be 
part of the same transaction under step-transaction principles.
    (2) Exception. Notwithstanding paragraph (g)(1) of this section, the 
active conduct exception provided by this section shall apply to the 
initial transfer if--
    (i) The initial transfer is followed by one or more subsequent 
transfers described in section 351 or 721; and
    (ii) Each subsequent transferee is either a partnership in which the 
preceding transferor is a general partner or a corporation in which the 
preceding transferor owns common stock; and
    (iii) The ultimate transferee uses the property in the active 
conduct of a trade or business outside the United States.
    (h) Compulsory transfers of property. Property is presumed to be 
transferred for use in the active conduct of a trade or business outside 
of the United States, if--
    (1) The property was previously in use in the country in which the 
foreign corporation is organized; and
    (2) The transfer is either:
    (i) Legally required by the foreign government as a necessary 
condition of doing business; or
    (ii) Compelled by a genuine threat of immediate expropriation by the 
foreign government.
    (i) [Reserved]
    (j) Failure to comply with reporting requirements of section 6038B--
(1) Failure to comply. For purposes of the exception to the application 
of section 367(a)(1) provided in paragraph (a)(2) of this section, a 
failure to comply with the reporting requirements of section 6038B and 
the regulations thereunder (failure to comply) has the meaning set forth 
in Sec. 1.6038B-1(f)(2).
    (2) Relief for certain failures to comply that are not willful--(i) 
In general. A failure to comply described in paragraph (j)(1) of this 
section will be

[[Page 345]]

deemed not to have occurred for purposes of satisfying the requirements 
of this section if the taxpayer demonstrates that the failure was not 
willful using the procedure set forth in this paragraph (j)(2). For this 
purpose, willful is to be interpreted consistent with the meaning of 
that term in the context of other civil penalties, which would include a 
failure due to gross negligence, reckless disregard, or willful neglect. 
Whether a failure to comply was a willful failure will be determined by 
the Director of Field Operations, Cross Border Activities Practice Area, 
Large Business & International (or any successor to the roles and 
responsibilities of such position, as appropriate) (Director) based on 
all the facts and circumstances. The taxpayer must submit a request for 
relief and an explanation as provided in paragraph (j)(2)(ii)(A) of this 
section. Although a taxpayer whose failure to comply is determined not 
to be willful will not be subject to gain recognition under this 
section, the taxpayer will be subject to a penalty under section 6038B 
if the taxpayer fails to demonstrate that the failure was due to 
reasonable cause and not willful neglect. See Sec. 1.6038B-1(b)(1) and 
(f). The determination of whether the failure to comply was willful 
under this section has no effect on any request for relief made under 
Sec. 1.6038B-1(f).
    (ii) Procedures for establishing that a failure to comply was not 
willful--(A) Time and manner of submission. A taxpayer's statement that 
the failure to comply was not willful will be considered only if, 
promptly after the taxpayer becomes aware of the failure, an amended 
return is filed for the taxable year to which the failure relates that 
includes the information that should have been included with the 
original return for such taxable year or that otherwise complies with 
the rules of this section, and that includes a written statement 
explaining the reasons for the failure to comply. The amended return 
must be filed with the Internal Revenue Service at the location where 
the taxpayer filed its original return. The taxpayer may submit a 
request for relief from the penalty under section 6038B as part of the 
same submission. See Sec. 1.6038B-1(f).
    (B) Notice requirement. In addition to the requirements of paragraph 
(j)(2)(ii)(A) of this section, the taxpayer must comply with the notice 
requirements of this paragraph (j)(2)(ii)(B). If any taxable year of the 
taxpayer is under examination when the amended return is filed, a copy 
of the amended return and any information required to be included with 
such return must be delivered to the Internal Revenue Service personnel 
conducting the examination. If no taxable year of the taxpayer is under 
examination when the amended return is filed, a copy of the amended 
return and any information required to be included with such return must 
be delivered to the Director.
    (3) For illustrations of the application of the willfulness standard 
of this paragraph (j), see the examples in Sec. 1.367(a)-8(p)(3).
    (4) Paragraph (j) applies to requests for relief submitted on or 
after November 19, 2014.
    (k) Effective/applicability dates--(1) In general. Except as 
provided in paragraphs (j)(4) and (k)(2) of this section, the rules of 
this section apply to transfers occurring on or after September 14, 
2015, and to transfers occurring before September 14, 2015, resulting 
from entity classification elections made under Sec. 301.7701-3 that 
are filed on or after September 14, 2015. For transfers occurring before 
this section is applicable, see Sec. Sec. 1.367(a)-2, -2T, -4, -4T, -5, 
and -5T as contained in 26 CFR part 1 revised as of April 1, 2016.
    (2) Foreign currency exception. Notwithstanding paragraph (c)(3)(i) 
of this section, Sec. 1.367(a)-5T(d)(2) as contained in 26 CFR part 1 
revised as of April 1, 2016, applies to transfers of property 
denominated in a foreign currency occurring before December 16, 2016, 
other than transfers occurring before that date resulting from entity 
classification elections made under Sec. 301.7701-3 that are filed on 
or after that date.

[T.D. 9803, 81 FR 91024, Dec. 16, 2016]



Sec. 1.367(a)-3  Treatment of transfers of stock or securities to
foreign corporations.

    (a) In general--(1) Overview. This section provides rules concerning 
the transfer of stock or securities by a U.S. person to a foreign 
corporation in an

[[Page 346]]

exchange described in section 367(a)(1). In general, a transfer of stock 
or securities (including an indirect stock transfer described in 
paragraph (d) of this section) by a U.S. person to a foreign corporation 
that is described in section 351, 354 (including a section 354 exchange 
pursuant to a reorganization described in section 368(a)(1)(B)), 356, or 
section 361(a) or (b) is subject to section 367(a)(1). Therefore, gain 
is recognized on such a transfer unless one of the exceptions set forth 
in paragraph (a)(2) of this section (regarding general exceptions for 
certain exchanges of stock or securities), paragraph (b) of this section 
(regarding transfers of foreign stock or securities), paragraph (c) of 
this section (regarding transfers of domestic stock or securities), or 
paragraph (e) of this section (regarding transfers of stock or 
securities in a section 361 exchange) applies to the transfer. For rules 
applicable when, pursuant to section 304(a)(1), a U.S. person is treated 
as transferring stock of a domestic or foreign corporation to a foreign 
corporation in exchange for stock of such foreign corporation in a 
transaction to which section 351(a) applies, see Sec. 1.367(a)-9T.
    (2) Exceptions for certain exchanges of stock or securities. Unless 
otherwise provided, the following exchanges are not subject to section 
367(a)(1) and therefore gain is not recognized under section 367(a)(1).
    (i) Section 368(a)(1)(E) reorganizations. In an exchange under 
section 354 or 356, a U.S. person exchanges stock or securities of a 
foreign corporation in a reorganization described in section 
368(a)(1)(E).
    (ii) Certain section 368(a)(1) asset reorganizations. In an exchange 
under section 354 or 356, a U.S. person exchanges stock or securities of 
a domestic or foreign corporation pursuant to an asset reorganization 
that is not treated as an indirect stock transfer under paragraph (d) of 
this section. See paragraph (d)(3) Example 16 of this section. For 
purposes of this section, an asset reorganization is defined as a 
reorganization described in section 368(a)(1) involving a transfer of 
property under section 361.
    (iii) Certain reorganizations described in sections 368(a)(1)(A) and 
(a)(2)(E). If, in an exchange described in section 361, a domestic 
merging corporation transfers stock of a controlling corporation to a 
foreign surviving corporation in a reorganization described in section 
368(a)(1)(A) and (a)(2)(E), the stock of the controlling corporation 
transferred in such section 361 exchange is not subject to section 
367(a)(1) if the stock of the controlling corporation is provided to the 
merging corporation by the controlling corporation pursuant to the plan 
of reorganization. However, a section 361 exchange of other property, 
including stock of the controlling corporation not provided by the 
controlling corporation pursuant to the plan of reorganization, by the 
domestic merging corporation to the foreign surviving corporation 
pursuant to such a reorganization is described in section 367(a)(1) and 
therefore subject to section 367(a)(1) unless an exception to section 
367(a)(1) applies.
    (iv) Certain triangular reorganizations described in Sec. 1.367(b)-
10. If, in an exchange under section 354 or 356, one or more U.S. 
persons exchange stock or securities of T (as defined in Sec. 1.358-
6(b)(1)(iii)) in connection with a transaction described in Sec. 
1.367(b)-10 (applying to certain acquisitions of parent stock or 
securities for property in triangular reorganizations), section 
367(a)(1) shall not apply to such U.S. persons with respect to the 
exchange of the stock or securities of T if the condition specified in 
this paragraph (iv) is satisfied. The condition specified in this 
paragraph (iv) is that the amount of gain in the T stock or securities 
that would otherwise be recognized under section 367(a)(1) (without 
regard to any exceptions thereto) pursuant to the indirect stock 
transfer rules of paragraph (d) of this section is less than the sum of 
the amount of the deemed distribution under Sec. 1.367(b)-10 treated as 
a dividend under section 301(c)(1) and the amount of such deemed 
distribution treated as gain from the sale or exchange of property under 
section 301(c)(3). See Sec. 1.367(b)-10(a)(2)(iii) (providing a similar 
rule that excludes certain transactions from the application of Sec. 
1.367(b)-10).
    (3) Cross-references. For rules regarding other indirect or 
constructive transfers of stock or securities subject

[[Page 347]]

to section 367(a)(1) (unless an exception applies) see Sec. 1.367(a)-
1(c). For additional rules regarding a transfer of stock or securities 
in an exchange described in section 361(a) or (b), see Sec. 1.367(a)-7. 
For special basis and holding period rules involving foreign 
corporations that are parties to certain triangular reorganizations 
under section 368(a)(1), see Sec. 1.367(b)-13. For additional rules 
relating to certain nonrecognition exchanges involving a foreign 
corporation, see section 367(b) and the regulations under that section. 
For rules regarding reporting requirements with respect to transfers 
described under section 367(a), see section 6038B and the regulations 
thereunder. For rules related to expatriated entities, see section 7874 
and the regulations thereunder.
    (b) Transfers of stock or securities of foreign corporations --(1) 
General rule. Except as provided in paragraph (e) of this section, a 
transfer of stock or securities of a foreign corporation by a U.S. 
person to a foreign corporation that would otherwise be subject to 
section 367(a)(1) under paragraph (a) of this section will not be 
subject to section 367(a)(1) if either--
    (i) Less than 5-percent shareholder. The U.S. person owns less than 
five percent (applying the attribution rules of section 318, as modified 
by section 958(b)) of both the total voting power and the total value of 
the stock of the transferee foreign corporation immediately after the 
transfer; or
    (ii) 5-percent shareholder. The U.S. person enters into a five-year 
gain recognition agreement with respect to the transferred stock or 
securities as provided in Sec. 1.367(a)-8.
    (2) Certain transfers subject to sections 367(a) and (b)--(i) In 
general. A transfer of stock or securities described in section 367(a) 
or the regulations thereunder as well as in section 367(b) or the 
regulations thereunder shall be subject concurrently to sections 367(a) 
and (b) and the respective regulations thereunder, except as provided in 
paragraph (b)(2)(i)(A) through (C) of this section. See paragraph (d)(3) 
Examples 11 and 14 of this section.
    (A) Section 367(b) and the regulations thereunder shall not apply if 
a foreign corporation is not treated as a corporation under section 
367(a)(1). See the example in paragraph (b)(2)(ii) of this section and 
paragraph (d)(3) Example 14 of this section.
    (B) If a foreign corporation transfers assets to a domestic 
corporation in a transaction to which Sec. 1.367(b)-3(a) and (b) and 
the indirect stock transfer rules of paragraph (d) of this section 
apply, and all the earnings and profits amount attributable to the stock 
of an exchanging shareholder under Sec. 1.367(b)-3(b) is greater than 
the amount of gain in such stock subject to section 367(a) pursuant to 
the indirect stock transfer rules of paragraph (d) of this section, then 
the rules of section 367(b), and not the rules of section 367(a), shall 
apply to the exchange. See paragraph (d)(3) Example 15 of this section.
    (C) [Reserved] For further guidance, see Sec. 1.367(a)-
3T(b)(2)(i)(C).
    (ii) Example. The following example illustrates the provisions of 
this paragraph (b)(2):

    Example. (i) Facts. DC, a domestic corporation, owns all of the 
stock of FC1, a controlled foreign corporation within the meaning of 
section 957(a). DC's basis in the stock of FC1 is $50, and the value of 
such stock is $100. The section 1248 amount with respect to such stock 
is $30. FC2, also a foreign corporation, is owned entirely by foreign 
individuals who are not related to DC or FC1. In a reorganization 
described in section 368(a)(1)(B), FC2 acquires all of the stock of FC1 
from DC in exchange for 20 percent of the voting stock of FC2. FC2 is 
not a controlled foreign corporation after the reorganization.
    (ii) Result without gain recognition agreement. Under the provisions 
of this paragraph (b), if DC fails to enter into a gain recognition 
agreement, DC is required to recognize in the year of the transfer the 
$50 of gain that it realized upon the transfer, $30 of which will be 
treated as a dividend under section 1248.
    (iii) Result with gain recognition agreement. If DC enters into a 
gain recognition agreement under Sec. 1.367(a)-8 with respect to the 
transfer of FC1 stock, the exchange will also be subject to the 
provisions of section 367(b) and the regulations thereunder to the 
extent that it is not subject to tax under section 367(a)(1). In such 
case, DC will be required to recognize the section 1248 amount of $30 on 
the exchange of FC1 for FC2 stock. See Sec. 1.367(b)-4(b). The deemed 
dividend of $30 recognized by DC will increase its basis in the FC1 
stock exchanged in the transaction and, therefore, the basis of the FC2 
stock received in the transaction. The remaining

[[Page 348]]

gain of $20 realized by DC (otherwise recognizable under section 367(a)) 
in the exchange of FC1 stock will not be recognized if DC enters into a 
gain recognition agreement with respect to the transfer. (The result 
would be unchanged if, for example, the exchange of FC1 stock for FC2 
stock qualified as a section 351 exchange, or as an exchange described 
in both sections 351 and 368(a)(1)(B).)
    (c) Transfers of stock or securities of domestic corporations--(1) 
General rule. Except as provided in paragraph (e) of this section, a 
transfer of stock or securities of a domestic corporation by a U.S. 
person to a foreign corporation that would otherwise be subject to 
section 367(a)(1) under paragraph (a) of this section will not be 
subject to section 367(a)(1) if the domestic corporation the stock or 
securities of which are transferred (referred to as the U.S. target 
company) complies with the reporting requirements in paragraph (c)(6) of 
this section and if each of the following four conditions is met:
    (i) Fifty percent or less of both the total voting power and the 
total value of the stock of the transferee foreign corporation is 
received in the transaction, in the aggregate, by U.S. transferors 
(i.e., the amount of stock received does not exceed the 50-percent 
ownership threshold).
    (ii) Fifty percent or less of each of the total voting power and the 
total value of the stock of the transferee foreign corporation is owned, 
in the aggregate, immediately after the transfer by U.S. persons that 
are either officers or directors of the U.S. target company or that are 
five-percent target shareholders (as defined in paragraph (c)(5)(iii) of 
this section) (i.e., there is no control group). For purposes of this 
paragraph (c)(1)(ii), any stock of the transferee foreign corporation 
owned by U.S. persons immediately after the transfer will be taken into 
account, whether or not it was received in the exchange for stock or 
securities of the U.S. target company.
    (iii) Either--
    (A) The U.S. person is not a five-percent transferee shareholder (as 
defined in paragraph (c)(5)(ii) of this section); or
    (B) The U.S. person is a five-percent transferee shareholder and 
enters into a five-year agreement to recognize gain with respect to the 
U.S. target company stock or securities it exchanged in the form 
provided in Sec. 1.367(a)-8; and
    (iv) The active trade or business test (as defined in paragraph 
(c)(3) of this section) is satisfied.
    (2) Ownership presumption. For purposes of paragraph (c)(1) of this 
section, persons who transfer stock or securities of the U.S. target 
company in exchange for stock of the transferee foreign corporation are 
presumed to be U.S. persons. This presumption may be rebutted in 
accordance with paragraph (c)(7) of this section.
    (3) Active trade or business test--(i) In general. The tests of this 
paragraph (c)(3), collectively referred to as the active trade or 
business test, are satisfied if:
    (A) The transferee foreign corporation or any qualified subsidiary 
(as defined in paragraph (c)(5)(vii) of this section) or any qualified 
partnership (as defined in paragraph (c)(5)(viii) of this section) is 
engaged in an active trade or business outside the United States, within 
the meaning of Sec. 1.367(a)-2(d)(2), (3), and (4) for the entire 36-
month period immediately before the transfer;
    (B) At the time of the transfer, neither the transferors nor the 
transferee foreign corporation (and, if applicable, the qualified 
subsidiary or qualified partnership engaged in the active trade or 
business) have an intention to substantially dispose of or discontinue 
such trade or business; and
    (C) The substantiality test (as defined in paragraph (c)(3)(iii) of 
this section) is satisfied.
    (ii) Special rules. For purposes of paragraphs (c)(3)(i)(A) and (B) 
of this section, the following special rules apply:
    (A) The transferee foreign corporation, a qualified subsidiary, or a 
qualified partnership will be considered to be engaged in an active 
trade or business for the entire 36-month period preceding the exchange 
if it acquires at the time of, or any time prior to, the exchange a 
trade or business that has been active throughout the entire 36-month 
period preceding the exchange. This special rule shall not apply, 
however, if the acquired active trade or business assets were owned by 
the U.S. target company or any affiliate (within

[[Page 349]]

the meaning of section 1504(a) but excluding the exceptions contained in 
section 1504(b) and substituting ``50 percent'' for ``80 percent'' where 
it appears therein) at any time during the 36-month period prior to the 
acquisition. Nor will this special rule apply if the principal purpose 
of such acquisition is to satisfy the active trade or business test.
    (B) An active trade or business does not include the making or 
managing of investments for the account of the transferee foreign 
corporation or any affiliate (within the meaning of section 1504(a) but 
excluding the exceptions contained in section 1504(b) and substituting 
``50 percent'' for ``80 percent'' where it appears therein). (This 
paragraph (c)(3)(ii)(B) shall not create any inference as to the scope 
of Sec. 1.367(a)-2(d)(2) and (3) for other purposes.)
    (iii) Substantiality test--(A) General rule. A transferee foreign 
corporation will be deemed to satisfy the substantiality test if, at the 
time of the transfer, the fair market value of the transferee foreign 
corporation is at least equal to the fair market value of the U.S. 
target company.
    (B) Special rules for transferee foreign corporation value. (1) For 
purposes of paragraph (c)(3)(iii)(A) of this section, the value of the 
transferee foreign corporation shall include assets acquired outside the 
ordinary course of business by the transferee foreign corporation within 
the 36-month period preceding the exchange only if either--
    (i) Both--
    (A) At the time of the exchange, such assets or, as applicable, the 
proceeds thereof, do not produce, and are not held for the production 
of, passive income as defined in section 1297(b); and
    (B) Such assets are not acquired for the principal purpose of 
satisfying the substantiality test; or
    (ii) Such assets consist of the stock of a qualified subsidiary or 
an interest in a qualified partnership. See paragraph (c)(3)(iii)(B)(2) 
of this section.
    (2) For purposes of paragraph (c)(3)(iii)(A) of this section, the 
value of the transferee foreign corporation shall not include the value 
of the stock of any qualified subsidiary or the value of any interest in 
a qualified partnership, held directly or indirectly, to the extent that 
such value is attributable to assets acquired by such qualified 
subsidiary or partnership outside the ordinary course of business and 
within the 36-month period preceding the exchange unless those assets 
satisfy the requirements in paragraph (c)(3)(iii)(B)(1) of this section.
    (3) For purposes of paragraph (c)(3)(iii)(A) of this section, the 
value of the transferee foreign corporation shall not include the value 
of assets received within the 36-month period prior to the acquisition, 
notwithstanding the special rule in paragraph (c)(3)(iii)(B)(1) of this 
section, if such assets were owned by the U.S. target company or an 
affiliate (within the meaning of section 1504(a) but without the 
exceptions under section 1504(b) and substituting ``50 percent'' for 
``80 percent'' where it appears therein) at any time during the 36-month 
period prior to the transaction.
    (C) Special rule for U.S. target company value. For purposes of 
Sec. 1.367(a)-3(c)(3)(iii)(A), the fair market value of the U.S. target 
company includes the aggregate amount of non-ordinary course 
distributions (NOCDs) made by the U.S. target company. To calculate the 
aggregate value of NOCDs, the principles of Sec. 1.7874-10, including 
the rule regarding predecessors in Sec. 1.7874-10(e) and the rule 
regarding a deemed distribution of stock in certain cases in Sec. 
1.7874-10(g), apply. However, this paragraph (c)(3)(iii)(C) does not 
apply if the principles of the de minimis exception in Sec. 1.7874-
10(d) are satisfied.
    (4) Special rules--(i) Treatment of partnerships. For purposes of 
this paragraph (c), if a partnership (whether domestic or foreign) owns 
stock or securities in the U.S. target company or the transferee foreign 
corporation, or transfers stock or securities in an exchange described 
in section 367(a), each partner in the partnership, and not the 
partnership itself, is treated as owning and as having transferred, or 
as owning, a proportionate share of the stock or securities. See Sec. 
1.367(a)-1(c)(3).
    (ii) Treatment of options. For purposes of this paragraph (c), one 
or more options (or an interest similar to an option) will be treated as 
exercised and thus will be counted as stock for purposes of determining 
whether the 50-

[[Page 350]]

percent threshold is exceeded or whether a control group exists if a 
principal purpose of the issuance or the acquisition of the option (or 
other interest) was the avoidance of the general rule contained in 
section 367(a)(1).
    (iii) U.S. target has a vestigial ownership interest in transferee 
foreign corporation. In cases where, immediately after the transfer, the 
U.S. target company owns, directly or indirectly (applying the 
attribution rules of sections 267(c)(1) and (5)), stock of the 
transferee foreign corporation, that stock will not in any way be taken 
into account (and, thus, will not be treated as outstanding) in 
determining whether the 50-percent threshold under paragraph (c)(1)(i) 
of this section is exceeded or whether a control group under paragraph 
(c)(1)(ii) of this section exists.
    (iv) Attribution rule. Except as otherwise provided in this section, 
the rules of section 318, as modified by the rules of section 958(b) 
shall apply for purposes of determining the ownership or receipt of 
stock, securities or other property under this paragraph (c).
    (5) Definitions--(i) Ownership statement. An ownership statement is 
a statement, signed under penalties of perjury, stating--
    (A) The identity and taxpayer identification number, if any, of the 
person making the statement;
    (B) That the person making the statement is not a U.S. person (as 
defined in paragraph (c)(5)(iv) of this section);
    (C) That the person making the statement either--
    (1) Owns less than 1 percent of the total voting power and total 
value of a U.S. target company the stock of which is described in Rule 
13d-1(d) of Regulation 13D (17 CFR 240.13d-1(d)) (or any rule or 
regulation to generally the same effect) promulgated by the Securities 
and Exchange Commission under the Securities and Exchange Act of 1934 
(15 U.S.C. 78m), and such person did not acquire the stock with a 
principal purpose to enable the U.S. transferors to satisfy the 
requirement contained in paragraph (c)(1)(i) of this section; or
    (2) Is not related to any U.S. person to whom the stock or 
securities owned by the person making the statement are attributable 
under the rules of section 958(b), and did not acquire the stock with a 
principal purpose to enable the U.S. transferors to satisfy the 
requirement contained in paragraph (c)(1)(i) of this section;
    (D) The citizenship, permanent residence, home address, and U.S. 
address, if any, of the person making the statement; and
    (E) The ownership such person has (by voting power and by value) in 
the U.S. target company prior to the exchange and the amount of stock of 
the transferee foreign corporation (by voting power and value) received 
by such person in the exchange.
    (ii) Five-percent transferee shareholder. A five-percent transferee 
shareholder is a person that owns at least five percent of either the 
total voting power or the total value of the stock of the transferee 
foreign corporation immediately after the transfer described in section 
367(a)(1). For special rules involving cases in which stock is held by a 
partnership, see paragraph (c)(4)(i) of this section.
    (iii) Five-percent target shareholder and certain other 5-percent 
shareholders. A five-percent target shareholder is a person that owns at 
least five percent of either the total voting power or the total value 
of the stock of the U.S. target company immediately prior to the 
transfer described in section 367(a)(1). If the stock of the U.S. target 
company (or any company through which stock of the U.S. target company 
is owned indirectly or constructively) is described in Rule 13d-1(d) of 
Regulation 13D (17 CFR 240.13d-1(d)) (or any rule or regulation to 
generally the same effect), promulgated by the Securities and Exchange 
Commission under the Securities Exchange Act of 1934 (15 U.S.C. 78m), 
then, in the absence of actual knowledge to the contrary, the existence 
or absence of filings of Schedule 13-D or 13-G (or any similar 
schedules) may be relied upon for purposes of identifying five-percent 
target shareholders (or a five-percent shareholder of a corporation 
which itself is a five-percent shareholder of the U.S. target company). 
For special rules involving cases in which U.S. target company stock is 
held by a partnership, see paragraph (c)(4)(i) of this section.

[[Page 351]]

    (iv) U.S. Person. For purposes of this section, a U.S. person is 
defined by reference to Sec. 1.367(a)-1(d)(1). For application of the 
rules of this section to stock or securities owned or transferred by a 
partnership that is a U.S. person, however, see paragraph (c)(4)(i) of 
this section.
    (v) U.S. Transferor. A U.S. transferor is a U.S. person (as defined 
in paragraph (c)(5)(iv) of this section) that transfers stock or 
securities of one or more U.S. target companies in exchange for stock of 
the transferee foreign corporation in an exchange described in section 
367.
    (vi) Transferee foreign corporation. Except as provided in paragraph 
(d)(2)(i)(B) of this section, a transferee foreign corporation is the 
foreign corporation whose stock is received in the exchange by U.S. 
persons.
    (vii) Qualified Subsidiary. A qualified subsidiary is a foreign 
corporation whose stock is at least 80-percent owned (by total voting 
power and total value), directly or indirectly, by the transferee 
foreign corporation. However, a corporation will not be treated as a 
qualified subsidiary if it was affiliated with the U.S. target company 
(within the meaning of section 1504(a) but without the exceptions under 
section 1504(b) and substituting ``50 percent'' for ``80 percent'' where 
it appears therein) at any time during the 36-month period prior to the 
transfer. Nor will a corporation be treated as a qualified subsidiary if 
it was acquired by the transferee foreign corporation at any time during 
the 36-month period prior to the transfer for the principal purpose of 
satisfying the active trade or business test, including the 
substantiality test.
    (viii) Qualified partnership. (A) Except as provided in paragraph 
(c)(5)(viii)(B) or (C) of this section, a qualified partnership is a 
partnership in which the transferee foreign corporation--
    (1) Has active and substantial management functions as a partner 
with regard to the partnership business; or --
    (2) Has an interest representing a 25 percent or greater interest in 
the partnership's capital and profits.
    (B) A partnership is not a qualified partnership if the U.S. target 
company or any affiliate of the U.S. target company (within the meaning 
of section 1504(a) but without the exceptions under section 1504(b) and 
substituting ``50 percent'' for ``80 percent'' where it appears therein) 
held a 5 percent or greater interest in the partnership's capital and 
profits at any time during the 36-month period prior to the transfer.
    (C) A partnership is not a qualified partnership if the transferee 
foreign corporation's interest was acquired by that corporation at any 
time during the 36-month period prior to the transfer for the principal 
purpose of satisfying the active trade or business test, including the 
substantiality test.
    (6) Reporting requirements of U.S. target company. (i) In order for 
a U.S. person that transfers stock or securities of a domestic 
corporation to qualify for the exception provided by this paragraph (c) 
to the general rule under section 367(a)(1), in cases where 10 percent 
or more of the total voting power or the total value of the stock of the 
U.S. target company is transferred by U.S. persons in the transaction, 
the U.S. target company must comply with the reporting requirements 
contained in this paragraph (c)(6). The U.S. target company must attach 
to its timely filed U.S. income tax return for the taxable year in which 
the transfer occurs a statement titled ``Section 367(a)--Reporting of 
Cross-Border Transfer Under Reg. Sec. 1.367(a)-3(c)(6),'' signed under 
penalties of perjury by an officer of the corporation to the best of the 
officer's knowledge and belief, disclosing the following information--
    (A) A description of the transaction in which a U.S. person or 
persons transferred stock or securities in the U.S. target company to 
the transferee foreign corporation in a transfer otherwise subject to 
section 367(a)(1);
    (B) The amount (specified as to the percentage of the total voting 
power and the total value) of stock of the transferee foreign 
corporation received in the transaction, in the aggregate, by persons 
who transferred stock or securities of the U.S. target company. For 
additional information that may be required to rebut the ownership 
presumption of paragraph (c)(2) of this section in cases where more than 
50 percent of

[[Page 352]]

either the total voting power or the total value of the stock of the 
transferee foreign corporation is received in the transaction, in the 
aggregate, by persons who transferred stock or securities of the U.S. 
target company, see paragraph (c)(7) of this section;
    (C) The amount (if any) of transferee foreign corporation stock 
owned directly or indirectly (applying the attribution rules of sections 
267(c)(1) and (5)) immediately after the exchange by the U.S. target 
company;
    (D) A statement that there is no control group within the meaning of 
paragraph (c)(1)(ii) of this section;
    (E) A list of U.S. persons who are officers, directors or five-
percent target shareholders and the percentage of the total voting power 
and the total value of the stock of the transferee foreign corporation 
owned by such persons both immediately before and immediately after the 
transaction; and
    (F) A statement that includes the following--
    (1) A statement that the active trade or business test described in 
paragraph (c)(3) of this section is satisfied by the transferee foreign 
corporation and a description of such business;
    (2) A statement that on the day of the transaction, there was no 
intent on the part of the transferee foreign corporation (or its 
qualified subsidiary, if relevant) or the transferors of the transferee 
foreign corporation (or qualified subsidiary, if relevant) to 
substantially discontinue its active trade or business; and
    (3) A statement that the substantiality test described in paragraph 
(c)(3)(iii) of this section is satisfied, and documentation that such 
test is satisfied, including the value of the transferee foreign 
corporation and the value of the U.S. target company on the day of the 
transfer, and either one of the following--
    (i) A statement demonstrating that the value of the transferee 
foreign corporation 36 months prior to the acquisition, plus the value 
of any assets described in paragraph (c)(3)(iii)(B) of this section 
(including stock) acquired by the transferee foreign corporation within 
the 36-month period, less the amount of any liabilities acquired during 
that period, equals or exceeds the value of the U.S. target company on 
the acquisition date; or
    (ii) A statement demonstrating that the value of the transferee 
foreign corporation on the date of the acquisition, reduced by the value 
of any assets not described in paragraph (c)(3)(iii)(B) of this section 
(including stock) acquired by the transferee foreign corporation within 
the 36-month period, equals or exceeds the value of the U.S. target 
company on the date of the acquisition.
    (ii) Except as provided in paragraph (f) of this section, for 
purposes of this paragraph (c)(6), a U.S. income tax return will be 
considered timely filed if it is filed on or before the last date 
prescribed for filing (taking into account any extensions of time 
therefor) for the taxable year in which the transfer occurs.
    (7) Ownership statements. To rebut the ownership presumption of 
paragraph (c)(2) of this section, the U.S. target company must obtain 
ownership statements (described in paragraph (c)(5)(i) of this section) 
from a sufficient number of persons that transfer U.S. target company 
stock or securities in the transaction that are not U.S. persons to 
demonstrate that the 50-percent threshold of paragraph (c)(1)(i) of this 
section is not exceeded. In addition, the U.S. target company must 
attach to its timely filed U.S. income tax return (as described in 
paragraph (c)(6)(ii) of this section) for the taxable year in which the 
transfer occurs a statement, titled ``Section 367(a)--Compilation of 
Ownership Statements Under Reg. Sec. 1.367(a)-3(c),'' signed under 
penalties of perjury by an officer of the corporation, disclosing the 
following information:
    (i) The amount (specified as to the percentage of the total voting 
power and the total value) of stock of the transferee foreign 
corporation received, in the aggregate, by U.S. transferors;
    (ii) The amount (specified as to the percentage of total voting 
power and total value) of stock of the transferee foreign corporation 
received, in the aggregate, by foreign persons that filed ownership 
statements;

[[Page 353]]

    (iii) A summary of the information tabulated from the ownership 
statements, including--
    (A) The names of the persons that filed ownership statements stating 
that they are not U.S. persons;
    (B) The countries of residence and citizenship of such persons; and
    (C) Each of such person's ownership (by voting power and by value) 
in the U.S. target company prior to the exchange and the amount of stock 
of the transferee foreign corporation (by voting power and value) 
received by such persons in the exchange.
    (8) Certain transfers in connection with performance of services. 
Section 367(a)(1) shall not apply to a domestic corporation's transfer 
of its own stock or securities in connection with the performance of 
services, if the transfer is considered to be to a foreign corporation 
solely by reason of Sec. 1.83-6(d)(1). The transfer may still, however, 
be reportable under section 6038B. See Sec. 1.6038B-1(b)(2)(i)(A)(4) 
and (b)(2)(i)(B)(4).
    (9) Private letter ruling option. The Internal Revenue Service may, 
in limited circumstances, issue a private letter ruling to permit the 
taxpayer to qualify for an exception to the general rule under section 
367(a)(1) if--
    (i) A taxpayer is unable to satisfy all of the requirements of 
paragraph (c)(3) of this section relating to the active trade or 
business test of paragraph (c)(1)(iv) of this section, but such taxpayer 
meets all of the other requirements contained in paragraphs (c)(1)(i) 
through (c)(1)(iii) of this section, and such taxpayer is substantially 
in compliance with the rules set forth in paragraph (c)(3) of this 
section; or
    (ii) A taxpayer is unable to satisfy any requirement of paragraph 
(c)(1) of this section due to the application of paragraph (c)(4)(iv) of 
this section. Notwithstanding the preceding sentence, in no event will 
the Internal Revenue Service rule on the issue of whether the principal 
purpose of an acquisition was to satisfy the active trade or business 
test, including the substantiality test.
    (10) Examples. This paragraph (c) may be illustrated by the 
following examples:

    Example 1. Ownership presumption. (i) FC, a foreign corporation, 
issues 51 percent of its stock to the shareholders of S, a domestic 
corporation, in exchange for their S stock, in a transaction described 
in section 367(a)(1).
    (ii) Under paragraph (c)(2) of this section, all shareholders of S 
who receive stock of FC in the exchange are presumed to be U.S. persons. 
Unless this ownership presumption is rebutted, the condition set forth 
in paragraph (c)(1)(i) of this section will not be satisfied, and the 
exception in paragraph (c)(1) of this section will not be available. As 
a result, all U.S. persons that transferred S stock will recognize gain 
on the exchange. To rebut the ownership presumption, S must comply with 
the reporting requirements contained in paragraph (c)(6) of this 
section, obtaining ownership statements (described in paragraph 
(c)(5)(i) of this section) from a sufficient number of non-U.S. persons 
who received FC stock in the exchange to demonstrate that the amount of 
FC stock received by U.S. persons in the exchange does not exceed 50 
percent.
    Example 2. Filing of Gain Recognition Agreement. (i) The facts are 
the same as in Example 1, except that FC issues only 40 percent of its 
stock to the shareholders of S in the exchange. FC satisfies the active 
trade or business test of paragraph (c)(1)(iv) of this section. A, a 
U.S. person, owns 10 percent of S's stock immediately before the 
transfer. All other shareholders of S own less than five percent of its 
stock. None of S's officers or directors owns any stock in FC 
immediately after the transfer. A will own 15 percent of the stock of FC 
immediately after the transfer, 4 percent received in the exchange, and 
the balance being stock in FC that A owned prior to and independent of 
the transaction. No S shareholder besides A owns five percent or more of 
FC immediately after the transfer. The reporting requirements under 
paragraph (c)(6) of this section are satisfied.
    (ii) The condition set forth in paragraph (c)(1)(i) of this section 
is satisfied because, even after application of the presumption in 
paragraph (c)(2) of this section, U.S. transferors could not receive 
more than 50 percent of FC's stock in the transaction. There is no 
control group because five-percent target shareholders and officers and 
directors of S do not, in the aggregate, own more than 50 percent of the 
stock of FC immediately after the transfer (A, the sole five-percent 
target shareholder, owns 15 percent of the stock of FC immediately after 
the transfer, and no officers or directors of S own any stock of FC 
immediately after the transfer). Therefore, the condition set forth in 
paragraph (c)(1)(ii) of this section is satisfied. The facts assume that 
the condition set forth in paragraph (c)(1)(iv) of this section is 
satisfied. Thus, U.S. persons that are not five-percent transferee 
shareholders will not recognize gain on the exchange of S shares for FC 
shares. A, a five-percent transferee shareholder, will not

[[Page 354]]

be required to include in income any gain realized on the exchange in 
the year of the transfer if he files a 5-year gain recognition agreement 
(GRA) and complies with section 6038B.
    Example 3. Control Group. (i) The facts are the same as in Example 
2, except that B, another U.S. person, is a 5-percent target 
shareholder, owning 25 percent of S's stock immediately before the 
transfer. B owns 40 percent of the stock of FC immediately after the 
transfer, 10 percent received in the exchange, and the balance being 
stock in FC that B owned prior to and independent of the transaction.
    (ii) A control group exists because A and B, each a five-percent 
target shareholder within the meaning of paragraph (c)(5)(iii) of this 
section, together own more than 50 percent of FC immediately after the 
transfer (counting both stock received in the exchange and stock owned 
prior to and independent of the exchange). As a result, the condition 
set forth in paragraph (c)(1)(ii) of this section is not satisfied, and 
all U.S. persons (not merely A and B) who transferred S stock will 
recognize gain on the exchange.
    Example 4. Partnerships. (i) The facts are the same as in Example 3, 
except that B is a partnership (domestic or foreign) that has five equal 
partners, only two of whom, X and Y, are U.S. persons. Under paragraph 
(c)(4)(i) of this section, X and Y are treated as the owners and 
transferors of 5 percent each of the S stock owned and transferred by B 
and as owners of 8 percent each of the FC stock owned by B immediately 
after the transfer. U.S. persons that are five-percent target 
shareholders thus own a total of 31 percent of the stock of FC 
immediately after the transfer (A's 15 percent, plus X's 8 percent, plus 
Y's 8 percent).
    (ii) Because no control group exists, the condition in paragraph 
(c)(1)(ii) of this section is satisfied. The conditions in paragraphs 
(c)(1)(i) and (iv) of this section also are satisfied. Thus, U.S. 
persons that are not five-percent transferee shareholders will not 
recognize gain on the exchange of S shares for FC shares. A, X, and Y, 
each a five-percent transferee shareholder, will not be required to 
include in income in the year of the transfer any gain realized on the 
exchange if they file 5-year GRAs and comply with section 6038B.

    (11) Applicability date of this paragraph (c)--(i) In general. 
Except as otherwise provided, this paragraph (c) applies to transfers 
occurring after January 29, 1997. However, taxpayers may elect to apply 
this section in its entirety to all transfers occurring after April 17, 
1994, provided that the statute of limitations of the affected tax year 
or years is open.
    (ii) Applicability date of certain provisions of this paragraph (c). 
The first and second sentence of paragraph (c)(3)(iii)(C) of this 
section apply to transfers completed on or after September 22, 2014. The 
third sentence of paragraph (c)(3)(iii)(C) of this section applies to 
transfers completed on or after November 19, 2015. Taxpayers may, 
however, elect to apply the third sentence of paragraph (c)(3)(iii)(C) 
of this section to transfers completed on or after September 22, 2014, 
and before November 19, 2015.
    (d) Indirect stock transfers in certain nonrecognition transfers--
(1) In general. For purposes of this section, a U.S. person who 
exchanges, under section 354 (or section 356) stock or securities in a 
domestic or foreign corporation for stock or securities in a foreign 
corporation (or in a domestic corporation in control of a foreign 
acquiring corporation in a triangular section 368(a)(1)(B) 
reorganization) in connection with a transaction described in paragraphs 
(d)(1)(i) through (v) of this section (or who is deemed to make such an 
exchange under paragraph (d)(1)(vi) of this section) shall, except as 
provided in paragraph (d)(2)(vii) of this section, be treated as having 
made an indirect transfer of such stock or securities to a foreign 
corporation that is subject to the rules of this section, including, for 
example, the requirement, where applicable, that the U.S. transferor 
enter into a gain recognition agreement to preserve nonrecognition 
treatment under section 367(a). If the U.S. person exchanges stock or 
securities of a foreign corporation, see also section 367(b) and the 
regulations thereunder. For examples of the concurrent application of 
the indirect stock transfer rules under section 367(a) and the rules of 
section 367(b), see paragraph (d)(3) Examples 14 and 15 of this section. 
For purposes of this paragraph (d), if a corporation acquiring assets in 
an asset reorganization transfers all or a portion of such assets to a 
corporation controlled (within the meaning of section 368(c)) by the 
acquiring corporation as part of the same transaction, the subsequent 
transfer of assets to the controlled corporation will be referred to as 
a controlled asset transfer. See section 368(a)(2)(C).

[[Page 355]]

    (i) Mergers described in sections 368(a)(1)(A) and (a)(2)(D) and 
reorganizations described in sections 368(a)(1)(G) and (a)(2)(D). A U.S. 
person exchanges stock or securities of a corporation (the acquired 
corporation) for stock or securities of a foreign corporation that 
controls the acquiring corporation in a reorganization described in 
either sections 368(a)(1)(A) and (a)(2)(D), or in sections 368(a)(1)(G) 
and (a)(2)(D). See paragraph (d)(3) Example 1 of this section for an 
example of a reorganization described in sections 368(a)(1)(A) and 
(a)(2)(D) involving domestic acquired and acquiring corporations, and 
see paragraph (d)(3) Example 10 of this section for an example involving 
a domestic acquired corporation and a foreign acquiring corporation.
    (ii) Mergers described in sections 368(a)(1)(A) and (a)(2)(E). A 
U.S. person exchanges stock or securities of a corporation (the 
acquiring corporation) for stock or securities in a foreign corporation 
that controls the acquired corporation in a reorganization described in 
sections 368(a)(1)(A) and (a)(2)(E). See paragraph (d)(3) Example 2 of 
this section for an example of a reorganization described in sections 
368(a)(1)(A) and (a)(2)(E) involving domestic acquired and acquiring 
corporations, and see paragraph (d)(3) Example 11 of this section for an 
example involving a domestic acquired corporation and a foreign 
acquiring corporation.
    (iii) Triangular reorganizations described in section 368(a)(1)(B)--
(A) A U.S. person exchanges stock or securities of the acquired 
corporation for voting stock or securities of a foreign corporation that 
is in control (as defined in section 368(c)) of the acquiring 
corporation in a reorganization described in section 368(a)(1)(B). See 
paragraph (d)(3) Example 5 of this section.
    (B) A U.S. person exchanges stock or securities of the acquired 
corporation for voting stock or securities of a domestic corporation 
that is in control (as defined in section 368(c)) of a foreign acquiring 
corporation in a reorganization described in section 368(a)(1)(B). See 
paragraph (d)(3) Example 5A of this section.
    (iv) Triangular reorganizations described in section 368(a)(1)(C). A 
U.S. person exchanges stock or securities of a corporation (the acquired 
corporation) for voting stock or securities of a foreign corporation 
that controls the acquiring corporation in a reorganization described in 
section 368(a)(1)(C). See, e.g., paragraph (d)(3) Example 6 of this 
section (for an example of a triangular section 368(a)(1)(C) 
reorganization involving domestic acquired and acquiring corporations), 
and paragraph (d)(3) Example 8 of this section (for an example involving 
a domestic acquired corporation and a foreign acquiring corporation). If 
the acquired corporation is a foreign corporation, see paragraph (d)(3) 
Example 14 of this section, and section 367(b) and the regulations 
thereunder.
    (v) Transfers of assets to subsidiaries in certain section 368(a)(1) 
reorganizations. A U.S. person exchanges stock or securities of a 
corporation (the acquired corporation) for stock or securities of a 
foreign acquiring corporation in an asset reorganization (other than a 
triangular section 368(a)(1)(C) reorganization described in paragraph 
(d)(1)(iv) of this section, a reorganization described in sections 
368(a)(1)(A) and (a)(2)(D) or sections 368(a)(1)(G) and (a)(2)(D) 
described in paragraph (d)(1)(i) of this section, a reorganization 
described in sections 368(a)(1)(A) and (a)(2)(E) described in paragraph 
(d)(1)(ii) of this section, or a same-country section 368(a)(1)(F) 
reorganization) that is followed by a controlled asset transfer. For 
purposes of this section, a same-country section 368(a)(1)(F) 
reorganization is a reorganization described in section 368(a)(1)(F) in 
which both the acquired corporation and the acquiring corporation are 
foreign corporations and are created or organized under the laws of the 
same foreign country. In the case of a transaction described in this 
paragraph (d)(1)(v) in which some but not all of the assets of the 
acquired corporation are transferred in a controlled asset transfer, the 
transaction shall be considered to be an indirect transfer of stock or 
securities subject to this paragraph (d) only to the extent of the 
assets so transferred. The remaining assets shall be treated as having 
been transferred by the acquired corporation in an asset transfer rather 
than an indirect stock transfer, and, if

[[Page 356]]

the acquired corporation is a domestic corporation, such asset transfer 
shall be subject to the other provisions of section 367, including 
sections 367(a)(1), (3), and (5), and (d). See paragraph (d)(3) Examples 
6A and 6B of this section.
    (vi) Successive transfers of property to which section 351 applies. 
A U.S. person transfers property (other than stock or securities) to a 
foreign corporation in an exchange described in section 351, and all or 
a portion of such assets transferred to the foreign corporation by such 
person are, in connection with the same transaction, transferred to a 
second corporation that is controlled by the foreign corporation in one 
or more exchanges described in section 351. For purposes of this 
paragraph (d)(1) and Sec. 1.367(a)-8, the initial transfer by the U.S. 
person shall be deemed to be a transfer of stock described in section 
354. (Any assets transferred to the foreign corporation that are not 
transferred by the foreign corporation to a second corporation shall be 
treated as a transfer of assets subject to the general rules of section 
367, including sections 367(a)(1), (3), (5) and (d), and not as an 
indirect stock transfer under the rules of this paragraph (d).) See, 
e.g., paragraph (d)(3) Example 13 and Example 13A of this section.
    (2) Special rules for indirect transfers. If a U.S. person is 
considered to make an indirect transfer of stock or securities described 
in paragraph (d)(1) of this section, the rules of this section and Sec. 
1.367(a)-8 shall apply to the transfer. For purposes of applying the 
rules of this section and Sec. 1.367(a)-8:
    (i) Transferee foreign corporation--(A) General rule. Except as 
provided in paragraph (d)(2)(i)(B) of this section, the transferee 
foreign corporation shall be the foreign corporation that issues stock 
or securities to the U.S. person in the exchange.
    (B) Special rule for triangular reorganizations described in 
paragraph (d)(1)(iii)(B) of this section. In the case of a triangular 
reorganization described in paragraph (d)(1)(iii)(B) of this section, 
the transferee foreign corporation shall be the foreign acquiring 
corporation. See paragraph (d)(3) Example 5A of this section.
    (ii) Transferred corporation. The transferred corporation shall be 
the acquiring corporation, except as provided in this paragraph 
(d)(2)(ii). In the case of a triangular section 368(a)(1)(B) 
reorganization described in paragraph (d)(1)(iii) of this section, the 
transferred corporation shall be the acquired corporation. In the case 
of an indirect stock transfer described in paragraph (d)(1)(i), (ii), or 
(iv) of this section followed by a controlled asset transfer, or an 
indirect stock transfer described in paragraph (d)(1)(v) of this 
section, the transferred corporation shall be the controlled corporation 
to which the assets are transferred. In the case of successive section 
351 transfers described in paragraph (d)(1)(vi) of this section, the 
transferred corporation shall be the corporation to which the assets are 
transferred in the final section 351 transfer. The transferred property 
shall be the stock or securities of the transferred corporation, as 
appropriate under the circumstances.
    (iii) Amount of gain. For purposes of determining the amount of gain 
that a U.S. person is required to include in income as a result of a 
triggering event, see Sec. 1.367(a)-8(c)(1)(i).
    (iv) Gain recognition agreements involving multiple parties. The 
U.S. person's agreement to recognize gain, as provided in Sec. 
1.367(a)-8, shall include appropriate provisions consistent with the 
principles of Sec. 1.367(a)-8. See Examples 5 and 5A of this section 
and Sec. 1.367(a)-8(j)(9).
    (v) Determination of whether substantially all of the transferred 
corporation's assets are disposed of. For purposes of applying Sec. 
1.367(a)-8(j)(2)(i) to determine whether substantially all of the assets 
of the transferred corporation have been disposed of, the following 
assets shall be taken into account (but only if such assets are not 
fully taxable under section 367 in the taxable year that includes the 
indirect transfer)--
    (A) In the case of a reorganization described in paragraph (d)(1)(i) 
of this section (a reorganization described in sections 368(a)(1)(A) and 
(a)(2)(D) or sections 368(a)(1)(G) and (a)(2)(D)) or a reorganization 
described in section (d)(1)(iv) of this section (a triangular section 
368(a)(1)(C) reorganization), the assets of the acquired corporation;
    (B) In the case of a sections 368(a)(1)(A) and (a)(2)(E) 
reorganization

[[Page 357]]

described in paragraph (d)(1)(ii) of this section, the assets of the 
acquiring corporation immediately prior to the transaction;
    (C) In the case of an asset reorganization followed by a controlled 
asset transfer, as described in paragraph (d)(1)(v) of this section, the 
assets of the acquired corporation that are transferred to the 
corporation controlled by the acquiring corporation;
    (D) In the case of a triangular reorganization described in section 
368(a)(1)(C) followed by a controlled asset transfer, a reorganization 
described in sections 368(a)(1)(A) and (a)(2)(D) followed by a 
controlled asset transfer, or a reorganization described in sections 
368(a)(1)(G) and (a)(2)(D) followed by a controlled asset transfer, the 
assets of the acquired corporation including those transferred to the 
corporation controlled by the acquiring corporation;
    (E) In the case of a reorganization described in sections 
368(a)(1)(A) and (a)(2)(E) followed by a controlled asset transfer, the 
assets of the acquiring corporation including those transferred to the 
corporation controlled by the acquiring corporation; and
    (F) In the case of successive section 351 exchanges described in 
paragraph (d)(1)(vi) of this section, the assets that are both 
transferred initially to the foreign corporation, and transferred by the 
foreign corporation to a second corporation.
    (vi) Coordination between asset transfer rules and indirect stock 
transfer rules--(A) General rule. Except as otherwise provided in this 
paragraph (d)(2)(vi), if, pursuant to any of the transactions described 
in paragraph (d)(1) of this section, a U.S. person transfers (or is 
deemed to transfer) assets to a foreign corporation in an exchange 
described in section 351 or section 361, the rules of section 367, 
including sections 367(a)(1), (a)(3), and (a)(5), as well as section 
367(d), and the regulations thereunder shall apply prior to the 
application of the rules of this section.
    (B) Exceptions--(1) If a transaction is described in paragraph 
(d)(2)(vi)(A) of this section, section 367(a) and (d) will not apply to 
the extent a domestic corporation (domestic acquired corporation) 
transfers assets to a foreign corporation (foreign acquiring 
corporation) in an asset reorganization, and those assets (re-
transferred assets) are transferred to a domestic corporation (domestic 
controlled corporation) in a controlled asset transfer, provided that 
each of the following conditions is satisfied:
    (i) The domestic controlled corporation's adjusted basis in the re-
transferred assets is not greater than the domestic acquired 
corporation's adjusted basis in those assets. For this purpose, any 
increase in basis in the re-transferred assets that results because the 
domestic acquired corporation recognized gain or income with respect to 
the re-transferred assets in the transaction is not taken into account.
    (ii) The domestic acquired corporation includes a statement 
described in paragraph (d)(2)(vi)(C) of this section with its timely 
filed U.S. income tax return for the taxable year of the transfer; and
    (iii) The requirements of paragraphs (c)(1)(i), (ii), and (iv) and 
(c)(6) of this section are satisfied with respect to the indirect 
transfer of stock in the domestic acquired corporation.
    (2) Sections 367(a) and (d) shall not apply to transfers described 
in paragraph (d)(1)(vi) of this section if a U.S. person transfers 
assets to a foreign corporation in a section 351 exchange, to the extent 
that such assets are transferred by such foreign corporation to a 
domestic corporation in another section 351 exchange, but only if the 
domestic transferee's adjusted basis in the assets is not greater than 
the adjusted basis that the U.S. person had in such assets. Any increase 
in adjusted basis in the assets that results because the U.S. person 
recognized gain or income with respect to such assets in the initial 
section 351 exchange is not taken into account for purposes of 
determining whether the domestic transferee's adjusted basis in the 
assets is not greater than the U.S. person's adjusted basis in such 
assets. This paragraph (d)(2)(vi)(B)(2) will not, however, apply to an 
exchange described in section 351 that is also an exchange described in 
section 361(a) or (b). An exchange described in section 351 that is also 
an exchange described in section

[[Page 358]]

361(a) or (b) is only eligible for the exception in paragraph 
(d)(2)(vi)(B)(1) of this section.
    (C) Required statement. The statement required by paragraph 
(d)(2)(vi)(B)(1)(ii) of this section shall be entitled ``Required 
Statement under Sec. 1.367(a)-3(d) for Assets Transferred to a Domestic 
Corporation'' and shall be signed under penalties of perjury by an 
authorized officer of the domestic acquired corporation and by an 
authorized officer of the foreign acquiring corporation. The required 
statement shall contain a certification that, if the foreign acquiring 
corporation disposes of any stock of the domestic controlled corporation 
in a transaction described in paragraph (d)(2)(vi)(D) of this section, 
the domestic acquired corporation shall recognize gain as described in 
paragraph (d)(2)(vi)(E) of this section. The domestic acquired 
corporation (or the foreign acquiring corporation on behalf of the 
domestic acquired corporation) shall file a U.S. income tax return (or 
an amended U.S. tax return, as the case may be) for the year of the 
transfer reporting such gain.
    (D) Gain recognition transaction. (1) A transaction described in 
this paragraph (d)(2)(vi)(D) is one where a principal purpose of the 
transfer by the domestic acquired corporation is the avoidance of U.S. 
tax that would have been imposed on the domestic acquired corporation on 
the disposition of the re-transferred assets. A transfer may have a 
principal purpose of tax avoidance even though the tax avoidance purpose 
is outweighed by other purposes when taken together.
    (2) For purposes of paragraph (d)(2)(vi)(D)(1) of this section, a 
transaction is deemed to have a principal purpose of tax avoidance if 
the foreign acquiring corporation disposes of any stock of the domestic 
controlled corporation (whether in a recognition or non-recognition 
transaction) within 2 years of the transfer described in paragraph 
(d)(2)(vi)(A) of this section. The rule in this paragraph 
(d)(2)(vi)(D)(2) shall not apply if the domestic acquired corporation 
(or the foreign acquiring corporation on behalf of the domestic acquired 
corporation) demonstrates to the satisfaction of the Commissioner that 
the avoidance of U.S. tax was not a principal purpose of the 
transaction. For this purpose, a disposition by the foreign acquiring 
corporation of stock of the domestic controlled corporation more than 5 
years after completion of the transfer described in paragraph 
(d)(2)(vi)(A) of this section is deemed to not have a principal purpose 
of tax avoidance.
    (E) Amount of gain recognized and other matters. (1) In the case of 
a transaction described in paragraph (d)(2)(vi)(D) of this section, 
solely for purposes of this paragraph (d)(2)(vi)(E), the domestic 
acquired corporation shall be treated as if, immediately prior to the 
transfer described in paragraph (d)(2)(vi)(A) of this section, it 
transferred the re-transferred assets, including any intangible assets, 
directly to a domestic corporation in exchange for stock of such 
domestic corporation in a transaction that is treated as a section 351 
exchange, and immediately sold such stock to an unrelated party for its 
fair market value in a sale in which it shall recognize gain, if any 
(but not loss). Any gain recognized by the domestic acquired corporation 
pursuant to this paragraph (d)(2)(vi)(E) will increase the basis that 
the foreign acquiring corporation has in the stock of the domestic 
controlled corporation immediately before the transaction described in 
paragraph (d)(2)(vi)(D) of this section, but will not increase the basis 
of the re-transferred assets held by the domestic controlled 
corporation. Section 1.367(d)-1T(g)(6) shall not apply with respect to 
any intangible property included in the re-transferred assets described 
in this paragraph.
    (2) If additional tax is required to be paid as a result of a 
transaction described in paragraph (d)(2)(vi)(D) of this section, then 
interest must be paid on that amount at rates determined under section 
6621 with respect to the period between the date prescribed for filing 
the domestic acquired corporation's income tax return for the year of 
the transfer and the date on which the additional tax for that year is 
paid.
    (F) Examples. For illustrations of the rules in paragraph (d)(2)(vi) 
of this section, see paragraph (d)(3) Examples 6B, 6C, 9, and 13A of 
this section.

[[Page 359]]

    (vii) Change in status of a domestic acquired corporation to a 
foreign corporation. (A) A U.S. person that exchanges stock or 
securities of a domestic corporation for stock or securities of a 
foreign corporation under section 354 (or section 356) will be treated 
for purposes of this section as having made an indirect stock transfer 
of the stock or securities of a foreign corporation (and not of a 
domestic corporation) to a foreign corporation under paragraph (b) of 
this section (but not paragraph (c) of this section), if the acquired 
domestic corporation is a subsidiary member (within the meaning of Sec. 
1.1502-1(c)) of a consolidated group (within the meaning of Sec. 
1.1502-1(h)) immediately before the transaction, and if the transaction 
is either of the following:
    (1) Described in paragraph (d)(1)(i) or (iv) of this section, but 
only if the acquiring corporation is foreign. See paragraph (d)(3) 
Examples 8, 9, 10 and 12 of this section.
    (2) Described in paragraph (d)(1)(v) of this section, but only to 
the extent the controlled asset transfer is to a foreign corporation. 
See paragraph (d)(3) Example 6A of this section.
    (B) The rules of paragraph (d)(2)(vii)(A) of this section will not 
apply to the extent assets transferred to the foreign acquiring 
corporation in a transaction described in paragraph (d)(2)(vii)(A)(1) of 
this section, or assets transferred to a foreign corporation in a 
controlled asset transfer in a transaction described in paragraph 
(d)(2)(vii)(A)(2) of this section, are retransferred to a domestic 
controlled corporation in one or more successive transfers as part of 
the same transaction. See paragraph (d)(3) Example 9 of this section.
    (3) Examples. The rules of this paragraph (d) and Sec. 1.367(a)-8 
are illustrated by the following examples. For purposes of these 
examples, assume section 7874 does not apply.

    Example 1. Section 368(a)(1)(A)/(a)(2)(D) reorganization. (i) Facts. 
F, a foreign corporation, owns all the stock of Newco, a domestic 
corporation. A, a domestic corporation, owns all of the stock of W, also 
a domestic corporation. A and W file a consolidated Federal income tax 
return. A does not own any stock in F (applying the attribution rules of 
section 318, as modified by section 958(b)). In a reorganization 
described in sections 368(a)(1)(A) and (a)(2)(D), Newco acquires all of 
the assets of W, and A receives 40% of the stock of F in an exchange 
described in section 354.
    (ii) Result. Pursuant to paragraph (d)(1)(i) of this section, the 
reorganization is subject to the indirect stock transfer rules. F is 
treated as the transferee foreign corporation, and Newco is treated as 
the transferred corporation. Provided that the requirements of paragraph 
(c)(1) of this section are satisfied, including the requirement that A 
enter into a five-year gain recognition agreement as described in Sec. 
1.367(a)-8, A's exchange of W stock for F stock under section 354 will 
not be subject to section 367(a)(1). If F disposes (within the meaning 
of Sec. 1.367(a)-8(j)(1)) of all (or a portion) of Newco's stock within 
the five-year term of the agreement (and A has not made a valid election 
under Sec. 1.367(a)-8(c)(2)(vi)), A is required to file an amended 
return for the year of the transfer and include in income, with 
interest, the gain realized but not recognized on the initial section 
354 exchange. If A has made a valid election under Sec. 1.367(a)-
8(c)(2)(vi) to include the amount subject to the gain recognition 
agreement in the year of the triggering event, A would instead include 
the gain on its tax return for the taxable year that includes the 
triggering event, together with interest.
    Example 1A. Transferor is a subsidiary in consolidated group. (i) 
Facts. The facts are the same as in Example 1, except that A is owned by 
P, a domestic corporation, and for the taxable year in which the 
transaction occurred, P, A and W filed a consolidated Federal income tax 
return.
    (ii) Result. Even though A is the U.S. transferor, P is required 
under Sec. 1.367(a)-8(d)(3) and (e)(1)(i) to enter into the gain 
recognition agreement and comply with the requirements under Sec. 
1.367(a)-8. If A leaves the P group, the gain recognition agreement 
would be triggered pursuant to Sec. 1.367(a)-8(j)(5), unless the 
exception provided under Sec. 1.367(a)-8(k)(10) applies.
    Example 2. Section 368(a)(1)(A)/(a)(2)(E) reorganization. (i) 
Facts.The facts are the same as in Example 1, except that Newco merges 
into W and Newco receives stock of W which it distributes to F in a 
reorganization described in sections 368(a)(1)(A) and (a)(2)(E). 
Pursuant to the reorganization, A receives 40 percent of the stock of F 
in an exchange described in section 354.
    (ii) Result. The consequences of the transfer are similar to those 
described in Example 1. Pursuant to paragraph (d)(1)(ii) of this 
section, A is considered to have transferred its W stock to F pursuant 
to the indirect stock transfer rules. F is treated as the transferee 
foreign corporation, and W is treated as the transferred corporation. 
Provided that the requirements of paragraph (c)(1) of this section are 
satisfied, including the requirement

[[Page 360]]

that A enter into a five-year gain recognition agreement as described in 
Sec. 1.367(a)-8, A's exchange of W stock for F stock under section 354 
will not be subject to section 367(a)(1).
    Example 3. Taxable transaction pursuant to indirect stock transfer 
rules. (i) Facts.The facts are the same as in Example 1, except that A 
receives 55 percent of either the total voting power or the total value 
of the stock of F in the transaction.
    (ii) Result. A is required to include in income in the year of the 
exchange the amount of gain realized on such exchange. See paragraph 
(c)(1)(i) of this section. If A fails to include the income on its 
timely-filed return, A will also be liable for the penalty under section 
6038B (together with interest and other applicable penalties) unless A's 
failure to include the income is due to reasonable cause and not willful 
neglect. See Sec. 1.6038B-1(f).
    Example 4. Disposition by U.S. transferred corporation of 
substantially all of its assets. (i) Facts. The facts are the same as in 
Example 1, except that, during the third year of the gain recognition 
agreement, Newco disposes of substantially all (as described inSec. 
1.367(a)-8(j)(2)(i)) of the assets described in paragraph (d)(2)(v)(A) 
of this section for cash and recognizes currently all of the gain 
realized on the disposition.
    (ii) Result. Under Sec. 1.367(a)-8(j)(2), the gain recognition 
agreement is generally triggered when the transferred corporation 
disposes of substantially all of its assets. However, under the special 
rule contained in Sec. 1.367(a)-8(o)(4), because A owned an amount of 
stock in W described in section 1504(a)(2) immediately before the 
transaction, because A and W filed a consolidated Federal income tax 
return prior to the transaction, and Newco, the transferred corporation, 
is a domestic corporation, the gain recognition agreement is terminated 
and has no further effect.
    Example 5. Triangular section 368(a)(1)(B) reorganization. (i) 
Facts. F, a foreign corporation, owns all the stock of S, a domestic 
corporation. U, a domestic corporation, owns all of the stock of Y, also 
a domestic corporation. U does not own any of the stock of F (applying 
the attribution rules of section 318, as modified by section 958(b)). In 
a triangular reorganization described in section 368(a)(1)(B) and 
paragraph (d)(1)(iii)(A) of this section, S acquires all the stock of Y, 
and U receives 10% of the voting stock of F.
    (ii) Result. U's exchange of Y stock for F stock will not be subject 
to section 367(a)(1), provided that all of the requirements of paragraph 
(c)(1) are satisfied, including the requirement that U enter into a 
five-year gain recognition agreement. For purposes of this section, F is 
treated as the transferee foreign corporation and Y is treated as the 
transferred corporation. See paragraphs (d)(2)(i) and (ii) of this 
section. Under Sec. 1.367(a)-8(j)(9), the gain recognition agreement 
would be triggered if F sold all or a portion of the stock of S.
    Example 5A. Triangular section 368(a)(1)(B) reorganization. (i) 
Facts. The facts are the same as in Example 5, except that F is a 
domestic corporation and S is a foreign corporation.
    (ii) Result. U's exchange of Y stock for stock of F, a domestic 
corporation in control of S, the foreign acquiring corporation, is 
treated as an indirect transfer of Y stock to a foreign corporation 
under paragraph (d)(1)(iii)(B) of this section. U's exchange of Y stock 
for F stock will not be subject to section 367(a)(1) provided that all 
of the requirements of paragraph (c)(1) of this section are satisfied, 
including the requirement that U enter into a five-year gain recognition 
agreement. In satisfying the 50 percent or less ownership requirements 
of paragraphs (c)(1)(i) and (ii) of this section, U's indirect ownership 
of S stock (through its direct ownership of F) will determine whether 
the requirement of paragraph (c)(1)(i) of this section is satisfied and 
will be taken into account in determining whether the requirement of 
paragraph (c)(1)(ii) of this section is satisfied. See paragraph 
(c)(4)(iv) of this section. For purposes of this section, S is treated 
as the transferee foreign corporation (see paragraph (d)(2)(i)(B) of 
this section). If Y sold substantially all of its assets (within the 
meaning of section 368(a)(1)(C)), the gain recognition agreement would 
be terminated because U owned an amount of stock in Y described in 
section 1504(a)(2) immediately before the transaction and Y is a 
domestic corporation. See Sec. 1.367(a)-8(o)(4).
    Example 6. Triangular section 368(a)(1)(C) reorganization. (i) 
Facts. F, a foreign corporation, owns all of the stock of R, a domestic 
corporation that operates an historical business. V, a domestic 
corporation, owns all of the stock of Z, also a domestic corporation. V 
does not own any of the stock of F (applying the attribution rules of 
section 318 as modified by section 958(b)). In a triangular 
reorganization described in section 368(a)(1)(C) (and paragraph 
(d)(1)(iv) of this section), R acquires all of the assets of Z, and V 
receives 30% of the voting stock of F.
    (ii) Result. The consequences of the transfer are similar to those 
described in Example 1; V is required to enter into a 5-year gain 
recognition agreement under Sec. 1.367(a)-8 to secure nonrecognition 
treatment under section 367(a). Under paragraphs (d)(2)(i) and (ii) of 
this section, F is treated as the transferee foreign corporation and R 
is treated as the transferred corporation. In determining whether, in a 
later transaction, R has disposed of substantially all of its assets 
under Sec. 1.367(a)-8(j)(2)(i), see paragraph (d)(2)(v)(A) of this 
section.
    Example 6A. Section 368(a)(1)(C) reorganization followed by section 
368(a)(2)(C) exchange. 

[[Page 361]]

(i) Facts. The facts are the same as in Example 6, except that the 
transaction is structured as a section 368(a)(1)(C) reorganization with 
Z transferring its assets to F, followed by a controlled asset transfer, 
and R is a foreign corporation. The following additional facts are 
present. Z has 3 businesses: Business A with a basis of $10 and a value 
of $50, Business B with a basis of $10 and a value of $40, and Business 
C with a basis of $10 and a value of $30. V and Z file a consolidated 
Federal income tax return and V has a basis of $30 in the Z stock, which 
has a value of $120. Assume that Businesses A and B consist solely of 
assets that will satisfy the section 367(a)(3) active trade or business 
exception; none of Business C's assets will satisfy the exception. Z 
transfers all 3 businesses to F in exchange for 30 percent of the F 
stock, which Z distributes to V pursuant to a section 368(a)(1)(C) 
reorganization. F then contributes Businesses B and C to R in a 
controlled asset transfer.
    (ii) Result. The transfer of the Business A assets by Z to F does 
not constitute an indirect stock transfer under paragraph (d) of this 
section, and, subject to the conditions and requirements of section 
367(a)(5) and Sec. 1.367(a)-7(c), the Business A assets qualify for the 
section 367(a)(3) active trade or business exception and are not subject 
to section 367(a)(1). The transfer of the Business B and C assets by Z 
to F must first be tested under sections 367(a)(1), (a)(3), and (a)(5). 
Z recognizes $20 of gain on the outbound transfer of the Business C 
assets, as those assets do not qualify for an exception to section 
367(a)(1). Subject to the conditions and requirements of section 
367(a)(5) and Sec. 1.367(a)-7(c), the Business B assets qualify for the 
active trade or business exception under section 367(a)(3). Pursuant to 
paragraphs (d)(1) and (d)(2)(vii)(A)(2) of this section, V is deemed to 
transfer the stock of a foreign corporation to F in a section 354 
exchange subject to the rules of paragraphs (b) and (d) of this section. 
V must enter into the gain recognition agreement in the amount of $30 to 
preserve Z's nonrecognition treatment with respect to its transfer of 
Business B assets. Under paragraphs (d)(2)(i) and (d)(2)(ii) of this 
section, F is the transferee foreign corporation and R is the 
transferred corporation.
    Example 6B. Section 368(a)(1)(C) reorganization followed by a 
controlled asset transfer to a domestic controlled corporation--(i) 
Facts. The facts are the same as in paragraph (d)(3), Example 6A, of 
this section, except that R is a domestic corporation.
    (ii) Result. As in paragraph (d)(3), Example 6A, of this section, 
the outbound transfer of the Business A assets to F is not affected by 
the rules of Sec. 1.367-3(d) and is subject to the general rules under 
section 367. Subject to the conditions and requirements of section 
367(a)(5) and Sec. 1.367(a)-7(c), the Business A assets qualify for the 
section 367(a)(3) active trade or business exception and are not subject 
to section 367(a)(1). The Business B and C assets are part of an 
indirect stock transfer under Sec. 1.367-3(d), but must first be tested 
under section 367(a) and (d). The Business B assets qualify for the 
active trade or business exception under section 367(a)(3); the Business 
C assets do not. However, pursuant to paragraph (d)(2)(vi)(B)(1) of this 
section, the Business B and C assets are not subject to section 367(a) 
or (d), provided that the basis of the Business B and C assets in the 
hands of R is not greater than the basis of the assets in the hands of 
Z, the requirements of paragraphs (c)(1)(i), (ii), and (iv) and (c)(6) 
of this section are satisfied, and Z attaches a statement described in 
paragraphs (d)(2)(vi)(C) of this section to its U.S. income tax return 
for the taxable year of the transfer. V also is deemed to make an 
indirect transfer of Z stock under the rules of paragraph (d) of this 
section to the extent the assets are transferred to R. To preserve non-
recognition treatment, and assuming the other requirements of paragraph 
(c) of this section are satisfied, V must enter into a gain recognition 
agreement in the amount of $50, which equals the aggregate gain in the 
Business B and C assets, because the transfer of those assets by Z was 
not taxable under section 367(a)(1) and constitute an indirect stock 
transfer.
    Example 6C. Section 368(a)(1)(C) reorganization followed by a 
controlled asset transfer to a domestic controlled corporation--(i) 
Facts. The facts are the same as in paragraph (d)(3), Example 6B, of 
this section, except that Z is owned by U.S. individuals, none of whom 
qualify as five-percent target shareholders with respect to Z within the 
meaning of paragraph (c)(5)(iii) of this section. The following 
additional facts are present. No U.S. persons that are either officers 
or directors of Z own any stock of F immediately after the transfer. F 
is engaged in an active trade or business outside the United States that 
satisfies the test set forth in paragraph (c)(3) of this section.
    (ii) Result. The Business A assets transferred to F are not re-
transferred to R and therefore Z's transfer of these assets is not 
subject to the rules of paragraph (d) of this section. However, gain 
must be recognized on the transfer of those assets under section 
367(a)(1) because the section 367(a)(3) active trade or business 
exception is inapplicable pursuant to section 367(a)(5) and Sec. 
1.367(a)-7(b). The Business B and C assets are part of an indirect stock 
transfer under paragraph (d) of this section, but must first be tested 
with respect to Z under section 367(a) and (d), as provided in paragraph 
(d)(2)(vi) of this section. The transfer of the Business B assets (which 
otherwise would satisfy the section 367(a)(3) active trade or business 
exception) generally is subject to section 367(a)(1) pursuant to section 
367(a)(5) and Sec. 1.367(a)-7(b).

[[Page 362]]

The transfer of the Business C assets generally is subject to section 
367(a)(1) because these assets do not qualify for the active trade or 
business exception under section 367(a)(3). However, pursuant to 
paragraph (d)(2)(vi)(B) of this section, the transfer of the Business B 
and C assets is not subject to sections 367(a)(1) and (d), provided the 
basis of the Business B and C assets in the hands of R is no greater 
than the basis in the hands of Z and certain other requirements are 
satisfied. Z may avoid immediate gain recognition under section 367(a) 
and (d) on the transfers of the Business B and Business C assets to F 
if, pursuant to paragraph (d)(2)(vi)(B) of this section, the indirect 
transfer of Z stock satisfies the requirements of paragraphs (c)(1)(i), 
(ii), and (iv) and (c)(6) of this section, and Z attaches a statement 
described in paragraph (d)(2)(vi)(C) of this section to its U.S. income 
tax return for the taxable year of the transfer. In general, the 
statement must contain a certification that, if F disposes of the stock 
of R (in a recognition or nonrecognition transaction) and a principal 
purpose of the transfer is the avoidance of U.S. tax that would have 
been imposed on Z on the disposition of the Business B and C assets 
transferred to R, then Z (or F on behalf of Z) will file a return (or 
amended return as the case may be) recognizing gain ($50), as if, 
immediately prior to the reorganization, Z transferred the Business B 
and C assets to a domestic corporation in exchange for stock in a 
transaction treated as a section 351 exchange and immediately sold such 
stock to an unrelated party for its fair market value. A transaction is 
deemed to have a principal purpose of U.S. tax avoidance if F disposes 
of R stock within two years of the transfer, unless Z (or F on behalf of 
Z) can rebut the presumption to the satisfaction of the Commissioner. 
See paragraph (d)(2)(vi)(D)(2) of this section. With respect to the 
indirect transfer of Z stock, assume the requirements of paragraphs 
(c)(1)(i), (ii), and (iv) of this section are satisfied. Thus, assuming 
Z attaches the statement described in paragraph (d)(2)(vi)(C) of this 
section to its U.S. income tax return and satisfies the reporting 
requirements of paragraph (c)(6) of this section, the transfer of 
Business B and C assets is not subject to immediate gain recognition 
under section 367(a) or (d).
    Example 7. Triangular section 368(a)(1)(C) reorganization followed 
by 351 exchange. (i) Facts. The facts are the same as in Example 6, 
except that, during the fourth year of the gain recognition agreement, R 
transfers substantially all of the assets received from Z to K, a 
wholly-owned domestic subsidiary of R, in an exchange described in 
section 351.
    (ii) Result. The disposition by R, the transferred corporation, of 
substantially all of its assets would terminate the gain recognition 
agreement if the assets were disposed of in a taxable transaction 
because V owned an amount of stock in Z described in section 1504(a)(2) 
immediately before the transaction, and R is a domestic corporation. See 
Sec. 1.367(a)-8(o)(4). Because the assets were transferred in an 
exchange to which section 351 applies, such transfer does not trigger 
the gain recognition agreement if V complies with the requirements 
contained in Sec. 1.367(a)-8(k)(4). See also paragraph (d)(2)(iv) of 
this section. To determine whether substantially all of the assets are 
disposed of, any assets of Z that were transferred by Z to R and then 
contributed by R to K are taken into account.
    Example 7A. Triangular section 368(a)(1)(C) reorganization followed 
by section 351 exchange with foreign transferee. (i) Facts. The facts 
are the same as in Example 7 except that K is a foreign corporation.
    (ii) Result. This transfer of assets by R to K must be analyzed to 
determine its effect upon the gain recognition agreement, and such 
transfer is also an outbound transfer of assets that is taxable under 
section 367(a)(1) unless the active trade or business exception under 
section 367(a)(3) applies. If the transfer is fully taxable under 
section 367(a)(1), the transfer is treated as if the transferred 
company, R, sold substantially all of its assets. Thus, the gain 
recognition agreement would terminate because V owned an amount of stock 
in Z described in section 1504(a)(2) immediately before the transaction, 
and R is a domestic corporation. See Sec. 1.367(a)-8(o)(4). If each 
asset transferred qualifies for nonrecognition treatment under section 
367(a)(3) and the regulations thereunder (which require, under Sec. 
1.367(a)-2(a)(2)(iii), the transferor to comply with the reporting 
requirements under section 6038B), the result is the same as in Example 
7. If a portion of the assets transferred qualify for nonrecognition 
treatment under section 367(a)(3) and a portion are taxable under 
section 367(a)(1) (but such portion does not result in the disposition 
of substantially all of the assets), the gain recognition agreement will 
not be triggered if such information is reported as required under Sec. 
1.367(a)-8(g) and V satisfies the requirements contained in Sec. 
1.367(a)-8(k)(4).
    Example 8. Concurrent application of asset transfer and indirect 
stock transfer rules in consolidated return setting. (i) Facts. Assume 
the same facts as in Example 6, except that R is a foreign corporation 
and V and Z file a consolidated return for Federal income tax purposes. 
The properties of Z consist of Business A assets, with an adjusted basis 
of $50 and fair market value of $90, and Business B assets, with an 
adjusted basis of $50 and a fair market value of $110. Assume that the 
Business A assets do not qualify for the active trade or business 
exception under section 367(a)(3), but that the Business B assets do 
qualify for the exception. V's basis in the Z stock is $100, and the 
value of such stock is $200.

[[Page 363]]

    (ii) Result. Under paragraph (d)(2)(vi), the assets of Businesses A 
and B that are transferred to R must be tested under sections 367(a)(3) 
and (a)(5) prior to consideration of the indirect stock transfer rules 
of this paragraph (d). Thus, Z must recognize $40 of income under 
section 367(a)(1) on the outbound transfer of Business A assets. Subject 
to the conditions and requirements of section 367(a)(5) and Sec. 
1.367(a)-7(c), the Business B assets qualify for the active trade or 
business exception under section 367(a)(3). Under Sec. 1.1502-32, 
because V and Z file a consolidated return, V's basis in its Z stock 
increases from $100 to $140 as a result of Z's $40 gain. Pursuant to 
paragraphs (d)(1) and (d)(2)(vii)(A)(1) of this section, V is deemed to 
transfer the stock of a foreign corporation to F in a section 354 
exchange subject to the rules of paragraphs (b) and (d) of this section, 
and therefore must enter into a gain recognition agreement in the amount 
of $60 (the gain realized but not recognized by V in the stock of Z 
after the $40 basis adjustment). If F sells a portion of its stock in R 
during the term of the agreement, V will be required to recognize a 
portion of the $60 gain subject to the agreement. To determine whether R 
disposes of substantially all of its assets (under Sec. 1.367(a)-
8(j)(2)(i)), only the Business B assets will be considered (because the 
transfer of the Business A assets was taxable to Z under section 367). 
See paragraph (d)(2)(v)(A) of this section.
    Example 8A. Concurrent application without consolidated returns. (i) 
Facts. The facts are the same as in Example 8, except that V and Z do 
not file consolidated income tax returns.
    (ii) Result. Z would still recognize $40 of gain on the transfer of 
its Business A assets, and the Business B assets would still qualify for 
the active trade or business exception under section 367(a)(3). However, 
V's basis in its stock of Z would not be increased by the amount of Z's 
gain. V's indirect transfer of stock will be taxable unless V enters 
into a gain recognition agreement (as described in Sec. 1.367(a)-8) for 
the $100 of gain realized but not recognized with respect to the stock 
of Z.
    Example 8B. Concurrent application with individual U.S. shareholder. 
(i) Facts. The facts are the same as in Example 8, except that V is an 
individual U.S. citizen.
    (ii) Result. Under section 367(a)(5) and Sec. 1.367(a)-7(b), the 
active trade or business exception under section 367(a)(3) does not 
apply to Z's transfer of assets to R. Thus, Z's transfer of assets to R 
would be fully taxable under section 367(a)(1). Z would recognize $100 
of income. V's basis in its stock of Z is not increased by this amount. 
V is taxable with respect to its indirect transfer of its Z stock unless 
V enters into a gain recognition agreement in the amount of the $100, 
the gain realized but not recognized with respect to its Z stock.
    Example 8C. Concurrent application with nonresident alien 
shareholder. (i) Facts. The facts are the same as in Example 8, except 
that V is a nonresident alien.
    (ii) Result. Under section 367(a)(5) and Sec. 1.367(a)-7(b), the 
active trade or business exception under section 367(a)(3) does not 
apply to Z's transfer of assets to R. Thus, Z has $100 of gain with 
respect to the Business A and B assets. Because V is a nonresident 
alien, however, V is not subject to section 367(a) with respect to its 
indirect transfer of Z stock.
    Example 9. Indirect stock transfer by reason of a controlled asset 
transfer--(i) Facts. The facts are the same as in paragraph (d)(3), 
Example 8, of this section, except that R transfers the Business A 
assets to M, a wholly owned domestic subsidiary of R, in a controlled 
asset transfer. In addition, V's basis in its Z stock is $90.
    (ii) Result. Pursuant to paragraph (d)(2)(vi)(B) of this section, 
sections 367(a) and (d) do not apply to Z's transfer of the Business A 
assets to R if M's basis in the Business A assets is not greater than 
the basis of the assets in the hands of Z, the requirements of 
paragraphs (c)(1)(i), (ii), and (iv) and (c)(6) of this section are 
satisfied, and Z includes a statement described in paragraph 
(d)(2)(vi)(C) of this section with its U.S. income tax return for the 
taxable year of the transfer. Subject to the conditions and requirements 
of section 367(a)(5) and Sec. 1.367(a)-7(c), Z's transfer of the 
Business B assets to R (which are not re-transferred to M) qualifies for 
the active trade or business exception under section 367(a)(3). Pursuant 
to paragraphs (d)(1) and (d)(2)(vii)(A)(1) of this section, V is 
generally deemed to transfer the stock of a foreign corporation to F in 
a section 354 exchange subject to the rules of paragraphs (b) and (d) of 
this section, including the requirement that V enter into a gain 
recognition agreement and comply with the requirements of Sec. 
1.367(a)-8. However, pursuant to paragraph (d)(2)(vii)(B) of this 
section, paragraph (d)(2)(vii)(A) of this section does not apply to the 
extent of the transfer of business A assets by R to M, a domestic 
corporation. As a result, to the extent of the business A assets 
transferred by R to M, V is deemed to transfer the stock of Z (a 
domestic corporation) to F in a section 354 exchange subject to the 
rules of paragraphs (c) and (d) of this section. Thus, with respect to 
V's indirect transfer of stock of a domestic corporation to F, such 
transfer is not subject to gain recognition under section 367(a)(1) if 
the requirements of paragraph (c) of this section are satisfied, 
including the requirement that V enter into a gain recognition agreement 
(separate from the gain recognition agreement described above with 
respect to the deemed transfer of

[[Page 364]]

stock of a foreign corporation to F) and comply with the requirements of 
Sec. 1.367(a)-8. Under paragraphs (d)(2)(i) and (ii) of this section, 
the transferee foreign corporation is F and the transferred corporation 
is R (with respect to the transfer of stock of a foreign corporation) 
and M (with respect to the transfer of stock of a domestic corporation). 
Pursuant to paragraph (d)(2)(iv) of this section, a disposition by F of 
the stock of R would trigger both gain recognition agreements. In 
addition, a disposition by R of the stock of M would trigger the gain 
recognition agreement filed with respect to the transfer of the stock of 
a domestic corporation. To determine whether there is a triggering event 
under Sec. 1.367(a)-8(j)(2)(i) for the gain recognition agreement filed 
with respect to the transfer of stock of the domestic corporation, the 
Business A assets in M must be considered. To determine whether there is 
such a triggering event for the gain recognition agreement filed with 
respect to the transfer of stock of the foreign corporation, the 
Business B assets in R must be considered.
    Example 10. Concurrent application of asset transfer and indirect 
stock transfer rules in section 368(a)(1)(A)/(a)(2)(D) reorganization. 
(i) Facts. The facts are the same as in Example 8, except that R 
acquires all of the assets of Z in a reorganization described in 
sections 368(a)(1)(A) and (a)(2)(D). Pursuant to the reorganization, V 
receives 30 percent of the stock of F in a section 354 exchange.
    (ii) Result. The consequences of the transaction are similar to 
those in Example 8. The assets of Businesses A and B that are 
transferred to R must be tested under section 367(a) and (d) prior to 
the consideration of the indirect stock transfer rules of this paragraph 
(d). Subject to the conditions and requirements of section 367(a)(5) and 
Sec. 1.367(a)-7(c), the Business B assets qualify for the active trade 
or business exception under section 367(a)(3). Because the Business A 
assets do not qualify for the exception, Z must recognize $40 of gain 
under section 367(a) on the transfer of Business A assets to R. Further, 
because V and Z file a consolidated return, V's basis in the stock of Z 
is increased from $100 to $140 as a result of Z's $40 gain. Pursuant to 
paragraphs (d)(1) and (d)(2)(vii)(A)(1) of this section, V is deemed to 
transfer the stock of a foreign corporation to F in a section 354 
exchange subject to the rules of paragraphs (b) and (d) of this section. 
V's indirect transfer of foreign stock will be taxable under section 
367(a) unless V enters into a gain recognition agreement in the amount 
of $60 ($200 value of Z stock less $140 adjusted basis).
    Example 11. Concurrent application of section 367(a) and (b) in 
section 368(a)(1)(A)/(a)(2)(E) reorganization. (i) Facts. F, a foreign 
corporation, owns all the stock of D, a domestic corporation. V, a 
domestic corporation, owns all the stock of Z, a foreign corporation. V 
has a basis of $100 in the stock of Z which has a fair market value of 
$200. D is an operating corporation with assets valued at $100 with a 
basis of $60. In a reorganization described in sections 368(a)(1)(A) and 
(a)(2)(E), D merges into Z, and V exchanges its Z stock for 55 percent 
of the outstanding F stock.
    (ii) Result. Under paragraph (d)(1)(ii) of this section, V is 
treated as indirectly transferring Z stock to F. V must recognize gain 
on its indirect transfer of Z stock to F under section 367(a) (and 
section 1248 will be applicable) if V does not enter into a gain 
recognition agreement with respect to the indirect stock transfer in 
accordance with Sec. 1.367(a)-8. Under paragraph (b)(2) of this 
section, if V enters into a gain recognition agreement with respect to 
the indirect stock transfer, the exchange will be subject to the 
provisions of section 367(b) and the regulations pursuant to such 
section as well as section 367(a). Under Sec. 1.367(b)-4(b), however, 
no income inclusion is required because, immediately after the exchange, 
F and Z are controlled foreign corporations with respect to which V is a 
section 1248 shareholder. Under paragraphs (d)(2)(i) and (d)(2)(ii) of 
this section, the transferee foreign corporation is F, and the 
transferred corporation is Z (the acquiring corporation). If F disposes 
(within the meaning of Sec. 1.367(a)-8(j)(1)) of all (or a portion) of 
Z stock within the term of the gain recognition agreement, V must either 
file an amended return for the year of the indirect stock transfer and 
include in income, with interest, the gain realized but not recognized 
on the initial exchange or if a valid election under Sec. 1.367(a)-
8(c)(2)(vi) was made, currently recognize the gain and pay the related 
interest. Under paragraph (d)(2)(v)(B) of this section, to determine 
whether, for purposes of the gain recognition agreement, Z (the 
transferred corporation) disposes of substantially all of its assets, 
only the assets held by Z immediately before the transaction are taken 
into account. Because D is wholly owned by F, a foreign corporation, the 
control requirement of section 367(a)(5) and Sec. 1.367(a)-7(c)(1) 
cannot be satisfied. Therefore, section 367(a)(5) and Sec. 1.367(a)-
7(b) preclude the application of the active trade or business exception 
under section 367(a)(3) to any property transferred by D to Z. Thus, 
under section 367(a)(1), D must recognize the gross amount of gain in 
each asset transferred to Z, or $40.
    Example 12. Concurrent application of direct and indirect stock 
transfer rules. (i) Facts. F, a foreign corporation, owns all of the 
stock of O, also a foreign corporation. D, a domestic corporation, owns 
all of the stock of E, also a domestic corporation, which owns all of 
the stock of N, also a domestic corporation. Prior to the transactions 
described in this Example 12, D, E and N filed a consolidated income tax 
return. D has a basis of $100 in

[[Page 365]]

the stock of E, which has a fair market value of $160. The N stock has a 
fair market value of $100, and E has a basis of $60 in such stock. In 
addition to the stock of N, E owns the assets of Business X. The assets 
of Business X have a fair market value of $60, and E has a basis of $50 
in such assets. Assume that the Business X assets qualify for 
nonrecognition treatment under section 367(a)(3). D does not own any 
stock in F (applying the attribution rules of section 318 as modified by 
section 958(b)). In a triangular reorganization described in section 
368(a)(1)(C) and paragraph (d)(1)(iv) of this section, O acquires all of 
the assets of E, and D exchanges its stock in E for 40% of the voting 
stock of F.
    (ii) Result. E's transfer of its assets, including the N stock, must 
be tested under the general rules of section 367(a) before consideration 
of D's indirect transfer of the stock of E. Subject to the conditions 
and requirements of section 367(a)(5) and Sec. 1.367(a)-7(c), the 
active trade or business exception under section 367(a)(3) applies to 
E's transfer of Business X assets. E's transfer of its N stock could 
qualify for nonrecognition treatment if D satisfies the requirements in 
Sec. 1.367(a)-3(e)(3). O is the transferee foreign corporation; N is 
the transferred corporation. Pursuant to paragraphs (d)(1) and 
(d)(2)(vii)(A)(1) of this section, D is deemed to transfer the stock of 
a foreign corporation to F in a section 354 exchange subject to the 
rules of paragraphs (b) and (d) of this section, and therefore may enter 
into a gain recognition agreement for such indirect stock transfer as 
provided in paragraph (b) of this section and Sec. 1.367(a)-8. As to 
this transfer, F is the transferee foreign corporation; O is the 
transferred corporation.
    Example 13. Successive section 351 exchanges. (i) Facts. D, a 
domestic corporation, owns all the stock of X, a controlled foreign 
corporation that operates an historical business, which owns all the 
stock of Y, a controlled foreign corporation that also operates an 
historical business. The properties of D consist of Business A assets, 
with an adjusted basis of $50 and a fair market value of $90, and 
Business B assets, with an adjusted basis of $50 and a fair market value 
of $110. Assume that the Business B assets qualify for the exception 
under section 367(a)(3) and Sec. 1.367(a)-2(g)(2), but that the 
Business A assets do not qualify for the exception. In an exchange 
described in section 351, D transfers the assets of Businesses A and B 
to X, and, in connection with the same transaction, X transfers the 
assets of Business B to Y in another exchange described in section 351.
    (ii) Result. Under paragraph (d)(1)(vi) of this section, this 
transaction is treated as an indirect stock transfer for purposes of 
section 367(a), but the transaction is not recharacterized for purposes 
of section 367(b). Moreover, under paragraph (d)(2)(vi) of this section, 
the assets of Businesses A and B that are transferred to X must be 
tested under section 367(a)(3). The Business A assets, which were not 
transferred to Y, are subject to the general rules of section 367(a), 
and not the indirect stock transfer rules described in this paragraph 
(d). D must recognize $40 of income on the outbound transfer of Business 
A assets. The transfer of the Business B assets is subject to both the 
asset transfer rules (under section 367(a)(3)) and the indirect stock 
transfer rules of this paragraph (d) and Sec. 1.367(a)-8. Thus, D's 
transfer of the Business B assets will not be subject to section 
367(a)(1) if D enters into a five-year gain recognition agreement with 
respect to the stock of Y. Under paragraphs (d)(2)(i) and (ii) of this 
section, X will be treated as the transferee foreign corporation and Y 
will be treated as the transferred corporation for purposes of applying 
the terms of the agreement. If X sells all or a portion of the stock of 
Y during the term of the agreement, D will be required to recognize a 
proportionate amount of the $60 gain that was realized by D on the 
initial transfer of the Business B assets.
    Example 13A. Successive section 351 exchanges with ultimate domestic 
transferee. (i) Facts. The facts are the same as in Example 13, except 
that Y is a domestic corporation.
    (ii) Result. As in Example 13, D must recognize $40 of income on the 
outbound transfer of the Business A assets. Although the Business B 
assets qualify for the exception under section 367(a)(3) (and end up in 
U.S. corporate solution, in Y), the $60 of gain realized on the Business 
B assets is nevertheless taxable under paragraphs (c)(1) and (d)(1)(vi) 
of this section because the transaction is considered to be a transfer 
by D of stock of a domestic corporation, Y, in which D receives more 
than 50 percent of the stock of the transferee foreign corporation, X. A 
gain recognition agreement is not permitted.
    Example 14. Concurrent application of indirect stock transfer rules 
and section 367(b). (i) Facts. F, a foreign corporation, owns all of the 
stock of Newco, which is also a foreign corporation. P, a domestic 
corporation, owns all of the stock of S, a foreign corporation that is a 
controlled foreign corporation within the meaning of section 957(a). P's 
basis in the stock of S is $50 and the value of S is $100. The section 
1248 amount with respect to S stock is $30. In a reorganization 
described in section 368(a)(1)(C) (and paragraph (d)(1)(iv) of this 
section), Newco acquires all of the properties of S, and P exchanges its 
stock in S for 49 percent of the stock of F.
    (ii) Result. P's exchange of S stock for F stock under section 354 
will be taxable under section 367(a) (and section 1248 will be 
applicable) if P fails to enter into a 5-year gain recognition agreement 
in accordance with Sec. 1.367(a)-8. Under paragraph (b)(2) of this 
section, if P enters into a gain recognition

[[Page 366]]

agreement, the exchange will be subject to the provisions of section 
367(b) and the regulations thereunder as well as section 367(a). Under 
Sec. 1.367(b)-4(b), P must recognize the section 1248 amount of $30 
because P exchanged stock of a controlled foreign corporation, S, for 
stock of a foreign corporation that is not a controlled foreign 
corporation, F. The indirect stock transfer rules do not apply with 
respect to section 367(b). The deemed dividend of $30 recognized by P 
will increase P's basis in the F stock received in the transaction, and 
F's basis in the Newco stock. Thus, the amount of the gain recognition 
agreement is $20 ($50 gain realized on the transfer less the $30 
inclusion under section 367(b)). Under paragraphs (d)(2)(i) and (ii) of 
this section, F is treated as the transferee foreign corporation and 
Newco is the transferred corporation.
    Example 14A. Triangular section 368(a)(1)(C) reorganization 
involving foreign acquired corporation. (i) Facts. Assume the same facts 
as in Example 14, except that P receives 51 percent of the stock of F.
    (ii) Result. Assuming Sec. 1.367(b)-4(b) does not apply, there is 
no income inclusion under section 367(b), and the amount of the gain 
recognition agreement is $50.
    Example 15. Concurrent application of indirect stock transfer rules 
and section 367(b). (i) Facts. F, a foreign corporation, owns all of the 
stock of Newco, a domestic corporation. P, a domestic corporation, owns 
all of the stock of FC, a foreign corporation. P's basis in the stock of 
FC is $50 and the value of FC stock is $100. The all earnings and 
profits amount with respect to the FC stock held by P is $60. See Sec. 
1.367(b)-2(d). In a reorganization described in sections 368(a)(1)(A) 
and (a)(2)(D) (and paragraph (d)(1)(i) of this section), Newco acquires 
all of the properties of FC, and P exchanges its stock in FC for 20 
percent of the stock in F.
    (ii) Result. P's section 354 exchange is considered an indirect 
stock transfer under paragraph (d)(1)(i) of this section. Further, 
because the assets of FC were acquired by Newco, a domestic corporation, 
in an asset reorganization, the transaction is within Sec. 1.367(b)-
3(a) and (b). Because the transaction is subject to Sec. 1.367(b)-3 and 
the indirect stock rules of paragraph (d) of this section, and because 
the all earnings and profits amount with respect to the FC stock 
exchanged by P ($60) is greater than the gain in such stock subject to 
section 367(a) ($50), the section 367(b) rules (and not the section 
367(a) rules) apply to the exchange. See Sec. 1.367(a)-3(b)(2)(i)(B). 
Under the rules of section 367(b), P must include in income the all 
earnings and profits amount of $60 with respect to its FC stock. See 
Sec. 1.367(b)-3. Alternatively, if P's all earnings and profits amount 
with respect to its FC stock were $30 (which is less than the gain in 
such stock subject to section 367(a) ($50)), section 367(b) and the 
regulations thereunder would not apply if there is gain recognition 
under section 367(a). Thus, if P failed to enter into a 5-year gain 
recognition agreement in accordance with Sec. 1.367(a)-8, then P would 
recognize $50 of gain under section 367(a) and there would be no income 
inclusion under section 367(b). If, instead, P enters into a 5-year gain 
recognition agreement under Sec. 1.367(a)-8, thereby avoiding immediate 
gain recognition on the entire $50 of section 367(a) gain, P is required 
to include in income the all earnings and profits amount of $30. In such 
a case, P will adjust its basis in the FC stock pursuant to Sec. 
1.367(b)-2(e)(3)(ii) and enter into a gain recognition agreement in the 
amount of $20.
    Example 16. Direct asset reorganization not subject to stock 
transfer rules. (i) Facts. D is a domestic corporation that owns all the 
stock of F1 and F2, both foreign corporations. In a reorganization 
described in section 368(a)(1)(D), F2 acquires all of the assets of F1, 
and D receives 30 percent of the stock of F2 in an exchange described in 
section 354.
    (ii) Result. The section 368(a)(1)(D) reorganization is not an 
indirect stock transfer described in paragraph (d) of this section. 
Moreover, the section 354 exchange by D of F1 stock for F2 stock is not 
an exchange described under section 367(a). See paragraph (a)(2)(ii) of 
this section.

    (e) Transfers of stock or securities by a domestic corporation to a 
foreign corporation in a section 361 exchange--(1) Overview--(i) Scope 
and definitions. This paragraph (e) applies to a domestic corporation 
(U.S. transferor) that transfers stock or securities of a domestic or 
foreign corporation (transferred stock or securities) to a foreign 
corporation (foreign acquiring corporation) in a section 361 exchange. 
Except as otherwise provided in this paragraph (e), paragraphs (b) and 
(c) of this section do not apply to the U.S. transferor's transfer of 
the transferred stock or securities in the section 361 exchange. For 
purposes of this paragraph (e), the definitions of control group, 
control group member, and non-control group member in Sec. 1.367(a)-
7(f)(1), ownership interest percentage in Sec. 1.367(a)-7(f)(7), 
section 361 exchange in Sec. 1.367(a)-7(f)(8), and U.S. transferor 
shareholder in Sec. 1.367(a)-7(f)(13), apply.
    (ii) Ordering rules. Except as otherwise provided, this paragraph 
(e) applies to the transfer of the transferred stock or securities in 
the section 361 exchange prior to the application of any other provision 
of section 367 to

[[Page 367]]

such transfer. Furthermore, any gain recognized (including gain treated 
as a deemed dividend pursuant to section 1248(a)) by the U.S. transferor 
under this paragraph (e) shall be taken into account for purposes of 
applying any other provision of section 367 (including Sec. Sec. 
1.367(a)-6, 1.367(a)-7, and 1.367(b)-4) to the transfer of the 
transferred stock or securities.
    (2) General rule. Except as provided in paragraph (e)(3) of this 
section, the transfer by the U.S. transferor of the transferred stock or 
securities to the foreign acquiring corporation in the section 361 
exchange shall be subject to section 367(a)(1), and therefore the U.S. 
transferor shall recognize any gain (but not loss) realized with respect 
to the transferred stock or securities. Realized gain is recognized 
pursuant to the prior sentence notwithstanding that the transfer is 
described in any other nonrecognition provision enumerated in section 
367(a)(1) (such as section 351 or 354).
    (3) Exception. The general rule of paragraph (e)(2) of this section 
shall not apply if the conditions of paragraphs (e)(3)(i), (ii), and 
(iii) of this section are satisfied.
    (i) The conditions set forth in Sec. 1.367(a)-7(c) are satisfied 
with respect to the section 361 exchange.
    (ii) If the transferred stock or securities are of a domestic 
corporation, the U.S. target company (as defined in paragraph (c)(1) of 
this section) complies with the reporting requirements of paragraph 
(c)(6) of this section, and the conditions of paragraphs (c)(1)(i), 
(ii), and (iv) of this section are satisfied with respect to the 
transferred stock or securities.
    (iii) If the U.S. transferor owns (applying the attribution rules of 
section 318, as modified by section 958(b)) five percent or more of the 
total voting power or the total value of the stock of the transferee 
foreign corporation immediately after the transfer of the transferred 
stock or securities in the section 361 exchange, then the conditions set 
forth in paragraphs (e)(3)(iii)(A), (B), and (C) of this section are 
satisfied.
    (A) Except as otherwise provided in this paragraph (e)(3)(iii)(A), 
each U.S. transferor shareholder that is a qualified U.S. person (as 
defined in paragraph (e)(6)(vii) of this section) owning (applying the 
attribution rules of section 318, as modified by section 958(b)) five 
percent or more of the total voting power or the total value of the 
stock of the transferee foreign corporation immediately after the 
reorganization enters into a gain recognition agreement that satisfies 
the conditions of paragraph (e)(6) of this section and Sec. 1.367(a)-8. 
A U.S. transferor shareholder is not required to enter into a gain 
recognition agreement pursuant to this paragraph if the amount of gain 
that would be subject to the gain recognition agreement (as determined 
under paragraph (e)(6)(i) of this section) is zero.
    (B) With respect to non-control group members that are not described 
in paragraph (e)(3)(iii)(A) of this section, the U.S. transferor 
recognizes gain equal to the product of the aggregate ownership interest 
percentage of such non-control group members multiplied by the gain 
realized by the U.S. transferor on the transfer of the transferred stock 
or securities.
    (C) With respect to each control group member that is not described 
in paragraph (e)(3)(iii)(A) of this section, the U.S. transferor 
recognizes gain equal to the product of the ownership interest 
percentage of such control group member multiplied by the gain realized 
by the U.S. transferor on the transfer of the transferred stock or 
securities.
    (4) Application of certain rules at U.S. transferor-level. For 
purposes of paragraphs (c)(5)(iii) and (e)(3)(ii) and (iii) of this 
section, ownership of the stock of the transferee foreign corporation is 
determined by reference to stock owned by the U.S. transferor 
immediately after the transfer of the transferred stock or securities to 
the foreign acquiring corporation in the section 361 exchange, but prior 
to and without taking into account the U.S. transferor's distribution 
under section 361(c)(1) of the stock received.
    (5) Transferee foreign corporation--(i) General rule. Except as 
provided in paragraph (e)(5)(ii) of this section, the transferee foreign 
corporation for purposes of applying paragraph (e) of this

[[Page 368]]

section and Sec. 1.367(a)-8 shall be the foreign corporation that 
issues stock or securities to the U.S. transferor in the section 361 
exchange.
    (ii) Special rule for triangular asset reorganizations involving the 
receipt of stock or securities of a domestic corporation. In the case of 
a triangular asset reorganization described in Sec. 1.358-(6)(b)(2)(i), 
(ii), or (iii) or (b)(2)(v) (triangular asset reorganization) in which 
the U.S. transferor receives stock or securities of a domestic 
corporation that is in control (within the meaning of section 368(c)) of 
the foreign acquiring corporation, the transferee foreign corporation 
shall be the foreign acquiring corporation.
    (6) Special requirements for gain recognition agreements. A gain 
recognition agreement filed by a U.S. transferor shareholder pursuant to 
paragraph (e)(3)(iii)(A) of this section is, in addition to the terms 
and conditions of Sec. 1.367(a)-8, subject to the conditions of this 
paragraph (e)(6).
    (i) The amount of gain subject to the gain recognition agreement 
shall equal the product of the ownership interest percentage of the U.S. 
transferor shareholder multiplied by the gain realized by the U.S. 
transferor on the transfer of the transferred stock or securities, 
reduced (but not below zero) by the sum of the amounts described in 
paragraphs (e)(6)(i)(A),(B), (C), and (D) of this section.
    (A) Gain recognized by the U.S. transferor with respect to the 
transferred stock or securities under section 367(a)(1) (including any 
portion treated as a deemed dividend under section 1248(a)) that is 
attributable to such U.S. transferor shareholder pursuant to Sec. 
1.367(a)-7(c)(2) or (e)(5).
    (B) A deemed dividend included in the income of the U.S. transferor 
with respect to the transferred stock under Sec. 1.367(b)-4(b)(1)(i) 
that is attributable to such U.S. transferor shareholder pursuant to 
Sec. 1.367(a)-7(e)(4).
    (C) If the U.S. transferor shareholder is subject to an election 
under Sec. 1.1248(f)-2(c)(1), a deemed dividend included in the income 
of the U.S. transferor pursuant to Sec. 1.1248(f)-2(c)(3) that is 
attributable to the U.S. transferor shareholder.
    (D) If the U.S. transferor shareholder is not subject to an election 
under Sec. 1.1248(f)-2(c)(1), the hypothetical section 1248 amount (as 
defined in Sec. 1.1248(f)-1(c)(4)) with respect to the stock of each 
foreign corporation transferred in the section 361 exchange attributable 
to the U.S. transferor shareholder.
    (ii) The gain recognition agreement shall include the election 
described in Sec. 1.367(a)-8(c)(2)(vi).
    (iii) The gain recognition agreement shall designate the U.S. 
transferor shareholder as the U.S. transferor for purposes of Sec. 
1.367(a)-8.
    (iv) If the transfer of the transferred stock or securities in the 
section 361 exchange is pursuant to a triangular asset reorganization, 
the gain recognition agreement shall include appropriate provisions that 
are consistent with the principles of Sec. 1.367(a)-8 for gain 
recognition agreements involving multiple parties. See Sec. 1.367(a)-
8(j)(9).
    (v) The gain recognition agreement shall not be eligible for 
termination upon a taxable disposition pursuant to Sec. 1.367(a)-
8(o)(1) unless the value of the stock or securities received by the U.S. 
transferor shareholder in exchange for the stock or securities of the 
U.S. transferor under section 354 or 356 is at least equal to the amount 
of gain subject to the gain recognition agreement filed by such U.S. 
transferor shareholder.
    (vi) Except as otherwise provided in this paragraph (e)(6)(vi), if 
gain is subsequently recognized by the U.S. transferor shareholder under 
the terms of the gain recognition agreement pursuant to Sec. 1.367(a)-
8(c)(1)(i), the increase in stock basis provided under Sec. 1.367(a)-
8(c)(4)(i) with respect to the stock received by the U.S. transferor 
shareholder shall not exceed the amount of the stock basis adjustment 
made pursuant to Sec. 1.367(a)-7(c)(3) with respect to the stock 
received by the U.S. transferor shareholder. This paragraph (e)(6)(vi) 
shall not apply if the U.S. transferor shareholder and the U.S. 
transferor are members of the same consolidated group at the time of the 
reorganization.
    (vii) For purposes of this section, a qualified U.S. person means a 
U.S. person, as defined in Sec. 1.367(a)-1T(d)(1), but

[[Page 369]]

for this purpose does not include domestic partnerships, regulated 
investment companies (as defined in section 851(a)), real estate 
investment trusts (as defined in section 856(a)), and S corporations (as 
defined in section 1361(a)).
    (7) Gain subject to section 1248(a). If the U.S. transferor 
recognizes gain under paragraphs (e)(3)(iii)(B) or (C) of this section 
with respect to transferred stock that is stock in a foreign corporation 
to which section 1248(a) applies, then the portion of such gain treated 
as a deemed dividend under section 1248(a) is the product of the amount 
of the gain multiplied by the section 1248(a) ratio. The section 1248(a) 
ratio is the ratio of the amount that would be treated as a deemed 
dividend under section 1248(a) if all the gain in the transferred stock 
were recognized to the amount of gain realized in all the transferred 
stock.
    (8) Examples. The following examples illustrate the provisions of 
paragraph (e) of this section. Except as otherwise indicated: US1, US2, 
and UST are domestic corporations that are not members of a consolidated 
group; X is a United States citizen; US1, US2, and X are unrelated 
parties; CFC1, CFC2, and FA are foreign corporations; each corporation 
described herein has a single class of stock issued and outstanding and 
a tax year ending on December 31; the section 1248 amount (within the 
meaning of Sec. 1.367(b)-2(c)) with respect to the stock of CFC1 and 
CFC2 is zero; Asset A is section 367(a) property that, but for the 
application of section 367(a)(5), would qualify for the active foreign 
trade or business exception under Sec. 1.367(a)-2T; the requirements of 
Sec. 1.367(a)-7(c)(2) through (5) are satisfied with respect to a 
section 361 exchange; the provisions of Sec. 1.367(a)-6T (regarding 
branch loss recapture) are not applicable; and none of the foreign 
corporations in the examples is a surrogate foreign corporation (within 
the meaning of section 7874) as a result of the transactions described 
in the examples because one or more of the conditions of section 
7874(a)(2)(B) is not satisfied.

    Example 1. U.S. transferor owns less than 5% of stock of transferee 
foreign corporation--(i) Facts. US1, US2, and X own 80%, 5%, and 15%, 
respectively, of the stock of UST with a fair market value of $160x, 
$10x, and $30x, respectively. UST has two assets, Asset A and 100% of 
the stock of CFC1. UST has no liabilities. Asset A has a $150x basis and 
$100x fair market value (as defined in Sec. 1.367(a)-7(f)(3)), and the 
CFC1 stock has a $0x basis and $100x fair market value. UST transfers 
Asset A and the CFC1 stock to FA solely in exchange for $200x of FA 
voting stock in a reorganization described in section 368(a)(1)(C). 
UST's transfer of Asset A and the CFC1 stock to FA qualifies as a 
section 361 exchange. UST distributes the FA stock received in the 
section 361 exchange to US1, US2, and X pursuant to the plan of 
reorganization, and liquidates. US1 receives $160x of FA stock, US2 
receives $10x of FA stock, and X receives $30x of FA stock in exchange 
for the UST stock. Immediately after the transfer of Asset A and the 
CFC1 stock to FA in the section 361 exchange, but prior to and without 
taking into account UST's distribution of the FA stock pursuant to 
section 361(c)(1), UST does not own (applying the attribution rules of 
section 318, as modified by section 958(b)) five percent or more of the 
total voting power or the total value of the stock of FA.
    (ii) Result--(A) UST's transfer of the CFC1 stock to FA in the 
section 361 exchange is subject to the provisions of this paragraph (e), 
and this paragraph (e) applies to the transfer of the CFC1 stock prior 
to the application of any other provision of section 367 to such 
transfer. See paragraphs (e)(1)(i) and (ii) of this section. Pursuant to 
the general rule of paragraph (e)(2) of this section, UST must recognize 
the gain realized of $100x on the transfer of the CFC1 stock (computed 
as the excess of the $100x fair market value over the $0x basis) unless 
the requirements for the exception provided in paragraph (e)(3) of this 
section are satisfied. In this case, the requirements of paragraph 
(e)(3) of this section are satisfied. First, the requirement of 
paragraph (e)(3)(i) of this section is satisfied because the control 
requirement of Sec. 1.367(a)-7(c)(1) is satisfied, and a stated 
assumption is that the requirements of Sec. 1.367(a)-7(c)(2) through 
(5) will be satisfied. The control requirement is satisfied because US1 
and US2, each a control group member, own in the aggregate 85% of the 
stock of UST immediately before the reorganization. Second, the 
requirement of paragraph (e)(3)(ii) of this section is not applicable 
because that paragraph applies to the transfer of stock of a domestic 
corporation and CFC1 is a foreign corporation. Third, paragraph 
(e)(3)(iii) of this section is not applicable because immediately after 
the section 361 exchange, but prior to and without taking into account 
UST's distribution of the FA stock pursuant to section 361(c)(1), UST 
does not own (applying the attribution rules of section 318, as modified 
by section 958(b)) 5% or more of the total voting power or the total 
value of the stock of FA. See paragraph (e)(4) of this section.

[[Page 370]]

Accordingly, UST does not recognize the $100x of gain realized in the 
CFC1 stock pursuant to this section.
    (B) In order to meet the requirements of Sec. 1.367(a)-7(c)(2)(i), 
UST must recognize gain equal to the portion of the inside gain (as 
defined in Sec. 1.367(a)-7(f)(5)) attributable to non-control group 
members (X), or $7.50x. The $7.50x of gain is computed as the product of 
the inside gain ($50x) multiplied by X's ownership interest percentage 
in UST (15%). Pursuant to Sec. 1.367(a)-7(f)(5), the $50x of inside 
gain is the amount by which the aggregate fair market value ($200x) of 
the section 367(a) property (as defined in Sec. 1.367(a)-7(f)(10), or 
Asset A and the CFC1 stock) exceeds the sum of the inside basis ($150x) 
of such property and the product of the section 367(a) percentage (as 
defined in Sec. 1.367(a)-7(f)(9), or 100%) multiplied by UST's 
deductible liabilities (as defined in Sec. 1.367(a)-7(f)(2), or $0x). 
Pursuant to Sec. 1.367(a)-7(f)(4), the inside basis equals the 
aggregate basis of the section 367(a) property transferred in the 
section 361 exchange ($150x), increased by any gain or deemed dividends 
recognized by UST with respect to the section 367(a) property under 
section 367 ($0x), but not including the $7.50x of gain recognized by 
UST under Sec. 1.367(a)-7(c)(2)(i). Pursuant to Sec. 1.367(a)-7(e)(1), 
the $7.50x of gain recognized by UST is treated as recognized with 
respect to the CFC1 stock and Asset A in proportion to the amount of 
gain realized in each. However, because there is no gain realized by UST 
with respect to Asset A, all $7.50x of the gain is allocated to the CFC1 
stock. Furthermore, FA's basis in the CFC1 stock, as determined under 
section 362 is increased by the $7.50x of gain recognized by UST. See 
Sec. 1.367(a)-1(b)(4)(i)(B).
    (C) The requirement to recognize gain under Sec. 1.367(a)-
7(c)(2)(ii) is not applicable because the portion of the inside gain 
attributable to US1 and US2 (control group members) can be preserved in 
the stock received by each such shareholder. As described in paragraph 
(ii)(B) of this Example 1, the inside gain is $50x. US1's attributable 
inside gain of $40x (equal to the product of $50x inside gain multiplied 
by US1's 80% ownership interest percentage, reduced by $0x, the sum of 
the amounts described in Sec. 1.367(a)-7(c)(2)(ii)(A)(1) through (3)) 
does not exceed $160x (equal to the product of the section 367(a) 
percentage of 100% multiplied by $160x fair market value of FA stock 
received by US1). Similarly, US2's attributable inside gain of $2.50x 
(equal to the product of $50x inside gain multiplied by US2's 5% 
ownership interest percentage, reduced by $0x, the sum of the amounts 
described in Sec. 1.367(a)-7(c)(2)(ii)(A)(1) through (3)) does not 
exceed $10x (equal to the product of the section 367(a) percentage of 
100% multiplied by $10x fair market value of FA stock received by US2).
    (D) Each control group member (US1 and US2) must separately compute 
any required adjustment to stock basis under Sec. 1.367(a)-7(c)(3).
    Example 2. U.S. transferor owns 5% or more of the stock of the 
transferee foreign corporation--(i) Facts. The facts are the same as in 
paragraph (e), Example 1, of this section except that immediately after 
the section 361 exchange, but prior to and without taking into account 
UST's distribution of the FA stock pursuant to section 361(c)(1), UST 
owns (applying the attribution rules of section 318, as modified by 
section 958(b)) 5% or more of the total voting power or value of the 
stock of FA. Furthermore, immediately after the reorganization, US1 and 
X (but not US2) each own (applying the attribution rules of section 318, 
as modified by section 958(b)) five percent or more of the total voting 
power or value of the stock of FA.
    (ii) Result--(A) As is the case with paragraph (e), Example 1, of 
this section, UST's transfer of the CFC1 stock to FA in the section 361 
exchange is subject to the provisions of this paragraph (e), and this 
paragraph (e) applies to the transfer of the CFC1 stock prior to the 
application of any other provision of section 367 to such transfer. See 
paragraphs (e)(1)(i) and (ii) of this section. In addition, UST must 
recognize the gain realized of $100x on the transfer of the CFC1 stock 
(computed as the excess of the $100x fair market value over the $0x 
basis) unless the requirements for the exception provided in paragraph 
(e)(3) of this section are satisfied. For the same reasons provided in 
Example 1, the requirement in paragraph (e)(3)(i) of this section is 
satisfied and the requirement of paragraph (e)(3)(ii) of this section is 
not applicable.
    (B) Unlike paragraph (e), Example 1, of this section, however, UST 
owns 5% or more of the voting power or value of the stock of FA 
immediately after the transfer of the CFC1 stock in the section 361 
exchange, but prior to and without taking into account UST's 
distribution of the FA stock under section 361(c)(1). As a result, 
paragraph (e)(3)(iii) of this section is applicable to the section 361 
exchange of the CFC1 stock. Accordingly, in order to meet the 
requirements of paragraph (e)(3)(iii)(A) of this section US1 and X must 
enter into gain recognition agreements that satisfy the requirements of 
paragraph (e)(6) of this section and Sec. 1.367(a)-8. See paragraph 
(ii)(G) of this Example 2 for the computation of the amount of gain 
subject to each gain recognition agreement.
    (C) In order to meet the requirements of paragraph (e)(3)(iii)(C) of 
this section, UST must recognize $5x of gain attributable to US2 
(computed as the product of the $100x of gain realized with respect to 
the transfer of the CFC1 stock multiplied by the 5% ownership interest 
percentage of US2). The $5x of

[[Page 371]]

gain recognized is not included in the computation of inside basis (see 
Sec. 1.367(a)-7(f)(4)(i)), but reduces (but not below zero) the amount 
of gain recognized by UST pursuant to Sec. 1.367(a)-7(c)(2)(ii) that is 
attributable to US2. Furthermore, FA's basis in the CFC1 stock as 
determined under section 362 is increased for the $5x of gain 
recognized. See Sec. 1.367(a)-1(b)(4)(i)(B). Assuming US1 and X enter 
into the gain recognition agreements described in paragraph (ii)(B) of 
this Example 2, and UST recognizes the $5x of gain described in this 
example, the requirements of paragraph (e)(3) of this section are 
satisfied and, accordingly, UST does not recognize the remaining $95x of 
gain realized in the CFC1 stock pursuant to this section.
    (D) As described in paragraph (ii)(B) of Example 1 of this paragraph 
(e), UST must recognize $7.50x of gain pursuant to Sec. 1.367(a)-
7(c)(2)(i), the amount of the $50x of inside gain attributable to X. 
Pursuant to Sec. 1.367(a)-7(e)(1), the $7.50x of gain recognized by UST 
is treated as recognized with respect to the CFC1 stock and Asset A in 
proportion to the amount of gain realized in each. However, because 
there is no gain realized by UST with respect to Asset A, all $7.50x of 
the gain is allocated to the CFC1 stock. Furthermore, FA's basis in the 
CFC1 stock as determined under section 362 is increased for the $7.50x 
of gain recognized. See Sec. 1.367(a)-1(b)(4)(i)(B).
    (E) As described in paragraph (ii)(C) of Example 1 of this paragraph 
(e), the requirement to recognize gain pursuant to Sec. 1.367(a)-
7(c)(2)(ii) is not applicable because the attributable inside gain of 
US1 and US2 can be preserved in the stock received by each shareholder. 
However, if UST were required to recognize gain pursuant to Sec. 
1.367(a)-7(c)(2)(ii) for inside gain attributable to US2 (for example, 
if US2 received solely cash rather than FA stock in the reorganization), 
the amount of such gain would be reduced (but not below zero) by the 
amount of gain recognized by UST pursuant to paragraph (e)(3)(iii)(C) of 
this section that is attributable to US2 (computed as $5x in paragraph 
(ii)(C) of this Example 2). See Sec. 1.367(a)-7(c)(2)(ii)(A)(1).
    (F) Each control group member (US1 and US2) must separately compute 
any required adjustment to stock basis under Sec. 1.367(a)-7(c)(3).
    (G) The amount of gain subject to the gain recognition agreement 
filed by each of US1 and X is determined pursuant to paragraph (e)(6)(i) 
of this section. With respect to US1, the amount of gain subject to the 
gain recognition agreement is $80x. The $80x is computed as the product 
of US1's ownership interest percentage (80%) multiplied by the gain 
realized by UST in the CFC1 stock as determined prior to taking into 
account the application of any other provision of section 367 ($100x), 
reduced by the sum of the amounts described in paragraphs (e)(6)(i)(A) 
through (D) of this section attributable to US1 ($0x). With respect to 
X, the amount of gain subject to the gain recognition agreement is 
$7.50x. The $7.50x is computed as the product of X's ownership interest 
percentage (15%) multiplied by the gain realized by UST in the CFC1 
stock as determined prior to taking into account the application of any 
other provision of section 367 ($100x), reduced by the sum of the 
amounts described in paragraphs (e)(6)(i)(A) through (D) of this section 
attributable to X ($7.50x, as computed in paragraph (ii)(D) of this 
Example 2).
    (H) In order the meet the requirements of paragraph (e)(6)(ii) of 
this section, each gain recognition agreement must include the election 
described in Sec. 1.367(a)-8(c)(2)(vi). Furthermore, pursuant to 
paragraph (e)(6)(iii) of this section, US1 and X must be designated as 
the U.S. transferor on their respective gain recognition agreements for 
purposes of Sec. 1.367(a)-8.
    Example 3. U.S. transferor owns 5% or more of the stock of the 
transferee foreign corporation; interaction with section 1248(f)--(i) 
Facts. US1, US2, and X own 50%, 30%, and 20%, respectively, of the stock 
of UST. The UST stock owned by US1 has a $180x basis and $200x fair 
market value; the UST stock owned by US2 has a $100x basis and $120x 
fair market value; and the UST stock owned by X has a $80x fair market 
value. UST owns Asset A, and all the stock of CFC1 and CFC2. UST has no 
liabilities. Asset A has a $10x basis and $200x fair market value. The 
CFC1 stock is a single block of stock (as defined in Sec. 1.1248(f)-
1(c)(2)) with a $20x basis, $40x fair market value, and $30x of earnings 
and profits attributable to it for purposes of section 1248 (with the 
result that the section 1248 amount (as defined in Sec. 1.1248(f)-
1(c)(9)) is $20x). The CFC2 stock is also a single block of stock with a 
$30x basis, $160x fair market value, and $150x of earnings and profits 
attributable to it for purposes of section 1248 (with the result that 
the section 1248 amount is $130x). On December 31, Year 3, in a 
reorganization described in section 368(a)(1)(D), UST transfers the CFC1 
stock, CFC2 stock, and Asset A to FA in exchange for 60 shares of FA 
stock with a $400x fair market value. UST's transfer of the CFC1 stock, 
CFC2 stock, and Asset A to FA in exchange for the 60 shares of FA stock 
qualifies as a section 361 exchange. UST distributes the FA stock 
received in the section 361 exchange to US1, US2, and X pursuant to 
section 361(c)(1). US1, US2, and X exchange their UST stock for 30, 18, 
and 12 shares, respectively, of FA stock pursuant to section 354. 
Immediately after the reorganization, FA has 100 shares of stock 
outstanding, and US1 and US2 are each a section 1248 shareholder with 
respect to FA.
    (ii) Result--(A) UST's transfer of the CFC1 stock and CFC2 stock to 
FA in the section 361 exchange is subject to the provisions of

[[Page 372]]

this paragraph (e), and this paragraph (e) applies to the transfer of 
the CFC1 stock and CFC2 stock prior to the application of any other 
provision of section 367 to such transfer. See paragraphs (e)(1)(i) and 
(ii) of this section. Pursuant to the general rule of paragraph (e)(2) 
of this section, UST must recognize the gain realized of $20x on the 
transfer of the CFC1 stock (the excess of $40x fair market value over 
$20x basis) and the gain realized of $130x on the transfer of the CFC2 
stock (the excess of $160x fair market value over $30x basis), subject 
to the application of section 1248(a), unless the requirements for the 
exception provided in paragraph (e)(3) of this section are satisfied. In 
this case, the requirement of paragraph (e)(3)(i) of this section is 
satisfied because the control requirement of Sec. 1.367(a)-7(c)(1) is 
satisfied, and a stated assumption is that the requirements of Sec. 
1.367(a)-7(c)(2) through (5) will be satisfied. The control requirement 
is satisfied because US1 and US2, each a control group member, own in 
the aggregate 80% of the UST stock immediately before the 
reorganization. The requirement of paragraph (e)(3)(ii) of this section 
is not applicable because paragraph (e)(3)(ii) applies to the transfer 
of stock of a domestic corporation, and CFC1 and CFC2 are foreign 
corporations. UST owns 5% or more of the total voting power or value of 
the stock of FA (60%, or 60 of the 100 shares of FA stock outstanding) 
immediately after the transfer of the CFC1 stock and CFC2 stock in the 
section 361 exchange, but prior to and without taking into account UST's 
distribution of the FA stock under section 361(c)(1). As a result, 
paragraph (e)(3)(iii) of this section is applicable to the section 361 
exchange of the CFC1 stock and CFC2 stock. US1, US2, and X each own 
(applying the attribution rules of section 318, as modified by section 
958(b)) 5% or more of the total voting power or value of the FA stock 
immediately after the reorganization, or 30%, 18%, and 12%, 
respectively. Accordingly, in order to meet the requirements of 
paragraph (e)(3)(iii)(A) of this section, US1 and US2 must enter into 
gain recognition agreements with respect to the CFC1 stock and CFC2 
stock that satisfy the requirements of paragraph (e)(6) of this section 
and Sec. 1.367(a)-8. X is not required to enter into a gain recognition 
agreement because the amount of gain that would be subject to the gain 
recognition agreement is zero. See paragraph (ii)(J) of this Example 3 
for the computation of the amount of gain subject to each gain 
recognition agreement. Assuming US1 and US2 enter into the gain 
recognitions agreements described above, the requirements of paragraph 
(e)(3) of this section are satisfied and accordingly, UST does not 
recognize the gain realized of $20x in the stock of CFC1 or the gain 
realized of $130x in the stock of CFC2 pursuant to this section.
    (B) UST's transfer of the CFC1 stock and CFC2 stock to FA pursuant 
to the section 361 exchange is subject to Sec. 1.367(b)-4(b)(1)(i), 
which applies prior to the application of Sec. 1.367(a)-7(c). See 
paragraph (e)(1) of this section. UST (the exchanging shareholder) is a 
U.S. person and a section 1248 shareholder with respect to CFC1 and CFC2 
(each a foreign acquired corporation). However, UST is not required to 
include in income as a deemed dividend the section 1248 amount with 
respect to the CFC1 stock ($20x) or CFC2 stock ($130x) under Sec. 
1.367(b)-4(b)(1)(i) because, immediately after UST's section 361 
exchange of the CFC1 stock and CFC2 stock for FA stock (and before the 
distribution of the FA stock to US1, US2, and X under section 361(c)(1), 
FA, CFC1, and CFC2 are controlled foreign corporations as to which UST 
is a section 1248 shareholder. See Sec. 1.367(b)-4(b)(1)(ii)(A). 
However, if UST were required to include in income as a deemed dividend 
the section 1248 amount with respect to the CFC1 stock or CFC2 stock 
(for example, if FA were not a controlled foreign corporation), such 
deemed dividend would be taken into account prior to the application of 
Sec. 1.367(a)-7(c). Furthermore, because US1, US2, and X are all 
persons described in paragraph (e)(3)(iii)(A) of this section, any such 
deemed dividend would increase inside basis. See Sec. 1.367(a)-7(f)(4).
    (C) In order to meet the requirements of Sec. 1.367(a)-7(c)(2)(i), 
UST must recognize gain equal to the portion of the inside gain 
attributable to non-control group members (X), or $68x. The $68x of gain 
is computed as the product of the inside gain ($340x) multiplied by X's 
ownership interest percentage in UST (20%), reduced (but not below zero) 
by $0x, the sum of the amounts described in Sec. 1.367(a)-7(c)(2)(i)(A) 
through (C). Pursuant to Sec. 1.367(a)-7(f)(5), the $340x of inside 
gain is the amount by which the aggregate fair market value ($400x) of 
the section 367(a) property (Asset A, CFC1 stock, and CFC2 stock) 
exceeds the sum of the inside basis ($60x) and $0x (the product of the 
section 367(a) percentage (100%) multiplied by UST's deductible 
liabilities ($0x)). Pursuant to Sec. 1.367(a)-7(f)(4), the inside basis 
equals the aggregate basis of the section 367(a) property transferred in 
the section 361 exchange ($60x), increased by any gain or deemed 
dividends recognized by UST with respect to the section 367(a) property 
under section 367 ($0x), but not including the $68x of gain recognized 
by UST under Sec. 1.367(a)-7(c)(2)(i). Under Sec. 1.367(a)-7(e)(1), 
the $68x gain recognized is treated as being with respect to the CFC1 
stock, CFC2 stock, and Asset A in proportion to the amount of gain 
realized by UST on the transfer of the property. The amount treated as 
recognized with respect to the CFC1 stock is $4x ($68x gain multiplied 
by $20x/$340x). The amount treated as recognized with respect to the 
CFC2 stock is $26x ($68x gain multiplied by $130x/

[[Page 373]]

$340x). The amount treated as recognized with respect to Asset A is $38x 
($68x gain multiplied by $190x/$340x). Under section 1248(a), UST must 
include in gross income as a dividend the $4x gain recognized with 
respect to the CFC1 stock and the $26x gain recognized with respect to 
CFC2 stock. Furthermore, FA's basis in the CFC1 stock, CFC2 stock, and 
Asset A, as determined under section 362, is increased by the amount of 
gain recognized by UST with respect to such property. See Sec. 
1.367(a)-1(b)(4)(i)(B). Thus, FA's basis in the CFC1 stock is $24x ($20x 
increased by $4x of gain), the CFC2 stock is $56x ($30x increased by 
$26x of gain), and Asset A is $48x ($10x increased by $38x of gain).
    (D) The requirement to recognize gain under Sec. 1.367(a)-
7(c)(2)(ii) is not applicable because the portion of the inside gain 
attributable to US1 and US2 (control group members) can be preserved in 
the stock received by each such shareholder. As described in paragraph 
(ii)(C) of this Example 3, the inside gain is $340x. US1's attributable 
inside gain of $170x (equal to the product of $340x inside gain 
multiplied by US1's 50% ownership interest percentage, reduced by $0x, 
the sum of the amounts described in Sec. 1.367(a)-7(c)(2)(ii)(A)(1) 
through (3)) does not exceed $200x (equal to the product of the section 
367(a) percentage of 100% multiplied by $200x fair market value of FA 
stock received by US1). Similarly, US2's attributable inside gain of 
$102x (equal to the product of $340x inside gain multiplied by US2's 30% 
ownership interest percentage, reduced by $0x, the sum of the amounts 
described in Sec. 1.367(a)-7(c)(2)(ii)(A)(1) through (3)) does not 
exceed $120x (equal to the product of the section 367(a) percentage of 
100% multiplied by $120x fair market value of FA stock received by US2).
    (E) Each control group member (US1 and US2) separately computes any 
required adjustment to stock basis under Sec. 1.367(a)-7(c)(3). US1's 
section 358 basis in the FA stock received of $180x (equal to US1's 
basis in the UST stock exchanged) is reduced to preserve the 
attributable inside gain with respect to US1, less any gain recognized 
with respect to US1 under Sec. 1.367(a)-7(c)(2)(ii). Because UST does 
not recognize gain on the section 361 exchange with respect to US1 under 
Sec. 1.367(a)-7(c)(2)(ii) (as determined in paragraph (ii)(D) of this 
Example 3), the attributable inside gain of $170x with respect to US1 is 
not reduced under Sec. 1.367(a)-7(c)(3)(i)(A). US1's outside gain (as 
defined in Sec. 1.367(a)-7(f)(6)) in the FA stock is $20x, the product 
of the section 367(a) percentage (100%) multiplied by the $20x gain 
(equal to the difference between $200x fair market value and $180x 
section 358 basis in the FA stock). Thus, US1's $180x section 358 basis 
in the FA stock must be reduced by $150x (the excess of $170x 
attributable inside gain, reduced by $0x, over $20x outside gain) to 
$30x. Similarly, US2's section 358 basis in the FA stock received of 
$100x (equal to US2's basis in the UST stock exchanged) is reduced to 
preserve the attributable inside gain with respect to US2, less any gain 
recognized with respect to US2 under Sec. 1.367(a)-7(c)(2)(ii). Because 
UST does not recognize gain on the section 361 exchange with respect to 
US2 under Sec. 1.367(a)-7(c)(2)(ii) (as determined in paragraph (ii)(D) 
of this Example 3), the attributable inside gain of $102x with respect 
to US2 is not reduced under Sec. 1.367(a)-7(c)(3)(i)(A). US2's outside 
gain in the FA stock is $20x, the product of the section 367(a) 
percentage (100%) multiplied by the $20x gain (equal to the difference 
between $120x fair market value and $100x section 358 basis in FA 
stock). Thus, US2's $100x section 358 basis in the FA stock must be 
reduced by $82x (the excess of $102x attributable inside gain, reduced 
by $0x, over $20x outside gain) to $18x.
    (F) UST's distribution of the FA stock to US1, US2, and X under 
section 361(c)(1) (new stock distribution) is subject to Sec. 
1.1248(f)-1(b)(3). Except as provided in Sec. 1.1248(f)-2(c), under 
Sec. 1.1248(f)-1(b)(3) UST must include in gross income as a dividend 
the total section 1248(f) amount (as defined in Sec. 1.1248(f)-
1(c)(14)). The total section 1248(f) amount is $120x, the sum of the 
section 1248(f) amount (as defined in Sec. 1.1248(f)-1(c)(10)) with 
respect to the CFC1 stock ($16x) and CFC2 stock ($104x). The $16x 
section 1248(f) amount with respect to the CFC1 stock is the amount that 
UST would have included in income as a dividend under Sec. 1.367(b)-
4(b)(1)(i) with respect to the CFC1 stock if the requirements of Sec. 
1.367(b)-4(b)(1)(ii)(A) had not been satisfied ($20x), reduced by the 
amount of gain recognized by UST under Sec. 1.367(a)-7(c)(2) allocable 
to the CFC1 stock and treated as a dividend under section 1248(a) ($4x, 
as described in paragraph (ii)(C) of this Example 3). Similarly, the 
section 1248(f) amount with respect to the CFC2 stock is $104x ($130x 
reduced by $26x).
    (G) If, however, UST along with US1 and US2 (each a section 1248 
shareholder of FA immediately after the distribution) elect to apply the 
provisions of Sec. 1.1248(f)-2(c) (as provided in Sec. 1.1248(f)-
2(c)(1)), the amount that UST is required to include in income as a 
dividend under Sec. 1.1248(f)-1(b)(3) ($120x total section 1248(f) 
amount as computed in paragraph (ii)(F) of this Example 3) is reduced by 
the sum of the portions of the section 1248(f) amount with respect to 
the CFC1 stock and CFC2 stock that is attributable (under the rules of 
Sec. 1.1248(f)-2(d)) to the FA stock distributed to US1 and US2. Assume 
that the election is made to apply Sec. 1.1248(f)-2(c).
    (1) Under Sec. 1.1248(f)-2(d)(1), the portion of the section 
1248(f) amount with respect to the CFC1 stock that is attributed to the 
30 shares of FA stock distributed to US1 is

[[Page 374]]

equal to the hypothetical section 1248 amount (as defined in Sec. 
1.1248(f)-1(c)(4)) with respect to the CFC1 stock that is attributable 
to US1's ownership interest percentage in UST. US1's hypothetical 
section 1248 amount with respect to the CFC1 stock is the amount that 
UST would have included in income as a deemed dividend under Sec. 
1.367(b)-4(b)(1)(i) with respect to the CFC1 stock if the requirements 
of Sec. 1.367(b)-4(b)(1)(ii)(A) had not been satisfied ($20x) and that 
would be attributable to US1's ownership interest percentage in UST 
(50%), reduced by the amount of gain recognized by UST under Sec. 
1.367(a)-7(c)(2) attributable to US1 and allocable to the CFC1 stock, 
but only to the extent such gain is treated as a dividend under section 
1248(a) ($0x, as described in paragraphs (ii)(C) and (D) of this Example 
3). Thus, US1's hypothetical section 1248 amount with respect to the 
CFC1 stock is $10x ($20x multiplied by 50%, reduced by $0x). The $10x 
hypothetical section 1248 amount is attributed pro rata (based on 
relative values) among the 30 shares of FA stock distributed to US1, and 
the attributable share amount (as defined in Sec. 1.1248(f)-2(d)(1)) is 
$.33x ($10x/30 shares). Similarly, US1's hypothetical section 1248 
amount with respect to the CFC2 stock is $65x ($130x multiplied by 50%, 
reduced by $0x), and the attributable share amount is $2.17x ($65x/30 
shares). Similarly, US2's hypothetical section 1248 amount with respect 
to the CFC1 stock is $6x ($20x multiplied by 30%, reduced by $0x), and 
the attributable share amount is also $.33x ($6x/18 shares). Finally, 
US2's hypothetical section 1248 amount with respect to the CFC2 stock is 
$39x ($130x multiplied by 30%, reduced by $0x), and the attributable 
share amount is also $2.17x ($39x/18 shares). Thus, the sum of the 
portion of the section 1248(f) amount with respect to the CFC1 stock and 
CFC2 stock attributable to shares of stock of FA distributed to US1 and 
US2 is $120x ($10x plus $65x plus $6x plus $39x).
    (2) If the shares of FA stock are divided into portions, Sec. 
1.1248(f)-2(d)(2) applies to attribute the attributable share amount to 
portions of shares of FA stock distributed to US1 and US2. Under Sec. 
1.1248(f)-2(c)(2) each share of FA stock received by US1 (30 shares) and 
US2 (18 shares) is divided into three portions, one attributable to the 
single block of stock of CFC1, one attributable to the single block of 
stock of CFC2, and one attributable to Asset A. Thus, the attributable 
share amount of $.33x with respect to the CFC1 stock is attributed to 
the portion of each of the 30 shares and 18 shares of FA stock received 
by US1 and US2, respectively, that relates to the CFC1 stock. Similarly, 
the attributable share amount of $2.17x with respect to the CFC2 stock 
is attributed to the portion of each of the 30 shares and 18 shares of 
FA stock received by US1 and US2, respectively, that relates to the CFC2 
stock.
    (3) The total section 1248(f) amount ($120x) that UST is otherwise 
required to include in gross income as a dividend under Sec. 1.1248(f)-
1(b)(3) is reduced by $120x, the sum of the portions of the section 
1248(f) amount with respect to the CFC1 stock and CFC2 stock that are 
attributable to the shares of FA stock distributed to US1 and US2. Thus, 
the amount DC is required to include in gross income as a dividend under 
Sec. 1.1248(f)-1(b)(3) is $0x ($120x reduced by $120x).
    (H) As stated in paragraph (ii)(G)(2) of this Example 3, under Sec. 
1.1248(f)-2(c)(2) each share of FA stock received by US1 (30 shares) and 
US2 (18 shares) is divided into three portions, one attributable to the 
CFC1 stock, one attributable to the CFC2 stock, and one attributable to 
Asset A. Under Sec. 1.1248(f)-2(c)(4)(i), the basis of each portion is 
the product of US1's and US2's section 358 basis in the share of FA 
stock multiplied by the ratio of the section 362 basis of the property 
(CFC1 stock, CFC2 stock, or Asset A, as applicable) received by FA in 
the section 361 exchange to which the portion relates, to the aggregate 
section 362 basis of all property received by FA in the section 361 
exchange. Under Sec. 1.1248(f)-2(c)(4)(ii), the fair market value of 
each portion is the product of the fair market value of the share of FA 
stock multiplied by the ratio of the fair market value of the property 
(CFC1 stock, CFC2 stock, or Asset A, as applicable) to which the portion 
relates, to the aggregate fair market value of all property received by 
FA in the section 361 exchange. The section 362 basis of the CFC1 stock, 
CFC2 stock, and Asset A is $24x, $56x, and $48x, respectively, for an 
aggregate section 362 basis of $128x. See paragraph (ii)(C) of this 
Example 3. The fair market value of the CFC1 stock, CFC2 stock, and 
Asset A is $40x, $160x, and $200x, for an aggregate fair market value of 
$400x. Furthermore, US1's 30 shares of FA stock have an aggregate fair 
market value of $200x and section 358 basis of $30x (resulting in 
aggregate gain of $170x), and US2's 18 shares of FA stock have an 
aggregate fair market value of $120x and section 358 basis of $18x 
(resulting in aggregate gain of $102x). See paragraph (ii)(E) of this 
Example 3.
    (1) With respect to US1's 30 shares of FA stock, the portions 
attributable to the CFC1 stock have an aggregate basis of $5.63x ($30x 
multiplied by $24x/$128x) and fair market value of $20x ($200x 
multiplied by $40x/$400x), resulting in aggregate gain in such portions 
of $14.38x (or $.48x gain in each such portion of the 30 shares). The 
portions attributable to the CFC2 stock have an aggregate basis of 
$13.13x ($30x multiplied by $56x/$128x) and fair market value of $80x 
($200x multiplied by $160x/$400x), resulting in aggregate gain in such 
portions of $66.88x (or $2.23x in each such portion of the 30 shares). 
The portions attributable to Asset A have an aggregate basis of $11.25x 
($30x multiplied by $48x/$128x)

[[Page 375]]

and fair market value of $100x ($200x multiplied by $200x/$400x), 
resulting in aggregate gain in such portions of $88.75x (or $2.96x in 
each such portion of the 30 shares). Thus, the aggregate gain in all the 
portions of the 30 shares is $170x ($14.38x plus $66.88x plus $88.75x).
    (2) With respect to US2's 18 shares of FA stock, the portions 
attributable to the CFC1 stock have an aggregate basis of $3.38x ($18x 
multiplied by $24x/$128x) and fair market value of $12x ($120x 
multiplied by $40x/$400x), resulting in aggregate gain in such portions 
of $8.63x (or $.48x in each such portion of the 18 shares). The portions 
attributable to the CFC2 stock have an aggregate basis of $7.88x ($18x 
multiplied by $56x/$128x) and fair market value of $48x ($120x 
multiplied by $160x/$400x), resulting in aggregate gain of $40.13x (or 
$2.23x in each such portion of the 18 shares). The portions attributable 
to Asset A have an aggregate basis of $6.75x ($18x multiplied by $48x/
$128x) and fair market value of $60x ($120x multiplied by $200x/$400x), 
resulting in aggregate gain of $53.25x (or $2.96x in each such portion 
of the 18 shares). Thus, the aggregate gain in all the portions of the 
18 shares is $102x ($8.63x plus $40.13x plus $53.25x).
    (3) Under Sec. 1.1248-8(b)(2)(iv), the earnings and profits of CFC1 
attributable to the portions of US1's 30 shares of FA stock that relate 
to the CFC1 stock is $15x (the product of US1's 50% ownership interest 
percentage in UST multiplied by $30x of earnings and profits 
attributable to the CFC1 stock before the section 361 exchange, reduced 
by $0x of dividend included in UST's income with respect to the CFC1 
stock under section 1248(a) attributable to US1). The earnings and 
profits of CFC2 attributable to the portions of US1's 30 shares of FA 
stock that relate to the CFC2 stock is $75x (the product of US1's 50% 
ownership interest percentage in UST multiplied by $150x of earnings and 
profits attributable to the CFC2 stock before the section 361 exchange, 
reduced by $0x of dividend included in UST's income with respect to the 
CFC2 stock under section 1248(a) attributable to US1). Similarly, the 
earnings and profits of CFC1 attributable to the portions of US2's 18 
shares of FA stock that relate to the CFC1 stock is $9x (the product of 
US2's 30% ownership interest percentage in UST multiplied by $30x of 
earnings and profits attributable to the CFC1 stock before the section 
361 exchange, reduced by $0x of dividend included in UST's income with 
respect to the CFC1 stock under section 1248(a) attributable to US2). 
Finally, the earnings and profits of CFC2 attributable to the portions 
of US2's 18 shares of FA stock that relate to the CFC2 stock is $45x 
(the product of US2's 30% ownership interest percentage in UST 
multiplied by $150x of earnings and profits attributable to the CFC2 
stock before the section 361 exchange, reduced by $0x of dividend 
included in UST's income with respect to the CFC2 stock under section 
1248(a) attributable to US2).
    (I) Under Sec. 1.1248(f)-2(c)(3), neither US1 nor US2 is required 
to reduce the aggregate section 358 basis in the portions of their 
respective shares of FA stock, and UST is not required to include in 
gross income any additional deemed dividend.
    (1) US1 is not required to reduce the aggregate section 358 basis of 
the portions of its 30 shares of FA stock that relate to the CFC1 stock 
because the $10x section 1248(f) amount with respect to the CFC1 stock 
attributable to the portions of the shares of FA stock received by US1 
(as computed in paragraph (ii)(G) of this Example 3) does not exceed 
US1's postdistribution amount (as defined in Sec. 1.1248(f)-1(c)(6), or 
$14.38x) in those portions. The $14.38x postdistribution amount equals 
the amount that US1 would be required to include in income as a dividend 
under section 1248(a) with respect to such portion if it sold the 30 
shares of FA stock immediately after the distribution in a transaction 
in which all realized gain is recognized, without taking into account 
basis adjustments or income inclusions under Sec. 1.1248(f)-2(c)(3) 
($20x fair market value, $5.63x basis, and $15x earnings and profits 
attributable to the portions for purposes of section 1248). Similarly, 
US1 is not required to reduce the aggregate section 358 basis of the 
portions of its 30 shares of FA stock that relate to the CFC2 stock 
because the $65x section 1248(f) amount with respect to the CFC2 stock 
attributable to the portions of the shares of FA stock received by US1 
(as computed in paragraph (ii)(G) of this Example 3) does not exceed 
US1's postdistribution amount ($66.88x) in those portions. The $66.88x 
postdistribution amount equals the amount that US1 would be required to 
include in income as a dividend under section 1248(a) with respect to 
such portion if it sold the 30 shares of FA stock immediately after the 
distribution in a transaction in which all realized gain is recognized, 
without taking into account basis adjustments or income inclusions under 
Sec. 1.1248(f)-2(c)(3) ($80x fair market value, $13.13x basis, and $75x 
earnings and profits attributable to the portions for purposes of 
section 1248).
    (2) US2 is not required to reduce the aggregate section 358 basis of 
the portions of its 18 shares of FA stock that relate to the CFC1 stock 
because the $6x section 1248(f) amount with respect to the CFC1 stock 
attributable to the portions of the shares of FA stock received by US2 
(as computed in paragraph (ii)(G) of this Example 3) does not exceed 
US2's postdistribution amount ($8.63x) in those portions. The $8.63x 
postdistribution amount equals the amount that US2 would be required to 
include in income as a dividend under section 1248(a) with respect to 
such portion if it sold the 18 shares of FA

[[Page 376]]

stock immediately after the distribution in a transaction in which all 
realized gain is recognized, without taking into account basis 
adjustments or income inclusions under Sec. 1.1248(f)-2(c)(3) ($12x 
fair market value, $3.38x basis, and $9x earnings and profits 
attributable to the portions for purposes of section 1248). Similarly, 
US2 is not required to reduce the aggregate section 358 basis of the 
portions of its 18 shares of FA stock that relate to the CFC2 stock 
because the $39x section 1248(f) amount with respect to the CFC2 stock 
attributable to the portions of the shares of FA stock received by US2 
(as computed in paragraph (ii)(G) of this Example 3) does not exceed 
US1's postdistribution amount ($40.13x) in those portions. The $40.13x 
postdistribution amount equals the amount that US2 would be required to 
include in income as a dividend under section 1248(a) with respect to 
such portion if it sold the 18 shares of FA stock immediately after the 
distribution in a transaction in which all realized gain is recognized, 
without taking into account basis adjustments or income inclusions under 
Sec. 1.1248(f)-2(c)(3) ($48x fair market value, $7.88x basis, and $45x 
earnings and profits attributable to the portions for purposes of 
section 1248).
    (J) The amount of gain subject to the gain recognition agreement 
filed by each of US1 and US2 is determined pursuant to paragraph 
(e)(6)(i) of this section. The amount of gain subject to the gain 
recognition agreement filed by US1 with respect to the stock of CFC1 and 
CFC2 is $10x and $65x, respectively. The $10x and $65x are computed as 
the product of US1's ownership interest percentage (50%) multiplied by 
the gain realized by UST in the CFC1 stock ($20x) and CFC2 stock 
($130x), respectively, as determined prior to taking into account the 
application of any other provision of section 367, reduced by the sum of 
the amounts described in paragraphs (e)(6)(i)(A) through (D) of this 
section with respect to the CFC1 stock and CFC2 stock attributable to 
US1 ($0x with respect to the CFC1 stock, and $0x with respect to the 
CFC2 stock). The amount of gain subject to the gain recognition 
agreement filed by US2 with respect to the stock of CFC1 and CFC2 is $6x 
and $39x, respectively. The $6x and $39x are computed as the product of 
US2's ownership interest percentage (30%) multiplied by the gain 
realized by UST in the CFC1 stock ($20x) and CFC2 stock ($130x), 
respectively, as determined prior to taking into account the application 
of any other provision of section 367, reduced by the sum of the amounts 
described in paragraphs (e)(6)(i)(A) through (D) of this section with 
respect to the CFC1 stock and CFC2 stock attributable to US2 ($0x with 
respect to the CFC1 stock, and $0x with respect to the CFC2 stock). X is 
not required to enter into a gain recognition agreement because the 
amount of gain that would be subject to the gain recognition agreement 
is $0x with respect to the CFC1 stock, and $0x with respect to the CFC2 
stock, computed as X's ownership percentage (20%) multiplied by the gain 
realized in the stock of CFC1 ($20x multiplied by 20%, or $4x) and CFC2 
($130x multiplied by 20%, or $26x), reduced by the amount of gain 
recognized by UST with respect to the stock of CFC1 and CFC2 that is 
attributable to X pursuant to Sec. 1.367(a)-7(c)(2) ($4x and $26x, 
respectively, as determined in paragraph (ii)(C) of this Example 3). 
Pursuant to paragraph (e)(6)(ii) of this section, each gain recognition 
agreement must include the election described in Sec. 1.367(a)-
8(c)(2)(vi). Furthermore, pursuant to paragraph (e)(6)(iii) of this 
section, US1 and US2 must be designated as the U.S. transferor on their 
respective gain recognition agreements for purposes of Sec. 1.367(a)-8.

    (9) Illustration of rules. For rules relating to certain 
distributions of stock of a foreign corporation by a domestic 
corporation, see section 1248(f) and Sec. Sec. 1.1248(f)-1 through 
1.1248(f)-3.
    (f) Failure to file statements--(1) Failure to file. For purposes of 
the exceptions to the application of section 367(a)(1) provided in 
paragraphs (c) and (d)(2)(vi)(B) of this section, there is a failure to 
file a statement described in paragraph (c)(6), (c)(7), or (d)(2)(vi)(C) 
of this section (failure to file) if the statement is not filed with a 
timely filed U.S. income tax return or is not completed in all material 
respects.
    (2) Relief for certain failures to file that are not willful--(i) In 
general. A failure to file described in paragraph (f)(1) of this section 
will be deemed not to have occurred for purposes of satisfying the 
requirements of the applicable regulation if the taxpayer demonstrates 
that the failure was not willful using the procedure set forth in this 
paragraph (f)(2). For this purpose, willful is to be interpreted 
consistent with the meaning of that term in the context of other civil 
penalties, which would include a failure due to gross negligence, 
reckless disregard, or willful neglect. Whether a failure to file was a 
willful failure will be determined by the Director of Field Operations 
International, Large Business & International (or any successor to the 
roles and responsibilities of such position, as appropriate) (Director) 
based on all the facts and circumstances. The taxpayer must submit a 
request for relief and an explanation as provided in paragraph 
(f)(2)(ii)(A) of this section. Although a

[[Page 377]]

taxpayer whose failure to file is determined not to be willful will not 
be subject to gain recognition under this section, the taxpayer will be 
subject to a penalty under section 6038B if the taxpayer fails to 
satisfy the reporting requirements, if any, under that section and does 
not demonstrate that the failure was due to reasonable cause and not 
willful neglect. See Sec. 1.6038B-1(b) and (f). The determination of 
whether the failure to file was willful under this section has no effect 
on any request for relief made under Sec. 1.6038B-1(f).
    (ii) Procedures for establishing that a failure to file was not 
willful--(A) Time and manner of submission. A taxpayer's statement that 
the failure to file was not willful will be considered only if, promptly 
after the taxpayer becomes aware of the failure, an amended return is 
filed for the taxable year to which the failure relates that includes 
the information that should have been included with the original return 
for such taxable year or that otherwise complies with the rules of this 
section, and that includes a written statement explaining the reasons 
for the failure to file. The amended return must be filed with the 
Internal Revenue Service at the location where the taxpayer filed its 
original return. The taxpayer may submit a request for relief from the 
penalty under section 6038B as part of the same submission. See Sec. 
1.6038B-1(f).
    (B) Notice requirement. In addition to the requirements of paragraph 
(f)(2)(ii)(A) of this section, the taxpayer must comply with the notice 
requirements of this paragraph (f)(2)(ii)(B). If any taxable year of the 
taxpayer is under examination when the amended return is filed, a copy 
of the amended return and any information required to be included with 
such return must be delivered to the Internal Revenue Service personnel 
conducting the examination. If no taxable year of the taxpayer is under 
examination when the amended return is filed, a copy of the amended 
return and any information required to be included with such return must 
be delivered to the Director.
    (3) For illustrations of the application of the willfulness standard 
of this paragraph (f), see the examples in Sec. 1.367(a)-8(p)(3).
    (g) Effective/applicability dates--(1) Rules of applicability. (i) 
Except as otherwise provided in this paragraph (g), the rules in 
paragraphs (a), (b), and (d) of this section apply to transfers 
occurring on or after July 20, 1998.
    (ii) The following rules apply to transactions occurring on or after 
January 23, 2006--
    (A) The rules in paragraphs (a) and (d) of this section, as they 
apply to section 368(a)(1)(A) reorganizations (including reorganizations 
described in section 368(a)(2)(D) or (E)) involving a foreign acquiring 
or foreign acquired corporation;
    (B) The rules in paragraph (b)(2)(i)(B) of this section;
    (C) The rules in paragraph (d) of this section, as they apply to 
section 368(a)(1)(G) reorganizations (including reorganizations 
described in section 368(a)(2)(D));
    (D) The rules of paragraph (d)(1) and (d)(2)(iv), as they relate to 
exchanges by a U.S. person of securities of an acquired corporation for 
voting stock or securities of a foreign corporation in control of the 
acquiring corporation in a triangular section 368(a)(1)(B) 
reorganization;
    (E) The rules in paragraph (d)(1) and (d)(2)(iv) of this section, as 
they relate to exchanges by a U.S. person of stock or securities of an 
acquired corporation for voting stock or securities of a domestic 
corporation in control of the foreign acquiring corporation in a 
triangular section 368(a)(1)(B) reorganization; and
    (F) The rules in paragraph (d)(2)(vii) of this section.
    (iii) The rules of paragraph (a) of this section that apply to 
transfers of securities in a section 354 or 356 exchange (pursuant to a 
section 368(a)(1)(E) reorganization or an asset reorganization that is 
not treated as an indirect stock transfer) that is not subject to 
section 367(a) apply only to transfers occurring after January 5, 2005 
(although taxpayers may apply such provision to transfers of securities 
occurring on or after July 20, 1998, and on or before January 5, 2005, 
if done consistently to all transactions).
    (iv) The rules in paragraph (d)(1)(v) of this section apply to:

[[Page 378]]

    (A) A reorganization described in section 368(a)(1)(C) followed by a 
controlled asset transfer if such reorganization occurs on or after July 
20, 1998;
    (B) A reorganization described in section 368(a)(1)(D) followed by a 
controlled asset transfer if such reorganization occurs after December 
9, 2002 (for additional guidance concerning such reorganizations that 
occur on or after July 20, 1998 and on or before December 9, 2002, see 
Rev. Rul. 2002-85 (2002-2 C.B. 986) and Sec. 601.601(d)(2) of this 
chapter); and
    (C) A reorganization described in section 368(a)(1)(A), (F), or (G) 
followed by a controlled asset transfer if such reorganization occurs on 
or after January 23, 2006.
    (v) The rules of paragraph (d)(2)(vi) of this section apply only to 
transactions occurring on or after January 23, 2006. See Sec. 1.367(a)-
3(d)(2)(vi), as contained in 26 CFR part 1 revised as of April 1, 2005, 
for transactions occurring on or after July 20, 1998 and before January 
23, 2006.
    (A) Except as provided in paragraphs (g)(1)(v)(B) of this section 
and Sec. 1.367(a)-3T(g)(1)(ix), the rules of paragraph (d)(2)(vi) of 
this section apply only to transactions occurring on or after January 
23, 2006. See Sec. 1.367(a)-3(d)(2)(vi), as contained in 26 CFR part 1 
revised as of April 1, 2005, for transactions occurring on or after July 
20, 1998, and before January 23, 2006.
    (B)(1) For purposes of paragraph (d)(2)(vi)(B)(1) of this section as 
contained in 26 CFR part 1 revised as of April 1, 2007, except as 
provided in paragraph (g)(1)(v)(B)(3) of this section, the following 
conditions must be satisfied for transactions occurring on or after 
December 28, 2007, and before March 18, 2013: The conditions and 
requirements of section 367(a)(5) and paragraph (g)(1)(v)(B)(2) of this 
section must be satisfied with respect to the domestic acquired 
corporation's transfer of assets to the foreign acquiring corporation 
and those conditions and requirements apply before the application of 
the exception under paragraph (d)(2)(vi)(B)(1) of this section as 
contained in 26 CFR part 1 revised as of April 1, 2007.
    (2) The domestic acquired corporation is controlled (within the 
meaning of section 368(c)) by five or fewer (but at least one) domestic 
corporations (controlling domestic corporations) immediately before the 
reorganization, appropriate basis adjustments under section 367(a)(5) 
are made to the stock received by the controlling domestic corporations 
in the reorganization, and any other conditions as provided in 
regulations under section 367(a)(5) are satisfied. For purposes of 
determining whether the domestic acquired corporation is controlled by 
five or fewer domestic corporations, all members of the same affiliated 
group within the meaning of section 1504 are treated as one corporation. 
Any adjustments to stock basis required under section 367(a)(5) must be 
made to the stock received by the controlling domestic corporation in 
the reorganization so the appropriate amount of built-in gain in the 
property transferred by the domestic acquired corporation to the foreign 
acquiring corporation in the section 361 exchange is reflected in the 
stock received. The basis adjustment requirement cannot be satisfied by 
adjusting the basis in stock of the foreign acquiring corporation held 
by the controlling domestic corporation before the reorganization. To 
the extent the appropriate amount of built-in gain in the property 
transferred by the domestic acquired corporation to the foreign 
acquiring corporation in the section 361 exchange cannot be preserved in 
the stock received by the controlling domestic corporation in the 
reorganization, the domestic acquired corporation's transfer of property 
to the foreign acquiring corporation is subject to section 367(a) and 
(d).
    (3) For transactions occurring on or after August 19, 2008, and 
before March 18, 2013, the following condition also applies: To the 
extent any of the retransferred assets constitute property to which 
section 367(d) applies, the exception under paragraph (d)(2)(iv)(B)(1) 
of this section, as contained in 26 CFR part 1 revised as of April 1, 
2007, applies only if the property to which section 367(d) applies is 
treated as property subject to section 367(a) for purposes of satisfying 
the conditions and requirements of section 367(a)(5).

[[Page 379]]

    (vi) With respect to certain transfers of domestic stock or 
securities, the rules in paragraph (c) of this section are generally 
applicable for transfers occurring after January 29, 1997. See Sec. 
1.367(a)-3(c)(11). For transition rules regarding certain transfers of 
domestic stock or securities after December 16, 1987, and before January 
30, 1997, and transfers of foreign stock or securities after December 
16, 1987, and before July 20, 1998, see paragraph (j) of this section.
    (vii)(A) Except as provided in this paragraph (g)(1)(vii), the rules 
of paragraph (e) of this section apply to transfers of stock or 
securities occurring on or after April 17, 2013. For matters covered in 
this section for periods before April 17, 2013, but on or after March 
13, 2009, see Sec. 1.367(a)-3(e) as contained in 26 CFR part 1 revised 
as of April 1, 2012. For matters covered in this section for periods 
before March 13, 2009, but on or after March 7, 2007, see Sec. 
1.367(a)-3T(e) as contained in 26 CFR part 1 revised as of April 1, 
2007. For matters covered in this section for periods before March 7, 
2007, but on or after July 20, 1998, see Sec. 1.367(a)-8(f)(2)(i) as 
contained in 26 CFR part 1 revised as of April 1, 2006.
    (B) Taxpayers may apply the rules of Sec. 1.367(a)-3(e) to 
transfers occurring before March 13, 2009, and during a taxable year for 
which the period of limitations on assessments under section 6501(a) has 
not closed, if done consistently to all such transfers occurring during 
each taxable year. A taxpayer applies the rules of Sec. 1.367(a)-3(e) 
to transfers occurring before March 13, 2009, and during a taxable year 
for which the period of limitations on assessments under section 6501(a) 
has not closed, by including the gain recognition agreement, annual 
certification, or other information filing, that is required as a result 
of the rules of Sec. 1.367(a)-3(e) applying to such a transfer, with an 
amended tax return for the taxable year in which the transfer occurs 
that is filed on or before August 10, 2009. A taxpayer that wishes to 
apply the rules of Sec. 1.367(a)-3(e) to transfers occurring before 
March 13, 2009, and during a taxable year for which the period of 
limitations on assessments under section 6501(a) has not closed but that 
fails to meet the filing requirement described in the preceding sentence 
must request relief for reasonable cause for such failure as provided in 
Sec. 1.367(a)-8.
    (viii) Paragraph (a)(2)(iv) of this section applies to exchanges 
occurring on or after May 17, 2011. For exchanges that occur prior to 
May 17, 2011, see Sec. 1.367(a)-3T(b)(2)(i)(C) as contained in 26 CFR 
part 1 revised as of April 1, 2011.
    (ix) Paragraphs (d)(2)(vi)(B)(1)(i) and (iii), (d)(2)(vi)(B)(2), and 
(d)(3), Examples 6B, 6C, and 9 of this section apply to transfers that 
occur on or after March 18, 2013. See paragraphs (d)(2)(vi)(B)(1)(i) and 
(iii), (d)(2)(vi)(B)(2), and (d)(3), Examples 6B, 6C, and 9 of this 
section, as contained in 26 CFR part 1 revised as of April 1, 2012, for 
transfers that occur on or after January 23, 2006, and before March 18, 
2013. Paragraph (d)(2)(vi)(B)(1)(ii) of this section applies to 
statements that are required to be filed on or after November 19, 2014. 
See paragraph (d)(2)(vi)(B)(1)(ii) of this section, as contained in 26 
CFR part 1 revised as of April 1, 2014, for statements required to be 
filed on or after March 18, 2013, and before November 19, 2014.
    (x) Paragraphs (c)(6)(ii) and (f) of this section apply to 
statements that are required to be filed on or after November 19, 2014, 
as well as to requests for relief submitted on or after November 19, 
2014.
    (2) Election. Notwithstanding paragraphs (g)(1) and (j) of this 
section, taxpayers may, by timely filing an original or amended return, 
elect to apply paragraphs (b) and (d) of this section to all transfers 
of foreign stock or securities occurring after December 16, 1987, and 
before July 20, 1998, except to the extent that a gain recognition 
agreement has been triggered prior to July 20, 1998. If an election is 
made under this paragraph (g)(2), the provisions of Sec. 1.367(a)-3T(g) 
(see 26 CFR part 1, revised April 1, 1998) shall apply, and, for this 
purpose, the term substantial portion under Sec. 1.367(a)-3T(g)(3)(iii) 
(see 26 CFR part 1, revised April 1, 1998) shall be interpreted to mean 
substantially all as defined in section 368(a)(1)(C). In addition, if 
such an election is made, the taxpayer must apply the rules under 
section 367(b) and the regulations thereunder to any transfers occurring

[[Page 380]]

within that period as if the election to apply Sec. 1.367(a)-3(b) and 
(d) to transfers occurring within that period had not been made, except 
that in the case of an exchange described in section 351 the taxpayer 
must apply section 367(b) and the regulations thereunder as if the 
exchange was described in Sec. 7.367(b)-7 of this chapter (as in effect 
before February 23, 2000; see 26 CFR part 1, revised as of April 1, 
1999). For example, if a U.S. person, pursuant to a section 351 
exchange, transfers stock of a controlled foreign corporation in which 
it is a United States shareholder but does not receive back stock of a 
controlled foreign corporation in which it is a United States 
shareholder, the U.S. person must include in income under Sec. 
7.367(b)-7 of this chapter (as in effect before February 23, 2000; see 
26 CFR part 1, revised as of April 1, 1999) the section 1248 amount 
attributable to the stock exchanged (to the extent that the fair market 
value of the stock exchanged exceeds its adjusted basis). Such inclusion 
is required even though Sec. 7.367(b)-7 of this chapter (as in effect 
before February 23, 2000; see 26 CFR part 1, revised as of April 1, 
1999), by its terms, did not apply to section 351 exchanges.
    (h) Former 10-year gain recognition agreements. If a taxpayer elects 
to apply the rules of this section to all prior transfers occurring 
after December 16, 1987, any 10-year gain recognition agreement that 
remains in effect (has not been triggered in full) on July 20, 1998 will 
be considered by the Internal Revenue Service to be a 5-year gain 
recognition agreement with a duration of five full taxable years 
following the close of the taxable year of the initial transfer.
    (i) [Reserved]
    (j) Transition rules regarding certain transfers of domestic or 
foreign stock or securities after December 16, 1987, and prior to July 
20, 1998--(1) Scope. Transfers of domestic stock or securities described 
under section 367(a) that occurred after December 16, 1987, and prior to 
April 17, 1994, and transfers of foreign stock or securities described 
under section 367(a) that occur after December 16, 1987, and prior to 
July 20, 1998 are subject to the rules contained in section 367(a) and 
the regulations thereunder, as modified by the rules contained in 
paragraph (j)(2) of this section. For transfers of domestic stock or 
securities described under section 367(a) that occurred after April 17, 
1994 and before January 30, 1997, see Temporary Income Regulations under 
section 367(a) in effect at the time of the transfer (Sec. 1.367(a)-
3T(a) and (c), 26 CFR part 1, revised April 1, 1996) and paragraph 
(c)(11) of this section. For transfers of domestic stock or securities 
described under section 367(a) that occur after January 29, 1997, see 
Sec. 1.367(a)-3(c).
    (2) Transfers of domestic or foreign stock or securities: Additional 
substantive rules--(i) Rule for less than 5-percent shareholders. Unless 
paragraph (j)(2)(iii) of this section applies (in the case of domestic 
stock or securities) or paragraph (j)(2)(iv) of this section applies (in 
the case of foreign stock or securities), a U.S. transferor that 
transfers stock or securities of a domestic or foreign corporation in an 
exchange described in section 367(a) and owns less than 5 percent of 
both the total voting power and the total value of the stock of the 
transferee foreign corporation immediately after the transfer (taking 
into account the attribution rules of section 958) is not subject to 
section 367(a)(1) and is not required to enter into a gain recognition 
agreement.
    (ii) Rule for 5-percent shareholders. Unless paragraph (j)(2)(iii) 
or (iv) of this section applies, a U.S. transferor that transfers 
domestic or foreign stock or securities in an exchange described in 
section 367(a) and owns at least 5 percent of either the total voting 
power or the total value of the stock of the transferee foreign 
corporation immediately after the transfer (taking into account the 
attribution rules under section 958) may qualify for nonrecognition 
treatment by filing a gain recognition agreement in accordance with 
Sec. 1.367(a)-3T(g) in effect prior to July 20, 1998 (see 26 CFR part 
1, revised April 1, 1998) for a duration of 5 or 10 years. The duration 
is 5 years if the U.S. transferor (5-percent shareholder) determines 
that all U.S. transferors, in the aggregate, own less than 50 percent of 
both the total voting power and the total value of the transferee 
foreign corporation immediately after the

[[Page 381]]

transfer. The duration is 10 years in all other cases. See, however, 
Sec. 1.367(a)-3(h). If a 5-percent shareholder fails to properly enter 
into a gain recognition agreement, the exchange is taxable to such 
shareholder under section 367(a)(1).
    (iii) Gain recognition agreement option not available to controlling 
U.S. transferor if U.S. stock or securities are transferred. 
Notwithstanding the provisions of paragraph (j)(2)(ii) of this section, 
in no event will any exception to section 367(a)(1) apply to the 
transfer of stock or securities of a domestic corporation where the U.S. 
transferor owns (applying the attribution rules of section 958) more 
than 50 percent of either the total voting power or the total value of 
the stock of the transferee foreign corporation immediately after the 
transfer (i.e., the use of a gain recognition agreement to qualify for 
nonrecognition treatment is unavailable in this case).
    (iv) Loss of United States shareholder status in the case of a 
transfer of foreign stock. Notwithstanding the provisions of paragraphs 
(j)(2)(i) and (ii) of this section, in no event will any exception to 
section 367(a)(1) apply to the transfer of stock of a foreign 
corporation in which the U.S. transferor is a United States shareholder 
(as defined in Sec. 7.367(b)-2(b) of this chapter (as in effect before 
February 23, 2000; see 26 CFR part 1, revised as of April 1, 1999) or 
section 953(c)) unless the U.S. transferor receives back stock in a 
controlled foreign corporation (as defined in section 953(c), section 
957(a) or section 957(b)) as to which the U.S. transferor is a United 
States shareholder immediately after the transfer.
    (k) [Reserved] For further guidance, see Sec. 1.367-3T(k).

[T.D. 8702, 61 FR 68637, Dec. 30, 1996]

    Editorial Note: For Federal Register citations affecting Sec. 
1.367(a)-3, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.govinfo.gov.



Sec. 1.367(a)-4  Special rule applicable to U.S. depreciated property.

    (a) Depreciated property used in the United States--(1) In general. 
A U.S. person that transfers U.S. depreciated property (as defined in 
paragraph (a)(2) of this section) to a foreign corporation in an 
exchange described in section 367(a)(1), must include in its gross 
income for the taxable year in which the transfer occurs ordinary income 
equal to the gain realized that would have been includible in the 
transferor's gross income as ordinary income under section 617(d)(1), 
1245(a), 1250(a), 1252(a), 1254(a), or 1255(a), whichever is applicable, 
if at the time of the transfer the U.S. person had sold the property at 
its fair market value. Recapture of depreciation under this paragraph 
(a) is required regardless of whether the exception to section 367(a)(1) 
provided by Sec. 1.367(a)-2(a)(2) applies to the transfer of the U.S. 
depreciated property. However, the transfer of the U.S. depreciated 
property may qualify for the exception with respect to realized gain 
that is not included in ordinary income pursuant to this paragraph (a).
    (2) U.S. depreciated property. U.S. depreciated property subject to 
the rules of this paragraph (a) is any property that--
    (i) Is either mining property (as defined in section 617(f)(2)), 
section 1245 property (as defined in section 1245(a)(3)), section 1250 
property (as defined in section 1250(c)), farm land (as defined in 
section 1252(a)(2)), section 1254 property (as defined in section 
1254(a)(3)), or section 126 property (as defined in section 1255(a)(2)); 
and
    (ii) Has been used in the United States or has been described in 
section 168(g)(4) before its transfer.
    (3) Property used within and without the United States. (i) If U.S. 
depreciated property has been used partly within and partly without the 
United States, then the amount required to be included in ordinary 
income pursuant to this paragraph (a) is reduced to an amount determined 
in accordance with the following formula:

[[Page 382]]

[GRAPHIC] [TIFF OMITTED] TR16DE16.037

    (ii) For purposes of the fraction in paragraph (a)(3)(i) of this 
section, the ``full recapture amount'' is the amount that would 
otherwise be included in the transferor's income under paragraph (a)(1) 
of this section. ``U.S. use'' is the number of months that the property 
either was used within the United States or has been described in 
section 168(g)(4), and was subject to depreciation by the transferor or 
a related person. ``Total use'' is the total number of months that the 
property was used (or available for use), and subject to depreciation, 
by the transferor or a related person. For purposes of this paragraph 
(a)(3), property is not considered to have been in use outside of the 
United States during any period in which such property was, for purposes 
of section 168, treated as property not used predominantly outside the 
United States pursuant to section 168(g)(4). For purposes of this 
paragraph (a)(3), the term ``related person'' has the meaning set forth 
in Sec. 1.367(d)-1(h).
    (b) Effective/applicability dates. The rules of this section apply 
to transfers occurring on or after September 14, 2015, and to transfers 
occurring before September 14, 2015, resulting from entity 
classification elections made under Sec. 301.7701-3 that are filed on 
or after September 14, 2015. For transfers occurring before this section 
is applicable, see Sec. Sec. 1.367(a)-4 and 1.367(a)-4T as contained in 
26 CFR part 1 revised as of April 1, 2016.

[T.D. 9803, 81 FR 91027, Dec. 16, 2016]



Sec. 1.367(a)-5  [Reserved]



Sec. 1.367(a)-6  Transfer of foreign branch with previously deducted
losses.

    (a) through (b)(1) [Reserved]. For further guidance, see Sec. 
1.367(a)-6T(a) through (b)(1).
    (b)(2) No active conduct exception. The rules of this paragraph (b) 
apply regardless of whether any of the assets of the foreign branch 
satisfy the active trade or business exception of Sec. 1.367(a)-
2(a)(2).
    (c)(1) [Reserved]. For further guidance, see Sec. 1.367(a)-
6T(c)(1).
    (2) Gain limitation. The gain required to be recognized under 
paragraph (b)(1) of this section will not exceed the aggregate amount of 
gain realized on the transfer of all branch assets (without regard to 
the transfer of any assets on which loss is realized but not 
recognized).
    (3) [Reserved]
    (4) Transfers of certain intangible property. Gain realized on the 
transfer of intangible property (computed with reference to the fair 
market value of the intangible property as of the date of the transfer) 
that is an asset of a foreign branch is taken into account in computing 
the limitation on loss recapture under paragraph (c)(2) of this section. 
For rules relating to the crediting of gain recognized under this 
section against income deemed to arise by operation of section 367(d), 
see Sec. 1.367(d)-1(g)(3).
    (d) through (i) [Reserved]. For further guidance, see Sec. 
1.367(a)-6T(d) through (i).
    (j) Effective/applicability dates. The rules of this section apply 
to transfers occurring on or after September 14, 2015, and to transfers 
occurring before September 14, 2015, resulting from entity 
classification elections made under Sec. 301.7701-3 that are filed on 
or after September 14, 2015. For transfers occurring before this section 
is applicable, see Sec. 1.367(a)-6T as contained in 26 CFR part 1 
revised as of April 1, 2016.

[T.D. 9803, 81 FR 91028, Dec. 16, 2016]



Sec. 1.367(a)-6T  Transfer of foreign branch with previously deducted
losses (temporary).

    (a) In general. This section provides special rules relating to the 
transfer of the assets of a foreign branch with previously deducted 
losses. Paragraph (b) of this section provides generally that such 
losses must be recaptured by the recognition of the gain realized on the 
transfer. Paragraph (c) of this section sets forth rules concerning the 
character of, and limitations on, the gain

[[Page 383]]

required to be recognized. Paragraph (d) of this section defines the 
term previously deducted losses. Paragraph (e) of this section describes 
certain reductions that are made to the previously deducted losses 
before they are taken into income under this section. Finally, paragraph 
(g) of this section defines the term foreign branch.
    (b) Recognition of gain required--(1) In general. If a U.S. person 
transfers any assets of a foreign branch to a foreign corporation in an 
exchange described in section 367(a)(1), then the transferor shall 
recognize gain equal to--
    (i) The sum of the previously deducted branch ordinary losses as 
defined and reduced in paragraphs (d) and (e) of this section; and
    (ii) The sum of the previously deducted branch capital losses as 
defined and reduced in paragraphs (d) and (e) of this section.
    (2) [Reserved]
    (c) Special rules concerning gain recognized--(1) Character and 
source of gain. The gain described in paragraph (b)(1)(i) of this 
section shall be treated as ordinary income of the transferor, and the 
gain described in paragraph (b)(1)(ii) of this section shall be treated 
as long-term capital gain of the transferor. Gain that is recognized 
pursuant to the rules of this section shall be treated as income from 
sources outside the United States. Such recognized gain shall be treated 
as foreign oil and gas extraction income (as defined in section 907) in 
the same proportion that previously deducted foreign oil and gas 
extraction losses bore to the total amount of previously deducted 
losses.
    (2) [Reserved]
    (3) Foreign goodwill and going concern value. For purposes of this 
section, the assets of a foreign branch shall include foreign goodwill 
and going concern value related to the business of the foreign branch, 
as defined in Sec. 1.367(a)-1T(d)(5)(iii). Thus, gain realized upon the 
transfer of the foreign goodwill or going concern value of a foreign 
branch to a foreign corporation will be taken into account in computing 
the limitation on loss recapture under paragraph (c)(2) of this section.
    (4) [Reserved]
    (d) Previously deducted losses--(1) In general. This paragraph (d) 
provides rules for determining, for purposes of paragraph (b)(1) of this 
section, the previously deducted losses of a foreign branch any of whose 
assets are transferred to a foreign corporation in an exchange described 
in section 367(a)(1). Initially, the two previously deducted losses of a 
foreign branch for a taxable year are the total ordinary loss 
(``previously deducted branch ordinary loss'') and the total capital 
loss (``previously deducted branch capital loss'') that were realized by 
the foreign branch in that taxable year (a ``branch loss year'') prior 
to the transfer and that were or will be reflected on a U.S. income tax 
return of the transferor. The previously deducted branch ordinary loss 
for each branch loss year is reduced by expired net ordinary losses 
under paragraph (d)(2) of this section, while the previously deducted 
capital loss for each loss year is reduced by expired net capital losses 
under paragraph (d)(3) of this section. For each branch loss year, the 
remaining previously deducted branch ordinary loss and the remaining 
previously deducted branch capital loss are then reduced, proceeding 
from the first branch loss year to the last branch loss year, to reflect 
expired foreign tax credits under paragraph (d)(4) of this section. The 
reductions are made in the order of the taxable years in which the 
foreign tax credits arose. Finally, similar reductions are made to 
reflect expired investment credits under paragraph (d)(5) of this 
section.
    (2) Reduction by expired net ordinary loss--(i) In general. The 
previously deducted branch ordinary loss for each branch loss year shall 
be reduced under this paragraph (d)(2) by the amount of any expired net 
ordinary loss with respect to that branch loss year. Expired net 
ordinary losses arising in years other than the branch loss year shall 
reduce the previously deducted branch ordinary loss for the branch loss 
year only to the extent that the previously deducted branch ordinary 
loss exceeds the net operating loss, if any, incurred by the transferor 
in the branch loss year. The previously deducted branch ordinary losses 
shall be reduced proceeding from the first branch loss year

[[Page 384]]

to the last branch loss year. For each branch loss year, expired net 
operating losses shall be applied to reduce the previously deducted 
branch ordinary loss for that year in the order in which the expired net 
ordinary losses arose.
    (ii) Existence of expired net ordinary loss. An expired net ordinary 
loss exists with respect to a branch loss year to the extent that--
    (A) The transferor incurred a net operating loss (within the meaning 
of section 172(c));
    (B) That net operating loss arose in the branch loss year or was 
available for carryover or carryback to the branch loss year under 
section 172(b)(1);
    (C) That net operating loss has neither given rise to a net 
operating loss deduction (within the meaning of section 172(a)) for any 
taxable year prior to the year of the transfer, nor given rise to a 
reduction of any previously deducted branch ordinary loss (pursuant to 
paragraph (d)(2) of this section) of any foreign branch of the 
transferor upon a previous transfer to a foreign corporation; and
    (D) The period during which the transferor may claim a net operating 
loss deduction with respect to that net operating loss has expired.
    (3) Reduction by expired net capital loss--(i) In general. The 
previously deducted branch capital loss for each branch loss year shall 
be reduced under this paragraph (d)(3) by the amount of any expired net 
capital loss with respect to that branch loss year. Expired net capital 
losses arising in years other than the branch loss year shall reduce the 
previously deducted branch capital loss for the branch loss year only to 
the extent that the previously deducted branch capital loss exceeds the 
net capital loss, if any, incurred by the transferor in the branch loss 
year. The previously deducted branch capital losses shall be reduced 
proceeding from the first branch loss year to the last branch loss year. 
For each branch loss year, expired net capital losses shall be applied 
to reduce the previously deducted branch capital loss for that year in 
the order in which the expired net capital losses arose.
    (ii) Existence of expired net capital loss. An expired net capital 
loss exists with respect to a branch loss year to the extent that--
    (A) The transferor incurred a net capital loss (within the meaning 
of section 1222(10));
    (B) That net capital loss arose in the branch loss year or was 
available for carryover or carryback to the branch loss year under 
section 1212;
    (C) That net capital loss has neither been allowed for any taxable 
year prior to the year of the transfer, nor given rise to a reduction of 
any previously deducted branch capital loss (pursuant to paragraph 
(c)(3) of this section) of any foreign branch of the transferor upon any 
previous transfer to a foreign corporation; and
    (D) The period during which the transferor may claim a capital loss 
deduction with respect to that net capital loss has expired.
    (4) Reduction for expired foreign tax credit--(i) In general. The 
previously deducted branch ordinary loss and the previously deducted 
branch capital loss for each branch loss year remaining after the 
reductions described in paragraph (d)(2) and (3) of this section shall 
be further reduced under this paragraph (d)(4) proportionately by the 
amount of any expired foreign tax credit loss equivalent with respect to 
that branch loss year. The previously deducted branch losses shall be 
reduced proceeding from the first branch loss year to the last branch 
loss year. For each branch loss year, expired foreign tax credit loss 
equivalents shall be applied to reduce the previously deducted branch 
loss for that year in the order in which the expired foreign tax credits 
arose.
    (ii) Existence of foreign tax credit loss equivalent. A foreign tax 
credit loss equivalent exists with respect to a branch loss year if--
    (A) The transferor paid, accrued, or is deemed under section 902 or 
960 to have paid creditable foreign taxes in a taxable year;
    (B) The creditable foreign taxes were paid, accrued, or deemed paid 
in the branch loss year or were available for carryover or carryback to 
the branch loss year under section 904(c);
    (C) No foreign tax credit with respect to the foreign taxes paid, 
accrued, or deemed paid has been taken because of

[[Page 385]]

the operation of section 904(a) or similar limitations provided by the 
Code or an applicable treaty, and such taxes have not given rise to a 
reduction (pursuant to this paragraph (d)(5)) of any previously deducted 
branch loss of the foreign branch for a prior taxable year or of any 
previously deducted branch losses of any foreign branch of the 
transferor upon a prior transfer to a foreign corporation; and
    (D) The period during which the transferor may claim a foreign tax 
credit for the foreign taxes paid, accrued, or deemed paid has expired.
    (iii) Amount of foreign tax credit loss equivalent. The amount of 
the foreign tax credit loss equivalent for the branch loss year with 
respect to the creditable foreign taxes described in paragraph 
(d)(4)(ii) of this section is the amount of those creditable foreign 
taxes divided by the highest rate of tax to which the transferor was 
subject in the loss year.
    (5) Reduction for expired investment credits--(i) In general. The 
previously deducted branch ordinary loss and the previously deducted 
branch capital loss for each branch loss year shall be further reduced 
under this paragraph (d)(5) proportionately by the amount of any expired 
investment credit loss equivalent with respect to that branch year. The 
previously deducted branch losses shall be reduced proceeding from the 
first branch loss year to the last branch loss year. For each branch 
loss year, expired investment credit loss equivalents shall be applied 
to reduce the previously deducted branch loss for that year in the order 
in which the expired investment credits were earned.
    (ii) Existence of investment credit loss equivalent. An investment 
credit loss equivalent exists with respect to a branch loss year if--
    (A) The transferor earned an investment credit (within the meaning 
of section 46(a)) in a taxable year;
    (B) The investment credit was earned in the branch loss year or was 
available for carryover or carryback to the branch loss year under 
section 39;
    (C) The investment credit earned by the transferor in the credit 
year has been denied by section 38(a) or by similar provisions of the 
Code and has not given rise to a reduction (pursuant to this paragraph 
(d)(5)) of any previously deducted branch loss of the foreign branch for 
a preceding taxable year or of the previously deducted losses of any 
foreign branch of the transferor upon any previous transfer to a foreign 
corporation; and
    (D) The period during which the transferor may claim the investment 
credit has expired.
    (iii) Amount of investment tax credit loss equivalent. The amount of 
the investment credit loss equivalent for the branch loss year with 
respect to the investment credit described in paragraph (d)(5)(ii) of 
this section is 85 percent of the amount of that investment credit 
divided by the highest rate of tax to which the transferor was subject 
in the loss year.
    (e) Amounts that reduce previously deducted losses subject to 
recapture--(1) In general. This paragraph (e) describes five amounts 
that reduce the sum of the previously deducted branch ordinary losses 
and the sum of the previously deducted branch capital losses before they 
are taken into income under paragraph (b) of this section. Amounts 
representing ordinary income shall be applied to reduce first the sum of 
the previously deducted branch ordinary losses to the extent thereof, 
and then the sum of the previously deducted branch capital losses to the 
extent thereof. Similarly, amounts representing capital gains shall be 
applied to reduce first the sum of the previously deducted branch 
capital losses and then the sum of the previously deducted branch 
ordinary losses.
    (2) Taxable income. The previously deducted losses shall be reduced 
by any taxable income of the foreign branch recognized through the close 
of the taxable year of the transfer, whether before or after any taxable 
year in which losses were incurred.
    (3) Amounts currently recaptured under section 904(f)(3). The 
previously deducted losses shall be reduced by the amount recognized 
under section 904(f)(3) on account of the transfer.
    (4) [Reserved]
    (5) Amounts previously recaptured under section 904(f)(3)--(i) In 
general. The previously deducted branch losses shall be reduced by the 
portion of any amount recognized under section

[[Page 386]]

904(f)(3) upon a previous transfer of property that was attributable to 
the losses of the foreign branch, provided that the amount did not 
reduce any gain otherwise required to be recognized under section 
367(a)(3)(C) and this section (or Revenue Ruling 78-201, 1978-1 C.B. 
91).
    (ii) Portion attributable to the losses of the foreign branch--(A) 
Branch property. The full amount recognized under section 904(f)(3) upon 
a previous transfer of property of the branch shall be treated as 
attributable to the losses of the foreign branch.
    (B) Non-branch property. The portion of the amount previously 
recognized under section 904(f)(3) upon a transfer of non-branch 
property that was attributable to the losses of the foreign branch shall 
be the sum, over the taxable years in which the transferor sustained an 
overall foreign loss some portion of which was recaptured on the 
disposition, of the recaptured portions of those overall foreign losses 
after multiplication by the following fraction: 
[GRAPHIC] [TIFF OMITTED] TR25SE06.009


For purposes of this fraction, the term losses of the foreign branch for 
the year means the losses of the foreign branch that were taken into 
account under section 904(f)(2) in determining the amount of the 
transferor's overall foreign loss for the year, and the term all foreign 
losses for the year means all of the losses of the transferor that were 
taken into account under section 904(f)(2).
    (6) Amounts previously recognized under the rules of this section. 
The previously deducted losses shall be reduced by the amounts 
previously recognized under the rules of this section upon a previous 
transfer of assets of the foreign branch.
    (f) Example. The rules of paragraphs (b) through (e) of this section 
are illustrated by the following example.

    Example. (i) Facts. X, a U.S. corporation, is a calendar year 
taxpayer. On January 1, 1981, X established a branch in foreign country 
A to manufacture and sell X's products in country A. On July 1, 1986, X 
organized corporation Y, a country A subsidiary, and transferred to Y 
all of the assets of its country A branch, including goodwill and going 
concern value. During the period from January 1, 1981, through July 1, 
1986, X's country A branch earned income and incurred losses in the 
following amounts:

                            Country A Branch
------------------------------------------------------------------------
                                                      Ordinary   Capital
                        Year                           income     gain
                                                       (loss)    (loss)
------------------------------------------------------------------------
1981................................................     (200)        0
1982................................................     (300)     (100)
1983................................................     (400)        0
1984................................................     (200)        0
1985................................................     (100)        0
1986................................................       50         0
------------------------------------------------------------------------

    At the time of the transfer of X's country A branch assets to Y, 
those assets had a fair market value of $2,500 and an adjusted basis of 
$1,000. For each of the assets, fair market value exceeded adjusted 
basis. X had no net capital loss or unused investment credit during any 
taxable year relevant to the transfer. In 1984, X incurred a net 
operating loss of $400, $200 of which was carried back to prior years. 
An additional $50 of the 1984 net operating loss was carried over to 
1985. The remaining $150 of the 1984 net operating loss was not used in 
any year prior to the transfer. In 1979, X paid creditable foreign taxes 
of $330 that could not be claimed as a credit in that year or any 
earlier year because of section 904. Of those foreign taxes, $100 were 
carried over and claimed as a credit in 1983, but the remaining $230 
were not used in any year prior to the transfer. X was not required to 
recognize any gain under section 904(f)(3) on account of the 1986 
transfer or any prior transfer. X was not required to recognize gain 
upon the transfer under section 367(a) (other than by reason of the 
provisions of this section).
    (ii) Previously deducted losses. The previously deducted losses of 
X's country A branch are $575 of ordinary losses and $25 of

[[Page 387]]

capital losses, computed as follows: Initially, the branch has 
previously deducted ordinary losses of $1,000 ($200 + $300 + $400 + 
$100), and previously deducted capital losses of $100. (See paragraph 
(d)(1) of this section.)
    (iii) Expired losses and credits. Under the facts of this example, 
there are no reductions for expired net ordinary losses or expired net 
capital losses under paragraph (d)(2) or (3) of this section. However, 
the previously deducted losses are reduced proceeding from the first 
branch loss year to the last branch loss year to reflect the expired 
foreign tax credit from 1979. The amount of the foreign tax credit loss 
equivalent with respect to 1981 is $500 ($230/.46). It reduces the 
previously deducted losses for 1981 proportionately. Thus, the 
previously deducted ordinary loss for 1981 is reduced from $200 to $0. 
(See paragraph (d)(4) of this section.) The amount of the foreign tax 
credit loss equivalent with respect to 1982 is $300 ($500-$200, i.e., 
$138/.46). (See paragraph (d)(4)(ii)(C) of this section.) It reduces the 
previously deducted losses for 1982 proportionately. Thus, the 
previously deducted ordinary loss for 1982 is reduced from $300 to $75, 
and the previously deducted capital loss for 1982 is reduced from $100 
to $25.
    (iv) Further reductions. The previously deducted ordinary losses of 
$575 and the previously deducted capital losses of $25 are reduced by 
the taxable income earned by the branch prior to the date of the 
transfer ($250). (See paragraph (e)(2) of this section.) Since that 
income was ordinary income, it is applied first to reduce the previously 
deducted ordinary losses of $575 to $325. (See paragraph (e)(1) of this 
section.)
    (v) Recapture. Since the gain realized by X upon its transfer of the 
branch assets to Y exceeds the sum of the previously deducted branch 
losses as defined and reduced above $325 + $25), the limitation in 
paragraph (c)(2) of this section does not apply. Thus, X is required to 
recognize $325 of ordinary income and $25 of long-term capital gain upon 
the transfer. (See paragraph (b) and (c)(1) of this section.)

    (g) Definition of foreign branch--(1) In general. For purposes of 
this section, the term foreign branch means an integral business 
operation carried on by a U.S. person outside the United States. Whether 
the activities of a U.S. person outside the United States constitute a 
foreign branch operation must be determined under all the facts and 
circumstances. Evidence of the existence of a foreign branch includes, 
but is not limited to, the existence of a separate set of books and 
records, and the existence of an office or other fixed place of business 
used by employees or officers of the U.S. person in carrying out 
business activities outside the United States. Activities outside the 
United States shall be deemed to constitute a foreign branch for 
purposes of this section if the activities constitute a permanent 
establishment under the terms of a treaty between the United States and 
the country in which the activities are carried out. Any U.S. person may 
be treated as having a foreign branch for purposes of this section, 
whether that person is a corporation, partnership, trust, estate, or 
individual.
    (2) More than one branch. If a U.S. person carries on more than one 
branch operation outside the United States, then the rules of this 
section must be separately applied with respect to each foreign branch 
that is transferred to a foreign corporation. Thus, the previously 
deducted losses of one branch may not be offset, for purposes of 
determining the gain required to be recognized under the rules of this 
section, by the income of another branch that is also transferred to a 
foreign corporation. Similarly, the losses of one branch shall not be 
recaptured upon a transfer of the assets of a separate branch. Whether 
the foreign activities of a U.S. person are carried out through more 
than one branch must be determined under all of the facts and 
circumstances. In general, a separate branch exists if a particular 
group of activities is sufficiently integrated to constitute a single 
business that could be operated as an independent enterprise. For 
purposes of determining the combination of activities that constitute a 
branch operation as defined in this paragraph (g), the nominal 
relationship among those activities shall not be controlling. Factors 
suggesting that nominally separate business operations constitute a 
single foreign branch include a substantial identity of products, 
customers, operational facilities, operational processes, accounting and 
record-keeping functions, management, employees, distribution channels, 
or sales and purchasing forces. For examples of the application of the 
principles of this paragraph (g)(2), see Revenue Ruling 81-82, 1981-1 
C.B. 127.
    (3) Consolidated group. For purposes of this section, the activities 
of each of two domestic corporations outside the

[[Page 388]]

United States will be considered to constitute a single foreign branch 
if--
    (i) The two corporations are members of the same consolidated group 
of corporations; and
    (ii) The activities of the two corporations in the aggregate would 
constitute a single foreign branch if conducted by a single corporation.

Notwithstanding the preceding rule of this paragraph (g)(3), gains of a 
foreign branch of a domestic corporation arising in a year in which that 
corporation did not file a consolidated return with a second domestic 
corporation shall not be applied to reduce the previously deducted 
losses of a foreign branch of the second corporation (but may be applied 
to reduce such losses of the foreign branch of the first corporation) 
upon the transfer of the two branches to a foreign corporation, even 
though the two domestic corporations file a consolidated return for the 
year in which the transfer occurs and the two branches are considered at 
that time to constitute a single foreign branch. For an example of the 
application of the principles of this paragraph (g)(3), see Revenue 
Ruling 81-89, 1981-1 C.B. 129.
    (4) Property not transferred. A U.S. transferor's failure to 
transfer any property of a foreign branch shall be irrelevant to the 
determination of the previously deducted losses of the branch subject to 
recapture under the rules of this section. Thus, if the activities with 
respect to untransferred property constituted a part of the branch 
operation under the rules of this paragraph (g), then the losses 
generated by those activities shall be subject to recapture, 
notwithstanding the failure to transfer the property. For an example of 
the application of the principles of this paragraph (g)(4), see Revenue 
Ruling 80-247, 1980-2 C.B. 127, relating to property abandoned by the 
U.S. transferor.
    (h) Anti-abuse rule. If--
    (1) A U.S. person transfers property of a foreign branch to a 
domestic corporation for a principal purpose of avoiding the effect of 
this section; and
    (2) The domestic corporation thereafter transfers the property of 
the foreign branch to a foreign corporation,

Then, solely for purposes of this section, that U.S. person shall be 
treated as having transferred the property of the branch directly to the 
foreign corporation. A U.S. person shall be presumed to have transferred 
property of a foreign branch for a principal purpose of avoiding the 
effect of this section if the property is transferred to the domestic 
corporation less than two years prior to the domestic corporation's 
transfer of the property to a foreign corporation. This presumption may 
be rebutted by clear evidence that the subsequent transfer of the 
property was not contemplated at the time of the initial transfer to the 
domestic corporation and that avoidance of the effect of this section 
was not a principal purpose for the transaction. A transfer may have 
more than one principal purpose.
    (i) Basis adjustments. Basis adjustments reflecting gain recognized 
pursuant to this section shall be made as described in Sec. 1.367(a)-
1T(b)(4)(ii).
    (j) [Reserved]

[T.D. 8087, 51 FR 17950, May 16, 1986, as amended by T.D. 9615, 78 FR 
17063, Mar. 19, 2013; T.D. 9760, 81 FR 15169, Mar. 22, 2016; T.D. 9803, 
81 FR 91028, Dec. 16, 2016]



Sec. 1.367(a)-7  Outbound transfers of property described in section
361(a) or (b).

    (a) Scope and purpose. This section provides rules under section 
367(a)(5) that apply to the transfer of certain property (including 
stock or securities) by a domestic corporation (U.S. transferor) to a 
foreign corporation (foreign acquiring corporation) in a section 361 
exchange. This section applies only to the transfer of section 367(a) 
property. See section 367(d) for rules applicable to transfers of 
section 367(d) property. Paragraph (b) of this section provides the 
general rule requiring the recognition of gain on the transfer of 
section 367(a) property, while paragraph (c) of this section provides an 
elective exception to the general rule that is available if certain 
requirements are satisfied. Paragraph (d) of this section provides rules 
for applying the elective exception to a section 361 exchange followed 
by successive distributions to which section 355 applies. Paragraph (e) 
of this section provides rules for recognizing gain on section 367(a) 
property, not willful relief provisions, an anti-

[[Page 389]]

abuse rule, and special rules that take into account income inclusions 
under Sec. 1.367(b)-4 and gain recognition under Sec. 1.367(a)-6. 
Paragraph (f) of this section provides definitions, and paragraph (g) of 
this section provides examples. Paragraph (h) of this section provides 
applicable cross-references, paragraph (i) of this section is reserved, 
and paragraph (j) of this section provides effective/applicability 
dates.
    (b) General rule--(1) Nonrecognition exchanges enumerated in section 
367(a)(1). Except to the extent provided in paragraphs (b)(2) and (c) of 
this section, the exceptions to section 367(a)(1) provided in section 
367(a) and the regulations under that section do not apply to a transfer 
of section 367(a) property by a U.S. transferor to a foreign acquiring 
corporation in a section 361 exchange, and the U.S. transferor shall 
recognize any gain (but not loss) realized with respect to the section 
367(a) property under section 367(a)(1). Realized gain is recognized 
pursuant to the prior sentence notwithstanding the application of any 
other nonrecognition provision enumerated in section 367(a)(1) to the 
transfer (such as section 351 or 354).
    (2) Nonrecognition exchanges not enumerated in section 367(a)(1). To 
the extent a transfer of items of property described in paragraph (b)(1) 
of this section also qualifies for nonrecognition under a provision that 
is not enumerated in section 367(a)(1) (such as section 1036), the U.S. 
transferor recognizes gain or loss realized on the transfer of such 
items of property, but the amount of loss recognized on the property 
shall not exceed the amount of gain recognized on the property. See 
section 337(d).
    (c) Elective exception. Except to the extent provided in paragraph 
(d) of this section, paragraph (b) of this section does not apply to the 
transfer of section 367(a) property by a U.S. transferor to a foreign 
acquiring corporation in a section 361 exchange if the conditions of 
paragraphs (c)(1), (c)(2), (c)(3), and (c)(4) of this section are 
satisfied, and an election to apply the exception provided by this 
paragraph (c) is made in the manner provided by paragraph (c)(5) of this 
section. If this paragraph (c) applies to the section 361 exchange, see, 
for example, Sec. 1.367(a)-2, Sec. 1.367(a)-3, Sec. 1.367(a)-4, or 
Sec. 1.367(a)-6, as applicable, for additional requirements that must 
be satisfied in order for the U.S. transferor to not recognize gain 
under section 367(a)(1) on the transfer of section 367(a) property in 
the section 361 exchange. Nothing in this section provides for the 
nonrecognition of gain not otherwise permitted under another provision 
of the Internal Revenue Code (Code) or the regulations.
    (1) Control. Immediately before the reorganization, the U.S. 
transferor is controlled (within the meaning of section 368(c)) by five 
or fewer, but at least one, control group members. For illustrations of 
this rule, see paragraph (g) of this section, Example 4 and Example 5.
    (2) Gain recognition--(i) Non-control group members. The U.S. 
transferor recognizes gain equal to the product of the inside gain 
multiplied by the aggregate ownership interest percentage of all non-
control group members, reduced (but not below zero) by the sum of the 
amounts described in paragraphs (c)(2)(i)(A), (c)(2)(i)(B), and 
(c)(2)(i)(C) of this section.
    (A) Gain recognized with respect to stock or securities under Sec. 
1.367(a)-3(e)(3)(iii)(B) (including any portion treated as a deemed 
dividend under section 1248(a));
    (B) Gain recognized with respect to stock or securities under Sec. 
1.367(a)-6 (including any portion treated as a deemed dividend under 
section 1248(a)) attributable to non-control group members (as 
determined pursuant to Sec. 1.367(a)-7(e)(5)); and
    (C) A deemed dividend included in income under Sec. 1.367(b)-4 
attributable to non-control group members (as determined pursuant to 
Sec. 1.367(a)-7(e)(4)).
    (ii) Control group members. With respect to each control group 
member, the U.S. transferor recognizes gain equal to the amount, if any, 
by which the amount described in paragraph (c)(2)(ii)(A) of this section 
exceeds the amount described in paragraph (c)(2)(ii)(B) of this section.
    (A) The product of the inside gain multiplied by such control group 
member's ownership interest percentage, reduced (but not below zero) by 
the sum of the amounts described in paragraphs (c)(2)(ii)(A)(1), 
(c)(2)(ii)(A)(2), and

[[Page 390]]

(c)(2)(ii)(A)(3) of this section (attributable inside gain).
    (1) Gain recognized with respect to stock or securities under Sec. 
1.367(a)-3(e)(3)(iii)(C) (including any portion treated as a deemed 
dividend under section 1248(a)) attributable to the control group 
member;
    (2) Gain recognized with respect to stock or securities under Sec. 
1.367(a)-6 (including any portion treated as a deemed dividend under 
section 1248(a)) attributable to the control group member (as determined 
pursuant to Sec. 1.367(a)-7(e)(5)); and
    (3) A deemed dividend included in income under Sec. 1.367(b)-4 
attributable to the control group member (as determined pursuant to 
Sec. 1.367(a)-7(e)(4)).
    (B) The product of the section 367(a) percentage multiplied by the 
fair market value of the stock received by the U.S. transferor in the 
section 361 exchange and distributed to the control group member under 
section 354, 355, or 356.
    (iii) Illustration of rules. For an illustration of gain recognition 
under paragraph (c)(2)(i) of this section, see paragraph (g) of this 
section, Example 1. For an illustration of gain recognition under 
paragraph (c)(2)(ii) of this section, see paragraph (g) of this section, 
Example 2.
    (3) Basis adjustments required for control group members--(i) 
General rule. Except as provided in paragraph (c)(3)(iv) of this 
section, if there is any attributable inside gain (determined under 
paragraph (c)(2)(ii)(A) of this section) with respect to a control group 
member, then such control group member's aggregate basis in the stock 
received in exchange for (or with respect to, as applicable) stock or 
securities of the U.S. transferor under section 354, 355, or 356, as 
determined under section 358 and the regulations under that section 
(section 358 basis), is reduced by the amount in paragraph (c)(3)(i)(A), 
(c)(3)(i)(B), or (c)(3)(i)(C) of this section, as applicable.
    (A) If the control group member has outside gain, the amount, if 
any, by which the attributable inside gain, reduced by any gain 
recognized by the U.S. transferor with respect to the control group 
member under paragraph (c)(2)(ii) of this section, exceeds the control 
group member's outside gain.
    (B) If the control group member has outside loss, the amount, if 
any, by which the attributable inside gain, reduced by any gain 
recognized by the U.S. transferor with respect to the control group 
member under paragraph (c)(2)(ii) of this section, exceeds the control 
group member's outside loss (for this purpose, treating the outside loss 
as a negative amount).
    (C) If the control group member has no outside gain or outside loss, 
the amount of the attributable inside gain, reduced by any gain 
recognized by the U.S. transferor with respect to the control group 
member under paragraph (c)(2)(ii) of this section.
    (ii) Stock received in the section 361 exchange. This paragraph 
(c)(3) applies only to stock received by the U.S. transferor in the 
section 361 exchange and distributed to the control group member in 
exchange for (or with respect to, as applicable) stock or securities of 
the U.S. transferor.
    (iii) Pro rata adjustments. The section 358 basis of each share of 
stock received by the control group member must be reduced pro rata 
based on the relative section 358 basis of all shares of stock received 
by the control group member.
    (iv) Successive distributions to which section 355 applies. 
Paragraph (c)(3) of this section does not apply to a control group 
member that distributes the stock of a foreign acquiring corporation 
received from the U.S. transferor in a distribution satisfying the 
requirements of section 355 (section 355 distribution) that is in 
connection with a transaction described in paragraph (d) of this section 
(relating to successive section 355 distributions). If paragraph (c)(3) 
of this section does not apply to a control group member pursuant to 
this paragraph (c)(3)(iv), then paragraph (c)(3) of this section shall 
apply to the final distributee (as defined in paragraph (d) of this 
section) that receives the stock of the foreign acquiring corporation in 
the final section 355 distribution described in paragraph (d) of this 
section.
    (v) Illustration of rules. For illustrations of the adjustment to 
stock basis under paragraph (c)(3)(i) of this section, see paragraph (g) 
of this section,

[[Page 391]]

Example 1 and Example 2, Sec. 1.367(a)-3(e)(8), Example 3, and Sec. 
1.1248(f)-2(e), Example 3. For an illustration of the adjustment to 
stock basis under paragraph (c)(3)(iii) of this section, see paragraph 
(g) of this section, Example 3.
    (4) Agreement to amend or file a U.S. income tax return--(i) General 
rule. Except as provided in paragraph (c)(4)(ii) of this section, the 
U.S. transferor complies with the requirements of Sec. 1.6038B-
1(c)(6)(iii), relating to the requirement to report gain that was not 
recognized by the U.S. transferor upon certain subsequent dispositions 
by the foreign acquiring corporation of section 367(a) property received 
from the U.S. transferor in the section 361 exchange.
    (ii) Exception. To the extent section 367(a) property transferred in 
the section 361 exchange is subject to Sec. 1.367(a)-3(e) (relating to 
transfers of stock or securities by a domestic corporation to a foreign 
corporation in a section 361 exchange), Sec. 1.6038B-1(c)(6)(iii) does 
not apply with respect to the transfer of that property.
    (5) Election and reporting requirements--(i) General rule. The U.S. 
transferor and each control group member elect to apply the provisions 
of paragraph (c) of this section in the manner provided under paragraph 
(c)(5)(ii) or (c)(5)(iii) of this section, as applicable, and by 
entering into a written agreement described in paragraph (c)(5)(iv) of 
this section. If a control group member distributes the stock of the 
foreign acquiring corporation received from the U.S. transferor in a 
section 355 distribution that is in connection with a transaction 
described in paragraph (d) of this section, the final distributee that 
receives that stock in the final section 355 distribution elects to 
apply the provisions of this paragraph (c) and enters into the written 
agreement instead of the control group member. For this purpose, the 
term control group member will be replaced by the term final 
distributee, as appropriate.
    (ii) Control group member--(A) Time and manner of making election. 
Each control group member elects to apply the provisions of paragraph 
(c) of this section by including a statement (in the form and with the 
content specified in paragraph (c)(5)(ii)(B) of this section) on or with 
a timely filed return for the taxable year in which the reorganization 
occurs. If the control group member is a member of a consolidated group 
but is not the common parent of the consolidated group, the common 
parent makes the election on behalf of the control group member.
    (B) Form and content of election statement. The statement must be 
entitled, ``ELECTION TO APPLY EXCEPTION UNDER Sec. 1.367(a)-7(c),'' and 
set forth:
    (1) The name and taxpayer identification number (if any) of the 
control group member, the U.S. transferor, the foreign acquiring 
corporation and, in the case of a triangular reorganization (within the 
meaning of Sec. 1.358-6(b)(2)), the corporation that controls the 
foreign acquiring corporation; the control group member's ownership 
interest percentage in the U.S. transferor; and the percentage of voting 
stock and non-voting stock of the U.S. transferor owned by the control 
group member for purposes of satisfying the control requirement of 
paragraph (c)(1) of this section;
    (2) If the control group member is a member of a consolidated group 
but is not the common parent, the name and taxpayer identification 
number of the common parent;
    (3) The amount of the adjustment (if any) to stock basis required 
under paragraph (c)(3) of this section, the resulting adjusted basis in 
the stock, and the fair market value of the stock, or if no stock was 
received, indicate no stock was received; and
    (4) The date on which the written agreement described in paragraph 
(c)(5)(iv) of this section was entered into.
    (iii) Statement by U.S. transferor. The U.S. transferor elects to 
apply the provisions of paragraph (c) of this section in the form and 
manner set forth in Sec. 1.6038B-1(c)(6)(ii).
    (iv) Written agreement. The U.S. transferor and each control group 
member must enter into a written agreement satisfying the conditions of 
this paragraph on or before the due date (including extensions) for the 
U.S. transferor's tax return for the taxable year in which the 
reorganization occurs. Each party to the agreement must retain the 
original or a copy of the agreement in

[[Page 392]]

the manner specified by Sec. 1.6001-1(e). Each party to the agreement 
must provide a copy of the agreement to the Internal Revenue Service 
within 30 days of the receipt of a request for the copy of the 
agreement. The written agreement must--
    (A) State the document constitutes an agreement entered into 
pursuant to paragraph (c)(5) of this section;
    (B) Identify the U.S. transferor, the foreign acquiring corporation, 
the corporation that controls the foreign acquiring corporation (in the 
case of a triangular reorganization within the meaning of Sec. 1.358-
6(b)(2)), and each control group member, and provide the taxpayer 
identification number (if any) for each corporation;
    (C) State the amount of gain (if any) recognized by the U.S. 
transferor under paragraph (c)(2) of this section; and
    (D) With respect to each control group member, state the amount of 
the adjustment (if any) to stock basis required under paragraph (c)(3) 
of this section, the resulting adjusted basis in the stock, and the fair 
market value of the stock. Alternatively, if a control group member did 
not receive any stock, indicate that no stock was received.
    (d) Section 361 exchange followed by successive distributions to 
which section 355 applies. If the U.S. transferor distributes stock of 
the foreign acquiring corporation received in the section 361 exchange 
to a control group member in a section 355 distribution and, as part of 
a plan or series of related transactions, that stock is further 
distributed in one or more successive section 355 distributions, 
paragraph (c) of this section can apply to the section 361 exchange only 
to the extent each subsequent section 355 distribution is to a member of 
the affiliated group (within the meaning of section 1504) that includes 
the U.S. transferor immediately before the reorganization. In that case, 
each affiliated group member that receives stock of the foreign 
acquiring corporation in the final section 355 distribution (final 
distributee) is subject to the requirements of paragraphs (c)(3) and 
(c)(5) of this section. If this paragraph (d) applies, then for purposes 
of applying paragraphs (c)(3), (c)(5) or (e)(2) of this section the term 
control group member is replaced by the term final distributee, as 
appropriate.
    (e) Other rules--(1) Section 367(a) property with respect to which 
gain is recognized. Except as otherwise provided in this paragraph 
(e)(1), gain recognized by the U.S. transferor pursuant to paragraph 
(c)(2) of this section will be treated as recognized with respect to the 
section 367(a) property transferred in the section 361 exchange in 
proportion to the amount of gain realized by the U.S. transferor on the 
transfer of each item of section 367(a) property. This paragraph (e)(1) 
will be applied after taking into account any gain or deemed dividends 
(including any deemed dividends under section 1248(a)) recognized by the 
U.S. transferor on the transfer of the section 367(a) property in the 
section 361 exchange pursuant to all other provisions of sections 367(a) 
and (b) and the regulations under that section. See, for example, 
Sec. Sec. 1.367(a)-2, 1.367(a)-3(e), 1.367(a)-4, 1.367(a)-6, and 
1.367(b)-4. If the U.S. transferor recognizes gain (including gain 
treated as a deemed dividend under section 1248(a)) pursuant to Sec. 
1.367(a)-3(e)(3)(iii)(B) or (e)(3)(iii)(C) with respect to stock or 
securities transferred in the section 361 exchange, the realized gain in 
such stock or securities shall not be taken into account for purposes of 
applying this paragraph (e)(1) to gain recognized under paragraph (c)(2) 
of this section attributable to U.S. transferor shareholders described 
in Sec. 1.367(a)-3(e)(3)(iii)(B) or (e)(3)(iii)(C). Accordingly, gain 
recognized under paragraph (c)(2) attributable to such U.S. transferor 
shareholders shall not be treated as recognized with respect to such 
stock or securities under this paragraph. Furthermore, to the extent 
gain recognized by the U.S. transferor under paragraph (c)(2) is treated 
as recognized with respect to stock in a foreign corporation transferred 
in the section 361 exchange to which section 1248(a) applies, the 
portion of such gain treated as a deemed dividend under section 1248(a) 
is the product of the amount of the gain multiplied by the ratio of the 
amount that would be treated as a deemed dividend under section 1248(a) 
if all gain in the transferred stock were recognized under Sec. 
1.367(a)-7(b) and the

[[Page 393]]

amount of gain realized in the transferred stock. See Sec. 1.367(a)-
1(b)(4) for additional rules on the character, source, and adjustments 
relating to gain recognized under section 367(a)(1), and Sec. 1.367(b)-
2(e) for rules on the timing, treatment, and effect of amounts included 
in income as deemed dividends pursuant to regulations under section 
367(b).
    (2) Relief for certain failures to comply that are not willful--(i) 
In general. A control group member or U.S. transferor's failure to 
comply with any requirement of this section will be deemed not to have 
occurred for purposes of satisfying the requirements of this section if 
the control group member or U.S. transferor (or the foreign acquiring 
corporation on behalf of the U.S. transferor), as applicable, 
demonstrates that the failure was not willful using the procedure set 
forth in paragraph (e)(2)(ii) of this section. For this purpose, willful 
is to be interpreted consistent with the meaning of that term in the 
context of other civil penalties, which would include a failure due to 
gross negligence, reckless disregard, or willful neglect. Whether the 
failure to comply was a willful failure will be determined by the 
Director of Field Operations, Cross Border Activities Practice Area of 
Large Business & International (or any successor to the roles and 
responsibilities of such person) (Director) based on all the facts and 
circumstances. The control group member or U.S. transferor (or the 
foreign acquiring corporation on behalf of the U.S. transferor), as 
applicable, must submit a request for relief and an explanation as 
provided in paragraph (e)(2)(ii) of this section. Although a U.S 
transferor whose failure to comply is determined not to be willful will 
not be subject to gain recognition under this section, the U.S. 
transferor will be subject to a penalty under section 6038B if the U.S. 
transferor fails to demonstrate that the failure was due to reasonable 
cause and not willful neglect. See Sec. 1.6038B-1(b) and (f). The 
determination of whether the failure to comply was willful under this 
section has no effect on any request for relief made under Sec. 
1.6038B-1(f).
    (ii) Procedures for establishing that a failure to comply was not 
willful--(A) Time and manner of submission. A control group member or 
U.S. transferor's statement that the failure to comply was not willful 
will be considered only if, promptly after the control group member or 
U.S. transferor, as applicable, becomes aware of the failure, an amended 
return is filed for the taxable year to which the failure relates that 
includes the information that should have been included with the 
original return for such taxable year or that otherwise complies with 
the rules of this section, and that includes a written statement 
explaining the reasons for the failure to comply. The amended return 
must be filed with the Internal Revenue Service at the location where 
the taxpayer filed its original return. The U.S. transferor may submit a 
request for relief from the penalty under section 6038B as part of the 
same submission. See Sec. 1.6038B-1(f).
    (B) Notice requirement. In addition to the requirements of paragraph 
(e)(2)(ii)(A) of this section, a control group member or U.S. 
transferor, as applicable, must comply with the notice requirements of 
this paragraph (e)(2)(ii)(B). If any taxable year of the control group 
member or U.S. transferor, as applicable, is under examination when the 
amended return is filed, a copy of the amended return and any 
information required to be included with such return must be delivered 
to the Internal Revenue Service personnel conducting the examination. If 
no taxable year of the control group member or U.S transferor, as 
applicable, is under examination when the amended return is filed, a 
copy of the amended return and any information required to be included 
with such return must be delivered to the Director.
    (iii) For illustrations of the application of the willfulness 
standard of this paragraph (e)(2), see the examples in Sec. 1.367(a)-
8(p)(3).
    (3) Anti-abuse rule. Any property of the U.S. transferor acquired 
with a principal purpose of affecting any determination under this 
section (including, for example, the section 367(a) percentage, inside 
gain, or inside basis) shall not be taken in account for purposes of any 
determination under this section. Nothing in this paragraph (e)(3) 
constitutes a limitation on or

[[Page 394]]

modification to judicial doctrines, including step-transaction or 
substance-over-form.
    (4) Certain income inclusions under Sec. 1.367(b)-4--(i) Income 
inclusion attributable to U.S. transferor shareholder described in Sec. 
1.367(a)-3(e)(3)(iii)(A). If pursuant to Sec. 1.367(a)-3(e)(3)(iii)(B) 
or (e)(3)(iii)(C) the U.S. transferor is required to recognize gain on 
the transfer of foreign stock (all or a portion of which is treated as a 
deemed dividend under section 1248(a)), and if pursuant to Sec. 
1.367(b)-4(b)(1)(i) the U.S. transferor is also required to include in 
income as a deemed dividend the section 1248 amount (within the meaning 
of Sec. 1.367(b)-2(c)) in the foreign stock, then the section 1248 
amount included in income under Sec. 1.367(b)-4(b)(1)(i) is 
attributable to each U.S. transferor shareholder described in Sec. 
1.367(a)-3(e)(3)(iii)(A) pursuant to this paragraph (e)(4)(i). The 
portion of the section 1248 amount attributable to each U.S. transferor 
shareholder described in Sec. 1.367(a)-3(e)(3)(iii)(A) is the portion 
of the section 1248 amount that bears the same ratio as such U.S. 
transferor shareholder's ownership interest percentage bears to the 
aggregate ownership interest percentage of all U.S. transferor 
shareholders described in Sec. 1.367(a)-3(e)(3)(iii)(A).
    (ii) Ordering rules for determining section 1248 amount. The section 
1248 amount (within the meaning of Sec. 1.367(b)-2(c)) included in 
income as a deemed dividend under Sec. 1.367(b)-4(b)(1)(i) is 
determined after taking into account any gain recognized under 
Sec. Sec. 1.367(a)-3(e)(3)(iii)(B) or (e)(3)(iii)(C) or 1.367(a)-6 that 
is treated as a deemed dividend under section 1248(a). See Sec. 
1.367(a)-3(e)(7) and paragraph (e)(5)(ii) of this section for rules to 
determine the amount of gain recognized under Sec. Sec. 1.367(a)-
3(e)(3)(iii)(B) or (e)(3)(iii)(C) or 1.367(a)-6, respectively, that is 
treated as a deemed dividend under section 1248(a).
    (5) Certain gain under Sec. 1.367(a)-6--(i) Gain attributable to 
U.S. transferor shareholder described in Sec. 1.367(a)-3(e)(3)(iii)(A). 
If pursuant to Sec. 1.367(a)-3(e)(3)(iii)(B) or (e)(3)(iii)(C), the 
U.S. transferor is required to recognize gain on the transfer of stock 
or securities, and if pursuant to Sec. 1.367(a)-6 the U.S. transferor 
is also required to recognize gain, then gain recognized under Sec. 
1.367(a)-6 (including any portion treated as a deemed dividend under 
section 1248(a)) to the extent treated as recognized with respect to the 
stock or securities, is attributable to each U.S. transferor shareholder 
described in Sec. 1.367(a)-3(e)(3)(iii)(A) pursuant to this paragraph 
(e)(5)(i). The portion of the gain (including any portion treated as a 
deemed dividend under section 1248(a)) that is attributable to each U.S. 
transferor shareholder described in Sec. 1.367(a)-3(e)(3)(iii)(A) is 
the portion of the gain that bears the same ratio as such U.S. 
transferor shareholder's ownership interest percentage bears to the 
aggregate ownership interest percentage of all U.S. transferor 
shareholders described in Sec. 1.367(a)-3(e)(3)(iii)(A).
    (ii) Gain subject to section 1248(a). If the U.S. transferor 
recognizes gain under Sec. 1.367(a)-6 with respect to transferred stock 
that is stock in a foreign corporation to which section 1248(a) applies, 
the portion of such gain treated as a deemed dividend under section 
1248(a) is determined after taking into account any gain recognized 
under Sec. 1.367(a)-3(e)(3)(iii)(B) or (e)(3)(iii)(C) and the amount of 
such gain treated as a deemed dividend under section 1248(a) pursuant to 
Sec. 1.367(a)-3(e)(7).
    (f) Definitions. The following definitions apply for purposes of 
this section:
    (1) Control group, control group member, and non-control group 
member--(i) General rule. Except as provided in paragraph (f)(1)(ii) of 
this section, the control group is the group of five or fewer, but at 
least one, domestic corporations that controls (within the meaning of 
section 368(c)) the U.S. transferor immediately before the 
reorganization. If the U.S. transferor is owned directly by more than 
five domestic corporations immediately before the reorganization, but 
some combination of five or fewer domestic corporations controls the 
U.S. transferor, the U.S. transferor must designate the five or fewer 
domestic corporations that comprise the control group on Form 926, 
``Return by a U.S. Transferor of Property to a Foreign Corporation.'' 
For purposes of identifying the control group, members of an affiliated 
group (within the meaning of section 1504) are

[[Page 395]]

treated as a single corporation. Except as provided in paragraph 
(f)(1)(ii) of this section, a control group member is a domestic 
corporation that is part of the control group. A non-control group 
member is a shareholder of the U.S. transferor immediately before the 
reorganization that is not a control group member.
    (ii) Exception for certain entities. Regulated investment companies 
(as defined in section 851(a)), real estate investment trusts (as 
defined in section 856(a)), and S corporations (as defined in section 
1361(a)) cannot be control group members.
    (2) Deductible liability is any liability of the U.S. transferor 
that is assumed in the section 361 exchange if payment of the liability 
would give rise to a deduction.
    (3) Fair market value is the fair market value determined without 
regard to mortgages, liens, pledges, or other liabilities. For this 
purpose, the fair market value of any property subject to a nonrecourse 
indebtedness shall be treated as being not less than the amount of any 
nonrecourse indebtedness to which such property is subject.
    (4) Inside basis is the aggregate basis of the section 367(a) 
property transferred by the U.S. transferor in the section 361 exchange 
and, except as otherwise provided in this paragraph (f)(4), increased by 
any gain recognized or any deemed dividend included in income by the 
U.S. transferor under section 367 on the transfer of the section 367(a) 
property in the section 361 exchange, but not including any gain 
recognized under paragraph (c)(2) of this section. If the U.S. 
transferor transfers stock or securities and recognizes gain under Sec. 
1.367(a)-3(e)(3)(iii)(B) or (e)(3)(iii)(C) with respect to such stock or 
securities, then inside basis is not increased for gain recognized or 
deemed dividends included in income that are described in paragraph 
(f)(4)(i), (f)(4)(ii), or (f)(4)(iii) of this section.
    (i) Gain recognized under Sec. 1.367(a)-3(e)(3)(iii)(B) or 
(e)(3)(iii)(C) (including any portion treated as a deemed dividend under 
section 1248(a));
    (ii) Gain recognized under Sec. 1.367(a)-6 (including any portion 
treated as a deemed dividend under section 1248(a)) attributable to U.S. 
transferor shareholders described in Sec. 1.367(a)-3(e)(3)(iii)(A) (as 
determined pursuant to Sec. 1.367(a)-7(e)(5));
    (iii) A deemed dividend included in income under Sec. 1.367(b)-4(b) 
attributable to U.S. transferor shareholders described in Sec. 
1.367(a)-3(e)(3)(iii)(A) (as determined pursuant to Sec. 1.367(a)-
7(e)(4)).
    (5) Inside gain is the amount (but not below zero) by which the 
aggregate fair market value of the section 367(a) property transferred 
in the section 361 exchange exceeds the sum of:
    (i) The inside basis; and
    (ii) The product of the section 367(a) percentage multiplied by the 
aggregate deductible liabilities of the U.S. transferor.
    (6) Outside gain or loss is the product of the section 367(a) 
percentage multiplied by the difference between--
    (i) The aggregate fair market value of the stock received by a 
control group member in exchange for (or with respect to, as applicable) 
stock or securities of the U.S. transferor under section 354, 355, or 
356, and
    (ii) The control group member's aggregate section 358 basis (as 
defined in paragraph (c)(3) of this section) in such stock received, 
determined without regard to any adjustment to that basis under 
paragraph (c)(3) of this section.
    (7) Ownership interest percentage is the ratio of the fair market 
value of the stock in the U.S. transferor owned by a shareholder to the 
fair market value of all of the outstanding stock of the U.S. 
transferor. Except as provided in this paragraph (f)(7), the ownership 
interest percentage of a shareholder is determined immediately before 
the reorganization. For purposes of determining the ownership interest 
percentage with respect to each shareholder, however, the numerator and 
denominator of the fraction are first reduced as described in this 
paragraph (f)(7). The numerator is reduced (but not below zero) by any 
distributions by the U.S. transferor of money or other property (within 
the meaning of section 356) to such shareholder pursuant to the plan of 
reorganization, but only to the extent such money or other property is 
not provided by the foreign acquiring corporation in exchange for 
property of the U.S. transferor acquired in the section

[[Page 396]]

361 exchange. Furthermore, the denominator of the fraction is reduced 
(but not below zero) by all such distributions by the U.S. transferor to 
all shareholders. For illustrations of this definition, see paragraph 
(g) of this section, Example 4 and Example 5.
    (8) Section 361 exchange is an exchange described in section 361(a) 
or (b).
    (9) Section 367(a) percentage is the ratio of the aggregate fair 
market value of the section 367(a) property transferred by the U.S. 
transferor in the section 361 exchange to the aggregate fair market 
value of all property transferred by the U.S. transferor in the section 
361 exchange.
    (10) Section 367(a) property. Except as provided in paragraph (e)(3) 
of this section, section 367(a) property is any property, as defined in 
Sec. 1.367(a)-1(d)(4), other than section 367(d) property.
    (11) Section 367(d) property is intangible property as defined in 
Sec. 1.367(a)-1(d)(5).
    (12) Timely filed return is a U.S. income tax return filed on or 
before the due date set forth in section 6072(b), including any 
extensions of time to file the return granted under section 6081.
    (13) U.S. transferor shareholder is a person that is either a 
control group member or a non-control group member.
    (g) Examples. The rules of this section are illustrated by the 
examples set forth in this paragraph (g). See also Sec. 1.367(a)-
3(e)(8), Example 2 and Example 3. The analysis of the following examples 
is limited to a discussion of issues under this section. Unless 
otherwise indicated, for purposes of the following examples: DP1, DP2, 
and DC are domestic corporations that do not join in the filing of a 
consolidated return and none of which is a regulated investment company, 
a real estate investment trust, or an S corporation; FP and FA are 
foreign corporations created or organized under the laws of Country B 
and are unrelated to DP1, DP2, and DC; each corporation has a single 
class of stock outstanding; each share of stock of DC owned by a 
shareholder of DC has an identical stock basis; Business A consists 
solely of section 367(a) property whose fair market value exceeds its 
basis and that, but for the application of this section, would qualify 
for the active foreign trade or business exception under Sec. 1.367(a)-
2; the fair market value of any FA stock received in a reorganization is 
equal to the fair market value of property exchanged therefor; FA is not 
a surrogate foreign corporation for purposes of section 7874 because one 
or more of the conditions of section 7874(a)(2)(B) is not satisfied; DC 
has no liabilities; DP1 and DP2 satisfy the requirements of paragraph 
(c)(5) of this section, and DC satisfies the requirements of Sec. 
1.6038B-1(c)(6)(ii).

    Example 1. Tainted assets and non-control group ownership. (i) 
Facts. DP1, DP2, and FP own 50%, 30%, and 20%, respectively, of the 
outstanding stock of DC. DP1 and DP2 are members of the same affiliated 
group within the meaning of section 1504. DP1's DC stock has a $120x 
basis and $100x fair market value. DP2's DC stock has a $50x basis and 
$60x fair market value. DC owns inventory with a $40x basis and a $100x 
fair market value. DC also owns Business A (excluding the inventory) 
with a $10x basis and $100x fair market value. In a reorganization 
described in section 368(a)(1)(F), DC transfers the inventory and 
Business A to FA, a newly formed corporation, in exchange for all of the 
outstanding stock of FA. DC's transfer of the inventory and Business A 
to FA qualifies as a section 361 exchange. DP1, DP2, and FP exchange the 
DC stock for a proportionate amount of FA stock pursuant to section 354.
    (ii) Result. (A) Under section 367(a)(3)(B)(i), DC must recognize 
$60x gain ($100x fair market value less $40x basis) on the transfer of 
the inventory to FA. The basis of the inventory in the hands of FA is 
increased by the gain recognized of $60x (that is, increased from $40x 
to $100x). See Sec. 1.367(a)-1(b)(4)(i)(B). Under section 367(a)(5) and 
paragraph (b) of this section, DC's transfer of Business A to FA is 
subject to the general rule of section 367(a)(1). As a result, DC must 
also generally recognize $90x gain ($100x fair market value less $10x 
basis) on the transfer of Business A to FA notwithstanding the 
application of section 361 (or any other nonrecognition provision 
enumerated in section 367(a)(1)). However, if the conditions and 
requirements of paragraph (c) of this section are met, DC's transfer of 
Business A to FA would qualify for the active foreign trade or business 
exception provided by section 367(a)(3) and Sec. 1.367(a)-2.
    (B) The requirement of paragraph (c)(1) of this section is satisfied 
because DC is controlled (within the meaning of section 368(c)) by five 
or fewer domestic corporations immediately before the reorganization (in 
this case, by a single domestic corporation because DP1 and DP2 together 
own 80% of the stock of DC). DP1 and DP2 are treated as a

[[Page 397]]

single domestic corporation for this purpose under paragraph (f)(1)(i) 
of this section because DP1 and DP2 are members of the same affiliated 
group.
    (C) Paragraph (c)(2)(i) of this section would be satisfied only if 
DC recognizes $18x gain on the transfer of Business A, which is the 
amount of inside gain attributable to FP, a non-control group member. 
The $18x gain equals the product of the inside gain ($90x) multiplied by 
FP's ownership interest percentage (20%) in DC, reduced by $0x (the sum 
of the amounts described in paragraphs (c)(2)(i)(A) through (c)(2)(i)(C) 
of this section). Under paragraph (f)(5) of this section, the $90x 
inside gain is the amount by which the aggregate fair market value 
($200x) of the section 367(a) property (inventory and Business A) 
exceeds $110x, the sum of the inside basis of $110x and the product of 
the section 367(a) percentage (100%) multiplied by the deductible 
liabilities of DC ($0x). Under paragraph (f)(4) of this section, the 
inside basis equals the $50x aggregate basis of the section 367(a) 
property transferred in the section 361 exchange, increased by the $60x 
gain recognized by DC on the transfer of the inventory to FA, but not by 
the $18x gain recognized by DC under paragraph (c)(2)(i) of this section 
attributable to FP. The section 367(a) percentage is 100% because the 
only assets transferred are the inventory and Business A, which are 
section 367(a) property. Under paragraph (e)(1) of this section, the 
$18x gain recognized under paragraph (c)(2)(i) of this section is 
treated as recognized with respect to Business A. FA's basis in Business 
A as determined under section 362 is increased for the $18x gain 
recognized. See Sec. 1.367(a)-1(b)(4)(i)(B).
    (D) Paragraph (c)(2)(ii) of this section is not applicable with 
respect to either DP1 or DP2 because the attributable inside gain with 
respect to each such shareholder can be preserved in the FA stock 
received. As stated in paragraph (ii)(C) of this Example 1, the amount 
of the inside gain is $90x. The attributable inside gain with respect to 
DP1 of $45x (equal to the product of $90x inside gain multiplied by 
DP1's 50% ownership interest percentage, reduced by $0x (the sum of the 
amounts described in paragraphs (c)(2)(ii)(A)(1) through 
(c)(2)(ii)(A)(3) of this section)) does not exceed $100x (equal to the 
product of the section 367(a) percentage of 100% multiplied by $100x 
fair market value of FA stock received by DP1). Similarly, the 
attributable inside gain with respect to DP2 of $27x (equal to the 
product of $90x inside gain multiplied by DP2's 30% ownership interest 
percentage, reduced by $0x (the sum of the amounts described in 
paragraphs (c)(2)(ii)(A)(1) through (c)(2)(ii)(A)(3) of this section)) 
does not exceed $60x (equal to the product of the section 367(a) 
percentage of 100% multiplied by $60x fair market value of FA stock 
received by DP2).
    (E) Each control group member (DP1 and DP2) separately computes any 
required adjustment to stock basis under paragraph (c)(3) of this 
section. DP1's section 358 basis in the FA stock received of $120x (the 
amount of DP1's basis in the DC stock exchanged) is reduced to preserve 
the attributable inside gain with respect to DP1, less any gain 
recognized with respect to DP1 under paragraph (c)(2)(ii) of this 
section. Because DC does not recognize gain on the section 361 exchange 
with respect to DP1 under paragraph (c)(2)(ii) of this section (as 
determined in paragraph (ii)(D) of this Example 1), the attributable 
inside gain of $45x with respect to DP1 is not reduced under paragraph 
(c)(3)(i)(B) of this section. DP1's outside loss in the FA stock is 
$20x, the product of the section 367(a) percentage of 100% multiplied by 
$20x loss (equal to the difference between $100x fair market value and 
$120x section 358 basis in FA stock). Thus, DP1's $120x section 358 
basis in the FA stock must be reduced by $65x (excess of $45x, reduced 
by $0x, over $20x outside loss) to $55x.
    (F) DP2's aggregate section 358 basis in the FA stock received of 
$50x (the amount of DP2's basis in the DC stock exchanged) is reduced to 
preserve the attributable inside gain with respect to DP2, less any gain 
recognized with respect to DP2 under paragraph (c)(2)(ii) of this 
section. Because DC does not recognize gain on the section 361 exchange 
with respect to DP2 (as determined in paragraph (ii)(D) of this Example 
1), the attributable inside gain of $27x with respect to DP2 is not 
reduced under paragraph (c)(3)(i)(A) of this section. DP2's outside gain 
in the FA stock is $10x, the product of the section 367(a) percentage of 
100% multiplied by $10x gain (equal to the difference between $60x fair 
market value and $50x section 358 basis in FA stock). Thus, DP2's $50x 
section 358 basis in the FA stock must be reduced by $17x (excess of 
$27x, reduced by $0x, over the $10x outside gain) to $33x.
    (G) Paragraph (c)(4) of this section would be satisfied only if DC 
complies with the requirements of Sec. 1.6038B-1(c)(6)(iii), including 
filing with its timely filed return for the year of the reorganization a 
statement agreeing to file an amended return reporting the gain realized 
but not recognized on the section 361 exchange in certain cases if a 
significant amount of the section 367(a) property received in the 
section 361 exchange is disposed of, directly or indirectly, in one or 
more related transactions within the prescribed 60-month period.
    Example 2. Triangular reorganization involving an exchange of 
section 367(a) property for foreign stock and cash. (i) Facts. (A) DP1 
wholly owns DC. DP1 and DC file a consolidated return. DP1's DC stock 
has a $170x basis and $200x fair market value. DC owns Business A, which 
has a $10x basis and $200x fair market value. FP wholly owns FA.

[[Page 398]]

    (B) In a triangular reorganization described in section 368(a)(1)(A) 
by reason of section 368(a)(2)(D), DC transfers Business A to FA in 
exchange for $180x of FP stock and $20x cash. DC's transfer of Business 
A to FA qualifies as a section 361 exchange. DP1 exchanges its DC stock 
for $180x of FP stock and $20x cash pursuant to section 356. The 
triangular reorganization constitutes an indirect stock transfer under 
Sec. 1.367(a)-3(d)(1)(i), and DP1 properly files a gain recognition 
agreement under Sec. 1.367(a)-8 with respect to the transfer. See also 
Sec. 1.367(a)-3(d)(2)(vii).
    (ii) Result. (A) Under section 367(a)(5) and paragraph (b) of this 
section, DC's transfer of Business A to FA is subject to the general 
rule of section 367(a)(1). As a result, DC must generally recognize 
$190x gain ($200x fair market value less $10x basis) on the transfer of 
Business A to FA notwithstanding the application of section 361 (or any 
other nonrecognition exchange enumerated in section 367(a)(1)). However, 
if the requirements of paragraph (c) of this section are satisfied, DC's 
transfer of Business A to FA would qualify for the active foreign trade 
or business exception provided in section 367(a)(3) and Sec. 1.367(a)-
2.
    (B) The requirement of paragraph (c)(1) of this section is satisfied 
because DC is controlled (within the meaning of section 368(c)) by five 
or fewer domestic corporations immediately before the reorganization (in 
this case, by a single domestic corporation, DP1).
    (C) DC is not required to recognize gain under paragraph (c)(2)(i) 
of this section because, immediately before the reorganization, DC is 
wholly owned by DP1, a control group member. In addition, DP1's 
ownership interest percentage is 100%. Paragraph (c)(2)(ii) of this 
section would be satisfied only if DC recognizes $10x gain, computed as 
the amount by which the attributable inside gain with respect to DP1 of 
$190x (the product of $190x inside gain multiplied by DP1's ownership 
interest percentage of 100%, reduced by $0x (the sum of the amounts in 
paragraphs (c)(2)(ii)(A)(1) through (c)(2)(ii)(A)(3) of this section)) 
exceeds $180x (the product of the section 367(a) percentage of 100% 
multiplied by $180x fair market value of FP stock received by DP1). 
Under paragraph (f)(5) of this section, the $190x inside gain is the 
amount by which the $200x aggregate fair market value of Business A 
exceeds $10x (the sum of the inside basis of $10x and the product of the 
section 367(a) percentage (100%) multiplied by the deductible 
liabilities of DC ($0x)). Under paragraph (f)(4) of this section, the 
inside basis equals the $10x aggregate basis of the section 367(a) 
property transferred in the section 361 exchange (not increased by the 
$10x gain recognized by DC under paragraph (c)(2)(ii) of this section). 
The section 367(a) percentage is 100% because the only asset transferred 
is Business A, which is section 367(a) property. Under Sec. 1.1502-
32(b)(2), DP1 increases the basis of its DC stock by the $10x gain 
recognized, that is, from $170x to $180x. Under paragraph (e)(1) of this 
section, the $10x gain recognized under paragraph (c)(2)(ii) of this 
section is treated as recognized with respect to Business A. FA's basis 
in Business A as determined under section 362 is increased for the $10x 
gain recognized. See Sec. 1.367(a)-1(b)(4)(i)(B).
    (D) Paragraph (c)(3) of this section would be satisfied only if 
DP1's section 358 basis in the FP stock is reduced by the amount by 
which the attributable inside gain with respect to DP1, reduced by any 
gain recognized by DC with respect to DP1 under paragraph (c)(2)(ii) of 
this section, exceeds DP1's outside gain in the FP stock. DP1's section 
358 basis in the FP stock is $180x, computed as $180x basis in DC stock, 
as determined in paragraph (ii)(C) of this Example 2, decreased by $20x 
cash received and increased by $20x gain recognized under section 356 
(such amount equal to the lesser of the $20x cash received and the $20x 
gain in the DC stock, computed as $200x fair market value less $180x 
basis). Because DC recognizes $10x gain on the section 361 exchange with 
respect to DP1 under paragraph (c)(2)(ii) of this section as determined 
in paragraph (ii)(C) of this Example 2, the $190x attributable inside 
gain with respect to DP1 is reduced by $10x to $180x under paragraph 
(c)(3)(i)(C) of this section. DP1's outside gain in the FP stock is $0x, 
the product of the section 367(a) percentage of 100% multiplied by $0x 
gain (the difference between $180x fair market value and $180x section 
358 basis in FP stock). Thus, DP1's section 358 basis in the FP stock 
($180x) must be reduced by $180x ($190x attributable inside gain reduced 
by $10x) to $0x.
    (E) Paragraph (c)(4)(i) of this section would be satisfied only if 
DC complies with the requirements of Sec. 1.6038B-1(c)(6)(iii), 
including filing with its tax return for the year of the reorganization 
a statement agreeing to file an amended return reporting the gain on the 
section 361 exchange in certain cases if a significant amount of the 
section 367(a) property received in the section 361 exchange is disposed 
of, directly or indirectly, in one or more related transactions within 
the prescribed 60-month period.
    Example 3. Adjustment to basis of multiple blocks of stock; transfer 
of section 367(d) property. (i) Facts. (A) DP1 wholly owns DC. One half 
of DP1's shares of stock in DC, each with an identical basis, has an 
aggregate basis of $60x and fair market value of $100x (Block 1). The 
other one half of DP's shares of stock in DC, each with an identical 
basis, has an aggregate basis of $120x and fair market value of $100x 
(Block 2). DC owns Business A ($15x basis and $150x fair market value) 
(excluding the patent) and a patent ($0x basis and $50x

[[Page 399]]

fair market value). The patent is section 367(d) property.
    (B) In a reorganization described in section 368(a)(1)(F), DC 
transfers Business A and the patent to FA, a newly formed corporation, 
in exchange for 2 shares of FA stock. DC's transfer of Business A and 
the patent to FA qualifies as a section 361 exchange. DP1 exchanges 
Block 1 and Block 2 for the two shares of FA stock pursuant to section 
354. Pursuant to Sec. 1.358-2(a)(2)(i), one share of the FA stock 
corresponds to Block 1 (Share 1) and the other share of FA stock 
corresponds to Block 2 (Share 2). The basis of Share 1 and Share 2 
correspond to the basis of Block 1 and Block 2, respectively.
    (ii) Result. (A) Under section 367(a)(5) and paragraph (b) of this 
section, DC's transfer of Business A to FA is subject to the general 
rule of section 367(a)(1). As a result, DC must generally recognize 
$135x of gain on the transfer of Business A to FA notwithstanding the 
application of section 361 (or any other nonrecognition exchange 
described in section 367(a)(1)). However, if the requirements of 
paragraph (c) of this section are met, DC's transfer of Business A to FA 
would qualify for the active foreign trade or business exception 
provided in section 367(a)(3). For rules applicable to DC's transfer of 
the patent to FA, see section 367(d).
    (B) The requirement of paragraph (c)(1) of this section is satisfied 
because DC is controlled (within the meaning of section 368(c)) by five 
or fewer domestic corporations immediately before the reorganization (in 
this case, by a single domestic corporation, DP1).
    (C) Paragraph (c)(2)(i) of this section is not applicable because, 
immediately before the reorganization, DC is wholly owned by DP1, a 
control group member. In addition, DP1's ownership interest percentage 
is 100%. Paragraph (c)(2)(ii) of this section is not applicable because 
the attributable inside gain with respect to DP1 can be preserved in the 
FA stock received. The attributable inside gain with respect to DP1 of 
$135x (equal to the product of $135x inside gain multiplied by DP1's 
100% ownership interest percentage, reduced by $0x (the sum of the 
amounts in paragraphs (c)(2)(ii)(A)(1) through (c)(2)(ii)(A)(3) of this 
section)) does not exceed $150x (equal to the product of the section 
367(a) percentage of 75% multiplied by $200x fair market value of FA 
stock received by DP1). Under paragraph (f)(5) of this section, the 
$135x inside gain is the amount by which the aggregate fair market value 
of Business A ($150x) exceeds $15x, the sum of the inside basis of 
Business A ($15x) and the product of the section 367(a) percentage (75%) 
multiplied by the deductible liabilities of DC ($0x). Under paragraph 
(f)(4) of this section, the inside basis equals the $15x aggregate basis 
of the section 367(a) property transferred in the exchange. The section 
367(a) percentage of 75% is equal to the ratio of the fair market value 
of the section 367(a) property ($150x for Business A) to the fair market 
value of all the property transferred ($200x, the sum of $150x for 
Business A and $50x for the patent).
    (D) Under paragraph (c)(3) of this section, DP1's aggregate section 
358 basis of $180x in the stock of FA (computed as the sum of $60x basis 
in Share 1 and $120x basis in Share 2) is reduced by the amount by which 
the attributable inside gain with respect to DP1, reduced by any gain 
recognized by DC with respect to DP1 under paragraph (c)(2)(ii) of this 
section, exceeds DP1's outside gain in the FP stock received. Because DC 
recognizes no gain on the section 361 exchange with respect to DP1 under 
paragraph (c)(2)(ii) of this section as determined in paragraph (ii)(C) 
of this Example 3, the $135x attributable inside gain with respect to 
DP1 is not reduced under paragraph (c)(3)(i)(A) of this section. DP1's 
outside gain in Share 1 and Share 2 in the aggregate is $15x, the 
product of the section 367(a) percentage of 75% multiplied by $20x (the 
difference between $200x aggregate fair market value and $180x aggregate 
section 358 basis in the FA stock received by DP1). Thus, DP1's section 
358 basis in the FA stock ($180x) must be reduced by $120x (the excess 
of $135x attributable inside gain, reduced by $0x, over $15x outside 
gain) to $60x.
    (E) Under paragraph (c)(3)(iii) of this section, the $120x reduction 
to basis is allocated between Share 1 and Share 2 based on the relative 
section 358 basis of each share. Therefore, the basis in Share 1 is 
reduced by $40x ($120x multiplied by $60x/$180x). As adjusted, DP1's 
basis in Share 1 is $20x ($60x less $40x). The basis in Share 2 is 
reduced by $80x ($120x multiplied by $120x/$180x). As adjusted, DP1's 
basis in Share 2 is $40x ($120x less $80x).
    (F) Paragraph (c)(4)(i) of this section would be satisfied only if 
DC complies with the requirements of Sec. 1.6038B-1(c)(6)(iii), 
including filing with its tax return for the year of the reorganization, 
a statement agreeing to file an amended return reporting the gain 
realized but not recognized on the section 361 exchange in certain cases 
if a significant amount of the section 367(a) property received in the 
section 361 exchange is disposed of, directly or indirectly, in one or 
more related transactions within the prescribed 60-month period.
    Example 4. Control requirement and ownership interest percentage; 
non-qualified property provided by foreign acquiring corporation. (i) 
Facts. DP1 and FP own 80% and 20%, respectively, of the outstanding 
stock of DC. DC owns Business A with a basis of $0x and $100x fair 
market value. DP1's DC stock has a fair market value of $80x, and FP's 
DC stock has a fair market value of $20x. In a reorganization described 
in section 368(a)(1)(D), DC transfers Business A to FA in exchange for 
$80x of FA stock and $20x cash. DC's transfer

[[Page 400]]

of Business A to FA qualifies as a section 361 exchange. DP1 exchanges 
its $80x of DC stock for $60x of FA stock and $20x cash, and FP 
exchanges its $20x of DC stock for $20x of FA stock.
    (ii) Result. (A) The requirement of paragraph (c)(1) of this section 
is satisfied because DC is controlled (within the meaning of section 
368(c)) by five or fewer domestic corporations immediately before the 
reorganization (in this case, by a single domestic corporation, DP1). 
The fact that the $20x cash is distributed solely to DP1 does not change 
the analysis of the control requirement. The control requirement is 
determined immediately before the reorganization and is not affected by 
distributions of property.
    (B) Pursuant to paragraph (f)(7) of this section, the ownership 
interest percentages of DP1 and FP immediately before the reorganization 
are 80% ($80x/($80x + $20x)) and 20% ($20x/($80x + $20x)), respectively. 
The fact that the $20x of cash is distributed solely to DP1 does not 
change this result. The distribution of the $20x of cash is not taken 
into account for purposes of the ownership interest percentage 
computation because the $20x of cash distributed by DC is provided by FA 
to DC in the section 361 exchange.
    Example 5. Control requirement and ownership interest percentage; 
non-qualified property provided by U.S. transferor. (i) Facts. The facts 
are the same as in Example 4, except as follows. Business A has a fair 
market value of $80x (and not $100x) and DC also owns inventory with a 
basis of $0x and fair market value of $20x. DC transfers Business A, but 
not the inventory, to FA in exchange for $80x of FA stock. DP1 exchanges 
its $80x of DC stock for $60x of FA stock and the $20x of inventory, and 
FP exchanges its $20x of DC stock for $20x of FA stock.
    (ii) Result. (A) The requirement of paragraph (c)(1) of this section 
is satisfied because DC is controlled (within the meaning of section 
368(c)) by five or fewer domestic corporations immediately before the 
reorganization (in this case, by a single domestic corporation, DP1). 
The fact that the $20x of inventory is not transferred to FA, but is 
instead distributed solely to DP1, does not change the analysis of the 
control requirement. The control requirement is determined immediately 
before the reorganization, and is not affected by distributions of 
property.
    (B) Pursuant to the general rule of paragraph (f)(7) of this 
section, the ownership interest percentages of DP1 and FP immediately 
before the reorganization would be 80% ($80x/($80x + $20x)) and 20% 
($20x/($80x + $20x)), respectively. In this case, however, the 
distribution of the $20x inventory to DP1 is taken into account for 
purposes of computing the ownership interest percentage of DP1 and FP 
because the inventory is not provided by FA to DC in the section 361 
exchange. With respect to DP1, the numerator of the ownership interest 
percentage computation is $60x, computed as the fair market value of DC 
stock owned by DP1 immediately before the reorganization but reduced by 
the fair market value of the inventory distributed to DP1 ($80x less 
$20x). With respect to FP, the numerator of the ownership interest 
percentage computation is $20x, the fair market value of the DC stock 
owned by FP immediately before the reorganization. With respect to both 
DP1 and FP, the denominator of the ownership interest percentage 
computation is $80x, computed as the fair market value of all DC stock 
immediately before the reorganization, but reduced by the fair market 
value of the inventory distributed to DP1 ($100x, less $20x). 
Accordingly, the ownership interest percentage of DP1 is 75% ($60x/
$80x), and the ownership interest percentage of FP is 25% ($20x/$80x).

    (h) Applicable cross-references. For rules relating to the 
character, source, and adjustments resulting from gain recognized by a 
U.S. transferor under section 367(a), see Sec. 1.367(a)-1(b)(4). For 
rules relating to transfers of stock or securities in a section 361 
exchange, see Sec. 1.367(a)-3(e). For rules relating to the acquisition 
of the stock or assets of a foreign corporation by another foreign 
corporation, see Sec. 1.367(b)-4. For rules relating to transfers of 
section 367(d) property by a U.S. transferor to a foreign corporation, 
see section 367(d). For rules relating to distributions of stock of a 
foreign corporation by a domestic corporation under section 355 or 361, 
see Sec. Sec. 1.367(b)-5, 1.367(e)-1, and 1.1248(f)-1 through 
1.1248(f)-3. For additional rules relating to certain reporting 
requirements of a U.S. transferor, see Sec. 1.6038B-1. For rules 
regarding expatriated entities, see section 7874 and the regulations 
under that section.
    (i) [Reserved]
    (j)(1) Effective/applicability dates. Except for paragraph (e)(2) of 
this section, and as provided in paragraph (j)(2) of this section, this 
section applies to transfers occurring on or after April 18, 2013. 
Paragraph (e)(2) applies to requests for relief submitted on or after 
November 19, 2014. Paragraph (e)(2) of this section also applies to 
requests for relief submitted before November 19, 2014 if the statute of 
limitations on the assessment of tax has not expired for any year to 
which the request relates and the control group member or U.S.

[[Page 401]]

transferor, as applicable, resubmits the request under paragraph (e)(2) 
of this section and notes, on the request, that the request is being 
submitted pursuant to the third sentence of this paragraph (j). See 
paragraph (e)(2) of this section, as contained in 26 CFR part 1 revised 
as of April 1, 2014, for requests for relief submitted after April 17, 
2013, and before November 19, 2014, that are not resubmitted under 
paragraph (e)(2) of this section.
    (2) Section 367(d) property. The definition provided in paragraph 
(f)(11) of this section applies to transfers occurring on or after 
September 14, 2015, and to transfers occurring before September 14, 
2015, resulting from entity classification elections made under Sec. 
301.7701-3 that are filed on or after September 14, 2015. For transfers 
occurring before this section is applicable, see Sec. 1.367(a)-7 as 
contained in 26 CFR part 1 revised as of April 1, 2016.

[T.D. 9614, 78 FR 17032, Mar. 19, 2013, as amended by T.D. 9704, 79 FR 
68767, Nov. 19, 2014; T.D. 9760, 81 FR 15169, Mar. 22, 2016; T.D. 9803, 
81 FR 91028, Dec. 16, 2016; T.D. 9614, 85 FR 51347, Aug. 20, 2020]



Sec. 1.367(a)-8  Gain recognition agreement requirements.

    (a) Scope. This section provides the terms and conditions for a gain 
recognition agreement entered into by a United States person pursuant to 
Sec. 1.367(a)-3(b) through (e) in connection with a transfer of stock 
or securities to a foreign corporation pursuant to an exchange that 
would otherwise be subject to section 367(a)(1). Paragraph (b) of this 
section provides definitions and special rules. Paragraphs (c) through 
(h) of this section identify the form, content, and other conditions of 
a gain recognition agreement. Paragraph (i) of this section is reserved. 
Paragraph (j) of this section identifies certain events that may require 
gain to be recognized under a gain recognition agreement. Paragraph (k) 
of this section provides exceptions for certain events that would 
otherwise require gain to be recognized under a gain recognition 
agreement. Paragraph (l) of this section is reserved. Paragraph (m) of 
this section provides rules that require gain to be recognized under a 
gain recognition agreement in connection with certain events to which an 
exception under paragraph (k) of this section otherwise applies. 
Paragraph (n) of this section provides special rules in the case of a 
distribution of property with respect to stock to which section 301 
applies. Paragraph (o) of this section provides rules for certain 
transactions that terminate or reduce the amount of gain subject to a 
gain recognition agreement. Paragraph (p) of this section provides 
relief for certain failures to file an initial gain recognition 
agreement (as defined in paragraph (b)(1)(vi) of this section) or to 
comply with the requirements of this section with respect to a gain 
recognition agreement (as described in paragraph (c) of this section). 
Paragraph (q) of this section provides examples that illustrate the 
rules of the section. Paragraph (r) of this section provides effective 
dates for the provisions of this section.
    (b) Definitions and special rules. The following definitions and 
special rules apply for purposes of this section.
    (1) Definitions--(i) Asset reorganization--(A) General rule. Except 
as provided in paragraph (b)(1)(i)(B) of this section, an asset 
reorganization is a reorganization described in section 368(a)(1) that 
involves an exchange of property described in section 361(a) or (b) (a 
section 361 exchange).
    (B) Exceptions. An asset reorganization does not include the 
following:
    (1) A reorganization described in section 368(a)(1)(D) or (G) if the 
requirements of section 354(b)(1)(A) and (B) are not met.
    (2) For purposes of paragraphs (j)(2)(ii)(B), (k)(6)(ii), and 
(k)(6)(iii) of this section, a triangular asset reorganization. For 
rules applicable to a triangular asset reorganization, see paragraph 
(k)(7) of this section.
    (ii) A consolidated group has the meaning set forth in Sec. 1.1502-
1(h).
    (iii) Disposition. Except as provided in this paragraph (b)(1)(iii), 
a disposition includes any transfer that would constitute a disposition 
for any purpose of the Internal Revenue Code. A disposition includes an 
indirect disposition of the stock of the transferred corporation as 
described in Sec. 1.367(a)-3(d). Except as provided in paragraph (n)(1) 
of

[[Page 402]]

this section, a disposition does not include the receipt of a 
distribution of property with respect to stock to which section 301 
applies (including by reason of section 302(d)). See paragraphs (n)(2) 
and (o)(3) of this section for rules that apply if gain is recognized 
under section 301(c)(3). A complete or partial disposition by 
installment sale (under section 453) shall be treated as a disposition 
in the year of the installment sale.
    (iv) A gain recognition agreement document means any agreement, 
statement, schedule, or form required to be filed under this section, 
including an initial gain recognition agreement (as defined in paragraph 
(b)(1)(vi) of this section), a new gain recognition agreement described 
in paragraph (c)(5) of this section, a Form 8838 extending the period of 
limitations on assessment of tax described in paragraph (f) of this 
section, and an annual certification described in paragraph (g) of this 
section.
    (v) A gain recognition event is an event described in paragraphs (j) 
through (o) of this section that requires gain to be recognized under a 
gain recognition agreement.
    (vi) An initial gain recognition agreement means the gain 
recognition agreement entered into under paragraph (c) of this section 
with respect to the initial transfer.
    (vii) The initial transfer means a transfer of stock or securities 
(transferred stock or securities) to a foreign corporation pursuant to 
an exchange that would otherwise be subject to section 367(a)(1) but 
with respect to which a gain recognition agreement is entered into by a 
United States person pursuant to Sec. 1.367(a)-3(b) through (e).
    (viii) An intercompany item has the meaning set forth in Sec. 
1.1502-13(b)(2).
    (ix) An intercompany transaction has the meaning set forth in Sec. 
1.1502-13(b)(1).
    (x) A nonrecognition transaction has the meaning set forth in 
section 7701(a)(45). In addition, a nonrecognition transaction includes 
an exchange described in section 351(b) or 356 even if all gain realized 
in the exchange is recognized.
    (xi) The terms P, S, and T have the meanings set forth in Sec. 
1.358-6(b)(1)(i), (ii), and (iii), respectively.
    (xii) The determination of whether substantially all of the assets 
of the transferred corporation have been disposed of is based on all the 
facts and circumstances.
    (xiii) A timely filed return means a Federal income tax return filed 
on or before the last date prescribed for filing (taking into account 
any extensions of time therefor) such return.
    (xiv) Transferee foreign corporation. Except as provided in this 
paragraph (b)(1)(xiv), the transferee foreign corporation is the foreign 
corporation to which the transferred stock or securities are transferred 
in an initial transfer. In the case of an indirect stock transfer, the 
transferee foreign corporation has the meaning set forth in Sec. 
1.367(a)-3(d)(2)(i). The transferee foreign corporation also includes a 
corporation designated as the transferee foreign corporation in the case 
of a new gain recognition agreement entered into under this section.
    (xv) Transferred corporation. Except as provided in this paragraph 
(b)(1)(xv), the transferred corporation is the corporation the stock or 
securities of which are transferred in the initial transfer. In the case 
of an indirect stock transfer, the transferred corporation has the 
meaning set forth in Sec. 1.367(a)-3(d)(2)(ii). The transferred 
corporation also includes a corporation designated as the transferred 
corporation in the case of a new gain recognition agreement entered into 
under this section.
    (xvi) A triangular asset reorganization is a reorganization 
described in Sec. 1.358-6(b)(2)(i), (ii), (iii), or (v).
    (xvii) The U.S. transferor is the United States person (as defined 
in Sec. 1.367(a)-1(d)(1)) that transfers the transferred stock or 
securities to the transferee foreign corporation in the initial 
transfer. For purposes of determining the U.S. transferor in the case of 
a transfer by a partnership, see Sec. 1.367(a)-1(c)(3)(i). The U.S. 
transferor also includes the United States person designated as the U.S. 
transferor in the case of a new gain recognition agreement entered into 
under this section including, for example, under paragraph (k)(14) of 
this section.
    (2) Special rules--(i) Stock deemed received or transferred. 
References to

[[Page 403]]

stock received include stock deemed received (for example, pursuant to 
section 367(c)(2)). References to a transfer of stock or securities 
include a deemed transfer of stock or securities.
    (ii) Stock of the transferee foreign corporation. References to 
stock of the transferee foreign corporation include any stock of the 
transferee foreign corporation the basis of which is determined, in 
whole or in part, by reference to the basis of the stock of the 
transferee foreign corporation received by the U.S. transferor in the 
initial transfer.
    (iii) Transferred stock or securities. References to transferred 
stock or securities include any stock or securities of the transferred 
corporation the basis of which is determined, in whole or in part, by 
reference to the basis of the stock or securities transferred in the 
initial transfer.
    (c) Gain recognition agreement--(1) Terms of agreement--(i) General 
rule. Except as provided in this paragraph (c)(1)(i), if a gain 
recognition event occurs during the period beginning on the date of the 
initial transfer and ending as of the close of the fifth full taxable 
year (not less than 60 months) following the close of the taxable year 
in which the initial transfer occurs (GRA term), the U.S. transferor 
must include in income the gain realized but not recognized on the 
initial transfer by reason of entering into the gain recognition 
agreement. In the case of a gain recognition event that occurs as a 
result of a partial disposition of stock, securities, or a partnership 
interest, as applicable, the U.S. transferor is required to recognize a 
proportionate amount of the gain subject to the gain recognition 
agreement, determined based on the fair market value of the stock, 
securities, or partnership interest, as applicable, disposed of 
(measured at the time of the partial disposition) as compared to the 
fair market value of all the stock, securities, or partnership interest, 
as applicable (measured at the time of the partial disposition). If the 
U.S. transferor must recognize gain under this paragraph as a result of 
an event described in paragraph (m) or (n) of this section, see those 
paragraphs to determine the amount of the gain that must be recognized. 
The amount of gain subject to the gain recognition agreement shall be 
reduced by the amount of gain recognized under this paragraph. If the 
amount of gain subject to the gain recognition agreement is reduced to 
zero, the gain recognition agreement shall terminate without further 
effect.
    (ii) Ordering rule for gain recognized under multiple gain 
recognition agreements. If a gain recognition event occurs that requires 
gain to be recognized under multiple gain recognition agreements, gain 
shall first be recognized under the gain recognition agreement that 
relates to the earliest initial transfer, then under the gain 
recognition agreement that relates to the immediately following initial 
transfer and so forth until the appropriate amount of gain has been 
recognized under each gain recognition agreement. The amount of gain 
recognized under a gain recognition agreement shall be determined after 
taking into account, as appropriate, any increase to basis (including 
the basis of the transferred stock or securities) under paragraph (c)(4) 
of this section resulting from gain recognized under another gain 
recognition agreement. For an illustration of this ordering rule, see 
paragraph (q)(2)(vi) of this section.
    (iii) Taxable year in which gain is reported--(A) Year of initial 
transfer. Except as provided in paragraph (c)(1)(iii)(B) of this 
section, the U.S. transferor must report any gain recognized under 
paragraph (c)(1)(i) of this section on an amended Federal income tax 
return for the taxable year of the initial transfer. The amended return 
must be filed on or before the 90th day following the date on which the 
gain recognition event occurs.
    (B) Year of gain recognition event. If an election under paragraph 
(c)(2)(vi) of this section is made with the gain recognition agreement 
or if paragraph (c)(5)(ii) of this section applies to the gain 
recognition agreement, the U.S. transferor must report any gain 
recognized under paragraph (c)(1)(i) of this section on its Federal 
income tax return for the taxable year during which the gain recognition 
event occurs. If an election under paragraph (c)(2)(vi) of this section 
is made with the gain recognition agreement or if paragraph

[[Page 404]]

(c)(5)(ii) of this section applies to the gain recognition agreement but 
the U.S. transferor does not report the gain recognized on its Federal 
income tax return for the taxable year during which the gain recognition 
event occurs, the Commissioner may require the U.S. transferor to report 
the gain on an amended Federal income tax return for the taxable year 
during which the initial transfer occurred.
    (iv) Offsets. No special limitations apply with respect to 
offsetting gain recognized under paragraph (c)(1)(i) of this section 
with net operating losses, capital losses, credits against tax, or 
similar items.
    (v) Payment and reporting of interest. Interest must be paid on any 
additional tax due with respect to gain recognized by the U.S. 
transferor under paragraph (c)(1)(i) of this section. Any interest due 
shall be determined based on the rates under section 6621 for the period 
between the date that was prescribed for filing the Federal income tax 
return of the U.S. transferor for the year of the initial transfer and 
the date on which the additional tax due is paid. If paragraph 
(c)(1)(iii)(B) of this section applies, any interest due must be 
included with the payment of tax due with the Federal income tax return 
of the U.S. transferor for the taxable year during which the gain 
recognition event occurs (or should reduce the amount of any refund due 
to the U.S. transferor for such taxable year). A schedule entitled 
``Calculation of Section 367 Tax and Interest'' that separately 
identifies and calculates any additional tax and interest due must be 
included with the Federal income tax return on which any interest due is 
reported.
    (2) Content of gain recognition agreement. The gain recognition 
agreement must be entitled ``GAIN RECOGNITION AGREEMENT UNDER Sec. 
1.367(a)-8'' and include the information described in paragraphs 
(c)(2)(i) through (viii) of this paragraph with the corresponding 
paragraph numbers. The information required under this paragraph (c)(2) 
and paragraph (c)(3) of this section must be included in the gain 
recognition agreement as filed.
    (i) A statement that the document constitutes an agreement by the 
U.S. transferor to recognize gain in accordance with the requirements of 
this section.
    (ii) A description of the transferred stock or securities and other 
information as required in paragraph (c)(3) of this section.
    (iii) A statement that the U.S. transferor agrees to comply with all 
the conditions and requirements of this section, including to recognize 
gain under the gain recognition agreement in accordance with paragraph 
(c)(1)(i) of this section, to extend the period of limitations on 
assessment of tax as provided in paragraph (f) of this section, to file 
the certification described in paragraph (g) of this section, and, as 
provided in paragraph (j)(8) of this section, to treat a failure to 
comply (as described in paragraph (j)(8) of this section) as extending 
the period of limitations on assessment of tax for the taxable year in 
which gain is required to be reported.
    (iv) A statement that arrangements have been made to ensure that the 
U.S. transferor is informed of any events that affect the gain 
recognition agreement, including triggering events or other gain 
recognition events.
    (v) In the case of a new gain recognition agreement filed under this 
section--
    (A) A description of the event (such as a triggering event) and the 
applicable exception, if any, that gave rise to the new gain recognition 
agreement (such as a triggering event exception), including the date of 
the event and the name, address, and taxpayer identification number (if 
any) of each person that is a party to the event;
    (B) As applicable, a description of the class, amount, and 
characteristics of the stock, securities or partnership interest 
received in the transaction; and
    (C) As applicable, a calculation of the amount of gain that remains 
subject to the new gain recognition agreement as a result of the 
application of paragraph (m), (n), or (o) of this section.
    (vi) A statement whether the U.S. transferor elects to include in 
income any gain recognized under paragraph (c)(1)(i) of this section in 
the taxable year during which a gain recognition event occurs. See 
paragraph (c)(5)(ii) of this section for a rule that requires, in

[[Page 405]]

certain cases, for the gain recognized pursuant to a new gain 
recognition agreement to be included in income during the taxable year 
in which the gain recognition event occurs.
    (vii) A statement whether a gain recognition event has occurred 
during the taxable year of the initial transfer.
    (viii) A statement describing any disposition of assets of the 
transferred corporation during such taxable year other than in the 
ordinary course of business.
    (3) Description of transferred stock or securities and other 
information. The gain recognition agreement shall include the following:
    (i) A description of the transferred stock or securities including--
    (A) The type or class, amount, and characteristics of the 
transferred stock or securities;
    (B) A calculation of the amount of the built-in gain in the 
transferred stock or securities that are subject to the gain recognition 
agreement, reflecting the basis and fair market value on the date of the 
initial transfer;
    (C) The amount of any gain recognized by the U.S. transferor on the 
initial transfer; and
    (D) The percentage (by voting power and value) that the transferred 
stock (if any) represents of the total stock outstanding of the 
transferred corporation on the date of the initial transfer.
    (ii) The name, address, place of incorporation, and taxpayer 
identification number (if any) of the transferred corporation.
    (iii) The date on which the U.S. transferor acquired the transferred 
stock or securities.
    (iv) The name, address and place of incorporation of the transferee 
foreign corporation, and a description of the stock or securities 
received by the U.S. transferor in the initial transfer, including the 
percentage of stock (by vote and value) of the transferee foreign 
corporation received in such exchange.
    (v) If the initial transfer is described in Sec. 1.367(a)-3(e), a 
statement that the conditions of section 367(a)(5) and any regulations 
under that section have been satisfied, and a description of any 
adjustments to the basis of the stock received in the transaction or 
other adjustments made pursuant to section 367(a)(5) and any regulations 
under that section.
    (vi) If the transferred corporation is domestic, a statement 
describing the application of section 7874 to the transaction, and 
indicating that the requirements of Sec. 1.367(a)-3(c)(1) are 
satisfied.
    (vii) If the transferred corporation is foreign, a statement 
indicating whether the U.S. transferor was a section 1248 shareholder 
(as defined in Sec. 1.367(b)-2(b)) of the transferred corporation 
immediately before the initial transfer, and whether the U.S. transferor 
is a section 1248 shareholder with respect to the transferee foreign 
corporation immediately after the initial transfer, and whether any 
reporting requirements or other rules contained in regulations under 
section 367(b) are applicable, and, if so, whether they have been 
satisfied.
    (viii) If the initial transfer involves a transfer by a partnership 
(see Sec. 1.367(a)-1(c)(3)(i)) or a transfer of a partnership interest 
(see section 367(a)(4) and Sec. 1.367(a)-1(c)(3)(ii)) a complete 
description of the transfer, including a description of the partners in 
the partnership.
    (ix) If the transaction involved the transfer of property other than 
the transferred stock or securities and the transaction was subject to 
the indirect stock transfer rules of Sec. 1.367(a)-3(d), a statement 
indicating whether--
    (A) The reporting requirements under section 6038B have been 
satisfied with respect to the transfer of such other property;
    (B) Whether gain was recognized under section 367(a)(1);
    (C) Whether section 367(d) applied to the transfer of such property; 
and
    (D) Whether the other property transferred qualified for the active 
foreign trade or business exception under section 367(a)(3).
    (4) Basis adjustments for gain recognized. The following basis 
adjustments shall be made if gain is recognized under paragraph 
(c)(1)(i) of this section.
    (i) Stock or securities of transferee foreign corporation. The basis 
of the stock or securities, as applicable, of the transferee foreign 
corporation received by the U.S. transferor in the initial

[[Page 406]]

transfer shall be increased as of the date of the initial transfer by 
the amount of gain recognized.
    (ii) Transferred stock or securities. The basis of the transferred 
stock or securities shall be increased as of the date of the initial 
transfer by the amount of the gain recognized.
    (iii) Other appropriate adjustments. The basis of other stock, 
securities, or a partnership interest shall be increased, as 
appropriate, in accordance with the principles of this paragraph (c)(4). 
Under no circumstances shall the basis of stock, securities, or of a 
partnership interest held by a U.S. person that does not recognize gain 
under paragraph (c)(1)(i) of this section be increased under this 
paragraph (c)(4). In addition, under no circumstances shall the basis of 
any property be increased by the amount of any additional tax due or 
interest paid with respect to such tax, nor shall the basis of the 
assets of the transferred corporation be increased as a result of gain 
recognized by the U.S. transferor under paragraph (c)(1)(i) of this 
section.
    (iv) Cross-reference. See paragraphs (q)(2)(i), (ii), (iii), and (v) 
of this section for illustrations of the rules of this paragraph (c)(4). 
See also Sec. 1.367(a)-1(b)(4) for rules that determine the increase to 
basis of property resulting from the application of section 367(a).
    (5) Terms and conditions of a new gain recognition agreement--(i) 
General rule. A new gain recognition agreement entered into pursuant to 
this section shall replace the existing gain recognition agreement, 
which shall terminate without further effect. The term of the new gain 
recognition agreement shall be the remaining term of the existing gain 
recognition agreement. The amount of gain subject to the new gain 
recognition agreement shall equal the amount of gain subject to the 
existing gain recognition agreement, reduced by any gain recognized 
under paragraph (c)(1)(i) of this section with respect to the existing 
gain recognition agreement by reason of the gain recognition event that 
gives rise to the new gain recognition agreement. The new gain 
recognition agreement shall, as applicable, be subject to the conditions 
and requirements of this section to the same extent as the existing gain 
recognition agreement. For example, a triggering event with respect to 
the new gain recognition agreement will generally include a disposition 
of the transferred stock or securities or of substantially all the 
assets of the transferred corporation. If, however, the transferred 
stock is canceled or redeemed pursuant to the disposition or other event 
that gives rise to the new gain recognition agreement (for example, 
pursuant to a liquidation where the transferee foreign corporation is 
the corporate distributee (within the meaning of section 334(b)(2)), or 
an asset reorganization where the transferee foreign corporation is the 
acquiring corporation) the transferred stock is not subject to the new 
gain recognition agreement.
    (ii) Special rule for inclusion of gain. If the U.S. transferor with 
respect to the new gain recognition agreement is not the U.S. transferor 
with respect to the existing gain recognition agreement, or a member of 
the consolidated group of which the U.S. transferor with respect to the 
existing gain recognition agreement was a member on the date of the 
initial transfer, then any gain recognized under paragraph (c)(1)(i) of 
this section with respect to the new gain recognition agreement must be 
included in income in the taxable year during which the gain recognition 
event occurs.
    (6) Cross-reference. For gain recognition agreements entered into 
pursuant to certain outbound asset reorganizations, see Sec. 1.367(a)-
3(e)(6).
    (d) Filing requirements--(1) General rule. An initial gain 
recognition agreement must be timely filed in order for the U.S. 
transferor to avoid recognizing gain under section 367(a)(1) with 
respect to the transferred stock or securities by reason of the 
applicable exceptions provided under Sec. 1.367(a)-3. Except as 
provided in paragraph (p) of this section, an initial gain recognition 
agreement is timely filed only if--
    (i) The initial gain recognition agreement and any other gain 
recognition agreement document required to be filed with the initial 
gain recognition agreement are included with a timely filed return of 
the U.S. transferor for the taxable year during which the initial 
transfer occurs; and

[[Page 407]]

    (ii) Each gain recognition agreement document identified in 
paragraph (d)(1)(i) of this section is completed in all material 
respects.
    (2) Special requirements--(i) New gain recognition agreement. A new 
gain recognition agreement entered into under this section must be 
included with the timely-filed return of the U.S. transferor (as 
identified in the new gain recognition agreement) for the taxable year 
during which the disposition or event that requires the new gain 
recognition agreement occurs. If the new gain recognition agreement is 
entered into by the U.S. transferor that entered into the existing gain 
recognition agreement, the new gain recognition agreement is in lieu of 
the annual certification otherwise required for such taxable year under 
paragraph (g) of this section with respect to the existing gain 
recognition agreement.
    (ii) Multiple events within a taxable year. Except as otherwise 
provided in this paragraph (d)(2)(ii), if the initial transfer and one 
or more dispositions or other events (even if a triggering event 
exception applies) that affect the gain recognition agreement entered 
into by the U.S. transferor with respect to the initial transfer occur 
within the same taxable year of such U.S. transferor, or if multiple 
dispositions or other events occur in a taxable year of the U.S. 
transferor that does not include the initial transfer, only one gain 
recognition agreement is required to be entered into and included with 
the timely-filed return of the U.S. transferor for such taxable year. 
The gain recognition agreement must describe the initial transfer and/or 
each disposition or other event that affects the gain recognition 
agreement (even if a triggering event exception applies). This paragraph 
does not apply, however, if any such disposition or other event requires 
a new gain recognition agreement to be entered into by a United States 
person other than the U.S. transferor with respect to the initial 
transfer or that entered into the existing gain recognition agreement, 
as applicable.
    (3) Common parent as agent for U.S. transferor. If the U.S. 
transferor is a member but not the common parent of a consolidated 
group, the common parent of the consolidated group is the agent for the 
U.S. transferor under Sec. 1.1502-77(a)(1). Thus, the common parent 
must file the gain recognition agreement on behalf of the U.S. 
transferor. References in this section to the timely-filed return of the 
U.S. transferor include the timely-filed return of the consolidated 
group of which the U.S. transferor is a member, as applicable.
    (e) Signatory--(1) General rule. The gain recognition agreement must 
be signed under penalties of perjury by an agent of the U.S. transferor 
that is authorized to sign under a general or specific power of 
attorney, or by the appropriate party based on the category of the U.S. 
transferor described in this paragraph (e)(1).
    (i) If the U.S. transferor is a corporation but not a member of a 
consolidated group, a responsible officer of the U.S. transferor. If the 
U.S. transferor is a member of a consolidated group, a responsible 
officer of the common parent of the consolidated group.
    (ii) If the U.S. transferor is an individual, the individual.
    (iii) If the U.S. transferor is a trust or estate, a trustee, 
executor, or equivalent fiduciary of the U.S. transferor.
    (iv) In a bankruptcy case under title 11, United States Code, a 
debtor in possession or trustee.
    (2) Signature requirement. The inclusion of an unsigned copy of the 
gain recognition agreement with the timely-filed return of the U.S. 
transferor shall satisfy the signature requirement of paragraph (e)(1) 
of this section if the U.S. transferor retains the original signed gain 
recognition agreement in the manner specified by Sec. 1.6001-1(e).
    (f) Extension of period of limitations on assessments of tax--(1) 
General rule. In connection with the filing of a gain recognition 
agreement, the U.S. transferor must extend the period of limitations on 
assessments of tax with respect to the gain realized but not recognized 
on the initial transfer through the close of the eighth full taxable 
year following the taxable year during which the initial transfer 
occurs. The U.S. transferor extends the period of limitations by filing 
Form 8838 ``Consent to Extend the Time to Assess Tax Under Section 367--
Gain Recognition

[[Page 408]]

Agreement.'' The Form 8838 must be signed by a person authorized to sign 
the gain recognition agreement under paragraph (e)(1) of this section.
    (2) New gain recognition agreement. If a new gain recognition 
agreement is entered into under this section, the U.S. transferor must 
extend the period of limitations on assessments of tax on the initial 
transfer through the close of the eighth full taxable year following the 
taxable year during which the initial transfer occurs, consistent with 
paragraph (f)(1) of this section, unless the U.S. transferor with 
respect to the new gain recognition agreement is the U.S. transferor 
with respect to the existing gain recognition agreement, or a member of 
the consolidated group of which the U.S. transferor with respect to the 
existing gain recognition agreement was a member on the date of the 
initial transfer.
    (g) Annual certification. Except as provided in paragraph (d)(2)(i) 
of this section, the U.S. transferor must include with its timely-filed 
return for each of the five full taxable years following the taxable 
year of the initial transfer a certification (annual certification) that 
includes the information described in paragraphs (g)(1) through (3) of 
this section, as appropriate. The annual certification must be signed by 
a person authorized under paragraph (e)(1) of this section to sign the 
gain recognition agreement for the initial transfer. The inclusion of an 
unsigned copy of the annual certification with the relevant timely-filed 
return of the U.S. transferor shall satisfy the signature requirement of 
paragraph (e)(1) of this section provided the U.S. transferor retains 
the original signed certification in the manner specified by Sec. 
1.6001-1(e).
    (1) A statement of whether a gain recognition event has or has not 
occurred during such taxable year. If a gain recognition event has 
occurred during such taxable year, the annual certification must state:
    (i) The amount of gain subject to the gain recognition agreement at 
the time of the gain recognition event;
    (ii) The amount of gain recognized under the gain recognition 
agreement by reason of the gain recognition event; and
    (iii) A calculation of the reduction to the amount of gain subject 
to the gain recognition agreement by reason of the gain recognition 
event (for example, in the case of a gain recognition event described in 
paragraph (n)(2) of this section).
    (2) A complete description of any event occurring during such 
taxable year that has terminated or reduced the amount of gain subject 
to the gain recognition agreement (for example, an event described in 
paragraph (o) of this section), including a calculation of any reduction 
to the amount of gain subject to the gain recognition agreement.
    (3) A statement describing any disposition of assets of the 
transferred corporation during the taxable year not in the ordinary 
course of business.
    (h) Use of security. The U.S. transferor may be required to furnish 
a bond or other security that satisfies the requirements of Sec. 
301.7101-1 if the Area Director, Field Examination, Small Business/Self 
Employed or the Director of Field Operations, Large and Mid-Size 
Business (Director) determines that such security is necessary to ensure 
the payment of any tax on the gain realized, but not recognized, upon 
the initial transfer. Such bond or security generally will be required 
only if the transferred stock or securities are a principal asset of the 
U.S. transferor and the Director has reason to believe that a 
disposition of the stock or securities may be contemplated.
    (i) [Reserved]
    (j) Triggering events. Except as provided in this section, if an 
event described in paragraphs (j)(1) through (10) of this section 
(triggering event) occurs during the GRA term, the U.S. transferor must 
recognize gain under the gain recognition agreement in accordance with 
paragraph (c)(1)(i) of this section. This paragraph (j) generally 
requires the U.S. transferor to recognize gain (and pay applicable 
interest with respect to any additional tax due as provided in paragraph 
(c)(1)(v) of this section) under the gain recognition agreement to the 
extent the transferred stock or securities are disposed of, directly or 
indirectly. This paragraph (j) also requires the U.S. transferor to 
recognize gain under the gain recognition agreement in certain cases

[[Page 409]]

where it is not appropriate for the gain recognition agreement to 
continue. See paragraph (k) of this section for exceptions available for 
certain events that would otherwise constitute triggering events under 
this paragraph (j). See paragraph (o) of this section for certain events 
that terminate or reduce the amount of gain subject to a gain 
recognition agreement.
    (1) Disposition of transferred stock or securities. A complete or 
partial disposition of the transferred stock or securities. See 
paragraph (q)(2)(ii) of this section for an illustration of the rule of 
this paragraph (j)(1).
    (2) Disposition of substantially all of the assets of the 
transferred corporation--(i) General rule. Except as provided in 
paragraph (j)(2)(ii) of this section, a disposition in one or more 
related transactions of substantially all of the assets of the 
transferred corporation (including stock or securities in a subsidiary 
corporation or a partnership interest). If the transferred corporation 
is domestic, see paragraph (o)(4) of this section.
    (ii) Exceptions. For purposes of paragraph (j)(2)(i) of this 
section, the following dispositions shall be disregarded--
    (A) Dispositions of property described in section 1221(a)(1) 
occurring in the ordinary course of business;
    (B) An exchange of stock or securities described in section 354 that 
is pursuant to an asset reorganization; and
    (C) An exchange of stock by a corporate distributee (as defined in 
section 334(b)(2)) pursuant to a complete liquidation to which section 
332 applies.
    (3) Disposition of certain partnership interests. If the initial 
transfer occurs by reason of the transfer of a partnership interest, a 
complete or partial disposition of such partnership interest. See 
section 367(a)(4) and Sec. 1.367(a)-1(c)(3)(ii).
    (4) Disposition of stock of the transferee foreign corporation. A 
complete or partial disposition of the stock of the transferee foreign 
corporation received by the U.S. transferor in the initial transfer. For 
purposes of this section, an individual U.S. transferor that loses U.S. 
citizenship or ceases to be a lawful permanent resident of the United 
States (within the meaning of section 7701(b)(6)) shall be treated as 
disposing of all the stock of the transferee foreign corporation 
received in the initial transfer as of the date before the loss of such 
status.
    (5) Deconsolidation. A U.S. transferor that is a member of a 
consolidated group ceases to be a member of the consolidated group, 
other than by reason of an acquisition of the assets of the U.S. 
transferor in a transaction to which section 381(a) applies, or by 
reason of the U.S. transferor joining another consolidated group as part 
of the same transaction.
    (6) Consolidation. A U.S. transferor becomes a member of a 
consolidated group, including a U.S. transferor that is a member of a 
consolidated group and that becomes a member of another consolidated 
group.
    (7) Death of an individual; trust or estate ceases to exist. A U.S. 
transferor that is an individual dies, or a U.S. transferor that is a 
trust or estate ceases to exist.
    (8) Failure to comply. A U.S. transferor fails to comply in any 
material respect with any requirement of this section, or the terms of 
the gain recognition agreement as described in paragraph (c)(1) of this 
section. A failure to comply under this paragraph (j)(8) will extend the 
period of limitations on assessment of tax for the taxable year in which 
gain is required to be reported until the close of the third full 
taxable year ending after the date on which the U.S. transferor 
furnishes to the Director of Field Operations, Cross Border Activities 
Practice Area of Large Business & International (or any successor to the 
roles and responsibilities of such person) (Director) the information 
that should have been provided under this section. Except as provided in 
paragraph (p) of this section, for purposes of this paragraph (j)(8), a 
failure to comply includes--
    (i) If there is a gain recognition event in a taxable year, a 
failure to report gain or pay any additional tax or interest due under 
the terms of the gain recognition agreement; and
    (ii) A failure to file a gain recognition agreement document, other 
than an initial gain recognition agreement or a document required to be 
filed with

[[Page 410]]

the initial gain recognition agreement. For this purpose, there is a 
failure to file a gain recognition agreement document if--
    (A) The gain recognition agreement document is not timely filed as 
required under this section, or
    (B) The gain recognition agreement document is not completed in all 
material respects.
    (9) Gain recognition agreement filed in connection with indirect 
stock transfers and certain triangular asset reorganizations. With 
respect to a gain recognition agreement entered into in connection with 
an indirect stock transfer (as defined in Sec. 1.367(a)-3(d)), or a 
triangular asset reorganization described in Sec. 1.367(a)-3(e)(6)(iv), 
an indirect disposition of the transferred stock or securities. For 
example, in the case of an indirect stock transfer described in Sec. 
1.367(a)-3(d)(1)(iii)(A), a complete or partial disposition of the stock 
of the acquiring corporation.
    (10) Gain recognition agreement filed pursuant to paragraph (k)(14) 
of this section. In the case of a gain recognition agreement entered 
into pursuant to paragraph (k)(14) of this section, in addition to any 
disposition or other event described in paragraphs (j)(1) through (9) of 
this section,--
    (i) Any disposition or other event identified as a triggering event 
in a new gain recognition agreement as required under paragraph 
(k)(14)(iii) of this section; and
    (ii) Any disposition or other event that is inconsistent with the 
principles of paragraph (k) of this section including, for example, an 
indirect disposition of the transferred stock or securities.
    (k) Triggering event exceptions. Notwithstanding paragraph (j) of 
this section, a disposition or other event described in paragraphs 
(k)(1) through (14) of this section shall not constitute a triggering 
event. This paragraph (k) generally provides exceptions for certain 
dispositions that constitute nonrecognition transactions but only if, 
immediately after the disposition, a U.S. transferor retains, as 
applicable, a direct or indirect interest in the transferred stock or 
securities, or in the assets of the transferred corporation, and a new 
gain recognition agreement is entered into with respect to the initial 
transfer in accordance with this paragraph (k). Notwithstanding the 
application of this paragraph (k), if a gain recognition event described 
under paragraphs (m) and (n) of this section occurs during the GRA term 
the U.S. transferor may be required to recognize gain under the gain 
recognition agreement in accordance with paragraph (c)(1)(i) of this 
section. See paragraph (o) of this section which provides that, 
notwithstanding paragraph (j) of this section, certain dispositions or 
other events shall instead terminate or reduce the amount of gain 
subject to a gain recognition agreement.
    (1) Transfers of stock of the transferee foreign corporation to a 
corporation or partnership. A disposition of stock of the transferee 
foreign corporation received in the initial transfer pursuant to an 
exchange to which section 351, 354 (but only in a reorganization 
described in section 368(a)(1)(B) that is not a triangular 
reorganization), 361 (but only in a divisive reorganization to which 
section 355 applies), or 721 applies, shall not constitute a triggering 
event if a new gain recognition agreement is entered into in accordance 
with paragraphs (k)(1)(i) through (iv) of this section, as applicable. 
In the case of an exchange to which section 354 applies that is pursuant 
to a triangular reorganization described in section 368(a)(1)(B), see 
paragraph (k)(14) of this section and paragraph (q)(2)(iv) of this 
section.
    (i) In the case of an exchange to which section 351 or 354 applies 
in which stock of a foreign acquiring corporation is received, the U.S. 
transferor includes with the new gain recognition agreement a statement 
that a complete or partial disposition of the stock of the foreign 
acquiring corporation received in the exchange shall constitute a 
triggering event. The principles of paragraph (o)(1)(i) or (ii), as 
appropriate, shall be applied to determine whether a subsequent complete 
or partial disposition of the stock of the foreign acquiring corporation 
received in the exchange shall instead terminate or reduce the amount of 
the new gain recognition agreement.
    (ii) In the case of an exchange to which section 351 or 354 applies 
in

[[Page 411]]

which stock of a domestic acquiring corporation is received, the 
domestic acquiring corporation enters into the new gain recognition 
agreement, which must designate the domestic acquiring corporation as 
the U.S. transferor for purposes of this section. For an illustration of 
the rule provided by this paragraph (k)(1)(ii), see paragraph 
(q)(2)(iii) of this section.
    (iii) In the case of a section 361 exchange that is pursuant to a 
divisive reorganization to which section 355 applies and in which stock 
of a domestic corporation (domestic controlled corporation) is received, 
the domestic controlled corporation enters into the new gain recognition 
agreement, which must designate the domestic controlled corporation as 
the U.S. transferor for purposes of this section. For an illustration of 
the rule provided by this paragraph (k)(1)(iii), see paragraph 
(q)(2)(xi) of this section.
    (iv) In the case of an exchange to which section 721 applies, the 
U.S. transferor includes with the new gain recognition agreement a 
statement that a complete or partial disposition of the partnership 
interest received in the exchange shall constitute a triggering event 
for purposes of the new gain recognition agreement.
    (2) Complete liquidation of U.S. transferor under sections 332 and 
337. A distribution by the U.S. transferor of the stock of the 
transferee foreign corporation received in the initial transfer to which 
section 337 applies, that is pursuant to a complete liquidation under 
section 332, shall not constitute a triggering event if the corporate 
distributee (as defined in section 334(b)(2)) is a domestic corporation 
(domestic corporate distributee) and the domestic corporate distributee 
enters into a new gain recognition agreement. The new gain recognition 
agreement must designate the domestic corporate distributee as the U.S. 
transferor for purposes of this section.
    (3) Transfers of transferred stock or securities to a corporation or 
partnership. A disposition of the transferred stock or securities 
pursuant to an exchange to which section 351, 354 (but only in a 
reorganization described in section 368(a)(1)(B)), or 721 applies, shall 
not constitute a triggering event if the U.S. transferor enters in to a 
new gain recognition agreement that provides that the dispositions 
described in paragraphs (k)(3)(i) and (ii) of this section shall 
constitute triggering events for purposes of the new gain recognition 
agreement.
    (i) A complete or partial disposition of the stock, securities, or 
partnership interest (as applicable) received in exchange for the 
transferred stock or securities.
    (ii) Any other event that is inconsistent with the principles of 
this paragraph (k), including the indirect disposition of the 
transferred stock or securities.
    (4) Transfers of substantially all of the assets of the transferred 
corporation. A disposition of substantially all of the assets of the 
transferred corporation pursuant to an exchange to which section 351, 
354 (but only in a reorganization described in section 368(a)(1)(B)), or 
721 applies, shall not constitute a triggering event if the U.S. 
transferor enters into a new gain recognition agreement that provides 
that a complete or partial disposition of the stock, securities, or 
partnership interest (as applicable) received in exchange for the assets 
shall constitute a triggering event for purposes of the new gain 
recognition agreement.
    (5) Recapitalizations and section 1036 exchanges. A complete or 
partial disposition of the transferred stock or securities, or of the 
stock of the transferee foreign corporation received in the initial 
transfer, pursuant to a reorganization described under section 
368(a)(1)(E), or pursuant to a transaction to which section 1036 
applies, shall not constitute a triggering event if the U.S. transferor 
enters into a new gain recognition agreement.
    (6) Certain asset reorganizations--(i) Stock of transferee foreign 
corporation. If stock of the transferee foreign corporation received in 
the initial transfer is transferred to a domestic acquiring corporation 
in a section 361 exchange that is pursuant to an asset reorganization, 
the exchanges made pursuant to the asset reorganization shall not 
constitute triggering events if the domestic acquiring corporation 
enters into a new gain recognition agreement that

[[Page 412]]

designates the domestic acquiring corporation as the U.S. transferor for 
purposes of this section. For an illustration of the rule provided by 
this paragraph (k)(6), see paragraph (q)(2)(v) of this section. If the 
acquiring corporation is foreign, see paragraph (k)(14) of this section 
and paragraph (q)(2)(vi) of this section.
    (ii) Transferred stock or securities. If the transferred stock or 
securities are transferred to a foreign acquiring corporation in a 
section 361 exchange that is pursuant to an asset reorganization, the 
exchanges made pursuant to the asset reorganization shall not constitute 
triggering events if the U.S. transferor enters into a new gain 
recognition agreement that designates the foreign acquiring corporation 
as the transferee foreign corporation for purposes of this section. For 
an illustration of the rule provided by this paragraph, see paragraph 
(q)(2)(vii) of this section. If the transfer is to a domestic acquiring 
corporation, or is pursuant to a triangular asset reorganization, see 
paragraph (k)(14) or (o)(5) of this section.
    (iii) Assets of transferred corporation. If substantially all of the 
assets of the transferred corporation are transferred to a foreign or 
domestic acquiring corporation in a section 361 exchange that is 
pursuant to an asset reorganization, the exchanges made pursuant to the 
asset reorganization shall not constitute triggering events if the U.S. 
transferor enters into a new gain recognition agreement that, unless the 
acquiring corporation is the transferee foreign corporation, designates 
the acquiring corporation as the transferred corporation for purposes of 
this section. Only the assets of the transferred corporation received by 
the acquiring corporation shall be treated as assets of the transferred 
corporation for purposes of this section (for example, only such assets 
will be taken into account for purposes of paragraph (j)(2) of this 
section). For an illustration of the rule provided by this paragraph, 
see paragraph (q)(2)(viii) of this section. If the transferred 
corporation is domestic, see section 367(a)(1) and (a)(5), and paragraph 
(o)(4) of this section. If the transfer is pursuant to a triangular 
asset reorganization, see paragraph (k)(14) of this section.
    (7) Certain triangular reorganizations--(i) Transferee foreign 
corporation. If substantially all of the assets of the transferee 
foreign corporation are transferred to a foreign acquiring corporation 
in a section 361 exchange that is pursuant to a triangular asset 
reorganization, the exchanges made pursuant to the reorganization shall 
not constitute triggering events if a new gain recognition agreement is 
entered into in accordance with paragraphs (k)(7)(i)(A) through (C) of 
this section. If the acquiring corporation is domestic, see paragraph 
(k)(14) of this section. For rules that apply to gain recognition 
agreements entered into as a result of an indirect stock transfer, see 
Sec. 1.367(a)-3(d)(2)(iv) and paragraph (j)(9) of this section.
    (A) If P is foreign, the new gain recognition agreement designates P 
as the transferee foreign corporation and includes a statement that the 
U.S. transferor agrees to treat a complete or partial disposition of the 
S stock held by P as a triggering event.
    (B) Except as provided in paragraph (k)(7)(i)(C) of this section, if 
P is domestic, P enters into the new gain recognition agreement that 
designates P as the U.S. transferor and S as the transferee foreign 
corporation.
    (C) If the triangular asset reorganization is described in section 
368(a)(1)(A) by reason of section 368(a)(2)(E) and the transferee 
foreign corporation is the merged corporation, the U.S. transferor 
enters into the new gain recognition agreement and designates the 
surviving corporation as the transferee foreign corporation.
    (ii) Transferred corporation. If substantially all of the assets of 
the transferred corporation are transferred in a section 361 exchange 
pursuant to a triangular asset reorganization, the exchanges made 
pursuant to the reorganization shall not constitute triggering events if 
the U.S. transferor enters into a new gain recognition agreement in 
accordance with paragraph (k)(7)(ii)(A) of this section and, as 
applicable, paragraph (k)(7)(ii)(B) or (C) of this section.
    (A) The new gain recognition agreement includes a statement that the

[[Page 413]]

U.S. transferor agrees to treat a complete or partial disposition of the 
P stock received in the reorganization as a triggering event.
    (B) If the triangular asset reorganization is described in section 
368(a)(1)(C), or section 368(a)(1)(A) or (G) by reason of section 
368(a)(2)(D), the new gain recognition agreement includes a statement 
that the U.S. transferor agrees to treat a complete or partial 
disposition of the S stock held by P as a triggering event.
    (C) If the triangular asset reorganization is described in section 
368(a)(1)(A) by reason of section 368(a)(2)(E) and the transferred 
corporation is the merged corporation, the new gain recognition 
agreement includes a statement that the U.S. transferor agrees to treat 
a complete or partial disposition of the stock of the surviving 
corporation as a triggering event.
    (8) Complete liquidation of transferred corporation. A distribution 
of substantially all of the assets of the transferred corporation to 
which section 337 applies, and the related exchange of the transferred 
stock to which section 332 applies, shall not constitute triggering 
events, if the U.S. transferor enters into a new gain recognition 
agreement. If the transferred corporation is domestic, see Sec. 
1.367(e)-2 and paragraph (o)(4) of this section. See paragraph 
(q)(2)(ix) of this section for an illustration of the rules provided in 
this paragraph (k)(8).
    (9) Death of U.S. transferor. The death of a U.S. transferor shall 
not constitute a triggering event if the person winding up the affairs 
of the U.S. transferor--
    (i) Retains sufficient assets of the U.S. transferor to satisfy any 
possible Federal tax liability of the U.S. transferor under the gain 
recognition agreement for the duration of the extended period of 
limitations on assessments of tax on the gain realized but not 
recognized in the initial transfer;
    (ii) Provides security as required under paragraph (h) of this 
section for any possible Federal tax liability of the U.S. transferor 
under the gain recognition agreement; or
    (iii) Obtains a ruling from the Internal Revenue Service providing 
for one or more successors to the U.S. transferor under the gain 
recognition agreement.
    (10) Deconsolidation. A deconsolidation of the U.S. transferor shall 
not constitute a triggering event if the U.S. transferor enters into a 
new gain recognition agreement.
    (11) Consolidation. A consolidation of the U.S. transferor shall not 
constitute a triggering event if the U.S. transferor enters into a new 
gain recognition agreement. See paragraph (d)(3) of this section.
    (12) Intercompany transactions--(i) General rule. If, pursuant to an 
intercompany transaction, the U.S. transferor disposes of stock of the 
transferee foreign corporation received in the initial transfer, this 
paragraph (k)(12) applies to such disposition to the extent the 
intercompany transaction creates an intercompany item that is not taken 
into account in the taxable year during which the intercompany 
transaction occurs. To the extent this paragraph (k)(12) applies, the 
disposition shall not constitute a triggering event, and the U.S. 
transferor shall remain subject to the gain recognition agreement if the 
conditions of paragraphs (k)(12)(i)(A) and (B) of this section are 
satisfied. To the extent the intercompany transaction does not create an 
intercompany item see, for example, paragraph (k)(1) and paragraph 
(q)(2)(xx) of this section. See paragraph (o)(6) of this section for the 
effect on a gain recognition agreement when an intercompany item from an 
intercompany transaction to which this paragraph (k)(12)(i) applies is 
taken into account.
    (A) At the time of the disposition, the basis of the stock of the 
transferee foreign corporation received in the initial transfer that is 
disposed of in the intercompany transaction is not greater than the sum 
of the amounts described in paragraphs (k)(12)(i)(A)(1) through (3) of 
this section. If only a portion of the stock of the transferee foreign 
corporation received in the initial transfer is disposed of, then the 
basis of such stock shall be compared with a proportionate amount 
(measured by value as determined at the time of the disposition) of the 
amounts described in paragraph (k)(12)(i)(A)(1) through (3) of this 
section. To satisfy

[[Page 414]]

the basis condition of this paragraph (k)(12)(i)(A), the U.S. transferor 
may reduce the basis of the stock of the transferee foreign corporation 
received in the initial transfer that is disposed of in the intercompany 
transaction in accordance with the principles of paragraph (o)(1)(iii) 
of this section.
    (1) The aggregate basis of the transferred stock or securities at 
the time of the initial transfer;
    (2) The amount of any increase to the basis of the transferred stock 
or securities by reason of gain recognized by the U.S. transferor on the 
initial transfer; and
    (3) The amount of any increase to the basis of the stock disposed of 
by reason of an income inclusion by the U.S. transferor with respect to 
such stock (for example, pursuant to section 961(a)).
    (B) The annual certification filed with respect to the existing gain 
recognition agreement for the taxable year during which the intercompany 
transaction occurs includes a complete description of the intercompany 
transaction and a schedule illustrating how the basis condition of 
paragraph (k)(12)(i)(A) of this section is satisfied.
    (ii) Certain dispositions following intercompany transaction. A 
subsequent disposition of stock of the transferee foreign corporation 
that is transferred in an intercompany transaction to which the 
exception provided by paragraph (k)(12)(i) of this section applies shall 
not constitute a triggering event if--
    (A) The stock is transferred to a member of the consolidated group 
that includes the U.S. transferor immediately after the disposition, and
    (B) The annual certification filed with respect to the existing gain 
recognition agreement for the taxable year during which the subsequent 
disposition occurs includes a complete description of the disposition.
    (13) Deemed asset sales pursuant to section 338(g) elections. A 
deemed sale of the assets of the transferred corporation or the 
transferee foreign corporation as a result of an election under section 
338(g) shall not constitute a triggering event. This paragraph does not 
apply to the sale of the stock of the target corporation (within the 
meaning of section 338(d)(2)) with respect to which such election is 
made.
    (14) Other dispositions or events. A disposition or other event that 
would constitute a triggering event, without regard to this paragraph 
(k)(14), shall not constitute a triggering event if the conditions of 
paragraph (k)(14)(i) through (iii) of this section, as applicable, are 
satisfied. See paragraphs (q)(2)(iv), (vi), (x), (xii), (xvii), (xxi), 
and (xxiii) of this section for illustrations of the rules provided by 
this paragraph (k)(14).
    (i) The disposition qualifies as a nonrecognition transaction.
    (ii) Immediately after the disposition or other event, a U.S. 
transferor retains a direct or indirect interest in the transferred 
stock or securities or, as applicable, in substantially all of the 
assets of the transferred corporation (for example, in a case where the 
transferred corporation has been liquidated pursuant to section 332). 
If, as a result of the disposition or other event, a foreign corporation 
acquires the transferred stock or securities or, as applicable, 
substantially all the assets of the transferred corporation, the 
condition of this paragraph (k)(14)(ii) is satisfied only if the U.S. 
transferor owns at least five percent (applying the attribution rules of 
section 318, as modified by section 958(b) but without applying section 
318(a)(3)(A), (B), and (C) so as to consider the U.S. transferor as 
owning stock which is owned by a person who is not a United States 
person) of the total voting power and the total value of the outstanding 
stock of such foreign corporation.
    (iii) A new gain recognition agreement is entered into by the U.S. 
transferor described in paragraph (k)(14)(ii) of this section that 
includes--
    (A) An explanation of why this paragraph (k)(14) applies to the 
disposition or other event; and
    (B) A description of each subsequent disposition or other event that 
would constitute a triggering event, other than those described in 
paragraph (j) of this section, with respect to the new gain recognition 
agreement based on the principles of paragraphs (j) and (k) of this 
section including, for example, an indirect disposition of the 
transferred stock or securities.

[[Page 415]]

    (l) [Reserved]
    (m) Receipt of boot in nonrecognition transactions--(1) Dispositions 
of transferred stock or securities. Notwithstanding paragraph (k) of 
this section, if gain is required to be recognized (not including any 
gain that would be treated as a dividend under section 356(a)(2)) in 
connection with a disposition of the transferred stock or securities to 
which an exception under paragraph (k) of this section otherwise applies 
(triggering event exception), the U.S. transferor shall recognize gain 
under paragraph (c)(1)(i) of this section equal to the amount of gain 
required to be recognized in connection with the disposition, but not in 
excess of the amount of gain subject to the gain recognition agreement. 
For purposes of this paragraph (m)(1), the amount of gain required to be 
recognized in connection with the disposition shall be determined before 
taking into account any increase to the basis of the transferred stock 
or securities under paragraph (c)(4)(ii) of this section. See paragraph 
(q)(2)(xiii) of this section, for an illustration of the rule provided 
by this paragraph (m)(1).
    (2) Dispositions of assets of transferred corporation. If gain is 
required to be recognized (not including any gain that would be treated 
as a dividend under section 356(a)(2)) in connection with a disposition 
of substantially all of the assets of the transferred corporation to 
which a triggering event exception otherwise applies, the U.S. 
transferor shall recognize gain under paragraph (c)(1)(i) of this 
section equal to the amount of gain required to be recognized in 
connection with the disposition, but not in excess of the amount of gain 
subject to the gain recognition agreement.
    (n) Special rules for distributions with respect to stock--(1) 
Certain dividend equivalent redemptions treated as dispositions. A 
redemption of the transferred stock or of stock of the transferee 
foreign corporation received in the initial transfer that is treated by 
reason of section 302(d) as a distribution of property to which section 
301 applies shall constitute a disposition for purposes of this section 
unless the U.S. transferor enters into a new gain recognition agreement 
that includes appropriate provisions to account for the redemption. For 
an illustration of the rule of this paragraph (n)(1), see paragraph 
(q)(2)(xiv) of this section.
    (2) Gain recognized under section 301(c)(3). If gain is required to 
be recognized under section 301(c)(3) with respect to the transferred 
stock, the U.S. transferor shall recognize gain under the gain 
recognition agreement in accordance with paragraph (c)(1)(i) of this 
section in an amount equal to the gain required to be recognized under 
section 301(c)(3), but not in excess of the amount of gain subject to 
the gain recognition agreement. For this purpose, the amount of gain 
required to be recognized under section 301(c)(3) shall be determined 
before taking into account any increase in the basis of the transferred 
stock under paragraph (c)(4)(ii) of this section.
    (o) Dispositions or other events that terminate or reduce the amount 
of gain subject to the gain recognition agreement. Notwithstanding 
paragraph (j) of this section, the following dispositions or other 
events shall not constitute triggering events but instead shall 
terminate or reduce the amount of gain subject to the gain recognition 
agreement.
    (1) Taxable disposition of stock of the transferee foreign 
corporation--(i) Complete disposition. Except as otherwise provided in 
this paragraph (o)(1)(i), if the U.S. transferor disposes of all the 
stock of the transferee foreign corporation received in the initial 
transfer in a transaction in which all gain realized is recognized and 
included in taxable income during the taxable year of the disposition, 
the gain recognition agreement shall terminate without further effect 
if, at the time of the disposition, the aggregate basis of such stock is 
not greater than the sum of the amounts described in paragraphs 
(o)(1)(i)(A) through (C) of this section. This paragraph shall not apply 
to a disposition of stock of the transferee foreign corporation pursuant 
to an intercompany transaction to which paragraph (k)(12) of this 
section applies. This paragraph shall also not apply to an individual 
U.S. transferor that loses U.S. citizenship or ceases to be a lawful 
permanent resident of the United States (within the meaning of section 
7701(b)(6)).

[[Page 416]]

    (A) The aggregate basis of the transferred stock or securities at 
the time of the initial transfer;
    (B) The amount of any increase to the basis of the transferred stock 
or securities by reason of gain recognized by the U.S. transferor on the 
initial transfer; and
    (C) The amount of any increase to the basis of the stock disposed of 
by reason of an income inclusion by the U.S. transferor with respect to 
such stock (for example, pursuant to section 961(a)).
    (ii) Partial dispositions. A partial disposition by the U.S. 
transferor of the stock of the transferee foreign corporation received 
in the initial transfer in a transaction otherwise described in 
paragraph (o)(1)(i) of this section shall reduce the amount of gain 
subject to the gain recognition agreement based on the relative fair 
market value of the stock disposed of (measured at the time of the 
disposition) compared to the fair market value of all of the stock of 
the transferee foreign corporation received in the initial transfer 
(measured at the time of the disposition). For determining whether the 
basis condition of paragraph (o)(1)(i) of this section is satisfied in 
the case of a partial disposition, the aggregate basis of the stock 
disposed of is compared to a proportionate amount (based on fair market 
value, as measured at the time of the partial disposition) of the 
amounts described in paragraphs (o)(1)(i)(A) through (C) of this 
section. For an illustration of the rules of this paragraph (o)(1)(ii), 
see paragraph (q)(2)(xv) of this section.
    (iii) Reduction of stock basis. For purposes of satisfying the basis 
condition of paragraph (o)(1)(i) or (ii) of this section, the U.S. 
transferor may reduce the aggregate basis of the stock of the transferee 
foreign corporation received in the initial transfer, effective 
immediately before the disposition. For an illustration of the rules of 
this paragraph (o)(1)(iii), see paragraph (q)(2), Example 16, of this 
section. The U.S. transferor reduces the basis of the stock of the 
transferee foreign corporation by including a statement with the timely-
filed return of the U.S. transferor for the taxable year in which the 
disposition occurs, entitled ``Election to Reduce Stock Basis Under 
Sec. 1.367(a)-8(o)(1)(iii)'' and that includes--
    (A) A description, including the date, of the disposition;
    (B) A description of the stock of the transferee foreign corporation 
disposed of and the basis adjustments made under this paragraph 
(o)(1)(iii); and
    (C) The fair market value of all the stock of the transferee foreign 
corporation held by the U.S. transferor at the time of the disposition.
    (2) Gain recognized in connection with certain nonrecognition 
transactions. If the U.S. transferor recognizes gain in connection with 
a complete or partial disposition of stock of the transferee foreign 
corporation received in the initial transfer that is described in 
paragraph (k) of this section, and the basis condition of paragraph 
(o)(1)(i) or (ii) of this section, as applicable, is satisfied with the 
respect to such disposition, the amount of gain subject to the new gain 
recognition agreement filed under paragraph (k) of this section as a 
result of such disposition shall equal the amount of gain subject to the 
existing gain recognition agreement reduced by the amount of gain 
recognized by the U.S. transferor on the disposition. If the U.S. 
transferor recognizes gain in connection with a complete or partial 
disposition of the stock of the transferee foreign corporation received 
in the initial transfer that is described in paragraph (k) of this 
section, and the condition of paragraph (o)(1)(i) or (ii) of this 
section, as applicable, is satisfied with the respect to the 
disposition, but a new gain recognition agreement is not filed with 
respect to such disposition so that a triggering event exception does 
not apply to the disposition, the amount of gain required to be 
recognized by the U.S. transferor under the existing gain recognition 
agreement shall be reduced by the amount of the gain recognized on the 
disposition.
    (3) Gain recognized under section 301(c)(3). If the U.S. transferor 
recognizes gain under section 301(c)(3) with respect to the stock of the 
transferee foreign corporation received in the initial transfer, the 
amount of gain subject to the gain recognition agreement shall be 
reduced by the amount of such recognized gain.

[[Page 417]]

    (4) Dispositions of substantially all of the assets of a domestic 
transferred corporation. Except as otherwise provided in this paragraph 
(o)(4), the gain recognition agreement shall terminate without further 
effect if substantially all of the assets of the transferred corporation 
are disposed of in a transaction in which all gain realized is 
recognized and included in taxable income during the taxable year of the 
disposition, but only if, at the time of the initial transfer, the U.S. 
transferor owned stock in the transferred corporation satisfying the 
requirements of section 1504(a)(2) and the U.S. transferor and the 
transferred corporation were members of the same consolidated group. If 
the initial transfer was part of an indirect stock transfer, the gain 
recognition agreement shall terminate without further effect if 
substantially all of the assets of the transferred corporation (taking 
into account Sec. 1.367(a)-3(d)(2)(v)) are disposed of in a transaction 
in which all gain realized is recognized and included in taxable income 
during the taxable year of the disposition, but only if at the time of 
the initial transfer the U.S. transferor owned stock in the transferred 
corporation satisfying the requirements of section 1504(a)(2) (for 
example, in the case of a reorganization described in section 
368(a)(1)(A) by reason of section 368(a)(2)(E)) and the U.S. transferor 
and the transferred corporation were members of the same consolidated 
group.
    (5) Certain distributions or transfers of transferred stock or 
securities to U.S. persons. To the extent a distribution or transfer of 
the transferred stock or securities satisfies the conditions of 
paragraphs (o)(5)(i) through (iii) of this section, the gain recognition 
agreement shall terminate without further effect, or the amount of gain 
subject to the gain recognition agreement shall be reduced, as 
appropriate.
    (i) Distributions or transfers described in section 337, 355, or 
361. The transferred stock or securities are distributed or transferred 
pursuant to a transaction described in paragraph (o)(5)(i)(A) through 
(D) of this section, as appropriate.
    (A) A distribution described in section 337 that is pursuant to a 
complete liquidation described in section 332. See paragraph 
(q)(2)(xviii) of this section, for an illustration of the rule provided 
by this paragraph (o)(5)(i)(A).
    (B) A distribution to which section 355 applies. See paragraph 
(q)(2)(xix) of this section, for an illustration of the rule provided by 
this paragraph (o)(5)(i)(B).
    (C) A section 361 exchange that is pursuant to an asset 
reorganization. See paragraph (q)(2)(xxii) of this section, for an 
illustration of the rule provided by this paragraph (o)(5)(i)(C).
    (D) A distribution to which section 361(c) applies that is pursuant 
to an asset reorganization. See paragraph (q)(2)(xxii) of this section, 
for an illustration of the rule provided by this paragraph (o)(5)(i)(D).
    (ii) Qualified recipient. The recipient of the transferred stock or 
securities in the relevant transaction described in paragraph (o)(5)(i) 
of this section (qualified recipient) is--
    (A) The U.S. transferor;
    (B) A member of the consolidated group that includes the U.S. 
transferor immediately after the transaction; or
    (C) An individual that is a United States person.
    (iii) Basis requirement--(A) General rule. Immediately after the 
relevant transaction described in paragraph (o)(5)(i) of this section, 
the aggregate basis of the transferred stock or securities received by 
the qualified recipient is not greater than the aggregate basis of such 
stock or securities at the time of the initial transfer (as adjusted for 
gain recognized by the U.S. transferor on the initial transfer 
attributable to such stock or securities). For this purpose, the basis 
of the transferred stock in the hands of the qualified recipient shall 
be determined without regard to any basis attributable to income 
inclusions with respect to the stock (for example, under section 
961(a)). In the case of a distribution to which section 355 applies, any 
adjustments to basis under Sec. 1.367(b)-5(c) shall be made before 
determining whether the basis condition of this paragraph is satisfied.
    (B) Election to reduce basis in transferred stock or securities. If 
the basis condition of paragraph (o)(5)(iii)(A) of this section is not 
satisfied, each qualified recipient may reduce the basis of

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the transferred stock or securities received in the transaction to the 
extent necessary to satisfy the basis condition. A qualified recipient 
reduces the basis of the transferred stock or securities by including a 
statement with its timely-filed return for the taxable year during which 
the distribution or transfer occurs entitled ``Election to Reduce Stock 
Basis Under Sec. 1.367(a)-8(o)(5)(iii)(B)'' and that includes--
    (1) A complete description and the date of the distribution or 
transfer;
    (2) The fair market value of the transferred stock or securities 
received by the qualified recipient in the transaction; and
    (3) The basis of the transferred stock or securities received by the 
qualified recipient immediately before and after the basis reduction.
    (6) Dispositions or other event following certain intercompany 
transactions. If, subsequent to an intercompany transaction to which 
paragraph (k)(12) of this section applies, a disposition or other event 
occurs that requires the U.S. transferor to take into account the 
intercompany item related to the intercompany transaction (under the 
provisions of Sec. 1.1502-13), the gain recognition agreement shall 
terminate without further effect or the amount of gain subject to the 
gain recognition agreement shall be reduced based on the principles of 
paragraph (o)(1)(i) or (ii) of this section, as appropriate. For an 
illustration of the rules of this paragraph (o)(6), see paragraph 
(q)(2)(xx) of this section.
    (7) Expropriations under foreign law. The amount of gain subject to 
the gain recognition agreement shall be reduced to the extent the stock 
or securities of the transferee foreign corporation received in the 
initial transfer, the transferred stock or securities, or substantially 
all the assets of the transferred corporation, are expropriated, seized, 
or subjected to a similar taking of such property by the government of a 
foreign country, any political subdivision thereof, or any agency or 
instrumentality of the foregoing. Principles similar to those of 
paragraph (o)(1)(i) or (o)(1)(ii) of this paragraph, as relevant, shall 
be applied to determine the amount of the reduction.
    (p) Relief for certain failures to file or failures to comply that 
are not willful--(1) In general. This paragraph (p) provides relief if 
there is a failure to file an initial gain recognition agreement as 
required under paragraph (d)(1) of this section (failure to file), or a 
failure to comply that is a triggering event under paragraph (j)(8) of 
this section (failure to comply). A failure to file or failure to comply 
will be deemed not to have occurred for purposes of paragraph (d)(1) of 
this section or paragraph (j)(8) of this section if the U.S. transferor 
demonstrates that the failure was not willful using the procedure set 
forth in this paragraph (p). For this purpose, willful is to be 
interpreted consistent with the meaning of that term in the context of 
other civil penalties, which would include a failure due to gross 
negligence, reckless disregard, or willful neglect. Whether a failure to 
file or failure to comply was willful will be determined by the Director 
(as described in paragraph (j)(8) of this section) based on all the 
facts and circumstances. The U.S. transferor must submit a request for 
relief and an explanation as provided in paragraph (p)(2)(i) of this 
section. Although a U.S. transferor whose failure to file or failure to 
comply is determined not to be willful will not be subject to gain 
recognition under paragraph (b), (c), or (e) of Sec. 1.367(a)-3 or 
paragraph (c)(1) of this section, as applicable, the U.S. transferor 
will be subject to a penalty under section 6038B if the U.S. transferor 
fails to satisfy the reporting requirements under that section and does 
not demonstrate that the failure was due to reasonable cause and not 
willful neglect. See Sec. 1.6038B-1(b)(2) and (f). The determination of 
whether the failure to file or failure to comply was willful under this 
section has no effect on any request for relief made under Sec. 
1.6038B-1(f).
    (2) Procedures for establishing that a failure to file or failure to 
comply was not willful--(i) Time and manner of submission. A U.S. 
transferor's statement that a failure to file or failure to comply was 
not willful will be considered only if, promptly after the U.S. 
transferor becomes aware of the failure, an amended return is filed for 
the taxable year to which the failure relates that

[[Page 419]]

includes the information that should have been included with the 
original return for such taxable year or that otherwise complies with 
the rules of this section, and that includes a written statement 
explaining the reasons for the failure to file or failure to comply. The 
U.S. transferor must file, with the amended return, a Form 8838 
extending the period of limitations on assessment of tax with respect to 
the gain realized but not recognized on the initial transfer to the 
later of: The close of the eighth full taxable year following the 
taxable year during which the initial transfer occurred (date one); or 
the close of the third full taxable year ending after the date on which 
the required information is provided to the Director (date two). 
However, the U.S. transferor is not required to file a Form 8838 with 
the amended return if both date one is later than date two and a Form 
8838 was previously filed extending the period of limitations on 
assessment of tax with respect to the gain realized but not recognized 
on the initial transfer to date one. If a Form 8838 is not required to 
be filed with the amended return pursuant to the previous sentence, a 
copy of the previously filed Form 8838 must be filed with the amended 
return. The amended return and either a Form 8838 or a copy of the 
previously filed Form 8838, as the case may be, must be filed with the 
Internal Revenue Service at the location where the U.S. transferor filed 
its original return. The U.S. transferor may submit a request for relief 
from the penalty under section 6038B as part of the same submission. See 
Sec. 1.6038B-1(f).
    (ii) Notice requirement. In addition to the requirements of 
paragraph (p)(2)(i) of this section, the U.S. transferor must comply 
with the notice requirements of this paragraph (p)(2)(ii). If any 
taxable year of the U.S. transferor is under examination when the 
amended return is filed, a copy of the amended return and any 
information required to be included with such return must be delivered 
to the Internal Revenue Service personnel conducting the examination. If 
no taxable year of the U.S. transferor is under examination when the 
amended return is filed, a copy of the amended return and any 
information required to be included with such return must be delivered 
to the Director.
    (3) Examples. The following examples illustrate the application of 
this paragraph (p). All of the examples are based solely on the 
following facts and any additional facts stated in the particular 
example. DC, a domestic corporation, wholly owns FS and FA, each a 
foreign corporation. In Year 1, pursuant to a transaction qualifying 
both as an exchange under section 351 and a reorganization under section 
368(a)(1)(B), DC transferred all the FS stock to FA solely in exchange 
for voting stock of FA (FS Transfer). The fair market value of the FS 
stock exceeded DC's tax basis in the stock at the time of the FS 
transfer. Absent the application of section 367 to the transaction, DC's 
exchange of the FS stock for the stock of FA qualified as a tax-free 
exchange under sections 351(a) and section 354. Immediately after the 
transaction, both FA and FS were controlled foreign corporations (as 
defined in section 957). Furthermore, DC was a section 1248 shareholder 
(as defined in Sec. 1.367(b)-2(b)) with respect to FA and FS, and a 5-
percent shareholder with respect to FA for purposes of Sec. 1.367(a)-
3(b)(ii). Thus, DC was required to recognize gain under section 
367(a)(1) by reason of the FS Transfer unless DC timely filed an initial 
gain recognition agreement (GRA) as required by paragraph (d)(1) of this 
section and complies in all material respects with the requirements of 
this section throughout the term of the GRA. The application of section 
6038B is not addressed in these examples. DC may be subject to a penalty 
under section 6038B even if DC demonstrates under this section that a 
failure to file or failure to comply was not willful. See Sec. 1.6038B-
1(b) and (f) for the application of section 6038B.
    (i) Example 1. Taxpayer failed to file a GRA due to accidental 
oversight--(A) Facts. DC filed its tax return for the year of the FS 
Transfer, reporting no gain with respect to the exchange of the FS 
stock. DC, through its tax department, was aware of the requirement to 
file a GRA in order for DC to avoid recognizing gain with respect to the 
FS Transfer under section 367(a)(1), and had the experience and 
competency

[[Page 420]]

to properly prepare the GRA. DC had filed many GRAs over the years and 
had never failed to timely file a GRA. However, although DC prepared the 
GRA with respect to the FS Transfer, it was not filed with DC's tax 
return for the year of the FS Transfer due to an accidental oversight. 
During the preparation of the following year's tax return, DC discovered 
that the GRA was not filed. DC filed an amended return to file the GRA 
and complied with the procedures set forth under paragraph (p)(2) of 
this section promptly after it became aware of the failure.
    (B) Result. Because DC failed to file a GRA with its timely filed 
tax return for the year of the FS Transfer, there is a failure to timely 
file the GRA as required by paragraph (d)(1) of this section. However, 
based on the facts of in paragraph (p)(3)(i)(A) of this section (the 
facts of this Example 1), including that the failure to timely file the 
GRA was an isolated and accidental oversight, the failure to timely file 
is not a willful failure to file. Accordingly, the timely filed 
requirement of paragraph (d)(1) of this section is considered to be 
satisfied, and DC is not required to recognize the gain realized on the 
FS Transfer under section 367(a)(1).
    (ii) Example 2. Taxpayer's course of conduct is taken into account 
in determination--(A) Facts. DC filed its tax return for the year of the 
FS Transfer, reporting no gain with respect to the exchange of the FS 
stock, but failed to file a GRA. DC, through its tax department, was 
aware of the requirement to file a GRA in order for DC to avoid 
recognizing gain with respect to the FS Transfer under section 
367(a)(1). DC had not consistently and in a timely manner filed GRAs in 
the past, and also had an established history of failing to timely file 
other tax and information returns for which it was subject to penalties. 
In a year subsequent to Year 1, DC transferred stock of another foreign 
subsidiary with respect to which DC had a built-in gain (FS2) to FA in a 
transaction that qualified as both a reorganization under section 
368(a)(1)(B) and an exchange described under section 351 (FS2 Transfer). 
DC was required to recognize gain on the FS2 Transfer under section 
367(a)(1) unless DC timely filed a GRA as required by paragraph (d)(1) 
of this section and complied with the requirements of this section 
during the term of the GRA. DC reported no gain on the FS2 Transfer on 
its tax return, but failed to file a GRA. At the time of the FS2 
Transfer, DC was already aware of its failure to file the GRA required 
for the prior FS Transfer, but had not implemented any safeguards to 
ensure that it would timely file GRAs for future transactions. DC filed 
an amended return to file the GRA for the FS2 Transfer and complied with 
the procedures set forth under paragraph (p)(2) of this section promptly 
after it became aware of the failure. DC asserts that its failure to 
timely file a GRA with respect to the FS2 Transfer was due to an 
isolated oversight similar to the one that occurred with respect to the 
FS Transfer. At issue is DC's failure to timely file a GRA for the FS2 
Transfer.
    (B) Result. Because DC failed to file a GRA with its timely filed 
tax return for the year of the FS2 Transfer, there is a failure to 
timely file the GRA as required by paragraph (d)(1) of this section. 
DC's course of conduct is taken into account in determining whether its 
failure to timely file a GRA for the FS2 Transfer was willful. Based on 
the facts of in paragraph (p)(3)(ii)(A) of this section (the facts of 
this Example 2), including DC's history of failing to file required tax 
and information returns in general and GRAs in particular, and its 
failure to implement safeguards to ensure that it would timely file 
GRAs, the failure to timely file a GRA with respect to the FS2 Transfer 
rises to the level of a willful failure to timely file. Accordingly, DC 
is ineligible for relief under paragraph (p) of this section, the GRA is 
not considered timely filed for purposes of paragraph (d)(1) of this 
section, and DC must recognize the full amount of the gain realized on 
the FS2 Transfer.
    (iii) Example 3. GRA not completed in all material respects--(A) 
Facts. DC timely filed its tax return for the year of the FS Transfer, 
reporting no gain with respect to the exchange of the FS stock. DC was 
aware of the requirement to file a GRA to avoid recognizing gain under 
section 367(a)(1), including the requirement to provide the basis and 
fair market value of the

[[Page 421]]

transferred stock. However, DC filed a purported GRA that did not 
contain the fair market value of the FS stock. Instead, the GRA was 
filed with the statement that the fair market value information was 
``available upon request.'' Other than the omission of the fair market 
value of the FS stock, the GRA contained all other information required 
by this section.
    (B) Result. Because DC omitted the fair market value of the FS stock 
from the GRA, the GRA was not completed in all material respects. 
Accordingly, there is a failure to timely file the GRA. Furthermore, 
because DC knowingly omitted such information, DC's omission is a 
willful failure to timely file a GRA. Accordingly, DC is ineligible for 
relief under paragraph (p) of this section, the GRA is not considered 
timely filed for purposes of paragraph (d)(1) of this section, and DC 
must recognize the full amount of the gain realized on the FS Transfer. 
The same result would arise if DC had included the fair market value of 
the FS stock, but knowingly omitted its tax basis from the GRA.
    (iv) Example 4. Taxpayer knew of GRA filing requirement, but 
intentionally chose not to file--(A) Facts. When DC filed its tax return 
for the tax year of the FS Transfer, it was aware of the requirement to 
file a GRA to avoid recognizing gain under section 367(a)(1). However, 
because DC anticipated selling Business A in the following tax year, 
which was expected to produce a capital loss that could be carried back 
to fully offset the gain recognized on the FS Transfer, DC intentionally 
chose not to file a GRA. DC recognized the gain from the FS Transfer 
under section 367(a)(1) and reported the gain on its timely filed tax 
return. At the end of the following year, a large class action lawsuit 
was filed against Business A and, consequently, DC was unable to sell 
the business. As a result, DC did not realize the expected capital loss, 
and it was not able to offset the gain from the FS Transfer. DC now 
seeks to file a GRA for the FS Transfer.
    (B) Result. Because DC failed to file a GRA with its timely filed 
tax return for the year of the FS Transfer, there is a failure to timely 
file the GRA as required by paragraph (d)(1) of this section. 
Furthermore, because DC intentionally chose not to file a GRA for the FS 
Transfer, its actions constitute a willful failure to timely file a GRA. 
Accordingly, DC is ineligible for relief under paragraph (p) of this 
section, the GRA is not considered timely filed for purposes of 
paragraph (d)(1) of this section, and DC must recognize the full amount 
of the gain realized on the FS Transfer in Year 1.
    (q) Examples--(1) Presumed facts and references. For purposes of the 
examples in paragraph (q)(2) of this section, and except where otherwise 
indicated, the following is presumed.
    (i) UST, USP, and DC are domestic corporations that each use a 
calendar taxable year.
    (ii) USP wholly owns UST and is the common parent of the 
consolidated group of which UST is a member.
    (iii) TFC, TFD, F1, and FA are foreign corporations.
    (iv) UST wholly owns TFD.
    (v) In a section 351 exchange, UST transfers all of the stock of TFD 
(TFD stock) to TFC in exchange solely for stock of TFC (the initial 
transfer).
    (vi) Pursuant to Sec. 1.367(a)-3(b)(1)(ii) and this section, UST 
enters into a gain recognition agreement in connection with the initial 
transfer and makes the election described under paragraph (c)(2)(vi) of 
this section with respect to the gain recognition agreement.
    (vii) As applicable, the section 1248 amount (within the meaning of 
Sec. 1.367(b)-2(c)) or all earnings and profits amount (within the 
meaning of Sec. 1.367(b)-2(d)) attributable to the stock of a foreign 
corporation is zero.
    (viii) All transactions are respected under general principles of 
tax law, including the step transaction doctrine.
    (ix) References to a U.S. transferor entering into a gain 
recognition agreement mean, where applicable, that the common parent of 
the consolidated group of which the U.S. transferor is a member has 
filed the gain recognition agreement on behalf of the U.S. transferor in 
accordance with paragraph (d)(3) of this section.
    (x) Taxable years during the GRA term are referred to, for example, 
as year 1 and year 2.

[[Page 422]]

    (2) Examples. The following examples illustrate the application of 
the rules of this section.
    (i) Example 1. Basis adjustments from gain recognized under the gain 
recognition agreement--(A) Facts. TFC wholly owns F1. In year 3, 
pursuant to a section 351 exchange, TFC transfers all of the TFD stock 
to F1 in exchange solely for voting stock of F1. UST enters into a new 
gain recognition agreement with respect to the initial transfer under 
paragraph (k)(3) of this section, and therefore the transfer by TFC of 
the TFD stock to F1 is not a triggering event. Under paragraph (c)(5)(i) 
of this section, the existing gain recognition agreement terminates 
without further effect. In year 4, in an exchange to which section 721 
applies, UST contributes the TFC stock received in the initial transfer 
to PRS, a domestic partnership, in exchange for a partnership interest. 
UST enters into a new gain recognition agreement with respect to the 
initial transfer under paragraph (k)(1) of this section, and therefore 
the transfer by UST of the TFC stock to PRS is not a triggering event. 
Under paragraph (c)(5)(i) of this section, the new gain recognition 
agreement filed by UST in year 3 terminates without further effect. In 
year 5, TFD disposes of substantially all of its assets in a transaction 
that constitutes a triggering event under paragraph (j)(2)(i) of this 
section. Under paragraph (c)(1)(i) of this section, UST recognizes the 
gain realized but not recognized on the initial transfer by reason of 
entering into the gain recognition agreement.
    (B) Result. Under paragraph (c)(4) of this section, the basis of the 
PRS interest held by UST, the TFC stock held by PRS that was received 
from UST in year 4, the F1 stock held by TFC that was received in 
exchange for the TFD stock in year 3, and the TFD stock held by F1 that 
was received from TFC in year 3 is increased by the amount of gain 
recognized by UST (but not by the additional tax or interest paid as 
result of such gain) with respect to the initial transfer under the gain 
recognition agreement. However, the basis of the assets of TFD 
(including the assets disposed of in year 5) is not increased as a 
result of the gain recognized by UST.
    (ii) Example 2. Impact of gain recognition event on computation of 
income--(A) Facts. At the time of the initial transfer, the TFD stock 
has a $50x basis, a $100x fair market value, and a $30x section 1248 
amount. The amount of gain subject to the gain recognition agreement is 
$50x. UST did not make an election under paragraph (c)(2)(vi) of this 
section with respect to the gain recognition agreement. In year 3, TFC 
disposes of the TFD stock received in the initial transfer in exchange 
for $120x cash.
    (B) Result--(1) Gain recognition without an election. The 
disposition by TFC of the TFD stock in year 3 is a triggering event 
under paragraph (j)(1) of this section. As a result, under paragraph 
(c)(1)(i) of this section, UST must recognize and include in income $50x 
gain under the gain recognition agreement. Under paragraph 
(c)(1)(iii)(A) of this section, UST must report the $50x gain on an 
amended return filed for the taxable year of the initial transfer. Under 
paragraph (c)(1)(v) of this section, UST must pay applicable interest on 
any additional tax due with respect to the $50x gain recognized. Under 
section 1248(a), $30x of the gain recognized by UST under the gain 
recognition agreement is recharacterized as a dividend. Under paragraph 
(c)(4) of this section, as of the date of the initial transfer, the 
basis of the TFC stock received by UST in the initial transfer and the 
TFD stock received by TFC in the initial transfer, respectively, is 
increased by $50x. After taking into account the increase to the basis 
of the TFD stock, TFC recognizes $20x gain on the disposition of the TFD 
stock in year 3.
    (2) Gain recognition with an election. If UST made an election under 
paragraph (c)(2)(vi) of this section with the gain recognition agreement 
filed for the initial transfer, the result would be the same as in 
paragraph (q)(2)(ii)(B)(1) of this section (paragraph (1) in the results 
in this Example 2), except that UST must include in income the $50x gain 
recognized under the gain recognition agreement on its tax return filed 
for year 3. Any additional tax due with respect to the $50x gain and 
applicable interest on the additional tax due must be included with such 
return. The

[[Page 423]]

amount, if any, of the $50x gain recognized by UST under the gain 
recognition agreement that is characterized as a dividend under section 
1248(a) is determined in year 3.
    (iii) Example 3. Transfer of stock of the transferee foreign 
corporation to a domestic corporation in a section 351 exchange--(A) 
Facts. UST wholly owns DC. In year 3, pursuant to a section 351 
exchange, UST transfers all of the TFC stock received in the initial 
transfer to DC in an exchange solely for voting stock of DC.
    (B) Result. The year 3 transfer of the TFC stock by UST to DC 
constitutes a triggering event under paragraph (j)(4) of this section. 
However, the transfer shall not constitute a triggering event pursuant 
to paragraph (k)(1)(ii) of this section if DC enters into a new gain 
recognition agreement with respect to the initial transfer that 
designates DC as the U.S. transferor for purposes of this section. 
Pursuant to paragraphs (c)(4)(i) and (ii) of this section, if DC is 
required to recognize gain under the new gain recognition agreement, the 
basis of the stock of TFC and TFD would be increased by the amount of 
gain recognized. However, pursuant to paragraph (c)(4)(iii) of this 
section, no adjustment would be made to the basis of the DC voting stock 
received by UST in year 3 as a result of such gain recognition. 
Alternatively, if the conditions for the application of paragraph 
(k)(14) of this section are satisfied UST could instead enter into the 
new gain recognition agreement with respect to the initial transfer.
    (iv) Example 4. Transfer of stock of the transferee foreign 
corporation in a triangular section 368(a)(1)(B) reorganization--(A) 
Facts. DC wholly owns FA. In year 3, pursuant to a triangular 
reorganization described in section 368(a)(1)(B), UST transfers all of 
the TFC stock received in the initial transfer to FA in exchange solely 
for 20% of the outstanding voting stock of DC. At the time of the 
reorganization, the TFC stock has a basis in excess of fair market 
value.
    (B) Result. (1) The transfer by UST of the TFC stock to FA is an 
indirect stock transfer under Sec. 1.367(a)-3(d)(1)(iii)(B). 
Accordingly, to preserve nonrecognition treatment, UST must enter into a 
separate gain recognition agreement under this section with respect to 
such transfer.
    (2) With respect to the gain recognition agreement filed for the 
initial transfer of the TFD stock, the transfer by UST of the TFC stock 
to FA is a triggering event under paragraph (j)(4) of this section. 
However, the transfer shall not constitute a triggering event if the 
conditions of the exception provided by paragraph (k)(14) of this 
section are satisfied.
    (i) The condition of paragraph (k)(14)(i) of this section is 
satisfied because the transfer qualifies as a nonrecognition transaction 
(assuming UST enters into a gain recognition agreement as described in 
paragraph (q)(2)(iv)(B)(1) of this section (paragraph (1) in the results 
in this Example 4).
    (ii) The condition of paragraph (k)(14)(ii) of this section is 
satisfied because immediately after the transfer DC, a domestic 
corporation that is eligible to be a U.S. transferor, owns at least 5% 
(determined as provided in paragraph (k)(14)(ii) of this section) of the 
total voting power and total fair market value of the outstanding stock 
of FA. As a result, DC is treated as retaining an indirect interest in 
the TFD stock immediately following the transfer.
    (iii) The condition of paragraph (k)(14)(iii) of this section is 
satisfied if DC enters into a new gain recognition agreement with 
respect to the initial transfer of the TFD stock that, based on the 
principles of paragraph (j) of this section, describes the subsequent 
dispositions or other events that would constitute triggering events for 
purposes of the new gain recognition agreement (other than the 
dispositions and other events described in paragraph (j) of this 
section). For example, a complete or partial disposition of the stock of 
FA would constitute a triggering event for purposes of the new gain 
recognition agreement.
    (v) Example 5. Transfer of stock of the transferee foreign 
corporation to a domestic corporation pursuant to an asset 
reorganization--(A) Facts. At the time of the initial transfer the TFD 
stock has a $50x basis and a $100x fair market value. Therefore, the 
amount of gain

[[Page 424]]

subject to the gain recognition agreement is $50x. In year 3, pursuant 
to an asset reorganization described in section 368(a)(1)(A), UST 
transfers its assets to DC in exchange solely for 20% of the outstanding 
stock of DC. UST distributes the stock of DC to USP pursuant to the plan 
of reorganization.
    (B) Result. The transfer by UST of the TFC stock to DC constitutes a 
triggering event under paragraph (j)(4) of this section. However, 
pursuant to paragraph (k)(6)(i) of this section, if DC enters into a new 
gain recognition agreement with respect to the initial transfer that 
designates DC as the U.S. transferor, the transfer shall not constitute 
a triggering event.
    (vi) Example 6. Transfer of stock of the transferee foreign 
corporation to a foreign corporation pursuant to an asset 
reorganization--(A) Facts. The facts are the same as in Example 5, 
except the acquiring corporation in the asset reorganization is FA, and, 
at the time of the asset reorganization, the TFC stock transferred by 
UST to FA has a $50x basis and a $150x fair market value. All of the 
conditions under section 367(a)(5) and the regulations under that 
section are satisfied, and no adjustment is required to the basis of the 
FA stock received by USP in the transaction.
    (B) Result. (1) The transfer by UST of the TFC stock to FA is 
described in section 361(a) and is therefore subject to section 
367(a)(5). In general, UST cannot file a gain recognition agreement with 
respect to such transfer, and the transfer therefore is subject to the 
general rule of section 367(a)(1). However, if the conditions of Sec. 
1.367(a)-3(e)(1)(i) through (iv) are satisfied, USP can enter into a 
gain recognition agreement with respect to the transfer to avoid the 
recognition of gain by UST on the transfer under section 367(a)(1). If 
the exception provided by paragraph (k)(14) of this section applies so 
that the transfer by UST of the TFC stock to FA is not a triggering 
event with respect to the gain recognition agreement filed for the 
initial transfer (discussed in paragraph (q)(2)(vi)(B)(2) of this 
section (paragraph (2) in the results in this Example 6), the amount of 
gain subject to the gain recognition agreement (if entered into) with 
respect to the transfer by UST of the TFC stock to FA in the asset 
reorganization is $100x.
    (2) Under paragraph (j)(4) of this section, the transfer of the TFC 
stock by UST to FA is a triggering event with respect to the gain 
recognition agreement for the initial transfer. The exception provided 
by paragraph (k)(6)(i) of this section does not apply to such transfer 
because FA, the acquiring corporation in the asset reorganization, is 
foreign. However, the transfer shall not constitute a triggering event 
if the conditions of the exception provided by paragraph (k)(14) of this 
section are satisfied.
    (i) The condition of paragraph (k)(14)(i) of this section is 
satisfied because the transfer of the TFC stock to FA qualifies as a 
nonrecognition transaction (assuming USP enters into a gain recognition 
agreement with respect to such transfer).
    (ii) The condition of paragraph (k)(14)(ii) of this section is 
satisfied because immediately after the transfer USP, a domestic 
corporation that is eligible to be a U.S. transferor, owns at least 5% 
(determined as provided in paragraph (k)(14)(ii) of this section) of the 
total voting power and total fair market value of the outstanding stock 
of FA. As a result, USP is treated as retaining an indirect interest in 
the TFD stock immediately following the transfer.
    (iii) The condition of paragraph (k)(14)(iii) of this section is 
satisfied if USP enters into a new gain recognition agreement with 
respect to the initial transfer of the TFD stock that, based on the 
principles of paragraph (j) of this section, describes the subsequent 
dispositions or other events that would constitute triggering events for 
purposes of the new gain recognition agreement, other than those already 
provided in paragraph (j) of this section. For example, a disposition of 
the stock of FA would constitute such a triggering event for purposes of 
the new gain recognition agreement.
    (C) Alternate facts. Assume the same facts as in paragraph 
(q)(2)(vi)(A) of this section (the facts in this Example 6), including 
that paragraph (k)(14) of this section applies to the year 3 
reorganization so that USP enters into a new gain recognition agreement 
with

[[Page 425]]

respect to the initial transfer of the TFD stock that occurred in year 1 
(GRA 1), and that under Sec. 1.367(a)-3(e) USP enters into a separate 
gain recognition agreement with respect to the initial transfer of the 
TFC stock by UST to FA pursuant to the year 3 asset reorganization (GRA 
2). Assume further that in year 4 TFC disposes of 10% of the TFD stock 
pursuant to a transaction that constitutes a triggering event with 
respect to GRA 1. The disposition of the TFD stock is not a triggering 
event with respect to GRA 2 because the TFD stock disposed of does not 
constitute substantially all the assets of TFC. Under paragraphs (j)(1) 
and (c)(1)(i) of this section, USP must recognize $5x gain (10% of $50x) 
under GRA 1. Under paragraph (c)(4)(i) and (ii) of this section, as of 
the date of the initial transfer (with respect to which GRA 1 was 
filed), the basis of the TFC stock and TFD stock, respectively, is 
increased by $5x. Under paragraph (c)(1)(i) of this section, the amount 
of gain subject to GRA 1 is reduced from $50x to $45x. Similarly, 
because the transferred stock for purposes of GRA 2 is the TFC stock, 
the amount of gain subject to GRA 2 is reduced from $100x to $95x to 
reflect the increase to the basis of the TFC stock.
    (vii) Example 7. Transfer of transferred stock to a foreign 
corporation pursuant to an asset reorganization--(A) Facts. UST wholly 
owns FA. In year 4, pursuant to a reorganization described in section 
368(a)(1)(D), TFC transfers all of the TFD stock to FA in exchange 
solely for stock of FA. TFC distributes the FA stock to UST pursuant to 
the plan of reorganization.
    (B) Analysis. In general, the year 4 transfer by TFC of the TFD 
stock to FA and the exchange by UST of the TFC stock for FA stock 
constitute triggering events under paragraphs (j)(1) and (4) of this 
section, respectively. However, under paragraph (k)(6)(ii) of this 
section, the transfers shall not constitute triggering events if UST 
enters into a new gain recognition agreement with respect to the initial 
transfer that designates FA as the transferee foreign corporation.
    (viii) Example 8. Transfer of substantially all the assets of the 
transferred corporation pursuant to an asset reorganization--(A) Facts. 
In year 4, pursuant to an asset reorganization described in section 
368(a)(1)(C), TFD transfers all of its assets to FA in exchange solely 
for voting stock of FA. TFD distributes the FA voting stock to TFC 
pursuant to the plan of reorganization.
    (B) Analysis. The year 4 transfer by TFD of all its assets to FA and 
the exchange by TFC of its TFD stock for FA voting stock pursuant to the 
reorganization constitute triggering events under paragraphs (j)(2) and 
(j)(1) of this section, respectively. However, under paragraph 
(k)(6)(iii) of this section, the transfers shall not constitute 
triggering events if UST enters into a new gain recognition agreement 
with respect to the initial transfer that designates FA as the 
transferred corporation. In addition, under paragraph (k)(6)(iii) of 
this section only the assets of TFD acquired by FA in the asset 
reorganization shall be treated as assets of the transferred corporation 
for purposes of the new gain recognition agreement.
    (ix) Example 9. Complete liquidation of transferred corporation into 
transferee foreign corporation--(A) Facts. UST does not make an election 
under paragraph (c)(2)(vi) of this section in connection with the gain 
recognition agreement entered into with respect to the initial transfer. 
In year 3, TFD distributes all of its assets to TFC pursuant to a 
complete liquidation to which sections 332 and 337 apply. Under 
paragraph (k)(8) of this section, UST enters into a new gain recognition 
agreement with respect to the initial transfer such that the liquidation 
is not a triggering event. Under paragraph (c)(5)(i) of this section, 
the new gain recognition agreement is subject to the conditions and 
requirements of this section to the same extent as the existing gain 
recognition agreement, except that the transferred stock is no longer 
subject to the gain recognition agreement because the transferred stock 
is cancelled by reason of the liquidation. In year 5 TFC disposes of 
substantially all of the assets received from TFD in the year 3 
liquidation.
    (B) Result. The year 5 disposition by TFC of substantially all of 
the assets received from TFD in the year 3 liquidation is a triggering 
event under

[[Page 426]]

paragraph (j)(2) of this section, and therefore UST must recognize the 
gain subject to the gain recognition agreement. UST must report the gain 
recognized on an amended return for the taxable year during which the 
initial transfer occurred. UST must also pay applicable interest on any 
additional tax due with respect to the gain recognized. Under paragraph 
(c)(4)(i) of this section, the basis of the TFC stock received by UST in 
the initial transfer is increased as of the date of the initial transfer 
by the amount of gain recognized under the gain recognition agreement. 
The basis of the assets of TFD, however, is not increased.
    (x) Example 10. Transfer of transferred stock to foreign corporation 
in section 351 exchange, followed by a section 332 liquidation of the 
foreign corporation--(A) Facts. In year 3, pursuant to a section 351 
exchange, TFC transfers the TFD stock to F1, a newly formed corporation, 
in exchange solely for voting stock of F1. The transfer by TFC of the 
TFD stock to F1 is not a triggering event because UST complies with the 
conditions of paragraph (k)(3) of this section. In year 5, F1 
distributes all of its assets to TFC in a complete liquidation to which 
sections 332 and 337 apply.
    (B) Result. The distribution of the TFD stock by F1, and the 
exchange of F1 stock by TFC pursuant to the year 5 liquidation of F1 
constitute triggering events under paragraphs (j)(1) and (k)(3)(i) of 
this section, respectively. However, if paragraph (k)(14) of this 
section applies, neither the distribution of the TFD stock by F1, nor 
the exchange by TFC of the F1 stock, shall constitute a triggering 
event.
    (1) The condition of paragraph (k)(14)(i) of this section is 
satisfied because the distribution of the TFD stock, and the exchange of 
F1 stock, both qualify as nonrecognition transactions.
    (2) The condition of paragraph (k)(14)(ii) of this section is 
satisfied because immediately after the distribution UST, a domestic 
corporation that is eligible to be a U.S. transferor, owns at least 5% 
(determined as provided in paragraph (k)(14)(ii) of this section) of the 
stock of TFC. As a result, UST is treated as retaining an indirect 
interest in the TFD stock following the complete liquidation of F1.
    (3) The condition of paragraph (k)(14)(iii) of this section is 
satisfied if UST enters into a new gain recognition agreement. Because 
after the complete liquidation of F1, UST wholly owns TFC, which wholly 
owns TFD, as was the case immediately after the initial transfer, UST is 
not required to describe, with the new gain recognition agreement, other 
dispositions or events that would constitute triggering events based on 
the principles of paragraph (j) of this section, other than the 
dispositions or events described in paragraph (j) of this section.
    (xi) Example 11. Disposition of stock of transferee foreign 
corporation pursuant to a divisive reorganization--(A) Facts. In year 3, 
pursuant to a divisive reorganization described in section 368(a)(1)(D), 
UST transfers all of the TFC stock to DC, a newly-formed corporation, in 
exchange solely for stock of DC. UST then distributes all of the DC 
stock to USP in a transaction to which section 355 applies.
    (B) Result. The transfer of the TFC stock by UST to DC constitutes a 
triggering event under paragraph (j)(4) of this section. However, under 
paragraph (k)(1)(iii) of this section, the transfer of the TFC stock 
shall not constitute a triggering event if DC enters into a new gain 
recognition agreement that designates DC as the U.S. transferor for 
purposes of this section.
    (C) Alternate facts. The facts are the same as in paragraph 
(q)(2)(xi)(A) of this section (the facts in this Example 11), except 
that UST transfers only 90% of the TFC stock to DC. Paragraph 
(k)(1)(iii) of this section applies only with respect to the TFC stock 
transferred to DC. Thus, the conditions of paragraph (k)(1)(iii) of this 
section are satisfied if DC enters into a new gain recognition agreement 
with respect to the TFC stock received from UST. The amount of gain 
subject to the new gain recognition agreement entered into by DC equals 
90% of the amount of gain subject to the gain recognition agreement 
entered into by UST with respect to the initial transfer. The amount of 
gain subject to the gain recognition agreement entered into by UST with

[[Page 427]]

respect to the initial transfer is reduced by the amount of gain subject 
to the new gain recognition agreement entered into by DC. The gain 
recognition agreement entered into by UST with respect to the initial 
transfer continues to apply to the remaining TFC stock held by UST.
    (xii) Example 12. Disposition of transferred stock pursuant to a 
divisive reorganization--(A) Facts. In year 3, pursuant to a divisive 
reorganization described in section 368(a)(1)(D), TFC transfers all of 
the TFD stock to F1, a newly formed corporation, in exchange solely for 
all of the outstanding stock of F1. TFC then distributes all of the F1 
stock to UST in a transaction to which section 355 applies.
    (B) Result. The transfer by TFC of the TFD stock to F1 constitutes a 
triggering event under paragraph (j)(1) of this section. However, if 
paragraph (k)(14) of this section applies, neither the transfer of the 
TFD stock by TFC to F1, nor the distribution of the F1 stock by TFC to 
UST, shall constitute triggering events.
    (1) The condition of paragraph (k)(14)(i) of this section is 
satisfied because the dispositions of the TFD stock and F1 stock qualify 
as nonrecognition transactions.
    (2) The condition of paragraph (k)(14)(ii) of this section is 
satisfied because immediately after the transfer UST, an eligible U.S. 
transferor, owns at least 5% (determined as provided in paragraph 
(k)(14)(ii) of this section) of the total voting power and the total 
fair market value of the outstanding stock of F1. As a result, UST is 
treated as retaining an indirect interest in the TFD stock following the 
dispositions.
    (3) The condition of paragraph (k)(14)(iii) of this section is 
satisfied if UST enters into a new gain recognition agreement with 
respect to the initial transfer that describes the subsequent 
dispositions or other events that would constitute triggering events 
based on the principles of paragraph (j) of this section, other than 
those described in paragraph (j) of this section. For example, a 
complete or partial disposition of the F1 stock would constitute a 
triggering event for purposes of the new gain recognition agreement 
(subject to the exceptions provided by paragraph (k) of this section).
    (xiii) Example 13. Receipt of boot by the transferee foreign 
corporation in a subsequent section 351 exchange--(A) Facts. At the time 
of the initial transfer, the TFD stock has a $50x basis and $100x fair 
market value. The amount of gain subject to the gain recognition 
agreement is $50x. In year 3, TFC and X, an unrelated foreign 
corporation, form F1. TFC transfers the TFD stock to F1 in exchange for 
$35x cash and $65x stock of F1. At the time of the transfer, the TFD 
stock has a $50x basis and $100x fair market value. The F1 stock 
received by TFC represents 25% of the outstanding stock of F1. Without 
regard to the gain recognized under the gain recognition agreement and 
any adjustments to basis under paragraph (c)(4)(ii) of this section, 
under section 351(b) TFC would recognize $35x gain in connection with 
the transfer of the TFD stock to F1. UST complies with the conditions of 
paragraph (k)(3) of this section, and therefore the disposition by TFC 
of the TFD stock does not constitute a triggering event.
    (B) Result. Under paragraph (m)(1) of this section, UST must 
recognize $35x gain under the gain recognition agreement as a result of 
the year 3 disposition by TFC of the TFD stock. Thus, the amount of gain 
subject to the new gain recognition agreement entered into by UST 
pursuant to paragraph (k)(3) of this section is $15x. Under paragraph 
(c)(4)(ii) of this section, as of the date of the initial transfer, the 
basis of the TFD stock held by TFC is increased by $35x, the amount of 
the gain recognized by UST under the gain recognition agreement. Under 
paragraph (c)(4)(i) of this section, the basis of the TFC stock received 
by UST in the initial transfer is also increased by $35x. After taking 
into account the increase to the basis of the TFD stock under paragraph 
(c)(4)(ii) of this section, TFC recognizes $15x gain under section 
351(b) in connection with the year 3 transfer of the TFD stock to F1. 
Under section 362(a), the basis of the TFD stock in the hands of F1 is 
$100x.
    (xiv) Example 14. Complete disposition of transferred stock pursuant 
to a section 304(a)(1) transaction--(A) Facts. UST

[[Page 428]]

wholly owns FA. In year 3, in a transaction to which section 304(a)(1) 
applies, TFC transfers all of the TFD stock to FA in exchange for cash. 
Under section 304(a)(1), TFC and FA are treated as if TFC transferred 
the TFD stock to FA in a section 351 exchange in exchange solely for FA 
stock, and then FA redeemed the FA stock deemed issued in exchange for 
the cash. Under section 302(d), the redemption of the FA stock deemed 
issued by FA to TFC under section 304(a)(1) is treated as a distribution 
to which section 301 applies.
    (B) Result. (1) In general, the deemed contribution by TFC of the 
TFD stock to FA in the section 351 exchange is a triggering event under 
paragraph (j)(1) of this section. However, under paragraph (k)(3) of 
this section the deemed contribution shall not be a triggering event if 
UST enters into a new gain recognition agreement with respect to the 
initial transfer in which it agrees to treat as a triggering event a 
complete or partial disposition of the FA stock deemed received by TFC.
    (2) Under paragraph (n)(1) of this section, the redemption of the FA 
stock deemed received by TFC in exchange for the TFD stock shall not 
constitute a disposition if UST enters into a new gain recognition 
agreement with respect to the initial transfer that includes appropriate 
provisions to take into account such redemption. Therefore, under the 
new gain recognition agreement UST must agree to treat as a triggering 
event a complete or partial disposition of the stock of FA. Pursuant to 
paragraph (d)(2)(ii) of this section, UST is permitted to enter into a 
single new gain recognition agreement in year 3, but the gain 
recognition agreement must provide a complete description of the section 
304(a)(1) transaction including the deemed section 351 exchange and 
redemption of the FA stock.
    (xv) Example 15. Reduction in amount of gain subject to gain 
recognition agreement, followed by triggering event--(A) Facts. In year 
3, UST disposes of 60% of the TFC stock received in the initial transfer 
in a transaction in which the conditions of paragraph (o)(1)(ii) of this 
section are satisfied. Thus, the amount of gain subject to the gain 
recognition agreement is reduced by 60%. In year 5, TFC disposes of 50% 
of the TFD stock in a transaction that constitutes a triggering event.
    (B) Result. As a result of the year 5 disposition by TFC of 50% of 
the TFD stock, under paragraphs (j)(1) and (c)(1)(i) of this section, 
UST must recognize and include in income 50% of the gain subject to the 
gain recognition agreement (because of the year 3 disposition of TFC 
stock, the amount of gain subject to the gain recognition agreement 
equals 40% of the gain realized, but not recognized, on the initial 
transfer). UST must pay applicable interest on any additional tax due 
with respect to the gain recognized. The amount of gain subject to the 
gain recognition agreement is reduced by the amount of gain recognized 
by UST (the remaining gain equals 20% of the gain realized, but not 
recognized, by UST on the initial transfer).
    (xvi) Example 16. Taxable sale of stock of transferee foreign 
corporation and election to reduce stock basis--(A) Facts. UST wholly 
owns F1 and TFD. The F1 stock has a $100x basis and $90x fair market 
value, and the TFD stock has a $0x basis and $100x fair market value. 
UST also owns real property with a $10x basis and $10x fair market 
value. In year 1, pursuant to a section 351 exchange, UST transfers the 
real property, the TFD stock, and the F1 stock to TFC in exchange solely 
for 20 shares of TFC stock. UST enters into a gain recognition agreement 
with respect to the transfer of the TFD stock. The amount of the gain 
recognition agreement is $100x. UST takes the position that the basis of 
each share of TFC stock received in the exchange is $5.5x (a 
proportionate amount of the $110x aggregate basis of the transferred 
property). In year 3, UST disposes of all its TFC stock in a transaction 
in which all gain realized is recognized and included in taxable income.
    (B) Result. The year 3 disposition of the TFC stock is a triggering 
event under paragraph (j)(4) of this section. The disposition does not 
terminate the gain recognition agreement pursuant to paragraph (o)(1)(i) 
of this section because the basis of each share of TFC stock received in 
exchange for the TFD stock in the initial transfer is $5.5x,

[[Page 429]]

which exceeds the $0x basis of the TFD stock at time of the initial 
transfer. However, under paragraph (o)(1)(iii) of this section, to 
satisfy the basis condition of paragraph (o)(1)(i) of this section, UST 
can reduce the basis of the 10 shares of the TFC stock received in 
exchange for the TFD stock to $0x. If UST reduces the basis of the 10 
shares of TFC stock to $0x, under paragraph (o)(1)(i) of this section 
the disposition of the TFC stock shall not constitute a triggering event 
but instead shall terminate the gain recognition agreement without 
further effect.
    (xvii) Example 17. Successive section 351 exchanges, section 301 
distributions, and transactions involving partnerships--(A) Facts. UST 
owns a 40 percent capital and profits interest in a foreign partnership 
(PRS). PRS wholly owns TFD and other assets with basis equal to fair 
market value. The TFD stock has a $50x basis and $200x fair market 
value. TFC wholly owns F1. On day 1 of year 1, in a section 351 
exchange, UST transfers its PRS interest to TFC in exchange solely for 
stock of TFC (initial transfer). On that same day, in a section 351 
exchange, TFC transfers the PRS interest received from UST to F1 in 
exchange solely for stock of F1. In year 3, PRS receives a $150x 
distribution from TFD to which section 301 applies. Under section 
301(c), $25x of the distribution constitutes a dividend, $50x is applied 
against and reduces the basis of the TFD stock held by PRS, and the 
remaining $75x is treated as gain from the sale or exchange of property. 
With respect to the TFD stock deemed transferred by UST in the initial 
transfer, under section 301(c), $10x (40% of $25x) of the distribution 
constitutes a dividend, $20x (40% of $50x) is applied against and 
reduces the basis of TFD stock, and $30x (40% of $75x) is treated as 
gain from the sale or exchange of property. In year 5, pursuant to a 
distribution to which section 731 applies, PRS distributes all of the 
TFD stock to F1.
    (B) Result. (1) Successive section 351 transfers. Under section 
367(a)(4) and Sec. 1.367(a)-1T(c)(3)(ii), the transfer of the PRS 
interest by UST to TFC is treated, for purposes of section 367(a), as a 
transfer by UST to TFC of its proportionate share of the TFD stock held 
by PRS (the initial transfer). The initial transfer by UST of the TFD 
stock to TFC is subject to the general rule of section 367(a)(1), unless 
UST enters into a gain recognition agreement with respect to such 
transfer pursuant to Sec. 1.367(a)-3(b)(1)(ii) and this section. Under 
paragraph (c)(3)(viii) of this section, the gain recognition agreement 
must include a complete description of the transfer, including a 
description of the partners of PRS. Even if UST enters into a gain 
recognition agreement with respect to the initial transfer, under 
paragraph (j)(3) of this section, the subsequent transfer by TFC of the 
PRS interest to F1 is a triggering event unless UST enters into a new 
gain recognition agreement with respect to the initial transfer under 
paragraph (k)(14) that provides that, in addition to the triggering 
events provided in paragraph (j) of this section, a complete or partial 
disposition of the F1 stock received by TFC in exchange for the PRS 
interest shall constitute a triggering event for purposes of the gain 
recognition agreement. The new gain recognition agreement must also 
provide that any other disposition that is inconsistent with the 
principles of paragraph (k), including an indirect disposition of the 
TFD stock or of substantially all of the assets of TFD, shall constitute 
a triggering event for purposes of the new gain recognition agreement. 
Under paragraph (d)(2)(ii) of this section, UST is permitted to enter 
into a single gain recognition agreement with respect to the initial 
transfer and the subsequent transfer by TFC of the PRS interest, but the 
agreement must include a complete description of the initial transfer 
and the subsequent transfer of the PRS interest.
    (2) Section 301 distribution from TFD to PRS. Under paragraph 
(b)(1)(iii) of this section, the section 301 distribution received by 
PRS from TFD is not a disposition (and therefore does not affect the 
gain recognition agreement) to the extent it is described in section 
301(c)(1) or (2). However, under paragraph (n)(2) of this section, to 
the extent the distribution is described in section 301(c)(3), UST must 
recognize gain ($30x) under the gain recognition agreement. For this 
purpose, the

[[Page 430]]

amount of the distribution that is described in section 301(c)(3) is 
determined before taking into account the increase to the basis of the 
TFD stock under paragraph (c)(4)(ii) of this section.
    (3) Distribution of TFD stock by PRS to F1. The year 5 distribution 
of the TFD stock by PRS to F1 is a triggering event under paragraph 
(j)(1) of this section, unless paragraph (k)(14) of this section 
applies.
    (i) The condition of paragraph (k)(14)(i) of this section is 
satisfied because the distribution qualifies as a nonrecognition 
transaction.
    (ii) The condition of paragraph (k)(14)(ii) of this section is 
satisfied because immediately after the distribution UST, a domestic 
corporation that is eligible to be a U.S. transferor, owns at least 5% 
(determined as provided in paragraph (k)(14)(ii) of this section) of the 
total voting power and total value of the outstanding stock of F1. As a 
result, UST is treated as retaining an indirect interest in the TFD 
stock following the distribution.
    (iii) The condition of paragraph (k)(14)(iii) of this section is 
satisfied if UST enters into a new gain recognition agreement with 
respect to the initial transfer. The new gain recognition agreement need 
not describe additional dispositions or other events that would 
constitute triggering events because, pursuant to paragraph (c)(5) of 
this section, the dispositions or other events described in paragraph 
(j) of this section or in the existing gain recognition agreement apply 
to the new gain recognition agreement.
    (xviii) Example 18. Complete liquidation of transferee foreign 
corporation--(A) Facts. TFD has 10 shares of stock outstanding 
immediately before the initial transfer. On the date of the initial 
transfer, the TFD stock has a $0x basis and $90x fair market value. In 
year 2, in exchange for 1 share of TFD stock TFC transfers real estate 
to TFD with a $10x basis and $10x fair market value. In year 4, TFC 
distributes the 11 shares of TFD stock to UST in a complete liquidation 
to which sections 332 and 337 apply.
    (B) Result. In determining whether the gain recognition agreement 
entered into by UST with respect to the initial transfer is terminated 
under paragraph (o)(5) of this section, or triggered under paragraphs 
(j)(1) and (j)(4) of this section, only the 10 shares of TFD stock 
transferred by UST in the initial transfer are considered. Thus, the 1 
share of TFD stock received by TFC in exchange for the real estate in 
year 2 is not taken into account.
    (xix) Example 19. Spin-off of transferred corporation--(A) Facts. 
Before the initial transfer, the TFD stock has an $80x basis and a $100x 
fair market value, and the TFC stock has a $100x basis and a $100x fair 
market value. In year 4, TFC distributes all of the TFD stock to UST in 
a transaction to which section 355 applies. At the time of the 
distribution, the TFD stock has a $200x fair market value, and the TFC 
stock (without regard to the value of the TFD stock held by TFC) has a 
$100x fair market value. At such time, the TFC stock has a $180x basis. 
As determined under section 358, immediately after the distribution, the 
TFC stock has a $60x basis, and the TFD stock has a $120x basis.
    (B) Result. The distribution of the TFD stock by TFC in year 4 is a 
triggering event under paragraph (j)(1) of this section. The 
distribution does not terminate the gain recognition agreement under 
paragraph (o)(5) of this section because after the distribution, the 
basis of the TFD stock in the hands of UST ($120x) is greater than the 
basis of the TFD stock at the time of the initial transfer ($80x). 
However, if UST reduces the basis of the TFD stock to $80x (as provided 
under paragraph (o)(5)(iii) of this section) the gain recognition 
agreement will terminate without further effect. If UST does not elect 
to reduce the basis of the TFD stock, see paragraph (k)(14) of this 
section.
    (xx) Example 20. Intercompany transaction followed by disposition to 
nonmember--(A) Facts. At the time of the initial transfer, the TFD stock 
has a $50x basis and $100x fair market value. The amount of the gain 
recognition agreement is $50x. In year 3, UST distributes all of the TFC 
stock to USP in a transaction to which section 301 applies. At the time 
of the distribution, the TFC stock has a $50x basis and $90x fair market 
value. Under section 311(b),

[[Page 431]]

UST must recognize $40x gain (the intercompany item) on the 
distribution, but because the distribution is an intercompany 
transaction, under the provisions of Sec. 1.1502-13, the $40x gain is 
not taken into account in year 3. In year 4, USP sells all of the TFC 
stock to X, an unrelated corporation. Under the provisions of Sec. 
1.1502-13, in year 4 UST takes into account the $40x intercompany item 
as a result of the sale of the TFC stock to X.
    (B) Result. (1) The year 3 distribution of the TFC stock by UST to 
USP does not terminate the gain recognition agreement under paragraph 
(o)(1) of this section because UST does not include the $40x gain in 
taxable income during year 3. Under paragraph (j)(4) of this section, 
the year 3 distribution of the TFC stock by UST to USP is generally a 
triggering event; however, because the distribution is an intercompany 
transaction that creates an intercompany item, the distribution shall 
not constitute a triggering event if the conditions of paragraph 
(k)(12)(i) of this section are satisfied.
    (1) The condition of paragraph (k)(12)(i)(A) of this section is 
satisfied because the aggregate basis of the TFC stock distributed 
($50x) is not greater than the sum of the aggregate basis of the TFD 
stock at the time of the initial transfer ($50x).
    (2) The condition of paragraph (k)(12)(i)(B) of this section is 
satisfied if the next annual certification for the existing gain 
recognition agreement includes a complete description of the 
intercompany transaction and an explanation of how the basis condition 
of paragraph (k)(12)(i)(A) of this section is satisfied.
    (2) Under paragraph (o)(6) of this section and the principles of 
paragraph (o)(1)(i) of this section, because the year 4 sale of the TFC 
stock to X requires UST to take into account the $40x gain (the 
intercompany item) from the year 3 distribution, the year 4 sale 
terminates the gain recognition agreement. If, alternatively, in year 4 
USP had sold only 30% of the TFC stock, then under paragraph (o)(6) of 
this section and the principles of paragraph (o)(1)(ii) of this section 
the amount of gain subject to the gain recognition agreement would be 
reduced by 30%.
    (C) Alternate facts. Intercompany transaction followed by sale of 
transferee foreign corporation to member. Assume the same facts as in 
paragraph (q)(2)(xx)(A) of this section (the facts in this Example 20), 
except that, instead of USP selling the TFC stock to X, in year 4 USP 
sells the TFC stock to USS in exchange for $90x cash. UST and USS are 
members of the USP consolidated group immediately after the sale. The 
results of the year 3 distribution of the TFC stock by UST to USP are 
the same as in paragraph (q)(2)(xx)(B) of this section (the results in 
this Example 20). In addition, under paragraph (k)(12)(ii) of this 
section, the year 4 sale by USP of the TFC stock to USS is not a 
triggering event, provided UST includes a complete description of the 
sale with the annual certification filed for the gain recognition 
agreement in year 4.
    (D) Alternate facts. Intercompany transaction followed by complete 
liquidation of transferee foreign corporation. Assume the same facts as 
in paragraph (q)(2)(xx)(A) of this section (the facts in this Example 
20), except that, instead of USP selling the TFC stock to X, in year 4 
TFC distributes all of its assets to USP in a complete liquidation to 
which sections 332 and 337 apply. The result is the same as in paragraph 
(q)(2)(xx)(B) of this section (the facts in this Example 20) because, 
under the provisions of Sec. 1.1502-13, in year 4 UST takes into 
account the $40x gain (the intercompany item) from the year 3 
distribution.
    (E) Alternate facts. Intercompany transaction followed by triggering 
event. Assume the same facts as in paragraph (q)(2)(xx)(A) of this 
section (the facts in this Example 20), except that instead of USP 
selling the TFC stock to X, in year 4 TFC disposes of all of the TFD 
stock in a transaction that constitutes a triggering event under 
paragraph (j)(1) of this section. Under paragraph (c)(1)(i) of this 
section UST must recognize $50x gain under the gain recognition 
agreement. Under paragraphs (c)(4)(i) and (ii) of this section, as of 
the date of the initial transfer the basis of the TFC stock and TFD 
stock, respectively, is increased by $50x.
    (F) Alternate facts. Intercompany transaction followed by section 
351 transfer to member. The facts are the same as

[[Page 432]]

in paragraph (q)(2)(xx)(A) of this section (the facts in this Example 
20), except that, in year 3, in a section 351 exchange UST transfers all 
of the TFC stock to USS in exchange for $10x cash and $80x of stock of 
USS. USS is a member of the USP consolidated group immediately after the 
exchange. The transfer of the TFC stock by UST to USS is an intercompany 
transaction. Under section 351(b), UST must generally recognize $10x 
gain (intercompany item) in connection with the transfer; however, under 
the provisions of Sec. 1.1502-13, UST does not take the $10x gain into 
account in year 3. Under paragraph (k)(12) of this section, as result of 
the intercompany transaction creating an intercompany item ($10x gain), 
the existing gain recognition agreement ($50x gain) must be divided 
between UST and USS. UST shall remain subject to a gain recognition 
agreement of $10x (equal to the amount of the intercompany item). The 
amount of the gain recognition agreement entered into by USS under 
paragraph (k)(1) of this section is $40x (equal to the amount of the 
existing gain recognition agreement, reduced by the amount of the of the 
gain recognition agreement to which UST remains subject).
    (xxi) Example 21. Transfer of transferred stock to United States 
person other than U.S. transferor--(A) Facts. An individual (A) that is 
a United States citizen wholly owns TFD, TFC, and DC. A transfers the 
TFD stock to TFC in a section 351 exchange and enters into a gain 
recognition agreement with respect to such transfer. In year 5, pursuant 
to an asset reorganization, TFC transfers all of its assets to DC in 
exchange solely for DC stock. TFC distributes the DC stock to A pursuant 
to the plan of reorganization.
    (B) Result. The transfer by TFC of the TFD stock to DC and the 
exchange by A of the TFC stock for DC stock pursuant to the asset 
reorganization are triggering events under paragraphs (j)(1) and (j)(4) 
of this section, respectively. The gain recognition agreement does not 
terminate under paragraph (o)(5) of this section because DC is neither 
the U.S. transferor, nor an individual that is a United States person, 
nor a member of the same consolidated group of which the U.S. transferor 
is a member. However, if paragraph (k)(14) of this section applies the 
exchanges shall not constitute triggering events.
    (1) The condition of paragraph (k)(14)(i) of this section is 
satisfied because the transfer of the TFD stock to DC qualifies as a 
nonrecognition transaction.
    (2) The condition of paragraph (k)(14)(ii) of this section is 
satisfied because immediately after the transfer DC, a domestic 
corporation that is eligible to be a U.S. transferor, retains a direct 
interest in the TFD stock following the transfer.
    (3) The condition of paragraph (k)(14)(iii) of this section is 
satisfied if DC enters into a new gain recognition agreement with 
respect to the initial transfer. Under paragraph (k)(14)(iii)(B) of this 
section, DC is not required to describe any subsequent dispositions or 
other events that (based on the principles of paragraph (j) of this 
section) would constitute triggering events for purposes of the new gain 
recognition agreement, other than the dispositions or other events 
described in paragraph (j) of this section, because DC holds a direct 
interest in TFD after the asset reorganization.
    (xxii) Example 22. Transfer of transferred stock to consolidated 
group member--(A) Facts. UST wholly owns DC, a member of the USP 
consolidated group that includes UST. In year 5, pursuant to an asset 
reorganization described in section 368(a)(1)(A) TFC merges with and 
into DC. Immediately after the asset reorganization, DC wholly owns TFD, 
and the basis of the TFD stock is not greater than the aggregate basis 
of such stock at the time of the initial transfer.
    (B) Result. The gain recognition agreement filed by UST with respect 
to the initial transfer terminates without further effect if the 
conditions of paragraph (o)(5) of this section are satisfied.
    (1) The condition of paragraph (o)(5)(i) of this section is 
satisfied because the transfer of the TFD stock is a section 361 
exchange.

[[Page 433]]

    (2) The condition of paragraph (o)(5)(ii) of this section is 
satisfied because DC is a member of the consolidated group that includes 
UST immediately after the section 361 exchange.
    (3) The condition of paragraph (o)(5)(iii) of this section is 
satisfied because the aggregate basis of the TFD stock immediately after 
the section 361 exchange is not greater than the aggregate basis of the 
TFD stock at the time of the initial transfer (as adjusted for any gain 
recognized by UST on such transfer). If the basis condition of paragraph 
(o)(5)(iii) were not satisfied, under paragraph (o)(5)(iii) of this 
section, DC could reduce the basis of the TFD stock received in the 
reorganization. Alternatively, a new gain recognition agreement could be 
entered into if paragraph (k)(14) of this section applied to the 
disposition of the TFD stock pursuant to the section 361 exchange.
    (C) Alternate facts. The facts are the same as in paragraph 
(q)(2)(xxii)(A) of this section (the facts in this Example 22), except 
that instead of TFC merging into DC, TFC merges into TFD in a 
reorganization described in section 368(a)(1)(A). The gain recognition 
agreement terminates without further effect if the conditions of 
paragraph (o)(5) of this section are satisfied.
    (1) The condition of paragraph (o)(5)(i) of this section is 
satisfied because the TFD stock issued by TFD to TFC in the 
reorganization, which is treated as transferred stock under paragraph 
(b)(2)(iii) of this section, is distributed by TFC to UST pursuant to 
section 361(c).
    (2) The condition of paragraph (o)(5)(ii) of this section is 
satisfied because UST is the U.S. transferor.
    (3) The condition of paragraph (o)(5)(iii) of this section is 
satisfied if the aggregate basis of the TFD stock received by UST from 
TFC is not greater than the aggregate basis of the TFD stock at the time 
of the initial transfer (as adjusted for any gain recognized by UST on 
such transfer). If the basis condition of paragraph (o)(5)(iii) were not 
satisfied, under paragraph (o)(5)(iii) of this section, UST could reduce 
the basis of the TFD stock received in the reorganization.
    (xxiii) Example 23. Split-off of transferred stock--(A) Facts. X, a 
domestic corporation that is unrelated to USP and UST, wholly owns TFC. 
Pursuant to a reorganization described in section 368(a)(1)(B), UST 
transfers all of the TFD stock to TFC in exchange for 50% of the 
outstanding voting stock of TFC. UST enters into a gain recognition 
agreement with respect to such transfer. In year 4, in a split-off 
transaction to which section 355 applies, TFC distributes all of the TFD 
stock to X in exchange for all the TFC stock held by X.
    (B) Result. Under paragraph (j)(1) of this section, the year 4 
distribution of the TFD stock to X constitutes a triggering event. 
However, the distribution shall not constitute a triggering event if 
paragraph (k)(14) of this section applies. The gain recognition 
agreement does not terminate under paragraph (o)(5) of this section 
because X is not a recipient described in paragraph (o)(5)(ii) of this 
section.
    (1) The condition of paragraph (k)(14)(i) of this section is 
satisfied because the distribution of the TFD stock qualifies as a 
nonrecognition transaction.
    (2) The condition of paragraph (k)(14)(ii) of this section is 
satisfied because immediately after the distribution X, a domestic 
corporation that is eligible to be a U.S. transferor, retains a direct 
interest in the TFD stock.
    (3) The condition of paragraph (k)(14)(iii) of this section is 
satisfied if X enters into a new gain recognition agreement with respect 
to the initial transfer. Under paragraph (k)(14)(iii)(B) of this 
section, X is not required to describe, with the new gain recognition 
agreement, any subsequent dispositions or other events that (based on 
the principles of paragraph (j) of this section) would constitute 
triggering events, other than the dispositions described in paragraph 
(j) of this section, because X directly owns TFD after the distribution.
    (4) If X were a United States citizen, the gain recognition 
agreement would terminate if the condition of paragraph (o)(5)(iii) of 
this section were satisfied. Alternatively, the gain recognition 
agreement would continue for its remaining term if the conditions for 
the

[[Page 434]]

application of paragraph (k)(14) of this section were satisfied.
    (C) Alternate facts. Distribution to unrelated foreign corporation. 
The facts are the same as in paragraph (q)(2)(xxiii)(A) of this section 
(the facts in this Example 23), except that X is a foreign corporation 
wholly owned by DC. DC is unrelated to UST. The results are the same as 
in paragraph (q)(2)(xxiii)(B) of this section (the results in this 
Example 23), except as follows.
    (1) The condition of paragraph (k)(14)(ii) of this section is 
satisfied because immediately after the distribution DC, a domestic 
corporation that is eligible to be a U.S. transferor, owns at least 5% 
(determined as provided in paragraph (k)(14)(ii) of this section) of the 
total voting power and total value of the outstanding stock of X. As a 
result, DC is treated as retaining an indirect interest in the TFD stock 
immediately following the distribution.
    (2) The condition of paragraph (k)(14)(iii) of this section is 
satisfied if DC enters into a new gain recognition agreement with 
respect to the initial transfer. Under paragraph (k)(14)(iii)(B) of this 
section, DC must, in addition to the dispositions described in paragraph 
(j) of this section, include as a triggering event a complete or partial 
disposition of the stock of X.
    (D) Alternate facts. Distribution to nonresident alien individual. 
The facts are the same as in paragraph (q)(2)(xxiii)(A) of this section 
(the facts in this Example 23), except that X is a nonresident alien 
individual. Paragraph (k)(14) of this section does not apply to the 
distribution because the conditions of paragraph (k)(14)(ii) and (iii) 
of this section cannot be satisfied. Therefore, the distribution is a 
triggering event, and UST will recognize gain under the gain recognition 
agreement as required under paragraphs (c)(1)(i) and (v) of this 
section. The result would be the same if X were a foreign corporation 
and, immediately after the distribution, no United States person owned 
at least 5% (determined as provided in paragraph (k)(14)(ii) of this 
section) of the total voting power and value of the outstanding stock of 
X.
    (xxiv) Example 24. Applicability of this section to gain recognition 
agreements filed before March 13, 2009--(A) Facts. The facts are the 
same as in paragraph (q)(2)(vi)(A) of this section (the facts in Example 
6), except that the initial transfer occurred on March 7, 2007, and the 
asset reorganization occurred on July 1, 2008.
    (B) Result. Under paragraph (r)(1)(ii) of this section, the rules of 
Sec. 1.367(a)-8T (see 26 CFR part 1, revised April 1, 2007) apply to 
the transfers pursuant to the asset reorganization because the initial 
transfer occurred on March 7, 2007. As a result of the disposition of 
the TFC stock pursuant to the asset reorganization, under Sec. 
1.367(a)-8T(d), USP is required to recognize the gain subject to the 
gain recognition agreement and pay applicable interest on any additional 
tax due with respect to such gain. Because the acquiring corporation in 
the asset reorganization is foreign, an exception under Sec. 1.367(a)-
8T(e) is not available for the exchange of TFC stock by USP. However, 
pursuant to paragraph (r)(2)(i) of this section, because the exception 
provided by paragraph (k)(14) of this section is not included in Sec. 
1.367(a)-8T, USP may apply paragraph (k)(14) of this section to such 
exchange (provided the conditions of paragraph (k)(14) of this section 
are satisfied), if the statute of limitations on assessments of tax for 
the 2007 tax year has not closed. If USP applies paragraph (k)(14) of 
this section to its exchange of the TFC stock pursuant to the asset 
reorganization, under paragraph (r)(2)(ii) of this section USP must 
include the new gain recognition agreement required under paragraph 
(k)(14)(iii) of this section with an amended Federal income tax return 
for its 2008 tax year that is filed August 10, 2009.
    (xxv) Example 25. Applicability of this section to gain recognition 
agreements filed before March 13, 2009--(A) Facts. The initial transfer 
occurs in 2004. In 2005, pursuant to a section 351 exchange, TFC 
transfers the TFD stock to F1 in exchange solely for F1 voting stock. 
UST does not file a new gain recognition agreement under Sec. 1.367(a)-
8(g)(2) with respect to the exchange.
    (B) Result. Under paragraph (r)(1)(ii) of this section, the rules of 
Sec. 1.367(a)-8

[[Page 435]]

(see 26 CFR part 1, revised April 1, 2006) apply to the year 2005 
disposition of the TFD stock because UST filed the gain recognition 
agreement after July 20, 1998, but before March 7, 2007. Under Sec. 
1.367(a)-8(e) (see 26 CFR part 1, revised April 1, 2006), as a result of 
the disposition of the TFD stock by TFC, UST must recognize the amount 
of gain subject to the gain recognition agreement. Paragraph (r)(2)(i) 
of this section does not apply because the rule provided by paragraph 
(k)(3) of this section was included in Sec. 1.367(a)-8(g)(2) (see 26 
CFR part 1, revised April 1, 2006). However, UST may request relief for 
reasonable cause under Sec. 1.367(a)-8(c)(2) (see 26 CFR part 1, 
revised April 1, 2006) to file a new gain recognition agreement with 
respect to the disposition of the TFD stock by TFC in 2005.
    (r) Applicability dates--(1) General rule--(i) Transfers occurring 
on or after March 13, 2009; relief for certain failures that are not 
willful. The rules of this section apply to gain recognition agreements 
filed with respect to transfers of stock or securities occurring on or 
after March 13, 2009. However, the rules of this section do not apply to 
gain recognition agreements filed with respect to any such transfer 
occurring on or after March 13, 2009, if such transfer was entered into 
pursuant to a written agreement that was (subject to customary 
conditions) binding before February 11, 2009, and at all times 
thereafter. Solely for purposes of this paragraph (r), a transfer 
described in the preceding sentence shall be deemed to be a transfer 
occurring before March 13, 2009 to which the rules of Sec. 1.367(a)-8 
(see 26 CFR part 1, revised April 1, 2006) apply. See paragraph 
(r)(2)(iii) of this section for the ability to apply the rules of this 
section with respect to gain recognition agreements filed for taxable 
years ending before March 13, 2009. The eleventh sentence of paragraph 
(a) and paragraphs (b)(1)(iv), (b)(1)(vi), (b)(1)(xiii), (d)(1), (j)(8), 
and (p) of this section will apply to gain recognition agreement 
documents that are required to be filed on or after November 19, 2014, 
as well as to requests for relief submitted on or after November 19, 
2014. Paragraph (k)(14)(ii) of this section applies to transfers 
occurring on or after October 1, 2019, and to transfers occurring before 
October 1, 2019, that result from an entity classification election made 
under Sec. 301.7701-3 of this chapter that is filed on or after October 
1, 2019. For transfers occurring before October 1, 2019, other than 
transfers occurring before October 1, 2019, that result from an entity 
classification election made under Sec. 301.7701-3 of this chapter that 
is filed on or after October 1, 2019, a taxpayer may apply paragraph 
(k)(14)(ii) of this section to transfers occurring during the last 
taxable year of a transferee foreign corporation beginning before 
January 1, 2018, and each subsequent taxable year of the foreign 
corporation, provided that the taxpayer and United States persons that 
are related (within the meaning of section 267 or 707) to the taxpayer 
consistently apply such paragraph with respect to all foreign 
corporations. For transfers occurring before October 1, 2019, other than 
transfers occurring before October 1, 2019, that result from an entity 
classification election made under Sec. 301.7701-3 of this chapter that 
is filed on or after October 1, 2019, where the taxpayer does not apply 
paragraph (k)(14)(ii) of this section as described in the preceding 
sentence, see paragraph (k)(14)(ii) of this section as in effect and 
contained in 26 CFR part 1, as revised April 1, 2020.
    (ii) Transfers occurring before March 13, 2009. For matters covered 
in this section for periods before March 13, 2009 but on or after March 
7, 2007, the corresponding rules of Sec. 1.367(a)-8T (see 26 CFR part 
1, revised April 1, 2007) apply. For matters covered in this section for 
periods before March 7, 2007 but on or after July 20, 1998, the 
corresponding rules of Sec. 1.367(a)-8 (see 26 CFR part 1, revised 
April 1, 2006) apply. For matters covered in this section for periods 
before July 20, 1998, the corresponding rules of Sec. 1.367(a)-3T(g) 
(see 26 CFR part 1, revised April 1, 1998) and Notice 87-85 (1987-2 CB 
395) apply. In addition, if a U.S. transferor entered into a gain 
recognition agreement for transfers before July 20, 1998, then the rules 
of Sec. 1.367(a)-3T(g) (see 26 CFR part 1, revised April 1, 1998) 
continue to apply in lieu of this section in the

[[Page 436]]

event of any direct or indirect nonrecognition transfer of the same 
property. See also, Sec. 1.367(a)-3(h).
    (2) Applicability to transfers occurring before March 13, 2009 March 
13, 2009--(i) General rule. Taxpayers may apply the rules of this 
regulation Sec. 1.367(a)-8 that were not included in Sec. 1.367(a)-8T 
(see 26 CFR part 1, revised April 1, 2007), to gain recognition 
agreements filed with respect to transfers of stock or securities for 
all open taxable years, if done consistently to all transfers. A U.S. 
transferor subject to section 877 and Sec. 1.367(a)-8T(d)(6) shall not 
apply the rules of this regulation to reach a contrary result. A 
taxpayer that failed to file a gain recognition agreement for a 
transfer, or to comply materially with any requirement of this section 
with respect to an existing gain recognition agreement, must obtain 
relief for reasonable cause for such failure under Sec. 1.367(a)-
8T(e)(10) before applying the rules of this regulation Sec. 1.367(a)-8 
that were not included in Sec. 1.367(a)-8T as permitted by this 
paragraph (r)(2). See paragraphs (q)(2)(xxiv) and (xxv) of this section 
for illustrations of the rule provided by this paragraph (r)(2)(i).
    (ii) Taxable years ending before March 13, 2009. Notwithstanding the 
requirements of Sec. 1.367(a)-8(d), any gain recognition agreement or 
other filing required by reason of electing to apply the rules of this 
regulation Sec. 1.367(a)-8 that were not included in Sec. 1.367(a)-8T, 
as permitted by this paragraph (r)(2), for a taxable year ending before 
March 13, 2009 shall be considered filed in accordance with the 
requirements of Sec. 1.367(a)-8(d), provided the gain recognition 
agreement or other filing is attached to an original or amended return 
for such taxable year. An amended return required to be filed by reason 
of electing to apply the rules of this regulation Sec. 1.367(a)-8 that 
were not included in Sec. 1.367(a)-8T, as permitted by this paragraph 
(r)(2), must be filed on or before August 10, 2009. A taxpayer that 
wishes to apply the rules of this regulation Sec. 1.367(a)-8 that were 
not included in Sec. 1.367(a)-8T, as permitted by this paragraph 
(r)(2), but that fails to meet the filing requirement described in the 
preceding sentence must request relief for reasonable cause under 
paragraph (p) of this section.
    (iii) Taxable years ending after effective date. A taxpayer that 
entered into a gain recognition agreement to which Sec. 1.367(a)-8T 
(see 26 CFR part 1, revised April 1, 2007) applies may apply the rules 
of this section in a tax year ending on or after March 13, 2009 by 
attaching the agreement, certification, or other information related to 
such gain recognition agreement that the rules of this section require 
in accordance with the rules of this section and with the time and 
manner rules provided in Sec. 1.367(a)-8(d).
    (3) Applicability to requests for relief submitted before November 
19, 2014. The eleventh sentence of paragraph (a) and paragraphs 
(b)(1)(iv), (b)(1)(vi), (b)(1)(xiii), (d)(1), (j)(8), and (p) of this 
section will apply to requests for relief submitted before November 19, 
2014 if--
    (i) The statute of limitations on the assessment of tax has not 
expired for any year to which the request relates; and
    (ii) The U.S. transferor resubmits the request under paragraph (p) 
of this section, notes on the request that the request is being 
submitted pursuant to this paragraph (r)(3), and acknowledges on the 
request that the last sentence of Sec. 1.6038B-1(g)(6) provides a 
special rule regarding the application of Sec. 1.6038B-1 to any 
transfer that is the subject of the request.

[T.D. 9446, 74 FR 6960, Feb. 11, 2009; 74 FR 10175, Mar. 10, 2009, as 
amended at T.D. 9446, 74 FR 13341, Mar. 27, 2009; T.D. 9614, 78 FR 
17039, Mar. 19, 2013; T.D. 9704, 79 FR 68768, Nov. 19, 2014; 80 FR 167, 
Jan. 5, 2015; T.D. 9760, 81 FR 15169, Mar. 22, 2016; T.D. 9803, 81 FR 
91029, Dec. 16, 2016; T.D. 9908, 85 FR 59431, Sept. 22, 2020]

    Editorial Note: By T.D. 9908, 85 FR 59431, Sept. 22, 2020, Sec. 
1.367(a)-8 was amended; however, the a portion of amendment could not be 
incorporated due to inaccurate amendatory instruction.



Sec. 1.367(a)-9T  Treatment of deemed section 351 exchanges pursuant
to section 304(a)(1) (temporary).

    (a) Scope and general rule. This section applies to the extent that, 
pursuant to section 304(a)(1), a United States person is treated as 
transferring stock of a domestic or foreign corporation to a foreign 
corporation (foreign acquiring corporation) in exchange for stock of the 
foreign acquiring corporation in

[[Page 437]]

a transaction to which section 351(a) applies (deemed section 351 
exchange). Except to the extent provided in paragraph (b) of this 
section, a transfer of stock by a United States person to a foreign 
acquiring corporation in a deemed section 351 exchange is not subject to 
section 367(a)(1).
    (b) Special rule. Notwithstanding paragraph (a) of this section, if 
the distribution received by the United States person in redemption of 
the stock of the foreign acquiring corporation deemed issued in the 
deemed section 351 exchange is applied against and reduces (in whole or 
in part), pursuant to section 301(c)(2), the basis of stock of the 
foreign acquiring corporation held by the United States person other 
than the stock deemed issued in the deemed section 351 exchange, the 
United States person shall recognize gain pursuant to this paragraph 
(b). The exceptions described in Sec. 1.367(a)-3(b)(1) and (c)(1) shall 
not apply to a transfer of stock described in paragraph (a) of this 
section. The amount of gain recognized by a United States person 
pursuant to this paragraph (b) shall equal the amount, if any, by 
which--
    (1) The gain realized by the United States person with respect to 
the transferred stock in connection with the deemed section 351 exchange 
exceeds;
    (2) The amount of the distribution received by the United States 
person in redemption of the stock of the foreign acquiring corporation 
deemed issued in the deemed section 351 exchange that is treated as a 
dividend under section 301(c)(1) and included in gross income by the 
United States person.
    (c) Ordering rule. For purposes of paragraph (b)(1) of this section, 
the amount of gain realized by the United States person in connection 
with the deemed section 351 exchange shall be determined without regard 
to the amount of gain recognized by the United States person under 
paragraph (b) of this section.
    (d) Allocation of recognized gain. Gain recognized by a United 
States person pursuant to paragraph (b) of this section shall be treated 
as recognized with respect to the stock transferred in the deemed 
section 351 exchange in proportion to the amount of gain realized by the 
United States person with respect to such stock. See Sec. 1.367(a)-
1T(b)(4) for additional rules on the character, source, and adjustments 
relating to gain recognized under section 367(a).
    (e) Example. The following example illustrates the rules of this 
section:

    Example. (i) Facts. (A) USP, a domestic corporation, wholly owns FC1 
and FC2, each a foreign corporation. USP, FC1 and FC2 use a calendar 
taxable year. The FC1 stock has a $40x basis and $100x fair market 
value. The FC2 stock has a $100x basis and $100x fair market value. As 
of December 31, year 1, FC1 has zero earnings and profits, and FC2 has 
$20x earnings and profits. On December 31, year 1, in a transaction 
described in section 304(a)(1), USP sells the FC1 stock to FC2 for $100x 
cash.
    (B) Because USP wholly owns FC1 before the transactions and is 
treated, under section 318, as indirectly owning 100% of the FC1 stock 
after the transfer, under section 304(a)(1), USP and FC2 are treated in 
the same manner as if USP contributed the FC1 stock to FC2 in a deemed 
section 351 exchange in exchange solely for $100x of FC2 stock, and then 
FC2 redeemed for $100x cash its stock deemed issued to USP. Because USP 
wholly owns FC1 before the sale and is treated as owning 100% of FC1 
after the sale, section 302(a) does not apply to the redemption. 
Instead, under section 302(d), the redemption is treated as a 
distribution to which section 301 applies. Pursuant to section 
304(b)(2), $20x of the distribution is treated as a dividend from FC2. 
With respect to the remaining $80x, USP takes the position that $40x is 
applied against and reduces the basis of the FC2 stock issued in the 
deemed section 351 exchange, and $40x is applied against and reduces the 
basis of the FC2 stock held by USP prior to (and after) the transaction.
    (ii) Analysis. Under paragraph (b) of this section, USP must 
recognize gain of $40x on its transfer of the FC1 stock to FC2 in the 
deemed section 351 exchange (the amount by which the $60x gain realized 
by USP on the deemed section 351 exchange with respect to the F1 stock 
exceeds the $20x dividend inclusion). Pursuant to paragraph (b) of this 
section, the exception under Sec. 1.367(a)-3(b) is not available to the 
transfer of the FC1 stock by USP to FC2 in the deemed section 351 
exchange. Thus, USP cannot avoid gain recognition under paragraph (b) of 
this section by entering into a gain recognition agreement with respect 
to its transfer of the FC1 stock to FC2 in the deemed section 351 
exchange. Under paragraph (d) of this section, the $40x gain recognized 
is allocated among the shares of FC1 stock transferred to FC2 in the 
deemed section 351 exchange in proportion to the gain realized by USP on 
the

[[Page 438]]

transfer of such shares. Under paragraph (c) of this section, the 
application of paragraph (b) of this section is determined prior to 
taking into account the $40x increase to the basis of the FC1 stock 
transferred by USP. Under section 362, the basis of the FC1 stock in the 
hands of FC2 is increased by $40x, the amount of gain recognized by the 
USP on the transfer of the FC1 stock under paragraph (b) of this 
section. Under section 358, the basis of the FC2 stock received by USP 
in the deemed section 351 exchange is similarly increased by $40x. See 
Sec. 1.367(a)-1T(b)(4). The $40x increase to the basis of the FC2 stock 
is taken into account before determining the consequences of the 
redemption of such stock under section 304(a)(1).

    (f) Effective/applicability date. This section applies to transfers 
occurring on or after February 10, 2009. See Sec. 1.367(a)-3(a), as 
contained in 26 CFR part 1 revised as of April 1, 2008, for transfers 
occurring on or after February 21, 2006, and before February 10, 2009.
    (g) Expiration date. This section expires on or before February 10, 
2012.

[T.D. 9444, 74 FR 6826, Feb. 11, 2009; 74 FR 10175, Mar. 10, 2009]



Sec. 1.367(b)-0  Table of contents.

    This section lists the paragraphs contained in Sec. Sec. 1.367(b)-1 
through 1.367(b)-13.

                    Sec. 1.367(b)-1 Other transfers.

    (a) Scope.
    (b) General rules.
    (1) Rules.
    (2) Example.
    (c) Notice required.
    (1) In general.
    (2) Persons subject to section 367(b) notice.
    (3) Time and manner for filing notice.
    (i) United States persons described in Sec. 1.367(b)-1(c)(2).
    (ii) Foreign corporations described in Sec. 1.367(b)-1(c)(2).
    (4) Information required.
    (5) Abbreviated notice provision for shareholders that make the 
election described in Sec. 1.367(b)-3(c)(3).
    (6) Supplemental published guidance.

             Sec. 1.367(b)-2 Definitions and special rules.

    (a) Controlled foreign corporation.
    (b) Section 1248 shareholder.
    (c) Section 1248 amount.
    (1) Rule.
    (2) Examples.
    (d) All earnings and profits amount.
    (1) General rule.
    (2) Rules for determining earnings and profits.
    (i) Domestic rules generally applicable.
    (ii) Certain adjustments to earnings and profits.
    (iii) Effect of section 332 liquidating distribution.
    (3) Amount attributable to a block of stock.
    (i) Application of section 1248 principles.
    (A) In general.
    (1) Rule.
    (2) Example.
    (B) Foreign shareholders.
    (ii) Exclusion of lower-tier earnings.
    (e) Treatment of deemed dividends.
    (1) In general.
    (2) Consequences of dividend characterization.
    (3) Ordering rules.
    (4) Examples.
    (f) Deemed asset transfer and closing of taxable year in certain 
section 368(a)(1)(F) reorganizations.
    (1) Scope.
    (2) Deemed asset transfer.
    (3) Other applicable rules.
    (4) Closing of taxable year.
    (g) Stapled stock under section 269B.
    (h) Section 953(d) domestication elections.
    (1) Effect of election.
    (2) Post-election exchanges.
    (i) Section 1504(d) elections.
    (j) Sections 985 through 989.
    (1) Change in functional currency of a qualified business unit.
    (i) Rule.
    (ii) Example.
    (2) Previously taxed earnings and profits.
    (i) Exchanging shareholder that is a United States person.
    (ii) Exchanging shareholder that is a foreign corporation.
    (3) Other rules.
    (k) Partnerships, trusts and estates.
    (l) Additional definitions.
    (1) Foreign income taxes.
    (2) Post-1986 undistributed earnings.
    (3) Post-1986 foreign income taxes.
    (4) Pre-1987 accumulated profits.
    (5) Pre-1987 foreign income taxes.
    (6) Pre-1987 section 960 earnings and profits.
    (7) Pre-1987 section 960 foreign income taxes.
    (8) Earnings and profits.
    (9) Pooling corporation.
    (10) Nonpooling corporation.
    (11) Separate category.
    (12) Passive category.
    (13) General category

  Sec. 1.367(b)-3 Repatriation of foreign corporate assets in certain 
                      nonrecognition transactions.

    (a) Scope.

[[Page 439]]

    (b) Exchange of stock owned directly by a United States shareholder 
or by certain foreign corporate shareholders.
    (1) Scope.
    (2) United States shareholder.
    (3) Income inclusion.
    (i) Inclusion of all earnings and profits amount.
    (ii) Examples.
    (iii) Recognition of exchange gain or loss with respect to capital. 
[Reserved]
    (4) [Reserved]
    (c) Exchange of stock owned by a United States person that is not a 
United States shareholder.
    (1) Scope.
    (2) Requirement to recognize gain.
    (3) Election to include all earnings and profits amount.
    (4) De minimis exception.
    (5) Examples.
    (d) Carryover of certain foreign taxes.
    (1) Rule.
    (2) Example.
    (e) Net operating loss and capital loss carryovers.
    (f) Carryover of earnings and profits.
    (1) General rule.
    (2) Previously taxed earnings and profits. [Reserved

 Sec. 1.367(b)-4 Acquisition of foreign corporate stock or assets by a 
       foreign corporation in certain nonrecognition transactions.

    (a) Scope.
    (b) Income inclusion.
    (1) Exchange that results in loss of status as section 1248 
shareholder.
    (i) General rule.
    (ii) Special rules.
    (iii) Examples.
    (2) Receipt by exchanging shareholder of preferred or other stock in 
certain instances.
    (i) Rule.
    (ii) Examples.
    (3) Certain recapitalizations.
    (c) Exclusion of deemed dividend from foreign personal holding 
company income.
    (1) Rule.
    (2) Example.
    (d) Rules for subsequent exchanges.
    (1) Rule.
    (2) Example.

    Sec. 1.367(b)-5 Distributions of stock described in section 355.

    (a) In general.
    (1) Scope.
    (2) Treatment of distributees as exchanging shareholders.
    (b) Distribution by a domestic corporation.
    (1) General rule.
    (2) Section 367(e) transactions.
    (3) Determining whether distributees are individuals.
    (4) Applicable cross-references.
    (c) Pro rata distribution by a controlled foreign corporation.
    (1) Scope.
    (2) Adjustment to basis in stock and income inclusion.
    (3) Interaction with Sec. 1.367(b)-2(e)(3)(ii).
    (4) Basis redistribution.
    (d) Non-pro rata distribution by a controlled foreign corporation.
    (1) Scope.
    (2) Treatment of certain shareholders as distributees.
    (3) Inclusion of excess section 1248 amount by exchanging 
shareholder.
    (4) Interaction with Sec. 1.367(b)-2(e)(3)(ii).
    (i) Limited application.
    (ii) Interaction with predistribution amount.
    (e) Definitions.
    (1) Predistribution amount.
    (2) Postdistribution amount.
    (f) Exclusion of deemed dividend from foreign personal holding 
company income.
    (g) Examples.

 Sec. 1.367(b)-6 Effective/applicability dates and coordination rules.

    (a) Effective/applicability dates.
    (1) In general.
    (2) Exception.
    (b) Certain recapitalizations described in Sec. 1.367(b)-4(b)(3).
    (c) Use of reasonable method to comply with prior published 
guidance.
    (1) Prior exchanges.
    (2) Future exchanges.
    (d) Effect of removal of attribution rules.

 Sec. 1.367(b)-7 Carryover of earnings and profits and foreign income 
    taxes in certain foreign-to-foreign nonrecognition transactions.

    (a) Scope.
    (b) General rules.
    (1) Non-previously taxed earnings and profits and related taxes.
    (2) Previously taxed earnings and profits. [Reserved]
    (c) Ordering rule for post-transaction distributions.
    (1) If foreign surviving corporation is a pooling corporation.
    (2) If foreign surviving corporation is a nonpooling corporation.
    (d) Post-1986 pool.
    (1) In general.
    (i) Qualifying earnings and taxes.
    (ii) Carryover rule.
    (2) Hovering deficit.
    (i) In general.
    (ii) Offset rule.
    (iii) Related taxes.
    (3) Examples.
    (e) Pre-pooling annual layers.
    (1) If foreign surviving corporation is a pooling corporation.
    (i) Qualifying earnings and taxes.

[[Page 440]]

    (ii) Carryover rule.
    (iii) Deficits.
    (A) In general.
    (B) Aggregate positive pre-1987 accumulated profits.
    (C) Aggregate deficit in pre-1987 accumulated profits.
    (D) Deficit and positive separate categories within annual layers
    (iv) Pre-1987 section 960 earnings and profits and foreign income 
taxes.
    (v) Examples.
    (2) If foreign surviving corporation is a nonpooling corporation.
    (i) Qualifying earnings and taxes.
    (ii) Carryover rule.
    (iii) Deficits.
    (A) In general.
    (B) Aggregate positive pre-1987 accumulated profits.
    (C) Aggregate deficit in pre-1987 accumulated profits.
    (D) Deficit and positive separate categories within annual layers.
    (iv) Pre-1987 section 960 earnings and profits and foreign income 
taxes.
    (v) Examples.
    (f) Special rules.
    (1) Treatment of deficit.
    (i) General rule.
    (ii) Exceptions.
    (iii) Examples.
    (2) Reconciling taxable years.
    (3) Post-transaction change of status.
    (4) Ordering rule for multiple hovering deficits.
    (i) Rule.
    (ii) Example.
    (5) Pro rata rule for earnings and deficits during transaction year.
    (g) Effective date.

 Sec. 1.367(b)-8 Allocation of earnings and profits and foreign income 
       taxes in certain foreign corporate separations. [Reserved]

    Sec. 1.367(b)-9 Special rule for F reorganizations and similar 
                              transactions.

    (a) Scope.
    (b) Hovering deficit rules inapplicable.
    (c) Foreign divisive transactions. [Reserved]
    (d) Examples.
    (e) Effective date.

Sec. 1.367(b)-10 Acquisition of parent stock or securities for property 
                     in triangular reorganizations.

    (a) In general.
    (1) Scope.
    (2) Exceptions.
    (3) Definitions.
    (b) General rules.
    (1) Deemed distribution.
    (2) Deemed contribution.
    (3) Timing of deemed distribution and deemed contribution.
    (4) Application of other provisions.
    (5) Example.
    (c) Collateral adjustments.
    (1) Deemed distribution.
    (2) Deemed contribution.
    (d) Anti-abuse rule.
    (e) Effective/applicability date.

Sec. 1.367(b)-12 Subsequent treatment of amounts attributed or included 
                               in income.

    (a) In general.
    (b) Applicable rules.
    (c) Effective date.

   Sec. 1.367(b)-13 Special rules for determining basis and holding 
                                 period.

    (a) Scope and definitions.
    (1) Scope.
    (2) Definitions.
    (b) Determination of basis for exchanges of foreign stock or 
securities under section 354 or 356.
    (c) Determination of basis and holding period for triangular 
reorganizations.
    (1) Application.
    (2) Basis and holding period rules.
    (i) Portions attributable to S stock.
    (ii) Portions attributable to T stock.
    (d) Special rules applicable to divided shares of stock.
    (1) In general.
    (2) Pre-exchange earnings and profits.
    (3) Post-exchange earnings and profits.
    (e) Examples.
    (f) Effective date.

[T.D. 8862, 65 FR 3596, Jan. 24, 2000; 65 FR 66501, Nov. 6, 2000, as 
amended by T.D. 8937, 66 FR 2257, Jan. 11, 2001; T.D. 9273, 71 FR 44984, 
Aug. 8, 2006; T.D. 9526, 76 FR 28893, May 19, 2011; T.D. 9614, 78 FR 
17039, Mar. 19, 2013]

    Editorial Note: By T.D. 9526, 76 FR 28893, May 19, 2011, Sec. 
1.367(b)-0 was amended by redesignating the entries for Sec. 1.367(b)-
2(d)(3)(iii)(A) and (B) as entries for (d)(3)(ii)(A) and (B); however, 
the amendment could not be incorporated due to inaccurate amendatory 
instruction.



Sec. 1.367(b)-1  Other transfers.

    (a) Scope. The regulations promulgated under section 367(b) (the 
section 367(b) regulations) set forth rules regarding the proper 
inclusions and adjustments that must be made as a result of an exchange 
described in section 367(b) (a section 367(b) exchange). A section 
367(b) exchange is any exchange described in section 332, 351, 354, 355, 
356 or 361, with respect to which the status of a foreign corporation as 
a corporation is relevant for determining the extent to which income 
shall be recognized or for determining the effect of

[[Page 441]]

the transaction on earnings and profits, basis of stock or securities, 
basis of assets, or other relevant tax attributes. For rules 
coordinating the concurrent application of sections 367(a) and (b), see 
Sec. 1.367(a)-3(b)(2).
    (b) General rules--(1) Rules. The following general rules apply 
under the section 367(b) regulations--
    (i) A foreign corporation in a section 367(b) exchange is considered 
to be a corporation and, as a result, all of the related provisions 
(e.g., section 381) shall apply, except to the extent provided in the 
section 367(b) regulations; and
    (ii) Nothing in the section 367(b) regulations shall permit--
    (A) The nonrecognition of income that would otherwise be required to 
be recognized under another provision of the Internal Revenue Code or 
the regulations thereunder; or
    (B) The recognition of a loss or deduction that would otherwise not 
be recognized under another provision of the Internal Revenue Code or 
the regulations thereunder.
    (2) Example. The following example illustrates the rules of this 
paragraph (b):

    Example. (i) Facts. DC, a domestic corporation, owns 90 percent of 
P, a partnership. The remaining 10 percent of P is owned by a person 
unrelated to DC. P owns all of the outstanding stock of FC, a controlled 
foreign corporation. FC liquidates into P.
    (ii) Result. FC's liquidation is not a transaction described in 
section 332. Nothing in the section 367(b) regulations, including Sec. 
1.367(b)-2(k), permits FC's liquidation to qualify as a liquidation 
described in section 332.

    (c) Notice Required--(1) In general. A notice under this paragraph 
(c) (section 367(b) notice) must be filed with regard to any person 
described in paragraph (c)(2) of this section. A section 367(b) notice 
must be filed in the time and manner described in paragraph (c)(3) of 
this section and must include the information described in paragraph 
(c)(4) of this section.
    (2) Persons subject to section 367(b) notice. The following persons 
are described in this paragraph (c)(2)--
    (i) A shareholder described in Sec. 1.367(b)-3(b)(1) that realizes 
income in a transaction described in Sec. 1.367(b)-3(a);
    (ii) A shareholder that makes the election described in Sec. 
1.367(b)-3(c)(3);
    (iii) A shareholder described in Sec. 1.367(b)-4(b)(1)(i)(A)(1) or 
(2) that realizes income in a transaction described in Sec. 1.367(b)-
4(a);
    (iv) A shareholder that realizes income in a transaction described 
in Sec. 1.367(b)-5(c) or 1.367(b)-5(d) and that is either--
    (A) A section 1248 shareholder of the distributing or controlled 
corporation; or
    (B) A foreign corporation with one or more shareholders that are 
described in paragraph (c)(2)(iv)(A) of this section; and
    (v) A foreign surviving corporation described in Sec. 1.367(b)-
7(a).
    (3) Time and manner for filing notice--(i) United States persons 
described in Sec. 1.367(b)-1(c)(2). A United States person described in 
paragraph (c)(2) of this section must file a section 367(b) notice 
attached to a timely filed Federal tax return (including extensions) for 
the person's taxable year in which income is realized in the section 
367(b) exchange. In the case of a shareholder that makes the election 
described in Sec. 1.367(b)-3(c)(3), notification of such election must 
be sent to the foreign acquired corporation (or its successor in 
interest) on or before the date the section 367(b) notice is filed, so 
that appropriate corresponding adjustments can be made in accordance 
with the rules of Sec. 1.367(b)-2(e).
    (ii) Foreign corporations described in Sec. 1.367(b)-1(c)(2). Each 
United States person listed in this paragraph (c)(3)(ii) must file a 
section 367(b) notice with regard to a foreign corporation described in 
paragraph (c)(2) of this section. Such notice must be attached to a 
timely filed Federal tax return (including extensions) for the United 
States person's taxable year in which income is realized in the section 
367(b) exchange and, if the United States person is required to file a 
Form 5471 (Information Return of U.S. Persons With Respect to Certain 
Foreign Corporations), the section 367(b) notice must be attached to the 
Form 5471. The following persons are listed in this paragraph 
(c)(3)(ii)--
    (A) United States shareholders (as defined in Sec. 1.367(b)-
3(b)(2)) of foreign

[[Page 442]]

corporations described in paragraph (c)(2)(i) or (v) of this section; 
and
    (B) Section 1248 shareholders of foreign corporations described in 
paragraph (c)(2)(iii) or (iv) of this section.
    (4) Information required. Except as provided in paragraph (c)(5) of 
this section, a section 367(b) notice shall include the following 
information--
    (i) A statement that the exchange is a section 367(b) exchange;
    (ii) A complete description of the exchange;
    (iii) A description of any stock, securities or other consideration 
transferred or received in the exchange;
    (iv) A statement that describes any amount (or amounts) required, 
under the section 367(b) regulations, to be taken into account as income 
or loss or as an adjustment (including an adjustment under Sec. 
1.367(b)-7 or 1.367(b)-9) to basis, earnings and profits, or other tax 
attributes as a result of the exchange;
    (v) Any information that is or would be required to be furnished 
with a Federal income tax return pursuant to regulations under section 
332, 351, 354, 355, 356, 361, 368, or 381 (whether or not a Federal 
income tax return is required to be filed), if such information has not 
otherwise been provided by the person filing the section 367(b) notice;
    (vi) Any information required to be furnished with respect to the 
exchange under sections 6038, 6038A, 6038B, 6038C or 6046, or the 
regulations under those sections, if such information has not otherwise 
been provided by the person filing the section 367(b) notice; and
    (vii) If applicable, a statement that the shareholder is making the 
election described in Sec. 1.367(b)-3(c)(3). This statement must 
include--
    (A) A copy of the information the shareholder received from the 
foreign acquired corporation (or its successor in interest) establishing 
and substantiating the shareholder's all earnings and profits amount 
with respect to the shareholder's stock in the foreign acquired 
corporation; and
    (B) A representation that the shareholder has notified the foreign 
acquired corporation (or its successor in interest) that the shareholder 
is making the election described in Sec. 1.367(b)-3(c)(3).
    (5) Abbreviated notice provision for shareholders that make the 
election described in Sec. 1.367(b)-3(c)(3). In the case of a foreign 
acquired corporation that has never had earnings and profits that would 
result in any shareholder having an all earnings and profits amount, a 
shareholder making the election described in Sec. 1.367(b)-3(c)(3) may 
satisfy the information requirements of paragraph (c)(4) of this section 
by filing a section 367(b) notice that includes--
    (i) A statement from the foreign acquired corporation (or its 
successor in interest) that the foreign acquired corporation has never 
had any earnings and profits that would result in any shareholder having 
an all earnings and profits amount; and
    (ii) The information described in paragraphs (c)(4) (i) through 
(iii) of this section.
    (6) Supplemental published guidance. The section 367(b) notice 
requirements may be updated or amended by revenue procedure or other 
published guidance.

[T.D. 8862, 65 FR 3597, Jan. 24, 2000; 65 FR 66501, Nov. 6, 2000, as 
amended by T.D. 9243, 71 FR 4288, Jan. 26, 2006; T.D. 9273, 71 FR 44894, 
Aug. 8, 2006]



Sec. 1.367(b)-2  Definitions and special rules.

    (a) Controlled foreign corporation. The term controlled foreign 
corporation means a controlled foreign corporation as defined in section 
957 (taking into account section 953(c)).
    (b) Section 1248 shareholder. The term section 1248 shareholder 
means any United States person that satisfies the ownership requirements 
of section 1248 (a)(2) or (c)(2) with respect to a foreign corporation.
    (c) Section 1248 amount--(1) Rule. The term section 1248 amount with 
respect to stock in a foreign corporation means the net positive 
earnings and profits (if any) that would have been attributable to such 
stock and includible in income as a dividend under section 1248 and the 
regulations thereunder if the stock were sold by the shareholder. In the 
case of a transaction in which the shareholder is a foreign corporation 
(foreign shareholder), the following additional rules shall apply--
    (i) The foreign shareholder shall be deemed to be a United States 
person for purposes of this paragraph (c), except that the foreign 
shareholder shall

[[Page 443]]

not be considered a United States person for purposes of determining 
whether the stock owned by the foreign shareholder is stock of a 
controlled foreign corporation; and
    (ii) The foreign shareholder's holding period in the stock of the 
foreign corporation shall be determined by reference to the period that 
the foreign shareholder's section 1248 shareholders held (directly or 
indirectly) an interest in the foreign corporation. This paragraph 
(c)(1)(ii) applies in addition to the section 1248 regulations' 
incorporation of section 1223 holding periods. See Sec. 1.1248-8.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (c):

    Example 1. (i) Facts. DC, a domestic corporation, owns all of the 
outstanding stock of FC1, a controlled foreign corporation (CFC). FC1 
owns all of the outstanding stock of FC2, a CFC. DC has always owned all 
of the stock of FC1, and FC1 has always owned all of the stock of FC2.
    (ii) Result. Under this paragraph (c), DC's section 1248 amount with 
respect to its FC1 stock is computed by reference to all of FC1's and 
FC2's earnings and profits. See section 1248(c)(2). Because FC1's 
section 1248 shareholder (DC) always indirectly held all of the stock of 
FC2, FC1's section 1248 amount with respect to its FC2 stock is computed 
by reference to all of FC2's earnings and profits.
    Example 2. (i) Facts. DC, a domestic corporation, owns 40 percent of 
the outstanding stock of FC1, a foreign corporation. The other 60 
percent of FC1 stock is owned (directly and indirectly) by foreign 
persons that are unrelated to DC. FC1 owns all of the outstanding stock 
of FC2, a foreign corporation. On January 1, 2001, DC purchases the 
remaining 60 percent of FC1 stock.
    (ii) Result. Under this paragraph (c), DC's section 1248 amount with 
respect to its FC1 stock is computed by reference to FC1's and FC2's 
earnings and profits that accumulated on or after January 1, 2001, the 
date FC1 and FC2 became controlled foreign corporations (CFCs). See 
section 1248(a). Because FC1 is not considered a United States person 
for purposes of determining whether FC2 is a CFC, FC1's section 1248 
amount with respect to its FC2 stock is computed by reference to FC2's 
earnings and profits that accumulated on or after January 1, 2001, the 
date FC2 became an actual CFC.
    Example 3. (i) Facts. FC1, a foreign corporation, owns all of the 
outstanding stock of FC2, a foreign corporation. DC is a domestic 
corporation that is unrelated to FC1, FC2, and their direct and indirect 
owners. On January 1, 2001, DC purchases all of the outstanding stock of 
FC1.
    (ii) Result. Under this paragraph (c), DC's section 1248 amount with 
respect to its FC1 stock is computed by reference to FC1's and FC2's 
earnings and profits that accumulated on or after January 1, 2001, the 
first day DC held the stock of FC1. See section 1248(a). FC1's section 
1248 amount with respect to its FC2 stock is computed by reference to 
FC2's earnings and profits that accumulated on or after January 1, 2001, 
the first day FC1's section 1248 shareholder (DC) indirectly held the 
stock of FC2.

    (d) All earnings and profits amount--(1) General rule. The term all 
earnings and profits amount with respect to stock in a foreign 
corporation means the net positive earnings and profits (if any) 
determined as provided under paragraph (d)(2) of this section and 
attributable to such stock as provided under paragraph (d)(3) of this 
section. The all earnings and profits amount shall be determined without 
regard to the amount of gain that would be realized on a sale or 
exchange of the stock of the foreign corporation.
    (2) Rules for determining earnings and profits--(i) Domestic rules 
generally applicable. For purposes of this paragraph (d), except as 
provided in sections 312(k)(4) and (n)(8), 964 and 986, the earnings and 
profits of a foreign corporation for any taxable year shall be 
determined according to principles substantially similar to those 
applicable to domestic corporations.
    (ii) Certain adjustments to earnings and profits. Notwithstanding 
paragraph (d)(2)(i) of this section, for purposes of this paragraph (d), 
the earnings and profits of a foreign corporation for any taxable year 
shall not include the amounts specified in section 1248(d). In the case 
of amounts specified in section 1248(d)(4), the preceding sentence 
requires that the earnings and profits for any taxable year be decreased 
by the net positive amount (if any) of earnings and profits attributable 
to activities described in section 1248(d)(4), and increased by the net 
reduction (if any) in earnings and profits attributable to activities 
described in section 1248(d)(4).
    (iii) Effect of section 332 liquidating distribution. The all 
earnings and profits amount with respect to stock of a corporation that 
distributes all of its

[[Page 444]]

property in a liquidation described in section 332 shall be determined 
without regard to the adjustments prescribed by section 312(a) and (b) 
resulting from the distribution of such property in liquidation, except 
that gain or loss realized by the corporation on the distribution shall 
be taken into account to the extent provided in section 312(f)(1). See 
Sec. 1.367(b)-3(b)(3)(ii) Example 3.
    (3) Amount attributable to a block of stock--(i) Application of 
section 1248 principles--(A) In general--(1) Rule. The all earnings and 
profits amount with respect to stock of a foreign corporation is 
determined according to the attribution principles of section 1248 and 
the regulations thereunder. The attribution principles of section 1248 
shall apply without regard to the requirements of section 1248 that are 
not relevant to the determination of a shareholder's pro rata portion of 
earnings and profits. Thus, for example, the all earnings and profits 
amount is determined without regard to whether the foreign corporation 
was a controlled foreign corporation at any time during the five years 
preceding the section 367(b) exchange in question, without regard to 
whether the shareholder owned a 10 percent or greater interest in the 
stock, and without regard to whether the earnings and profits of the 
foreign corporation were accumulated in post-1962 taxable years or while 
the corporation was a controlled foreign corporation.
    (2) Example. The following example illustrates the rules of this 
paragraph (d)(3)(i)(A):

    Example. (i) Facts. On January 1, 2001, DC, a domestic corporation, 
purchases 9 percent of the outstanding stock of FC, a foreign 
corporation. On January 1, 2002, DC purchases an additional 1 percent of 
FC stock. On January 1, 2003, DC exchanges its stock in FC in a section 
367(b) exchange in which DC is required to include the all earnings and 
profits amount in income. FC was not a controlled foreign corporation 
during the entire period DC held its FC stock.
    (ii) Result. The all earnings and profits amount with respect to 
DC's stock in FC is computed by reference to 9 percent of FC's earnings 
and profits from January 1, 2001, through December 31, 2001, and by 
reference to 10 percent of FC's earnings and profits from January 1, 
2002, through January 1, 2003.
    (B) Foreign shareholders. In the case of a transaction in which the 
exchanging shareholder is a foreign corporation (foreign shareholder), 
the following additional rules shall apply--
    (1) The attribution principles of section 1248 shall apply without 
regard to whether the person directly owning the stock is a United 
States person; and
    (2) The foreign shareholder's holding period in the stock of the 
foreign acquired corporation shall be determined by reference to the 
period that the foreign shareholder's United States shareholders (as 
defined in Sec. 1.367(b)-3(b)(2)) held (directly or indirectly) an 
interest in the foreign acquired corporation. This paragraph 
(d)(3)(i)(B)(2) applies in addition to the section 1248 regulations' 
incorporation of section 1223 holding periods. See Sec. 1.1248-8.
    (ii) Exclusion of lower-tier earnings. In applying the attribution 
principles of section 1248 and the regulations thereunder to determine 
the all earnings and profits amount with respect to stock of a foreign 
corporation, the earnings and profits of subsidiaries of the foreign 
corporation shall not be taken into account notwithstanding section 
1248(c)(2).
    (e) Treatment of deemed dividends--(1) In general. In certain 
circumstances these regulations provide that an exchanging shareholder 
shall include an amount in income as a deemed dividend. This paragraph 
provides rules for the treatment of the deemed dividend.
    (2) Consequences of dividend characterization. A deemed dividend 
described in paragraph (e)(1) of this section shall be treated as a 
dividend for purposes of the Internal Revenue Code. The deemed dividend 
shall be considered as paid out of the earnings and profits with respect 
to which the amount of the deemed dividend was determined. Thus, for 
example, a deemed dividend that is determined by reference to the all 
earnings and profits amount or the section 1248 amount will never be 
considered as paid out of (and therefore will never reduce) earnings and 
profits specified in section 1248(d), because such earnings and profits 
are excluded in computing the all earnings and profits amount (under 
paragraph (d)(2)(ii) of this section) and the section 1248 amount (under 
section 1248(d) and paragraph

[[Page 445]]

(c)(1) of this section). If the deemed dividend is determined by 
reference to the earnings and profits of a foreign corporation that is 
owned indirectly (i.e., through one or more tiers of intermediate 
owners) by the person that is required to include the deemed dividend in 
income, the deemed dividend shall be considered as having been paid by 
such corporation to such person through the intermediate owners, rather 
than directly to such person.
    (3) Ordering rules. In the case of an exchange of stock in which the 
exchanging shareholder is treated as receiving a deemed dividend from a 
foreign corporation, the following ordering rules concerning the timing, 
treatment, and effect of such a deemed dividend shall apply. See also 
paragraph (j)(2) of this section.
    (i) For purposes of the section 367(b) regulations, the gain 
realized by an exchanging shareholder shall be determined before 
increasing (as provided in paragraph (e)(3)(ii) of this section) the 
basis in the stock of the foreign corporation by the amount of the 
deemed dividend.
    (ii) Except as provided in paragraph (e)(3)(i) of this section, the 
deemed dividend shall be considered to be received immediately before 
the exchanging shareholder's receipt of consideration for its stock in 
the foreign corporation, and the shareholder's basis in the stock 
exchanged shall be increased by the amount of the deemed dividend. Such 
basis increase shall be taken into account before determining the gain 
otherwise recognized on the exchange (for example, under section 356), 
the basis that the exchanging shareholder takes in the property that it 
receives in the exchange (under section 358(a)(1)), and the basis that 
the transferee otherwise takes in the transferred stock (under section 
362).
    (iii) Except as provided in paragraph (e)(3)(i) of this section, the 
earnings and profits of the appropriate foreign corporation shall be 
reduced by the deemed dividend amount before determining the 
consequences of the recognition of gain in excess of the deemed dividend 
amount (for example, under section 356(a)(2) or sections 356(a)(1) and 
1248).
    (4) Examples. The following examples illustrate the rules of this 
paragraph (e):

    Example 1. DC, a domestic corporation, exchanges stock in FC, a 
foreign corporation, in a section 367(b) exchange in which DC includes 
the all earnings and profits amount in income as a deemed dividend. 
Under paragraph (e)(2) of this section, a deemed dividend is treated as 
a dividend for purposes of the Internal Revenue Code. As a result, if 
the requirements of section 902 are met, DC may qualify for a deemed 
paid foreign tax credit with respect to the deemed dividend that it 
receives from FC.
    Example 2. DC, a domestic corporation, exchanges stock in FC1, a 
foreign corporation that is a controlled foreign corporation, in a 
transaction in which DC is required to include the section 1248 amount 
in income as a deemed dividend. A portion of the section 1248 amount is 
determined by reference to the earnings and profits of FC1 (the upper-
tier portion of the section 1248 amount), and the remainder of the 
section 1248 amount is determined by reference to the earnings and 
profits of FC2, which is a wholly owned foreign subsidiary of FC1 (the 
lower-tier portion of the section 1248 amount). Under paragraph (e)(2) 
of this section, DC computes its deemed paid foreign tax credit as if 
the lower-tier portion of the section 1248 amount were distributed as a 
dividend by FC2 to FC1, and as if such portion and the upper-tier 
portion of the section 1248 amount were then distributed as a dividend 
by FC1 to DC.
    Example 3. DC, a domestic corporation, exchanges stock in FC, a 
foreign corporation that is a controlled foreign corporation, in a 
transaction in which DC realizes gain of $100 (prior to the application 
of the section 367(b) regulations). In connection with the transaction, 
DC is required to include $40 in income as a deemed dividend under the 
section 367(b) regulations. In addition to receiving property permitted 
to be received under section 354 without the recognition of gain, DC 
also receives cash in the amount of $70. Under paragraph (e)(3) of this 
section, the $40 deemed dividend increases DC's basis in its FC stock 
before determining the gain to be recognized under section 356. Thus, in 
applying section 356, DC is considered to realize $60 of gain on the 
exchange, all of which is recognized under section 356(a)(1).

    (f) Deemed asset transfer and closing of taxable year in certain 
section 368(a)(1)(F) reorganizations--(1) Scope. This paragraph applies 
to a reorganization described in section 368(a)(1)(F) in which the 
transferor corporation is a foreign corporation.
    (2) Deemed asset transfer. In a reorganization described in 
paragraph (f)(1) of

[[Page 446]]

this section, there is considered to exist--
    (i) A transfer of assets by the foreign transferor corporation to 
the acquiring corporation in exchange for stock (or stock and 
securities) of the acquiring corporation and the assumption by the 
acquiring corporation of the foreign transferor corporation's 
liabilities;
    (ii) A distribution of such stock (or stock and securities) by the 
foreign transferor corporation to its shareholders (or shareholders and 
security holders); and
    (iii) An exchange by the foreign transferor corporation's 
shareholders (or shareholders and security holders) of their stock (or 
stock and securities) for stock (or stock and securities) of the 
acquiring corporation.
    (3) Other applicable rules. For purposes of this paragraph (f), it 
is immaterial that the applicable foreign or domestic law treats the 
acquiring corporation as a continuation of the foreign transferor 
corporation.
    (4) Closing of taxable year. In a reorganization described in 
paragraph (f)(1) of this section, the taxable year of the foreign 
transferor corporation shall end with the close of the date of the 
transfer and, except as otherwise required under the Internal Revenue 
Code (e.g. section 1502 and the regulations thereunder), the taxable 
year of the acquiring corporation shall end with the close of the date 
on which the transferor's taxable year would have ended but for the 
occurrence of the reorganization if--
    (i) The acquiring corporation is a domestic corporation; or
    (ii) The foreign transferor corporation has effectively connected 
earnings and profits (as defined in section 884(d)) or accumulated 
effectively connected earnings and profits (as defined in section 
884(b)(2)(B)(ii)).
    (g) Stapled stock under section 269B. For rules addressing the 
deemed conversion of a foreign corporation to a domestic corporation 
under section 269B, see Sec. 1.269B-1(c).
    (h) Section 953(d) domestication elections--(1) Effect of election. 
A foreign corporation that elects under section 953(d) to be treated as 
a domestic corporation shall be treated for purposes of section 367(b) 
as transferring, as of the first day of the first taxable year for which 
the election is effective, all of its assets to a domestic corporation 
in a reorganization described in section 368(a)(1)(F). Notwithstanding 
paragraph (d) of this section, for purposes of determining the 
consequences of the reorganization under Sec. 1.367(b)-3, the all 
earnings and profits amount shall not be considered to include earnings 
and profits accumulated in taxable years beginning before January 1, 
1988.
    (2) Post-election exchanges. For purposes of applying section 367(b) 
to post-election exchanges with respect to a corporation that has made a 
valid election under section 953(d) to be treated as a domestic 
corporation, such corporation shall be treated as a domestic corporation 
as to earnings and profits that were taken into account at the time of 
the section 953(d) election or which accrue after such election, and 
shall be treated as a foreign corporation as to earnings and profits 
accumulated in taxable years beginning before January 1, 1988. Thus, for 
example, if the section 953(d) corporation subsequently transfers its 
assets to a domestic corporation (other than another section 953(d) 
corporation) in a transaction described in section 381(a), the rules of 
Sec. 1.367(b)-3 shall apply to such transaction to the extent of the 
section 953(d) corporation's earnings and profits accumulated in taxable 
years beginning before January 1, 1988.
    (i) Section 1504(d) elections. An election under section 1504(d), 
which permits certain foreign corporations to be treated as domestic 
corporations, is treated as a transfer of property to a domestic 
corporation and will generally constitute a reorganization described in 
section 368(a)(1)(F). However, if an election under section 1504(d) is 
made with respect to a foreign corporation from the first day of the 
foreign corporation's existence, then the foreign corporation shall be 
treated as a domestic corporation, and the section 367(b) regulations 
will not apply.
    (j) Sections 985 through 989--(1) Change in functional currency of a 
qualified business unit--(i) Rule. If, as a result of a section 367(b) 
exchange described in section 381(a), a qualified business unit (as 
defined in section 989(a)) (QBU) has

[[Page 447]]

a different functional currency determined under the rules of section 
985(b) than it used prior to the transaction, then the QBU shall be 
deemed to have automatically changed its functional currency immediately 
prior to the transaction. A QBU that is deemed to change its functional 
currency pursuant to this paragraph (j) must make the adjustments 
described in Sec. 1.985-5.
    (ii) Example. The following example illustrates the rule of this 
paragraph (j)(1):

    Example. (i) Facts. DC, a domestic corporation, owns 100 percent of 
FC1, a foreign corporation. FC1 owns and operates a qualified business 
unit (QBU) (B1) in France, whose functional currency is the euro. FC2, 
an unrelated foreign corporation, owns and operates a QBU (B2) in 
France, whose functional currency is the dollar. FC2 acquires FC1's 
assets (including B1) in a reorganization described in section 
368(a)(1)(C). As a part of the reorganization, B1 and B2 combine their 
operations into one QBU. Applying the rules of section 985(b), the 
functional currency of the combined operations of B1 and B2 is the euro.
    (ii) Result. FC2's acquisition of FC1's assets is a section 367(b) 
exchange that is described in section 381(a). Because the functional 
currency of the combined operations of B1 and B2 after the exchange is 
the euro, B2 is deemed to have automatically changed its functional 
currency to the euro immediately prior to the section 367(b) exchange. 
B2 must make the adjustments described in Sec. 1.985-5.

    (2) Previously taxed earnings and profits--(i) Exchanging 
shareholder that is a United States person. If an exchanging shareholder 
that is a United States person is required to include in income either 
the all earnings and profits amount or the section 1248 amount under the 
provisions of Sec. 1.367(b)-3 or 1.367(b)-4, then immediately prior to 
the exchange, and solely for the purpose of computing exchange gain or 
loss under section 986(c), the exchanging shareholder shall be treated 
as receiving a distribution of previously taxed earnings and profits 
from the appropriate foreign corporation that is attributable (under the 
principles of section 1248) to the exchanged stock. If an exchanging 
shareholder that is a United States person is a distributee in an 
exchange described in Sec. 1.367(b)-5(c) or (d), then immediately prior 
to the exchange, and solely for the purpose of computing exchange gain 
or loss under section 986(c), the exchanging shareholder shall be 
treated as receiving a distribution of previously taxed earnings and 
profits from the appropriate foreign corporation to the extent such 
shareholder has a diminished interest in such previously taxed earnings 
and profits after the exchange. The exchange gain or loss recognized 
under this paragraph (j)(2)(i) will increase or decrease the exchanging 
shareholder's adjusted basis in the stock of the foreign corporation, 
including for purposes of computing gain or loss realized with respect 
to the stock on the transaction. The exchanging shareholder's dollar 
basis with respect to each account of previously taxed income shall be 
increased or decreased by the exchange gain or loss recognized.
    (ii) Exchanging shareholder that is a foreign corporation. If an 
exchanging shareholder that is a foreign corporation is required to 
include in income either the all earnings and profits amount or the 
section 1248 amount under the provisions of Sec. 1.367(b)-3 or 
1.367(b)-4, then, immediately prior to the exchange, the exchanging 
shareholder shall be treated as receiving a distribution of previously 
taxed earnings and profits from the appropriate foreign corporation that 
is attributable (under the principles of section 1248) to the exchanged 
stock. If an exchanging shareholder that is a foreign corporation is a 
distributee in an exchange described in Sec. 1.367(b)-5(c) or (d), then 
the exchanging shareholder shall be treated as receiving (immediately 
prior to the exchange) a distribution of previously taxed earnings and 
profits from the appropriate foreign corporation. Such distribution 
shall be measured by the extent to which the exchanging shareholder's 
direct or indirect United States shareholders (as defined in section 
951(b)) have a diminished interest in such previously taxed earnings and 
profits after the exchange.
    (3) Other rules. See sections 985 through 989 for other currency 
rules that may apply in connection with a section 367(b) exchange.
    (k) Partnerships, trusts and estates. In applying the section 367(b) 
regulations, stock of a corporation that is owned by a foreign 
partnership, trust or estate

[[Page 448]]

shall be considered as owned proportionately by its partners, owners, or 
beneficiaries under the principles of Sec. 1.367(e)-1(b)(2). Stock 
owned by an entity that is disregarded as an entity separate from its 
owner under Sec. 301.7701-3 is owned directly by the owner of such 
entity. In applying Sec. 1.367(b)-5(b), the principles of Sec. 
1.367(e)-1(b)(2) shall also apply to a domestic partnership, trust or 
estate.
    (l) Additional definitions--(1) Foreign income taxes. The term 
foreign income taxes has the meaning set forth in Sec. 1.902-1(a)(7).
    (2) Post-1986 undistributed earnings. The term post-1986 
undistributed earnings has the meaning set forth in Sec. 1.902-1(a)(9).
    (3) Post-1986 foreign income taxes. The term post-1986 foreign 
income taxes has the meaning set forth in Sec. 1.902-1(a)(8).
    (4) Pre-1987 accumulated profits. The term pre-1987 accumulated 
profits means the earnings and profits described in Sec. 1.902-
1(a)(10)(i), computed in accordance with the rules of Sec. 1.902-
1(a)(10)(ii).
    (5) Pre-1987 foreign income taxes. The term pre-1987 foreign income 
taxes has the meaning set forth in Sec. 1.902-1(a)(10)(iii).
    (6) Pre-1987 section 960 earnings and profits. The term pre-1987 
section 960 earnings and profits means the earnings and profits of a 
foreign corporation accumulated in taxable years beginning before 
January 1, 1987, computed under Sec. 1.964-1(a) through (e), and 
translated into the functional currency (as determined under section 
985) of the foreign corporation at the spot rate on the first day of the 
foreign corporation's first taxable year beginning after December 31, 
1986. For further guidance, see Notice 88-70 (1988-2 C.B. 369, 370) (see 
also Sec. 601.601(d)(2) of this chapter). The term pre-1987 section 960 
earnings and profits does not include earnings and profits that 
represent previously taxed earnings and profits described in section 
959.
    (7) Pre-1987 section 960 foreign income taxes. The term pre-1987 
section 960 foreign income taxes means the foreign income taxes related 
to pre-1987 section 960 earnings and profits, determined in accordance 
with the principles of Sec. 1.902-1(a)(10)(iii), except that the U.S. 
dollar amounts of pre-1987 section 960 foreign income taxes are 
determined by reference to the exchange rates in effect when the taxes 
were paid or accrued.
    (8) Earnings and profits. For purposes of Sec. Sec. 1.367(b)-7 and 
1.367(b)-9, the term earnings and profits means post-1986 undistributed 
earnings, pre-1987 accumulated profits, and pre-1987 section 960 
earnings and profits.
    (9) Pooling corporation. The term pooling corporation means a 
foreign corporation with respect to which the requirements of section 
902(c)(3)(B) have been met in the current taxable year or any prior 
taxable year.
    (10) Nonpooling corporation. The term nonpooling corporation means a 
foreign corporation that is not a pooling corporation.
    (11) Separate category. The term separate category has the meaning 
set forth in section 904(d)(1), and shall also include any other 
category of income to which section 904(a), (b), and (c) are applied 
separately under any other provision of the Internal Revenue Code (e.g., 
sections 56(g)(4)(C)(iii)(IV), 245(a)(10), 865(h), 901(j), and 
904(h)(10) (or section 904(g)(10) for taxable years beginning on or 
before December 31, 2006).
    (12) Passive category. The term passive category means the separate 
category that includes income described in section 904(d)(1)(A).
    (13) General category. The term general category means the separate 
category that includes income described in section 904(d)(1)(B) (or 
section 904(d)(1)(I) for taxable years beginning on or before December 
31, 2006).

[T.D. 8862, 65 FR 3598, Jan. 24, 2000; 65 FR 66501, Nov. 6, 2000, as 
amended by T.D. 9216, 70 FR 43760, July 29, 2005; T.D. 9273, 71 FR 
44894, Aug. 8, 2006; T.D. 9345, 72 FR 41444, July 30, 2007; T.D. 9400, 
73 FR 30303, May 27, 2008]



Sec. 1.367(b)-3  Repatriation of foreign corporate assets in certain
nonrecognition transactions.

    (a) Scope. This section applies to an acquisition by a domestic 
corporation (the domestic acquiring corporation) of the assets of a 
foreign corporation (the foreign acquired corporation) in a liquidation 
described in section 332 or an asset acquisition described in section 
368(a)(1).

[[Page 449]]

    (b) Exchange of stock owned directly by a United States shareholder 
or by certain foreign corporate shareholders--(1) Scope. This paragraph 
(b) applies in the case of an exchanging shareholder that is either--
    (i) A United States shareholder of the foreign acquired corporation; 
or
    (ii) A foreign corporation with respect to which there are one or 
more United States shareholders.
    (2) United States shareholder. For purposes of this section (and for 
purposes of the other section 367(b) regulation provisions that 
specifically refer to this paragraph (b)(2)), the term United States 
shareholder means any shareholder described in section 951(b) (without 
regard to whether the foreign corporation is a controlled foreign 
corporation), and also any shareholder described in section 953(c)(1)(A) 
(but only if the foreign corporation is a controlled foreign corporation 
as defined in section 953(c)(1)(B) subject to the rules of section 
953(c)).
    (3) Income inclusion--(i) Inclusion of all earnings and profits 
amount. An exchanging shareholder shall include in income as a deemed 
dividend the all earnings and profits amount with respect to its stock 
in the foreign acquired corporation. For the consequences of the deemed 
dividend, see Sec. 1.367(b)-2(e). Notwithstanding Sec. 1.367(b)-2(e), 
however, a deemed dividend from the foreign acquired corporation to an 
exchanging foreign corporate shareholder shall not qualify for the 
exception from foreign personal holding company income provided by 
section 954(c)(3)(A)(i), although it may qualify for the look-through 
treatment provided by section 904(d)(3) if the requirements of that 
section are met with respect to the deemed dividend.
    (ii) Examples. The following examples illustrate the rules of 
paragraph (b)(3)(i) of this section:

    Example 1. (i) Facts. DC, a domestic corporation, owns all of the 
outstanding stock of FC, a foreign corporation. The stock of FC has a 
value of $100, and DC has a basis of $30 in such stock. The all earnings 
and profits amount attributable to the FC stock owned by DC is $20, of 
which $15 is described in section 1248(a) and the remaining $5 is not 
(for example, because it accumulated prior to 1963). FC has a basis of 
$50 in its assets. In a liquidation described in section 332, FC 
distributes all of its property to DC, and the FC stock held by DC is 
canceled.
    (ii) Result. Under paragraph (b)(3)(i) of this section, DC must 
include $20 in income as a deemed dividend from FC. Under section 337(a) 
FC does not recognize gain or loss in the assets that it distributes to 
DC, and under section 334(b), DC takes a basis of $50 in such assets. 
Because the requirements of section 902 are met, DC qualifies for a 
deemed paid foreign tax credit with respect to the deemed dividend that 
it receives from FC.
    Example 2. (i) Facts. DC, a domestic corporation, owns all of the 
outstanding stock of FC, a foreign corporation. The stock of FC has a 
value of $100, and DC has a basis of $30 in such stock. The all earnings 
and profits amount attributable to the FC stock owned by DC is $75. FC 
has a basis of $50 in its assets. In a liquidation described in section 
332, FC distributes all of its property to DC, and the FC stock held by 
DC is canceled.
    (ii) Result. Under paragraph (b)(3)(i) of this section, DC must 
include $75 in income as a deemed dividend from FC. Under section 337(a) 
FC does not recognize gain or loss in the assets that it distributes to 
DC, and under section 334(b), DC takes a basis of $50 in such assets. 
Because the requirements of section 902 are met, DC qualifies for a 
deemed paid foreign tax credit with respect to the deemed dividend that 
it receives from FC.
    Example 3. (i) Facts. DC, a domestic corporation, owns 80 percent of 
the outstanding stock of FC, a foreign corporation. DC has owned its 80 
percent interest in FC since FC was incorporated. The remaining 20 
percent of the outstanding stock of FC is owned by a person unrelated to 
DC (the minority shareholder). The stock of FC owned by DC has a value 
of $80, and DC has a basis of $24 in such stock. The stock of FC owned 
by the minority shareholder has a value of $20, and the minority 
shareholder has a basis of $18 in such stock. FC's only asset is land 
having a value of $100, and FC has a basis of $50 in the land. Gain on 
the land would not generate earnings and profits qualifying under 
section 1248(d) for an exclusion from earnings and profits for purposes 
of section 1248. FC has earnings and profits of $20 (determined under 
the rules of Sec. 1.367(b)-2(d)(2) (i) and (ii)), $16 of which is 
attributable to the stock owned by DC under the rules of Sec. 1.367(b)-
2(d)(3). FC subdivides the land and distributes to the minority 
shareholder land with a value of $20 and a basis of $10. As part of the 
same transaction, in a liquidation described in section 332, FC 
distributes the remainder of its land to DC, and the FC stock held by DC 
and the minority shareholder is canceled.
    (ii) Result. Under section 336, FC must recognize the $10 of gain it 
realizes in the land it distributes to the minority shareholder,

[[Page 450]]

and under section 331 the minority shareholder recognizes its gain of $2 
in the stock of FC. Such gain is included in income by the minority 
shareholder as a dividend to the extent provided in section 1248 if the 
minority shareholder is a United States person that is described in 
section 1248(a)(2). Under Sec. 1.367(b)-2(d)(2)(iii), the $10 of gain 
recognized by FC increases its earnings and profits for purposes of 
computing the all earnings and profits amount and, as a result, $8 of 
such increase (80 percent of $10) is considered to be attributable to 
the FC stock owned by DC under Sec. 1.367(b)-2(d)(3)(i)(A)(1). DC's all 
earnings and profits amount with respect to its stock in FC is $24 (the 
$16 of initial all earnings and profits amount with respect to the FC 
stock held by DC, plus the $8 addition to such amount that results from 
FC's recognition of gain on the distribution to the minority 
shareholder). Under paragraph (b)(3)(i) of this section, DC must include 
the $24 all earnings and profits amount in income as a deemed dividend 
from FC.
    Example 4. (i) Facts. DC1, a domestic corporation, owns all of the 
outstanding stock of DC2, a domestic corporation. DC1 also owns all of 
the outstanding stock of FC, a foreign corporation. The stock of FC has 
a value of $100, and DC1 has a basis of $30 in such stock. The assets of 
FC have a value of $100. The all earnings and profits amount with 
respect to the FC stock owned by DC1 is $20. In a reorganization 
described in section 368(a)(1)(D), DC2 acquires all of the assets of FC 
solely in exchange for DC2 stock. FC distributes the DC2 stock to DC1, 
and the FC stock held by DC1 is canceled.
    (ii) Result. DC1 must include $20 in income as a deemed dividend 
from FC under paragraph (b)(3)(i) of this section. Under section 361, FC 
does not recognize gain or loss in the assets that it transfers to DC2 
or in the DC2 stock that it distributes to DC1, and under section 362(b) 
DC2 takes a basis in the assets that it acquires from FC equal to the 
basis that FC had therein. Under Sec. 1.367(b)-2(e)(3)(ii) and section 
358(a)(1), DC1 takes a basis of $50 (its $30 basis in the stock of FC, 
plus the $20 that was treated as a deemed dividend to DC1) in the stock 
of DC2 that it receives in exchange for the stock of FC. Under Sec. 
1.367(b)-2(e)(3)(iii) and section 312(a), the earnings and profits of FC 
are reduced by the $20 deemed dividend.
    Example 5. (i) Facts. DC1, a domestic corporation, owns all of the 
outstanding stock of FC1, a foreign corporation. FC1 owns all of the 
outstanding stock of FC2, a foreign corporation. The all earnings and 
profits amount with respect to the FC2 stock owned by FC1 is $20. In a 
reorganization described in section 368(a)(1)(A), DC2, a domestic 
corporation unrelated to FC1 or FC2, acquires all of the assets and 
liabilities of FC2 pursuant to a State W merger. FC2 receives DC2 stock 
and distributes such stock to FC1. The FC2 stock held by FC1 is 
canceled, and FC2 ceases its separate legal existence.
    (ii) Result. FC1 must include $20 in income as a deemed dividend 
from FC2 under paragraph (b)(3)(i) of this section. The deemed dividend 
is treated as a dividend for purposes of the Internal Revenue Code as 
provided in Sec. 1.367(b)-2(e)(2); however, under paragraph (b)(3)(i) 
of this section the deemed dividend cannot qualify for the exception 
from foreign personal holding company income provided by section 
954(c)(3)(A)(i), even if the provisions of that section would otherwise 
have been met in the case of an actual dividend.
    Example 6. (i) Facts. DC1, a domestic corporation, owns 99 percent 
of USP, a domestic partnership. The remaining 1 percent of USP is owned 
by a person unrelated to DC1. DC1 and USP each directly own 9 percent of 
the outstanding stock of FC, a foreign corporation that is not a 
controlled foreign corporation subject to the rule of section 953(c). In 
a reorganization described in section 368(a)(1)(C), DC2, a domestic 
corporation, acquires all of the assets and liabilities of FC in 
exchange for DC2 stock. FC distributes to its shareholders DC2 stock, 
and the FC stock held by its shareholders is canceled.
    (ii) Result. (A) DC1 and USP are United States persons that are 
exchanging shareholders in a transaction described in paragraph (a) of 
this section. As a result, DC1 and USP are subject to the rules of 
paragraph (b) of this section if they qualify as United States 
shareholders as defined in paragraph (b)(2) of this section. 
Alternatively, if they do not qualify as United States shareholders as 
defined in paragraph (b)(2) of this section, DC1 and USP are subject to 
the rules of paragraph (c) of this section. Paragraph (b)(2) of this 
section defines the term United States shareholder to include any 
shareholder described in section 951(b) (without regard to whether the 
foreign corporation is a controlled foreign corporation). A shareholder 
described in section 951(b) is a United States person that is considered 
to own, applying the rules of section 958(a) and 958(b), 10 percent or 
more of the total combined voting power of all classes of stock entitled 
to vote of a foreign corporation. Under section 958(b), the rules of 
section 318(a), as modified by section 958(b) and the regulations 
thereunder, apply so that, in general, stock owned directly or 
indirectly by a partnership is considered as owned proportionately by 
its partners, and stock owned directly or indirectly by a partner is 
considered as owned by the partnership. Thus, under section 958(b), DC1 
is treated as owning its proportionate share of FC stock held by USP, 
and USP is treated as owning all of the FC stock held by DC1.
    (B) Accordingly, for purposes of determining whether DC1 is a United 
States shareholder under paragraph (b)(2) of this

[[Page 451]]

section, DC1 is considered as owning 99 percent of the 9 percent of FC 
stock held by USP. Because DC1 also owns 9 percent of FC stock directly, 
DC1 is considered as owning more than 10 percent of FC stock. DC1 is 
thus a United States shareholder of FC under paragraph (b)(2) of this 
section and, as a result, is subject to the rules of paragraph (b) of 
this section. However, for purposes of determining DC1's all earnings 
and profits amount, DC1 is not treated as owning the FC stock held by 
USP. Under Sec. 1.367(b)-2(d)(3), DC1's all earnings and profits amount 
is determined by reference to the 9 percent of FC stock that it directly 
owns.
    (C) For purposes of determining whether USP is a United States 
shareholder under paragraph (b)(2) of this section, USP is considered as 
owning the 9 percent of FC stock held by DC1. Because USP also owns 9 
percent of FC stock directly, USP is considered as owning more than 10 
percent of FC stock. USP is thus a United States shareholder of FC under 
paragraph (b)(2) of this section and, as a result, is subject to the 
rules of paragraph (b) of this section. However, for purposes of 
determining USP's all earnings and profits amount, USP is not treated as 
owning the FC shares held by DC1. Under Sec. 1.367(b)-2(d)(3), USP's 
all earnings and profits amount is determined by reference to the 9 
percent of FC stock that it directly owns.
    (iii) Recognition of exchange gain or loss with respect to capital. 
[Reserved]

    (4) Reserved. For further guidance concerning section 367(b) 
exchanges occurring before February 23, 2001, see Sec. 1.367(b)-
3T(b)(4).
    (c) Exchange of stock owned by a United States person that is not a 
United States shareholder--(1) Scope. This paragraph (c) applies in the 
case of an exchanging shareholder that is a United States person not 
described in paragraph (b)(1)(i) of this section (i.e., a United States 
person that is not a United States shareholder of the foreign acquired 
corporation).
    (2) Requirement to recognize gain. An exchanging shareholder 
described in paragraph (c)(1) of this section shall recognize realized 
gain (but not loss) with respect to the stock of the foreign acquired 
corporation.
    (3) Election to include all earnings and profits amount. In lieu of 
the treatment prescribed by paragraph (c)(2) of this section, an 
exchanging shareholder described in paragraph (c)(1) of this section may 
instead elect to include in income as a deemed dividend the all earnings 
and profits amount with respect to its stock in the foreign acquired 
corporation. For the consequences of a deemed dividend, see Sec. 
1.367(b)-2(e). Such election may be made only if--
    (i) The foreign acquired corporation (or its successor in interest) 
has provided the exchanging shareholder information to substantiate the 
exchanging shareholder's all earnings and profits amount with respect to 
its stock in the foreign acquired corporation; and
    (ii) The exchanging shareholder complies with the section 367(b) 
notice requirement described in Sec. 1.367(b)-1(c), including the 
specific rules contained therein concerning the time and manner for 
electing to apply the rules of this paragraph (c)(3).
    (4) De minimis exception. This paragraph (c) shall not apply in the 
case of an exchanging shareholder whose stock in the foreign acquired 
corporation has a fair market value of less than $50,000 on the date of 
the section 367(b) exchange.
    (5) Examples. The following examples illustrate the rules of this 
paragraph (c):

    Example 1. (i) Facts. DC1, a domestic corporation, owns 5 percent of 
the outstanding stock of FC, a foreign corporation that is not a 
controlled foreign corporation subject to the rule of section 953(c). 
Persons unrelated to DC1 own the remaining 95 percent of the outstanding 
stock of FC. DC1 has owned its 5 percent interest in FC since FC was 
incorporated. DC1's stock in FC has a basis of $40,000 and a value of 
$100,000. The all earnings and profits amount with respect to DC1's 
stock in FC is $50,000. In a reorganization described in section 
368(a)(1)(C), DC2, a domestic corporation, acquires all of the assets 
and liabilities of FC in exchange for DC2 stock. FC distributes DC2 
stock to its shareholders, and the FC stock held by its shareholders is 
canceled.
    (ii) Alternate result 1. If DC1 does not make the election described 
in paragraph (c)(3) of this section, then the general rule of paragraph 
(c)(2) of this section applies and DC1 must recognize its $60,000 gain 
in the FC stock. Under section 358(a)(1), DC1 has a $100,000 basis (its 
$40,000 basis in the FC stock, plus the $60,000 recognized gain) in the 
DC2 stock that it receives in exchange for its FC stock. Because DC1 is 
not a shareholder described in section 1248(a)(2), section 1248 does not 
apply to recharacterize any of DC1's gain as a dividend.
    (iii) Alternate result 2. If DC1 makes a valid election under 
paragraph (c)(3) of this section, then DC1 must include in income as a 
deemed dividend the $50,000 all earnings and

[[Page 452]]

profits amount with respect to its FC stock. Under Sec. 1.367(b)-
2(e)(3) and section 358(a)(1), DC1 has a $90,000 basis (its $40,000 
basis in the FC stock, plus the $50,000 that was treated as a deemed 
dividend to DC1) in the DC2 stock that it receives in exchange for its 
FC stock. Because DC1 owns less than 10 percent of the voting stock of 
FC, DC1 does not qualify for a deemed paid foreign tax credit under 
section 902.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that DC1's stock in FC has a fair market value of $48,000 on the date 
DC1 receives the DC2 stock.
    (ii) Result. Because DC1's stock in FC has a fair market value of 
less than $50,000 on the date of the section 367(b) exchange, the de 
minimis exception of paragraph (c)(4) of this section applies. As a 
result, DC1 is not subject to the gain or income inclusion requirements 
of this paragraph (c).

    (d) Carryover of certain foreign taxes--(1) Rule. Excess foreign 
taxes under section 904(c) allowable to the foreign acquired corporation 
under section 906 shall carry over to the domestic acquiring corporation 
and become allowable under section 901, subject to the limitations 
prescribed by the Internal Revenue Code (for example, sections 383, 904 
and 907). The domestic acquiring corporation shall not succeed to any 
other foreign taxes paid or incurred by the foreign acquired 
corporation.
    (2) Example. The following example illustrates the rules of this 
paragraph (d):

    Example. (i) Facts. DC, a domestic corporation owns 100 percent of 
the outstanding stock of FC, a foreign corporation. FC has net positive 
earnings and profits, none of which are attributable to DC's FC stock 
under Sec. 1.367(b)-2(d)(3). FC has paid foreign taxes that are not 
eligible for credit under section 906. In a liquidation described in 
section 332, FC distributes all of its property to DC, and the FC stock 
held by DC is canceled.
    (ii) Result. The liquidation of FC into DC is a section 367(b) 
exchange. Thus, DC is subject to the section 367(b) regulations, and 
must file a section 367(b) notice pursuant to Sec. 1.367(b)-1(c). 
Pursuant to the provisions of paragraph (d)(1) of this section, the 
foreign taxes paid by FC do not carryover to DC because FC's foreign 
taxes are not eligible for credit under section 906.

    (e) Net operating loss and capital loss carryovers. A net operating 
loss or capital loss carryover of the foreign acquired corporation is 
described in section 381(c)(1) and (c)(3) and thus is eligible to carry 
over from the foreign acquired corporation to the domestic acquiring 
corporation only to the extent the underlying deductions or losses were 
allowable under chapter 1 of subtitle A of the Internal Revenue Code. 
Thus, only a net operating loss or capital loss carryover that is 
effectively connected with the conduct of a trade or business within the 
United States (or that is attributable to a permanent establishment, in 
the context of an applicable United States income tax treaty) is 
eligible to be carried over under section 381. For further guidance, see 
Rev. Rul. 72-421 (1972-2 C.B. 166) (see also Sec. 601.601(d)(2) of this 
chapter).
    (f) Carryover of earnings and profits--(1) General rule. Except to 
the extent otherwise specifically provided (see, e.g., Notice 89-79 
(1989-2 C.B. 392) (see also Sec. 601.601(d)(2) of this chapter)), 
earnings and profits of the foreign acquired corporation that are not 
included in income as a deemed dividend under the section 367(b) 
regulations (or deficit in earnings and profits) are eligible to carry 
over from the foreign acquired corporation to the domestic acquiring 
corporation under section 381(c)(2) only to the extent such earnings and 
profits (or deficit in earnings and profits) are effectively connected 
with the conduct of a trade or business within the United States (or are 
attributable to a permanent establishment in the United States, in the 
context of an applicable United States income tax treaty). All other 
earnings and profits (or deficit in earnings and profits) of the foreign 
acquired corporation shall not carry over to the domestic acquiring 
corporation and, as a result, shall be eliminated.
    (2) Previously taxed earnings and profits. [Reserved]

[T.D. 8862, 65 FR 3601, Jan. 24, 2000; 65 FR 66501, Nov. 6, 2000, as 
amended by T.D. 9243, 71 FR 4288, Jan. 26, 2006; T.D. 9273, 71 FR 44895, 
Aug. 8, 2006]



Sec. 1.367(b)-3T  Repatriation of foreign corporate assets in certain
nonrecognition transactions (temporary).

    (a)-(b)(3) [Reserved]. For further guidance, see Sec. 1.367(b)-3(a) 
through (b)(3).

[[Page 453]]

    (4) Election of taxable exchange treatment--(i) Rules--(A) In 
general. In lieu of the treatment prescribed by Sec. 1.367(b)-
3(b)(3)(i), an exchanging shareholder described in Sec. 1.367(b)-
3(b)(1) may instead elect to recognize the gain (but not loss) that it 
realizes in the exchange (taxable exchange election). To make a taxable 
exchange election, the following requirements must be satisfied--
    (1) The exchanging shareholder (and its direct or indirect owners 
that would be affected by the election, in the case of an exchanging 
shareholder that is a foreign corporation) reports the exchange in a 
manner consistent therewith (see, e.g., sections 954(c)(1)(B)(i), 1001 
and 1248);
    (2) The notification requirements of paragraph (b)(4)(i)(C) of this 
section are satisfied; and
    (3) The adjustments described in paragraph (b)(4)(i)(B) of this 
section are made when the following circumstances are present--
    (i) The transaction is described in section 332 or is an asset 
acquisition described in section 368(a)(1), with regard to which one 
U.S. person owns (directly or indirectly) 100 percent of the foreign 
acquired corporation; and
    (ii) The all earnings and profits amount described in Sec. 
1.367(b)-3(b)(3)(i) with respect to the exchange exceeds the gain 
recognized by the exchanging shareholder.
    (B) Attribute reduction--(1) Reduction of NOL carryovers. The amount 
by which the all earnings and profits amount exceeds the gain recognized 
by the exchanging shareholder (the excess earnings and profits amount) 
shall be applied to reduce the net operating loss carryovers (if any) of 
the foreign acquired corporation to which the domestic acquiring 
corporation would otherwise succeed under section 381(a) and (c)(1). See 
also Rev. Rul. 72-421 (1972-2 C.B. 166) (see Sec. 601.601(d)(2) of this 
chapter).
    (2) Reduction of capital loss carryovers. After the application of 
paragraph (b)(4)(i)(B)(1) of this section, any remaining excess earnings 
and profits amount shall be applied to reduce the capital loss 
carryovers (if any) of the foreign acquired corporation to which the 
domestic acquiring corporation would otherwise succeed under section 
381(a) and (c)(3).
    (3) Reduction of basis. After the application of paragraph 
(b)(4)(i)(B)(2) of this section, any remaining excess earnings and 
profits amount shall be applied to reduce (but not below zero) the basis 
of the assets (other than dollar-denominated money) of the foreign 
acquired corporation that are acquired by the domestic acquiring 
corporation. Such remaining excess earnings and profits amount shall be 
applied to reduce the basis of such assets in the following order: 
first, tangible depreciable or depletable assets, according to their 
class lives (beginning with those assets with the shortest class life); 
second, other non-inventory tangible assets; third, intangible assets 
that are amortizable; and finally, the remaining assets of the foreign 
acquired corporation that are acquired by the domestic acquiring 
corporation. Within each of these categories, if the total basis of all 
assets in the category is greater than the excess earnings and profits 
amount to be applied against such basis, the taxpayer may choose to 
which specific assets in the category the basis reduction first applies.
    (C) Notification. The exchanging shareholder shall elect to apply 
the rules of this paragraph (b)(4)(i) by attaching a statement of its 
election to its section 367(b) notice. See Sec. 1.367(b)-1(c) For the 
rules concerning filing a section 367(b) notice.
    (D) Example. The following example illustrates the rules of this 
paragraph (b)(4)(i):

    Example. (i) Facts. DC, a domestic corporation, owns all of the 
outstanding stock of FC, a foreign corporation. The stock of FC has a 
value of $100, and DC has a basis of $80 in such stock. The assets of FC 
are one parcel of land with a value of $60 and a basis of $30, and 
tangible depreciable assets with a value of $40 and a basis of $80. FC 
has no net operating loss carryovers or capital loss carryovers. The all 
earnings and profits amount with respect to the FC stock owned by DC is 
$30, of which $19 is described in section 1248(a) and the remaining $11 
is not (for example, because it was earned prior to 1963). In a 
liquidation described in section 332, FC distributes all of its property 
to DC, and the FC stock held by DC is canceled. Rather than including in 
income as a deemed dividend the all earnings and profits amount of

[[Page 454]]

$30 as provided in Sec. 1.367(b)-3(b)(3)(i), DC instead elects taxable 
exchange treatment under paragraph (b)(4)(i)(A) of this section.
    (ii) Result. DC recognizes the $20 of gain it realizes on its stock 
in FC. Of this $20 amount, $19 is included in income by DC as a dividend 
pursuant to section 1248(a). (For the source of the remaining $1 of gain 
recognized by DC, see section 865. For the treatment of the $1 for 
purposes of the foreign tax credit limitation, see generally section 
904(d)(2)(A)(i).) Because the transaction is described in section 332 
and because the all earnings and profits amount with respect to the FC 
stock held by DC ($30) exceeds by $10 the income recognized by DC ($20), 
the attribute reduction rules of paragraph (b)(4)(i)(B) of this section 
apply. Accordingly, the $10 excess earnings and profits amount is 
applied to reduce the basis of the tangible depreciable assets of FC, 
beginning with those assets with the shortest class lives. Under section 
337(a) FC does not recognize gain or loss in the assets that it 
distributes to DC, and under section 334(b) (which is applied taking 
into account the basis reduction prescribed by paragraph (b)(4)(i)(A)(3) 
of this section) DC takes a basis of $30 in the land and $70 in the 
tangible depreciable assets that it receives from FC.

    (ii) Effective date. This paragraph (b)(4) applies for section 
367(b) exchanges that occur between February 23, 2000, and February 23, 
2001.
    (c)-(d) [Reserved]. For further guidance, see Sec. 1.367(b)-3(c) 
through (d).

[T.D. 8863, 65 FR 3588, Jan. 24, 2000, as amended by T.D. 9243, 71 FR 
4288, Jan. 26, 2006]



Sec. 1.367(b)-4  Acquisition of foreign corporate stock or assets by
a foreign corporation in certain nonrecognition transactions.

    (a) Scope. This section applies to certain acquisitions by a foreign 
corporation of the stock or assets of a foreign corporation in an 
exchange described in section 351 or in a reorganization described in 
section 368(a)(1). Paragraph (b) of this section provides a rule 
regarding when an exchanging shareholder is required to include in 
income as a deemed dividend the section 1248 amount attributable to the 
stock that it exchanges. Paragraph (c) of this section provides a rule 
excluding deemed dividends from foreign personal holding company income. 
Paragraph (d) of this section provides rules for subsequent sales or 
exchanges. Paragraphs (e) and (f) of this section provide rules 
regarding certain exchanges following inversion transactions. Paragraph 
(g) of this section provides definitions and special rules, including 
special rules regarding triangular reorganizations and 
recapitalizations. Paragraph (h) of this section provides the 
applicability dates for certain paragraphs of this section. See also 
Sec. 1.367(a)-3(b)(2) for transactions subject to the concurrent 
application of sections 367(a) and (b) and Sec. 1.367(b)-2 for 
additional definitions that apply.
    (b) Income inclusion. If a foreign corporation (the transferee 
foreign corporation) acquires the stock of a foreign corporation in an 
exchange described in section 351 or the stock or assets of a foreign 
corporation in a reorganization described in section 368(a)(1) (in 
either case, the foreign acquired corporation), then an exchanging 
shareholder must, if its exchange is described in paragraph (b)(1)(i), 
(b)(2)(i), or (b)(3) of this section, include in income as a deemed 
dividend the section 1248 amount attributable to the stock that it 
exchanges.
    (1) Exchange that results in loss of status as section 1248 
shareholder--(i) General rule. Except as provided in paragraph 
(b)(1)(ii) of this section, an exchange is described in this paragraph 
(b)(1)(i) if--
    (A) Immediately before the exchange, the exchanging shareholder is--
    (1) A United States person that is a section 1248 shareholder with 
respect to the foreign acquired corporation; or
    (2) A foreign corporation, and a United States person is a section 
1248 shareholder with respect to such foreign corporation and with 
respect to the foreign acquired corporation;
    (B) Either of the following conditions is satisfied--
    (1) Immediately after the exchange, the stock received in the 
exchange is not stock in a corporation that is a controlled foreign 
corporation as to which the United States person described in paragraph 
(b)(1)(i)(A) of this section is a section 1248 shareholder; or
    (2) Immediately after the exchange, the transferee foreign 
corporation or the foreign acquired corporation (in the case of the 
acquisition of the stock of a foreign acquired corporation) is not a 
controlled foreign corporation as

[[Page 455]]

to which the United States person described in paragraph (b)(1)(i)(A) of 
this section is a section 1248 shareholder; and
    (C) The exchange is not a specified exchange to which paragraph 
(e)(1) of this section applies.
    (ii) Special rules--(A) Receipt of foreign stock in an exchange to 
which Sec. 1.367(a)-7(c) applies. If an exchanging shareholder is a 
domestic corporation that transfers stock of a foreign acquired 
corporation in an exchange under section 361(a) or (b) (section 361 
exchange) to which the exception to section 367(a)(5) in Sec. 1.367(a)-
7(c) applies, and the exchanging shareholder receives stock in either 
the transferee foreign corporation or foreign controlling corporation 
(in the case of a triangular reorganization), such exchange will not be 
described in paragraph (b)(1)(i) of this section only if immediately 
after the exchanging shareholder's receipt of the foreign stock in the 
section 361 exchange, but prior to, and without taking into account, the 
exchanging shareholder's distribution of the foreign stock under section 
361(c)(1), the foreign acquired corporation, transferee foreign 
corporation, and foreign controlling corporation (in the case of a 
triangular reorganization) are controlled foreign corporations as to 
which the exchanging shareholder is a section 1248 shareholder. See 
paragraph (b)(1)(iii) of this section, Example 4, for an illustration of 
this rule. If an exchange is not described in paragraph (b)(1)(i) of 
this section as a result of the application of this paragraph, see 
Sec. Sec. 1.1248(f)-1(b)(3) and 1.1248(f)-2(c), as applicable. For 
adjustments to the basis of stock of the foreign surviving corporation 
in certain triangular reorganizations, see paragraph (b)(1)(ii)(B)(2)(i) 
of this section.
    (B) Special rules for certain triangular reorganizations--(1) 
Receipt of domestic stock. In the case of a triangular reorganization in 
which the stock received in the exchange is stock of a domestic 
controlling corporation, such exchange is not described in paragraph 
(b)(1)(i) of this section if immediately after the exchange the 
following foreign corporations are controlled foreign corporations as to 
which the domestic controlling corporation is a section 1248 
shareholder--
    (i) The foreign acquired corporation and foreign surviving 
corporation, in the case of a section 354 exchange of the stock of the 
foreign acquired corporation pursuant to a triangular B reorganization.
    (ii) The foreign surviving corporation, in the case of a section 354 
or section 356 exchange of the stock of the foreign acquired corporation 
pursuant to a forward triangular merger, triangular C reorganization, 
reverse triangular merger, or triangular G reorganization. See paragraph 
(b)(1)(iii) of this section, Example 3B for an illustration of this 
rule.
    (iii) The foreign acquired corporation and foreign surviving 
corporation, in the case of a section 361 exchange of the stock of the 
foreign acquired corporation by an exchanging shareholder that is a 
foreign corporation described in paragraph (b)(1)(i)(A)(2) of this 
section and that is a foreign acquired corporation the assets of which 
are acquired in a triangular reorganization described in paragraph 
(b)(1)(ii)(B)(1)(ii) of this section.
    (iv) The foreign acquired corporation and foreign surviving 
corporation, in the case of a section 361 exchange of the stock of the 
foreign acquired corporation by an exchanging shareholder that is a 
domestic corporation described in paragraph (b)(1)(i)(A)(1) of this 
section and that is acquired in a triangular reorganization to which the 
exception to section 367(a)(5) in Sec. 1.367(a)-7(c) applies. See 
paragraph (b)(1)(iii) of this section, Example 5 for an illustration of 
this rule.
    (2) Adjustments to basis of stock of foreign surviving corporation--
(i) Section 361 exchanges to which Sec. 1.367(a)-7(c) applies. If stock 
of the foreign acquired corporation is acquired by the foreign surviving 
corporation in a section 361 exchange by reason of triangular 
reorganization (other than a triangular B reorganization) to which the 
exception to section 367(a)(5) provided in Sec. 1.367(a)-7(c) applies, 
and if paragraph (b)(1)(i) of this section does not apply to the section 
361 exchange by reason of (b)(1)(ii)(A) of this section (if the stock 
received is stock of a foreign controlling corporation) or by reason of

[[Page 456]]

(b)(1)(ii)(B)(1)(iv) of this section (if the stock received is stock of 
a domestic controlling corporation), then the controlling corporation 
(foreign or domestic) must apply the principles of Sec. 1.367(b)-13 to 
adjust the basis of the stock of the foreign surviving corporation so 
that the section 1248 amount in the stock of the foreign acquired 
corporation (determined when the foreign surviving corporation acquires 
such stock) is reflected in the stock of the foreign surviving 
corporation immediately after the exchange. See paragraph (b)(1)(iii) of 
this section, Example 5, for an illustration of this rule.
    (ii) Other exchanges. See Sec. 1.367(b)-13 for rules regarding the 
adjustment to the basis of the stock of the foreign surviving 
corporation in exchanges pursuant to triangular reorganizations that are 
not subject to paragraph (b)(1)(ii)(B)(2)(i) of this section.
    (iii) Examples. The following examples illustrate the rules of this 
paragraph (b)(1):

    Example 1. (i) Facts. FC1 is a foreign corporation that is owned, 
directly and indirectly (applying the ownership rules of section 958), 
solely by foreign persons. DC is a domestic corporation that is 
unrelated to FC1. DC owns all of the outstanding stock of FC2, a foreign 
corporation. Thus, under Sec. 1.367(b)-2(a) and (b), DC is a section 
1248 shareholder with respect to FC2, and FC2 is a controlled foreign 
corporation. Under Sec. 1.367(b)-2(c)(1), the section 1248 amount 
attributable to the stock of FC2 held by DC is $20. In a reorganization 
described in section 368(a)(1)(C), FC1 acquires all of the assets and 
assumes all of the liabilities of FC2 in exchange for FC1 voting stock. 
The FC1 voting stock received does not represent more than 50 percent of 
the voting power or value of FC1's stock. FC2 distributes the FC1 stock 
to DC, and the FC2 stock held by DC is canceled.
    (ii) Result. FC1 is not a controlled foreign corporation immediately 
after the exchange. As a result, the exchange is described in paragraph 
(b)(1)(i) of this section. Under paragraph (b) of this section, DC must 
include in income, as a deemed dividend from FC2, the section 1248 
amount ($20) attributable to the FC2 stock that DC exchanged.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that the voting stock of FC1, which is received by FC2 in exchange for 
its assets and distributed by FC2 to DC, represents more than 50 percent 
of the voting power of FC1's stock under the rules of section 957(a).
    (ii) Result. Paragraph (b)(1)(i) of this section does not apply to 
require inclusion in income of the section 1248 amount, because FC1 is a 
controlled foreign corporation as to which DC is a section 1248 
shareholder immediately after the exchange.
    Example 3. (i) Facts. The facts are the same as in Example 1, except 
that FC2 receives and distributes voting stock of FP, a foreign 
corporation that is in control (within the meaning of section 368(c)) of 
FC1, instead of receiving and distributing voting stock of FC1.
    (ii) Result. For purposes of section 367(a), the transfer is an 
indirect stock transfer subject to section 367(a). See Sec. 1.367(a)-
3(d)(1)(iv). Accordingly, DC's exchange of FC2 stock for FP stock under 
section 354 will be taxable under section 367(a) (and section 1248 will 
be applicable) if DC fails to enter into a gain recognition agreement in 
accordance with Sec. 1.367(a)-8. Under Sec. 1.367(a)-3(b)(2), if DC 
enters into a gain recognition agreement, the exchange will be subject 
to the provisions of section 367(b) and the regulations thereunder, as 
well as section 367(a). If FP and FC1 are controlled foreign 
corporations as to which DC is a (direct or indirect) section 1248 
shareholder immediately after the reorganization, then the section 
367(b) result is the same as in Example 2--that is, paragraph (b)(1)(i) 
of this section does not apply to require inclusion in income of the 
section 1248 amount. Under these circumstances, the amount of the gain 
recognition agreement would equal the amount of the gain realized on the 
indirect stock transfer. If FP or FC1 is not a controlled foreign 
corporation as to which DC is a (direct or indirect) section 1248 
shareholder immediately after the exchange, then the section 367(b) 
result is the same as in Example 1--that is, DC must include in income, 
as a deemed dividend from FC2, the section 1248 amount ($20) 
attributable to the FC2 stock that DC exchanged. Under these 
circumstances, the amount of the gain recognition agreement would equal 
the amount of the gain realized on the indirect stock transfer, less the 
$20 section 1248 amount inclusion.
    Example 3A. (i) Facts. The facts are the same as in Example 3, 
except that FC1 merges into FC2 in a reorganization described in 
sections 368(a)(1)(A) and (a)(2)(E). Pursuant to the reorganization, DC 
exchanges its FC2 stock for stock of FP.
    (ii) Result. The result is similar to the result in Example 3. The 
transfer is an indirect stock transfer subject to section 367(a). See 
Sec. 1.367(a)-3(d)(1)(ii). Accordingly, DC's exchange of FC2 stock for 
FP stock will be taxable under section 367(a) (and section 1248 will be 
applicable) if DC fails to enter into a gain recognition agreement. If 
DC enters into a gain recognition agreement, the exchange will be 
subject to the provisions of section 367(b) and the regulations 
thereunder, as well as section 367(a). If FP and

[[Page 457]]

FC2 are controlled foreign corporations as to which DC is a section 1248 
shareholder immediately after the reorganization, then paragraph 
(b)(1)(i) of this section does not apply to require DC to include in 
income the section 1248 amount attributable to the FC2 stock that was 
exchanged and the amount of the gain recognition agreement is the amount 
of gain realized on the indirect stock transfer. If FP or FC2 is not a 
controlled foreign corporation as to which DC is a section 1248 
shareholder immediately after the exchange, then DC must include in 
income as a deemed dividend from FC2 the section 1248 amount ($20) 
attributable to the FC2 stock that DC exchanged. Under these 
circumstances, the gain recognition agreement would be the amount of 
gain realized on the indirect transfer, less the $20 section 1248 amount 
inclusion.
    Example 3B. (i) Facts. The facts are the same as Example 3, except 
that USP, a domestic corporation, owns the controlling interest (within 
the meaning of section 368(c)) in FC1 stock. In addition, FC2 merges 
into FC1 in a reorganization described in sections 368(a)(1)(A) and 
(a)(2)(D). Pursuant to the reorganization, DC exchanges its FC2 stock 
for USP stock.
    (ii) Result. Because DC receives stock of a domestic corporation, 
USP, in the section 354 exchange, the transfer is not an indirect stock 
transfer subject to section 367(a). Accordingly, the exchange will be 
subject only to the provisions of section 367(b) and the regulations 
thereunder. Under paragraph (b)(1)(ii) of this section, because the 
stock received is stock of a domestic corporation (USP) and, immediately 
after the exchange, USP is a section 1248 shareholder of FC1 (the 
surviving corporation) and FC1 is a controlled foreign corporation, the 
exchange is not described in paragraph (b)(1)(i) of this section and DC 
is not required to include in income the section 1248 amount 
attributable to the FC2 stock that was exchanged. See Sec. 1.367(b)-
13(c) for the basis and holding period rules applicable to this 
transaction, which cause USP's adjusted basis and holding period in the 
stock of FC1 after the transaction to reflect the basis and holding 
period that DC had in its FC2 stock.
    Example 4. (i) Facts. DC1, a domestic corporation, owns all of the 
outstanding stock of DC2, a domestic corporation. DC2 owns various 
assets, including all of the outstanding stock of FC2, a foreign 
corporation. The stock of FC2 has a value of $100, and DC2 has a basis 
of $30 in the stock. The section 1248 earnings and profits attributable 
to the FC2 stock held by DC2 is $20. DC2 does not own any stock other 
than the FC2 stock. FC1 is a foreign corporation that is unrelated to 
DC1, DC2, and FC2. In a reorganization described in section 
368(a)(1)(C), FC1 acquires all of the assets of DC2 in exchange for the 
assumption of DC2's liabilities and voting stock of FC1 that represents 
20% of the outstanding voting stock of FC1. DC2 distributes the FC1 
stock to DC1 under section 361(c)(1), and the DC2 stock held by DC1 is 
canceled. The exception to section 367(a)(5) provided in Sec. 1.367(a)-
7(c) applies to the section 361 exchange. DC1 properly files a gain 
recognition agreement that satisfies the conditions of Sec. Sec. 
1.367(a)-3(e)(6) and 1.367(a)-8 to qualify for nonrecognition treatment 
under section 367(a) with respect to DC2's transfer of the FC2 stock to 
FC1. See Sec. 1.367(a)-3(e). FC1 is not a surrogate foreign corporation 
(within the meaning of section 7874) because DC1 does not hold at least 
60% of the stock of FC1 by reason of holding stock of DC2.
    (ii) Result. DC2, the exchanging shareholder, is a U.S. person and a 
section 1248 shareholder with respect to FC2, the foreign acquired 
corporation. Whether DC2 is required to include in income the section 
1248 amount attributable to the FC2 stock under paragraph (b)(1)(i) of 
this section depends on whether, immediately after DC2's section 361 
exchange of the FC2 stock for FC1 stock (and before the distribution of 
the FC1 stock to DC1 under section 361(c)(1)), FC1 and FC2 are 
controlled foreign corporations as to which DC2 is a section 1248 
shareholder. See paragraph (b)(1)(ii)(A) of this section. If, 
immediately after the section 361 exchange (and before the distribution 
of the FC1 stock to DC1 under section 361(c)(1)), FC1 and FC2 are both 
controlled foreign corporations as to which DC2 is a section 1248 
shareholder, then DC2 is not required to include in income the section 
1248 amount attributable to the FC2 stock under paragraph (b)(1)(i) of 
this section because neither condition in paragraph (b)(1)(i)(B) of this 
section is satisfied. Alternatively, if immediately after the section 
361 exchange (and before the distribution of the FC1 stock to DC1 under 
section 361(c)(1)) either FC1 or FC2 is not a controlled foreign 
corporation as to which DC2 is a section 1248 shareholder, then, 
pursuant to paragraph (b)(1)(i) of this section, DC2 must include in 
income the section 1248 amount attributable to the FC2 stock. For the 
treatment of DC2's transfer of assets other than the FC2 stock to FC1, 
see section 367(a)(1) and (a)(3) and the regulations under that section. 
Furthermore, because DC2's transfer of any other assets to FC1 is 
pursuant to a section 361 exchange, see section 367(a)(5) and Sec. 
1.367(a)-7. If any of the assets transferred are intangible assets for 
purposes of section 367(d), see section 367(d). With respect to DC2's 
distribution of the FC1 stock to DC1 under section 361(c)(1), see 
section 1248(f)(1), and Sec. Sec. 1.1248(f)-1 and 1.1248(f)-2.
    Example 5. (i) Facts. DC1, a domestic corporation, wholly owns DC2, 
a domestic corporation. The DC2 stock has a $100x fair market value, and 
DC1 has a basis of $30x in the stock. DC2's only asset is all of the 
outstanding stock of FC2, a foreign corporation.

[[Page 458]]

The FC2 stock has a $100x fair market value, and DC2 has a basis of $30x 
in the stock. There are $20x of earnings and profits attributable to the 
FC2 stock for purposes of section 1248. USP, a domestic corporation 
unrelated to DC1, DC2, and FC2, wholly owns FC1, a foreign corporation. 
In a triangular reorganization described in section 368(a)(1)(C), DC2 
transfers all the FC2 stock to FC1 in exchange solely for voting stock 
of USP, and distributes the USP stock to DC1 under section 361(c)(1). 
DC1 exchanges its DC2 stock for the USP stock under section 354. DC2's 
transfer of the FC2 stock to FC1 is described in section 361(a) and 
therefore, under section 367(a)(5) and Sec. 1.367(a)-7, is generally 
subject to section 367(a)(1). However, the exception to section 
367(a)(5) provided in Sec. 1.367(a)-7(c) applies to the section 361 
exchange. In addition, DC1 is not required to adjust the basis of its 
USP stock (determined under section 358) under section 367(a)(5) and 
Sec. 1.367(a)-7(c)(3). DC1 properly files a gain recognition agreement 
that satisfies the conditions of Sec. Sec. 1.367(a)-3(e)(6) and 
1.367(a)-8 to qualify for nonrecognition treatment under section 367(a) 
with respect to DC2's transfer of the FC2 stock to FC1. See Sec. 
1.367(a)-3(e).
    (ii) Result. Immediately after the exchange, FC1 and FC2 are 
controlled foreign corporations as to which USP is a section 1248 
shareholder because USP directly and indirectly owns all the FC1 stock 
and FC2 stock, respectively. Because DC2 receives stock of a domestic 
corporation (USP) in exchange for the FC2 stock and, immediately after 
the exchange, FC1 and FC2 are controlled foreign corporations as to 
which USP is a section 1248 shareholder, DC2's exchange of the FC2 stock 
for the USP stock is not described in paragraph (b)(1)(i) of this 
section. See paragraph (b)(1)(ii)(B)(1)(iv) of this section. Therefore, 
DC2 is not required to include in income the section 1248 amount in the 
FC2 stock. Under paragraph (b)(1)(ii)(B)(2)(i) of this section, USP must 
apply the principles of Sec. 1.367(b)-13 to adjust the basis of its FC1 
stock to preserve the section 1248 amount ($20x) in the FC2 stock. Under 
the principles of Sec. 1.367(b)-13, each share of FC1 stock held by USP 
after the exchange must be divided into portions, one portion 
attributable to the FC1 stock owned before the exchange and one portion 
attributable to the FC2 stock received in the exchange. The $30x basis 
in the FC2 stock and the $20x earnings and profits attributable to the 
FC2 stock before the exchange are attributable to the divided portions 
of the FC1 stock to which the FC2 stock relates.

    (2) Receipt by exchanging shareholder of preferred or other stock in 
certain instances--(i) Rule. An exchange is described in this paragraph 
(b)(2)(i) if--
    (A) Immediately before the exchange, the foreign acquired 
corporation and the transferee foreign corporation are not members of 
the same affiliated group (within the meaning of section 1504(a), but 
without regard to the exceptions set forth in section 1504(b), and 
substituting the words ``more than 50'' in place of the words ``at least 
80'' in sections 1504(a)(2)(A) and (B));
    (B) Immediately after the exchange, a domestic corporation meets the 
ownership threshold specified by section 902(a) or (b) such that it may 
qualify for a deemed paid foreign tax credit if it receives a 
distribution from the transferee foreign corporation (directly or 
through tiers); and
    (C) The exchanging shareholder receives preferred stock (other than 
preferred stock that is fully participating with respect to dividends, 
redemptions and corporate growth) in consideration for common stock or 
preferred stock that is fully participating with respect to dividends, 
redemptions and corporate growth, or, in the discretion of the 
Commissioner or the Commissioner's delegate (and without regard to 
whether the stock exchanged is common stock or preferred stock), 
receives stock that entitles it to participate (through dividends, 
redemption payments or otherwise) disproportionately in the earnings 
generated by particular assets of the foreign acquired corporation or 
transferee foreign corporation.
    (ii) Examples. The following examples illustrate the rules of this 
paragraph (b)(2):

    Example 1. (i) Facts. FC1 is a foreign corporation. DC is a domestic 
corporation that is unrelated to FC1. DC owns all of the outstanding 
stock of FC2, a foreign corporation, and FC2 has no outstanding 
preferred stock. The value of FC2 is $100 and DC has a basis of $50 in 
the stock of FC2. Under Sec. 1.367(b)-2(c)(1), the section 1248 amount 
attributable to the stock of FC2 held by DC is $20. In a reorganization 
described in section 368(a)(1)(B), FC1 acquires all of the stock of FC2 
and, in exchange, DC receives FC1 voting preferred stock that 
constitutes 10 percent of the voting stock of FC1 for purposes of 
section 902(a). Immediately after the exchange, FC1 and FC2 are 
controlled foreign corporations and DC is a section 1248 shareholder of 
FC1 and FC2, so paragraph (b)(1)(i) of this section does not require 
inclusion in income of the section 1248 amount.

[[Page 459]]

    (ii) Result. Pursuant to Sec. 1.367(a)-3(b)(2), the transfer is 
subject to both section 367(a) and section 367(b). Under Sec. 1.367(a)-
3(b)(1), DC will not be subject to tax under section 367(a)(1) if it 
enters into a gain recognition agreement in accordance with Sec. 
1.367(a)-8. Even though paragraph (b)(1)(i) of this section does not 
apply to require inclusion in income by DC of the section 1248 amount, 
DC must nevertheless include the $20 section 1248 amount in income as a 
deemed dividend from FC2 under paragraph (b)(2)(i) of this section. 
Thus, if DC enters into a gain recognition agreement, the amount is $30 
(the $50 gain realized less the $20 recognized under section 367(b)). If 
DC fails to enter into a gain recognition agreement, it must include in 
income under section 367(a)(1) the $50 of gain realized ($20 of which is 
treated as a dividend under section 1248). Section 367(b) does not apply 
in such case.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that DC owns all of the outstanding stock of FC1 immediately before the 
transaction.
    (ii) Result. Both section 367(a) and section 367(b) apply to the 
transfer. Paragraph (b)(2)(i) of this section does not apply to require 
inclusion of the section 1248 amount. Under paragraph (b)(2)(i)(A) of 
this section, the transaction is outside the scope of paragraph 
(b)(2)(i) of this section because FC1 and FC2 are, immediately before 
the transaction, members of the same affiliated group (within the 
meaning of such paragraph). Thus, if DC enters into a gain recognition 
agreement in accordance with Sec. 1.367(a)-8, the amount of such 
agreement is $50. As in Example 1, if DC fails to enter into a gain 
recognition agreement, it must include in income $50, $20 of which will 
be treated as a dividend under section 1248.
    Example 3. (i) Facts. FC1 is a foreign corporation. DC is a domestic 
corporation that is unrelated to FC1. DC owns all of the outstanding 
stock of FC2, a foreign corporation. The section 1248 amount 
attributable to the stock of FC2 held by DC is $20. In a reorganization 
described in section 368(a)(1)(B), FC1 acquires all of the stock of FC2 
in exchange for FC1 voting stock that constitutes 10 percent of the 
voting stock of FC1 for purposes of section 902(a). The FC1 voting stock 
received by DC in the exchange carries voting rights in FC1, but by 
agreement of the parties the shares entitle the holder to dividends, 
amounts to be paid on redemption, and amounts to be paid on liquidation, 
that are to be determined by reference to the earnings or value of FC2 
as of the date of such event, and that are affected by the earnings or 
value of FC1 only if FC1 becomes insolvent or has insufficient capital 
surplus to pay dividends.
    (ii) Result. Under Sec. 1.367(a)-3(b)(1), DC will not be subject to 
tax under section 367(a)(1) if it enters into a gain recognition 
agreement with respect to the transfer of FC2 stock to FC1. Under Sec. 
1.367(a)-3(b)(2), the exchange will be subject to the provisions of 
section 367(b) and the regulations thereunder to the extent that it is 
not subject to tax under section 367(a)(1). Furthermore, even if DC 
would not otherwise be required to recognize income under this section, 
the Commissioner or the Commissioner's delegate may nevertheless require 
that DC include the $20 section 1248 amount in income as a deemed 
dividend from FC2 under paragraph (b)(2)(i) of this section.

    (3) Certain recapitalizations. An exchange pursuant to a 
recapitalization under section 368(a)(1)(E) shall be deemed to be an 
exchange described in this paragraph (b)(3) if the following conditions 
are satisfied--
    (i) During the 24-month period immediately preceding or following 
the date of the recapitalization, the corporation that undergoes the 
recapitalization (or a predecessor of, or successor to, such 
corporation) also engages in a transaction that would be described in 
paragraph (b)(2)(i) of this section but for paragraph (b)(2)(i)(C) of 
this section, either as the foreign acquired corporation or the 
transferee foreign corporation; and
    (ii) The exchange in the recapitalization is described in paragraph 
(b)(2)(i)(C) of this section.
    (c) Exclusion of deemed dividend from foreign personal holding 
company income--(1) Rule. In the event the section 1248 amount is 
included in income as a deemed dividend by a foreign corporation under 
paragraph (b) of this section, such deemed dividend shall not be 
included as foreign personal holding company income under section 
954(c).
    (2) Example. The following example illustrates the rule of this 
paragraph (c):

    Example. (i) Facts. FC1 is a foreign corporation that is owned, 
directly and indirectly (applying the ownership rules of section 958), 
solely by foreign persons. DC is a domestic corporation that is 
unrelated to FC1. DC owns all of the outstanding stock of FC2, a foreign 
corporation. FC2 owns all of the outstanding stock of FC3, a foreign 
corporation. Under Sec. 1.367(b)-2(c)(1), the section 1248 amount 
attributable to the stock of FC3 held by FC2 is $20. In a reorganization 
described in section 368(a)(1)(B), FC1 acquires from FC2 all of the 
stock of FC3 in exchange for FC1 voting stock. The FC1 voting stock 
received by FC2 does not represent more than 50 percent of the voting 
power or value of FC1's stock.

[[Page 460]]

    (ii) Result. FC1 is not a controlled foreign corporation immediately 
after the exchange. Under paragraph (b)(1) of this section, FC2 must 
include in income, as a deemed dividend from FC3, the section 1248 
amount ($20) attributable to the FC3 stock that FC2 exchanged. The 
deemed dividend is treated as a dividend for purposes of the Internal 
Revenue Code as provided in Sec. 1.367(b)-2(e)(2); however, under this 
paragraph (c) the deemed dividend is not foreign personal holding 
company income to FC2.

    (d) Rules for subsequent sales or exchanges--(1) Rule. If an 
exchanging shareholder (as defined in Sec. 1.1248-8(b)(1)(iv)) is not 
required to include in income as a deemed dividend the section 1248 
amount under paragraph (b) or paragraph (e)(1) of this section (non-
inclusion exchange), then, for purposes of applying section 367(b) or 
1248 to subsequent sales or exchanges, and subject to the limitation of 
Sec. 1.367(b)-2(d)(3)(ii) (in the case of a transaction described in 
Sec. 1.367(b)-3), the determination of the earnings and profits 
attributable to the stock an exchanging shareholder receives in the non-
inclusion exchange is determined pursuant to the rules of section 1248 
and the regulations under that section.
    (2) Example. The following example illustrates the rules of this 
section. For purposes of the example, assume that--
    (i) There is no immediate gain recognition pursuant to section 
367(a)(1) and the regulations under that section (either through 
operation of the rules or because the appropriate parties have entered 
into a gain recognition agreement under Sec. Sec. 1.367(a)-3(b) and 
1.367(a)-8);
    (ii) References to earnings and profits are to earnings and profits 
that would be includible in income as a dividend under section 1248 and 
the regulations under that section if stock to which the earnings and 
profits are attributable were sold or exchanged by its shareholder;
    (iii) Each corporation has only a single class of stock outstanding 
and uses the calendar year as its taxable year; and
    (iv) Each transaction is unrelated to all other transactions.

    Example. Acquisition of the stock of a foreign corporation that 
controls a transferee foreign corporation in a reorganization described 
in section 368(a)(1)(C). (i) Facts. DC1, a domestic corporation, has 
owned all the stock of CFC1, a controlled foreign corporation, since its 
formation on January 1, year 1. CFC1 has owned all the stock of CFC2, a 
controlled foreign corporation, since its formation on January 1, year 
1. FC, a foreign corporation that is not a controlled foreign 
corporation, has owned all of the stock of FC2, a foreign corporation, 
since its formation on January 1, year 2. On December 31, year 3, 
pursuant to a restructuring transaction that was a triangular 
reorganization described in section 368(a)(1)(C), CFC1 transfers all of 
its assets, including the CFC2 stock, to FC2 in exchange for 80% of the 
voting stock of FC. CFC1 transfers the voting stock of FC to DC1 and the 
CFC1 stock is cancelled. Pursuant to section 1223(1), DC1 is considered 
to have held the stock of FC since January 1, year 1. Under section 
1223(2), FC2 is considered to have held the stock of CFC2 since January 
1, year 1. On December 31, year 3, CFC1 has $100 of earnings and 
profits. From January 1, year 4, until December 31, year 5, FC (a 
controlled foreign corporation after the restructuring transaction) 
accumulates an additional $50 of earnings and profits. FC2, a controlled 
foreign corporation after the restructuring transaction, accumulates 
$100 of earnings and profits from January 1, year 4, until December 31, 
year 5. On December 31, year 5, FC is liquidated into DC1 in a 
transaction described in section 332.
    (ii) Result. Generally, this paragraph (d) requires that DC1 include 
in income the earnings and profits attributable to its stock in FC as 
determined under Sec. 1.1248-8. However, since the liquidation of FC 
into DC1 is a transaction described in Sec. 1.367(b)-3, the earnings 
and profits attributable to the stock of FC are limited by Sec. 
1.367(b)-2(d) (3)(ii) to that portion of the earnings and profits 
accumulated by FC itself before or after the restructuring transaction, 
and do not include the earnings and profits of FC's subsidiaries 
accumulated before or after the restructuring transaction. Thus, DC1 
will include $40 of earnings and profits in income (80% of the $50 of 
earnings and profits accumulated by FC after the restructuring 
transaction).

    (e) Income inclusion and gain recognition in certain exchanges 
following an inversion transaction--(1) General rule. If a foreign 
corporation (the transferee foreign corporation) acquires stock of a 
foreign corporation in an exchange described in section 351 or stock or 
assets of a foreign corporation in a reorganization described in section 
368(a)(1) (in either case, the foreign acquired corporation), then an 
exchanging shareholder must, if its exchange is a specified exchange and 
the exception in

[[Page 461]]

paragraph (e)(3) of this section does not apply--
    (i) Include in income as a deemed dividend the section 1248 amount 
attributable to the stock that it exchanges; and
    (ii) After taking into account the increase in basis provided in 
Sec. 1.367(b)-2(e)(3)(ii) resulting from the deemed dividend (if any), 
recognize all realized gain with respect to the stock that would not 
otherwise be recognized.
    (2) Specified exchanges. An exchange is a specified exchange if--
    (i) Immediately before the exchange, the foreign acquired 
corporation is an expatriated foreign subsidiary and the exchanging 
shareholder is either an expatriated entity described in paragraph 
(b)(1)(i)(A)(1) of this section or an expatriated foreign subsidiary 
described in paragraph (b)(1)(i)(A)(2) of this section;
    (ii) The stock received in the exchange is stock of a foreign 
corporation; and
    (iii) The exchange occurs during the applicable period.
    (3) De minimis exception. The exception in this paragraph (e)(3) 
applies if--
    (i) Immediately after the exchange, the foreign acquired corporation 
(in the case of an acquisition of stock of the foreign acquired 
corporation) or the transferee foreign corporation (in the case of an 
acquisition of assets of the foreign acquired corporation) is a 
controlled foreign corporation;
    (ii) The post-exchange ownership percentage with respect to the 
foreign acquired corporation (in the case of an acquisition of stock of 
the foreign acquired corporation) or the transferee foreign corporation 
(in the case of an acquisition of assets of the foreign acquired 
corporation) is at least 90 percent of the pre-exchange ownership 
percentage with respect to the foreign acquired corporation; and
    (iii) The post-exchange ownership percentage with respect to each 
lower-tier expatriated foreign subsidiary of the foreign acquired 
corporation is at least 90 percent of the pre-exchange ownership 
percentage with respect to the lower-tier expatriated foreign 
subsidiary.
    (4) Certain exceptions from foreign personal holding company not 
available. An income inclusion of a foreign corporation under paragraph 
(e)(1) of this section does not qualify for the exceptions from foreign 
personal holding company income provided by sections 954(c)(3)(A)(i) and 
954(c)(6) (to the extent in effect).
    (5) Examples. The following examples illustrate the application of 
this paragraph (e). For purposes of all of the examples, unless 
otherwise indicated: FP, a foreign corporation, owns all of the stock of 
USP, a domestic corporation, and all 40 shares of stock of FS, a 
controlled foreign corporation for its taxable year beginning January 1, 
2017, but not for prior taxable years, except as a result of a 
transaction described in the facts of an example. USP owns all 50 shares 
of stock of FT1, a controlled foreign corporation, which, in turn, owns 
all 50 shares of FT2, a controlled foreign corporation. FP acquired all 
of the stock of USP in an inversion transaction that was completed on 
July 1, 2016. Therefore, with respect to that inversion transaction, USP 
is an expatriated entity; FT1 and FT2 are expatriated foreign 
subsidiaries; and FP and FS are each a non-EFS foreign related person. 
All entities have a calendar year tax year for U.S. tax purposes. All 
shares of stock have a fair market value of $1x, and each corporation 
has a single class of stock outstanding.

    Example 1. Specified exchange to which general rule applies--(i) 
Facts. During the applicable period, and pursuant to a reorganization 
described in section 368(a)(1)(B), FT1 transfers all 50 shares of FT2 
stock to FS in exchange solely for 50 newly issued voting shares of FS. 
Immediately before the exchange, USP is a section 1248 shareholder with 
respect to FT1 and FT2. At the time of the exchange, the FT2 stock owned 
by FT1 has a fair market value of $50x and an adjusted basis of $5x, 
such that the FT2 stock has a built-in gain of $45x. In addition, the 
earnings and profits of FT2 attributable to FT1's stock in FT2 for 
purposes of section 1248 is $30x, taking into account the rules of Sec. 
1.367(b)-2(c)(1)(i) and (ii), and therefore the section 1248 amount with 
respect to the FT2 stock is $30x (the lesser of the $45x of built-in 
gain and the $30x of earnings and profits attributable to the stock).
    (ii) Analysis. FT1's exchange is a specified exchange because the 
requirements set forth in paragraphs (e)(2)(i) through (iii) of this 
section are satisfied. The requirement set forth in paragraph (e)(2)(i) 
of this section is

[[Page 462]]

satisfied because, immediately before the exchange, FT2 (the foreign 
acquired corporation) is an expatriated foreign subsidiary and FT1 (the 
exchanging shareholder) is an expatriated foreign subsidiary that is 
described in paragraph (b)(1)(i)(A)(2) of this section. The requirement 
set forth in paragraph (e)(2)(ii) of this section is also satisfied 
because the stock received in the exchange (FS stock) is stock of a 
foreign corporation. The requirement set forth in paragraph (e)(2)(iii) 
of this section is satisfied because the exchange occurs during the 
applicable period. Accordingly, under paragraph (e)(1)(i) of this 
section, FT1 must include in income as a deemed dividend $30x, the 
section 1248 amount with respect to its FT2 stock. In addition, under 
paragraph (e)(1)(ii) of this section, FT1 must, after taking into 
account the increase in basis provided in Sec. 1.367(b)-2(e)(3)(ii) 
resulting from the deemed dividend (which increases FT1's basis in its 
FT2 stock from $5x to $35x), recognize $15x ($50x amount realized less 
$35x basis), the realized gain with respect to the FT2 stock that would 
not otherwise be recognized.
    Example 2. De minimis shift to non-EFS foreign related persons--(i) 
Facts. The facts are the same as in the introductory sentences of this 
paragraph (e)(5), except as follows. FT1 does not own any shares of FT2, 
and all 40 shares of FS are owned by DX, a domestic corporation wholly 
owned by individual A, and thus FS is not a non-EFS foreign related 
person. During the applicable period and pursuant to a reorganization 
described in section 368(a)(1)(D), FT1 transfers all of its assets to FS 
in exchange for 50 newly issued FS shares, FT1 distributes the 50 FS 
shares to USP in liquidation under section 361(c)(1), and USP exchanges 
its 50 shares of FT1 stock for the 50 FS shares under section 354. 
Further, immediately after the exchange, FS is a controlled foreign 
corporation.
    (ii) Analysis. Although USP's exchange is a specified exchange, 
paragraph (e)(1) of this section does not apply to the exchange because, 
as described in paragraphs (ii)(A) through (C) of this Example 2, the 
requirements of paragraph (e)(3) of this section are satisfied.
    (A) Because the assets, rather than the stock, of FT1 (the foreign 
acquired corporation) are acquired, the requirement set forth in 
paragraph (e)(3)(i) of this section is satisfied if FS (the transferee 
foreign corporation) is a controlled foreign corporation immediately 
after the exchange. As stated in the facts, FS is a controlled foreign 
corporation immediately after the exchange.
    (B) The requirement set forth in paragraph (e)(3)(ii) of this 
section is satisfied if the post-exchange ownership percentage with 
respect to FS is at least 90% of the pre-exchange ownership percentage 
with respect to FT1. Because USP, a domestic corporation that is an 
expatriated entity, directly owns 50 shares of FT1 stock immediately 
before the exchange, none of those shares are treated as indirectly 
owned by FP (a non-EFS foreign related person) for purposes of 
calculating the pre-exchange ownership percentage with respect to FT1. 
See paragraph (g)(1) of this section. Thus, for purposes of calculating 
the pre-exchange ownership percentage with respect to FT1, FP is treated 
as directly or indirectly owning 0%, or 0 of 50 shares, of the stock of 
FT1. Accordingly, the pre-exchange ownership percentage with respect to 
FT1 is 100 (calculated as 100% less 0%, the percentage of FT1 stock that 
non-EFS foreign related persons are treated as directly or indirectly 
owning immediately before the exchange). Consequently, for the 
requirement set forth in paragraph (e)(3)(ii) of this section to be 
satisfied, the post-exchange ownership percentage with respect to FS 
must be at least 90. Because USP, a domestic corporation that is an 
expatriated entity, directly owns 50 shares of FS stock immediately 
after the exchange, none of those shares are treated as indirectly owned 
by FP (a non-EFS foreign related person) for purposes of calculating the 
post-exchange ownership percentage with respect to FS. See paragraph 
(g)(1) of this section. Thus, for purposes of calculating the post-
exchange ownership percentage with respect to FS, FP is treated as 
directly or indirectly owning 0%, or 0 of 90 shares, of the stock of FS. 
As a result, the post-exchange ownership percentage with respect to FS 
is 100 (calculated as 100% less 0%, the percentage of FS stock that non-
EFS foreign related persons are treated as directly or indirectly owning 
immediately after the exchange). Therefore, because the post-exchange 
ownership percentage with respect to FS (100) is at least 90, the 
requirement set forth in paragraph (e)(3)(ii) of this section is 
satisfied.
    (C) Because there is not a lower-tier expatriated foreign subsidiary 
of FT1, the requirement set forth in paragraph (e)(3)(iii) of this 
section does not apply.

    (f) Gain recognition upon certain transfers of property described in 
section 351 following an inversion transaction--(1) General rule. If, 
during the applicable period, an expatriated foreign subsidiary 
transfers specified property to a foreign corporation (the transferee 
foreign corporation) in an exchange described in section 351, then the 
expatriated foreign subsidiary must recognize all realized gain with 
respect to the specified property transferred that would not otherwise 
be recognized, unless the exception in paragraph (f)(2) of this section 
applies.
    (2) De minimis exception. The exception in this paragraph (f)(2) 
applies if--

[[Page 463]]

    (i) Immediately after the transfer, the transferee foreign 
corporation is a controlled foreign corporation; and
    (ii) The post-exchange ownership percentage with respect to the 
transferee foreign corporation is at least 90 percent of the pre-
exchange ownership percentage with respect to the expatriated foreign 
subsidiary.
    (3) Examples. The following examples illustrate the application of 
this paragraph (f). For purposes of all of the examples, unless 
otherwise indicated: FP, a foreign corporation, owns all of the stock of 
USP, a domestic corporation, and all 10 shares of stock of FS, a 
controlled foreign corporation for its taxable year beginning January 1, 
2017, but not for prior taxable years, except as a result of a 
transaction described in the facts of an example. USP owns all 50 shares 
of stock of FT, a controlled foreign corporation. FT owns Asset A, which 
is specified property with a fair market value of $50x and an adjusted 
basis of $10x. FP acquired all of the stock of USP in an inversion 
transaction that was completed on or after September 22, 2014. 
Accordingly, with respect to that inversion transaction, USP is an 
expatriated entity, FT is an expatriated foreign subsidiary, and FP and 
FS are each a non-EFS foreign related person. All entities have a 
calendar year tax year for U.S. tax purposes. All shares of stock have a 
fair market value of $1x, and each corporation has a single class of 
stock outstanding.

    Example 1. Transfer to which general rule applies--(i) Facts. In 
addition to the stock of USP and FS, FP owns Asset B, which has a fair 
market value of $40x. During the applicable period, and pursuant to an 
exchange described in section 351, FT transfers Asset A to FS in 
exchange for 50 newly issued shares of FS stock, and FP transfers Asset 
B to FS in exchange for 40 newly issued shares of FS stock. (ii) 
Analysis. Paragraph (f)(1) of this section applies to the transfer by FT 
(an expatriated foreign subsidiary) of Asset A, which is specified 
property, to FS (the transferee foreign corporation). Thus, FT must 
recognize gain of $40x under paragraph (f)(1) of this section, which is 
the realized gain with respect to Asset A that would not otherwise be 
recognized ($50x amount realized less $10x basis). For rules regarding 
whether the FS stock held by FT is treated as United States property for 
purposes of section 956, see Sec. 1.956-2(a)(4)(i).
    Example 2. De minimis shift to non-EFS foreign related persons--(i) 
Facts. Individual, a United States person, owns Asset B, which has a 
fair market value of $40x. During the applicable period, and pursuant to 
an exchange described in section 351, FT transfers Asset A to FS in 
exchange for 50 newly issued shares of FS stock, and Individual 
transfers Asset B to FS in exchange for 40 newly issued shares of FS 
stock. (ii) Analysis. Paragraph (f)(1) of this section does not apply to 
the transfer by FT (an expatriated foreign subsidiary) of Asset A, which 
is specified property, to FS (the transferee foreign corporation)) 
because the requirements set forth in paragraph (f)(2) of this section 
are satisfied. The requirement set forth in paragraph (f)(2)(i) of this 
section is satisfied because FS is a controlled foreign corporation 
immediately after the transfer. The requirement set forth in paragraph 
(f)(2)(ii) of this section is satisfied if the post-exchange ownership 
percentage with respect to FS is at least 90 percent of the pre-exchange 
ownership percentage with respect to FT. Because USP, a domestic 
corporation that is an expatriated entity, directly owns 50 shares of FT 
stock immediately before the transfer, none of those shares are treated 
as indirectly owned by FP (a non-EFS foreign related person) for 
purposes of calculating the pre-exchange ownership percentage with 
respect to FT. See paragraph (g)(1) of this section. Thus, for purposes 
of calculating the pre-exchange ownership percentage with respect to FT, 
FP is treated as directly or indirectly owning 0 percent, or 0 of 50 
shares, of the stock of FT. Accordingly, the pre-exchange ownership 
percentage with respect to FT is 100 (calculated as 100 percent less 0 
percent, the percentage of FT stock that non-EFS foreign related persons 
are treated as directly or indirectly owning immediately before the 
transfer). Consequently, for the requirement set forth in paragraph 
(f)(2)(ii) of this section to be satisfied, the post-exchange ownership 
percentage with respect to FS must be at least 90. Although FP directly 
owns 10 FS shares, none of the 50 FS shares that FP owns through USP (a 
domestic corporation that is an expatriated entity) are treated as 
indirectly owned by FP for purposes of calculating the post-exchange 
ownership percentage with respect to FS because USP directly owns them. 
See paragraph (g)(1) of this section. Thus, for purposes of calculating 
the post-exchange ownership percentage with respect to FS, FP is treated 
as directly or indirectly owning 10 percent, or 10 of 100 shares, of the 
stock of FS. As a result, the post-exchange ownership percentage with 
respect to FS is 90 (calculated as 100 percent less 10 percent, the 
percentage of FS stock that non-EFS foreign related persons are treated 
as directly or indirectly owning immediately after the transfer). 
Therefore, because the post-exchange ownership percentage with respect 
to FS (90) is at least 90,

[[Page 464]]

the requirement set forth in paragraph (f)(2)(ii) of this section is 
satisfied.

    (g) Definitions and special rules. In addition to the definitions 
and special rules in Sec. Sec. 1.367(b)-2 and 1.7874-12, the following 
definitions and special rules apply for purposes of this section.
    (1) Indirect ownership. To determine indirect ownership of the stock 
of a corporation for purposes of calculating a pre-exchange ownership 
percentage or post-exchange ownership percentage with respect to that 
corporation, the principles of section 958(a) apply without regard to 
whether an intermediate entity is foreign or domestic. For this purpose, 
stock of the corporation that is directly or indirectly (applying the 
principles of section 958(a) without regard to whether an intermediate 
entity is foreign or domestic) owned by a domestic corporation that is 
an expatriated entity is not treated as indirectly owned by a non-EFS 
foreign related person.
    (2) A lower-tier expatriated foreign subsidiary means an expatriated 
foreign subsidiary whose stock is directly or indirectly owned (under 
the principles of section 958(a)) by an expatriated foreign subsidiary.
    (3) Pre-exchange ownership percentage means, with respect to a 
corporation, 100 percent less the percentage of stock (by value) in the 
corporation that, immediately before an exchange, is owned, in the 
aggregate, directly or indirectly by non-EFS foreign related persons.
    (4) Post-exchange ownership percentage means, with respect to a 
corporation, 100 percent less the percentage of stock (by value) in the 
corporation that, immediately after the exchange, is owned, in the 
aggregate, directly or indirectly by non-EFS foreign related persons.
    (5) Specified property means any property other than stock of a 
lower-tier expatriated foreign subsidiary.
    (6) Recapitalizations. A foreign corporation that undergoes a 
reorganization described in section 368(a)(1)(E) is treated as both the 
foreign acquired corporation and the transferee foreign corporation.
    (7) Triangular reorganizations--(i) Definition. A triangular 
reorganization means a reorganization described in Sec. 1.358-
6(b)(2)(i) (forward triangular merger), (ii) (triangular C 
reorganization), (iii) (reverse triangular merger), (iv) (triangular B 
reorganization), and (v) (triangular G reorganization).
    (ii) Special rules--(A) Triangular reorganizations other than a 
reverse triangular merger. In the case of a triangular reorganization 
other than a reverse triangular merger, the surviving corporation is the 
transferee foreign corporation that acquires the assets or stock of the 
foreign acquired corporation, and the reference to controlling 
corporation (foreign or domestic) is to the corporation that controls 
the surviving corporation.
    (B) Reverse triangular merger. In the case of a reverse triangular 
merger, the surviving corporation is the entity that survives the 
merger, and the controlling corporation (foreign or domestic) is the 
corporation that before the merger controls the merged corporation. In 
the case of a reverse triangular merger, this section applies only if 
stock of the foreign surviving corporation is exchanged for stock of a 
foreign corporation in control of the merging corporation; in such a 
case, the foreign surviving corporation is treated as a foreign acquired 
corporation.
    (h) Applicability date of certain paragraphs in this section. Except 
as otherwise provided in this paragraph (h), paragraphs (a), (b) 
introductory text, (b)(1)(i)(C), (d)(1), (e), (f), and (g) of this 
section apply to exchanges completed on or after September 22, 2014, but 
only if the inversion transaction was completed on or after September 
22, 2014. Paragraph (e)(1)(ii) of this section applies to exchanges 
completed on or after November 19, 2015, but only if the inversion 
transaction was completed on or after September 22, 2014. The portion of 
paragraph (e)(2)(i) of this section that requires the exchanging 
shareholder to be an expatriated entity or an expatriated foreign 
subsidiary apply to exchanges completed on or after April 4, 2016, but 
only if the inversion transaction was completed on or after September 
22, 2014. For inversion transactions completed on or after September 22, 
2014, however, taxpayers may elect to apply the portion of paragraph 
(e)(2)(i) of this section that requires the exchanging shareholder to

[[Page 465]]

be an expatriated entity or an expatriated foreign subsidiary to 
exchanges completed on or after September 22, 2014, and before April 4, 
2016. Paragraphs (f) and (g)(5) of this section apply to transfers 
completed on or after April 4, 2016, but only if the inversion 
transaction was completed or after September 22, 2014. See Sec. 
1.367(b)-4, as contained in 26 CFR part 1 revised as of April 1, 2016, 
for exchanges completed before September 22, 2014.

[T.D. 8862, 65 FR 3603, Jan. 24, 2000; 65 FR 66501, Nov. 6, 2000]

    Editorial Note: For Federal Register citations affecting Sec. 
1.367(b)-4, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.govinfo.gov.



Sec. 1.367(b)-5  Distributions of stock described in section 355.

    (a) In general--(1) Scope. This section provides rules relating to a 
distribution described in section 355 (or so much of section 356 as 
relates to section 355) and to which section 367(b) applies. For 
purposes of this section, the terms distributing corporation, controlled 
corporation, and distributee have the same meaning as used in section 
355 and the regulations thereunder.
    (2) Treatment of distributees as exchanging shareholders. For 
purposes of the section 367(b) regulations, all distributees in a 
transaction described in paragraph (b), (c), or (d) of this section 
shall be treated as exchanging shareholders that realize income in a 
section 367(b) exchange.
    (b) Distribution by a domestic corporation--(1) General rule. In a 
distribution described in section 355, if the distributing corporation 
is a domestic corporation and the controlled corporation is a foreign 
corporation, the following general rules shall apply--
    (i) If the distributee is a corporation, then the controlled 
corporation shall be considered to be a corporation; and
    (ii) If the distributee is an individual, then, solely for purposes 
of determining the gain recognized by the distributing corporation, the 
controlled corporation shall not be considered to be a corporation, and 
the distributing corporation shall recognize any gain (but not loss) 
realized on the distribution.
    (2) Section 367(e) transactions. The rules of paragraph (b)(1) of 
this section shall not apply to a foreign distributee to the extent gain 
is recognized under section 367(e)(1) and the regulations thereunder.
    (3) Determining whether distributees are individuals. All 
distributees in a distribution described in paragraph (b)(1) of this 
section are presumed to be individuals. However, the shareholder 
identification principles of Sec. 1.367(e)-1(d) (including the 
reporting procedures in Sec. 1.367(e)-1(d)(2) and (3)) shall apply for 
purposes of rebutting this presumption.
    (4) Applicable cross-references. For rules with respect to a 
distributee that is a partnership, trust or estate, see Sec. 1.367(b)-
2(k). For additional rules relating to a distribution of stock of a 
foreign corporation by a domestic corporation, see section 1248(f) and 
the regulations thereunder. For additional rules relating to a 
distribution described in section 355 by a domestic corporation to a 
foreign distributee, see section 367(e)(1) and the regulations 
thereunder.
    (c) Pro rata distribution by a controlled foreign corporation--(1) 
Scope. This paragraph (c) applies to a distribution described in section 
355 in which the distributing corporation is a controlled foreign 
corporation and in which the stock of the controlled corporation is 
distributed pro rata to each of the distributing corporation's 
shareholders.
    (2) Adjustment to basis in stock and income inclusion. If the 
distributee's postdistribution amount (as defined in paragraph (e)(2) of 
this section) with respect to the distributing or controlled corporation 
is less than the distributee's predistribution amount (as defined in 
paragraph (e)(1) of this section) with respect to such corporation, then 
the distributee's basis in such stock immediately after the distribution 
(determined under the normal principles of section 358) shall be reduced 
by the amount of the difference. However, the distributee's basis in 
such stock shall not be reduced below zero, and to the extent the 
foregoing reduction would have reduced basis below zero, the distributee 
shall instead include such amount in income as a deemed dividend from 
such corporation.

[[Page 466]]

    (3) Interaction with Sec. 1.367(b)-2(e)(3)(ii). The basis increase 
provided in Sec. 1.367(b)-2(e)(3)(ii) shall not apply to a deemed 
dividend that is included in income pursuant to paragraph (c)(2) of this 
section.
    (4) Basis redistribution. If a distributee reduces the basis in the 
stock of the distributing or controlled corporation (or has an inclusion 
with respect to such stock) under paragraph (c)(2) of this section, the 
distributee shall increase its basis in the stock of the other 
corporation by the amount of the basis decrease (or deemed dividend 
inclusion) required by paragraph (c)(2) of this section. However, the 
distributee's basis in such stock shall not be increased above the fair 
market value of such stock and shall not be increased to the extent the 
increase diminishes the distributee's postdistribution amount with 
respect to such corporation.
    (d) Non-pro rata distribution by a controlled foreign corporation--
(1) Scope. This paragraph (d) applies to a distribution described in 
section 355 in which the distributing corporation is a controlled 
foreign corporation and in which the stock of the controlled corporation 
is not distributed pro rata to each of the distributing corporation's 
shareholders.
    (2) Treatment of certain shareholders as distributees. For purposes 
of the section 367(b) regulations, all persons owning stock of the 
distributing corporation immediately after a transaction described in 
paragraph (d)(1) of this section shall be treated as distributees of 
such stock. For other applicable rules, see paragraph (a)(2) of this 
section.
    (3) Inclusion of excess section 1248 amount by exchanging 
shareholder. If the distributee's postdistribution amount (as defined in 
paragraph (e)(2) of this section) with respect to the distributing or 
controlled corporation is less than the distributee's predistribution 
amount (as defined in paragraph (e)(1) of this section) with respect to 
such corporation, then the distributee shall include in income as a 
deemed dividend the amount of the difference. For purposes of this 
paragraph (d)(3), if a distributee owns no stock in the distributing or 
controlled corporation immediately after the distribution, the 
distributee's postdistribution amount with respect to such corporation 
shall be zero.
    (4) Interaction with Sec. 1.367(b)--2(e)(3)(ii)--(i) Limited 
application. The basis increase provided in Sec. 1.367(b)--2(e)(3)(ii) 
shall apply to a deemed dividend that is included in income pursuant to 
paragraph (d)(3) of this section only to the extent that such basis 
increase does not increase the distributee's basis above the fair market 
value of such stock and does not diminish the distributee's 
postdistribution amount with respect to such corporation.
    (ii) Interaction with predistribution amount. For purposes of this 
paragraph (d), the distributee's predistribution amount (as defined in 
paragraph (e)(1) of this section) shall be determined without regard to 
any basis increase permitted under paragraph (d)(4)(i) of this section.
    (e) Definitions--(1) Predistribution amount. For purposes of this 
section, the predistribution amount with respect to a distributing or 
controlled corporation is the distributee's section 1248 amount (as 
defined in Sec. 1.367(b)--2(c)(1)) computed immediately before the 
distribution (and after any section 368(a)(1)(D) transfer connected with 
the section 355 distribution), but only to the extent that such amount 
is attributable to the distributing corporation and any corporations 
controlled by it immediately before the distribution (the distributing 
group) or the controlled corporation and any corporations controlled by 
it immediately before the distribution (the controlled group), as the 
case may be, under the principles of Sec. Sec. 1.1248-1(d)(3), 1.1248-2 
and 1.1248-3. However, the predistribution amount with regard to the 
distributing group shall be computed without taking into account the 
distributee's predistribution amount with respect to the controlled 
group.
    (2) Postdistribution amount. For purposes of this section, the 
postdistribution amount with respect to a distributing or controlled 
corporation is the distributee's section 1248 amount (as defined in 
Sec. 1.367(b)-2(c)(1)) with respect to such stock, computed immediately 
after the distribution (but without regard to paragraph (c) or (d)

[[Page 467]]

of this section (whichever is applicable)). The postdistribution amount 
under this paragraph (e)(2) shall be computed before taking into account 
the effect (if any) of any inclusion under section 356(a) or (b).
    (f) Exclusion of deemed dividend from foreign personal holding 
company income. In the event an amount is included in income as a deemed 
dividend by a foreign corporation under paragraph (c) or (d) of this 
section (including amounts received as an intermediate owner under the 
rule of Sec. 1.367(b)-2(e)(2)), such deemed dividend shall not be 
included as foreign personal holding company income under section 
954(c).
    (g) Examples. The following examples illustrate the rules of this 
section:

    Example 1. (i) Facts. USS, a domestic corporation, owns 40 percent 
of the outstanding stock of FD, a controlled foreign corporation (CFC). 
USS has owned the stock since FD was incorporated, and FD has always 
been a CFC. USS has a basis of $80 in its FD stock, which has a fair 
market value of $200. FD owns 100 percent of the outstanding stock of 
FC, a foreign corporation. FD has owned the stock since FC was 
incorporated. Neither FD nor FC own stock in any other corporation. FD 
has earnings and profits of $0 and a fair market value of $250 (not 
considering its ownership of FC). FC has earnings and profits of $300, 
none of which is described in section 1248(d), and a fair market value 
of $250. In a pro rata distribution described in section 355, FD 
distributes to USS stock in FC worth $100; thereafter, USS's FD stock is 
worth $100 as well.
    (ii) Result--(A) FD's distribution is a transaction described in 
paragraph (c)(1) of this section. Under paragraph (c)(2) of this 
section, USS must compare its predistribution amounts with respect to FD 
and FC to its respective postdistribution amounts. Under paragraph 
(e)(1) of this section, USS's predistribution amount with respect to FD 
or FC is its section 1248 amount computed immediately before the 
distribution, but only to the extent such amount is attributable to FD 
or FC. Under Sec. 1.367(b)-2(c)(1), USS's section 1248 amount computed 
immediately before the distribution is $120, all of which is 
attributable to FC. Thus, USS's predistribution amount with respect to 
FD is $0, and its predistribution amount with respect to FC is $120. 
These amounts are computed as follows: If USS had sold its FD stock 
immediately before the transaction, it would have recognized $120 of 
gain ($200 fair market value $80 basis). All of the gain would have been 
treated as a dividend under section 1248, and all of the section 1248 
amount would have been attributable to FC (based on USS's pro rata share 
of FC's earnings and profits (40 percent x $300)).
    (B) Under paragraph (e)(2) of this section, USS's postdistribution 
amount with respect to FD or FC is its section 1248 amount with respect 
to such corporation, computed immediately after the distribution (but 
without regard to paragraph (c) of this section). Under Sec. 1.367(b)-
2(c)(1), USS's section 1248 amounts computed immediately after the 
distribution with respect to FD and FC are $0 and $60, respectively. 
These amounts, which are USS's postdistribution amounts, are computed as 
follows: Under the normal principles of section 358, USS allocates its 
$80 predistribution basis in FD between FD and FC according to the stock 
blocks' relative values, yielding a $40 basis in each block. If USS sold 
its FD stock immediately after the distribution, none of the resulting 
gain would be treated as a dividend under section 1248. If USS sold its 
FC stock immediately after the distribution, it would have a $60 gain 
($100 fair market value--$40 basis), all of which would be treated as a 
dividend under section 1248.
    (C) The basis adjustment and income inclusion rules of paragraph 
(c)(2) of this section apply to the extent of any difference between 
USS's postdistribution and predistribution amounts. In the case of FD, 
there is no difference between the two amounts and, as a result, no 
adjustment or income inclusion is required. In the case of FC, USS's 
postdistribution amount is $60 less than its predistribution amount. 
Accordingly, under paragraph (c)(2) of this section, USS is required to 
reduce its basis in its FC stock from $40 to $0 and include $20 in 
income as a deemed dividend. Under Sec. 1.367(b)-2(e)(2), the $20 
deemed dividend is considered as having been paid by FC to FD, and by FD 
to USS, immediately prior to the distribution. Under paragraph (f) of 
this section, the deemed dividend is not included by FD as foreign 
personal holding company income under section 954(c). Under paragraph 
(c)(3) of this section, the basis increase provided in Sec. 1.367(b)-
2(e)(3)(ii) does not apply with regard to the $20 deemed dividend. Under 
the rules of paragraph (c)(4) of this section, USS increases its basis 
in FD by the amount by which it decreased its basis in FC, as well as by 
the amount of its deemed dividend inclusion ($40 + $40 + $20 = $100).
    Example 2. (i) Facts. USS1 and USS2, domestic corporations, each own 
50 percent of the outstanding stock of FD, a controlled foreign 
corporation (CFC). USS1 and USS2 have owned their FD stock since it was 
incorporated, and FD has always been a CFC. USS1 and USS2 each have a 
basis of $500 in their FD stock, and the fair market value of each block 
of FD stock is $750. FD owns 100 percent of the outstanding stock of FC, 
a foreign corporation. FD owned the stock since FC was incorporated. 
Neither FD nor FC own

[[Page 468]]

stock in any other corporation. FD has earnings and profits of $0 and a 
fair market value of $750 (not considering its ownership of FC). FC has 
earnings and profits of $500, none of which is described in section 
1248(d), and a fair market value of $750. In a non-pro rata distribution 
described in section 355, FD distributes all of the stock of FC to USS2 
in exchange for USS2's FD stock.
    (ii) Result--(A) FD's distribution is a transaction described in 
paragraph (d)(1) of this section. Under paragraph (d)(2) of this 
section, USS1 is considered a distributee of FD stock. Under paragraph 
(d)(3) of this section, USS1 and USS2 must compare their predistribution 
amounts with respect to FD and FC stock to their respective 
postdistribution amounts. Under paragraph (e)(1) of this section, USS1's 
predistribution amount with respect to FD or FC is USS1's section 1248 
amount computed immediately before the distribution, but only to the 
extent such amount is attributable to FD or FC. USS2's predistribution 
amount is determined in the same manner. Under Sec. 1.367(b)-2(c)(1), 
USS1 and USS2 each have a section 1248 amount computed immediately 
before the distribution of $250, all of which is attributable to FC. 
Thus, USS1 and USS2 each have a predistribution amount with respect to 
FD of $0, and each have a predistribution amount with respect to FC of 
$250. These amounts are computed as follows: If either USS1 or USS2 had 
sold its FD stock immediately before the transaction, it would have 
recognized $250 of gain ($750 fair market value--$500 basis). All of the 
gain would have been treated as a dividend under section 1248, and all 
of the section 1248 amount would have been attributable to FC (based on 
USS1's and USS2's pro rata shares of FC's earnings and profits (50 
percent x $500)).
    (B) Under paragraph (d)(3) of this section, a distributee that owns 
no stock in the distributing or controlled corporation immediately after 
the distribution has a postdistribution amount with regard to that stock 
of zero. Accordingly, USS2 has a postdistribution amount of $0 with 
respect to FD and USS1 has a postdistribution amount of $0 with respect 
to FC. Under paragraph (e)(2) of this section, USS1's postdistribution 
amount with respect to FD is its section 1248 amount with respect to 
such corporation, computed immediately after the distribution (but 
without regard to paragraph (d) of this section). USS2's 
postdistribution amount with respect to FC is determined in the same 
manner. Under Sec. 1.367(b)-2(c)(1), USS1's section 1248 amount 
computed immediately after the distribution with respect to FD is $0 and 
USS2's section 1248 amount computed immediately after the distribution 
with respect to FC is $250. These amounts, which are USS1's and USS2's 
postdistribution amounts, are computed as follows: After the non-pro 
rata distribution, USS1 owns all the stock of FD and USS2 owns all the 
stock of FC. If USS1 sold its FD stock immediately after the 
distribution, none of the resulting $250 gain ($750 fair market value 
$500 basis) would be treated as a dividend under section 1248. If USS2 
sold its FC stock immediately after the distribution, it would have a 
$250 gain ($750 fair market value--$500 basis), all of which would be 
treated as a dividend under section 1248.
    (C) The income inclusion rule of paragraph (d)(3) of this section 
applies to the extent of any difference between USS1's and USS2's 
postdistribution and predistribution amounts. In the case of USS2, there 
is no difference between the two amounts with respect to either FD or FC 
and, as a result, no income inclusion is required. In the case of USS1, 
there is no difference between the two amounts with respect to its FD 
stock. However, USS1's postdistribution amount with respect to FC is 
$250 less than its predistribution amount. Accordingly, under paragraph 
(d)(3) of this section, USS1 is required to include $250 in income as a 
deemed dividend. Under Sec. 1.367(b)-2(e)(2), the $250 deemed dividend 
is considered as having been paid by FC to FD, and by FD to USS1, 
immediately prior to the distribution. This deemed dividend increases 
USS1's basis in FD ($500 + $250 = $750). Under paragraph (f) of this 
section, the deemed dividend is not included by FD as foreign personal 
holding company income under section 954(c).

[T.D. 8862, 65 FR 3606, Jan. 24, 2000; 65 FR 66502, Nov. 6, 2000]



Sec. 1.367(b)-6  Effective/applicability dates and coordination rules.

    (a) Effective/applicability dates--(1) In general. (i) Except as 
otherwise provided in this paragraph (a)(1) and paragraph (a)(2) of this 
section, Sec. Sec. 1.367(b)-1 through 1.367(b)-5, and this section, 
apply to section 367(b) exchanges that occur on or after February 23, 
2000.
    (ii) The rules of Sec. Sec. 1.367(b)-3 and 1.367(b)-4, as they 
apply to reorganizations described in section 368(a)(1)(A) (including 
reorganizations described in section 368(a)(2)(D) or (a)(2)(E)) 
involving a foreign acquiring or foreign acquired corporation, apply 
only to transfers occurring on or after January 23, 2006.
    (iii) Section 1.367(b)-1(c)(2)(v), (c)(3)(ii)(A), (c)(4)(iv), 
(c)(4)(v), Sec. 1.367(b)-2(j)(1)(i) and (l), and Sec. 1.367(b)-3(e) 
and (f), apply to section 367(b) exchanges that occur on or after 
November 6, 2006. For guidance with respect to Sec. 1.367(b)-
1(c)(3)(ii)(A), (c)(4)(iv), and

[[Page 469]]

(c)(4)(v) and Sec. 1.367(b)-2(j)(1)(i) for exchanges that occur before 
November 6, 2006, see 26 CFR part 1 revised as of April 1, 2006.
    (iv) Section 1.367(b)-4(b)(1)(i)(B)(2), Sec. 1.367(b)-4(b)(1)(ii), 
Sec. 1.367(b)-4(b)(1)(iii), Example 4 and Example 5 apply to section 
367(b) exchanges that occur on or after April 18, 2013. For guidance 
with respect to Sec. 1.367(b)-4(b)(1)(i)(B)(2), Sec. 1.367(b)-
4(b)(1)(ii) and Sec. 1.367(b)-4(b)(1)(iii), Example 4, for exchanges 
that occur before April 18, 2013, see 26 CFR part 1 revised as of April 
1, 2012.
    (2) Exception. A taxpayer may, however, elect to have Sec. Sec. 
1.367(b)-1 through 1.367(b)-5, and this section, apply to section 367(b) 
exchanges that occur (or occurred) before February 23, 2000, if the due 
date for the taxpayer's timely filed Federal tax return (including 
extensions) for the taxable year in which the section 367(b) exchange 
occurs (or occurred) is after February 23, 2000. The election under this 
paragraph (a)(2) will be valid only if--
    (i) The electing taxpayer makes the election on a timely filed 
section 367(b) notice;
    (ii) In the case of an exchanging shareholder that is a foreign 
corporation, the election is made on the section 367(b) notice that is 
filed by each of its shareholders listed in Sec. 1.367(b)-1(c)(3)(ii); 
and
    (iii) The electing taxpayer provides notice of the election to all 
corporations (or their successors in interest) whose earnings and 
profits are affected by the election on or before the date the section 
367(b) notice is filed.
    (b) Certain recapitalizations described in Sec. 1.367(b)-4(b)(3). 
In the case of a recapitalization described in Sec. 1.367(b)-4(b)(3) 
that occurred prior to July 20, 1998, the exchanging shareholder shall 
include the section 1248 amount on its tax return for the taxable year 
that includes the exchange described in Sec. 1.367(b)-4(b)(3)(i) (and 
not in the taxable year of the recapitalization), except that no 
inclusion is required if both the recapitalization and the exchange 
described in Sec. 1.367(b)-4(b)(3)(i) occurred prior to July 20, 1998.
    (c) Use of reasonable method to comply with prior published 
guidance--(1) Prior exchanges. The taxpayer may use a reasonable method 
to comply with the following prior published guidance to the extent such 
guidance relates to section 367(b): Notice 88-71 (1988-2 C.B. 374); 
Notice 89-30 (1989-1 C.B. 670); and Notice 89-79 (1989-2 C.B. 392) (see 
Sec. 601.601(d)(2) of this chapter). This rule applies to section 
367(b) exchanges that occur (or occurred) before February 23, 2000, or, 
if a taxpayer makes the election described in paragraph (a)(2) of this 
section, for section 367(b) exchanges that occur (or occurred) before 
the date described in paragraph (a)(2) of this section. This rule also 
applies to section 367(b) exchanges and distributions described in 
paragraph (d) of this section.
    (2) Future exchanges. Section 367(b) exchanges that occur on or 
after February 23, 2000, (or, if a taxpayer makes the election described 
in paragraph (a)(2) of this section, for section 367(b) exchanges that 
occur on or after the date described in paragraph (a)(2) of this 
section) are governed by the section 367(b) regulations and, as a 
result, paragraph (c)(1) of this section shall not apply.
    (d) Effect of removal of attribution rules. To the extent that the 
rules under Sec. Sec. 7.367(b)-9 and 7.367(b)-10(h) of this chapter, as 
in effect prior to February 23, 2000 (see 26 CFR part 1, revised as of 
April 1, 1999), attributed earnings and profits to the stock of a 
foreign corporation in connection with an exchange described in section 
351, 354, 355, or 356 before February 23, 2000, the foreign corporation 
shall continue to be subject to the rules of Sec. 7.367(b)-12 of this 
chapter in the event of any subsequent exchanges and distributions with 
respect to such stock, notwithstanding the fact that such subsequent 
exchange or distribution occurs on or after the effective date described 
in paragraph (a) of this section.

[T.D. 8862, 65 FR 3608, Jan. 24, 2000, as amended by T.D. 9243, 71 FR 
4289, Jan. 26, 2006; T.D. 9250, 71 FR 8805, Feb. 21, 2006; T.D. 9243, 71 
FR 28266, May 16, 2006; T.D. 9273, 71 FR 44895, Aug. 8, 2006; 73 FR 
14386, Mar. 18, 2008; T.D. 9614, 78 FR 17041, Mar. 19, 2013; T.D. 9834, 
83 FR 32536, July 12, 2018]



Sec. 1.367(b)-7  Carryover of earnings and profits and foreign income 
taxes in certain foreign-to-foreign nonrecognition transactions.

    (a) Scope. This section applies to an acquisition by a foreign 
corporation

[[Page 470]]

(foreign acquiring corporation) of the assets of another foreign 
corporation (foreign target corporation) in a transaction described in 
section 381 (foreign section 381 transaction). This section describes 
the manner and extent to which earnings and profits and foreign income 
taxes of the foreign acquiring corporation and the foreign target 
corporation carry over to the surviving foreign corporation (foreign 
surviving corporation) and the ordering of distributions by the foreign 
surviving corporation. See Sec. 1.367(b)-9 for special rules governing 
reorganizations described in section 368(a)(1)(F) and foreign section 
381 transactions involving foreign corporations that hold no property 
and have no tax attributes immediately before the transaction, other 
than a nominal amount of assets (and related tax attributes).
    (b) General rules--(1) Non-previously taxed earnings and profits and 
related taxes. Earnings and profits and related foreign income taxes of 
the foreign acquiring corporation and the foreign target corporation 
(pre-transaction earnings and pre-transaction taxes, respectively) shall 
carry over to the foreign surviving corporation in the manner described 
in paragraphs (d), (e), and (f) of this section. Dividend distributions 
by the foreign surviving corporation (post-transaction distributions) 
shall be out of earnings and profits and shall reduce related foreign 
income taxes in the manner described in paragraph (c) of this section.
    (2) Previously taxed earnings and profits. [Reserved]
    (c) Ordering rule for post-transaction distributions. Dividend 
distributions out of a foreign surviving corporation's earnings and 
profits shall be ordered in accordance with the rules of paragraph 
(c)(1) or (2) of this section, depending on whether the foreign 
surviving corporation is a pooling corporation or a nonpooling 
corporation.
    (1) If foreign surviving corporation is a pooling corporation. In 
the case of a foreign surviving corporation that is a pooling 
corporation, post-transaction distributions shall be first out of the 
post-1986 pool (as described in paragraph (d) of this section) and 
second out of the pre-pooling annual layers (as described in paragraph 
(e)(1) of this section) under an annual last-in, first-out (LIFO) 
method.
    (2) If foreign surviving corporation is a nonpooling corporation. In 
the case of a foreign surviving corporation that is a nonpooling 
corporation, post-transaction distributions shall be out of the pre-
pooling annual layers (as described in paragraph (e)(2) of this section) 
under the LIFO method.
    (d) Post-1986 pool. If the foreign surviving corporation is a 
pooling corporation, then the post-1986 pool shall be determined under 
the rules of this paragraph (d).
    (1) In general--(i) Qualifying earnings and taxes. The post-1986 
pool shall consist of the post-1986 undistributed earnings and related 
post-1986 foreign income taxes of the foreign acquiring corporation and 
the foreign target corporation.
    (ii) Carryover rule. Subject to paragraph (d)(2) of this section, 
the amounts described in paragraph (d)(1)(i) of this section 
attributable to the foreign acquiring corporation and the foreign target 
corporation shall carry over to the foreign surviving corporation and 
shall be combined on a separate category-by-separate category basis.
    (2) Hovering deficit--(i) In general. If immediately prior to the 
foreign section 381 transaction either the foreign acquiring corporation 
or the foreign target corporation has a deficit in one or more separate 
categories of post-1986 undistributed earnings or an aggregate deficit 
in pre-1987 accumulated profits, such deficit will be a hovering deficit 
of the foreign surviving corporation. The rules of this paragraph (d)(2) 
apply to hovering deficits in separate categories of post-1986 
undistributed earnings. See paragraphs (e)(1)(iii) and (e)(2)(iii) of 
this section for rules that apply to hovering deficits in pre-1987 
accumulated profits. If the foreign acquiring corporation and the 
foreign target corporation each have a post-1986 hovering deficit in the 
same separate category of post-1986 undistributed earnings, such 
deficits and their related post-1986 foreign income taxes shall be 
combined for purposes of applying this paragraph (d)(2). See also 
paragraphs (f)(1) and (4) of this section (describing other rules 
applicable to a

[[Page 471]]

deficit described in this paragraph (d)(2)).
    (ii) Offset rule. A hovering deficit in a separate category of post-
1986 undistributed earnings shall offset only earnings and profits 
accumulated by the foreign surviving corporation after the foreign 
section 381 transaction (post-transaction earnings) in the same separate 
category of post-1986 undistributed earnings. For purposes of this rule, 
however, post-transaction earnings do not include post-1986 
undistributed earnings in the same category that are earned after the 
foreign section 381 transaction, but are distributed or deemed 
distributed in the same year they are earned (that is, that do not 
become accumulated). The offset shall occur as of the first day of the 
foreign surviving corporation's first taxable year following the year in 
which the post-transaction earnings accumulated.
    (iii) Related taxes. Post-1986 foreign income taxes that are related 
to a hovering deficit in a separate category of post-1986 undistributed 
earnings shall only be added to the foreign surviving corporation's 
post-1986 foreign income taxes in that separate category on a pro rata 
basis as the hovering deficit is absorbed. Pro rata means in the same 
proportion as the portion of the hovering deficit that offsets post-
transaction earnings in the separate category under paragraph (d)(2)(ii) 
of this section bears to the total amount of the hovering deficit.
    (3) Examples. The following examples illustrate the rules of this 
paragraph (d). The examples assume the following facts: Foreign 
corporations A and B are controlled foreign corporations (CFCs) that 
were incorporated after December 31, 1986, have always been pooling 
corporations, and have always had calendar taxable years. None of the 
shareholders of foreign corporations A and B are required to include any 
amount in income under Sec. 1.367(b)-4 as a result of the foreign 
section 381 transaction. Foreign corporations A and B (and all of their 
respective qualified business units as defined in section 989) maintain 
a ``u'' functional currency. Finally, unless otherwise stated, any post-
1986 undistributed earnings in the passive category resulted from a 
look-through dividend that was paid by a lower-tier CFC out of earnings 
accumulated when the CFC was a noncontrolled section 902 corporation and 
that qualified for the subpart F same-country exception under section 
954(c)(3)(A). The examples are as follows:

    Example 1. (i) Facts. (A) On December 31, 2006, foreign corporations 
A and B have the following post-1986 undistributed earnings and post-
1986 foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                  Separate category                      E&P      taxes
------------------------------------------------------------------------
                          Foreign Corporation A
------------------------------------------------------------------------
General.............................................      300u       $60
Passive.............................................      100u        40
                                                     -------------------
                                                          400u      $100
------------------------------------------------------------------------
                          Foreign Corporation B
------------------------------------------------------------------------
General.............................................      300u       $70
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation B acquires the assets of 
foreign corporation A in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a CFC.
    (ii) Result. Under the rules described in paragraph (d)(1) of this 
section, foreign surviving corporation has the following post-1986 
undistributed earnings and post-1986 foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                  Separate category                      E&P      taxes
------------------------------------------------------------------------
General.............................................      600u      $130
Passive.............................................      100u        40
                                                     -------------------
                                                          700u      $170
------------------------------------------------------------------------

    (iii) Post-transaction distribution. (A) During 2007, foreign 
surviving corporation does not accumulate any earnings and profits or 
pay or accrue any foreign income taxes. On December 31, 2007, foreign 
surviving corporation distributes 350u to its shareholders. Under the 
rules described in Sec. 1.902-1(d)(1) and paragraph (c)(1) of this 
section, the distribution is out of, and reduces, post-1986 
undistributed earnings and post-1986 foreign income taxes in the 
separate categories on a pro rata basis, as follows:

------------------------------------------------------------------------
                                                                 Foreign
                  Separate category                      E&P      taxes
------------------------------------------------------------------------
General.............................................      300u       $65
Passive.............................................       50u        20
                                                     -------------------
                                                          350u       $85
------------------------------------------------------------------------

    (B) The foreign income taxes deemed paid by qualifying shareholders 
of foreign surviving corporation upon the distribution are

[[Page 472]]

subject to generally applicable rules and limitations, such as those of 
sections 78, 902, and 904(d).
    (C) Immediately after the distribution, foreign surviving 
corporation has the following post-1986 undistributed earnings and post-
1986 foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                  Separate category                      E&P      taxes
------------------------------------------------------------------------
General.............................................      300u       $65
Passive.............................................       50u        20
                                                     -------------------
                                                          350u       $85
------------------------------------------------------------------------

    Example 2. (i) Facts. (A) On December 31, 2006, foreign corporations 
A and B have the following post-1986 undistributed earnings and post-
1986 foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                  Separate category                      E&P      taxes
------------------------------------------------------------------------
                          Foreign Corporation A
------------------------------------------------------------------------
General.............................................      200u       $30
Passive.............................................    (100u)        10
                                                     -------------------
                                                          100u       $40
------------------------------------------------------------------------
                          Foreign Corporation B
------------------------------------------------------------------------
General.............................................      300u       $60
Passive.............................................      100u        30
                                                     -------------------
                                                          400u       $90
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation B acquires the assets of 
foreign corporation A in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a CFC.
    (ii) Result. Under the rules described in paragraphs (d)(1) and (2) 
of this section, foreign surviving corporation has the following post-
1986 undistributed earnings and post-1986 foreign income taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                      Separate category                         Positive     Hovering     Foreign     associated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................         500u  ...........         $ 90  ...........
Passive.....................................................         100u       (100u)           30          $10
                                                             ---------------------------------------------------
                                                                     600u       (100u)         $120          $10
----------------------------------------------------------------------------------------------------------------

    (iii) Post-transaction distribution. (A) During 2007, foreign 
surviving corporation does not accumulate any earnings and profits or 
pay or accrue any foreign income taxes. On December 31, 2007, foreign 
surviving corporation distributes 300u to its shareholders. Under the 
rules described in Sec. 1.902-1(d)(1) and paragraph (c)(1) of this 
section, the distribution is out of, and reduces, post-1986 
undistributed earnings and post-1986 foreign income taxes on a pro rata 
basis as follows:

------------------------------------------------------------------------
                                                                 Foreign
                  Separate category                      E&P      taxes
------------------------------------------------------------------------
General.............................................      250u       $45
Passive.............................................       50u        15
                                                     -------------------
                                                          300u       $60
------------------------------------------------------------------------

    (B) The foreign income taxes deemed paid by qualifying shareholders 
of foreign surviving corporation upon the distribution are subject to 
generally applicable rules and limitations, such as those of sections 
78, 902, and 904(d).
    (C) Immediately after the distribution, foreign surviving 
corporation has the following post-1986 undistributed earnings and post-
1986 foreign income taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                      Separate category                         Positive     Hovering     Foreign     associated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................         250u  ...........          $45  ...........
Passive.....................................................          50u       (100u)           15          $10
                                                             ---------------------------------------------------
                                                                     300u       (100u)          $60          $10
----------------------------------------------------------------------------------------------------------------


[[Page 473]]

    (iv) Post-transaction earnings--(A) In its taxable year ending on 
December 31, 2008, foreign surviving corporation accumulates earnings 
and profits and pays related foreign income taxes as follows:

------------------------------------------------------------------------
                                                                 Foreign
                  Separate category                      E&P      taxes
------------------------------------------------------------------------
General.............................................      100u       $20
Passive.............................................       50u       $10
                                                     -------------------
                                                          150u       $40
------------------------------------------------------------------------

    (B) None of foreign surviving corporation's earnings and profits for 
its 2008 taxable year qualifies as subpart F income as defined in 
section 952(a). Under the rules described in paragraphs (d)(2)(ii) and 
(iii) of this section, the hovering deficit in the passive category will 
offset the post-transaction earnings in that category and a 
proportionate amount of the foreign taxes related to the hovering 
deficit will be added to the post-1986 foreign income taxes pool. 
Because the post-transaction earnings in the passive category are half 
of the amount of the hovering deficit, half of the related taxes are 
added to the post-1986 foreign income taxes pool. Accordingly, foreign 
surviving corporation has the following post-1986 undistributed earnings 
and post-1986 foreign income taxes on January 1, 2009:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                      Separate category                         Positive     Hovering     Foreign     associated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................         350u  ...........          $65  ...........
Passive.....................................................          50u        (50u)           30           $5
                                                             ---------------------------------------------------
                                                                     400u        (50u)          $95           $5
----------------------------------------------------------------------------------------------------------------

    Example 3. (i) Facts. The facts are the same as Example 2, except 
that the 50u of earnings in the passive category accrued by foreign 
surviving corporation during 2008 is subpart F income, all of which is 
included in income under section 951(a) by United States shareholders 
(as defined in section 951(b)). This example assumes that none of the 
United States shareholders are able to reduce their subpart F income 
inclusion with a qualified deficit under section 952(c)(1)(B).
    (ii) Result. (A) Under the rule described in paragraph (f)(1) of 
this section, the (100u) hovering deficit in the passive category does 
not reduce foreign surviving corporation's current passive earnings and 
profits for purposes of determining subpart F income or associated 
deemed paid credits. Thus, foreign surviving corporation's United States 
shareholders include their pro rata shares of 50u in taxable income for 
the year and are eligible for a deemed paid foreign tax credit under 
section 960, computed by reference to their pro rata shares of $12.50 
(50u subpart F inclusion / (50u + 50u post-1986 undistributed earnings 
in the passive category = 100u) = 50%, x $25 post-1986 foreign income 
taxes in the passive category = $12.50). The United States shareholders 
will also include their pro rata shares of the deemed-paid taxes of 
$12.50 in taxable income for the year as a deemed dividend pursuant to 
section 78.
    (B) Immediately after the subpart F inclusion and section 960 deemed 
paid taxes (and taking into account the taxable year 2008 earnings and 
profits and related taxes in the general category), foreign surviving 
corporation has the following post-1986 undistributed earnings and post-
1986 foreign income taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits                    Foreign
                                                             --------------------------                 taxes
                                                                                                    ------------
                                                                                          Foreign      Foreign
                      Separate category                                                    taxes        taxes
                                                                Positive     Hovering    available    associated
                                                                  E&P        deficit                     with
                                                                                                       hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................         350u  ...........       $65.00  ...........
Passive.....................................................          50u       (100u)        12.50          $10
                                                             ---------------------------------------------------
                                                                     400u       (100u)        77.50           10
----------------------------------------------------------------------------------------------------------------

    (C) The 50u included as subpart F income constitutes previously 
taxed earnings and profits under section 959.
    Example 4. (i) Facts. (A) On December 31, 2006, foreign corporations 
A and B have the

[[Page 474]]

following post-1986 undistributed earnings and post-1986 foreign income 
taxes:

------------------------------------------------------------------------
                                                                 Foreign
                  Separate category                      E&P      taxes
------------------------------------------------------------------------
                          Foreign Corporation A
------------------------------------------------------------------------
General.............................................       50u       $10
------------------------------------------------------------------------
                          Foreign Corporation B
------------------------------------------------------------------------
General.............................................    (100u)       $20
------------------------------------------------------------------------
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation B acquires the assets of 
foreign corporation A in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a CFC.
    (ii) Result. (A) Under the rules described in paragraphs (d)(1) and 
(2) of this section, foreign surviving corporation has the following 
post-1986 undistributed earnings and post-1986 foreign income taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits                    Foreign
                                                             --------------------------                 taxes
                                                                                                    ------------
                                                                                          Foreign      Foreign
                      Separate category                                                    taxes        taxes
                                                                Positive     Hovering    available    associated
                                                                  E&P        deficit                     with
                                                                                                       hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................          50u       (100u)          $10          $20
----------------------------------------------------------------------------------------------------------------

    (iii) Post-transaction earnings and distribution. (A) In its taxable 
year ending on December 31, 2007, foreign surviving corporation earns 
100u in the general category and pays related foreign income taxes of 
$24. On December 31, 2007, foreign surviving corporation distributes 75u 
to its shareholders.
    (B) Result. For purposes of determining the dividend amount under 
section 316 and the foreign income taxes deemed paid with respect to 
that dividend under section 902, under paragraph (d)(2)(ii) of this 
section the hovering deficit does not offset the post-transaction 
current year earnings. Accordingly, the full 75u will be a dividend 
under section 316. The deemed paid taxes on that dividend are $17 (75u 
distribution / (100u current earnings + 50u accumulated earnings) = 50%, 
x ($10 accumulated foreign taxes + $24 current year foreign taxes) = 
$17). The 25u of undistributed earnings and profits in 2007 will be 
offset by (25u) of the hovering deficit for purposes of determining the 
opening balance of the post-1986 undistributed earnings pool in 2008. 
Because the amount of earnings offset by the hovering deficit is 25% of 
the amount of the hovering deficit, under paragraph (d)(2)(iii) of this 
section $5 (25% of $20) of the related taxes are added to the post-1986 
foreign income taxes pool at the beginning of the next taxable year. 
Accordingly, foreign surviving corporation has the following post-1986 
undistributed earnings and post-1986 foreign income taxes on January 1, 
2008:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                      Separate category                         Positive     Hovering     Foreign     associated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................          50u        (75u)          $22          $15
----------------------------------------------------------------------------------------------------------------

    (e) Pre-pooling annual layers--(1) If foreign surviving corporation 
is a pooling corporation. If the foreign surviving corporation is a 
pooling corporation, the pre-pooling annual layers shall be determined 
under the rules of this paragraph (e)(1).
    (i) Qualifying earnings and taxes. The pre-pooling annual layers 
shall consist of the pre-1987 accumulated profits and the pre-1987 
foreign income taxes of the foreign acquiring corporation and the 
foreign target corporation.
    (ii) Carryover rule. Subject to paragraph (e)(1)(iii) of this 
section, the amounts described in paragraph (e)(1)(i) of this section 
shall carry over to the foreign surviving corporation but shall not be 
combined. If the foreign acquiring corporation and the foreign target 
corporation have pre-1987 accumulated profits in the same year and a 
distribution is made therefrom,

[[Page 475]]

the rules of Sec. 1.902-1(b)(2)(ii) and (b)(3) shall apply separately 
to reduce pre-1987 accumulated profits and pre-1987 foreign income taxes 
of the foreign acquiring corporation and the foreign target corporation 
on a pro rata basis. For further guidance, see Rev. Rul. 68-351 (1968-2 
C.B. 307); Rev. Rul. 70-373 (1970-2 C.B. 152) (see also Sec. 
601.601(d)(2) of this chapter); see also paragraph (f)(2) of this 
section (governing the reconciliation of taxable years).
    (iii) Deficit--(A) In general. The rules of this paragraph 
(e)(1)(iii) apply when, immediately prior to the foreign section 381 
transaction, the foreign acquiring corporation or the foreign target 
corporation (or both) has a deficit in earnings and profits for one or 
more of the years that comprise its pre-1987 accumulated profits (see 
also paragraphs (f)(1) and (4) of this section, describing other rules 
applicable to a deficit described in this paragraph (e)(1)(iii)).
    (B) Aggregate positive pre-1987 accumulated profits. If the foreign 
acquiring corporation or the foreign target corporation (or both) has an 
aggregate positive (or zero) amount of pre-1987 accumulated profits, but 
a deficit in earnings and profits for one or more years, then the rules 
otherwise applicable to such deficits shall apply separately to the pre-
1987 accumulated profits and related pre-1987 foreign income taxes of 
such corporation. A deficit in pre-1987 accumulated profits for one or 
more years is applied to reduce pre-1987 accumulated profits on a LIFO 
basis. Any remaining deficit shall be applied to reduce pre-1987 
accumulated profits in succeeding years. See Rev. Rul. 74-550 (1974-2 
C.B. 209) (see also Sec. 601.601(d)(2) of this chapter); Champion Int'l 
Corp. v. Commissioner, 81 T.C. 424 (1983), acq. in result, 1987-2 C.B. 
1; Rev. Rul. 87-72 (1987-2 C.B. 170) (see also Sec. 601.601(d)(2) of 
this chapter). As a result, no amount in excess of the aggregate 
positive amount of pre-1987 accumulated profits shall be distributed 
from the pre-transaction earnings of the foreign acquiring corporation 
or the foreign target corporation.
    (C) Aggregate deficit in pre-1987 accumulated profits. If the 
foreign acquiring corporation or the foreign target corporation (or 
both) has an aggregate deficit in pre-1987 accumulated profits, a 
hovering deficit as defined under paragraph (d)(2)(i) of this section, 
then the rules under Sec. 1.902-2(b) shall apply to such hovering 
deficit (and related pre-1987 foreign income taxes) immediately prior to 
the transaction, except that the aggregate hovering deficit that is 
carried forward into the foreign surviving corporation's post-1986 pool 
shall offset only post-transaction earnings accumulated by the foreign 
surviving corporation in the same separate category of post-1986 
undistributed earnings to which the relevant portion of the hovering 
deficit is attributable. Post-transaction earnings do not include 
earnings and profits that are earned after the foreign section 381 
transaction but distributed or deemed distributed in the same year they 
are earned.
    (D) Deficit and positive separate categories within annual layers. 
For purposes of applying the rules of paragraphs (e)(1)(iii)(B) and (C) 
of this section, if within a single pre-pooling annual layer, the 
foreign acquiring corporation or the foreign target corporation (or 
both) has a deficit in pre-1987 accumulated profits in a separate 
category and positive pre-1987 accumulated profits in another separate 
category, the deficit shall first be used to offset the positive pre-
1987 accumulated profits in the other separate category in the same pre-
pooling annual layer. Any remaining deficit shall be carried forward or 
back to other years according to the rules of paragraph (e)(1)(iii)(B) 
or (C) of this section as applicable.
    (iv) Pre-1987 section 960 earnings and profits and foreign income 
taxes. The pre-1987 section 960 earnings and profits and pre-1987 
section 960 foreign income taxes of the foreign acquiring corporation 
and the foreign target corporation shall carry over to the foreign 
surviving corporation but shall not be combined. The rules otherwise 
applicable to such amounts shall apply separately to the pre-1987 
section 960 earnings and profits and pre-1987 section 960 foreign income 
taxes of the foreign acquiring corporation and the foreign target 
corporation on a pro rata basis. For further guidance, see Notice 88-70

[[Page 476]]

(1988-2 C.B. 369) (see also Sec. 601.601(d)(2) of this chapter).
    (v) Examples. The following examples illustrate the rules of this 
paragraph (e)(1). The examples assume the following facts: Foreign 
corporation A was incorporated in 2003 and was a nonpooling corporation 
through December 31, 2004. Foreign corporation A became a CFC on January 
1, 2005 and, as a result, began to maintain a pool of post-1986 
undistributed earnings on that date. Foreign corporation B was 
incorporated in 2003 and has always been owned by foreign shareholders 
(and thus never has met the requirements of section 902(c)(3)(B)). Both 
foreign corporation A and foreign corporation B have always had calendar 
taxable years. Foreign corporations A and B (and all of their respective 
qualified business units as defined in section 989) maintain a ``u'' 
functional currency. Finally, unless otherwise stated, all earnings and 
profits of foreign corporations A and B are in the general category. The 
examples are as follows:

    Example 1. (i) Facts. (A) On December 31, 2006, foreign corporations 
A and B have the following earnings and profits and foreign income 
taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Foreign Corporation A:
  Post-1986 pool....................................    1,000u      $350
  2004..............................................      400u      160u
  2003..............................................      100u        5u
                                                     -------------------
                                                        1,500u  ........
Foreign Corporation B:
    2006............................................      100u       20u
    2005............................................      150u       30u
    2004............................................        0u       50u
    2003............................................       50u        5u
                                                     -------------------
                                                          300u      105u
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation B acquires the assets of 
foreign corporation A in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a CFC.
    (ii) Result. Under the rules described in paragraphs (e)(1)(i) and 
(ii) of this section, foreign surviving corporation has the following 
earnings and profits and foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Post-1986 Pool......................................    1,000u      $350
2006................................................      100u       20u
2005................................................      150u       30u
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1 (from Corp A).....................      400u      160u
    2004 layer 2 (from Corp B).....................        0u       50u
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1 (from Corp A).....................      100u        5u
    2003 layer 2 (from Corp B).....................       50u        5u
                                                     -------------------
                                                        1,800u  ........
------------------------------------------------------------------------

    (iii) Post-transaction distribution. (A) During 2007, foreign 
surviving corporation does not accumulate any earnings and profits or 
pay or accrue any foreign income taxes. On December 31, 2007, foreign 
surviving corporation distributes 1,725u to its shareholders. Under the 
rules of paragraph (c)(1) of this section, the distribution is first out 
of the post-1986 pool, and then out of the pre-pooling annual layers 
under the LIFO method, as follows:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Post-1986 pool......................................    1,000u      $350
2006................................................      100u       20u
2005................................................      150u       30u
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1...................................      400u      160u
    2004 layer 2...................................        0u        0u
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1...................................     * 50u      2.5u
    2003 layer 2...................................    ** 25u      2.5u
                                                     -------------------
                                                       1,725u
------------------------------------------------------------------------
* 100u in layer/150u aggregate 2003 earnings = 66.67% x 75u
  distribution.
** 50u in layer/150u aggregate 2003 earnings = 33.33% x 75u
  distribution.

    (B) The foreign income taxes deemed paid by qualifying shareholders 
of foreign surviving corporation upon the distribution are subject to 
generally applicable rules and limitations, such as those of sections 
78, 902, and 904(d).
    (C) Immediately after the distribution, foreign surviving 
corporation has the following earnings and profits and foreign income 
taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
2004 layer 2.......................................        0u       50u
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1...................................       50u      2.5u
    2003 layer 2...................................       25u      2.5u
ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½
                                                           75u       55u
------------------------------------------------------------------------

    (iv) Post-transaction earnings. For the taxable year ending on 
December 31, 2008, foreign surviving corporation has 500u of current 
earnings and profits in the general category, none of which qualify as 
subpart F income under section 952(a), and pays $70 in foreign income 
taxes. As of the close of the

[[Page 477]]

2008 taxable year, foreign surviving corporation has the following 
earnings and profits and foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Post-1986 pool......................................      500u       $70
2004................................................        0u       50u
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1...................................       50u      2.5u
    2003 layer 2...................................       25u      2.5u
                                                     -------------------
                                                          575u
------------------------------------------------------------------------

    Example 2. (i) Facts. (A) On December 31, 2006, foreign corporations 
A and B have the following earnings and profits and foreign income 
taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Foreign Corporation A:
  Post-1986 pool....................................    1,000u      $350
    2004............................................      100u       20u
    2003............................................     (50u)        5u
                                                     -------------------
                                                        1,050u
Foreign Corporation B:
    2006............................................      100u       20u
    2005............................................     (50u)        5u
    2004............................................        0u       50u
    2003............................................      100u       10u
                                                     -------------------
                                                          150u       85u
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation B acquires the assets of 
foreign corporation A in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a CFC.
    (ii) Result. Because foreign corporations A and B have aggregate 
positive amounts of pre-1987 accumulated profits with a deficit in one 
or more years, the rules of paragraph (e)(1)(iii)(B) of this section 
apply. Accordingly, after the foreign section 381 transaction, foreign 
surviving corporation has the following earnings and profits and foreign 
income taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                          Foreign       taxes
                                                                Positive   Deficit E&P     taxes      assoicated
                                                                  E&P                    available       with
                                                                                                     deficit E&P
----------------------------------------------------------------------------------------------------------------
Post-1986 pool..............................................       1,000u  ...........         $350  ...........
2006........................................................         100u  ...........          20u  ...........
2005........................................................  ...........        (50u)  ...........           5u
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1 (from Corp A).............................         100u  ...........          20u  ...........
    2004 layer 2 (from Corp B).............................           0u  ...........          50u  ...........
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1 (from Corp A).............................  ...........        (50u)  ...........           5u
    2003 layer 2 (from Corp B).............................         100u  ...........          10u  ...........
                                                             ---------------------------------------------------
                                                                   1,300u       (100u)  ...........          10u
----------------------------------------------------------------------------------------------------------------

    (iii) Post-transaction distribution. (A) During 2007, foreign 
surviving corporation does not accumulate any earnings and profits or 
pay or accrue any foreign income taxes. On December 31, 2007, foreign 
surviving corporation distributes 1,175u to its shareholders. Under the 
rules described in paragraphs (c)(1) and (e)(1)(iii)(B) of this section, 
the distribution is first out of the post-1986 pool, and then out of the 
pre-pooling annual layers, as follows:

------------------------------------------------------------------------
                                                                 Foreign
                    Distribution                         E&P      taxes
------------------------------------------------------------------------
Post-1986 pool......................................    1,000u      $350
2006................................................      100u       20u
2005................................................        0u        0u
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1...................................       50u       20u
    2004 layer 2...................................        0u        0u
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1...................................        0u        0u
    2003 layer 2...................................       25u        5u
                                                     -------------------
                                                        1,175u  ........
------------------------------------------------------------------------

    (B) Under paragraph (e)(1)(iii)(B) of this section, the rules 
otherwise applicable when a foreign corporation has an aggregate 
positive (or zero) amount of pre-1987 accumulated profits, but a deficit 
in one or more years, apply separately to the pre-1987 accumulated 
profits and related foreign income taxes of foreign corporation A and 
foreign corporation B. As a result, distributions out of the pre-pooling 
annual layers of foreign corporation A and foreign corporation B cannot 
exceed the aggregate positive amount of

[[Page 478]]

pre-1987 accumulated profits of each corporation. Accordingly, only 50u 
can be distributed from foreign corporation A's pre-pooling annual 
layers and is out of its 2004 layer 1 (after rolling forward the (50u) 
deficit in 2003 layer 1 to reduce earnings in 2004 layer 1 to 50u 
(100u -50u)). Under the principles of Sec. 1.902-1(b)(3), the full 20u 
of taxes related to 2004 layer 1 is reduced or deemed paid ($20 x (50/
50)). 100u is distributed from foreign corporation B's 2006 annual 
layer. Foreign corporation B's (50u) deficit in 2005 is then rolled back 
to offset its 2003 annual layer to reduce earnings in that layer to 50u, 
25u of which is distributed. Thus, after the distribution, 25u remains 
in 2003 layer  2 along with 5u of foreign income taxes (10u x (25u/
50u)).
    (C) The foreign income taxes deemed paid by qualifying shareholders 
of foreign surviving corporation upon the distribution are subject to 
generally applicable rules and limitations, such as those of sections 
78, 902, and 904(d).
    (D) Immediately after the distribution, foreign surviving 
corporation has the following earnings and profits and foreign income 
taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
2005................................................        0u        5u
2004 layer 2.......................................        0u       50u
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1...................................        0u        5u
    2003 layer 2...................................       25u        5u
                                                     -------------------
                                                           25u       65u
------------------------------------------------------------------------

    (E) Under paragraph (e)(1)(iii)(B) of this section, the 5u, 50u, and 
5u of pre-1987 foreign income taxes related to foreign surviving 
corporation's 2005 layer, 2004 layer 2, and 2003 layer 1, 
respectively, remain in those layers. These foreign income taxes 
generally will not be reduced or deemed paid unless a foreign tax refund 
restores a positive balance to the associated earnings pursuant to 
section 905(c), and thus will be trapped. See Sec. 1.902-2(b)(2).
    Example 3. (i) Facts. (A) On December 31, 2006, foreign corporations 
A and B have the following earnings and profits and foreign income 
taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Foreign Corporation A:
Post-1986 pool......................................    1,000u      $350
    2004............................................      150u       20u
    2003............................................      100u        5u
                                                     -------------------
                                                        1,250u  ........
Foreign Corporation B:
    2006............................................      100u       20u
    2005............................................    (250u)        5u
    2004............................................        0u       50u
    2003............................................      100u       10u
                                                     -------------------
                                                         (50u)       85u
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation B acquires the assets of 
foreign corporation A in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a CFC.
    (ii) Result. (A) Because foreign corporation B has an aggregate 
hovering deficit in pre-1987 accumulated profits, the rules of paragraph 
(e)(1)(iii)(C) of this section apply. Accordingly, Sec. 1.902-2(b) 
applies immediately prior to the foreign section 381 transaction, except 
that the hovering deficit is carried forward into the foreign surviving 
corporation's post-1986 undistributed earnings pool and will offset only 
post-transaction earnings accumulated by foreign surviving corporation 
in the general category. Accordingly, after the foreign section 381 
transaction, foreign surviving corporation has the following earnings 
and profits and foreign income taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                                                                Positive     Hovering     Foreign     assoicated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
Post-1986 pool..............................................       1,000u        (50u)         $350           $0
2006........................................................           0u  ...........          20u  ...........
2005........................................................           0u  ...........           5u  ...........
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1 (from Corp A).............................         150u  ...........          20u  ...........
    2004 layer 2 (from Corp B).............................           0u  ...........          50u  ...........
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1 (from Corp A).............................         100u  ...........           5u  ...........
    2003 layer 2 (from Corp B).............................           0u  ...........          10u  ...........
                                                             ---------------------------------------------------
                                                                   1,250u        (50u)  ...........           $0
----------------------------------------------------------------------------------------------------------------


[[Page 479]]

    (B) Under paragraph (e)(1)(iii)(C) of this section, the 20u, 5u, 
50u, and 10u of pre-1987 foreign income taxes associated with foreign 
corporation B's pre-1987 accumulated profits for 2006, 2005, 2004 layer 
2, and 2003 layer 2, respectively, remain in those layers. These 
foreign income taxes generally will not be reduced or deemed paid unless 
a foreign tax refund restores a positive balance to the associated 
earnings pursuant to section 905(c), and thus will be trapped. See Sec. 
1.902-2(b)(2).

    (2) If foreign surviving corporation is a nonpooling corporation. If 
the foreign surviving corporation is a nonpooling corporation, then the 
pre-pooling annual layers shall be determined under the rules of this 
paragraph (e)(2).
    (i) Qualifying earnings and taxes. The pre-pooling annual layers 
shall consist of the pre-1987 accumulated profits and the pre-1987 
foreign income taxes of the foreign acquiring corporation and the 
foreign target corporation. If the foreign acquiring corporation or the 
foreign target corporation (or both) has post-1986 undistributed 
earnings or a deficit in post-1986 undistributed earnings, then those 
earnings or deficits and any related post-1986 foreign income taxes 
shall be recharacterized as pre-1987 accumulated profits or deficits and 
pre-1987 foreign income taxes of the foreign acquiring corporation or 
the foreign target corporation accumulated immediately prior to the 
foreign section 381 transaction.
    (ii) Carryover rule. Subject to paragraph (e)(2)(iii) of this 
section, the amounts described in paragraph (e)(2)(i) of this section 
shall carry over to the foreign surviving corporation but shall not be 
combined. If the foreign acquiring corporation and the foreign target 
corporation have pre-1987 accumulated profits in the same year and a 
distribution is made therefrom, the principles of Sec. 1.902-
1(b)(2)(ii) and (3) shall apply separately to reduce pre-1987 
accumulated profits and pre-1987 foreign income taxes of the foreign 
acquiring corporation and the foreign target corporation on a pro rata 
basis. For further guidance, see Rev. Rul. 68-351 (1968-2 C.B. 307); 
Rev. Rul. 70-373 (1970-2 C.B. 152) (see also Sec. 601.601(d)(2) of this 
chapter); see also paragraph (f)(2) of this section (governing the 
reconciliation of taxable years).
    (iii) Deficits--(A) In general. The rules of this paragraph 
(e)(2)(iii) apply when, immediately prior to the foreign section 381 
transaction (and after application of the last sentence of paragraph 
(e)(2)(i) of this section), the foreign acquiring corporation or the 
foreign target corporation (or both) has a deficit in one or more years 
that comprise its pre-1987 accumulated profits. See also paragraphs 
(f)(1) and (4) of this section (describing other rules applicable to a 
deficit described in this paragraph (e)(2)(iii)).
    (B) Aggregate positive pre-1987 accumulated profits. If the foreign 
acquiring corporation or the foreign target corporation (or both) has an 
aggregate positive (or zero) amount of pre-1987 accumulated profits, but 
a deficit in pre-1987 accumulated profits in one or more years, then the 
rules otherwise applicable to such deficits shall apply separately to 
the pre-1987 accumulated profits and related foreign income taxes of 
such corporation. A deficit in pre-1987 accumulated profits for one or 
more years is applied to reduce pre-1987 accumulated profits on a LIFO 
basis. Any remaining deficit shall be applied to reduce pre-1987 
accumulated profits in succeeding years. See Rev. Rul. 74-550 (1974-2 
C.B. 209) (see also Sec. 601.601(d)(2) of this chapter); Champion Int'l 
Corp. v. Commissioner, 81 T.C. 424 (1983), acq. in result, 1987-2 C.B. 
1; Rev. Rul. 87-72 (1987-2 C.B. 170) (see also Sec. 601.601(d)(2) of 
this chapter). As a result, no amount in excess of the aggregate 
positive amount of pre-1987 accumulated profits shall be distributed 
from the pre-transaction earnings of the foreign acquiring corporation 
or the foreign target corporation.
    (C) Aggregate deficit in pre-1987 accumulated profits. If the 
foreign acquiring corporation or the foreign target corporation (or 
both) has an aggregate deficit in pre-1987 accumulated profits, a 
hovering deficit as defined under paragraph (d)(2)(i) of this section, 
then the rules otherwise applicable to such hovering deficits shall 
apply separately to the pre-transaction earnings and profits and related 
taxes of the relevant corporation. See, e.g., sections 316(a) and 
381(c)(2)(B). Thus, any hovering deficit shall offset only post-
transaction earnings accumulated by the foreign surviving corporation in 
the same separate category of earnings

[[Page 480]]

and profits to which the relevant portion of the hovering deficit is 
attributable. Post-transaction earnings do not include earnings and 
profits that are earned after the foreign section 381 transaction but 
distributed or deemed distributed in the same year they are earned. 
Following the principles of Sec. 1.902-2(b), if there is an aggregate 
deficit in pre-1987 accumulated profits, any related pre-1987 foreign 
income taxes generally will not be reduced or deemed paid unless a 
foreign tax refund restores a positive balance to the associated 
earnings pursuant to section 905(c), and creates a pre-transaction 
aggregate positive balance for pre-1987 accumulated profits.
    (D) Deficit and positive separate categories within annual layers. 
For purposes of applying the rules of paragraphs (e)(2)(iii)(B) and (C) 
of this section, if within a single pre-pooling annual layer, the 
foreign acquiring corporation or the foreign target corporation (or 
both) has a deficit in pre-1987 accumulated profits in a separate 
category and positive pre-1987 accumulated profits in another separate 
category, the deficit shall first be used to offset the positive pre-
1987 accumulated profits in the other separate category in the same pre-
pooling annual layer. Any remaining deficit shall be carried forward or 
back to other years according to the rules of paragraph (e)(2)(iii)(B) 
or (C) as applicable.
    (iv) Pre-1987 section 960 earnings and profits and foreign income 
taxes. The pre-1987 section 960 earnings and profits and pre-1987 
section 960 foreign income taxes of the foreign acquiring corporation 
and the foreign target corporation shall carry over to the foreign 
surviving corporation but shall not be combined. The rules otherwise 
applicable to such amounts shall apply separately to the pre-1987 
section 960 earnings and profits and pre-1987 section 960 foreign income 
taxes of the foreign acquiring corporation and the foreign target 
corporation on a pro rata basis. For further guidance, see Notice 88-70 
(1988-2 C.B. 369) (see also Sec. 601.601(d)(2) of this chapter).
    (v) Examples. The following examples illustrate the rules of this 
paragraph (e)(2). The examples assume the following facts: Both foreign 
corporation A and foreign corporation B have always had calendar taxable 
years. Foreign corporations A and B (and all of their respective 
qualified business units as defined in section 989) maintain a ``u'' 
functional currency, and 1u = US$1 at all times. Finally, unless 
otherwise stated, all earnings and profits of foreign corporations A and 
B are in the general category. The examples are as follows:

    Example 1. (i) Facts. (A) Foreign corporations A and B both were 
incorporated in 2003. Nine percent of the voting stock of foreign 
corporation A is owned by domestic corporate shareholder C. Nine percent 
of the voting stock of foreign corporation B is owned by domestic 
corporate shareholder D. Shareholders C and D are unrelated. The 
remaining 91% of the voting stock of each foreign corporation is owned 
by unrelated foreign shareholders. Thus, neither corporation meets the 
requirements of section 902(c)(3)(B). On December 31, 2006, foreign 
corporations A and B have the following earnings and profits and foreign 
income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Foreign Corporation A:
    2006............................................      500u      350u
    2005............................................      400u      300u
    2004............................................      400u      160u
    2003............................................      100u        5u
                                                     ==========---------
                                                        1,400u      815u
 
Foreign Corporation B:
    2006............................................      100u       20u
    2005............................................      300u       60u
    2004............................................        0u       50u
    2003............................................       50u        5u
                                                     -------------------
                                                          450u      135u
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation B acquires the assets of 
foreign corporation A in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a nonpooling corporation that does not 
meet the requirements of section 902(c)(3)(B).
    (ii) Result. Under the rules described in paragraphs (e)(2)(i) and 
(ii) of this section, foreign surviving corporation has the following 
earnings and profits and foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Two Side-by-Side Layers of 2006 E&P:
    2006 layer 1 (from Corp A).....................      500u      350u
    2006 layer 2 (from Corp B).....................      100u       20u
Two Side-by-Side Layers of 2005 E&P:
    2005 layer 1 (from Corp A).....................      400u      300u

[[Page 481]]

 
    2005 layer 2 (from Corp B).....................      300u       60u
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1 (from Corp A).....................      400u      160u
    2004 layer 2 (from Corp B).....................        0u       50u
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1 (from Corp A).....................      100u        5u
    2003 layer 2 (from Corp B).....................       50u        5u
                                                     -------------------
                                                        1,850u      950u
------------------------------------------------------------------------

    (iii) Post-transaction distribution. (A) During 2007, foreign 
surviving corporation does not accumulate any earnings and profits or 
pay or accrue any foreign income taxes. On December 31, 2007, foreign 
surviving corporation distributes 600u to its shareholders. Under the 
rules of paragraph (c)(3) of this section, the distribution is out of 
pre-pooling annual layers under the LIFO method as follows:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Two Side-by-Side Layers of 2006 E&P:
    2006 layer 1 (from Corp A).....................      500u      350u
    2006 layer 2 (from Corp B).....................      100u       20u
                                                     -------------------
 
                                                          600u      370u
------------------------------------------------------------------------

    (B) Foreign surviving corporation's foreign income tax accounts are 
reduced to reflect the distribution of earnings and profits 
notwithstanding that no shareholders are eligible to claim deemed paid 
foreign income taxes under section 902. See Sec. 1.902-1(a)(10)(iii).
    (C) Immediately after the distribution, foreign surviving 
corporation has the following earnings and profits and foreign income 
taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Two Side-by-Side Layers of 2005 E&P:
    2005 layer 1 (from Corp A).....................      400u      300u
    2005 layer 2 (from Corp B).....................      300u       60u
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1 (from Corp A).....................      400u      160u
    2004 layer 2 (from Corp B).....................        0u       50u
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1 (from Corp A).....................      100u        5u
    2003 layer 2 (from Corp B).....................       50u        5u
                                                     -------------------
                                                        1,250u      580u
------------------------------------------------------------------------

    Example 2. (i) Facts. (A) The facts are the same as in Example 1 
(i)(A), except that foreign corporation A met the requirements of 
section 902(c)(3)(B) on January 1, 2005, when U.S. corporate shareholder 
C acquired an additional 1% of voting stock for a total ownership 
interest of 10%; foreign corporation A thereby became a pooling 
corporation. On December 31, 2006, foreign corporations A and B have the 
following earnings and profits and foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Foreign Corporation A:
    Post-1986 pool..................................      900u      $650
    2004............................................      400u      160u
    2003............................................      100u        5u
                                                     -------------------
                                                        1,400u  ........
                                                     ===================
Foreign Corporation B:
    2006............................................      100u       20u
    2005............................................      300u       60u
    2004............................................        0u       50u
    2003............................................       50u        5u
                                                     -------------------
                                                          450u      135u
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation B acquires the assets of 
foreign corporation A in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a nonpooling corporation that does not 
meet the requirements of section 902(c)(3)(B).
    (ii) Result. Under the rules described in paragraphs (e)(2)(i) and 
(ii) of this section, foreign surviving corporation has the following 
earnings and profits and foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Two Side-by-Side Layers of 2006 E&P:
    2006 layer 1 (from Corp A's pool)..............      900u      $650
    2006 layer 2 (from Corp B's layer).............      100u       20u
    2005 (from Corp B):.............................      300u       60u
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1 (from Corp A).....................      400u      160u
    2004 layer 2 (from Corp B).....................        0u       50u
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1 (from Corp A).....................      100u        5u
    2003 layer 2 (from Corp B).....................       50u        5u
                                                     -------------------
                                                        1,850u
------------------------------------------------------------------------

    (iii) Subsequent ownership change. On July 1, 2010, USS (a domestic 
corporation) acquires 100% of the stock of foreign surviving 
corporation. Under the rules of paragraph (f)(3) of this section, 
foreign surviving corporation begins to pool its earnings and profits 
under section 902(c)(3) as of January 1, 2010. Foreign surviving 
corporation's earnings and profits and foreign income taxes accrued 
before January 1, 2010 retain their character as pre-1987 accumulated 
profits and pre-1987 foreign income taxes.
    Example 3. (i) Facts. (A) The facts are the same as in Example 
2(i)(A), except that on December 31, 2006, foreign corporations A and B 
have the following earnings and profits and foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      Taxes
------------------------------------------------------------------------
Foreign Corporation A:

[[Page 482]]

 
    Post-1986 pool..................................    1,000u      $500
    2004............................................    (200u)       10u
    2003............................................      400u        5u
                                                     -------------------
                                                        1,200u  ........
                                                     ===================
Foreign Corporation B
    2006............................................      300u       20u
    2005............................................    (100u)       60u
    2004............................................        0u       50u
    2003............................................       50u        5u
                                                     -------------------
                                                          250u      135u
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation B acquires the assets of 
foreign corporation A in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a nonpooling corporation that does not 
meet the requirements of section 902(c)(3)(B).
    (ii) Result. Because foreign corporations A and B have aggregate 
positive amounts of pre-1987 accumulated profits with a deficit in one 
or more years, the rules of paragraph (e)(2)(iii)(B) of this section 
apply. Accordingly, after the foreign section 381 transaction, foreign 
surviving corporation has the following earnings and profits and foreign 
income taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                          Foreign       taxes
                                                                Positive   Deficit E&P     taxes      associated
                                                                  E&P                    available       with
                                                                                                     deficit E&P
----------------------------------------------------------------------------------------------------------------
Two Side-by-Side Layers of 2006 E&P:
    2006 layer 1 (from Corp A's pool)......................       1,000u  ...........         $500  ...........
    2006 layer 2 (from Corp B's layer).....................         300u  ...........          20u
    2005 (from Corp B)......................................  ...........       (100u)  ...........          60u
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1 (from Corp A).............................  ...........       (200u)  ...........          10u
    2004 layer 2 (from Corp B).............................           0u  ...........          50u  ...........
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1 (from Corp A).............................         400u  ...........           5u  ...........
    2003 layer 2 (from Corp B).............................          50u  ...........           5u  ...........
                                                             ---------------------------------------------------
                                                                   1,750u       (300u)  ...........          70u
----------------------------------------------------------------------------------------------------------------

    (iii) Post-transaction distribution. (A) During 2007, foreign 
surviving corporation does not accumulate any earnings and profits or 
pay or accrue any foreign income taxes. On December 31, 2007, foreign 
surviving corporation distributes 1,300u to its shareholders. Under the 
rules described in paragraphs (c)(3) and (e)(2)(iii)(B) of this section, 
the distribution is out of the pre-pooling annual layers, as follows:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Two Side-by-Side Layers of 2006 E&P:
    2006 layer 1...................................    1,000u      $500
    2006 layer 2...................................      250u       20u
2003 E&P:
                                                     -------------------
    2003 layer 1...................................       50u     1.25u
                                                                 (25% of
                                                                      5u
                                                                  taxes)
                                                        1,300u  ........
------------------------------------------------------------------------

    (B) Under paragraph (e)(2)(iii)(B) of this section, the rules 
otherwise applicable when a foreign corporation has an aggregate 
positive (or zero) amount of pre-1987 accumulated profits, but a deficit 
in one or more years, apply separately to the pre-1987 accumulated 
profits and related pre-1987 foreign income taxes of foreign corporation 
A and foreign corporation B. As a result, distributions out of the pre-
pooling annual layers of foreign corporation A and foreign corporation B 
cannot exceed the aggregate positive amount of pre-1987 accumulated 
profits of each corporation. Accordingly, only 1,200u and 250u can be 
distributed out of foreign corporation A's and foreign corporation B's 
pre-pooling annual layers, respectively. Thus, 1,000u of the 
distribution is out of foreign corporation A's 2006 layer 1 and 250u is 
out of foreign corporation B's 2006 layer 2 (after rolling forward 
(50u) of the deficit in 2005 layer to reduce earnings in 2006 layer 1 
to 250u (300u-50u)). Under the principles of Sec. 1.902-1(b)(3), all of 
the taxes in each of those respective layers are reduced. The remaining 
50u is distributed from foreign corporation A's 2003 layer 1 (after 
rolling back the (200u) deficit in 2004 layer 1 to reduce earnings in 
2003 layer 1 to 200u (400u-200u)). Thus, after the distribution, 150u 
remains in the 2003 layer 1 along with 3.75u of foreign income taxes 
(5u x (150u/200u)).
    (C) Foreign surviving corporation's foreign income tax accounts are 
reduced to reflect the distribution of earnings and profits 
notwithstanding that no shareholders are eligible to claim a credit for 
deemed paid foreign

[[Page 483]]

income taxes under section 902. See Sec. 1.902-1(a)(10)(iii).
    (D) Immediately after the distribution, foreign surviving 
corporation has the following earnings and profits and foreign income 
taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
2005................................................        0u       60u
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1...................................        0u       10u
    2004 layer 2...................................        0u       50u
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1...................................      150u     3.75u
    2003 layer 2...................................        0u        5u
                                                     -------------------
                                                          150u   128.75u
------------------------------------------------------------------------

    (E) Under paragraph (e)(2)(iii)(B) of this section, the 60u, 10u, 
50u, and 5u of foreign income taxes related to foreign surviving 
corporation's 2005 layer, 2004 layer 1, 2004 layer 2, and 2003 layer 
2, respectively, remain in those layers. These foreign income taxes 
generally will not be reduced or deemed paid unless a foreign tax refund 
restores a positive balance to the associated earnings pursuant to 
section 905(c), and thus will be trapped. See Sec. 1.902-2(b)(2).
    Example 4. (i) Facts. (A) The facts are the same as in Example 2 
(i)(A), except that on December 31, 2006, foreign corporations A and B 
have the following earnings and profits and foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      Taxes
------------------------------------------------------------------------
Foreign Corporation A:
    Post-1986 pool..................................  (1,000u)       $20
    2004............................................    (200u)       10u
    2003............................................      400u        5u
                                                     -------------------
                                                        (800u)
Foreign Corporation B:
                                                     ===================
    2006............................................      100u       20u
    2005............................................      300u       60u
    2004............................................        0u       50u
    2003............................................       50u        5u
                                                     -------------------
                                                          450u      135u
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation A acquires the assets of 
foreign corporation B in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a nonpooling corporation.
    (ii) Result. (A) Under paragraph (e)(2)(i) of this section, foreign 
corporation A's post-1986 pool is recharacterized as a 2006 layer of 
pre-1987 accumulated profits. Because after the foreign section 381 
transaction foreign corporation A has an aggregate deficit in pre-1987 
accumulated profits, the rules of paragraph (e)(2)(iii)(C) of this 
section apply and the rules otherwise applicable apply separately to the 
pre-1987 accumulated profits that carry over to foreign surviving 
corporation from foreign corporation A. The (800u) aggregate deficit in 
foreign corporation A's pre-1987 accumulated profits is a hovering 
deficit that will offset only post-transaction earnings accumulated by 
foreign surviving corporation in the general category. Accordingly, 
after the foreign section 381 transaction, foreign surviving corporation 
has the following earnings and profits and foreign income taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                Positive                  Foreign       taxes
                                                                  E&P      Deficit E&P     taxes      associated
                                                                                         available   deficit E&P
----------------------------------------------------------------------------------------------------------------
Hovering deficit from Corp A's annual layers................  ...........       (800u)  ...........            0
Two Side-by-Side Layers of 2006 E&P:
    2006 layer 1 (from Corp A's pool)......................  ...........           0u  ...........          $20
    2006 layer 2 (from Corp B's layer).....................         100u  ...........          20u  ...........
    2005 (from Corp B)......................................         300u  ...........          60u  ...........
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1 (from Corp A).............................  ...........           0u  ...........          10u
    2004 layer 2 (from Corp B).............................           0u  ...........          50u  ...........
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1 (from Corp A).............................           0u  ...........           5u  ...........
    2003 layer 2 (from Corp B).............................          50u  ...........           5u  ...........
                                                             ---------------------------------------------------
                                                                     450u       (800u)         140u  ...........
----------------------------------------------------------------------------------------------------------------

    (B) Under paragraph (e)(2)(iii)(C) of this section, the $20, 10u, 
and 5u of pre-1987 foreign income taxes associated with foreign 
corporation A's pre-1987 accumulated profits for 2006 layer 1, 2004 
layer 1, and 2003 layer 1, respectively, remain in those layers. These 
foreign income taxes generally will

[[Page 484]]

not be reduced or deemed paid unless a foreign tax refund restores a 
positive balance to the associated earnings pursuant to section 905(c), 
and thus will be trapped. See Sec. 1.902-2(b)(2).
    (iii) Post-transaction distribution. (A) During 2007, foreign 
surviving corporation does not accumulate any earnings and profits or 
pay or accrue any foreign income taxes. On December 31, 2007, foreign 
surviving corporation distributes 200u to its shareholders. Under the 
rules described in paragraph (e)(2)(iii)(C) of this section, no 
distribution can be made out of the pre-1987 accumulated profits of 
foreign corporation A (and the (800u) aggregate hovering deficit will 
offset only post-transaction earnings accumulated by foreign surviving 
corporation). Thus, the distribution is out of pre-pooling annual layers 
as follows:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
                                                                  paid
------------------------------------------------------------------------
2006 layer 2.......................................      100u       20u
2005................................................      100u       20u
                                                     -------------------
                                                          200u       40u
------------------------------------------------------------------------

    (B) Foreign surviving corporation's foreign income tax accounts are 
reduced to reflect the distribution of earnings and profits 
notwithstanding that no shareholders are eligible to claim deemed paid 
foreign income taxes under section 902. See Sec. 1.902-1(a)(10)(iii).
    (C) Immediately after the distribution, foreign surviving 
corporation has the following earnings and profits and foreign income 
taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                          Foreign       taxes
                                                                Positive   Deficit E&P     taxes      associated
                                                                  E&P                    available       with
                                                                                                     deficit E&P
----------------------------------------------------------------------------------------------------------------
Hovering deficit from Corp A's annual layers................  ...........       (800u)  ...........            0
Two Side-by-Side Layers of 2006 E&P:
    2006 layer 1 (from Corp A's pool)......................  ...........           0u  ...........          $20
    2006 layer 2 (from Corp B's layer).....................           0u  ...........           0u  ...........
    2005 (from Corp B)......................................         200u  ...........          40u  ...........
Two Side-by-Side Layers of 2004 E&P:
    2004 layer 1 (from Corp A).............................  ...........           0u  ...........          10u
    2004 layer 2 (from Corp B).............................           0u  ...........          50u  ...........
Two Side-by-Side Layers of 2003 E&P:
    2003 layer 1 (from Corp A).............................           0u  ...........           5u  ...........
    2003 layer 2 (from Corp B).............................          50u  ...........           5u  ...........
                                                                     250u       (800u)         140u  ...........
----------------------------------------------------------------------------------------------------------------

    (f) Special rules--(1) Treatment of deficit--(i) General rule. Any 
deficit described in paragraph (d)(2), (e)(1)(iii), or (e)(2)(iii) of 
this section shall not be taken into account in determining current or 
accumulated earnings and profits of a foreign surviving corporation 
other than to offset post-transaction accumulated earnings, as defined 
in paragraph (d)(2)(ii) of this section, including for purposes of 
calculating--
    (A) The earnings and profits limitation of section 952(c)(1)(A); and
    (B) The amount of the foreign surviving corporation's subpart F 
income as defined in section 952(a).
    (ii) Exceptions. The rule in paragraph (i) shall not apply for 
purposes of calculating an earnings and profits limitation under section 
952(c)(1)(B) or (C).
    (iii) Examples. The following examples illustrate the principles of 
this paragraph (f)(1). The examples assume the following facts: foreign 
corporation A, incorporated in 2002, is and always has been a wholly 
owned subsidiary of USP, a domestic corporation. Foreign corporation B, 
incorporated in 2004, is and always has been a wholly owned subsidiary 
of foreign corporation A. Both foreign corporation A and foreign 
corporation B are organized under the laws of foreign country X and have 
always had a calendar taxable year. Foreign corporations A and B (and 
all of their respective qualified business units as defined in section 
989) maintain a ``u'' functional currency. Unless otherwise stated, any 
earnings and profits or deficit in earnings and profits of foreign 
corporation A and B in the general category are attributable to subpart 
F income derived from foreign base company sales income. Foreign 
corporation C is a wholly owned subsidiary of USP2 and was organized

[[Page 485]]

in 2004 under the laws of foreign country Y. Foreign corporation C (and 
all of its qualified business units as defined in section 989) maintains 
a ``u'' functional currency. Earnings and profits of foreign corporation 
C in the general category are not attributable to subpart F income. The 
examples are as follows:

    Example 1. (i) Facts. (A) On December 31, 2007, foreign corporations 
A and B have the following post-1986 undistributed earnings and post-
1986 foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Foreign Corporation A Separate Category:
    General.........................................    (100u)       $25
Foreign Corporation B Separate Category:
    General.........................................        0u       $10
------------------------------------------------------------------------

    (B) On January 1, 2008, foreign corporation B elects under Sec. 
301.7701-3(c) of this chapter to be disregarded as an entity separate 
from foreign corporation A. Accordingly, foreign corporation B is deemed 
to have distributed all its property to foreign corporation A in a 
liquidation described in section 332.
    (ii) Result. Under the rules described in paragraphs (d)(1) and (2) 
of this section, foreign surviving corporation A has the following post-
1986 undistributed earnings and post-1986 foreign income taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits:         Foreign taxes:
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                      Separate category                         Positive     Hovering     Foreign     associated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................           0u       (100u)          $10          $25
----------------------------------------------------------------------------------------------------------------

    (iii) Post-transaction earnings and subpart F limitations. (A) In 
its taxable year ending on December 31, 2008, foreign surviving 
corporation A earns 300u of subpart F general category income with 
respect to which it pays $50 in foreign income taxes. The hovering 
deficit of (100u) meets the requirements under section 952(c)(1)(B) and 
therefore is taken into account as a qualified deficit that may be used 
by USP to offset a portion of its income inclusion related to foreign 
surviving corporation A's subpart F income of 300u in the 2008 taxable 
year. Accordingly, USP includes 200u in taxable income for the year and 
is eligible for a deemed paid foreign tax credit under section 960 of 
$40 (200u subpart F inclusion/300 post-1986 undistributed earnings in 
the general category = 66.67%, x $60 foreign income taxes in the general 
category = $40). USP will also include the deemed paid foreign taxes of 
$40 in taxable income for the year as a deemed dividend pursuant to 
section 78. The 100u offset under section 952(c)(1)(B) does not result 
in a reduction of the hovering deficit for purposes of section 316 or 
section 902.
    (B) Foreign surviving corporation A's 100u of subpart F income not 
included in income by USP will accumulate and be added to its post-1986 
undistributed earnings as of the beginning of 2009. This 100u of post-
transaction earnings will be offset by the (100u) hovering deficit. 
Because the amount of earnings offset by the hovering deficit is 100% of 
the total amount of the hovering deficit, all $25 of the related taxes 
are added to the post-1986 foreign income taxes pool as well. 
Accordingly, foreign surviving corporation A has the following post-1986 
undistributed earnings and post-1986 foreign income taxes on January 1, 
2009:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                      Separate category                         Positive     Hovering     Foreign     associated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................           0u         (0u)          $45           $0
----------------------------------------------------------------------------------------------------------------

    (C) The 200u included as subpart F income constitutes previously 
taxed earnings under section 959.
    Example 2. (i) Facts. (A) On July 1, 2007, foreign corporation B 
elects under Sec. 301.7701-3(c) of this chapter to be disregarded as an 
entity

[[Page 486]]

separate from foreign corporation A. Accordingly, foreign corporation B 
is deemed to have distributed all of its property to foreign corporation 
A in a liquidation described in section 332.
    (B) Neither foreign corporation A nor B has any post-1986 
undistributed earnings or post-1986 foreign income taxes as of the 
beginning of the 2007 taxable year. For its short taxable year ending on 
June 30, 2007, foreign corporation B has the following post-1986 
undistributed earnings and post-1986 foreign income taxes:

                          Foreign Corporation B
------------------------------------------------------------------------
                                                                 Foreign
                  Separate category                      E&P      taxes
------------------------------------------------------------------------
General.............................................    (200u)       $30
------------------------------------------------------------------------

    (C) For the 2007 taxable year, foreign surviving corporation A earns 
a total of 200u of subpart F foreign based company sales income in the 
general category with respect to which it pays $40 in foreign income 
taxes.
    (ii) Result. (A) Under paragraph (d)(2) of this section, foreign 
corporation B's (200u) deficit carries over to foreign surviving 
corporation A as a hovering deficit. Nevertheless, because it is a 
deficit of a qualified chain member for a taxable year ending within the 
2007 taxable year of foreign surviving corporation A, the (200u) deficit 
meets the requirements under section 952(c)(1)(C) and therefore may 
still be taken into account for purposes of limiting foreign surviving 
corporation A's subpart F income. Accordingly, foreign surviving 
corporation A's 200u of subpart F income for the 2007 taxable year is 
fully offset by the (200u) deficit of foreign corporation B, and USP 
will have no subpart F income inclusion for the 2007 taxable year. The 
offset under section 952(c)(1)(C) does not result in a reduction of the 
hovering deficit for purposes of section 316 or section 902. The 
hovering deficit may not also be taken into account under section 
952(c)(1)(B).
    (B) Because USP has no subpart F income inclusion, foreign surviving 
corporation A's subpart F earnings of 200u will accumulate and be added 
to its post-1986 undistributed earnings as of the beginning of 2008. 
Under the rules of paragraph (f)(5) of this section, a pro rata amount, 
in this case 50% or 100u, will be deemed to have been accumulated prior 
to the foreign section 381 transaction and the other 50%, or 100u, will 
be deemed to have been accumulated after the foreign section 381 
transaction. The 100u of post-transaction earnings will be offset by 
(100u) of the hovering deficit for purposes of determining the opening 
balance of the post-1986 undistributed earnings pool in 2008. Because 
the amount of earnings offset by the hovering deficit is 50% of the 
total amount of the hovering deficit, $15 (50% of $30) of the related 
taxes are added to the post-1986 foreign income taxes pool as well. The 
100u of pre-transaction earnings remain in the post-1986 undistributed 
earnings pool. Accordingly, foreign surviving corporation A has the 
following post-1986 undistributed earnings and post-1986 foreign income 
taxes on January 1, 2008:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                      Separate category                         Positive    Hoverinig     Foreign     associated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................         100u       (100u)          $55          $15
----------------------------------------------------------------------------------------------------------------

    Example 3. (i) Facts. (A) On January 1, 2007, foreign corporation B 
and foreign corporation C have the following post-1986 undistributed 
earnings and post-1986 foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Foreign Corporation B Separate Category:
    General.........................................    (100u)        $0
Foreign Corporation C Separate Category:
    General.........................................        0u       $10
------------------------------------------------------------------------

    (B) On July 1, 2007, foreign corporation B acquires the assets of 
foreign corporation C in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation B is a CFC.
    (C) During the 2007 taxable year foreign surviving corporation B has 
a current deficit of (400u) and $60 of related foreign income taxes. 
During its short taxable year ending on June 30, 2007, foreign 
corporation C has no additional earnings and pays or accrues no foreign 
income taxes.
    (ii) Result. (A) Under the rules of paragraph (f)(5) of this 
section, a pro rata amount, in this case 50% or (200u), of foreign 
surviving corporation B's (400u) current year deficit for the 2007 
taxable year will be deemed to have

[[Page 487]]

been accumulated prior to the foreign section 381 transaction and be 
treated as a hovering deficit. The other 50%, or (200u) of the deficit 
will be deemed to have been accumulated after the foreign section 381 
transaction. The related foreign income taxes of $60 will also be 
allocated on a similar 50/50 basis.
    (B) Under the rules described in paragraphs (d)(1) and (2) of this 
section, foreign surviving corporation B has the following post-1986 
undistributed earnings and post-1986 foreign income taxes as of January 
1, 2008:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                      Separate category                                      Hovering     Foreign     assoicated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................       (200u)       (300u)          $40          $30
----------------------------------------------------------------------------------------------------------------

    (iii) Subpart F income limitations. Even though (200u) of the 
current year deficit is treated as a hovering deficit, the full (400u) 
current year deficit in 2007 of foreign surviving corporation B meets 
the requirements under section 952(c)(1)(C) and therefore is available 
as a limitation on subpart F income, to the extent foreign corporation 
A, which wholly owns foreign surviving corporation B, earns any subpart 
F income in the 2007 taxable year. Any such offset under section 
952(c)(1)(C) will have no effect on the earnings and profits and foreign 
income tax accounts above of foreign surviving corporation B for 
purposes of sections 316 and 902. Moreover, to the extent the hovering 
deficit reduces subpart F income under section 952(c)(1)(C), it may not 
also be taken into account under section 952(c)(1)(B).

    (2) Reconciling taxable years. If a foreign acquiring corporation 
and a foreign target corporation had taxable years ending on different 
dates, then the pro rata distribution rules of paragraphs (e)(1)(ii) and 
(e)(2)(ii) of this section shall apply with respect to the taxable years 
that end within the same calendar year.
    (3) Post-transaction change of status. If a foreign surviving 
corporation that is subject to the rules of paragraph (c)(2) of this 
section subsequently becomes a pooling corporation (by reason, for 
example, of a reorganization, liquidation, or change of ownership), then 
post-1986 undistributed earnings and post-1986 foreign income taxes that 
were recharacterized as pre-1987 accumulated profits and pre-1987 
foreign income taxes, respectively, under paragraph (e)(2)(i) of this 
section retain their characterization as a pre-pooling annual layer.
    (4) Ordering rule for multiple hovering deficits--(i) Rule. A 
foreign surviving corporation shall apply the deficit rules of 
paragraphs (d)(2), (e)(1)(iii), and (e)(2)(iii) of this section in that 
order if more than one of such rules applies to the foreign surviving 
corporation.
    (ii) Example. The following example illustrates the principles of 
this paragraph (f)(4). The example assumes the following facts: Foreign 
corporation A has been a pooling corporation since its incorporation on 
January 1, 1998. Foreign corporation B has been a nonpooling corporation 
since its incorporation on January 1, 2000. Foreign corporations A and B 
have always had calendar taxable years. Foreign corporations A and B 
(and all of their respective qualified business units as defined in 
section 989) maintain a ``u'' functional currency. All earnings and 
profits of foreign corporation B are in the general category. Finally, 
unless otherwise stated, any earnings and profits in the passive 
category resulted from a look-through dividend that was paid by a lower-
tier CFC out of earnings accumulated when the CFC was a noncontrolled 
section 902 corporation and that qualified for the subpart F same-
country exception under section 954(c)(3)(A). The example is as follows:

    Example. (i) Facts. (A) On December 31, 2006, foreign corporations A 
and B have the following earnings and profits and foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Foreign Corporation A Post-1986 Pool Separate
 Category:
    Passive.........................................      400u      $160
    General.........................................    (300u)        25
                                                     -------------------

[[Page 488]]

 
                                                          100u       185
Foreign Corporation B:
    2006............................................    (300u)       50u
    2005............................................      100u       25u
                                                     -------------------
                                                        (200u)       75u
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation B acquires the assets of 
foreign corporation A in a reorganization described in section 
368(a)(1)(C). Immediately following the foreign section 381 transaction, 
foreign surviving corporation is a CFC.
    (ii) Result. Under the rules described in paragraphs (d)(1), (d)(2), 
(e)(1)(i), (e)(1)(ii), and (e)(1)(iii) of this section, foreign 
surviving corporation has the following earnings and profits and foreign 
income taxes:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                                                                Positive     Hovering     Foreign     associated
                                                                  E&P        deficit       taxes         with
                                                                                          availabe     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
Post-1986 pool separate category:
    Passive.................................................         400u  ...........         $160  ...........
    General.................................................  ...........       (300u)  ...........          $25
    Carryforward pre-pooling deficit from Corp B............  ...........       (200u)  ...........            0
    2006 (from Corp B)......................................           0u  ...........          50u  ...........
    2005 (from Corp B)......................................           0u  ...........          25u  ...........
                                                             ---------------------------------------------------
                                                                     400u       (500u)  ...........          $25
----------------------------------------------------------------------------------------------------------------

    (iii) Post-transaction earnings. (A) In the taxable year ending on 
December 31, 2007, foreign surviving corporation accumulates earnings 
and profits and pays related foreign income taxes as follows:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Post-1986 pool separate category:
    Passive.........................................      150u       $40
    General.........................................      400u        60
                                                     -------------------
                                                          550u       100
------------------------------------------------------------------------

    (B) None of the earnings and profits qualify as subpart F income as 
defined in section 952(a). Under paragraph (f)(4)(i) of this section, 
the rules of paragraph (d)(2) of this section apply before the rules of 
paragraph (e)(1)(iii) of this section. Accordingly, post-transaction 
earnings in a separate category are first offset by a hovering deficit 
in the same separate category in the post-1986 pool. Thus, foreign 
surviving corporation's (300u) deficit in the general category offsets 
300u of post-transaction earnings in the general category. After 
application of paragraph (d)(2) of this section, the (200u) deficit in 
the general category carried forward from foreign corporation B's pre-
pooling aggregate deficit offsets the remaining 100u of post-transaction 
earnings in the general category. Accordingly, foreign surviving 
corporation has the following earnings and profits and foreign income 
taxes at the end of 2007:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                                                                Positive     Hovering     Foreign     associated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
Post-1986 pool separate category:
    Passive.................................................         550u  ...........         $200  ...........
    General.................................................  ...........  ...........          $85  ...........
Carryforward pre-pooling deficit from Corp B................  ...........       (100u)  ...........           $0
2006 (from Corp B)..........................................           0u  ...........          50u  ...........
2005 (from Corp B)..........................................           0u  ...........          25u  ...........
                                                             ---------------------------------------------------
                                                                     550u       (100u)  ...........           $0
----------------------------------------------------------------------------------------------------------------

    (C) Under paragraph (d)(2)(iii) of this section, all of the $25 of 
post-1986 foreign income taxes related to the (300u) hovering deficit in 
the general category is added to the foreign surviving corporation's 
post-1986 foreign income taxes of $60 in that category (because

[[Page 489]]

post-transaction earnings in the general category have exceeded the 
deficit in that category). Under paragraph (e)(1)(iii)(C) of this 
section, the 50u and 25u of foreign income taxes associated with foreign 
corporation B's pre-1987 accumulated profits for 2006 and 2005 remain in 
those layers. These foreign income taxes generally will not be reduced 
or deemed paid unless a foreign tax refund restores a positive balance 
to the associated earnings pursuant to section 905(c), and thus will be 
trapped. See Sec. 1.902-2(b)(2).

    (5) Pro rata rule for earnings and deficits during transaction year. 
(i) For purposes of offsetting post-transaction earnings of a foreign 
surviving corporation under the rules described in paragraphs (d)(2), 
(e)(1)(iii), and (e)(2)(iii) of this section, the earnings and profits, 
and any related foreign income taxes, in each separate category for the 
taxable year of the foreign surviving corporation in which the 
transaction occurs shall be deemed to have been accumulated after such 
transaction in an amount which bears the same ratio to the undistributed 
earnings and profits of the foreign surviving corporation for such 
taxable year (computed without regard to any earnings and profits 
carried over) as the number of days in the taxable year after the date 
of transaction bears to the total number of days in the taxable year. 
See, e.g., Sec. 1.381(c)(2)-1(a)(7) Example 2 (illustrating application 
of this rule with respect to domestic corporations).
    (ii) For purposes of determining the amount of pre-transaction 
deficits described in paragraphs (d)(2), (e)(1)(iii), and (e)(2)(iii) of 
this section, of a foreign surviving corporation that has a deficit in 
earnings and profits in any separate category for its taxable year in 
which the transaction occurs, unless the actual accumulated earnings and 
profits, or deficit, as of such date can be shown, such pre-transaction 
deficit, and any related foreign income taxes, shall be deemed to have 
accumulated in a manner similar to that described in paragraph (f)(5)(i) 
of this section. See, e.g., Sec. 1.381(c)(2)-1(a)(7) Example 4 
(illustrating application of this rule with respect to domestic 
corporations).
    (g) Effective date. This section shall apply to section 367(b) 
transactions that occur on or after November 6, 2006.

[T.D. 9273, 71 FR 44985, Aug. 8, 2006; 71 FR 57889, Oct. 2, 2006, as 
amended at 71 FR 70876, Dec. 7, 2006]



Sec. 1.367(b)-8  Allocation of earnings and profits and foreign income
taxes in certain foreign corporate separations. [Reserved]



Sec. 1.367(b)-9  Special rule for F reorganizations and similar transactions.

    (a) Scope. This section applies to a foreign section 381 transaction 
(as defined in Sec. 1.367(b)-7(a)) either--
    (1) That is described in section 368(a)(1)(F); or
    (2) That involves--
    (i) At least one foreign corporation that holds no property and has 
no tax attributes immediately before the transaction, other than a 
nominal amount of assets (and related tax attributes) to facilitate its 
organization or preserve its existence as a corporation; and
    (ii) No more than one foreign corporation that holds more than a 
nominal amount of property or has more than a nominal amount of tax 
attributes immediately before the transaction.
    (b) Hovering deficit rules inapplicable. If a transaction is 
described in paragraph (a) of this section, a foreign surviving 
corporation shall succeed to earnings and profits, deficits in earnings 
and profits, and foreign income taxes without regard to the hovering 
deficit rules of Sec. 1.367(b)-7(d)(2), (e)(1)(iii), and (e)(2)(iii).
    (c) Foreign divisive transactions. [Reserved]
    (d) Examples. The following examples illustrate the principles of 
this section:

    Example 1. (i) Facts. (A) Foreign corporation A is and always has 
been a wholly owned subsidiary of USP, a domestic corporation. Foreign 
corporation A was incorporated in 1995, and has always had a calendar 
taxable year. Foreign corporation A (and all of its respective qualified 
business units as defined in section 989) maintains a ``u'' functional 
currency. On December 31, 2006, foreign corporation A has the following 
post-1986 undistributed earnings and post-1986 foreign income taxes:

[[Page 490]]



------------------------------------------------------------------------
                                                                 Foreign
                  Separate Category                      E&P      taxes
------------------------------------------------------------------------
Passive.............................................  (1,000u)        $5
General.............................................      200u       200
                                                     -------------------
                                                        (800u)       205
------------------------------------------------------------------------

    (B) On January 1, 2007, foreign corporation A moves its place of 
incorporation from Country 1 to Country 2 in a reorganization described 
in section 368(a)(1)(F).
    (ii) Result. Under Sec. 1.367(b)-7(d), as modified by paragraph (b) 
of this section, the pre-transaction deficit of foreign corporation A 
will not hover. Accordingly, foreign surviving corporation has the 
following post-1986 undistributed earnings and post-1986 foreign income 
taxes immediately after the foreign section 381 transaction:

------------------------------------------------------------------------
                                                                 Foreign
                  Separate category                      E&P      taxes
------------------------------------------------------------------------
Passive.............................................  (1,000u)        $5
General.............................................      200u       200
                                                     -------------------
                                                        (800u)       205
------------------------------------------------------------------------

    Example 2. (i) Facts. (A) Foreign corporations B, C and D are and 
always have been wholly owned subsidiaries of USP, a domestic 
corporation. Foreign corporation B was incorporated in 2000 and foreign 
corporations C and D were incorporated in 2001. Foreign corporation B 
does not own any significant property and has no earnings and profits or 
foreign income taxes accounts. Both foreign corporations C and D have 
always had a calendar taxable year. Foreign corporations C and D (and 
all of their respective qualified business units as defined in section 
989) maintain a ``u'' functional currency. On December 31, 2006, foreign 
corporations C and D have the following post-1986 undistributed earnings 
and post-1986 foreign income taxes:

------------------------------------------------------------------------
                                                                 Foreign
                                                         E&P      taxes
------------------------------------------------------------------------
Foreign corporation C Separate Category:
    Passive.........................................    (900u)       $50
    General.........................................    (200u)       100
                                                     -------------------
                                                       (1100u)       150
                                                     ===================
Foreign corporation D Separate Category:
    Passive.........................................     1200u       400
    General.........................................      400u       100
                                                     -------------------
                                                         1600u       500
------------------------------------------------------------------------

    (B) On January 1, 2007, USP foreign corporations C and D merge into 
foreign corporation B in a reorganization described in section 
368(a)(1)(A).
    (ii) Result. Although the merger is a foreign section 381 
transaction involving a foreign corporation with no property or tax 
attributes, paragraph (b) of this section does not apply because more 
than one foreign corporation with significant tax attributes is involved 
in the foreign section 381 transaction. Accordingly, under Sec. 
1.367(b)-7(d), foreign surviving corporation B has the following post-
1986 undistributed earnings and post-1986 foreign income taxes 
immediately after the foreign section 381 transaction:

----------------------------------------------------------------------------------------------------------------
                                                                 Earnings & profits           Foreign taxes
                                                             ---------------------------------------------------
                                                                                                       Foreign
                                                                                                        taxes
                      Separate Category                         Positive     Hovering     Foreign     associated
                                                                  E&P        deficit       taxes         with
                                                                                         available     hovering
                                                                                                       deficit
----------------------------------------------------------------------------------------------------------------
General.....................................................        1200u       (900u)         $400          $50
Passive.....................................................         400u       (200u)          100          100
                                                             ---------------------------------------------------
                                                                    1600u      (1100u)          500          150
----------------------------------------------------------------------------------------------------------------

    (e) Effective date. This section shall apply to section 367(b) 
transactions that occur on or after November 6, 2006.

[T.D. 9273, 71 FR 44913, Aug. 8, 2006]



Sec. 1.367(b)-10  Acquisition of parent stock or securities for property
in triangular reorganizations.

    (a) In general--(1) Scope. Except as provided in paragraphs 
(a)(2)(i) through (iii) of this section, this section applies to a 
triangular reorganization if P or S (or both) is a foreign corporation 
and, in connection with the reorganization, S acquires in exchange for 
property all or a portion of the P stock or P securities (P acquisition) 
that are used to acquire the stock, securities or property of T in the 
triangular reorganization. This section applies to a triangular 
reorganization regardless of whether P controls (within the meaning of 
section 368(c)) S at the time of the P acquisition.
    (2) Exceptions. This section shall not apply if--

[[Page 491]]

    (i) P and S are foreign corporations and neither P nor S is a 
controlled foreign corporation (within the meaning of Sec. 1.367(b)-
2(a)) immediately before or immediately after the triangular 
reorganization;
    (ii) S is a domestic corporation, P's stock in S is not a United 
States real property interest (within the meaning of section 897(c)), 
and P would not be subject to U.S. tax on a dividend (as determined 
under section 301(c)(1)) from S under either section 881 (for example, 
by reason of an applicable treaty) or section 882; or
    (iii) In an exchange under section 354 or 356, one or more U.S. 
persons exchange stock or securities of T and the amount of gain in the 
T stock or securities recognized by such U.S. persons under section 
367(a)(1) is equal to or greater than the sum of the amount of the 
deemed distribution that would be treated by P as a dividend under 
section 301(c)(1) and the amount of such deemed distribution that would 
be treated by P as gain from the sale or exchange of property under 
section 301(c)(3) if this section would otherwise apply to the 
triangular reorganization. See Sec. 1.367(a)-3(a)(2)(iv) (providing a 
similar rule that excludes certain transactions from the application of 
section 367(a)(1)).
    (3) Definitions. For purposes of this section, the following 
definitions apply:
    (i) The terms P, S, and T have the meanings set forth in Sec. 
1.358-6(b)(1)(i), (ii), and (iii), respectively.
    (ii) The term property has the meaning set forth in section 317(a), 
except that the term property also includes--
    (A) A liability assumed by S to acquire the P stock or securities; 
and
    (B) S stock (or any rights to acquire S stock) to the extent such S 
stock (or rights to acquire S stock) is used by S to acquire P stock or 
securities from a person other than P.
    (iii) The term security means an instrument that constitutes a 
security for purposes of section 354 or 356.
    (iv) The term triangular reorganization has the meaning set forth in 
Sec. 1.358-6(b)(2).
    (b) General rules--(1) Deemed distribution. If this section applies, 
adjustments shall be made that have the effect of a distribution of 
property (with no built-in gain or loss) from S to P under section 301 
(deemed distribution). The amount of the deemed distribution shall equal 
the sum of the amount of money transferred by S, the amount of any 
liabilities that are assumed by S and constitute property, and the fair 
market value of other property transferred by S in the P acquisition in 
exchange for the P stock or P securities described in paragraph (i) or 
(ii), respectively, of this paragraph (b)(1)--
    (i) P stock received by T shareholders or securityholders in an 
exchange to which section 354 or 356 applies.
    (ii) P securities received by T shareholders or securityholders to 
the extent such securities are ``other property'' (within the meaning of 
section 356(d)).
    (2) Deemed contribution. If this section applies, adjustments shall 
be made that have the effect of a contribution of property (with no 
built-in gain or loss) by P to S in an amount equal to the amount of the 
deemed distribution from S to P under paragraph (b)(1) of this section 
(deemed contribution).
    (3) Timing of deemed distribution and deemed contribution. If P 
controls (within the meaning of section 368(c)) S at the time of the P 
acquisition, the adjustments described in paragraphs (b)(1) and (2) of 
this section shall be made as if the deemed distribution and deemed 
contribution, respectively, are separate transactions occurring 
immediately before the P acquisition. If P does not control (within the 
meaning of section 368(c)) S at the time of the P acquisition, the 
adjustments described in paragraphs (b)(1) and (2) of this section shall 
be made as if the deemed distribution and deemed contribution, 
respectively, are separate transactions occurring immediately after P 
acquires control of S, but prior to the triangular reorganization.
    (4) Application of other provisions. Nothing in this section shall 
prevent the application of other provisions of the Internal Revenue Code 
from applying to the P acquisition. For example, section 304 may apply 
to the P acquisition. Furthermore, section 1001 or 267 may apply to S's 
transfer of property to acquire P stock or securities from P

[[Page 492]]

or a person other than P. In addition, generally applicable provisions 
that apply to triangular reorganizations, such as Sec. 1.358-6 and 
Sec. 1.1032-2, shall apply to the triangular reorganization in a manner 
consistent with S acquiring the P stock or securities in exchange for 
property from P or a person other than P, as the case may be.
    (5) Example. The rules of this paragraph (b) are illustrated by the 
following example:
    (i) Facts. P, a publicly traded domestic corporation, owns all of 
the outstanding stock of FS, a foreign corporation, and all of the 
outstanding stock of US1, a domestic corporation that is a member of the 
P consolidated group. US1 owns all of the outstanding stock of FT, a 
foreign corporation, the fair market value of which is $100x. US1's 
basis in the FT stock is $100x, such that there is a no built-in gain or 
loss in the FT stock. FS has earnings and profits in excess of $100x. FS 
purchases $100x of P stock from the public on the open market in 
exchange for $100x of cash. Pursuant to foreign law, FT merges with and 
into FS in a triangular reorganization that qualifies under section 
368(a)(1)(A) by reason of section 368(a)(2)(D). In an exchange to which 
section 354 applies, US1 exchanges all the outstanding stock of FT for 
the $100x of P stock purchased by FS on the open market.
    (ii) Analysis. The triangular reorganization is described in 
paragraph (a)(1) of this section. P is a domestic corporation and FS is 
a foreign corporation. In connection with FS purchasing the $100x of P 
stock in exchange for property (cash), FS uses the P stock to acquire 
the FT property in a triangular reorganization, and US1 receives the P 
stock in an exchange to which section 354 applies. Furthermore, none of 
the exceptions of paragraphs (a)(2)(i) through (iii) of this section 
apply. Therefore, pursuant to paragraph (b)(1) of this section, 
adjustments are made that have the effect of a deemed distribution of 
property (with no built-in gain or loss) in the amount of $100x from FS 
to P under section 301. Pursuant to paragraph (b)(2) of this section, 
adjustments are made that have the effect of a deemed contribution of 
property (with no built-in gain or loss) in the amount of $100x by P to 
FS. Pursuant to paragraph (b)(3) of this section, the adjustments 
described in paragraphs (b)(1) and (2) of this section are made as if 
the deemed distribution and deemed contribution, respectively, are 
separate transactions occurring immediately before FS's purchase of the 
P stock on the open market. Generally applicable provisions apply to 
FS's purchase of the P stock on the open market (see, for example, 
section 304) and in determining certain tax consequences to P and FS as 
a result of the triangular reorganization (see, for example, Sec. 
1.358-6(d) and Sec. 1.1032-2(c)).
    (c) Collateral adjustments. This paragraph (c) provides additional 
rules that apply by reason of the deemed distribution and deemed 
contribution described in paragraphs (b)(1) and (b)(2), respectively, of 
this section.
    (1) Deemed distribution. A deemed distribution described in 
paragraph (b)(1) of this section shall be treated as occurring for all 
purposes of the Internal Revenue Code. Thus, for example, the ordering 
rules of section 301(c) apply to characterize the deemed distribution to 
P as a dividend from the earnings and profits of S, return of stock 
basis, or gain from the sale or exchange of property, as the case may 
be. Furthermore, sections 902 or 959 may apply to the deemed 
distribution if S is a foreign corporation, and sections 881, 882, 897, 
1442, or 1445 may apply to the deemed distribution if S is a domestic 
corporation. Appropriate corresponding adjustments shall be made to S's 
earnings and profits consistent with the principles of section 312.
    (2) Deemed contribution. A deemed contribution described in 
paragraph (b)(2) of this section shall be treated as occurring for all 
purposes of the Internal Revenue Code. Thus, for example, appropriate 
adjustments shall be made to P's basis in the S stock.
    (d) Anti-abuse rule. Appropriate adjustments shall be made pursuant 
to this section if, in connection with a triangular reorganization, a 
transaction is engaged in with a view to avoid the purpose of this 
section. For example, if S is created, organized, or funded to avoid the 
application of this section with respect to the earnings and profits of 
a corporation related (within the

[[Page 493]]

meaning of section 267(b)) to P or S, the earnings and profits of S will 
be deemed to include the earnings and profits of such related 
corporation for purposes of determining the consequences of the 
adjustments provided in this section, and appropriate corresponding 
adjustments will be made to account for the application of this section 
to the earnings and profits of such related corporation.
    (e) Effective/applicability date. This section applies to triangular 
reorganizations occurring on or after May 17, 2011. For triangular 
reorganizations that occur prior to May 17, 2011, see Sec. 1.367(b)-14T 
as contained in 26 CFR part 1 revised as of April 1, 2011.

[T.D. 9526, 76 FR 28893, May 19, 2011]



Sec. 1.367(b)-12  Subsequent treatment of amounts attributed or 
included in income.

    (a) In general. This section applies to distributions with respect 
to, or a disposition of, stock--
    (1) To which, in connection with an exchange occurring before 
February 23, 2000, an amount has been attributed pursuant to Sec. 
7.367(b)-9 or 7.367(b)-10 of this chapter (as in effect prior to 
February 23, 2000, see 26 CFR part 1 revised as of April 1, 1999); or
    (2) In respect of which, before February 23, 2000, an amount has 
been included in income or added to earnings and profits pursuant to 
Sec. 7.367(b)-7 or Sec. 7.367(b)-10 of this chapter (as in effect 
prior to February 23, 2000, see 26 CFR part 1 revised as of April 1, 
1999).
    (b) Applicable rules. See Sec. 7.367(b)-12(b) through (e) of this 
chapter (as in effect prior to January 11, 2001, see 26 CFR part 1 
revised as of April 1, 2000) for purposes of applying paragraph (a) of 
this section.
    (c) Effective date. This section applies to distributions or 
dispositions that occur on or after January 11, 2001.

[T.D. 8937, 66 FR 2257, Jan. 11, 2001]



Sec. 1.367(b)-13  Special rules for determining basis and holding 
period.

    (a) Scope and definitions--(1) Scope. This section provides special 
basis and holding period rules to determine the basis and holding period 
of stock of certain foreign surviving corporations held by a controlling 
corporation whose stock is issued in an exchange under section 354 or 
356 in a triangular reorganization. This section applies to transactions 
that are subject to section 367(b) as well as section 367(a), including 
transactions concurrently subject to sections 367(a) and (b).
    (2) Definitions. For purposes of this section, the following 
definitions apply:
    (i) A block of stock has the meaning provided in Sec. 1.1248-2(b).
    (ii) The terms P, S, and T have the meanings set forth in Sec. 
1.358-6(b)(1)(i), (ii), and (iii), respectively.
    (iii) A triangular reorganization is a reorganization described in 
Sec. 1.358-6(b)(2)(i), (ii), or (iii), or (v) (a forward triangular 
merger, triangular C reorganization, reverse triangular merger, or 
triangular G reorganization, respectively).
    (b) Determination of basis for exchanges of foreign stock or 
securities under section 354 or 356. For rules determining the basis of 
stock or securities in a foreign corporation received in a section 354 
or 356 exchange, see Sec. 1.358-2.
    (c) Determination of basis and holding period for triangular 
reorganizations--(1) Application. In the case of a triangular 
reorganization described in paragraph (a)(2)(ii) of this section, this 
paragraph (c) applies, if--
    (i)(A) Immediately before the transaction, either P is a section 
1248 shareholder with respect to S, or P is a foreign corporation and a 
United States person is a section 1248 shareholder with respect to both 
P and S; and
    (B) In the case of a reverse triangular merger, P's exchange of S 
stock is not described in Sec. 1.367(b)-3(a) and (b) or in Sec. 
1.367(b)-4(b)(1)(i), (2)(i), or (3); or
    (ii)(A) Immediately before the transaction, a shareholder of T is a 
section 1248 shareholder with respect to T, or a shareholder of T is a 
foreign corporation and a United States person is a section 1248 
shareholder with respect to both such foreign corporation and T; and
    (B) With respect to at least one of the exchanging shareholders 
described in paragraph (c)(1)(ii)(A) of this section, the exchange of T 
stock is not described in Sec. 1.367(b)-3(a) and (b) or in Sec. 
1.367(b)-4(b)(1)(i), (2)(i), or (3).

[[Page 494]]

    (2) Basis and holding period rules. In the case of a triangular 
reorganization described in paragraph (c)(1) of this section, each share 
of stock of the surviving corporation (S or T) held by P must be divided 
into portions attributable to the S stock and the T stock immediately 
before the exchange. See paragraph (e) of this section Examples 1 
through 4 for illustrations of this rule.
    (i) Portions attributable to S stock--(A) In the case of a forward 
triangular merger, a triangular C reorganization, or a triangular G 
reorganization, the basis and holding period of the portion of each 
share of surviving corporation stock attributable to the S stock is the 
basis and holding period of such share of stock immediately before the 
exchange.
    (B) In the case of a reverse triangular merger, the basis and 
holding period of the portion of each share of surviving corporation 
stock attributable to the S stock is the basis and the holding period 
immediately before the exchange of a proportionate amount of the S stock 
to which the portion relates. If P is a shareholder described in 
paragraph (c)(1)(i)(A) of this section with respect to S, and P 
exchanges two or more blocks of S stock pursuant to the transaction, 
then each share of the surviving corporation (T) attributable to the S 
stock must be further divided into separate portions to account for the 
separate blocks of stock in S.
    (C) If the value of S stock immediately before the triangular 
reorganization is less than one percent of the value of the surviving 
corporation stock immediately after the triangular reorganization, then 
P may determine its basis in the surviving corporation stock by applying 
the rules of paragraph (c)(2)(ii) of this section to determine the basis 
and holding period of the surviving corporation stock attributable to 
the T stock, and then increasing the basis of each share of surviving 
corporation stock by the proportionate amount of P's aggregate basis in 
the S stock immediately before the exchange (without dividing the stock 
of the surviving corporation into separate portions attributable to the 
S stock).
    (ii) Portions attributable to T stock--(A) If any exchanging 
shareholder of T stock is described in paragraph (c)(1)(ii) of this 
section, the basis and holding period of the portion of each share of 
stock in the surviving corporation attributable to the T stock is the 
basis and holding period immediately before the exchange of a 
proportionate amount of the T stock to which such portion relates. If 
any exchanging shareholder of T stock is described in paragraph 
(c)(1)(ii) of this section, and such shareholder exchanges two or more 
blocks of T stock pursuant to the transaction, then each share of 
surviving corporation stock attributable to the T stock must be further 
divided into separate portions to account for the separate blocks of T 
stock.
    (B) If no exchanging shareholder of T stock is described in 
paragraph (c)(1)(ii) of this section, the rules of Sec. 1.358-6 apply 
to determine the basis of the portion of each share of the surviving 
corporation attributable to T immediately before the exchange.
    (d) Special rules applicable to divided shares of stock--(1) In 
general--(i) Shares of stock in different blocks are aggregated into one 
divided portion for basis purposes, if such shares immediately before 
the exchange are owned by one or more shareholders that are--
    (A) Not section 1248 shareholders with respect to the corporation; 
or
    (B) Foreign corporate shareholders, provided that no United States 
persons are section 1248 shareholders with respect to both such foreign 
corporate shareholders and the corporation.
    (ii) For purposes of determining the amount of gain realized on the 
sale or exchange of stock that has a divided portion pursuant to 
paragraph (c) of this section, any amount realized on such sale or 
exchange will be allocated to each divided portion of the stock based on 
the relative fair market value of the stock to which the portion is 
attributable at the time the portions were created. See paragraph (e) 
Example 5 of this section.
    (iii) Shares of stock will no longer be required to be divided if 
section 1248 or section 964(e) would not apply to a disposition or 
exchange of such stock.

[[Page 495]]

    (2) Pre-exchange earnings and profits. All earnings and profits (or 
deficits) accumulated by a foreign corporation before the reorganization 
and attributable to a share (or block) of stock for purposes of section 
1248 are attributable to the divided portion of stock with the basis and 
holding period of that share (or block). See Sec. 1.367(b)-4(d).
    (3) Post-exchange earnings and profits. Any earnings and profits (or 
deficits) accumulated by the surviving corporation subsequent to the 
reorganization are attributed to each divided share of stock pursuant to 
section 1248 and the regulations thereunder. The amount of earnings and 
profits (or deficits) attributable to a divided share of stock is 
further attributed to the divided portions of such share of stock based 
on the relative fair market value of each divided portion of stock. See 
paragraph (e) Example 5 of this section.
    (e) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1. Blocks of stock exchanged in a triangular reorganization. 
(i) Facts. (A) US1, a domestic corporation, owns all the stock of F1, a 
foreign corporation. F1 owns all the stock of FT, a foreign corporation, 
with 100 shares of stock outstanding. Each share of FT stock is valued 
at $10x. Because F1 acquired the stock of FT at two different dates, F1 
owns two blocks of FT stock for purposes of section 1248. The first 
block consists of 60 shares. The shares in the first block have a basis 
of $300x ($5x per share), a holding period of 10 years, and $240x ($4x 
per share) of earnings and profits attributable to the shares for 
purposes of section 1248. The second block consists of 40 shares. The 
shares in the second block have a basis of $600x ($15x per share), a 
holding period of 2 years, and $80x ($2x per share) of earnings and 
profits attributable to the shares for purposes of section 1248.
    (B) US2, a domestic corporation, owns all of the stock of FP, a 
foreign corporation, which owns all of the stock of FS, a foreign 
corporation. FP owns two blocks of FS stock. Each block consists of 10 
shares with a value of $200x ($20x per share). The shares in the first 
block have a basis of $50x ($5x per share), a holding period of 10 
years, and $50x ($5x per share) of earnings and profits attributable to 
such shares for purposes of section 1248. The shares in the second block 
had a basis of $100x ($10x per share), a holding period of 5 years, and 
$20x ($2x per share) of earnings and profits attributable to such shares 
for purposes of section 1248.
    (C) FT merges into FS, with FS surviving, and F1 receives 50 shares 
of FP stock with a value of $1,000x in exchange for its FT stock. The 
merger of FT into FS qualifies as forward triangular merger, and 
immediately after the exchange US1 is a section 1248 shareholder with 
respect to F1, the exchanging shareholder, FP and FS, all of which are 
controlled foreign corporations.
    (ii) Basis and holding period determination. (1) US1 is a section 
1248 shareholder of F1, the exchanging shareholder, and FT (both of 
which are controlled foreign corporations) immediately before the 
transaction. Moreover, F1 is not required to include amounts in income 
under Sec. 1.367(b)-3(b) or 1.367(b)-4(b) as described in paragraph 
(c)(1)(ii)(B) of this section. Accordingly, the basis and holding period 
of the FS stock held by FP immediately after the triangular 
reorganization is determined pursuant to paragraph (c) of this section.
    (2) Pursuant to paragraph (c) of this section, each share of FS 
stock is divided into portions attributable to the basis and holding 
period of the FS stock held by FP immediately before the exchange (the 
FS portion) and the FT stock held by F1 immediately before the exchange 
(the FT portion). The basis and holding period of the FS portion is the 
basis and holding period of the FS stock held by FP immediately before 
the exchange. Thus, each share of FS stock in the first block has a 
portion with a basis of $5x, a value of $20x, a holding period of 10 
years, and $5x of earnings and profits attributable to such portion for 
purposes of section 1248. Each share of FS stock in the second block has 
a portion with a basis of $10x, a value of $20x, a holding period of 5 
years, and $2x of earnings and profits attributable to such portion for 
purposes of section 1248.
    (3) Because the exchanging shareholder of FT stock (F1) has a 
section 1248 shareholder (US1), the holding period and basis of the FT 
portion is the holding period and the proportionate amount of the basis 
of the FT stock immediately before the exchange to which such portion 
relates. Further, because F1 exchanged two blocks of FT stock, the FT 
portion must be divided into two separate portions attributable to the 
two blocks of FT stock. Thus, each share of FS stock will have a second 
portion with a basis of $15x ($300x basis / 20 shares), a value of $30x 
($600x value / 20 shares), a holding period of 10 years, and $12x of 
earnings and profits ($240x / 20 shares) attributable to such portion 
for purposes of section 1248. Each share of FS stock will have a third 
portion with a basis of $30x ($600x basis / 20 shares), a value of $20x 
($400x value / 20 shares), a holding period of 2 years, and $4x of 
earnings and profits ($80x / 20 shares) attributable to such portion for 
purposes of section 1248.
    (iii) Subsequent disposition--first block. Assume, immediately after 
the transaction, FP

[[Page 496]]

disposes of a share of FS stock from the first block. When FP disposes 
of any share of its FS stock, it is treated as disposing of each divided 
portion of such share. With respect to the first portion (attributable 
to the FS stock), FP recognizes a gain of $15x ($20x value - $5x basis), 
$5x of which is treated as a dividend under section 1248. With respect 
to the second portion (attributable to the first block of FT stock), FP 
recognizes a gain of $15x ($30x value - $15x basis), $12x of which is 
treated as a dividend under section 1248. With respect to the third 
portion (attributable to the second block of FT stock), FP recognizes a 
capital loss of $10x ($20x value - $30x basis).
    (iv) Subsequent disposition--second block. Assume further, 
immediately after the transaction, FP also disposes of a share of stock 
from the second block of FS stock. With respect to the first portion 
(attributable to the FS stock), FP recognizes a gain of $10x ($20x value 
- $10x basis), $2x of which is treated as a dividend under section 1248. 
With respect to the second portion (attributable to the first block of 
FT stock), FP recognizes a gain of $15x ($30x value - $15x basis), $12x 
of which is treated as a dividend under section 1248. With respect to 
the third portion (attributable to the second block of FT stock), FP 
recognizes a capital loss of $10x ($20x value - $30x basis).
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that FS merges into FT with FT surviving in a reverse triangular merger. 
Pursuant to the merger, F1 receives FP stock with a value of $1,000x in 
exchange for its FT stock, and FP receives 10 shares of FT stock with a 
value of $1,000x in exchange for its FS stock. Immediately after the 
exchange, US1 is a section 1248 shareholder with respect to F1, the 
exchanging shareholder, FP, and FT, all of which are controlled foreign 
corporations.
    (ii) Basis and holding period determination--(A) The basis and 
holding period of the stock of the surviving corporation held by FP are 
the same as in Example 1, except that each share of the surviving 
corporation (FT, instead of FS) will be divided into four portions 
instead of three portions. Because FP exchanges two blocks of FS stock, 
the FS portion must be divided into two separate portions attributable 
to the two blocks of FS stock. Because F1 exchanges two blocks of FT 
stock, the FT portion must be divided into two separate portions 
attributable to the two blocks of FT stock.
    (B) Thus, each share of the surviving corporation (FT) will have a 
first portion (attributable to the first block of FS stock) with a basis 
of $5x ($50x / 10 shares), a value of $20x ($200x / 10 shares), a 
holding period of 10 years, and $5x of earnings and profits ($50x / 10 
shares) attributable to such portion for purposes of section 1248. Each 
share of FT stock will have a second portion (attributable to the second 
block of FS stock) with a basis of $10x ($100x / 10 shares), a value of 
$20x ($200x / 10 shares), a holding period of 5 years, and $2x of 
earnings and profits ($20x / 10 shares) attributable to such portion for 
purposes of section 1248. Moreover, each share of FT stock will have a 
third portion (attributable to the first block of FT stock) with a basis 
of $30x ($300x basis / 10 shares), a value of $60x ($600x value / 10 
shares), a holding period of 10 years, and $24x of earnings and profits 
($240x / 10 shares) attributable to such portion for purposes of section 
1248. Lastly, each share of FT stock will have a fourth portion 
(attributable to the second block of FT stock) with a basis of $60x 
($600x basis / 10 shares), a value of $40x ($400x value / 10 shares), a 
holding period of 2 years, and $8x of earnings and profits ($80x / 10 
shares) attributable to such portion for purposes of section 1248.
    Example 3. (i) Facts. USP, a domestic corporation, owns all the 
stock of FS, a foreign corporation with 10 shares of stock outstanding. 
Each share of FS stock has a value of $10x, a basis of $5x, a holding 
period of 10 years, and $7x of earnings and profits attributable to such 
share for purposes of section 1248. FP, a foreign corporation, owns the 
stock of FT, another foreign corporation. FP and FT do not have any 
section 1248 shareholders. FT has assets with a value of $100x, a basis 
of $50x, and no liabilities. The FT stock held by FP has a value of 
$100x and a basis of $75x. FT merges into FS with FS surviving in a 
forward triangular merger. Pursuant to the reorganization, FP receives 
USP stock with a value of $100x in exchange for its FT stock.
    (ii) Basis and holding period determination--(A) Because USP is a 
section 1248 shareholder of FS immediately before the transaction, the 
basis and holding period of the FS stock held by USP immediately after 
the triangular reorganization is determined pursuant to paragraph (c) of 
this section.
    (B) Pursuant to paragraph (c) of this section, each share of FS 
stock is divided into portions attributable to the basis and holding 
period of the FS stock held by USP immediately before the exchange (the 
FS portion) and the FT portion immediately before the exchange. Because 
FT does not have a section 1248 shareholder immediately before the 
transaction, the rules of Sec. 1.358-6 apply to determine the basis of 
the FT portion of each share of FS stock. Those rules determine the 
basis of FS stock held by USP by reference to the basis of FT's net 
assets. The basis and holding period of the FS portion is the basis and 
holding period of the FS stock held by USP immediately before the 
exchange. Thus, each share of FS stock has a portion with a basis of 
$5x, a value of $10x, a holding period of 10 years, and $7x of earnings 
and profits attributable to such portion for section 1248 purposes. The 
basis of the FT portion is the

[[Page 497]]

basis of the FT assets to which such portion relates. Thus, each share 
of FS stock has a second portion with a basis of $5x ($50x basis in FT's 
assets / 10 shares) and a value of $10x ($100x value of FT's assets / 10 
shares). All of FS's earnings and profits prior to the transaction 
($70x) is attributed solely to the FS portion in each share of FS stock. 
As a result of each share of stock being divided into portions, the 
basis of the FS stock is not averaged with the basis of the FT assets to 
increase the section 1248 amount with respect to the stock of the 
surviving corporation (FS).
    Example 4. (i) Facts. US, a domestic corporation, owns all of the 
stock of FT, a foreign corporation. The FT stock held by US constitutes 
a single block of stock with a value of $1,000x, a basis of $600x, and 
holding period of 5 years. USP, a domestic corporation, forms FS, a 
foreign corporation, pursuant to the plan of reorganization and 
capitalizes it with $10x of cash. FS merges into FT with FT surviving in 
a reverse triangular merger and a reorganization described in section 
368(a)(1)(B). Pursuant to the reorganization, US receives USP stock with 
a value of $1,000x in exchange for its FT stock, and USP receives 10 
shares of FT stock with a value of $1,010x in exchange for its FS stock.
    (ii) Basis and holding period determination. (A) US and USP are 
section 1248 shareholders of FT and FS, respectively, immediately before 
the transaction. Neither US nor USP is required to include amounts in 
income under Sec. 1.367(b)-3(b) or 1.367(b)-4(b) as described in 
paragraph (c)(1)(i)(B) or (c)(1)(ii)(B) of this section. The basis and 
holding period of the FT stock held by USP is determined pursuant to 
paragraph (c) of this section.
    (B) Pursuant to paragraph (c) of this section, because the 
exchanging shareholder of FT stock (US) is a section 1248 shareholder of 
FT, each share of the surviving corporation (FT) has a proportionate 
amount of the basis and holding period of the FT stock immediately 
before the exchange to which such share relates. Thus, the portion of 
each share of FT stock attributable to the FT stock has a basis of $60x 
($600x basis / 10 shares), a value of $100x ($1,000x value / 10 shares), 
and a holding period of 5 years. Because the value of FS stock 
immediately before the triangular reorganization ($10x) is less than one 
percent of the value of the surviving corporation (FT) immediately after 
the triangular reorganization ($1,010x), USP may determine its basis in 
the stock of the surviving corporation (FT) attributable to its FS stock 
basis held prior to the reorganization by increasing the basis of each 
share of FT stock by the proportionate amount of USP's aggregate basis 
in the FS stock immediately before the exchange (without dividing each 
share of FT stock into separate portions to account for FS and FT). If 
USP so elects, USP's basis in each share of FT stock is increased by $1x 
($10x basis in FS stock / 10 shares). As a result, each share of FT 
stock has a basis of $61x, a value of $101x, and a holding period of 5 
years.
    Example 5. (i) Facts. US, a domestic corporation, owns all of the 
stock of F1, a foreign corporation, which owns all the stock of FT, a 
foreign corporation. The FT stock held by F1 constitutes one block of 
stock with a basis of $170x, a value of $200x, a holding period of 5 
years, and $10x of earnings and profits attributable to such stock for 
purposes of section 1248. FP, a foreign corporation, owns all the stock 
of FS, a foreign corporation. FS has 10 shares of stock outstanding. No 
United States person is a section 1248 shareholder with respect to FP or 
FS. The FS stock held by FP has a value of $100x and a basis of $50x 
($5x per share). FT merges into FS with FS surviving in a forward 
triangular merger. Pursuant to the merger, F1 receives FP stock with a 
value of $200x for its FT stock in an exchange that qualifies for non-
recognition under section 354. US is a section 1248 shareholder with 
respect to F1, the exchanging shareholder, FP, and FS (all of which are 
controlled foreign corporations) immediately after the exchange.
    (ii) Basis and holding period determination. (A) Because US is a 
section 1248 shareholder of F1, the exchanging shareholder, and FT 
immediately before the transaction, and US is a section 1248 shareholder 
of F1, FP, and FS immediately after the transactions, F1 is not required 
to include amounts in income under Sec. Sec. 1.367(b)-3(b) and 
1.367(b)-4(b) as described in paragraph (c)(1)(ii)(B) of this section. 
Thus, the basis and holding period of the FS stock held by FP 
immediately after the triangular reorganization is determined pursuant 
to paragraph (c) of this section.
    (B) Pursuant to paragraph (c) of this section, each share of FS 
stock is divided into portions attributable to the basis and holding 
period of the FS stock held by FP immediately before the exchange (the 
FS portion) and the FT stock held by F1 immediately before the exchange 
(the FT portion). The basis and holding period of the FS portion is the 
basis and holding period of the FS stock held by FP immediately before 
the exchange. Thus, each share of FS stock has a portion with a basis of 
$5x and a value of $10x. Because the exchanging shareholder of FT stock 
(F1) has a section 1248 shareholder of both F1 and FT, the basis and 
holding period of the FT portion is the proportionate amount of the 
basis and the holding period of the FT stock immediately before the 
exchange to which such portion relates. Thus, each share of FS stock 
will have a second portion with a basis of $17x ($170x basis / 10 
shares), a value of $20x ($200x value / 10 shares), a holding period of 
5 years, and $1x of earnings and profits ($10x earnings and profits / 10 
shares) attributable to such portion for purposes of section 1248.

[[Page 498]]

    (iii) Subsequent disposition. (A) Several years after the merger, FP 
disposes of all of its FS stock in a transaction governed by section 
964(e). At the time of the disposition, FS stock has decreased in value 
to $210x (a post-merger reduction in value of $90x), and FS has incurred 
a post-merger deficit in earnings and profits of $30x.
    (B) Pursuant to paragraph (d)(1)(ii) of this section, for purposes 
of determining the amount of gain realized on the sale or exchange of 
stock that has a divided portion, any amount realized on such sale or 
exchange is allocated to each divided portion of the stock based on the 
relative fair market value of the stock to which the portion is 
attributable at the time the portions were created. Immediately before 
the merger, the value of the FS stock in relation to the value of both 
the FS stock and the FT stock was one-third ($100x / ($100x plus 
$200x)). Likewise, immediately before the merger, the value of the FT 
stock in relation to the value of both the FT stock and the FS stock was 
two-thirds ($200x / $100x plus $200x). Accordingly, one-third of the 
$210x amount realized is allocated to the FS portion of each share and 
two-thirds to the FT portion of each share. Thus, the amount realized 
allocated to the FS portion of each share is $7x (one-third of $210x 
divided by 10 shares). The amount realized allocated to the FT portion 
of each share is $14x (two-thirds of $210x divided by 10 shares).
    (C) Pursuant to paragraph (d)(3) of this section, any earnings and 
profits (or deficits) accumulated by the surviving corporation 
subsequent to the reorganization are attributed to the divided portions 
of shares of stock based on the relative fair market value of each 
divided portion of stock. Accordingly, one-third of the post-merger 
earnings and profits deficit of $30x is allocated to the FS portion of 
each share and two-thirds to the FT portion of each share. Thus, the 
deficit in earnings and profits allocated to the FS portion of each 
share is $1x (one-third of $30x divided by 10 shares). The deficit in 
earnings and profits allocated to the FT portion of each share is $2x 
(two-thirds of $30x divided by 10 shares).
    (D) When FP disposes of its FS stock, FP is treated as disposing of 
each divided portion of a share of stock. With respect to the FS portion 
of each share of stock, FP recognizes a gain of $2x ($7x value - $5x 
basis), which is not recharacterized as a dividend because a deficit in 
earnings and profits of $1x is attributable to such portion for purposes 
of section 1248. With respect to the FT portion of each share of stock, 
FP recognizes a loss of $3x ($14x value - $17x basis).

    (f) Effective date. This section applies to exchanges occurring on 
or after January 23, 2006.

[T.D. 9243, 71 FR 4289, Jan. 26, 2006, as amended by T.D. 9400, 73 FR 
30303, May 27, 2008; T.D. 9446, 74 FR 6958, Feb. 11, 2009]



Sec. 1.367(d)-1  Transfers of intangible property to foreign 
corporations.

    (a) [Reserved]. For further guidance, see Sec. 1.367(d)-1T(a).
    (b) Property subject to section 367(d). Section 367(d) and the rules 
of this section apply to the transfer of intangible property, as defined 
in Sec. 1.367(a)-1(d)(5), by a U.S. person to a foreign corporation in 
an exchange described in section 351 or 361. See section 367(a) and the 
regulations thereunder for the rules that apply to the transfer of any 
property other than intangible property.
    (c)(1) through (2) [Reserved]. For further guidance, see Sec. 
1.367(d)-1T(c)(1) and (2).
    (3) Useful life--(i) In general. For purposes of determining the 
period of inclusions for deemed payments under Sec. 1.367(d)-1T(c)(1), 
the useful life of intangible property is the entire period during which 
exploitation of the intangible property is reasonably anticipated to 
affect the determination of taxable income, as of the time of transfer. 
Exploitation of intangible property includes any direct or indirect use 
or transfer of the intangible property, including use without further 
development, use in the further development of the intangible property 
itself (and any exploitation of the further developed intangible 
property), and use in the development of other intangible property (and 
any exploitation of the other developed intangible property).
    (ii) Procedure to limit inclusions to 20 years. In cases where the 
useful life of the transferred property is indefinite or is reasonably 
anticipated to exceed twenty years, taxpayers may, in lieu of including 
amounts during the entire useful life of the intangible property, choose 
in the year of transfer to increase annual inclusions during the 20-year 
period beginning with the first year in which the U.S. transferor takes 
into account income pursuant to section 367(d), to reflect amounts that, 
but for this paragraph (c)(3)(ii), would have

[[Page 499]]

been required to be included following the end of the 20-year period. 
See Sec. 1.6038B-1(d)(1)(iv) for guidance on reporting this choice of 
method. If the taxpayer applies this method during the 20-year period, 
no adjustments will be made for taxable years beginning after the 
conclusion of the 20-year period. However, for purposes of determining 
whether amounts included during the 20-year period are commensurate with 
the income attributable to the transferred intangible property, the 
Commissioner may take into account information with respect to taxable 
years after that period, such as the income attributable to the 
transferred property during those later years. The application of this 
paragraph (c)(3)(ii) must be reflected in a statement (titled 
``Application of 20-Year Inclusion Period to Section 367(d) Transfers'') 
attached to a timely filed original federal income tax return (including 
extensions) for the year of the transfer. An increase to the deemed 
payment rate made pursuant to this paragraph (c)(3)(ii) will be 
irrevocable, and a failure to timely file the statement under this 
paragraph (c)(3)(ii) may not be remedied.
    (iii) Example. Property subject to section 367(d) is transferred 
from USP, a domestic corporation, to FA, a foreign corporation wholly 
owned by USP. The useful life of the transferred property, inclusive of 
derivative works, at the time of transfer is indefinite but is 
reasonably anticipated to exceed 20 years. In the first five years 
following the transfer, sales related to the property are expected to be 
$100x, $130x, $160x, $180x and $187.2x, respectively. Thereafter, for 
the remainder of the property's useful life, sales are expected to grow 
by four percent annually. In the first five years following the 
transfer, operating profits attributable to the property are expected to 
be $5x, $8x, $11x, $12.5x, and $13x, respectively. Thereafter, for the 
remainder of the property's useful life, operating profits are expected 
to grow by four percent annually. It is determined that the appropriate 
discount rate for sales and operating profits is 10 percent. The present 
value of operating profits through the property's indefinite useful life 
is $185x. The present value of sales through the property's indefinite 
useful life is $2698x. Accordingly, the sales based royalty rate during 
the property's useful life is 6.8 percent ($185x/$2698x). The taxpayer 
may choose to take income inclusions into account over a 20-year period. 
The present value of sales through the 20-year period is $1787x. 
Accordingly, the sales based royalty rate under the 20-year option is 
increased to 10.3 percent ($185x/$1787x).

    (c)(4) through (g)(2) (introductory text) [Reserved]. For further 
guidance, see Sec. 1.367(d)-1T(c)(4) through (g)(2) (introductory 
text).
    (g)(2)(i) The intangible property transferred constitutes an 
operating intangible, as defined in Sec. 1.367(a)-1(d)(6).
    (g)(2)(ii) through (iii)(D) [Reserved]. For further guidance, see 
Sec. 1.367(d)-1T(g)(2)(ii) through (iii)(D).
    (E) The transferred intangible property will be used in the active 
conduct of a trade or business outside of the United States within the 
meaning of Sec. 1.367(a)-2 and will not be used in connection with the 
manufacture or sale of products in or for use or consumption in the 
United States.
    (g)(2)(iii) undesignated concluding paragraph [Reserved]. For 
further guidance, see Sec. 1.367(d)-1T(g)(2)(iii) undesignated 
concluding paragraph.
    (3) Intangible property transferred from branch with previously 
deducted losses. (i) If income is required to be recognized under 
section 904(f)(3) and the regulations thereunder or under Sec. 
1.367(a)-6 upon the transfer of intangible property of a foreign branch 
that had previously deducted losses, then the income recognized under 
those sections with respect to that property is credited against amounts 
that would otherwise be required to be recognized with respect to that 
same property under paragraphs (c) through (f) of this section in either 
the current or future taxable years. The amount recognized under section 
904(f)(3) or Sec. 1.367(a)-6 with respect to the transferred intangible 
property is determined in accordance with the following formula:

[[Page 500]]

[GRAPHIC] [TIFF OMITTED] TR16DE16.038

    (ii) For purposes of the formula in paragraph (g)(3)(i) of this 
section, the ``loss recapture income'' is the total amount required to 
be recognized by the U.S. transferor pursuant to section 904(f)(3) or 
Sec. 1.367(a)-6. The ``gain from intangible property'' is the total 
amount of gain realized by the U.S. transferor pursuant to section 
904(f)(3) and Sec. 1.367(a)-6 upon the transfer of items of property 
that are subject to section 367(d). ``Gain from intangible property'' 
does not include gain realized with respect to intangible property by 
reason of an election under paragraph (g)(2) of this section. The ``gain 
from all branch assets'' is the total amount of gain realized by the 
transferor upon the transfer of items of property of the branch for 
which gain is realized.
    (g)(4) through (i) [Reserved]. For further guidance, see Sec. 
1.367(d)-1T(g)(4) through (i).
    (j) Effective/applicability dates. This section applies to transfers 
occurring on or after September 14, 2015, and to transfers occurring 
before September 14, 2015, resulting from entity classification 
elections made under Sec. 301.7701-3 that are filed on or after 
September 14, 2015. For transfers occurring before this section is 
applicable, see Sec. 1.367(d)-1T as contained in 26 CFR part 1 revised 
as of April 1, 2016.

[T.D. 9803, 81 FR 91029, Dec. 16, 2016]



Sec. 1.367(d)-1T  Transfers of intangible property to foreign 
corporations (temporary).

    (a) Purpose and scope. This section provides rules under section 
367(d) concerning transfers of intangible property by U.S. persons to 
foreign corporations pursuant to section 351 or 361. Paragraph (b) of 
this section specifies the transfers that are subject to section 367(d) 
and the rules of this section, while paragraph (c) provides rules 
concerning the consequences of such a transfer. In general, the U.S. 
transferor will be treated as receiving annual payments contingent on 
productivity or use of the transferred property, over the useful life of 
the property (regardless of whether such payments are in fact made by 
the transferee). Paragraphs (d), (e), and (f) of this section provide 
rules for cases in which there is a later direct or indirect disposition 
of the intangible property transferred. In general, deemed annual 
license payments will continue if a transfer is made to a related 
person, while gain must be recognized immediately if the transfer is to 
an unrelated person. Paragraph (g) of this section provides several 
special rules, including a rule allowing appropriate adjustments where 
deemed payments under section 367(d) are not in fact received by the 
U.S. transferor of the intangible property, and a rule providing for a 
limited election to treat certain transfers of intangible property as 
sales at fair market value (in lieu of applying the general useful life-
contingent payment rule). In addition, paragraph (g) of this section 
provides rules coordinating the application of section 367(d) with other 
relevant Code sections. Paragraph (h) of this section defines the term 
related person for purposes of this section. Finally, paragraph (i) of 
this section provides the effective date of this section. For rules 
concerning transfers of intangible property pursuant to section 332, see 
Sec. 1.367(a)-5T(e). For purposes of determining whether a U.S. person 
has made a transfer of intangible property that is subject to the rules 
of section 367(d), the rules of Sec. 1.367(a)-1T(c) shall apply.
    (b) [Reserved]
    (c) Deemed payments upon transfer of intangible property to foreign 
corporation--(1) In general. If a U.S. person transfers intangible 
property that is subject to section 367(d) and the rules of this section 
to a foreign corporation in an exchange described in section 351 or 361, 
then such person shall be treated as having transferred that property in 
exchange for annual payments contingent on the productivity or use of 
the property. Such person shall, over the useful life of the property, 
annually include in gross income an amount

[[Page 501]]

that represents an appropriate arms-length charge for the use of the 
property. The appropriate charge shall be determined in accordance with 
the provisions of section 482 and regulations thereunder. See Sec. 
1.482-2(d). The amount of the deemed payment thus calculated shall be 
reduced by any royalty or other periodic payment made or accrued by the 
transferee to an unrelated person during that taxable year for the right 
to use the intangible property. Amounts so included in the transferor's 
income shall be treated as ordinary income from sources within the 
United States. For purposes of computing estimated tax payments, deemed 
payments under this paragraph (c) shall be treated as received by the 
transferor on the last day of its taxable year.
    (2) Required adjustments. The following adjustments shall be made 
with respect to a U.S. person's recognition of a deemed payment for the 
use of intangible property under this paragraph (c):
    (i) For purposes of chapter 1 of the Code, the earnings and profits 
of the transferee foreign corporation shall be reduced by the amount of 
such deemed payment; and
    (ii) For purposes of subpart F of part III of subchapter N of the 
Code, the transferee foreign corporation may treat such deemed payment 
as an expense (whether or not that amount is actually paid), properly 
allocated and apportioned to gross income subject to subpart F, in 
accordance with the provisions of Sec. Sec. 1.954-1(c) and 1.861-8.

No other special adjustments to earning the profits, basis, or gross 
income shall be permitted by reason of the recognition of a deemed 
payment under this paragraph (c). However, see paragraph (g)(1) of this 
section for rules permitting the establishment of an account receivable 
with respect to deemed payments not actually received by the U.S. 
person.
    (3) [Reserved]
    (4) Blocked income. No deemed payment included in a taxpayer's 
income under paragraph (c)(1) of this section shall be treated as 
deferrable income for purposes of applying rules relating to blocked 
foreign income. See Revenue Ruling 74-351, 1974-2 C.B. 144.
    (d) Subsequent transfer of stock of transferee foreign corporation 
to unrelated person--(1) Treatment as sale of intangible property. If a 
U.S. person transfers intangible property that is subject to section 
367(d) and the rules of this section to a foreign corporation in an 
exchange described in section 351 or 361, and within the useful life of 
the intangible property that U.S. transferor subsequently disposes of 
the stock of the transferee foreign corporation to a person that is not 
a related person (within the meaning of paragraph (h) of this section), 
then the U.S. transferor shall be treated as having simultaneously sold 
the intangible property to the person acquiring the stock of the 
transferee foreign corporation. The U.S. transferor shall be required to 
recognize gain (but not loss) from sources within the United States in 
an amount equal to the difference between the fair market value of the 
transferred intangible property on the date of the subsequent 
disposition and the U.S. transferor's former adjusted basis in that 
property (determined as of the original transfer). If the U.S. 
transferor's disposition of the stock of the transferee foreign 
corporation is subject to U.S. tax other than by reason of this 
paragraph (d), then the amount of gain otherwise required to be 
recognized with respect to the stock of the transferee foreign 
corporation shall be reduced by the amount of gain recognized with 
respect to the intangible property pursuant to this paragraph (d).
    (2) Required adjustments. If a U.S. person disposes of the stock of 
a transferee foreign corporation, and under paragraph (d)(1) of this 
section is treated as having simultaneously sold intangible property, 
then, for purposes of computing basis and earnings and profits, the 
person acquiring the stock of the transferee foreign corporation shall 
be deemed to have purchased that property at fair market value and to 
have immediately thereafter contributed it to the transferee foreign 
corporation in a transaction not covered by section 367(d). Therefore, 
for purposes of chapter 1 of the Code--
    (i) The transferee foreign corporation's basis in the intangible 
property will be equal to its fair market value

[[Page 502]]

(as calculated for purposes of determining the gain required to be 
recognized by the U.S. transferor);
    (ii) The acquiring person's basis in the stock of the transferee 
foreign corporation shall be determined as if no portion of the 
consideration given by the acquiring person for the stock is 
attributable to the intangible property; and
    (iii) The earnings and profits of the transferee foreign corporation 
will not be affected by the transfer of its stock or the deemed transfer 
to it of the intangible property.
    (e) Subsequent transfer of stock of transferee foreign corporation 
to related person--(1) Transfer to related U.S. person treated as 
disposition of intangible property. If a U.S. person transfers 
intangible property that is subject to section 367(d) and the rules of 
this section to a foreign corporation in an exchange described in 
section 351 or 361 and, within the useful life of the transferred 
intangible property, that U.S. transferor subsequently transfers the 
stock of the transferee foreign corporation to U.S. persons that are 
related to the transferor within the meaning of paragraph (h) of this 
section, then the following rules shall apply:
    (i) Each such related U.S. person shall be treated as having 
received (with the stock of the transferee foreign corporation) a right 
to receive a proportionate share of the contingent annual payments that 
would otherwise be deemed to be received by the U.S. transferor under 
paragraph (c) of this section.
    (ii) Each such related U.S. person shall, over the useful life of 
the property, annually include in gross income a proportionate share of 
the amount that would have been included in the income of the U.S. 
transferor pursuant to paragraph (c) of this section. Such amounts shall 
be treated as ordinary income from sources within the United States.
    (iii) The amount of income required to be recognized by the U.S. 
transferor pursuant to the rule of paragraph (d)(1) of this section 
shall be reduced to the amount determined in accordance with the 
following formula:

(d)(1) amount x (100% - (e) percentage)


For purposes of the above formula, the (d)(1) amount is the income that 
would otherwise be required to be recognized by the transferor 
corporation pursuant to paragraph (d)(1) of this section, and the (e) 
percentage is the percentage of the transferor corporation's total 
deemed rights to receive contingent annual payments under paragraph (c) 
of this section that is deemed to be transferred to related U.S. persons 
under the rules of this paragraph (e).
    (iv) The rules of paragraphs (d) and (e) of this section shall be 
reapplied in the case of any later transfer of the stock of the 
transferee foreign corporation by a related U.S. person that received 
such stock in a transfer that was subject to the rules of this paragraph 
(e). For purposes of reapplying the rules of paragraphs (d) and (e), 
each such related U.S. person shall be treated as a U.S. transferor of 
intangible property to the transferee foreign corporation (to the extent 
of the interest attributed to such person pursuant to subdivision (i) of 
this paragraph (e)(1)).
    (2) Required adjustments. If a U.S. person transfers stock of a 
transferee foreign corporation to a U.S. related person in a transaction 
that is subject to the rules of paragraph (e)(1) of this section, the 
following adjustments shall be made:
    (i) For purposes of chapter 1 of the Code, the earnings and profits 
of the transferee foreign corporation shall be reduced by the amount of 
any payment deemed to be received by a related U.S. person under 
paragraph (e)(1)(ii) of this section;
    (ii) For purposes of subpart F of part III of subchapter N of the 
Code, the transferee foreign corporation may allocate and apportion such 
deemed payments (whether or not such payments are actually made to gross 
income subject to subpart F to the extent appropriate under the 
provisions of Sec. Sec. 1.954-1(c) and 1.861-8;
    (iii) For purposes of reapplying the rules of paragraph (d) and (e) 
of this section, if the related U.S. person is deemed to have received a 
right to contingent annual payments for the use of intangible property, 
then the U.S. related person shall be deemed to have

[[Page 503]]

held a proportionate share of the property with a basis equal to a 
proportionate share of the U.S. transferor's adjusted basis plus the 
gain, if any, recognized by the U.S. transferor on the earlier transfer 
of the stock to the U.S. related person, and then to have transferred 
that proportionate share of the property to the foreign corporation in a 
transfer subject to section 367(d); and
    (iv) If the U.S. transferor is itself required to recognize gain 
upon the transfer by reason of the operation of paragraphs (d)(1) and 
(e)(1)(iii) of this section (because stock of the transferee foreign 
corporation is also transferred to unrelated persons), then those 
unrelated persons shall be deemed to have purchased a proportionate 
share of the transferred intangible property at fair market value and 
immediately contributed that property to the transferee foreign 
corporation, consistent with the general rule of paragraph (d)(2) of 
this section concerning transfers of stock to unrelated persons. 
Therefore, for purposes of chapter 1 of the Code--
    (A) Each unrelated person's basis in the stock of the transferee 
foreign corporation shall be increased to the extent of the gain 
recognized by the U.S. transferor upon the deemed purchase of intangible 
property by that person; and
    (B) The transferee foreign corporation will receive an increase in 
its basis in the transferred intangible property equal to the fair 
market value of that portion of the intangible property deemed to be 
contributed to the transferee foreign corporation by unrelated persons 
(as calculated for purposes of determining the gain required to be 
recognized by the U.S. transferor).
    (3) Transfer to related foreign person not treated as disposition of 
intangible property. If a U.S. person transfers intangible property that 
is subject to section 367(d) and the rules of this section to a foreign 
corporation in an exchange described in section 351 or 361, and within 
the useful life of the transferred intangible property, that U.S. 
transferor subsequently transfers any of the stock of the transferee 
foreign corporation to one or more foreign persons that are related to 
the transferor within the meaning of paragraph (h) of this section, then 
the U.S. transferor shall continue to include in its income the deemed 
payments described in paragraph (c) of this section in the same manner 
as if the subsequent transfer of stock had not occurred. The rule of 
this paragraph (e)(3) shall not apply with respect to the subsequent 
transfer by the U.S. person of any of the remaining stock to any related 
U.S. person or unrelated person.
    (4) Proportionate share. For purposes of this paragraph (e), any 
``proportionate share'' shall be determined by reference to the fair 
market value (at the time of the original transfer) of the stock of the 
transferee foreign corporation that was transferred by the U.S. 
transferor and the fair market value of all of the stock of the 
transferee foreign corporation originally received by the U.S. 
transferor.
    (f) Subsequent disposition of transferred intangible property by 
transferee foreign corporation--(1) In general. If a U.S. person 
transfers intangible property that is subject to section 367(d) and the 
rules of this section to a foreign corporation in an exchange described 
in section 351 or 361, and within the useful life of the intangible 
property that transferee foreign corporation subsequently disposes of 
the intangible property to an unrelated person, then--
    (i) The U.S. transferor of the intangible property (or any person 
treated as such pursuant to paragraph (e)(1) of this section) shall be 
required to recognize gain from U.S. sources (but not loss) in an amount 
equal to the difference between the fair market value of the transferred 
intangible property on the date of the subsequent disposition and the 
U.S. transferor's former adjusted basis in that property (determined as 
of the orginial transfer); and
    (ii) The U.S. transferor shall be required to recognize a deemed 
payment under paragraph (c) of this section for that part of its taxable 
year that the intangible property was held by the transferee foreign 
corporation and thereafter shall not be required to recognize any 
further deemed payments under paragraph (c) or (e)(1) of this section 
with respect to the transferred intangible property disposed of by the 
transferee foreign corporation.
    (2) Required adjustments. If a U.S. transferor is required to 
recognize gain

[[Page 504]]

under paragraph (f)(1) of this section, then--
    (i) For purposes of chapter 1 of the Code, the earnings and profits 
of the transferee foreign corporation shall be reduced by the amount of 
gain required to be recognized; and
    (ii) The U.S. transferor's recognition of gain will permit the 
establishment of an account receivable from the transferee foreign 
corporation, in accordance with paragraph (g)(1) of this section.
    (3) Subsequent transfer of intangible property to related person. 
The requirement that a U.S. person recognize gain under paragraph (c) or 
(e) of this section shall not be affected by the transferee foreign 
corporation's subsequent disposition of the transferred intangible 
property to a related person. For purposes of any required adjustments, 
and of any accounts receivable created under paragraph (g)(1) of this 
section, the related person that receives the intangible property shall 
be treated as the transferee foreign corporation.
    (g) Special rules--(1) Establishment of accounts receivable--(i) In 
general. If a U.S. person is required to recognize income under the 
provisions of paragraph (c), (e), or (f) of this section, and the amount 
deemed to be received is not actually paid by the transferee foreign 
corporation, then the U.S. person may establish an account receivable 
from the transferee foreign corporation equal to the amount deemed paid 
that was not actually paid. A separate account receivable must be 
established for each taxable year in which payments deemed to be 
received are not actually made. Payments received from the transferee 
foreign corporation must be designated as payments upon a particular 
account and must be deducted from that account. Accounts receivable 
under this paragraph (g)(1) may be established and paid without further 
U.S. income tax consequences to the U.S. transferor or the transferee 
foreign corporation. No interest shall be paid or accrued on an account 
receivable created under this paragraph (g)(1), nor shall any bad debt 
deduction be allowed under section 166 with respect to any failure to 
receive payment on an account.
    (ii) Unpaid receivable treated as contribution to capital. If any 
portion of an account receivable established under this paragraph (g)(1) 
remains unpaid as of the last day of the third taxable year following 
the taxable year to which the account relates, then--
    (A) Such portion shall be deemed to have been paid on that date; and
    (B) The U.S. person shall be deemed to have contributed an 
equivalent amount to the capital of the foreign corporation, and the 
U.S. person's basis in the stock of the foreign corporation shall, 
therefore, be increased by that amount.
    (2) Election to treat transfer as sale. A U.S. person that transfers 
intangible property to a foreign corporation in a transaction subject to 
section 367(d) may elect to recognize income in accordance with the 
rules of this paragraph (g)(2), if--
    (i) [Reserved]
    (ii) The transfer of the intangible property is either legally 
required by the government of the country in which the transferee 
corporation is organized as a condition of doing business in that 
country, or compelled by a genuine threat of immediate expropriation by 
the foreign government; or
    (iii)(A) The U.S. person transferred the intangible property to the 
foreign corporation within three months of the organization of that 
corporation and as part of the original plan of capitalization of that 
corporation;
    (B) Immediately after the transfer, the U.S. person owns at least 40 
percent but not more than 60 percent of the total voting power and total 
value of the stock of the transferee foreign corporation;
    (C) Immediately after the transfer, at least 40 percent of the total 
voting power and total value of the stock of the transferee foreign 
corporation is owned by foreign persons unrelated to the U.S. person;
    (D) Intangible property constitutes at least 50 percent of the fair 
market value of the property transferred to the foreign corporation by 
the U.S. transferor; and
    (E) [Reserved]


A person that makes the election under this paragraph (g)(2) shall not 
be subject to the provisions of paragraphs (c)

[[Page 505]]

through (f) of this section. Such person shall instead recognize in the 
year of the transfer ordinary income from sources within the United 
States in an amount equal to the difference between the fair market 
value of the intangible property transferred and its adjusted basis. A 
U.S. person shall make an election under this paragraph (g)(2) by 
notifying the Internal Revenue Service of the election in accordance 
with the requirements of section 6038B and regulations thereunder, and 
subsequently including the appropriate amounts in gross income in a 
timely filed tax return for the year of the transfer.
    (3) [Reserved]
    (4) Coordination with section 482--(i) In general. Section 367(d) 
and the rules of this section shall not apply in the case of an actual 
sale or license of intangible property by a U.S. person to a foreign 
corporation. If an adjustment under section 482 is required with respect 
to an actual sale or license of intangible property, then section 367(d) 
and the rules of this section shall not apply with respect to the 
required adjustment. If a U.S. person transfers intangible property to a 
related foreign corporation without consideration, or in exchange for 
stock or securities of the transferee in a transaction described in 
sections 351 or 361, no sale or license subject to adjustment under 
section 482 will be deemed to have occurred. Instead, the U.S. person 
shall be treated as having made a transfer of the intangible property 
that is subject to section 367(d).
    (ii) Sham licenses and sales. For purposes of paragraph (g)(4)(i) of 
this section, a purported sale or license of intangible property may be 
disregarded, and treated as a transfer subject to section 367(d) and the 
rules of this section, if--
    (A) The purported sale or license is made to a foreign corporation 
in which the transferor holds (or is acquiring) an interest; and
    (B) The terms of the purported sale or license differ so greatly 
from the economic substance of the transaction or the terms that would 
obtain between unrelated persons that the purported sale or license is a 
sham.

The terms of a purported sale or license, for purposes of applying the 
rule of this paragraph (g)(4)(ii), shall be determined by reference not 
only to the nominal terms of the agreement but also to the actual 
practice of the parties under that agreement. A sale or license of 
intangible property shall not be disregarded under this paragraph 
(g)(4)(ii) solely because other property of an integrated business is 
simultaneously transferred to the foreign corporation by the U.S. 
transferor in a transaction described in section 367(a)(1) or any 
statutory or regulatory exception to section 367(a)(1).
    (5) Determination of fair market value. For purposes of determining 
the gain required to be recognized immediately under paragraph (d), (f), 
or (g)(2) of this section, the fair market value of transferred property 
shall be the single payment arm's-length price that would be paid for 
the property by an unrelated purchaser determined in accordance with the 
principles of section 482 and regulations thereunder. The allocation of 
a portion of the purchase price to intangible property agreed to by the 
parties to the transaction shall not necessarily be controlling for this 
purpose.
    (6) Anti-abuse rule. If a U.S. person--
    (i) Transfers intangible property to a domestic corporation with a 
principal purpose of avoiding the effect of section 367(d) and the rules 
of this section; and
    (ii) Thereafter transfers the stock of that domestic corporation to 
a related foreign corporation,

then solely for purposes of section 367(d) that U.S. person shall be 
treated as having transferred the intangible property directly to the 
foreign corporation. A U.S. person shall be presumed to have transferred 
intangible property for a principal purpose of avoiding the effect of 
section 367(d) if the property is transferred to the domestic 
corporation less than two years prior to the transfer of the stock of 
that domestic corporation to a foreign corporation. The presumption 
created by the previous sentence may be rebutted by clear evidence that 
the subsequent transfer of the stock of the domestic transferee 
corporation was not contemplated at the time the intangible property was 
transferred to that corporation and that avoidance of section 367(d) and 
the rules of this section

[[Page 506]]

was not a principal purpose of the transaction. A transfer may have more 
than one principal purpose.
    (h) Related person. For purposes of this section, persons are 
considered to be related if--
    (1) They are partners or partnerships described in section 707(b)(1) 
of the Code; or
    (2) They are related within the meaning of section 267 (b), (c), and 
(f) of the Code, except that--
    (i) ``10 percent or more'' shall be substituted for ``more than 50 
percent'' each place it appears; and
    (ii) Section 1563 shall apply (for purposes of section 267(d)), 
without regard to section 1563(b)(2).
    (i) Effective date. Except as specifically provided to the contrary 
elsewhere in this section, this section applies to transfers occurring 
after December 31, 1984.

[T.D. 8087, 51 FR 17953, May 16, 1986, as amended by T.D. 8770, 63 FR 
33568, June 19, 1998; T.D. 9803, 81 FR 91030, Dec. 16, 2016]



Sec. 1.367(e)-0  Outline of Sec. Sec. 1.367(e)-1 and 1.367(e)-2.

    This section lists captioned paragraphs contained in Sec. Sec. 
1.367(e)-1 and 1.367(e)-2 as follows:

     Sec. 1.367(e)-1 Distributions described in section 367(e)(1).

    (a) Purpose and scope.
    (b) Gain recognition.
    (1) General rule.
    (2) Stock owned through partnerships, disregarded entities, trusts, 
and estates.
    (3) Gain computation.
    (4) Treatment of distributee.
    (c) Nonrecognition of gain.
    (d) Determining whether distributees are qualified U.S. persons.
    (1) General rule--presumption of foreign status.
    (2) Non-publicly traded distributing corporations.
    (3) Publicly traded distributing corporations.
    (i) Five percent shareholders.
    (ii) Other distributees.
    (4) Qualified exchange or other market.
    (e) Reporting under section 6038B.
    (f) Effective date.

     Sec. 1.367(e)-2 Distributions described in section 367(e)(2).

    (a) Purpose and scope.
    (1) In general.
    (2) Nonapplicability of section 367(a).
    (b) Distribution by a domestic corporation.
    (1) General rule.
    (i) Recognition of gain and loss.
    (ii) Operating rules.
    (A) General rule.
    (B) Overall loss limitation.
    (1) Overall loss limitation rule.
    (2) Example.
    (C) Special rules for built-in gains and losses attributable to 
property received in liquidations and reorganizations.
    (iii) Distribution of partnership interest.
    (A) General rule.
    (B) Gain or loss calculation. [Reserved]
    (C) Basis adjustments.
    (D) Publicly traded partnerships.
    (2) Exceptions.
    (i) Distribution of property used in a U.S. trade or business.
    (A) Conditions for nonrecognition.
    (B) Qualifying property.
    (C) Required statement.
    (1) Declaration and certification.
    (2) Property description.
    (3) Distributee identification.
    (4) Treaty benefits waiver.
    (5) Statute of limitations extension.
    (D) Failure to file statement.
    (E) Operating rules.
    (1) Gain or loss recognition by the foreign distributee corporation.
    (i) Taxable dispositions.
    (ii) Other triggering events.
    (2) Gain recognition by the domestic liquidating corporation.
    (i) General rule.
    (ii) Amended return.
    (iii) Interest.
    (iv) Joint and several liability.
    (3) Schedule for property no longer used in a U.S. trade or 
business.
    (4) Nontriggering events.
    (i) Conversions, certain exchanges, and abandonment.
    (ii) Amendment to Master Property Description
    (5) Nontriggering transfers to qualified transferees.
    (ii) Distribution of certain U.S. real property interests.
    (iii) Distribution of stock of domestic subsidiary corporations.
    (A) Conditions for nonrecognition.
    (B) Exceptions when the liquidating corporation is a U.S. real 
property holding corporation.
    (C) Anti-abuse rule.
    (D) Required statement.
    (3) Other consequences.
    (i) Distributee basis in property.
    (ii) Reporting under section 6038B.
    (iii) Other rules.
    (c) Distribution by a foreign corporation.
    (1) General rule--gain and loss not recognized.
    (2) Exceptions.

[[Page 507]]

    (i) Property used in a U.S. trade or business.
    (A) General rule.
    (B) Ten-year active U.S. business exception.
    (C) Required statement.
    (D) Operating rules.
    (ii) Property formerly used in a U.S. trade or business.
    (3) Other consequences.
    (i) Distributee basis in property.
    (ii) Other rules.
    (d) Anti-abuse rule.
    (e) Effective date.

[T.D. 8834, 64 FR 43075, Aug. 9, 1999]



Sec. 1.367(e)-1  Distributions described in section 367(e)(1).

    (a) Purpose and scope. This section provides rules for recognition 
(and nonrecognition) of gain by a domestic corporation (distributing 
corporation) on a distribution of stock or securities of a corporation 
(controlled corporation) to foreign persons that is described in section 
355. Paragraph (b) of this section contains the general rule that gain 
is recognized on the distribution to the extent stock or securities of 
controlled are distributed to foreign persons. Paragraph (c) of this 
section provides an exception to the gain recognition rule for 
distributions of stock or securities of a domestic corporation. 
Paragraph (d) of this section contains rules for determining whether 
distributees of stock or securities in a section 355 distribution are 
qualified U.S. persons. Paragraph (e) of this section provides cross-
references. Finally, paragraph (f) of this section specifies the 
effective date of this section.
    (b) Gain recognition--(1) General rule. If a domestic corporation 
makes a distribution of stock or securities of a corporation that 
qualifies for nonrecognition under section 355 to a person who is not a 
qualified U.S. person, then, except as provided in paragraph (c) of this 
section, the distributing corporation shall recognize gain (but not 
loss) on the distribution under section 367(e)(1). A distributing 
corporation shall not recognize gain under this section with respect to 
a section 355 distribution to a qualified U.S. person. For purposes of 
this section, a qualified U.S. person is--
    (A) A citizen or resident of the United States; or
    (B) A domestic corporation.
    (2) Stock owned through partnerships, disregarded entities, trusts, 
and estates. For purposes of this section, distributing corporation 
stock or securities owned by or for a partnership (whether foreign or 
domestic) are owned proportionately by its partners. A partner's 
proportionate share of the stock or securities of the distributing 
corporation shall be equal to the partner's distributive share of the 
gain that would have been recognized had the partnership sold the stock 
or securities (at a taxable gain) immediately before the distribution. 
The partner's distributive share of gain shall be determined under the 
rules and principles of sections 701 through 761 and the regulations 
thereunder. For purposes of this section, stock or securities owned by 
or for an entity that is disregarded as an entity separate from its 
owner (disregarded entity) under Sec. 301.7701-3 of this chapter are 
owned directly by the owner of such disregarded entity. For purposes of 
this section, stock or securities owned by or for a trust or estate 
(whether foreign or domestic) are owned proportionately by the persons 
who would be treated as owning such stock or securities under section 
318(a)(2)(A) and (B). In applying section 318(a)(2)(B)(i), if a trust 
includes interests that are not actuarially ascertainable, all such 
interests shall be considered to be owned by foreign persons. In a case 
where an interest holder in a partnership, a disregarded entity, trust, 
or estate that (directly or indirectly) owns stock of the distributing 
corporation is itself a partnership, disregarded entity, trust, or 
estate, the rules of this paragraph (b)(2) apply to such interest 
holder.
    (3) Gain computation. Gain recognized under paragraph (b)(1) of this 
section shall be equal to the excess of the fair market value of the 
stock or securities distributed to persons who are not qualified U.S. 
persons (determined as of the time of the distribution) over the 
distributing corporation's adjusted basis in the stock or securities 
distributed to such distributees. For purposes of the preceding 
sentence, the distributing corporation's adjusted basis in each unit of 
each class of stock or securities distributed to a distributee shall

[[Page 508]]

be equal to the distributing corporation's total adjusted basis in all 
of the units of the respective class of stock or securities owned 
immediately before the distribution, divided by the total number of 
units of the class of stock or securities owned immediately before the 
distribution.
    (4) Treatment of distributee. If the distribution otherwise 
qualifies for nonrecognition under section 355, each distributee shall 
be considered to have received stock or securities in a distribution 
qualifying for nonrecognition under section 355, even though the 
distributing corporation may recognize gain on the distribution under 
this section. Thus, the distributee shall not be considered to have 
received a distribution described in section 301 or a distribution in an 
exchange described in section 302(b) upon the receipt of the stock or 
securities of the controlled corporation, and the domestic distributing 
corporation shall have no withholding responsibilities under section 
1441. Except where section 897(e)(1) and the regulations thereunder 
cause gain to be recognized by the distributee, the basis of the 
distributed domestic or foreign corporation stock in the hands of the 
foreign distributee shall be the basis of the distributed stock 
determined under section 358 without any increase for any gain 
recognized by the domestic corporation on the distribution.
    (c) Nonrecognition of gain. A domestic distributing corporation 
shall not recognize gain under paragraph (b)(1) of this section on the 
distribution of stock or securities of a domestic corporation.
    (d) Determining whether distributees are qualified U.S. persons--(1) 
General rule--presumption of foreign status. Except as provided in 
paragraphs (d)(2) and (3) of this section, all distributions of stock or 
securities in a distribution described in section 355 in which the 
distributing corporation is domestic and the controlled corporation is 
foreign are presumed to be to persons who are not qualified U.S. 
persons, as defined in paragraph (b)(1) of this section.
    (2) Non-publicly traded distributing corporations. If the class of 
stock or securities of the distributing corporation (in respect to which 
stock or securities of the controlled corporation are distributed) is 
not regularly traded on a qualified exchange or other market (as defined 
in paragraph (d)(4) of this section), then the distributing corporation 
may only rebut the presumption contained in paragraph (d)(1) of this 
section by identifying the qualified U.S. persons to which controlled 
corporation stock or securities were distributed and by certifying the 
amount of stock or securities that were distributed to the qualified 
U.S. persons.
    (3) Publicly traded distributing corporations. If the class of stock 
or securities of the distributing corporation (in respect to which stock 
or securities of the controlled corporation are distributed) is 
regularly traded on a qualified exchange or other market (as defined in 
paragraph (d)(4) of this section), then the distributing corporation may 
only rebut the presumption contained in paragraph (d)(1) of this section 
as described in this paragraph (d)(3).
    (i) Five percent shareholders. A publicly traded distributing 
corporation may only rebut the presumption contained in paragraph (d)(1) 
of this section with respect to distributees that are five percent 
shareholders of the class of stock or securities of the distributing 
corporation (in respect to which stock or securities of the controlled 
corporation are distributed) by identifying the qualified U.S. persons 
to which controlled corporation stock or securities were distributed and 
by certifying the amount of stock or securities that were distributed to 
the qualified U.S. persons. A five percent shareholder is a distributee 
who is required under U.S. securities laws to file with the Securities 
and Exchange Commission (SEC) a Schedule 13D or 13G under 17 CFR 
240.13d-1 or 17 CFR 240.13d-2, and provide a copy of same to the 
distributing corporation under 17 CFR 240.13d-7.
    (ii) Other distributees. A distributing corporation that has made a 
distribution described in paragraph (d)(3) of this section may rebut the 
presumption contained in paragraph (d)(1) of this section with respect 
to distributees that are not five percent

[[Page 509]]

shareholders (as defined in this paragraph (d)(3)) by relying on and 
providing a reasonable analysis of shareholder records and other 
relevant information that demonstrates a number of distributees that are 
qualified U.S. persons. Taxpayers may rely on such analysis, unless it 
is subsequently determined that there are actually fewer distributees 
who are qualified U.S. persons than were demonstrated in the analysis.
    (4) Qualified exchange or other market. For purposes of paragraph 
(d) of this section, the term qualified exchange or other market means, 
for any taxable year--
    (i) A national securities exchange which is registered with the SEC 
or the national market system established pursuant to section 11A of the 
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
    (ii) A foreign securities exchange that is regulated or supervised 
by a governmental authority of the country in which the market is 
located and which has the following characteristics--
    (A) The exchange has trading volume, listing, financial disclosure, 
and other requirements designed to prevent fraudulent and manipulative 
acts and practices, to remove impediments to and perfect the mechanism 
of a free and open market, and to protect investors; and the laws of the 
country in which the exchange is located and the rules of the exchange 
ensure that such requirements are actually enforced; and
    (B) The rules of the exchange ensure active trading of listed 
stocks.
    (e) Cross-references. For additional rules relating to the 
distribution of the stock of a foreign corporation by a domestic 
corporation, see Sec. Sec. 1.367(a)-3(e), 1.367(a)-7, 1.367(b)-5, and 
1.1248(f)-1 through 1.1248(f)-3. See the regulations under section 6038B 
for reporting requirements for distributions under this section.
    (f) Effective/applicability date. This section shall be applicable 
to distributions occurring in taxable years ending after August 8, 1999.

[T.D. 8834, 64 FR 43076, Aug. 9, 1999; 65 FR 14467, Mar. 3, 2000, as 
amended by T.D. 9614, 78 FR 17041, Mar. 19, 2013; T.D. 9760, 81 FR 
15169, Mar. 22, 2016]



Sec. 1.367(e)-2  Distributions described in section 367(e)(2).

    (a) Purpose and scope--(1) In general. This section provides rules 
requiring gain and loss recognition by a corporation on its distribution 
of property to a foreign corporation in a complete liquidation described 
in section 332. Paragraph (b)(1) of this section contains the general 
rule that gain and loss are recognized when a domestic corporation makes 
a distribution of property in complete liquidation under section 332 to 
a foreign corporation that meets the stock ownership requirements of 
section 332(b) with respect to stock in the domestic corporation. 
Paragraph (b)(2) of this section provides the only exceptions to the 
gain and loss recognition rule of paragraph (b)(1) of this section. 
Paragraph (b)(3) of this section refers to other consequences of 
distributions described in paragraphs (b)(1) and (2) of this section. 
Paragraph (c)(1) of this section contains the general rule that gain and 
loss are not recognized when a foreign corporation makes a distribution 
of property in complete liquidation under section 332 to a foreign 
corporation that meets the stock ownership requirements of section 
332(b) with respect to stock in the foreign liquidating corporation. 
Paragraph (c)(2) of this section provides the only exceptions to the 
nonrecognition rule of paragraph (c)(1) of this section. Paragraph 
(c)(3) of this section refers to other consequences of distributions 
described in paragraphs (c)(1) and (2) of this section. Paragraph (d) of 
this section contains an anti-abuse rule. Paragraph (e) of this section 
provides rules regarding failures to file statements or other documents 
required under this section or failures to comply with the requirements 
of this section. Paragraph (f) of this section provides relief for 
certain failures to file or comply. Finally, paragraph (g) of this 
section specifies the effective/applicability dates for the rules of 
this section. The

[[Page 510]]

rules of this section are issued pursuant to the authority conferred by 
section 367(e)(2).
    (2) Nonapplicability of section 367(a). Section 367(a) shall not 
apply to a complete liquidation described in section 332 by a domestic 
liquidating corporation into a foreign corporation that meets the stock 
ownership requirements of section 332(b).
    (b) Distribution by a domestic corporation--(1) General rule--(i) 
Recognition of gain and loss. If a domestic corporation (domestic 
liquidating corporation) makes a distribution of property in complete 
liquidation under section 332 to a foreign corporation (foreign 
distributee corporation) that meets the stock ownership requirements of 
section 332(b) with respect to stock in the domestic liquidating 
corporation, then--
    (A) Section 337(a) and (b)(1) will not apply; and
    (B) The domestic liquidating corporation will recognize gain or loss 
on the distribution of property to the foreign distributee corporation, 
except as provided in paragraph (b)(2) of this section.
    (ii) Operating rules--(A) General rule. Except as provided in 
paragraphs (b)(1)(ii) (B) and (C) of this section, the rules contained 
in section 336 will apply to the gain and loss recognized pursuant to 
this section.
    (B) Overall loss limitation--(1) Overall loss limitation rule. Loss 
in excess of gain from the distribution shall not be recognized. If 
realized losses exceed recognized losses, the losses shall be recognized 
on a pro rata basis with respect to the realized loss attributable to 
each distributed loss asset in the category of assets (i.e., capital or 
ordinary) to which the realized but unrecognized loss relates. For 
additional limitations on the recognition of losses, see, e.g., section 
1211.
    (2) Example. The following example illustrates the overall loss 
limitation rule, the pro rata loss allocation method, and the general 
capital loss limitation rule in section 1211(a):

    Example. F, a foreign corporation, owns all stock of US1, a domestic 
corporation. US1 owns the following capital assets: Asset A, which has a 
fair market value of $100 and an adjusted basis of $40; Asset B, which 
has a fair market value of $60 and an adjusted basis of $80; and, Asset 
C, which has a fair market value of $40 and an adjusted basis of $100. 
US1 also owns the following business assets that will generate ordinary 
income (or loss) upon disposition: Asset D, which has a fair market 
value of $100 and an adjusted basis of $40; Asset E, which has a fair 
market value of $60 and an adjusted basis of $100; and, Asset F, which 
has a fair market value of $40 and an adjusted basis of $80. US1 
liquidates into F and distributes all assets to F in liquidation. None 
of the assets qualify for nonrecognition under paragraph (b)(2) of this 
section. US1's total realized capital loss is $80, but it may only 
recognize $60 of that loss. See section 1211(a). US1's total realized 
ordinary loss is $80, but it may only recognize $60 of that loss. See 
paragraph (b)(1)(ii)(B)(1) of this section. US1 will allocate $15 (60 x 
.25) of the recognized capital loss to Asset B and will allocate the 
remaining $45 (60 x .75) of recognized capital loss to Asset C. See 
paragraph (b)(1)(ii)(B)(1) of this section. US1 will allocate $30 (60 x 
.50) of the recognized ordinary loss to Asset E and will allocate the 
remaining $30 (60 x .50) to Asset F. See paragraph (b)(1)(ii)(B)(1) of 
this section.

    (C) Special rules for built-in gains and losses attributable to 
property received in liquidations and reorganizations. Built-in losses 
attributable to property received in a transaction described in sections 
332 or 361 (during the two-year period ending on the date of the 
distribution in liquidation covered by this section) shall not offset 
gain from property not received in the same transaction. Built-in gains 
attributable to property received in a transaction described in sections 
332 or 361 (during the two-year period ending on the date of the 
distribution in liquidation covered by this section) shall not be offset 
by a loss from property not received in the same transaction. Built-in 
gain or loss is that amount of gain or loss on property that existed at 
the time the domestic liquidating corporation acquired such property. 
See sections 336(d) and 382 for additional limitations on the 
recognition of losses.
    (iii) Distribution of partnership interest--(A) General rule. If a 
domestic corporation distributes a partnership interest (whether foreign 
or domestic) in a distribution described in paragraph (b)(1)(i) of this 
section, then for purposes of applying this section the domestic 
liquidating corporation shall be

[[Page 511]]

treated as having distributed a proportionate share of partnership 
property. Accordingly, the applicability of the recognition rules of 
paragraphs (b)(1) (i) and (ii) of this section, and of any exception to 
recognition provided in this section shall be determined with reference 
to the partnership property, rather than to the partnership interest 
itself. Where the partnership property includes an interest in a lower-
tier partnership, the applicability of any exception with respect to the 
interest in the lower-tier partnership shall be determined with 
reference to the lower-tier partnership property. In the case of 
multiple tiers of partnerships, the applicability of an exception shall 
be determined with reference to the property of each partnership, 
applying the rule contained in the preceding sentence. A domestic 
liquidating corporation's proportionate share of partnership property 
shall be determined under the rules and principles of sections 701 
through 761 and the regulations thereunder.
    (B) Gain or loss calculation. [Reserved]
    (C) Basis adjustments. The foreign distributee corporation's basis 
in the distributed partnership interest shall be equal to the domestic 
liquidating corporation's basis in such partnership interest immediately 
prior to the distribution, increased by the amount of gain and reduced 
by the amount of loss recognized by the domestic liquidating corporation 
on the distribution of the partnership interest. Solely for purposes of 
sections 743 and 754, the foreign distributee corporation shall be 
treated as having purchased the partnership interest for an amount equal 
to the foreign corporation's adjusted basis therein.
    (D) Publicly traded partnerships. The distribution by a domestic 
liquidating corporation of an interest in a publicly traded partnership 
that is treated as a corporation for U.S. income tax purposes under 
section 7704(a) shall not be subject to the rules of paragraphs 
(b)(1)(iii) (A) and (B) of this section. Instead, the distribution of 
such an interest shall be treated in the same manner as a distribution 
of stock. Thus, a transfer of an interest in a publicly traded 
partnership that is treated as a U.S. corporation for U.S. income tax 
purposes shall be treated in the same manner as stock in a domestic 
corporation, and a transfer of an interest in a publicly traded 
partnership that is treated as a foreign corporation for U.S. income tax 
purposes shall be treated in the same manner as stock in a foreign 
corporation.
    (2) Exceptions--(i) Distribution of property used in a U.S. trade or 
business--(A) Conditions for nonrecognition. A domestic liquidating 
corporation shall not recognize gain or loss under paragraph (b)(1) of 
this section on its distribution of property (including inventory) used 
by the domestic liquidating corporation in the conduct of a trade or 
business within United States, if--
    (1) The foreign distributee corporation, immediately thereafter and 
for the ten-year period beginning on the date of the distribution of 
such property, uses the property in the conduct of a trade or business 
within the United States;
    (2) The domestic liquidating corporation attaches the statement 
described in paragraph (b)(2)(i)(C) of this section to its timely filed 
U.S. income tax returns for the taxable years that include the 
distributions in liquidation; and
    (3) The foreign distributee corporation attaches a copy of the 
property description contained in paragraph (b)(2)(i)(C)(2) of this 
section to its timely filed U.S. income tax returns for the tax year 
that includes the date of distribution.
    (B) Qualifying property. Property is used by the foreign distributee 
corporation in the conduct of a trade or business in the United States 
within the meaning of this paragraph (b)(2)(i) only if all income from 
the use of the property and all income or gain from the sale or exchange 
of the property would be subject to taxation under section 882(a) as 
effectively connected income. Also, stock held by a dealer as inventory 
or for sale in the ordinary course of its trade or business shall be 
treated as inventory and not as stock in the hands of both the domestic 
liquidating corporation and the distributee foreign corporation. 
Notwithstanding the foregoing, the exception provided in this paragraph 
(b)(2)(i) shall not apply to intangibles described in section 
936(h)(3)(B).

[[Page 512]]

    (C) Required statement. The statement required by paragraph 
(b)(2)(i)(A) of this section shall be entitled ``Required Statement 
under Sec. 1.367(e)-2(b)(2)(i)'' and shall be prepared by the domestic 
liquidating corporation and signed under penalties of perjury by an 
authorized officer of the domestic liquidating corporation and by an 
authorized officer of the foreign distributee corporation. The statement 
shall contain the following items:
    (1) A declaration that the distribution to the foreign distributee 
corporation is one to which the rules of this paragraph (b)(2)(i) apply 
and a certification that the domestic liquidating corporation and the 
foreign distributee corporation agree to comply with all the conditions 
and requirements of this section, including, as provided in paragraph 
(e)(4)(ii)(B) of this section, to treat a failure to comply (as 
described in paragraph (e)(4)(i) of this section) as extending the 
period of limitations on assessment of tax for the taxable year in which 
gain is required to be reported.
    (2) Property description. A description of all property distributed 
by the domestic liquidating corporation (irrespective of whether the 
property qualifies for nonrecognition). Such description shall be 
entitled ``Master Property Description'' and shall identify the property 
that continues to be used by the foreign distributee corporation in the 
conduct of a trade or business within the United States, including the 
location, adjusted basis, estimated fair market value, a summary of the 
method (including appraisals if any) used for determining such value, 
and the date of distribution of such items of property. The description 
shall also identify the property excepted from gain recognition under 
paragraphs (b)(2)(ii) and (iii) of this section.
    (3) Distributee identification. An identification of the foreign 
distributee corporation, including its name and address, taxpayer 
identification number, residence, and place of incorporation.
    (4) Treaty benefits waiver. With respect to property entitled to 
nonrecognition pursuant to this paragraph (b)(2)(i), a declaration by 
the foreign distributee corporation that it irrevocably waives any right 
under any treaty (whether or not currently in force at the time of the 
liquidation) to sell or exchange any item of such property without U.S. 
income taxation or at a reduced rate of taxation, or to derive income 
from the use of any item of such property without U.S. income taxation 
or at a reduced rate of taxation.
    (5) Statute of limitations extension. An agreement by the domestic 
liquidating corporation and the foreign distributee corporation to 
extend the statute of limitations on assessments and collections (under 
section 6501) with respect to the domestic liquidating corporation on 
the distribution of each item of property until three years after the 
date on which all such items of property have ceased to be used in a 
trade or business within the United States, but in no event shall the 
extension be for a period longer than 13 years from the filing of the 
original U.S. income tax return for the taxable year of the last 
distribution of any such item of property. The agreement to extend the 
statute of limitation shall be executed on a Form 8838, ``Consent to 
Extend the Time to Assess Tax Under Section 367--Gain Recognition 
Agreement.''
    (D) Failure to file statement. If a domestic liquidating corporation 
that would otherwise qualify for nonrecognition on the distribution of 
property under this paragraph (b)(2)(i) fails to file the statement 
described in paragraph (b)(2)(i)(C) of this section or files a statement 
that does not comply with the requirements of paragraph (b)(2)(i)(C) of 
this section, the Commissioner may treat the domestic liquidating 
corporation as if it had claimed nonrecognition under this paragraph 
(b)(2)(i) and met all the requirements of paragraph (b)(2)(i)(C) of this 
section, if such treatment is necessary to prevent the domestic 
liquidating corporation or the foreign distributee corporation from 
otherwise deriving a tax benefit by such failure.
    (E) Operating rules. By the domestic liquidating corporation's 
claiming nonrecognition under this paragraph (b)(2)(i) and filing a 
statement described in paragraph (b)(2)(i)(C) of this section, the 
domestic liquidating corporation and the foreign distributee corporation 
agree to be subject to the rules of this paragraph (b)(2)(i)(E).

[[Page 513]]

    (1) Gain or loss recognition by the foreign distributee 
corporation--(i) Taxable dispositions. If, within the ten-year period 
from the date of a distribution of qualifying property, the foreign 
distributee corporation disposes of any qualifying property in a 
transaction subject to tax under section 882(a), then the foreign 
distributee corporation shall recognize such gain (or loss) and properly 
report it on a timely filed U.S. income tax return. If the foreign 
distributee corporation recognizes gain (or loss) under this paragraph 
(b)(2)(i)(E)(1)(i) and properly reports such gain (or loss) on its U.S. 
income tax return, then the domestic liquidating corporation shall not 
recognize gain attributable to such property under paragraph 
(b)(2)(i)(E)(2) of this section.
    (ii) Other triggering events. If, within the ten-year period from 
the date of distribution, any qualifying property ceases to be used by 
the foreign distributee corporation in the conduct of a trade or 
business in the United States (other than by reason of a taxable 
disposition described in paragraph (b)(2)(i)(E)(1)(i) of this section, a 
nontriggering event described in paragraph (b)(2)(i)(E)(4) of this 
section, or a nontriggering transfer described in paragraph 
(b)(2)(i)(E)(5) of this section), then the foreign distributee 
corporation shall recognize gain (but not loss) attributable to such 
property and properly report it on a timely filed U.S. income tax 
return. If the foreign distributee corporation properly reports gain 
under this paragraph (or if such qualified property is not gain property 
on the date that it ceases to be used in the foreign distributee 
corporation's U.S. trade or business), then the domestic liquidating 
corporation shall not recognize gain attributable to such property under 
paragraph (b)(2)(i)(E)(2) of this section. The gain recognized under 
this paragraph (b)(2)(i)(E)(1)(ii) shall be an amount equal to the fair 
market value of the property on the date it ceases to be used in the 
foreign distributee corporation's U.S. trade or business less the 
foreign distributee corporation's adjusted basis in such property.
    (2) Gain recognition by the domestic liquidating corporation--(i) 
General rule. If, within the ten-year period from the date of 
distribution, any qualifying property described in paragraph 
(b)(2)(i)(B) of this section ceases to be used by the foreign 
distributee corporation (or a qualifying transferee described in 
paragraph (b)(2)(i)(E)(5) of this section) in the conduct of a trade or 
business in the United States for any reason (including but not limited 
to the sale or exchange of such property or the removal of the property 
from conduct of the trade or business), then, except to the extent gain 
(or loss) is recognized under paragraph (b)(1)(i)(E)(1) of this section, 
the domestic liquidating corporation shall recognize the gain (but not 
loss) realized but not recognized upon the initial distribution of such 
item of property. The domestic liquidating corporation shall recognize 
gain pursuant to this paragraph (b)(2)(i)(E)(2)(i) on the amended U.S. 
income tax return described in paragraph (b)(2)(i)(E)(2)(ii) of this 
section.
    (ii) Amended return. If gain recognition is required pursuant to 
paragraph (b)(2)(i)(E)(2)(i) of this section, the foreign distributee 
corporation shall file an amended U.S. income tax return on behalf of 
the domestic liquidating corporation for the year of the distribution of 
such item of property. On the amended return, the domestic liquidating 
corporation may use any losses (or credits) existing in the year of the 
distribution to offset the gain recognized pursuant to paragraph 
(b)(2)(i)(E)(2)(i) of this section (or the tax thereon), provided that 
the losses (or credits) were otherwise available in the year 
distribution and were not used in another year. The amended return shall 
be filed no later than the due date (including extensions) for the 
return of the foreign distributee corporation for the taxable year in 
which the property ceases to be used by the foreign distributee 
corporation in the conduct of a trade or business in the United States.
    (iii) Interest. If the domestic liquidating corporation owes 
additional tax pursuant to paragraph (b)(2)(i)(E)(2)(i) of this section 
for the year of liquidation, then interest must be paid on that amount 
at the rates determined under section 6621. The interest due

[[Page 514]]

will be calculated from the due date of the domestic liquidating 
corporation's U.S. income tax return for the year of the distribution to 
the date on which the additional tax for that year is paid.
    (iv) Joint and several liability. The foreign distributee 
corporation shall be jointly and severally liable for any tax owed by 
the domestic liquidating corporation as a result of the application of 
this section, and shall succeed to the domestic liquidating 
corporation's agreement to extend the statute of limitations on 
assessments and collections under section 6501.
    (3) Schedule for property no longer used in a U.S. trade or 
business. If qualifying property (other than inventory) ceases to be 
used by the foreign distributee corporation in the conduct of a U.S. 
trade or business in the ten-year period beginning on the date of 
distribution of such property from the domestic liquidating corporation 
to the foreign distributee corporation, then the foreign distributee 
corporation shall list on a separate schedule (attached to its timely 
filed U.S. income tax returnfor the year of cessation) all such 
qualifying property. For purposes of this paragraph (b)(2)(i)(E)(3), 
property ceases to be used in a U.S. trade or business whenever such 
property is sold, exchanged, or otherwise removed from the U.S. trade or 
business, irrespective of whether the domestic liquidating corporation 
filed an amended return under paragraph (b)(2)(i)(E)(2) of this section, 
and irrespective of whether the property ceases to be used in the 
foreign distributee corporation's U.S. trade or business by virtue of a 
nontriggering event described in paragraph (b)(2)(i)(E)(4) of this 
section or a nontriggering transfer described in paragraph 
(b)(2)(i)(E)(5) of this section.
    (4) Nontriggering events--(i) Conversions, certain exchanges, and 
abandonment. Gain (or loss) under this paragraph (b)(2)(i)(E) shall not 
be triggered if qualifying property described in paragraph (b)(2)(i)(B) 
of this section is involuntarily converted into, or exchanged for, 
similar qualifying property used in the conduct of a trade or business 
in the United States, to the extent such conversion or exchange 
qualifies for nonrecognition under section 1033 or 1031. Also, the 
abandonment or disposal of worthless or obsolete property shall not 
trigger gain (or loss) under this paragraph (b)(2)(i)(E).
    (ii) Amendment to Master Property Description. If the foreign 
distributee corporation acquires replacement property by virtue of a 
conversion or exchange of the qualifying property under this paragraph 
(b)(2)(i)(E)(4), then the foreign distributee corporation shall attach 
to its timely filed U.S. income tax return for the year of the 
acquisition such replacement property a schedule entitled ``Amendment to 
Master Property Description Required by Sec. 1.367(e)-2(b)(2)(i)'' that 
lists the replacement property and the property being replaced.
    (5) Nontriggering transfers to qualified transferees. Gain (or loss) 
under this paragraph (b)(2)(i)(E) will not be triggered if qualifying 
property described in paragraph (b)(2)(i)(B) of this section is 
transferred to another person (qualified transferee) in a transaction 
qualifying for nonrecognition under the Internal Revenue Code (other 
than transactions described in paragraphs (b)(2)(i)(E)(4)(i) and (c)(1) 
of this section), if--
    (i) The qualified transferee (and all other subsequent qualified 
transferees), immediately thereafter and for the ten-year period 
beginning on the date of the initial distribution of such qualifying 
property from the domestic liquidating corporation to the foreign 
distributee corporation, uses the property in the conduct of a trade or 
business in the United States;
    (ii) The foreign distributee corporation (or its successor in 
interest) prepares and attaches to its timely filed U.S. income tax 
return for the year of transfer a statement entitled ``Required 
Statement under Sec. 1.367(e)-2(b)(2)(i)(E)(5) for Property Transferred 
to a Qualified Transferee'' that is signed under penalties of perjury by 
an authorized officer of the foreign distributee corporation and by a 
person similarly authorized by the qualified transferee;
    (iii) The statement described in paragraph (b)(2)(i)(E)(5)(ii) of 
this section

[[Page 515]]

shall contain a description of all qualifying property transferred by 
the foreign distributee corporation (or qualified transferee) to the 
qualified transferee (or subsequent qualified transferee);
    (iv) The statement described in paragraph (b)(2)(i)(E)(5)(ii) of 
this section shall also contain an identification of the qualified 
transferee (or subsequent qualified transferee), including its name and 
address, taxpayer identification number, residence, and place of 
incorporation (if applicable);
    (v) The statement described in paragraph (b)(2)(i)(E)(5)(ii) of this 
section shall also contain a declaration by the qualifying transferee 
(or subsequent qualifying transferee) that it irrevocably waives any 
right under any treaty (whether or not currently in force at the time of 
the liquidation) to sell or exchange any item of such property without 
U.S. income taxation or at a reduced rate of taxation, or to derive 
income from the use of any item of such qualifying property without U.S. 
income taxation or at a reduced rate of taxation; and
    (vi) A declaration that the transfer to the qualifying transferee 
(or subsequent qualifying transferee) is one to which the rules of this 
paragraph (b)(2)(i)(E)(5) apply and a certification that the foreign 
distributee corporation (or its successor in interest) and the 
qualifying transferee (or subsequent qualifying transferee) agree to all 
of the terms and conditions set forth in paragraph (b)(2)(i)(E)(1) of 
this section, replacing ``foreign distributee corporation'' with 
``qualifying transferee'' and replacing references to ``section 882(a)'' 
with ``section 871(b)'' (as the case may be).
    (ii) Distribution of certain U.S. real property interests. A 
domestic liquidating corporation shall not recognize gain (or loss) 
under paragraph (b)(1) of this section on the distribution of a U.S. 
real property interest (other than stock in a former U.S. real property 
holding corporation that is treated as a U.S. real property interest for 
five years under section 897(c)(1)(A)(ii)). If property distributed by 
the domestic liquidating corporation is a U.S. real property interest 
that qualifies for nonrecognition under this paragraph (b)(2)(ii) in 
addition to nonrecognition provided by paragraph (b)(2)(i) of this 
section, then the domestic liquidating corporation shall secure 
nonrecognition pursuant to this paragraph (b)(2)(ii) and not pursuant to 
the provisions of paragraph (b)(2)(i) of this section.
    (iii) Distribution of stock of domestic subsidiary corporations--(A) 
Conditions for nonrecognition. A domestic liquidating corporation shall 
not recognize gain or loss under paragraph (b)(1) of this section on a 
distribution of stock of an 80 percent domestic subsidiary corporation, 
if the domestic liquidating corporation attaches a statement described 
in paragraph (b)(2)(iii)(D) of this section to its timely filed U.S. 
income tax return for the year of the distribution of such stock. For 
purposes of this paragraph (b)(2)(iii), a corporation is an 80 percent 
domestic subsidiary corporation, if--
    (1) The subsidiary corporation is a domestic corporation (but not a 
foreign corporation that has made an election under section 897(i) to be 
treated as a U.S. corporation for purposes of section 897);
    (2) The domestic liquidating corporation owns (directly and without 
regard to paragraph (b)(1)(iii) of this section) at least 80 percent of 
the total voting power of the stock of such corporation; and
    (3) The domestic liquidating corporation owns (directly and without 
regard to paragraph (b)(1)(iii) of this section) at least 80 percent of 
the total value of all stock of such corporation.
    (B) Exceptions when the liquidating corporation is a U.S. real 
property holding corporation. If the domestic liquidating corporation is 
a U.S. real property holding corporation (as defined in section 
897(c)(2)) at the time of liquidation (or is a former U.S. real property 
holding corporation the stock of which is treated as a U.S. real 
property interest for five years under section 897(c)(1)(A)(ii)), then 
the exception in paragraph (b)(2)(iii)(A) of this section shall apply 
only to the distribution of stock of an 80 percent domestic subsidiary 
corporation that is a U.S. real property holding corporation (as defined 
in section 897(c)(2)) at the time of

[[Page 516]]

the liquidation and immediately thereafter.
    (C) Anti-abuse rule. (1) The exception in paragraph (b)(2)(iii)(A) 
of this section shall not apply, if a principal purpose of the 
distribution of the 80 percent domestic subsidiary corporation's stock 
is the avoidance of U.S. tax that would have been imposed on the 
domestic liquidating corporation's disposition of such stock when taken 
together to an unrelated party. A distribution may have a principal 
purpose of tax avoidance even though the tax avoidance purpose is 
outweighed by other purposes when taken together.
    (2) For purposes of paragraph (b)(2)(iii)(C)(1) of this section, a 
distribution of stock of the 80 percent domestic subsidiary corporation 
will be deemed to have been made pursuant to a plan, one of the 
principal purposes of which was the avoidance of U.S. tax, if the 
foreign distributee corporation disposes of (whether in a recognition or 
nonrecognition transaction) any such stock within two years of such 
distribution. The rule in this paragraph (b)(2)(iii)(C)(2) will not 
apply if the foreign distributee corporation can demonstrate to the 
satisfaction of the Commissioner that the avoidance of U.S. tax was not 
a principal purpose of the liquidation.
    (D) Required statement. The statement required by paragraph 
(b)(2)(iii)(A) of this section shall be entitled ``Required Statement 
under Sec. 1.367(e)-2(b)(2)(iii) for Stock of 80 Percent Domestic 
Subsidiary Corporations'' and shall be prepared by the domestic 
liquidating corporation and shall be signed under penalties of perjury 
by an authorized officer of the domestic liquidating corporation and by 
an authorized officer of the foreign distributee corporation. The 
required statement shall contain a certification that states that if the 
foreign distributee corporation disposes of any stock subject to 
paragraph (b)(2)(iii)(A) of this section in a transaction described in 
paragraph (b)(2)(iii)(C) of this section, then the domestic liquidating 
corporation shall recognize all realized gain attributable to the 
distributed stock at the time of distribution, and the domestic 
liquidating corporation (or the foreign distributee corporation on 
behalf of the domestic liquidating corporation) shall file a U.S. income 
tax return (or amended U.S. income tax return, as the case may be) for 
the year of distribution reporting the gain attributable to such stock. 
The required statement shall also state that the domestic liquidating 
corporation agrees, as provided in paragraph (e)(4)(ii)(B) of this 
section, to treat a failure to comply (as described in paragraph 
(e)(4)(i) of this section) as extending the period of limitations on 
assessment of tax for the taxable year in which gain is required to be 
reported.
    (3) Other consequences--(i) Distributee basis in property. The 
foreign distributee corporation's basis in property subject to this 
paragraph (b) shall be the same as the domestic liquidating 
corporation's basis in such property immediately before the liquidation, 
increased by any gain, or reduced by any loss recognized by the domestic 
liquidating corporation on such property pursuant to paragraph (b)(1) of 
this section.
    (ii) Reporting under section 6038B. Section 6038B and the 
regulations thereunder apply to a domestic liquidating corporation's 
transfer of property to a foreign distributee corporation under section 
367(e)(2).
    (iii) Other rules. For other rules that may apply, see sections 381, 
897, 1248, and Sec. 1.482-1(f)(2)(i)(C).
    (c) Distribution by a foreign corporation--(1) General rule--gain 
and loss not recognized. If a foreign corporation (foreign liquidating) 
makes a distribution of property in complete liquidation under section 
332 to a foreign corporation (foreign distributee) that meets the stock 
ownership requirements of section 332(b) with respect to stock in the 
foreign liquidating corporation, then, except as provided in paragraph 
(c)(2) of this section, section 337 (a) and (b)(1) shall apply and the 
foreign liquidating corporation shall not recognize gain (or loss) on 
the distribution under section 367(e)(2). If a foreign liquidating 
corporation distributes a partnership interest (whether foreign or 
domestic), then such corporation shall be treated as having distributed 
a proportionate share of partnership property in accordance with the 
principles of paragraph (b)(1)(iii) of this section.

[[Page 517]]

    (2) Exceptions--(i) Property used in a U.S. trade or business--(A) 
General rule. A foreign liquidating corporation (including a corporation 
that has made an effective election under section 897(i)) that makes a 
distribution described in paragraph (c)(1) of this section shall 
recognize gain (or loss in accordance with principles contained in 
paragraph (b)(1)(ii) of this section) on the distribution of qualified 
property, as described in paragraph (b)(2)(i)(B) of this section (other 
than U.S. real property interests), that is used by the foreign 
liquidating corporation in the conduct of a trade or business within the 
United States at the time of distribution.
    (B) Ten-year active U.S. business exception. A foreign liquidating 
corporation shall not recognize gain under paragraph (c)(2)(i)(A) of 
this section, if--
    (1) The foreign distributee corporation, immediately thereafter and 
for the ten-year period beginning on the date of the distribution of 
such property, uses the property in the conduct of a trade or business 
in the United States;
    (2) The foreign distributee corporation is not entitled to benefits 
under a comprehensive income tax treaty (this requirement shall apply 
only if the foreign liquidating corporation (or predecessor corporation) 
was not entitled to benefits under a comprehensive income tax treaty); 
and
    (3) The foreign liquidating corporation and foreign distributee 
corporation attach the statement described in paragraph (c)(2)(i)(C) of 
this section to their timely filed U.S. income tax returnsfor their 
taxable years that include the distribution.
    (C) Required statement. The statement required by paragraph 
(c)(2)(i)(B)(3) of this section shall be entitled ``Required Statement 
under Sec. 1.367(e)-2(c)(2)(i),'' shall be prepared by foreign 
liquidating corporation, shall be signed under penalties of perjury by 
an authorized officer of the foreign liquidating corporation and by an 
authorized officer of the foreign distributee corporation, and shall be 
identical to the statement described in paragraph (b)(2)(i)(C) of this 
section, except that ``Sec. 1.367(e)-2(c)(2)(i)(B)'' shall be 
substituted for references to ``Sec. 1.367(e)-2(b)(2)(i)'' and 
``foreign liquidating corporation'' shall be substituted for ``domestic 
liquidating corporation'' each time it appears. References in the rules 
of paragraph (b)(2)(i)(C) of this section to various rules in paragraph 
(b) of this section shall be applied as if such references were to this 
paragraph (c). However, the statement described in this paragraph 
(c)(2)(i)(C) shall be modified as follows:
    (1) The foreign distributee corporation shall not be required to 
waive its income tax treaty benefits as required by Sec. 1.367(e)-
2(b)(2)(i)(C)(4), unless--
    (i) The foreign liquidating corporation was required to waive its 
treaty benefits under paragraph (b)(2)(i)(C)(4) of this section in 
connection with the distribution of such property in a prior liquidation 
distribution subject to the provisions of this section; or (ii) The 
foreign distributee corporation is entitled benefits under a treaty to 
which the foreign liquidating corporation was not entitled.
    (2) If the foreign distributee is required to waive treaty benefits 
because of paragraph (c)(2)(i)(C)(1)(ii) of this section, then the 
foreign distributee shall only be required to waive benefits that were 
not available to the foreign liquidating corporation (or a predecessor 
corporation) prior to liquidation.
    (3) The property description described in paragraph (b)(2)(i)(C)(2) 
of this section shall include only the qualified U.S. trade or business 
property described in paragraph (c)(2)(i) of this section.
    (D) Operating rules. By the foreign liquidating corporation's 
claiming nonrecognition under paragraph (c)(2)(i)(B) of this section and 
filing a statement described in paragraph (c)(2)(i)(C) of this section, 
the foreign liquidating corporation and the foreign distributee 
corporation agree to be subject to the rules of paragraph (c)(2)(i) of 
this section, as well as the rules of paragraphs (b)(2)(i)(D) and (E) of 
this section. In applying the rules of paragraphs (b)(2)(i)(D) and (E) 
of this section, ``foreign liquidating corporation'' shall

[[Page 518]]

be used instead of ``domestic liquidating corporation'' each time it 
appears. References in the rules of paragraphs (b)(2)(i)(D) and (E) of 
this section to various rules in paragraph (b) of this section shall be 
applied as if such references were to this paragraph (c).
    (ii) Property formerly used in a United States trade or business. A 
foreign liquidating corporation that makes a distribution described in 
paragraph (c)(1) of this section shall recognize gain (but not loss) on 
the distribution of property (other than U.S. real property interests) 
that had ceased to be used by the foreign liquidating corporation in the 
conduct of a U.S. trade or business within the ten-year period ending on 
the date of distribution and that would have been subject to section 
864(c)(7) had it been disposed. Section 864(c)(7) shall govern the 
treatment of any gain recognized on the distribution of assets described 
in this paragraph as income effectively connected with the conduct of a 
trade or business within the United States.
    (3) Other consequences--(i) Distributee basis in property. The 
foreign distributee corporation's basis in property subject to this 
paragraph (c) shall be the same as the foreign liquidating corporation's 
basis in such property immediately before the liquidation, increased by 
any gain, or reduced by any loss recognized by the foreign liquidating 
corporation on such property, pursuant to paragraph (c)(2) of this 
section.
    (ii) Other rules. For other rules that may apply, see sections 
367(b) and 381.
    (d) Anti-abuse rule. The Commissioner may require a domestic 
liquidating corporation to recognize gain on a distribution in 
liquidation described in paragraph (b) of this section (or treat the 
liquidating corporation as if it had recognized loss on a distribution 
in liquidation), if a principal purpose of the liquidation is the 
avoidance of U.S. tax (including, but not limited to, the distribution 
of a liquidating corporation's earnings and profits with a principal 
purpose of avoiding U.S. tax). A liquidation may have a principal 
purpose of tax avoidance even though the tax avoidance purpose is 
outweighed by other purposes when taken together.
    (e) Failures to file or failures to comply--(1) Scope. This 
paragraph (e) provides rules regarding a failure to file an initial 
liquidation document with respect to one or more liquidating 
distributions by a domestic liquidating corporation that, absent such 
failure, would qualify for nonrecognition treatment under paragraph 
(b)(2)(i) or (iii) of this section, or with respect to one or more 
liquidating distributions by a foreign liquidating corporation that, 
absent such failure, would qualify for nonrecognition treatment under 
paragraph (c)(2)(i)(B) of this section (failure to file). This paragraph 
(e) also provides rules regarding failures to comply in all material 
respects with the terms of this section with respect to one or more 
liquidating distributions for which nonrecognition treatment was 
initially claimed under paragraph (b)(2)(i), (b)(2)(iii), or 
(c)(2)(i)(B) of this section, as applicable (failure to comply).
    (2) Definitions. The following definitions apply for purposes of 
this section.
    (i) An initial liquidation document means any statement, schedule, 
or form required to be filed under this section in order for the 
domestic liquidating corporation or foreign liquidating corporation, as 
applicable, to initially qualify to claim nonrecognition treatment with 
respect to one or more liquidating distributions described in this 
section, including--
    (A) The statement and attachments described in paragraph 
(b)(2)(i)(C) of this section;
    (B) The statement described in paragraph (b)(2)(iii)(D) of this 
section; and
    (C) The statement and attachments described in paragraph 
(c)(2)(i)(C) of this section.
    (ii) A subsequent liquidation document means any statement, 
schedule, or form (other than an initial liquidation document) required 
to be filed under this section in order for the domestic liquidating 
corporation or foreign liquidating corporation, as applicable, to 
continue to qualify for nonrecognition treatment with respect to one or 
more liquidating distributions described in this section, including--
    (A) The schedule described in paragraph (b)(2)(i)(E)(3) of this 
section;

[[Page 519]]

    (B) The schedule described in paragraph (b)(2)(i)(E)(4)(ii) of this 
section; and
    (C) The statement and attachments described in paragraph 
(b)(2)(i)(E)(5) of this section.
    (iii) A timely filed U.S. income tax return means a Federal income 
tax return filed on or before the last date prescribed for filing 
(taking into account any extensions of time therefor) such return.
    (3) Failure to file--(i) General rule. For purposes of this section 
and except as provided in paragraph (b)(2)(i)(D) or (f) of this section, 
there is a failure to file an initial liquidation document if--
    (A) An initial liquidation document is not filed with the timely 
filed U.S. income tax return specified under this section, or
    (B) An initial liquidation document is not completed in all material 
respects.
    (ii) Consequences of a failure to file. If there is a failure to 
file an initial liquidation document, then nonrecognition treatment 
under paragraph (b)(2)(i), (b)(2)(iii), or (c)(2)(i)(B) of this section 
(as appropriate) will not apply.
    (4) Failure to comply--(i) General rule. For purposes of this 
section and except as provided in paragraph (b)(2)(i)(D) or (f) of this 
section, a failure to comply includes--
    (A) A failure to report gain, or pay any additional tax or interest 
due, in accordance with the requirements under this section; and
    (B) A failure to file a subsequent liquidation document, as 
determined by applying paragraph (e)(3)(i) of this section, but 
replacing the term ``initial liquidation document'' with the term 
``subsequent liquidation document.''
    (ii) Consequences of a failure to comply. If there is a failure to 
comply in any material respect with the terms of paragraph (b)(2)(i), 
(b)(2)(iii), or (c)(2)(i) of this section, as applicable, then--
    (A) Any gain (but not loss) that was not previously recognized by 
the domestic liquidating corporation or foreign liquidating corporation, 
as applicable, under paragraph (b)(2)(i), (b)(2)(iii), or (c)(2)(i)(B) 
of this section must be recognized; and
    (B) The period of limitations on assessment of tax for the taxable 
year in which gain is required to be reported will be extended until the 
close of the third full taxable year ending after the date on which the 
domestic liquidating corporation, foreign distributee corporation, or 
foreign liquidating corporation, as applicable, furnishes to the 
Director of Field Operations, Cross Border Activities Practice Area of 
Large Business & International (or any successor to the roles and 
responsibilities of such position, as appropriate) (Director) the 
information that should have been provided under this section.
    (f) Relief for certain failures to file or failures to comply that 
are not willful--(1) In general. This paragraph (f) provides relief if 
there is a failure to file an initial liquidation document as described 
in paragraph (e)(3)(i) of this section (failure to file), or a failure 
to comply in any material respect with the terms of this section as 
described in paragraph (e)(4)(i) of this section (failure to comply). A 
failure to file or a failure to comply will be deemed not to have 
occurred for purposes of paragraph (e)(3)(ii) or (e)(4)(ii) of this 
section if the taxpayer demonstrates that the failure was not willful 
using the procedure set forth in this paragraph (f). For this purpose, 
willful is to be interpreted consistent with the meaning of that term in 
the context of other civil penalties, which would include a failure due 
to gross negligence, reckless disregard, or willful neglect. Whether a 
failure to file or failure to comply was willful will be determined by 
the Director (as described in paragraph (e)(4)(ii)(B) of this section) 
based on all the facts and circumstances. The taxpayer must submit a 
request for relief and an explanation as provided in paragraph (f)(2)(i) 
of this section. Although a taxpayer whose failure to file or failure to 
comply is determined not to be willful will not be subject to gain or 
loss recognition under this section, the taxpayer will be subject to a 
penalty under section 6038B if the taxpayer fails to satisfy the 
reporting requirements, if any, under that section and does not 
demonstrate that the failure was due to reasonable cause and not willful 
neglect. See Sec. 1.6038B-1(e)(4) and (f). The determination of whether 
the failure to file or failure to comply was willful under this section 
has no effect

[[Page 520]]

on any request for relief made under Sec. 1.6038B-1(f).
    (2) Procedures for establishing that a failure to file or failure to 
comply was not willful--(i) Time and manner of submission. A taxpayer's 
statement that a failure to file or failure to comply was not willful 
will be considered only if, promptly after the taxpayer becomes aware of 
the failure, an amended return is filed for the taxable year to which 
the failure relates that includes the information that should have been 
included with the original return for such taxable year or that 
otherwise complies with the rules of this section, and that includes a 
written statement explaining the reasons for the failure. In the case of 
a liquidating distribution described in paragraph (b)(2)(iii) of this 
section, the taxpayer must file, with the amended return, a Form 8838 
extending the period of limitations on assessment of tax with respect to 
the gain realized but not recognized with respect to the liquidating 
distribution to the close of the third full taxable year ending after 
the date on which the required information is provided to the Director. 
In the case of a liquidating distribution described in paragraph 
(b)(2)(i) or (c)(2)(i)(B) of this section, the taxpayer must file, with 
the amended return, a Form 8838 extending the period of limitations on 
the assessment of tax with respect to the gain realized but not 
recognized with respect to the liquidating distribution to the later of: 
the date provided in paragraph (b)(2)(i)(C)(5), taking into account 
paragraph (c)(2)(i)(C) and (D), as applicable (date one); or, the close 
of the third full taxable year ending after the date on which the 
required information is provided to the Director (date two). However, 
the taxpayer is not required to file a Form 8838 with the amended return 
if both date one is later than date two and a Form 8838 was previously 
filed extending the period of limitations on assessment of tax with 
respect to the gain realized but not recognized with respect to the 
liquidating distribution to date one. If a Form 8838 is not required to 
be filed pursuant to the previous sentence, a copy of the previously 
filed Form 8838 must be filed with the amended return. The amended 
return and either a Form 8838 or a copy of the previously filed Form 
8838, as the case may be, must be filed with the Internal Revenue 
Service at the location where the taxpayer filed its original return. 
The taxpayer may submit a request for relief from the penalty under 
section 6038B as part of the same submission. See Sec. 1.6038B-1(f).
    (ii) Notice requirement. In addition to the requirements of 
paragraph (f)(2)(i) of this section, the taxpayer must comply with the 
notice requirements of this paragraph (f)(2)(ii). If any taxable year of 
the taxpayer is under examination when the amended return is filed, a 
copy of the amended return and any information required to be included 
with such return must be delivered to the Internal Revenue Service 
personnel conducting the examination. If no taxable year of the taxpayer 
is under examination when the amended return is filed, a copy of the 
amended return and any information required to be included with such 
return must be delivered to the Director.
    (3) For illustrations of the application of the willfulness standard 
of this paragraph (f), see the examples in Sec. 1.367(a)-8(p)(3).
    (g) Effective/applicability dates. Except as otherwise provided, 
this section applies to distributions occurring on or after September 7, 
1999 or, if the taxpayer so elects, to distributions in taxable years 
ending after August 8, 1999. The ninth, tenth, and eleventh sentences of 
paragraph (a) of this section, and paragraphs (b)(1)(i), 
(b)(2)(i)(A)(2), (b)(2)(i)(A)(3), (b)(2)(i)(E)(3), (b)(2)(i)(E)(4)(ii), 
(b)(2)(i)(E)(5)(ii), (b)(2)(iii)(A), (c)(2)(i)(B)(3), (e), and (f) of 
this section will apply to liquidation documents that are required to be 
filed on or after November 19, 2014, as well as to requests for relief 
submitted on or after November 19, 2014.

[T.D. 8834, 64 FR 43077, Aug. 9, 1999; 65 FR 11467, Mar. 3, 2000, as 
amended by T.D. 9066, 68 FR 39452, July 2, 2003; T.D. 9704, 79 FR 68771, 
Nov. 19, 2014; 80 FR 167, Jan. 5, 2015; T.D. 9803, 81 FR 91030, Dec. 16, 
2016]

                        special rule; definitions



Sec. 1.368-1  Purpose and scope of exception of reorganization 
exchanges.

    (a) Reorganizations. As used in the regulations under parts I, II, 
and III

[[Page 521]]

(section 301 and following), subchapter C, chapter 1 of the Code, the 
terms reorganization and party to a reorganization mean only a 
reorganization or a party to a reorganization as defined in subsections 
(a) and (b) of section 368. In determining whether a transaction 
qualifies as a reorganization under section 368(a), the transaction must 
be evaluated under relevant provisions of law, including the step 
transaction doctrine. But see Sec. Sec. 1.368-2 (f) and (k) and 1.338-
3(d). The preceding two sentences apply to transactions occurring after 
January 28, 1998, except that they do not apply to any transaction 
occurring pursuant to a written agreement which is binding on January 
28, 1998, and at all times thereafter. With respect to insolvency 
reorganizations, see part IV, subchapter C, chapter 1 of the Code.
    (b) Purpose. Under the general rule, upon the exchange of property, 
gain or loss must be accounted for if the new property differs in a 
material particular, either in kind or in extent, from the old property. 
The purpose of the reorganization provisions of the Code is to except 
from the general rule certain specifically described exchanges incident 
to such readjustments of corporate structures made in one of the 
particular ways specified in the Code, as are required by business 
exigencies and which effect only a readjustment of continuing interest 
in property under modified corporate forms. Requisite to a 
reorganization under the Internal Revenue Code are a continuity of the 
business enterprise through the issuing corporation under the modified 
corporate form as described in paragraph (d) of this section, and 
(except as provided in section 368(a)(1)(D)) a continuity of interest as 
described in paragraph (e) of this section. (For rules regarding the 
continuity of interest requirement under section 355, see Sec. 1.355-
2(c).) For purposes of this section, the term issuing corporation means 
the acquiring corporation (as that term is used in section 368(a)), 
except that, in determining whether a reorganization qualifies as a 
triangular reorganization (as defined in Sec. 1.358-6(b)(2)), the 
issuing corporation means the corporation in control of the acquiring 
corporation. The preceding three sentences apply to transactions 
occurring after January 28, 1998, except that they do not apply to any 
transaction occurring pursuant to a written agreement which is binding 
on January 28, 1998, and at all times thereafter. The continuity of 
business enterprise requirement is described in paragraph (d) of this 
section. Notwithstanding the requirements of this paragraph (b), for 
transactions occurring on or after February 25, 2005, a continuity of 
the business enterprise and a continuity of interest are not required 
for the transaction to qualify as a reorganization under section 
368(a)(1)(E) or (F). The Code recognizes as a reorganization the 
amalgamation (occurring in a specified way) of two corporate enterprises 
under a single corporate structure if there exists among the holders of 
the stock and securities of either of the old corporations the requisite 
continuity of interest in the new corporation, but there is not a 
reorganization if the holders of the stock and securities of the old 
corporation are merely the holders of short-term notes in the new 
corporation. In order to exclude transactions not intended to be 
included, the specifications of the reorganization provisions of the law 
are precise. Both the terms of the specifications and their underlying 
assumptions and purposes must be satisfied in order to entitle the 
taxpayer to the benefit of the exception from the general rule. 
Accordingly, under the Code, a short-term purchase money note is not a 
security of a party to a reorganization, an ordinary dividend is to be 
treated as an ordinary dividend, and a sale is nevertheless to be 
treated as a sale even though the mechanics of a reorganization have 
been set up.
    (c) Scope. The nonrecognition of gain or loss is prescribed for two 
specifically described types of exchanges, viz: The exchange that is 
provided for in section 354(a)(1) in which stock or securities in a 
corporation, a party to a reorganization, are, in pursuance of a plan of 
reorganization, exchanged for the stock or securities in a corporation, 
a party to the same reorganization; and the exchange that is provided 
for in section 361(a) in which a corporation, a party

[[Page 522]]

to a reorganization, exchanges property, in pursuance of a plan of 
reorganization, for stock or securities in another corporation, a party 
to the same reorganization. Section 368(a)(1) limits the definition of 
the term reorganization to six kinds of transactions and excludes all 
others. From its context, the term a party to a reorganization can only 
mean a party to a transaction specifically defined as a reorganization 
by section 368(a). Certain rules respecting boot received in either of 
the two types of exchanges provided for in section 354(a)(1) and section 
361(a) are prescribed in sections 356, 357, and 361(b). A special rule 
respecting a transfer of property with a liability in excess of its 
basis is prescribed in section 357(c). Under section 367 a limitation is 
placed on all these provisions by providing that except under specified 
conditions foreign corporations shall not be deemed within their scope. 
The provisions of the Code referred to in this paragraph are 
inapplicable unless there is a plan of reorganization. A plan of 
reorganization must contemplate the bona fide execution of one of the 
transactions specifically described as a reorganization in section 
368(a) and for the bona fide consummation of each of the requisite acts 
under which nonrecognition of gain is claimed. Such transaction and such 
acts must be an ordinary and necessary incident of the conduct of the 
enterprise and must provide for a continuation of the enterprise. A 
scheme, which involves an abrupt departure from normal reorganization 
procedure in connection with a transaction on which the imposition of 
tax is imminent, such as a mere device that puts on the form of a 
corporate reorganization as a disguise for concealing its real 
character, and the object and accomplishment of which is the 
consummation of a preconceived plan having no business or corporate 
purpose, is not a plan of reorganization.
    (d) Continuity of business enterprise--(1) General rule. Continuity 
of business enterprise (COBE) requires that the issuing corporation (P), 
as defined in paragraph (b) of this section, either continue the target 
corporation's (T's) historic business or use a significant portion of 
T's historic business assets in a business. The preceding sentence 
applies to transactions occurring after January 28, 1998, except that it 
does not apply to any transaction occurring pursuant to a written 
agreement which is binding on January 28, 1998, and at all times 
thereafter. The application of this general rule to certain 
transactions, such as mergers of holding companies, will depend on all 
facts and circumstances. The policy underlying this general rule, which 
is to ensure that reorganizations are limited to readjustments of 
continuing interests in property under modified corporate form, provides 
the guidance necessary to make these facts and circumstances 
determinations.
    (2) Business continuity. (i) The continuity of business enterprise 
requirement is satisfied if P continues T's historic business. The fact 
P is in the same line of business as T tends to establish the requisite 
continuity, but is not alone sufficient.
    (ii) If T has more than one line of business, continuity of business 
enterprise requires only that P continue a significant line of business.
    (iii) In general, a corporation's historic business is the business 
it has conducted most recently. However, a corporation's historic 
business is not one the corporation enters into as part of a plan of 
reorganization.
    (iv) All facts and circumstances are considered in determining the 
time when the plan comes into existence and in determining whether a 
line of business is ``significant''.
    (3) Asset continuity. (i) The continuity of business enterprise 
requirement is satisfied if P uses a significant portion of T's historic 
business assets in a business.
    (ii) A corporation's historic business assets are the assets used in 
its historic business. Business assets may include stock and securities 
and intangible operating assets such as good will, patents, and 
trademarks, whether or not they have a tax basis.
    (iii) In general, the determination of the portion of a 
corporation's assets considered ``significant'' is based on the relative 
importance of the assets to operation of the business. However, all 
other facts and circumstances, such as

[[Page 523]]

the net fair market value of those assets, will be considered.
    (4) Acquired assets or stock held by members of the qualified group 
or partnerships. The following rules apply in determining whether the 
COBE requirement of paragraph (d)(1) of this section is satisfied:
    (i) Businesses and assets of members of a qualified group. The 
issuing corporation is treated as holding all of the businesses and 
assets of all of the members of the qualified group, as defined in 
paragraph (d)(4)(ii) of this section.
    (ii) Qualified group. A qualified group is one or more chains of 
corporations connected through stock ownership with the issuing 
corporation, but only if the issuing corporation owns directly stock 
meeting the requirements of section 368(c) in at least one other 
corporation, and stock meeting the requirements of section 368(c) in 
each of the corporations (except the issuing corporation) is owned 
directly (or indirectly as provided in paragraph (d)(4)(iii)(D) of this 
section) by one or more of the other corporations.
    (iii) Partnerships--(A) Partnership assets. Each partner of a 
partnership will be treated as owning the T business assets used in a 
business of the partnership in accordance with that partner's interest 
in the partnership.
    (B) Partnership businesses. The issuing corporation will be treated 
as conducting a business of a partnership if--
    (1) Members of the qualified group, in the aggregate, own an 
interest in the partnership representing a significant interest in that 
partnership business; or
    (2) One or more members of the qualified group have active and 
substantial management functions as a partner with respect to that 
partnership business.
    (C) Conduct of the historic T business in a partnership. If a 
significant historic T business is conducted in a partnership, the fact 
that P is treated as conducting such T business under paragraph 
(d)(4)(iii)(B) of this section tends to establish the requisite 
continuity, but is not alone sufficient.
    (D) Stock attributed from certain partnerships. Solely for purposes 
of paragraph (d)(4)(ii) of this section, if members of the qualified 
group own interests in a partnership meeting requirements equivalent to 
section 368(c) (a section 368(c) controlled partnership), any stock 
owned by the section 368(c) controlled partnership shall be treated as 
owned by members of the qualified group. Solely for purposes of 
determining whether a lower-tier partnership is a section 368(c) 
controlled partnership, any interest in a lower-tier partnership that is 
owned by a section 368(c) controlled partnership shall be treated as 
owned by members of the qualified group.
    (iv) Effective/applicability dates. Paragraphs (d)(4)(i) and 
(d)(4)(iii) (other than paragraph (d)(4)(iii)(D)) of this section apply 
to transactions occurring after January 28, 1998, except that they do 
not apply to any transaction occurring pursuant to a written agreement 
which is binding on January 28, 1998, and at all times thereafter. 
Paragraphs (d)(4)(ii) and (d)(4)(iii)(D) of this section apply to 
transactions occurring on or after October 25, 2007, except that they do 
not apply to any transaction occurring pursuant to a written agreement 
which is binding before October 25, 2007, and at all times after that.
    (5) Examples. The following examples illustrate this paragraph (d). 
All the corporations have only one class of stock outstanding. The 
preceding sentence and paragraph (d)(5) Example 6 and Example 8 through 
Example 13 apply to transactions occurring after January 28, 1998, 
except that they do not apply to any transaction occurring pursuant to a 
written agreement which is binding on January 28, 1998, and at all times 
thereafter. Paragraph (d)(5) Example 7, Example 14, and Example 15 apply 
to transactions occurring on or after October 25, 2007, except that they 
do not apply to any transaction occurring pursuant to a written 
agreement which is binding before October 25, 2007, and at all times 
after that. The examples read as follows:

    Example 1. T conducts three lines of business: manufacture of 
synthetic resins, manufacture of chemicals for the textile industry, and 
distribution of chemicals. The three lines of business are approximately 
equal in value. On July 1, 1981, T sells the synthetic resin and 
chemicals distribution businesses to a third party for cash and 
marketable securities. On December 31, 1981, T transfers all of its 
assets to P solely for P voting stock. P

[[Page 524]]

continues the chemical manufacturing business without interruption. The 
continuity of business enterprise requirement is met. Continuity of 
business enterprise requires only that P continue one of T's three 
significant lines of business.
    Example 2. P manufactures computers and T manufactures components 
for computers. T sells all of its output to P. On January 1, 1981, P 
decides to buy imported components only. On March 1, 1981, T merges into 
P. P continues buying imported components but retains T's equipment as a 
backup source of supply. The use of the equipment as a backup source of 
supply constitutes use of a significant portion of T's historic business 
assets, thus establishing continuity of business enterprise. P is not 
required to continue T's business.
    Example 3. T is a manufacturer of boys' and men's trousers. On 
January 1, 1978, as part of a plan of reorganization, T sold all of its 
assets to a third party for cash and purchased a highly diversified 
portfolio of stocks and bonds. As part of the plan T operates an 
investment business until July 1, 1981. On that date, the plan of 
reorganization culminates in a transfer by T of all its assets to P, a 
regulated investment company, solely in exchange for P voting stock. The 
continuity of business enterprise requirement is not met. T's investment 
activity is not its historic business, and the stocks and bonds are not 
T's historic business assets.
    Example 4. T manufactures children's toys and P distributes steel 
and allied products. On January 1, 1981, T sells all of its assets to a 
third party for $100,000 cash and $900,000 in notes. On March 1, 1981, T 
merges into P. Continuity of business enterprise is lacking. The use of 
the sales proceeds in P's business is not sufficient.
    Example 5. T manufactures farm machinery and P operates a lumber 
mill. T merges into P. P disposes of T's assets immediately after the 
merger as part of the plan of reorganization. P does not continue T's 
farm machinery manufacturing business. Continuity of business enterprise 
is lacking.
    Example 6. Use of a significant portion of T's historic business 
assets by the qualified group. (i) Facts. T operates an auto parts 
distributorship. P owns 80 percent of the stock of a holding company 
(HC). HC owns 80 percent of the stock of ten subsidiaries, S-1 through 
S-10. S-1 through S-10 each separately operate a full service gas 
station. Pursuant to a plan of reorganization, T merges into P and the T 
shareholders receive solely P stock. As part of the plan of 
reorganization, P transfers T's assets to HC, which in turn transfers 
some of the T assets to each of the ten subsidiaries. No one subsidiary 
receives a significant portion of T's historic business assets. Each of 
the subsidiaries will use the T assets in the operation of its full 
service gas station. No P subsidiary will be an auto parts distributor.
    (ii) Continuity of business enterprise. Under paragraph (d)(4)(i) of 
this section, P is treated as conducting the ten gas station businesses 
of S-1 through S-10 and as holding the historic T assets used in those 
businesses. P is treated as holding all the assets and conducting the 
businesses of all of the members of the qualified group, which includes 
S-1 through S-10 (paragraphs (d)(4)(i) and (ii) of this section). No 
member of the qualified group continues T's historic distributorship 
business. However, subsidiaries S-1 through S-10 continue to use the 
historic T assets in a business. Even though no one corporation of the 
qualified group is using a significant portion of T's historic business 
assets in a business, the COBE requirement of paragraph (d)(1) of this 
section is satisfied because, in the aggregate, the qualified group is 
using a significant portion of T's historic business assets in a 
business.
    Example 7. Transfers of acquired stock to members of the qualified 
group--continuity of business enterprise satisfied. (i) Facts. The facts 
are the same as Example 6, except that, instead of P acquiring the 
assets of T, HC acquires all of the outstanding stock of T in exchange 
solely for stock of P. In addition, as part of the plan of 
reorganization, HC transfers 10 percent of the stock of T to each of 
subsidiaries S-1 through S-10. T will continue to operate an auto parts 
distributorship. Without regard to whether the transaction satisfies the 
COBE requirement, the transaction qualifies as a triangular B 
reorganization (as defined in Sec. 1.358-6(b)(2)(iv)).
    (ii) Continuity of business enterprise. Under paragraph (d)(4)(i) of 
this section, P is treated as holding the assets and conducting the 
business of T because T is a member of the qualified group (as defined 
in paragraph (d)(4)(ii) of this section). The COBE requirement of 
paragraph (d)(1) of this section is satisfied.
    Example 8. Continuation of the historic T business in a partnership 
satisfies continuity of business enterprise. (i) Facts. T manufactures 
ski boots. P owns all of the stock of S-1. S-1 owns all of the stock of 
S-2, and S-2 owns all of the stock of S-3. T merges into P and the T 
shareholders receive consideration consisting of P stock and cash. The T 
ski boot business is to be continued and expanded. In anticipation of 
this expansion, P transfers all of the T assets to S-1, S-1 transfers 
all of the T assets to S-2, and S-2 transfers all of the T assets to S-
3. S-3 and X (an unrelated party) form a new partnership (PRS). As part 
of the plan of reorganization, S-3 transfers all the T assets to PRS, 
and S-3, in its capacity as a partner, performs active and substantial 
management functions for the PRS ski boot business, including making 
significant business decisions and regularly participating in the 
overall supervision, direction, and control of the employees of the ski 
boot business. S-3 receives a 20

[[Page 525]]

percent interest in PRS. X transfers cash in exchange for an 80 percent 
interest in PRS.
    (ii) Continuity of business enterprise. Under paragraph 
(d)(4)(iii)(B)(2) of this section, P is treated as conducting T's 
historic business because S-3 performs active and substantial management 
functions for the ski boot business in S-3's capacity as a partner. P is 
treated as holding all the assets and conducting the businesses of all 
of the members of the qualified group, which includes S-3 (paragraphs 
(d)(4)(i) and (ii) of this section). The COBE requirement of paragraph 
(d)(1) of this section is satisfied.
    Example 9. Continuation of the historic T business in a partnership 
does not satisfy continuity of business enterprise. (i) Facts. The facts 
are the same as Example 8, except that S-3 transfers the historic T 
business to PRS in exchange for a 1 percent interest in PRS.
    (ii) Continuity of business enterprise. Under paragraph 
(d)(4)(iii)(B)(2) of this section, P is treated as conducting T's 
historic business because S-3 performs active and substantial management 
functions for the ski boot business in S-3's capacity as a partner. The 
fact that a significant historic T business is conducted in PRS, and P 
is treated as conducting such T business under (d)(4)(iii)(B) tends to 
establish the requisite continuity, but is not alone sufficient 
(paragraph (d)(4)(iii)(C) of this section). The COBE requirement of 
paragraph (d)(1) of this section is not satisfied.
    Example 10. Continuation of the T historic business in a partnership 
satisfies continuity of business enterprise. (i) Facts. The facts are 
the same as Example 8, except that S-3 transfers the historic T business 
to PRS in exchange for a 33\1/3\ percent interest in PRS, and no member 
of P's qualified group performs active and substantial management 
functions for the ski boot business operated in PRS.
    (ii) Continuity of business enterprise. Under paragraph 
(d)(4)(iii)(B)(1) of this section, P is treated as conducting T's 
historic business because S-3 owns an interest in the partnership 
representing a significant interest in that partnership business. P is 
treated as holding all the assets and conducting the businesses of all 
of the members of the qualified group, which includes S-3 (paragraphs 
(d)(4)(i) and (ii) of this section). The COBE requirement of paragraph 
(d)(1) of this section is satisfied.
    Example 11. Use of T's historic business assets in a partnership 
business. (i) Facts. T is a fabric distributor. P owns all of the stock 
of S-1. T merges into P and the T shareholders receive solely P stock. 
S-1 and X (an unrelated party) own interests in a partnership (PRS). As 
part of the plan of reorganization, P transfers all of the T assets to 
S-1, and S-1 transfers all the T assets to PRS, increasing S-1's 
percentage interest in PRS from 5 to 33\1/3\ percent. After the 
transfer, X owns the remaining 66\2/3\ percent interest in PRS. Almost 
all of the T assets consist of T's large inventory of fabric, which PRS 
uses to manufacture sportswear. All of the T assets are used in the 
sportswear business. No member of P's qualified group performs active 
and substantial management functions for the sportswear business 
operated in PRS.
    (ii) Continuity of business enterprise. Under paragraph 
(d)(4)(iii)(A) of this section, S-1 is treated as owning 33\1/3\ percent 
of the T assets used in the PRS sportswear manufacturing business. Under 
paragraph (d)(4)(iii)(B)(1) of this section, P is treated as conducting 
the sportswear manufacturing business because S-1 owns an interest in 
the partnership representing a significant interest in that partnership 
business. P is treated as holding all the assets and conducting the 
businesses of all of the members of the qualified group, which includes 
S-1 (paragraphs (d)(4)(i) and (ii) of this section). The COBE 
requirement of paragraph (d)(1) of this section is satisfied.
    Example 12. Aggregation of partnership interests among members of 
the qualified group: use of T's historic business assets in a 
partnership business. (i) Facts. The facts are the same as Example 11, 
except that S-1 transfers all the T assets to PRS, and P and X each 
transfer cash to PRS in exchange for partnership interests. After the 
transfers, P owns 11 percent, S-1 owns 22\1/3\ percent, and X owns 66\2/
3\ percent of PRS.
    (ii) Continuity of business enterprise. Under paragraph 
(d)(4)(iii)(B)(1) of this section, P is treated as conducting the 
sportswear manufacturing business because members of the qualified 
group, in the aggregate, own an interest in the partnership representing 
a significant interest in that business. P is treated as owning 11 
percent of the assets directly, and S-1 is treated as owning 22\1/3\ 
percent of the assets, used in the PRS sportswear business (paragraph 
(d)(4)(iii)(A) of this section). P is treated as holding all the assets 
of all of the members of the qualified group, which includes S-1, and 
thus in the aggregate, P is treated as owning 33\1/3\ of the T assets 
(paragraphs (d)(4)(i) and (ii) of this section). The COBE requirement of 
paragraph (d)(1) of this section is satisfied because P is treated as 
using a significant portion of T's historic business assets in its 
sportswear manufacturing business.
    Example 13. Tiered partnerships: use of T's historic business assets 
in a partnership business. (i) Facts. T owns and manages a commercial 
office building in state Z. Pursuant to a plan of reorganization, T 
merges into P, solely in exchange for P stock, which is distributed to 
the T shareholders. P transfers all of the T assets to a partnership, 
PRS-1, which owns and operates television stations nationwide. After the 
transfer, P owns a 50 percent interest in PRS-1. P does not have active 
and substantial management functions as a partner with respect to the 
PRS-1 business. X, not a member of P's qualified

[[Page 526]]

group, owns the remaining 50 percent interest in PRS-1. PRS-1, in an 
effort to expand its state Z television operation, enters into a joint 
venture with U, an unrelated party. As part of the plan of 
reorganization, PRS-1 transfers all the T assets and its state Z 
television station to PRS-2, in exchange for a 75 percent partnership 
interest. U contributes cash to PRS-2 in exchange for a 25 percent 
partnership interest and oversees the management of the state Z 
television operation. PRS-1 does not actively and substantially manage 
PRS-2's business. PRS-2's state Z operations are moved into the acquired 
T office building. All of the assets that P acquired from T are used in 
PRS-2's business.
    (ii) Continuity of business enterprise. Under paragraph 
(d)(4)(iii)(A) of this section, PRS-1 is treated as owning 75 percent of 
the T assets used in PRS-2's business. P, in turn, is treated as owning 
50 percent of PRS-1's interest the T assets. Thus, P is treated as 
owning 37\1/2\ percent (50 percent x 75 percent) of the T assets used in 
the PRS-2 business. Under paragraph (d)(4)(iii)(B)(1) of this section, P 
is treated as conducting PRS-2's business, the operation of the state Z 
television station, and under paragraph (d)(4)(iii)(A) of this section, 
P is treated as using 37\1/2\ percent of the historic T business assets 
in that business. The COBE requirement of paragraph (d)(1) of this 
section is satisfied because P is treated as using a significant portion 
of T's historic business assets in its television business.
    Example 14. Transfer of acquired stock to a partnership--continuity 
of business enterprise satisfied. (i) Facts. Pursuant to a plan of 
reorganization, the T shareholders transfer all of their T stock to a 
subsidiary of P, S-1, solely in exchange for P stock. In addition, as 
part of the plan of reorganization, S-1 transfers the T stock to its 
subsidiary, S-2, and S-2 transfers the T stock to its subsidiary, S-3. 
S-2 and S-3 form a new partnership, PRS. Immediately thereafter, S-3 
transfers all of the T stock to PRS in exchange for an 80 percent 
interest in PRS, and S-2 transfers cash to PRS in exchange for a 20 
percent interest in PRS.
    (ii) Continuity of business enterprise. Members of the qualified 
group, in the aggregate, own all of the interests in PRS. Because these 
interests in PRS meet requirements equivalent to section 368(c), under 
paragraph (d)(4)(iii)(D) of this section, the T stock owned by PRS is 
treated as owned by members of the qualified group. P is treated as 
holding all of the businesses and assets of T because T is a member of 
the qualified group (as defined in paragraph (d)(4)(ii) of this 
section). The COBE requirement of paragraph (d)(1) of this section is 
satisfied because P is treated as continuing T's business.
    Example 15. Transfer of acquired stock to a partnership--continuity 
of business enterprise not satisfied. (i) Facts. The facts are the same 
as in Example 14, except that S-3 and U, an unrelated corporation, form 
a new partnership, PRS, and, immediately thereafter, S-3 transfers all 
of the T stock to PRS in exchange for a 50 percent interest in PRS, and 
U transfers cash to PRS in exchange for a 50 percent interest in PRS.
    (ii) Continuity of business enterprise. Members of the qualified 
group, in the aggregate, own 50 percent of the interests in PRS. Because 
these interests in PRS do not meet requirements equivalent to section 
368(c), the T stock owned by PRS is not treated as owned by members of 
the qualified group under paragraph (d)(4)(iii)(D) of this section. P is 
not treated as holding all of the businesses and assets of T because T 
has ceased to be a member of the qualified group (as defined in 
paragraph (d)(4)(ii) of this section). The COBE requirement of paragraph 
(d)(1) of this section is not satisfied because P is not treated as 
continuing T's business or using T's historic business assets in a 
business.

    (e) Continuity of interest--(1) General rule. (i) The purpose of the 
continuity of interest requirement is to prevent transactions that 
resemble sales from qualifying for nonrecognition of gain or loss 
available to corporate reorganizations. Continuity of interest requires 
that in substance a substantial part of the value of the proprietary 
interests in the target corporation be preserved in the reorganization. 
A proprietary interest in the target corporation is preserved if, in a 
potential reorganization, it is exchanged for a proprietary interest in 
the issuing corporation (as defined in paragraph (b) of this section), 
it is exchanged by the acquiring corporation for a direct interest in 
the target corporation enterprise, or it otherwise continues as a 
proprietary interest in the target corporation. However, a proprietary 
interest in the target corporation is not preserved if, in connection 
with the potential reorganization, it is acquired by the issuing 
corporation for consideration other than stock of the issuing 
corporation, or stock of the issuing corporation furnished in exchange 
for a proprietary interest in the target corporation in the potential 
reorganization is redeemed. All facts and circumstances must be 
considered in determining whether, in substance, a proprietary interest 
in the target corporation is preserved. See paragraph (e)(6) of this 
section for rules related to when a creditor's claim

[[Page 527]]

against a target corporation is a proprietary interest in the 
corporation. For purposes of the continuity of interest requirement, a 
mere disposition of stock of the target corporation prior to a potential 
reorganization to persons not related (as defined in paragraph (e)(4) of 
this section determined without regard to paragraph (e)(4)(i)(A) of this 
section) to the target corporation or to persons not related (as defined 
in paragraph (e)(4) of this section) to the issuing corporation is 
disregarded and a mere disposition of stock of the issuing corporation 
received in a potential reorganization to persons not related (as 
defined in paragraph (e)(4) of this section) to the issuing corporation 
is disregarded.
    (ii) For purposes of paragraph (e)(1)(i) of this section, a 
proprietary interest in the target corporation (other than one held by 
the acquiring corporation) is not preserved to the extent that 
consideration received prior to a potential reorganization, either in a 
redemption of the target corporation stock or in a distribution with 
respect to the target corporation stock, is treated as other property or 
money received in the exchange for purposes of section 356, or would be 
so treated if the target shareholder also had received stock of the 
issuing corporation in exchange for stock owned by the shareholder in 
the target corporation. A proprietary interest in the target corporation 
is not preserved to the extent that creditors (or former creditors) of 
the target corporation that own a proprietary interest in the 
corporation under paragraph (e)(6) of this section (or would be so 
treated if they had received the consideration in the potential 
reorganization) receive payment for the claim prior to the potential 
reorganization and such payment would be treated as other property or 
money received in the exchange for purposes of section 356 had it been a 
distribution with respect to stock.
    (2) Measuring continuity of interest--(i) In general. In determining 
whether a proprietary interest in the target corporation is preserved, 
the consideration to be exchanged for the proprietary interests in the 
target corporation pursuant to a contract to effect the potential 
reorganization shall be valued on the last business day before the first 
date such contract is a binding contract (the pre-signing date), if such 
contract provides for fixed consideration. If a portion of the 
consideration provided for in such a contract consists of other property 
identified by value, then this specified value of such other property is 
used for purposes of determining the extent to which a proprietary 
interest in the target corporation is preserved. If the contract does 
not provide for fixed consideration, this paragraph (e)(2)(i) is not 
applicable.
    (ii) Binding contract--(A) In general. A binding contract is an 
instrument enforceable under applicable law against the parties to the 
instrument. The presence of a condition outside the control of the 
parties (including, for example, regulatory agency approval) shall not 
prevent an instrument from being a binding contract. Further, the fact 
that insubstantial terms remain to be negotiated by the parties to the 
contract, or that customary conditions remain to be satisfied, shall not 
prevent an instrument from being a binding contract.
    (B) Modifications--(1) In general. If a term of a binding contract 
that relates to the amount or type of the consideration the target 
shareholders will receive in a potential reorganization is modified 
before the closing date of the potential reorganization, and the 
contract as modified is a binding contract, the date of the modification 
shall be treated as the first date there is a binding contract.
    (2) Modification of a transaction that preserves continuity of 
interest. Notwithstanding paragraph (e)(2)(ii)(B)(1) of this section, a 
modification of a term that relates to the amount or type of 
consideration the target shareholders will receive in a transaction that 
would have resulted in the preservation of a substantial part of the 
value of the target corporation shareholders' proprietary interests in 
the target corporation if there had been no modification will not be 
treated as a modification if--
    (i) The modification has the sole effect of providing for the 
issuance of additional shares of issuing corporation

[[Page 528]]

stock to the target corporation shareholders;
    (ii) The modification has the sole effect of decreasing the amount 
of money or other property to be delivered to the target corporation 
shareholders; or
    (iii) The modification has the effect of decreasing the amount of 
money or other property to be delivered to the target corporation 
shareholders and providing for the issuance of additional shares of 
issuing corporation stock to the target corporation shareholders.
    (3) Modification of a transaction that does not preserve continuity 
of interest. Notwithstanding paragraph (e)(2)(ii)(B)(1) of this section, 
a modification of a term that relates to the amount or type of 
consideration the target shareholders will receive in a transaction that 
would not have resulted in the preservation of a substantial part of the 
value of the target corporation shareholders' proprietary interests in 
the target corporation if there had been no modification will not be 
treated as a modification if--
    (i) The modification has the sole effect of providing for the 
issuance of fewer shares of issuing corporation stock to the target 
corporation shareholders;
    (ii) The modification has the sole effect of increasing the amount 
of money or other property to be delivered to the target corporation 
shareholders; or
    (iii) The modification has the effect of increasing the amount of 
money or other property to be delivered to the target corporation 
shareholders and providing for the issuance of fewer shares of issuing 
corporation stock to the target corporation shareholders.
    (C) Tender offers. For purposes of this paragraph (e)(2), a tender 
offer that is subject to section 14(d) of the Securities and Exchange 
Act of 1934 [15 U.S.C. 78n(d)(1)] and Regulation 14D (17 CFR 240.14d-1 
through 240.14d-101) and is not pursuant to a binding contract, is 
treated as a binding contract made on the date of its announcement, 
notwithstanding that it may be modified by the offeror or that it is not 
enforceable against the offerees. If a modification (not pursuant to a 
binding contract) of such a tender offer is subject to the provisions of 
Regulation 14d-6(c) (17 CFR 240.14d-6(c)) and relates to the amount or 
type of the consideration received in the tender offer, then the date of 
the modification shall be treated as the first date there is a binding 
contract.
    (iii) Fixed consideration--(A) In general. A contract provides for 
fixed consideration if it provides the number of shares of each class of 
stock of the issuing corporation, the amount of money, and the other 
property (identified either by value or by specific description), if 
any, to be exchanged for all the proprietary interests in the target 
corporation, or to be exchanged for each proprietary interest in the 
target corporation. A shareholder's election to receive a number of 
shares of stock of the issuing corporation, money, or other property (or 
some combination of stock of the issuing corporation, money, or other 
property) in exchange for all of the shareholder's proprietary interests 
in the target corporation, or each of the shareholder's proprietary 
interests in the target corporation, will not prevent a contract from 
satisfying the definition of fixed consideration provided for in this 
paragraph (e)(2)(iii)(A).
    (B) Shareholder elections. A contract that provides a target 
corporation shareholder with an election to receive a number of shares 
of stock of the issuing corporation, money, or other property (or some 
combination of stock of the issuing corporation, money, or other 
property) in exchange for all of the shareholder's proprietary interests 
in the target corporation, or each of the shareholder's proprietary 
interests in the target corporation, provides for fixed consideration if 
the determination of the number of shares of issuing corporation stock 
to be provided to the target corporation shareholder is determined using 
the value of the issuing corporation stock on the last business day 
before the first date there is a binding contract. This is the case even 
though the shareholder election may preclude a determination, prior to 
the closing date, of the number of shares of each class of the issuing 
corporation, the amount of money, and the other property (or the 
combination of shares, money and other property) to be exchanged for 
each proprietary interest in the target corporation.

[[Page 529]]

    (C) Contingent adjustments to the consideration--(1) In general. 
Except as provided in paragraph (e)(2)(iii)(C)(2) of this section, a 
contract that provides for contingent adjustments to the consideration 
will be treated as providing for fixed consideration if it would satisfy 
the requirements of paragraph (e)(2)(iii)(A) of this section without the 
contingent adjustment provision.
    (2) Exceptions. A contract will not be treated as providing for 
fixed consideration if the contract provides for contingent adjustments 
to the consideration that prevent (to any extent) the target corporation 
shareholders from being subject to the economic benefits and burdens of 
ownership of the issuing corporation stock after the last business day 
before the first date the contract is a binding contract. For example, a 
contract will not be treated as providing for fixed consideration if the 
contract provides for contingent adjustments to the consideration in the 
event that the value of the stock of the issuing corporation, the value 
of the assets of the issuing corporation, or the value of any surrogate 
for either the value of the stock of the issuing corporation or the 
assets of the issuing corporation increases or decreases after the last 
business day before the first date there is a binding contract. 
Similarly, a contract will not be treated as providing for fixed 
consideration if the contract provides for contingent adjustments to the 
number of shares of the issuing corporation stock to be provided to the 
target corporation shareholders computed using any value of the issuing 
corporation shares after the last business day before the first date 
there is a binding contract.
    (D) Escrows. Placing part of the consideration to be exchanged for 
proprietary interests in the target corporation in escrow to secure 
target's performance of customary pre-closing covenants or customary 
target representations and warranties will not prevent a contract from 
being treated as providing for fixed consideration.
    (E) Anti-dilution clauses. The presence of a customary anti-dilution 
clause will not prevent a contract from being treated as providing for 
fixed consideration. However, the absence of such a clause will prevent 
a contract from being treated as providing for fixed consideration if 
the issuing corporation alters its capital structure between the first 
date there is an otherwise binding contract to effect the transaction 
and the effective date of the transaction in a manner that materially 
alters the economic arrangement of the parties to the binding contract. 
If the number of shares of the issuing corporation to be issued to the 
target corporation shareholders is altered pursuant to a customary anti-
dilution clause, the value of the shares determined under paragraph 
(e)(2)(i) of this section must be adjusted accordingly.
    (F) Dissenters' rights. The possibility that some shareholders may 
exercise dissenters' rights and receive consideration other than that 
provided for in the binding contract will not prevent the contract from 
being treated as providing for fixed consideration.
    (G) Fractional shares. The fact that money may be paid in lieu of 
issuing fractional shares will not prevent a contract from being treated 
as providing for fixed consideration.
    (iv) New issuances. For purposes of applying paragraph (e)(2)(i) of 
this section, any class of stock, securities, or indebtedness that the 
issuing corporation issues to the target corporation shareholders 
pursuant to the potential reorganization and that does not exist before 
the first date there is a binding contract to effect the potential 
reorganization is deemed to have been issued on the last business day 
before the first date there is a binding contract to effect the 
potential reorganization.
    (v) Examples. For purposes of the examples in this paragraph 
(e)(2)(v), P is the issuing corporation, T is the target corporation, S 
is a wholly owned subsidiary of P, all corporations have only one class 
of stock outstanding, A is an individual, no transactions other than 
those described occur, and the transactions are not otherwise subject to 
recharacterization. The following examples illustrate the application of 
this paragraph (e)(2):

    Example 1. Application of signing date rule. On January 3 of year 1, 
P and T sign a binding contract pursuant to which T will be merged with 
and into P on June 1 of year 1. Pursuant to the contract, the T 
shareholders

[[Page 530]]

will receive 40 P shares and $60 of cash in exchange for all of the 
outstanding stock of T. Twenty of the P shares, however, will be placed 
in escrow to secure customary target representations and warranties. The 
P stock is listed on an established market. On January 2 of year 1, the 
value of the P stock is $1 per share. On June 1 of year 1, T merges with 
and into P pursuant to the terms of the contract. On that date, the 
value of the P stock is $.25 per share. None of the stock placed in 
escrow is returned to P. Because the contract provides for the number of 
shares of P and the amount of money to be exchanged for all of the 
proprietary interests in T, under this paragraph (e)(2), there is a 
binding contract providing for fixed consideration as of January 3 of 
year 1. Therefore, whether the transaction satisfies the continuity of 
interest requirement is determined by reference to the value of the P 
stock on the pre-signing date. Because, for continuity of interest 
purposes, the T stock is exchanged for $40 of P stock and $60 of cash, 
the transaction preserves a substantial part of the value of the 
proprietary interest in T. Therefore, the transaction satisfies the 
continuity of interest requirement.
    Example 2. Treatment of forfeited escrowed stock. (i) Escrowed 
stock. The facts are the same as in Example 1 except that T's breach of 
a representation results in the escrowed consideration being returned to 
P. Because the contract provides for the number of shares of P and the 
amount of money to be exchanged for all of the proprietary interests in 
T, under this paragraph (e)(2), there is a binding contract providing 
for fixed consideration as of January 3 of year 1. Therefore, whether 
the transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on the pre-signing 
date. Pursuant to paragraph (e)(1)(i) of this section, for continuity of 
interest purposes, the T stock is exchanged for $20 of P stock and $60 
of cash, and the transaction does not preserve a substantial part of the 
value of the proprietary interest in T. Therefore, the transaction does 
not satisfy the continuity of interest requirement.
    (ii) Escrowed stock and cash. The facts are the same as in paragraph 
(i) of this Example 2 except that the consideration placed in escrow 
consists solely of eight of the P shares and $12 of the cash. Because 
the contract provides for the number of shares of P and the amount of 
money to be exchanged for all of the proprietary interests in T, under 
this paragraph (e)(2), there is a binding contract providing for fixed 
consideration as of January 3 of year 1. Therefore, whether the 
transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on the pre-signing 
date. Pursuant to paragraph (e)(1)(i) of this section, for continuity of 
interest purposes, the T stock is exchanged for $32 of P stock and $48 
of cash, and the transaction preserves a substantial part of the value 
of the proprietary interest in T. Therefore, the transaction satisfies 
the continuity of interest requirement.
    Example 3. Redemption of stock received pursuant to binding 
contract. The facts are the same as in Example 1 except that A owns 50 
percent of the outstanding stock of T immediately prior to the merger 
and receives 10 P shares and $30 in the merger and an additional 10 P 
shares upon the release of the stock placed in escrow. In connection 
with the merger, A and S agree that, immediately after the merger, S 
will purchase any P shares that A acquires in the merger for $1 per 
share. Shortly after the merger, S purchases A's P shares for $20. 
Because the contract provides for the number of shares of P and the 
amount of money to be exchanged for all of the proprietary interests in 
T, under this paragraph (e)(2), there is a binding contract providing 
for fixed consideration as of January 3 of year 1. Therefore, whether 
the transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on the pre-signing 
date. In addition, S is a person related to P under paragraph 
(e)(4)(i)(A) of this section. Accordingly, A is treated as exchanging 
his T shares for $50 of cash. Because, for continuity of interest 
purposes, the T stock is exchanged for $20 of P stock and $80 of cash, 
the transaction does not preserve a substantial part of the value of the 
proprietary interest in T. Therefore, the transaction does not satisfy 
the continuity of interest requirement.
    Example 4. Modification of binding contract--continuity not 
preserved. The facts are the same as in Example 1 except that on April 1 
of year 1, the parties modify their contract. Pursuant to the modified 
contract, which is a binding contract, the T shareholders will receive 
50 P shares (an additional 10 shares) and $75 of cash (an additional $15 
of cash) in exchange for all of the outstanding T stock. On March 31 of 
year 1, the value of the P stock is $.50 per share. Under this paragraph 
(e)(2), although there was a binding contract providing for fixed 
consideration as of January 3 of year 1, terms of that contract relating 
to the consideration to be provided to the target shareholders were 
modified on April 1 of year 1. The execution of the transaction without 
modification would have resulted in the preservation of a substantial 
part of the value of the target corporation shareholders' proprietary 
interests in the target corporation if there had been no modification. 
However, because the modified contract provides for additional P stock 
and cash to be exchanged for all the proprietary interests in T, the 
exception in paragraph (e)(2)(ii)(B)(2) of this section does not apply

[[Page 531]]

to preserve the original signing date. Therefore, whether the 
transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on March 31 of year 
1. Because, for continuity of interest purposes, the T stock is 
exchanged for $25 of P stock and $75 of cash, the transaction does not 
preserve a substantial part of the value of the proprietary interest in 
T. Therefore, the transaction does not satisfy the continuity of 
interest requirement.
    Example 5. Modification of binding contract disregarded--continuity 
preserved. The facts are the same as in Example 4 except that, pursuant 
to the modified contract, which is a binding contract, the T 
shareholders will receive 60 P shares (an additional 20 shares as 
compared to the original contract) and $60 of cash in exchange for all 
of the outstanding T stock. In addition, on March 31 of year 1, the 
value of the P stock is $.40 per share. Under this paragraph (e)(2), 
although there was a binding contract providing for fixed consideration 
as of January 3 of year 1, terms of that contract relating to the 
consideration to be provided to the target shareholders were modified on 
April 1 of year 1. Nonetheless, the modification has the sole effect of 
providing for the issuance of additional P shares to the T shareholders. 
In addition, the execution of the terms of the contract without regard 
to the modification would have resulted in the preservation of a 
substantial part of the value of the T shareholders' proprietary 
interest in T because, for continuity of interest purposes, the T stock 
would have been exchanged for $40 of P stock and $60 of cash. Pursuant 
to paragraph (e)(2)(ii)(B)(2) of this section, the modification is not 
treated as a modification for purposes of paragraph (e)(2)(ii)(B)(1) of 
this section. Accordingly, whether the transaction satisfies the 
continuity of interest requirement is determined by reference to the 
value of the P stock on the pre-signing date. Because, for continuity of 
interest purposes, the T stock is exchanged for $60 of P stock and $60 
of cash, the transaction preserves a substantial part of the value of 
the proprietary interest in T. Therefore the transaction satisfies the 
continuity of interest requirement.
    Example 6. New issuance. The facts are the same as in Example 1, 
except that, instead of cash, the T shareholders will receive a new 
class of P securities that will be publicly traded. In the aggregate, 
the securities will have a stated principal amount of $60 and bear 
interest at the average LIBOR (London Interbank Offered Rates) during 
the 10 days prior to the potential reorganization. If the T shareholders 
had been issued the P securities on January 2 of year 1, the P 
securities would have had a value of $60 (determined by reference to the 
value of comparable publicly traded securities). Whether the transaction 
satisfies the continuity of interest requirement is determined by 
reference to the value of the P stock and the P securities to be issued 
to the T shareholders on January 2 of year 1. Under paragraph (e)(2)(iv) 
of this section, for purposes of valuing the new P securities, they will 
be treated as having been issued on the pre-signing date. Because, for 
continuity of interest purposes, the T stock is exchanged for $40 of P 
stock and $60 of other property, the transaction preserves a substantial 
part of the value of the proprietary interest in T. Therefore, the 
transaction satisfies the continuity of interest requirement.
    Example 7. Fixed consideration--continuity not preserved. On January 
3 of year 1, P and T sign a binding contract pursuant to which T will be 
merged with and into P on June 1 of year 1. Pursuant to the contract, 60 
shares of the T stock will be exchanged for $80 of cash and 40 shares of 
the T stock will be exchanged for 20 shares of P stock. On January 2 of 
year 1, the value of the P stock is $1 per share. On June 1 of year 1, T 
merges with and into P pursuant to the terms of the contract. This 
contract provides for fixed consideration and therefore whether the 
transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on the pre-signing 
date. However, applying the signing date rule, the P stock represents 
only 20 percent of the value of the total consideration to be received 
by the T shareholders. Accordingly, based on the economic realities of 
the exchange, the transaction does not preserve a substantial part of 
the value of the proprietary interest in T. Therefore, the transaction 
does not satisfy the continuity of interest requirement.
    Example 8. Anti-dilution clause. (i) Absence of anti-dilution 
clause. On January 3 of year 1, P and T sign a binding contract pursuant 
to which T will be merged with and into P on June 1 of year 1. Pursuant 
to the contract, the T shareholders will receive 40 P shares and $60 of 
cash in exchange for all of the outstanding stock of T. The contract 
does not contain a customary anti-dilution provision. The P stock is 
listed on an established market. On January 2 of year 1, the value of 
the P stock is $1 per share. On April 10 of year 1, P issues its stock 
to effect a stock split; each shareholder of P receives an additional 
share of P for each P share that it holds. On April 11 of year 1, the 
value of the P stock is $.50 per share. Because P altered its capital 
structure between January 3 and June 1 of year 1 in a manner that 
materially alters the economic arrangement of the parties, under 
paragraph (e)(2)(iii)(E) of this section, the contract is not treated as 
a binding contract that provides for fixed consideration. Accordingly, 
whether the transaction satisfies the continuity of interest requirement 
cannot be determined by reference to the value of the P stock on January 
2 of year 1.

[[Page 532]]

    (ii) Adjustment for anti-dilution clause. The facts are the same as 
in paragraph (i) of this Example 8 except that the contract contains a 
customary anti-dilution provision, and the T shareholders receive 80 P 
shares and $60 of cash in exchange for all of the outstanding stock of 
T. Under paragraph (e)(2)(iii)(E) of this section, the contract is 
treated as a binding contract that provides for fixed consideration as 
of January 3 of year 1. Therefore, whether the transaction satisfies the 
continuity of interest requirement is generally determined by reference 
to the value of the P stock on January 2 of year 1. However, under 
paragraph (e)(2)(iii)(E) of this section, the value of the P stock on 
the pre-signing date must be adjusted to take the stock split into 
account. For continuity of interest purposes, the T stock is exchanged 
for $40 of P stock (($1/2) x 80) and $60 of cash. Therefore, the 
transaction satisfies the continuity of interest requirement.
    Example 9. Shareholder election. On January 3 of year 1, P and T 
sign a binding contract pursuant to which T will be merged with and into 
P on June 1 of year 1. On January 2 of year 1, the value of the P stock 
and the T stock is $1 per share. Pursuant to the contract, at the 
shareholders' election, each share of T's 100 shares will be exchanged 
for cash of $1, or alternatively, P stock. The contract provides that 
the determination of the number of shares of P stock to be exchanged for 
a share of T stock is made using the value of the P stock on the last 
business day before the first date there is a binding contract (that is, 
$1 per share). The contract further provides that, in the aggregate, 40 
shares of P stock and $60 will be delivered, and contains a proration 
mechanism in the event that either item of consideration is 
oversubscribed. On the closing date, the value of the P stock is $.20 
per share, and all target shareholders elect to receive cash. Pursuant 
to the proration provision, each target share is exchanged for $.60 of 
cash and $.08 of P stock. Pursuant to paragraph (e)(2)(iii)(A) of this 
section, the contract provides for fixed consideration because it 
provides for the number of shares of P stock and the amount of money to 
be exchanged for all the proprietary interests in the target 
corporation. Furthermore, pursuant to paragraph (e)(2)(iii)(B) of this 
section, the contract provides for fixed consideration because the 
number of shares of issuing corporation stock to be provided to the 
target corporation shareholders is determined using the pre-signing date 
value of P stock. Accordingly, whether the transaction satisfies the 
continuity of interest requirement is determined by reference to the 
value of the P stock on January 2 of year 1. Because, for continuity 
purposes, the T stock is exchanged for $40 of P stock and $60 of cash, 
the transaction preserves a substantial part of the value of the 
proprietary interest in T. Therefore, the transaction satisfies the 
continuity of interest requirement.
    Example 10. Contingent adjustment based on the value of the issuing 
corporation stock--continuity not preserved. On January 3 of year 1, P 
and T sign a binding contract pursuant to which T will be merged with 
and into P on June 1 of year 1. On January 2 of year 1, the value of the 
P stock is $1 per share. Pursuant to the contract, if the value of the P 
stock does not decrease after January 2 of year 1, the T shareholders 
will receive 40 P shares and $60 of cash in exchange for all of the 
outstanding stock of T. Furthermore, the contract provides that the T 
shareholders will receive $.16 of additional P shares and $.24 for every 
$.01 decrease in the value of one share of P stock after January 2 of 
year 1. On June 1 of year 1, T merges with and into P pursuant to the 
terms of the contract. On that date, the value of the P stock is $.40 
per share. Pursuant to the terms of the contract, the consideration is 
adjusted so that the T shareholders receive 24 more P shares ((60 x 
$.16)/$.40) and $14.40 more cash (60 x $.24) than they would absent an 
adjustment. Accordingly, at closing the T shareholders receive 64 P 
shares and $74.40 of cash. Because the contract provides that additional 
P shares and cash will be delivered to the T shareholders if the value 
of the stock of P decreases after January 2 of year 1, under paragraph 
(e)(2)(iii)(C)(2) of this section, the contract is not treated as 
providing for fixed consideration, and therefore whether the transaction 
satisfies the continuity of interest requirement cannot be determined by 
reference to the value of the P stock on January 2 of year 1. For 
continuity of interest purposes, the T stock is exchanged for $25.60 of 
P stock (64 x $.40) and $74.40 of cash and the transaction does not 
preserve a substantial part of the value of the proprietary interest in 
T. Therefore, the transaction does not satisfy the continuity of 
interest requirement.
    Example 11. Contingent adjustment to boot based on the value of the 
target corporation stock--continuity not preserved. On January 3 of year 
1, P and T sign a binding contract pursuant to which T will be merged 
with and into P on June 1 of year 1. On January 2 of year 1, T has 100 
shares outstanding, and each T share is worth $1. On January 2 of year 
1, each P share is worth $1. Pursuant to the contract, if the value of 
the T stock does not increase after January 3 of year 1, the T 
shareholders will receive 40 P shares and $60 of cash in exchange for 
all of the outstanding stock of T. Furthermore, the contract provides 
that the T shareholders will receive $1 of additional cash for every 
$.01 increase in the value of one share of T stock after January 3 of 
year 1. On June 1 of year 1, the value of the T stock is $1.40 per share 
and the value of the P stock is $.75 per share. Pursuant to the terms of 
the contract, the consideration

[[Page 533]]

is adjusted so that the T shareholders receive $40 more cash (40 x $1) 
than they would absent an adjustment. Accordingly, at closing the T 
shareholders receive 40 P shares and $100 of cash. Because the contract 
provides the number of shares of P stock and the amount of money to be 
exchanged for all the proprietary interests in T, and the contingent 
adjustment to the cash consideration is not based on changes in the 
value of the P stock, P assets, or any surrogate thereof, after January 
2 of year 1, there is a binding contract providing for fixed 
consideration as of January 3 of year 1. Therefore, whether the 
transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on January 2 of year 
1. For continuity of interest purposes, the T stock is exchanged for $40 
of P stock (40 x $1) and $100 of cash. Therefore, the transaction does 
not satisfy the continuity of interest requirement.
    Example 12. Contingent adjustment to stock based on the value of the 
target corporation stock--continuity preserved. On January 3 of year 1, 
P and T sign a binding contract pursuant to which T will be merged with 
and into P on June 1 of year 1. On that date T has 100 shares 
outstanding, and each T share is worth $1. On January 2 of year 1, each 
P share is worth $1. Pursuant to the contract, if the value of the T 
stock does not decrease after January 3 of year 1, the T shareholders 
will receive 40 P shares and $60 of cash in exchange for all of the 
outstanding stock of T. Furthermore, the contract provides that the T 
shareholders will receive $.40 less P stock and $.60 less cash for every 
$.01 decrease in the value of one share of T stock after January 3 of 
year 1. The contract also provides that the number of P shares by which 
the consideration will be reduced as a result of this adjustment will be 
determined based on the value of the P stock on January 2 of year 1. On 
June 1 of year 1, T merges with and into P pursuant to the terms of the 
contract. On that date, the value of the T stock is $.70 per share and 
the value of the P stock is $.75 per share. Pursuant to the terms of the 
contract, the consideration is adjusted so that the T shareholders 
receive 12 fewer P shares ((30 x $.40)/$1) and $18 less cash (30 x $.60) 
than they would absent an adjustment. Accordingly, at closing the T 
shareholders receive 28 P shares and $42 of cash. Because the contract 
provides for the number of shares of P stock and the amount of money to 
be exchanged for all of the proprietary interests in T, the contract 
does not provide for contingent adjustments to the consideration based 
on a change in value of the P stock, P assets, or any surrogate thereof, 
after January 2 of year 1, and the adjustment to the number of P shares 
the T shareholders receive is determined based on the value of the P 
shares on January 2 of year 1, there is a binding contract providing for 
fixed consideration as of January 3 of year 1. Therefore, whether the 
transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on January 2 of year 
1. For continuity of interest purposes, the T stock is exchanged for $28 
of P stock (28 x $1) and $42 of cash. Accordingly, the transaction 
satisfies the continuity of interest requirement.

    (3) Related persons acquisitions. A proprietary interest in the 
target corporation is not preserved if, in connection with a potential 
reorganization, a person related (as defined in paragraph (e)(4) of this 
section) to the issuing corporation acquires, for consideration other 
than stock of the issuing corporation, either a proprietary interest in 
the target corporation or stock of the issuing corporation that was 
furnished in exchange for a proprietary interest in the target 
corporation. The preceding sentence does not apply to the extent those 
persons who were the direct or indirect owners of the target corporation 
prior to the potential reorganization maintain a direct or indirect 
proprietary interest in the issuing corporation.
    (4) Definition of related person--(i) In general. For purposes of 
this paragraph (e), two corporations are related persons if either--
    (A) The corporations are members of the same affiliated group as 
defined in section 1504 (determined without regard to section 1504(b)); 
or
    (B) A purchase of the stock of one corporation by another 
corporation would be treated as a distribution in redemption of the 
stock of the first corporation under section 304(a)(2) (determined 
without regard to Sec. 1.1502-80(b)).
    (ii) Special rules. The following rules apply solely for purposes of 
this paragraph (e)(4):
    (A) A corporation will be treated as related to another corporation 
if such relationship exists immediately before or immediately after the 
acquisition of the stock involved.
    (B) A corporation, other than the target corporation or a person 
related (as defined in paragraph (e)(4) of this section determined 
without regard to paragraph (e)(4)(i)(A) of this section) to the target 
corporation, will be treated as related to the issuing corporation if

[[Page 534]]

the relationship is created in connection with the potential 
reorganization.
    (5) Acquisitions by partnerships. For purposes of this paragraph 
(e), each partner of a partnership will be treated as owning or 
acquiring any stock owned or acquired, as the case may be, by the 
partnership in accordance with that partner's interest in the 
partnership. If a partner is treated as acquiring any stock by reason of 
the application of this paragraph (e)(5), the partner is also treated as 
having furnished its share of any consideration furnished by the 
partnership to acquire the stock in accordance with that partner's 
interest in the partnership.
    (6) Creditors' claims as proprietary interests--(i) In general. A 
creditor's claim against a target corporation may be a proprietary 
interest in the target corporation if the target corporation is in a 
title 11 or similar case (as defined in section 368(a)(3)) or the amount 
of the target corporation's liabilities exceeds the fair market value of 
its assets immediately prior to the potential reorganization. In such 
cases, if any creditor receives a proprietary interest in the issuing 
corporation in exchange for its claim, every claim of that class of 
creditors and every claim of all equal and junior classes of creditors 
(in addition to the claims of shareholders) is a proprietary interest in 
the target corporation immediately prior to the potential reorganization 
to the extent provided in paragraph (e)(6)(ii) of this section.
    (ii) Value of proprietary interest--(A) Claims of most senior class 
of creditors receiving stock. A claim of the most senior class of 
creditors receiving a proprietary interest in the issuing corporation 
and a claim of any equal class of creditors will be treated as a 
proprietary interest in accordance with the rules of this paragraph 
(e)(6)(ii). For a claim of the most senior class of creditors receiving 
a proprietary interest in the issuing corporation, and a claim of any 
equal class of creditors, the value of the proprietary interest in the 
target corporation represented by the claim is determined by multiplying 
the fair market value of the claim by a fraction, the numerator of which 
is the fair market value of the proprietary interests in the issuing 
corporation that are received in the aggregate in exchange for the 
claims of those classes of creditors, and the denominator of which is 
the sum of the amount of money and the fair market value of all other 
consideration (including the proprietary interests in the issuing 
corporation) received in the aggregate in exchange for such claims. If 
only one class (or one set of equal classes) of creditors receives 
stock, such class (or set of equal classes) is treated as the most 
senior class of creditors receiving stock. When only one class (or one 
set of equal classes) of creditors receives issuing corporation stock in 
exchange for a creditor's proprietary interest in the target 
corporation, such stock will be counted for measuring continuity of 
interest provided that the stock issued by the issuing corporation is 
not de minimis in relation to the total consideration received by the 
insolvent target corporation, its shareholders, and its creditors.
    (B) Claims of junior classes of creditor receiving stock. The value 
of a proprietary interest in the target corporation held by a creditor 
whose claim is junior to the claims of other classes of target claims 
which are receiving proprietary interests in the issuing corporation is 
the fair market value of the junior creditor's claim.
    (iii) Bifurcated claims. If a creditor's claim is bifurcated into a 
secured claim and an unsecured claim pursuant to an order in a title 11 
or similar case (as defined in section 368(a)(3)) or pursuant to an 
agreement between the creditor and the debtor, the bifurcation of the 
claim and the allocation of consideration to each of the resulting 
claims will be respected in applying the rules of this paragraph (e)(6).
    (iv) Effect of treating creditors as proprietors. The treatment of a 
creditor's claim as a proprietary interest in the target corporation 
shall not preclude treating shares of the target corporation as 
proprietary interests in the target corporation.
    (7) Successors and predecessors. For purposes of this paragraph (e), 
any reference to the issuing corporation or the target corporation 
includes a reference to any successor or predecessor of such 
corporation, except that the target corporation is not treated as a

[[Page 535]]

predecessor of the issuing corporation and the issuing corporation is 
not treated as a successor of the target corporation.
    (8) Examples. For purposes of the examples in this paragraph (e)(7), 
P is the issuing corporation, T is the target corporation, S is a wholly 
owned subsidiary of P, all corporations have only one class of stock 
outstanding, A and B are individuals, PRS is a partnership, all 
reorganization requirements other than the continuity of interest 
requirement are satisfied, and the transaction is not otherwise subject 
to recharacterization. The following examples illustrate the application 
of this paragraph (e):

    Example 1. Sale of stock to third party. (i) Sale of issuing 
corporation stock after merger. A owns all of the stock of T. T merges 
into P. In the merger, A receives P stock having a fair market value of 
$50x and cash of $50x. Immediately after the merger, and pursuant to a 
preexisting binding contract, A sells all of the P stock received by A 
in the merger to B. Assume that there are no facts and circumstances 
indicating that the cash used by B to purchase A's P stock was in 
substance exchanged by P for T stock. Under paragraphs (e)(1) and (3) of 
this section, the sale to B is disregarded because B is not a person 
related to P within the meaning of paragraph (e)(4) of this section. 
Thus, the transaction satisfies the continuity of interest requirement 
because 50 percent of A's T stock was exchanged for P stock, preserving 
a substantial part of the value of the proprietary interest in T.
    (ii) Sale of target corporation stock before merger. The facts are 
the same as paragraph (i) of this Example 1, except that B buys A's T 
stock prior to the merger of T into P and then exchanges the T stock for 
P stock having a fair market value of $50x and cash of $50x. The sale by 
A is disregarded. The continuity of interest requirement is satisfied 
because B's T stock was exchanged for P stock, preserving a substantial 
part of the value of the proprietary interest in T.
    Example 2. Relationship created in connection with potential 
reorganization. Corporation X owns 60 percent of the stock of P and 30 
percent of the stock of T. A owns the remaining 70 percent of the stock 
of T. X buys A's T stock for cash in a transaction which is not a 
qualified stock purchase within the meaning of section 338. T then 
merges into P. In the merger, X exchanges all of its T stock for 
additional stock of P. As a result of the issuance of the additional 
stock to X in the merger, X's ownership interest in P increases from 60 
to 80 percent of the stock of P. X is not a person related to P under 
paragraph (e)(4)(i)(B) of this section, because a purchase of stock of P 
by X would not be treated as a distribution in redemption of the stock 
of P under section 304(a)(2). However, X is a person related to P under 
paragraphs (e)(4)(i)(A) and (ii)(B) of this section, because X becomes 
affiliated with P in the merger. The continuity of interest requirement 
is not satisfied, because X acquired a proprietary interest in T for 
consideration other than P stock, and a substantial part of the value of 
the proprietary interest in T is not preserved. See paragraph (e)(3) of 
this section.
    Example 3. Participation by issuing corporation in post-merger sale. 
A owns 80 percent of the T stock and none of the P stock, which is 
widely held. T merges into P. In the merger, A receives P stock. In 
addition, A obtains rights pursuant to an arrangement with P to have P 
register the P stock under the Securities Act of 1933, as amended. P 
registers A's stock, and A sells the stock shortly after the merger. No 
person who purchased the P stock from A is a person related to P within 
the meaning of paragraph (e)(4) of this section. Under paragraphs (e)(1) 
and (3) of this section, the sale of the P stock by A is disregarded 
because no person who purchased the P stock from A is a person related 
to P within the meaning of paragraph (e)(4) of this section. The 
transaction satisfies the continuity of interest requirement because A's 
T stock was exchanged for P stock, preserving a substantial part of the 
value of the proprietary interest in T.
    Example 4. Redemptions and purchases by issuing corporation or 
related persons. (i) Redemption by issuing corporation. A owns 100 
percent of the stock of T and none of the stock of P. T merges into S. 
In the merger, A receives P stock. In connection with the merger, P 
redeems all of the P stock received by A in the merger for cash. The 
continuity of interest requirement is not satisfied, because, in 
connection with the merger, P redeemed the stock exchanged for a 
proprietary interest in T, and a substantial part of the value of the 
proprietary interest in T is not preserved. See paragraph (e)(1) of this 
section.
    (ii) Purchase of target corporation stock by issuing corporation. 
The facts are the same as paragraph (i) of this Example 4, except that, 
instead of P redeeming its stock, prior to and in connection with the 
merger of T into S, P purchases 90 percent of the T stock from A for 
cash. The continuity of interest requirement is not satisfied, because 
in connection with the merger, P acquired a proprietary interest in T 
for consideration other than P stock, and a substantial part of the 
value of the proprietary interest in T is not preserved. See paragraph 
(e)(1) of this section. However, see Sec. 1.338-3(d) (which may change 
the result in this case by providing that, by virtue of section 338, 
continuity of

[[Page 536]]

interest is satisfied for certain parties after a qualified stock 
purchase).
    (iii) Purchase of issuing corporation stock by person related to 
issuing corporation. The facts are the same as paragraph (i) of this 
Example 4, except that, instead of P redeeming its stock, S buys all of 
the P stock received by A in the merger for cash. S is a person related 
to P under paragraphs (e)(4)(i)(A) and (B) of this section. The 
continuity of interest requirement is not satisfied, because S acquired 
P stock issued in the merger, and a substantial part of the value of the 
proprietary interest in T is not preserved. See paragraph (e)(3) of this 
section.
    Example 5. Redemption in substance by issuing corporation. A owns 
100 percent of the stock of T and none of the stock of P. T merges into 
P. In the merger, A receives P stock. In connection with the merger, B 
buys all of the P stock received by A in the merger for cash. Shortly 
thereafter, in connection with the merger, P redeems the stock held by B 
for cash. Based on all the facts and circumstances, P in substance has 
exchanged solely cash for T stock in the merger. The continuity of 
interest requirement is not satisfied, because in substance P redeemed 
the stock exchanged for a proprietary interest in T, and a substantial 
part of the value of the proprietary interest in T is not preserved. See 
paragraph (e)(1) of this section.
    Example 6. Purchase of issuing corporation stock through 
partnership. A owns 100 percent of the stock of T and none of the stock 
of P. S is an 85 percent partner in PRS. The other 15 percent of PRS is 
owned by unrelated persons. T merges into P. In the merger, A receives P 
stock. In connection with the merger, PRS purchases all of the P stock 
received by A in the merger for cash. Under paragraph (e)(5) of this 
section, S, as an 85 percent partner of PRS, is treated as having 
acquired 85 percent of the P stock exchanged for A's T stock in the 
merger, and as having furnished 85 percent of the cash paid by PRS to 
acquire the P stock. S is a person related to P under paragraphs 
(e)(4)(i)(A) and (B) of this section. The continuity of interest 
requirement is not satisfied, because S is treated as acquiring 85 
percent of the P stock issued in the merger, and a substantial part of 
the value of the proprietary interest in T is not preserved. See 
paragraph (e)(3) of this section.
    Example 7. Exchange by acquiring corporation for direct interest. A 
owns 30 percent of the stock of T. P owns 70 percent of the stock of T, 
which was not acquired by P in connection with the acquisition of T's 
assets. T merges into P. A receives cash in the merger. The continuity 
of interest requirement is satisfied, because P's 70 percent proprietary 
interest in T is exchanged by P for a direct interest in the assets of 
the target corporation enterprise.
    Example 8. Maintenance of direct or indirect interest in issuing 
corporation. X, a corporation, owns all of the stock of each of 
corporations P and Z. Z owns all of the stock of T. T merges into P. Z 
receives P stock in the merger. Immediately thereafter and in connection 
with the merger, Z distributes the P stock received in the merger to X. 
X is a person related to P under paragraph (e)(4)(i)(A) of this section. 
The continuity of interest requirement is satisfied, because X was an 
indirect owner of T prior to the merger who maintains a direct or 
indirect proprietary interest in P, preserving a substantial part of the 
value of the proprietary interest in T. See paragraph (e)(3) of this 
section.
    Example 9. Preacquisition redemption by target corporation. T has 
two shareholders, A and B. P expresses an interest in acquiring the 
stock of T. A does not wish to own P stock. T redeems A's shares in T in 
exchange for cash. No funds have been or will be provided by P for this 
purpose. P subsequently acquires all the outstanding stock of T from B 
solely in exchange for voting stock of P. The cash received by A in the 
prereorganization redemption is not treated as other property or money 
under section 356, and would not be so treated even if A had received 
some stock of P in exchange for his T stock. The prereorganization 
redemption by T does not affect continuity of interest, because B's 
proprietary interest in T is unaffected, and the value of the 
proprietary interest in T is preserved.
    Example 10. Creditors treated as owning a proprietary interest. (i) 
More than one class of creditor receives issuing corporation stock. T 
has assets with a fair market value of $150x and liabilities of $200x. T 
has two classes of creditors: two senior creditors with claims of $25x 
each; and one junior creditor with a claim of $150x. T transfers all of 
its assets to P in exchange for $95x in cash and shares of P stock with 
a fair market value of $55x. Each T senior creditor receives $20x in 
cash and P stock with a fair market value of $5x in exchange for his 
claim. The T junior creditor receives $55x in cash and P stock with a 
fair market value of $45x in exchange for his claim. The T shareholders 
receive no consideration in exchange for their T stock. Under paragraph 
(e)(6) of this section, because the amount of T's liabilities exceeds 
the fair market value of its assets immediately prior to the potential 
reorganization, the claims of the creditors of T may be proprietary 
interests in T. Because the senior creditors receive proprietary 
interests in P in the transaction in exchange for their claims, their 
claims and the claim of the junior creditor and the T stock are treated 
as proprietary interests in T immediately prior to the transaction. 
Under paragraph (e)(6)(ii)(A) of this section, the value of the 
proprietary interest of each of the senior creditors' claims is $5x (the 
fair market value of the senior creditor's claim, $25x, multiplied by a 
fraction, the numerator of which is $10x, the fair

[[Page 537]]

market value of the proprietary interests in the issuing corporation, P, 
received in the aggregate in exchange for the claims of all the 
creditors in the senior class, and the denominator of which is $50x, the 
sum of the amount of money and the fair market value of all other 
consideration (including the proprietary interests in P) received in the 
aggregate in exchange for such claims). Accordingly, $5x of the stock 
that each of the senior creditors receives is counted in measuring 
continuity of interest. Under paragraph (e)(6)(ii)(B) of this section, 
the value of the junior creditor's proprietary interest in T immediately 
prior to the transaction is $100x, the value of his claim. Thus, the 
value of the creditors' proprietary interests in total is $110x and the 
creditors received $55x worth of P stock in total in exchange for their 
proprietary interests. Therefore, P acquired 50 percent of the value of 
the proprietary interests in T in exchange for P stock. Because a 
substantial part of the value of the proprietary interests in T is 
preserved, the continuity of interest requirement is satisfied.
    (ii) One class of creditor receives issuing corporation stock and 
cash in disproportionate amounts. T has assets with a fair market value 
of $80x and liabilities of $200x. T has one class of creditor with two 
creditors, A and B, each having a claim of $100x. T transfers all of its 
assets to P for $60x in cash and shares of P stock with a fair market 
value of $20x. A receives $40x in cash in exchange for its claim. B 
receives $20x in cash and P stock with a fair market value of $20x in 
exchange for its claim. The T shareholders receive no consideration in 
exchange for their T stock. The P stock is not de minimis in relation to 
the total consideration received. Under paragraph (e)(6) of this 
section, because the amount of T's liabilities exceeds the fair market 
value of its assets immediately prior to the potential reorganization, 
the claims of the creditors of T may be proprietary interests in T. 
Because the creditors of T received proprietary interests in P in the 
transaction in exchange for their claims, their claims and the T stock 
are treated as proprietary interests in T immediately prior to the 
transaction. Under paragraph (e)(6)(ii)(A) of this section, the value of 
the proprietary interest of each of the senior creditors is $10x (the 
fair market value of a senior creditor's claim, $40x, multiplied by a 
fraction, the numerator of which is $20x, the fair market value of the 
proprietary interests in the issuing corporation, P, received in the 
aggregate in exchange for the claims of all the creditors in the class, 
and the denominator of which is $80x, the sum of the amount of money and 
the fair market value of all other consideration (including the 
proprietary interests in P) received in the aggregate in exchange for 
such claims). Accordingly, $10x of the cash that was received by A and 
$10x of the P stock that was received by B are counted in measuring 
continuity of interest. Thus, the value of the creditors' proprietary 
interests in total is $20x and the creditors received $10x worth of P 
stock in total in exchange for their proprietary interests. Therefore, P 
acquired 50 percent of the value of the proprietary interests in T in 
exchange for P stock. Because a substantial part of the value of the 
proprietary interests in T is preserved, the continuity of interest 
requirement is satisfied.

    (9) Effective/applicability dates--(i) In general. Paragraphs (e)(1) 
and (e)(3) through (e)(7) of this section apply to transactions 
occurring after January 28, 1998, except that they do not apply to any 
transaction occurring pursuant to a written agreement which is binding 
on January 28, 1998, and at all times thereafter. Paragraph (e)(1)(ii) 
of this section, however, applies to transactions occurring after August 
30, 2000, unless the transaction occurs pursuant to a written agreement 
that is (subject to customary conditions) binding on that date and at 
all times thereafter. Taxpayers who entered into a binding agreement on 
or after January 28, 1998, and before August 30, 2000, may request a 
private letter ruling permitting them to apply the final regulations to 
their transaction. A private letter ruling will not be issued unless the 
taxpayer establishes to the satisfaction of the IRS that there is not a 
significant risk of different parties to the transaction taking 
inconsistent positions, for Federal tax purposes, with respect to the 
applicability of the final regulations to the transaction. The sixth 
sentence of paragraph (e)(1)(i) of this section, the last sentence of 
paragraph (e)(1)(ii) of this section, paragraph (e)(3) of this section, 
paragraph (e)(6) of this section, and Example 10 of paragraph (e)(8) of 
this section apply to transactions occurring after December 12, 2008.
    (ii) COI measurement date. Paragraph (e)(2) of this section applies 
to transactions occurring pursuant to binding contracts entered into 
after December 19, 2011. For transactions entered into after March 19, 
2010, and occurring pursuant to binding contracts entered into on or 
before December 19, 2011, the parties to the transaction may elect to 
apply the provisions of Sec. 1.368-1T as contained in 26 CFR, Part 1, 
Sec. Sec. 1.301-

[[Page 538]]

1.400, revised as of April 1, 2009. However, the target corporation, the 
issuing corporation, the controlling corporation of the acquiring 
corporation if stock thereof is provided as consideration in the 
transaction, and any direct or indirect transferee of transferred basis 
property from any of the foregoing, may not elect to apply the 
provisions of Sec. 1.368-1T as contained in 26 CFR, Part 1, Sec. Sec. 
1.301-1.400, revised as of April 1, 2009, unless all such taxpayers 
elect to apply such provisions. This election requirement will be 
satisfied if none of the specified parties adopts inconsistent 
treatment. For transactions entered into on or before March 19, 2010, 
see Sec. 1.368-1T as contained in 26 CFR, Part 1, Sec. Sec. 1.301-
1.400, revised as of April 1, 2009.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960]

    Editorial Note: For Federal Register citations affecting Sec. 
1.368-1, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.govinfo.gov.



Sec. 1.368-2  Definition of terms.

    (a) The application of the term reorganization is to be strictly 
limited to the specific transactions set forth in section 368(a). The 
term does not embrace the mere purchase by one corporation of the 
properties of another corporation. The preceding sentence applies to 
transactions occurring after January 28, 1998, except that it does not 
apply to any transaction occurring pursuant to a written agreement which 
is binding on January 28, 1998, and at all times thereafter. If the 
properties are transferred for cash and deferred payment obligations of 
the transferee evidenced by short-term notes, the transaction is a sale 
and not an exchange in which gain or loss is not recognized.
    (b)(1)(i) Definitions. For purposes of this paragraph (b)(1), the 
following terms shall have the following meanings:
    (A) Disregarded entity. A disregarded entity is a business entity 
(as defined in Sec. 301.7701-2(a) of this chapter) that is disregarded 
as an entity separate from its owner for Federal income tax purposes. 
Examples of disregarded entities include a domestic single member 
limited liability company that does not elect to be classified as a 
corporation for Federal income tax purposes, a corporation (as defined 
in Sec. 301.7701-2(b) of this chapter) that is a qualified REIT 
subsidiary (within the meaning of section 856(i)(2)), and a corporation 
that is a qualified subchapter S subsidiary (within the meaning of 
section 1361(b)(3)(B)).
    (B) Combining entity. A combining entity is a business entity that 
is a corporation (as defined in Sec. 301.7701-2(b) of this chapter) 
that is not a disregarded entity.
    (C) Combining unit. A combining unit is composed solely of a 
combining entity and all disregarded entities, if any, the assets of 
which are treated as owned by such combining entity for Federal income 
tax purposes.
    (ii) Statutory merger or consolidation generally. For purposes of 
section 368(a)(1)(A), a statutory merger or consolidation is a 
transaction effected pursuant to the statute or statutes necessary to 
effect the merger or consolidation, in which transaction, as a result of 
the operation of such statute or statutes, the following events occur 
simultaneously at the effective time of the transaction--
    (A) All of the assets (other than those distributed in the 
transaction) and liabilities (except to the extent such liabilities are 
satisfied or discharged in the transaction or are nonrecourse 
liabilities to which assets distributed in the transaction are subject) 
of each member of one or more combining units (each a transferor unit) 
become the assets and liabilities of one or more members of one other 
combining unit (the transferee unit); and
    (B) The combining entity of each transferor unit ceases its separate 
legal existence for all purposes; provided, however, that this 
requirement will be satisfied even if, under applicable law, after the 
effective time of the transaction, the combining entity of the 
transferor unit (or its officers, directors, or agents) may act or be 
acted against, or a member of the transferee unit (or its officers, 
directors, or agents) may act or be acted against in the name of the 
combining entity of the transferor unit, provided that such actions 
relate to assets or obligations

[[Page 539]]

of the combining entity of the transferor unit that arose, or relate to 
activities engaged in by such entity, prior to the effective time of the 
transaction, and such actions are not inconsistent with the requirements 
of paragraph (b)(1)(ii)(A) of this section.
    (iii) Examples. The following examples illustrate the rules of 
paragraph (b)(1) of this section. In each of the examples, except as 
otherwise provided, each of R, V, Y, and Z is a C corporation. X is a 
domestic limited liability company. Except as otherwise provided, X is 
wholly owned by Y and is disregarded as an entity separate from Y for 
Federal income tax purposes. The examples are as follows:

    Example 1. Divisive transaction pursuant to a merger statute. (i) 
Facts. Under State W law, Z transfers some of its assets and liabilities 
to Y, retains the remainder of its assets and liabilities, and remains 
in existence for Federal income tax purposes following the transaction. 
The transaction qualifies as a merger under State W corporate law.
    (ii) Analysis. The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section because all of the assets and 
liabilities of Z, the combining entity of the transferor unit, do not 
become the assets and liabilities of Y, the combining entity and sole 
member of the transferee unit. In addition, the transaction does not 
satisfy the requirements of paragraph (b)(1)(ii)(B) of this section 
because the separate legal existence of Z does not cease for all 
purposes. Accordingly, the transaction does not qualify as a statutory 
merger or consolidation under section 368(a)(1)(A).
    Example 2. Merger of a target corporation into a disregarded entity 
in exchange for stock of the owner. (i) Facts. Under State W law, Z 
merges into X. Pursuant to such law, the following events occur 
simultaneously at the effective time of the transaction: all of the 
assets and liabilities of Z become the assets and liabilities of X and 
Z's separate legal existence ceases for all purposes. In the merger, the 
Z shareholders exchange their stock of Z for stock of Y.
    (ii) Analysis. The transaction satisfies the requirements of 
paragraph (b)(1)(ii) of this section because the transaction is effected 
pursuant to State W law and the following events occur simultaneously at 
the effective time of the transaction: all of the assets and liabilities 
of Z, the combining entity and sole member of the transferor unit, 
become the assets and liabilities of one or more members of the 
transferee unit that is comprised of Y, the combining entity of the 
transferee unit, and X, a disregarded entity the assets of which Y is 
treated as owning for Federal income tax purposes, and Z ceases its 
separate legal existence for all purposes. Accordingly, the transaction 
qualifies as a statutory merger or consolidation for purposes of section 
368(a)(1)(A).
    Example 3. Merger of a target S corporation that owns a QSub into a 
disregarded entity. (i) Facts. The facts are the same as in Example 2, 
except that Z is an S corporation and owns all of the stock of U, a 
QSub.
    (ii) Analysis. The deemed formation by Z of U pursuant to Sec. 
1.1361-5(b)(1) (as a consequence of the termination of U's QSub 
election) is disregarded for Federal income tax purposes. The 
transaction is treated as a transfer of the assets of U to X, followed 
by X's transfer of these assets to U in exchange for stock of U. See 
Sec. 1.1361-5(b)(3) Example 9. The transaction will, therefore, satisfy 
the requirements of paragraph (b)(1)(ii) of this section because the 
transaction is effected pursuant to State W law and the following events 
occur simultaneously at the effective time of the transaction: all of 
the assets and liabilities of Z and U, the sole members of the 
transferor unit, become the assets and liabilities of one or more 
members of the transferee unit that is comprised of Y, the combining 
entity of the transferee unit, and X, a disregarded entity the assets of 
which Y is treated as owning for Federal income tax purposes, and Z 
ceases its separate legal existence for all purposes. Moreover, the 
deemed transfer of the assets of U in exchange for U stock does not 
cause the transaction to fail to qualify as a statutory merger or 
consolidation. See Sec. 368(a)(2)(C). Accordingly, the transaction 
qualifies as a statutory merger or consolidation for purposes of section 
368(a)(1)(A).
    Example 4. Triangular merger of a target corporation into a 
disregarded entity. (i) Facts. The facts are the same as in Example 2, 
except that V owns 100 percent of the outstanding stock of Y and, in the 
merger of Z into X, the Z shareholders exchange their stock of Z for 
stock of V. In the transaction, Z transfers substantially all of its 
properties to X.
    (ii) Analysis. The transaction is not prevented from qualifying as a 
statutory merger or consolidation under section 368(a)(1)(A), provided 
the requirements of section 368(a)(2)(D) are satisfied. Because the 
assets of X are treated for Federal income tax purposes as the assets of 
Y, Y will be treated as acquiring substantially all of the properties of 
Z in the merger for purposes of determining whether the merger satisfies 
the requirements of section 368(a)(2)(D). As a result, the Z 
shareholders that receive stock of V will be treated as receiving stock 
of a corporation that is in control of Y, the combining entity of the 
transferee unit that is the acquiring corporation for purposes of 
section 368(a)(2)(D). Accordingly, the merger

[[Page 540]]

will satisfy the requirements of section 368(a)(2)(D).
    Example 5. Merger of a target corporation into a disregarded entity 
owned by a partnership. (i) Facts. The facts are the same as in Example 
2, except that Y is organized as a partnership under the laws of State W 
and is classified as a partnership for Federal income tax purposes.
    (ii) Analysis. The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section. All of the assets and 
liabilities of Z, the combining entity and sole member of the transferor 
unit, do not become the assets and liabilities of one or more members of 
a transferee unit because neither X nor Y qualifies as a combining 
entity. Accordingly, the transaction cannot qualify as a statutory 
merger or consolidation for purposes of section 368(a)(1)(A).
    Example 6. Merger of a disregarded entity into a corporation. (i) 
Facts. Under State W law, X merges into Z. Pursuant to such law, the 
following events occur simultaneously at the effective time of the 
transaction: all of the assets and liabilities of X (but not the assets 
and liabilities of Y other than those of X) become the assets and 
liabilities of Z and X's separate legal existence ceases for all 
purposes.
    (ii) Analysis. The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section because all of the assets and 
liabilities of a transferor unit do not become the assets and 
liabilities of one or more members of the transferee unit. The 
transaction also does not satisfy the requirements of paragraph 
(b)(1)(ii)(B) of this section because X does not qualify as a combining 
entity. Accordingly, the transaction cannot qualify as a statutory 
merger or consolidation for purposes of section 368(a)(1)(A).
    Example 7. Merger of a corporation into a disregarded entity in 
exchange for interests in the disregarded entity. (i) Facts. Under State 
W law, Z merges into X. Pursuant to such law, the following events occur 
simultaneously at the effective time of the transaction: all of the 
assets and liabilities of Z become the assets and liabilities of X and 
Z's separate legal existence ceases for all purposes. In the merger of Z 
into X, the Z shareholders exchange their stock of Z for interests in X 
so that, immediately after the merger, X is not disregarded as an entity 
separate from Y for Federal income tax purposes. Following the merger, 
pursuant to Sec. 301.7701-3(b)(1)(i) of this chapter, X is classified 
as a partnership for Federal income tax purposes.
    (ii) Analysis. The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section because immediately after the 
merger X is not disregarded as an entity separate from Y and, 
consequently, all of the assets and liabilities of Z, the combining 
entity of the transferor unit, do not become the assets and liabilities 
of one or more members of a transferee unit. Accordingly, the 
transaction cannot qualify as a statutory merger or consolidation for 
purposes of section 368(a)(1)(A).
    Example 8. Merger transaction preceded by distribution. (i) Facts. Z 
operates two unrelated businesses, Business P and Business Q, each of 
which represents 50 percent of the value of the assets of Z. Y desires 
to acquire and continue operating Business P, but does not want to 
acquire Business Q. Pursuant to a single plan, Z sells Business Q for 
cash to parties unrelated to Z and Y in a taxable transaction, and then 
distributes the proceeds of the sale pro rata to its shareholders. Then, 
pursuant to State W law, Z merges into Y. Pursuant to such law, the 
following events occur simultaneously at the effective time of the 
transaction: all of the assets and liabilities of Z related to Business 
P become the assets and liabilities of Y and Z's separate legal 
existence ceases for all purposes. In the merger, the Z shareholders 
exchange their Z stock for Y stock.
    (ii) Analysis. The transaction satisfies the requirements of 
paragraph (b)(1)(ii) of this section because the transaction is effected 
pursuant to State W law and the following events occur simultaneously at 
the effective time of the transaction: all of the assets and liabilities 
of Z, the combining entity and sole member of the transeferor unit, 
become the assets and liabilities of Y, the combining entity and sole 
member of the transferee unit, and Z ceases its separate legal existence 
for all purposes. Accordingly, the transaction qualifies as a statutory 
merger or consolidation for purposes of section 368(a)(1)(A).
    Example 9. State law conversion of target corporation into a limited 
liability company. (i) Facts. Y acquires the stock of V from the V 
shareholders in exchange for consideration that consists of 50 percent 
voting stock of Y and 50 percent cash. Immediately after the stock 
acquisition, V files the necessary documents to convert from a 
corporation to a limited liability company under State W law. Y's 
acquisition of the stock of V and the conversion of V to a limited 
liability company are steps in a single integrated acquisition by Y of 
the assets of V.
    (ii) Analysis. The acquisition by Y of the assets of V does not 
satisfy the requirements of paragraph (b)(1)(ii)(B) of this section 
because V, the combining entity of the transferor unit, does not cease 
its separate legal existence. Although V is an entity disregarded from 
its owner for Federal income tax purposes, it continues to exist as a 
juridical entity after the conversion. Accordingly, Y's acquisition of 
the assets of V does not qualify as a statutory merger or consolidation 
for purposes of section 368(a)(1)(A).
    Example 10. Dissolution of target corporation. (i) Facts. Y acquires 
the stock of Z from the

[[Page 541]]

Z shareholders in exchange for consideration that consists of 50 percent 
voting stock of Y and 50 percent cash. Immediately after the stock 
acquisition, Z files a certificate of dissolution pursuant to State W 
law and commences winding up its activities. Under State W dissolution 
law, ownership and title to Z's assets does not automatically vest in Y 
upon dissolution. Instead, Z transfers assets to its creditors in 
satisfaction of its liabilities and transfers its remaining assets to Y 
in the liquidation stage of the dissolution. Y's acquisition of the 
stock of Z and the dissolution of Z are steps in a single integrated 
acquisition by Y of the assets of Z.
    (ii) Analysis. The acquisition by Y of the assets of Z does not 
satisfy the requirements of paragraph (b)(1)(ii) of this section because 
Y does not acquire all of the assets of Z as a result of Z filing the 
certificate of dissolution or simultaneously with Z ceasing its separate 
legal existence. Instead, Y acquires the assets of Z by reason of Z's 
transfer of its assets to Y. Accordingly, Y's acquisition of the assets 
of Z does not qualify as a statutory merger or consolidation for 
purposes of section 368(a)(1)(A).
    Example 11. Merger of corporate partner into a partnership. (i) 
Facts. Y owns an interest in X, an entity classified as a partnership 
for Federal income tax purposes, that represents a 60 percent capital 
and profits interest in X. Z owns an interest in X that represents a 40 
percent capital and profits interest. Under State W law, Z merges into 
X. Pursuant to such law, the following events occur simultaneously at 
the effective time of the transaction: all of the assets and liabilities 
of Z become the assets and liabilities of X and Z ceases its separate 
legal existence for all purposes. In the merger, the Z shareholders 
exchange their stock of Z for stock of Y. As a result of the merger, X 
becomes an entity that is disregarded as an entity separate from Y for 
Federal income tax purposes.
    (ii) Analysis. The transaction satisfies the requirements of 
paragraph (b)(1)(ii) of this section because the transaction is effected 
pursuant to State W law and the following events occur simultaneously at 
the effective time of the transaction: all of the assets and liabilities 
of Z, the combining entity and sole member of the transferor unit, 
become the assets and liabilities of one or more members of the 
transferee unit that is comprised of Y, the combining entity of the 
transferee unit, and X, a disregarded entity the assets of which Y is 
treated as owning for Federal income tax purposes immediately after the 
transaction, and Z ceases its separate legal existence for all purposes. 
Accordingly, the transaction qualifies as a statutory merger or 
consolidation for purposes of section 368(a)(1)(A).
    Example 12. State law consolidation. (i) Facts. Under State W law, Z 
and V consolidate. Pursuant to such law, the following events occur 
simultaneously at the effective time of the transaction: all of the 
assets and liabilities of Z and V become the assets and liabilities of 
Y, an entity that is created in the transaction, and the existence of Z 
and V continues in Y. In the consolidation, the Z shareholders and the V 
shareholders exchange their stock of Z and V, respectively, for stock of 
Y.
    (ii) Analysis. With respect to each of Z and V, the transaction 
satisfies the requirements of paragraph (b)(1)(ii) of this section 
because the transaction is effected pursuant to State W law and the 
following events occur simultaneously at the effective time of the 
transaction: all of the assets and liabilities of Z and V, respectively, 
each of which is the combining entity of a transferor unit, become the 
assets and liabilities of Y, the combining entity and sole member of the 
transferee unit, and Z and V each ceases its separate legal existence 
for all purposes. Accordingly, the transaction qualifies as the 
statutory merger or consolidation of each of Z and V into Y for purposes 
of section 368(a)(1)(A).
    Example 13. Transaction effected pursuant to foreign statutes. (i) 
Facts. Z and Y are entities organized under the laws of Country Q and 
classified as corporations for Federal income tax purposes. Z and Y 
combine. Pursuant to statutes of Country Q the following events occur 
simultaneously: all of the assets and liabilities of Z become the assets 
and liabilities of Y and Z's separate legal existence ceases for all 
purposes.
    (ii) Analysis. The transaction satisfies the requirements of 
paragraph (b)(1)(ii) of this section because the transaction is effected 
pursuant to statutes of Country Q and the following events occur 
simultaneously at the effective time of the transaction: all of the 
assets and liabilities of Z, the combining entity of the transferor 
unit, become the assets and liabilities of Y, the combining entity and 
sole member of the transferee unit, and Z ceases its separate legal 
existence for all purposes. Accordingly, the transaction qualifies as a 
statutory merger or consolidation for purposes of section 368(a)(1)(A).
    Example 14. Foreign law amalgamation using parent stock. (i) Facts. 
Z and V are entities organized under the laws of Country Q and 
classified as corporations for Federal income tax purposes. Z and V 
amalgamate. Pursuant to statutes of Country Q, the following events 
occur simultaneously: all the assets and liabilities of Z and V become 
the assets and liabilities of R, an entity that is created in the 
transaction and that is wholly owned by Y immediately after the 
transaction, and Z's and V's separate legal existences cease for all 
purposes. In the transaction, the Z and V shareholders exchange their Z 
and V stock, respectively, for stock of Y.
    (ii) Analysis. With respect to each of Z and V, the transaction 
satisfies the requirements of paragraph (b)(1)(ii) of this section 
because

[[Page 542]]

the transaction is effected pursuant to Country Q law and the following 
events occur simultaneously at the effective time of the transaction: 
all of the assets and liabilities of Z and V, respectively, each of 
which is the combining entity of a transferor unit, become the assets 
and liabilities of R, the combining entity and sole member of the 
transferee unit, with regard to each of the above transfers, and Z and V 
each ceases its separate legal existence for all purposes. Because Y is 
in control of R immediately after the transaction, the Z shareholders 
and the V shareholders will be treated as receiving stock of a 
corporation that is in control of R, the combining entity of the 
transferee unit that is the acquiring corporation for purposes of 
section 368(a)(2)(D). Accordingly, the transaction qualifies as the 
statutory merger or consolidation of each of Z and V into R, a 
corporation controlled by Y, and is a reorganization under section 
368(a)(1)(A) by reason of section 368(a)(2)(D).
    (v) Effective date--(A) In general. This paragraph (b)(1) applies to 
transactions occurring on or after January 23, 2006. For rules regarding 
statutory mergers or consolidation occurring before January 23, 2006, 
see Sec. 1.368-2T as contained in 26 CFR part 1, revised April 1, 2005, 
and Sec. 1.368-2(b)(1) as in effect before January 24, 2003 (see 26 CFR 
part 1, revised April 1, 2002).
    (B) Transitional rule. A taxpayer may elect to apply the provisions 
of Sec. 1.368-2T(b) as contained in 26 CFR part 1, revised April 1, 
2005 (the temporary regulations), instead of the provisions of this 
paragraph (b), to a transaction that occurs on or after January 23, 
2006, pursuant to a written agreement which is (subject to customary 
conditions) binding on January 22, 2006, and at all times thereafter, or 
pursuant to a tender offer announced prior to January 23, 2006. However, 
the combining entity of the transferor unit, the combining entity of the 
transferee unit, any controlling corporation of the combining entity of 
the transferee unit if stock thereof is provided as consideration in the 
transaction, and any direct or indirect transferee of transferred basis 
property from any of the foregoing, may not elect to apply the 
provisions of the temporary regulations unless all such taxpayers elect 
to apply the provisions of the temporary regulations.
    (2) In order for the transaction to qualify under section 
368(a)(1)(A) by reason of the application of section 368(a)(2)(D), one 
corporation (the acquiring corporation) must acquire substantially all 
of the properties of another corporation (the acquired corporation) 
partly or entirely in exchange for stock of a corporation which is in 
control of the acquiring corporation (the controlling corporation), 
provided that (i) the transaction would have qualified under section 
368(a)(1)(A) if the merger had been into the controlling corporation, 
and (ii) no stock of the acquiring corporation is used in the 
transaction. The foregoing test of whether the transaction would have 
qualified under section 368(a)(1)(A) if the merger had been into the 
controlling corporation means that the general requirements of a 
reorganization under section 368(a)(1)(A) (such as a business purpose, 
continuity of business enterprise, and continuity of interest) must be 
met in addition to the special requirements of section 368(a)(2)(D). 
Under this test, it is not relevant whether the merger into the 
controlling corporation could have been effected pursuant to State or 
Federal corporation law. The term substantially all has the same meaning 
as it has in section 368(a)(1)(C). Although no stock of the acquiring 
corporation can be used in the transaction, there is no prohibition 
(other than the continuity of interest requirement) against using other 
property, such as cash or securities, of either the acquiring 
corporation or the parent or both. In addition, the controlling 
corporation may assume liabilities of the acquired corporation without 
disqualifying the transaction under section 368(a)(2(D), and for 
purposes of section 357(a) the controlling corporation is considered a 
party to the exchange. For example, if the controlling corporation 
agrees to substitute its stock for stock of the acquired corporation 
under an outstanding employee stock option agreement, this assumption of 
liability will not prevent the transaction from qualifying as a 
reorganization under section 368(a)(2)(D) and the assumption of 
liability is not treated as money or other property for purposes of 
section 361(b). Section 368(a)(2)(D) applies whether or not the 
controlling corporation (or the acquiring corporation) is formed 
immediately before the merger,

[[Page 543]]

in anticipation of the merger, or after preliminary steps have been 
taken to merge directly into the controlling corporation. Section 
368(a)(2)(D) applies only to statutory mergers occurring after October 
22, 1968.
    (3) For regulations under section 368(a)(2)(E), see paragraph (j) of 
this section.
    (c) In order to qualify as a ``reorganization'' under section 
368(a)(1)(B), the acquisition by the acquiring corporation of stock of 
another corporation must be in exchange solely for all or a part of the 
voting stock of the acquiring corporation (or, in the case of 
transactions occurring after December 31, 1963, solely for all or a part 
of the voting stock of a corporation which is in control of the 
acquiring corporation), and the acquiring corporation must be in control 
of the other corporation immediately after the transaction. If, for 
example, Corporation X in one transaction exchanges nonvoting preferred 
stock or bonds in addition to all or a part of its voting stock in the 
acquisition of stock of Corporation Y, the transaction is not a 
reorganization under section 368(a)(1)(B). Nor is a transaction a 
reorganization described in section 368(a)(1)(B) if stock is acquired in 
exchange for voting stock both of the acquiring corporation and of a 
corporation which is in control of the acquiring corporation. The 
acquisition of stock of another corporation by the acquiring corporation 
solely for its voting stock (or solely for voting stock of a corporation 
which is in control of the acquiring corporation) is permitted tax-free 
even though the acquiring corporation already owns some of the stock of 
the other corporation. Such an acquisition is permitted tax-free in a 
single transaction or in a series of transactions taking place over a 
relatively short period of time such as 12 months. For example, 
Corporation A purchased 30 percent of the common stock of Corporation W 
(the only class of stock outstanding) for cash in 1939. On March 1, 
1955, Corporation A offers to exchange its own voting stock for all the 
stock of Corporation W tendered within 6 months from the date of the 
offer. Within the 6-months' period Corporation A acquires an additional 
60 percent of stock of Corporation W solely for its own voting stock, so 
that it owns 90 percent of the stock of Corporation W. No gain or loss 
is recognized with respect to the exchanges of stock of Corporation A 
for stock of Corporation W. For this purpose, it is immaterial whether 
such exchanges occurred before Corporation A acquired control (80 
percent) of Corporation W or after such control was acquired. If 
Corporation A had acquired 80 percent of the stock of Corporation W for 
cash in 1939, it could likewise acquire some or all of the remainder of 
such stock solely in exchange for its own voting stock without 
recognition of gain or loss.
    (d) In order to qualify as a reorganization under section 
368(a)(1)(C), the transaction must be one described in subparagraph (1) 
or (2) of this paragraph:
    (1) One corporation must acquire substantially all the properties of 
another corporation solely in exchange for all or a part of its own 
voting stock, or solely in exchange for all or a part of the voting 
stock of a corporation which is in control of the acquiring corporation. 
For example, Corporation P owns all the stock of Corporation A. All the 
properties of Corporation W are transferred to Corporation A either 
solely in exchange for voting stock of Corporation P or solely in 
exchange for less than 80 percent of the voting stock of Corporation A. 
Either of such transactions constitutes a reorganization under section 
368(a)(1)(C). However, if the properties of Corporation W are acquired 
in exchange for voting stock of both Corporation P and Corporation A, 
the transaction will not constitute a reorganization under section 
368(a)(1)(C). In determining whether the exchange meets the requirement 
of ``solely for voting stock'', the assumption by the acquiring 
corporation of liabilities of the transferor corporation, or the fact 
that property acquired from the transferor corporation is subject to a 
liability, shall be disregarded. Though such an assumption does not 
prevent an exchange from being solely for voting stock for the purposes 
of the definition of a reorganization contained in section 368(a)(1)(C), 
it may in some cases, however, so alter the character of the transaction 
as to place the

[[Page 544]]

transaction outside the purposes and assumptions of the reorganization 
provisions. Section 368(a)(1)(C) does not prevent consideration of the 
effect of an assumption of liabilities on the general character of the 
transaction but merely provides that the requirement that the exchange 
be solely for voting stock is satisfied if the only additional 
consideration is an assumption of liabilities.
    (2) One corporation:
    (i) Must acquire substantially all of the properties of another 
corporation in such manner that the acquisition would qualify under (1) 
above, but for the fact that the acquiring corporation exchanges money, 
or other property in addition to such voting stock, and
    (ii) Must acquire solely for voting stock (either of the acquiring 
corporation or of a corporation which is in control of the acquiring 
corporation) properties of the other corporation having a fair market 
value which is at least 80 percent of the fair market value of all the 
properties of the other corporation.
    (3) For the purposes of subparagraph (2)(ii) only, a liability 
assumed or to which the properties are subject is considered money paid 
for the properties. For example, Corporation A has properties with a 
fair market value of $100,000 and liabilities of $10,000. In exchange 
for these properties, Corporation Y transfers its own voting stock, 
assumes the $10,000 liabilities, and pays $8,000 in cash. The 
transaction is a reorganization even though a part of the properties of 
Corporation A is acquired for cash. On the other hand, if the properties 
of Corporation A worth $100,000, were subject to $50,000 in liabilities, 
an acquisition of all the properties, subject to the liabilities, for 
any consideration other than solely voting stock would not qualify as a 
reorganization under this section since the liabilities alone are in 
excess of 20 percent of the fair market value of the properties. If the 
transaction would qualify under either subparagraph (1) or (2) of this 
paragraph and also under section 368(a)(1)(D), such transaction shall 
not be treated as a reorganization under section 368 (a)(1)(C).
    (4)(i) For purposes of paragraphs (d)(1) and (2)(ii) of this 
section, prior ownership of stock of the target corporation by an 
acquiring corporation will not by itself prevent the solely for voting 
stock requirement of such paragraphs from being satisfied. In a 
transaction in which the acquiring corporation has prior ownership of 
stock of the target corporation, the requirement of paragraph (d)(2)(ii) 
of this section is satisfied only if the sum of the money or other 
property that is distributed in pursuance of the plan of reorganization 
to the shareholders of the target corporation other than the acquiring 
corporation and to the creditors of the target corporation pursuant to 
section 361(b)(3), and all of the liabilities of the target corporation 
assumed by the acquiring corporation (including liabilities to which the 
properties of the target corporation are subject), does not exceed 20 
percent of the value of all of the properties of the target corporation. 
If, in connection with a potential acquisition by an acquiring 
corporation of substantially all of a target corporation's properties, 
the acquiring corporation acquires the target corporation's stock for 
consideration other than the acquiring corporation's own voting stock 
(or voting stock of a corporation in control of the acquiring 
corporation if such stock is used in the acquisition of the target 
corporation's properties), whether from a shareholder of the target 
corporation or the target corporation itself, such consideration is 
treated, for purposes of paragraphs (d)(1) and (2) of this section, as 
money or other property exchanged by the acquiring corporation for the 
target corporation's properties. Accordingly, the transaction will not 
qualify under section 368(a)(1)(C) unless, treating such consideration 
as money or other property, the requirements of section 368(a)(2)(B) and 
paragraph (d)(2)(ii) of this section are met. The determination of 
whether there has been an acquisition in connection with a potential 
reorganization under section 368(a)(1)(C) of a target corporation's 
stock for consideration other than an acquiring corporation's own voting 
stock (or voting stock of a corporation in control of the acquiring 
corporation if such stock is used in the acquisition of the target 
corporation's

[[Page 545]]

properties) will be made on the basis of all of the facts and 
circumstances.
    (ii) The following examples illustrate the principles of this 
paragraph (d)(4):

    Example 1. Corporation P (P) holds 60 percent of the Corporation T 
(T) stock that P purchased several years ago in an unrelated 
transaction. T has 100 shares of stock outstanding. The other 40 percent 
of the T stock is owned by Corporation X (X), an unrelated corporation. 
T has properties with a fair market value of $110 and liabilities of 
$10. T transfers all of its properties to P. In exchange, P assumes the 
$10 of liabilities, and transfers to T $30 of P voting stock and $10 of 
cash. T distributes the P voting stock and $10 of cash to X and 
liquidates. The transaction satisfies the solely for voting stock 
requirement of paragraph (d)(2)(ii) of this section because the sum of 
$10 of cash paid to X and the assumption by P of $10 of liabilities does 
not exceed 20% of the value of the properties of T.
    Example 2. The facts are the same as in Example 1 except that P 
purchased the 60 shares of T for $60 in cash in connection with the 
acquisition of T's assets. The transaction does not satisfy the solely 
for voting stock requirement of paragraph (d)(2)(ii) of this section 
because P is treated as having acquired all of the T assets for 
consideration consisting of $70 of cash, $10 of liability assumption and 
$30 of P voting stock, and the sum of $70 of cash and the assumption by 
P of $10 of liabilities exceeds 20% of the value of the properties of T.

    (iii) This paragraph (d)(4) applies to transactions occurring after 
December 31, 1999, unless the transaction occurs pursuant to a written 
agreement that is (subject to customary conditions) binding on that date 
and at all times thereafter.
    (e) A ``recapitalization'', and therefore a reorganization, takes 
place if, for example:
    (1) A corporation with $200,000 par value of bonds outstanding, 
instead of paying them off in cash, discharges them by issuing preferred 
shares to the bondholders;
    (2) There is surrendered to a corporation for cancellation 25 
percent of its preferred stock in exchange for no par value common 
stock;
    (3) A corporation issues preferred stock, previously authorized but 
unissued, for outstanding common stock;
    (4) An exchange is made of a corporation's outstanding preferred 
stock, having certain priorities with reference to the amount and time 
of payment of dividends and the distribution of the corporate assets 
upon liquidation, for a new issue of such corporation's common stock 
having no such rights;
    (5) An exchange is made of an amount of a corporation's outstanding 
preferred stock with dividends in arrears for other stock of the 
corporation. However, if pursuant to such an exchange there is an 
increase in the proportionate interest of the preferred shareholders in 
the assets or earnings and profits of the corporation, then under Sec. 
1.305-7(c)(2), an amount equal to the lesser of (i) the amount by which 
the fair market value or liquidation preference, whichever is greater, 
of the stock received in the exchange (determined immediately following 
the recapitalization) exceeds the issue price of the preferred stock 
surrendered, or (ii) the amount of the dividends in arrears, shall be 
treated under section 305(c) as a deemed distribution to which sections 
305(b)(4) and 301 apply.
    (f) The term a party to a reorganization includes a corporation 
resulting from a reorganization, and both corporations, in a transaction 
qualifying as a reorganization where one corporation acquires stock or 
properties of another corporation. If a transaction otherwise qualifies 
as a reorganization, a corporation remains a party to the reorganization 
even though stock or assets acquired in the reorganization are 
transferred in a transaction described in paragraph (k) of this section. 
If a transaction otherwise qualifies as a reorganization, a corporation 
shall not cease to be a party to the reorganization solely by reason of 
the fact that part or all of the assets acquired in the reorganization 
are transferred to a partnership in which the transferor is a partner if 
the continuity of business enterprise requirement is satisfied. See 
Sec. 1.368-1(d). The preceding three sentences apply to transactions 
occurring after January 28, 1998, except that they do not apply to any 
transaction occurring pursuant to a written agreement which is binding 
on January 28, 1998, and at all times thereafter. A corporation 
controlling an acquiring corporation is a party to the reorganization 
when the stock of such controlling corporation is used in the 
acquisition of

[[Page 546]]

properties. Both corporations are parties to the reorganization if, 
under statutory authority, Corporation A is merged into Corporation B. 
All three of the corporations are parties to the reorganization if, 
pursuant to statutory authority, Corporation C and Corporation D are 
consolidated into Corporation E. Both corporations are parties to the 
reorganization if Corporation F transfers substantially all its assets 
to Corporation G in exchange for all or a part of the voting stock of 
Corporation G. All three corporations are parties to the reorganization 
if Corporation H transfers substantially all its assets to Corporation K 
in exchange for all or a part of the voting stock of Corporation L, 
which is in control of Corporation K. Both corporations are parties to 
the reorganization if Corporation M transfers all or part of its assets 
to Corporation N in exchange for all or a part of the stock and 
securities of Corporation N, but only if (1) immediately after such 
transfer, Corporation M, or one or more of its shareholders (including 
persons who were shareholders immediately before such transfer), or any 
combination thereof, is in control of Corporation N, and (2) in 
pursuance of the plan, the stock and securities of Corporation N are 
transferred or distributed by Corporation M in a transaction in which 
gain or loss is not recognized under section 354 or 355, or is 
recognized only to the extent provided in section 356. Both Corporation 
O and Corporation P, but not Corporation S, are parties to the 
reorganization if Corporation O acquires stock of Corporation P from 
Corporation S in exchange solely for a part of the voting stock of 
Corporation O, if (1) the stock of Corporation P does not constitute 
substantially all of the assets of Corporation S, (2) Corporation S is 
not in control of Corporation O immediately after the acquisition, and 
(3) Corporation O is in control of Corporation P immediately after the 
acquisition. If a transaction otherwise qualifies as a reorganization 
under section 368(a)(1)(B) or as a reverse triangular merger (as defined 
in Sec. 1.358-6(b)(2)(iii)), the target corporation (in the case of a 
transaction that otherwise qualifies as a reorganization under section 
368(a)(1)(B)) or the surviving corporation (in the case of a transaction 
that otherwise qualifies as a reverse triangular merger) remains a party 
to the reorganization even though its stock or assets are transferred in 
a transaction described in paragraph (k) of this section. If a 
transaction otherwise qualifies as a forward triangular merger (as 
defined in Sec. 1.358-6(b)(2)(i)), a triangular B reorganization (as 
defined in Sec. 1.358-6(b)(2)(iv)), a triangular C reorganization (as 
defined in Sec. 1.358-6(b)(2)(ii)), or a reorganization under section 
368(a)(1)(G) by reason of section 368(a)(2)(D), the acquiring 
corporation remains a party to the reorganization even though its stock 
is transferred in a transaction described in paragraph (k) of this 
section. The two preceding sentences apply to transactions occurring on 
or after October 25, 2007, except that they do not apply to any 
transaction occurring pursuant to a written agreement which is binding 
before October 25, 2007, and at all times after that.
    (g) The term plan of reorganization has reference to a consummated 
transaction specifically defined as a reorganization under section 
368(a). The term is not to be construed as broadening the definition of 
reorganization as set forth in section 368(a), but is to be taken as 
limiting the nonrecognition of gain or loss to such exchanges or 
distributions as are directly a part of the transaction specifically 
described as a reorganization in section 368(a). Moreover, the 
transaction, or series of transactions, embraced in a plan of 
reorganization must not only come within the specific language of 
section 368(a), but the readjustments involved in the exchanges or 
distributions effected in the consummation thereof must be undertaken 
for reasons germane to the continuance of the business of a corporation 
a party to the reorganization. Section 368(a) contemplates genuine 
corporate reorganizations which are designed to effect a readjustment of 
continuing interests under modified corporate forms.
    (h) As used in section 368, as well as in other provisions of the 
Internal Revenue Code, if the context so requires, the conjunction 
``or'' denotes both the conjunctive and the disjunctive, and the 
singular includes the plural. For

[[Page 547]]

example, the provisions of the statute are complied with if ``stock and 
securities'' are received in exchange as well as if ``stock or 
securities'' are received.
    (i) [Reserved]
    (j)(1) This paragraph (j) prescribes rules relating to the 
application of section 368 (a)(2)(E).
    (2) Section 368(a)(2)(E) does not apply to a consolidation.
    (3) A transaction otherwise qualifying under section 368(a)(1)(A) is 
not disqualified by reason of the fact that stock of a corporation (the 
controlling corporation) which before the merger was in control of the 
merged corporation is used in the transaction, if the conditions of 
section 368(a)(2)(E) are satisfied. Those conditions are as follows:
    (i) In the transaction, shareholders of the surviving corporation 
must surrender stock in exchange for voting stock of the controlling 
corporation. Further, the stock so surrendered must constitute control 
of the surviving corporation. Control is defined in section 368(c). The 
amount of stock constituting control is measured immediately before the 
transaction. For purposes of this subdivision (i), stock in the 
surviving corporation which is surrendered in the transaction (by any 
shareholder except the controlling corporation) in exchange for 
consideration furnished by the surviving corporation (and not by the 
controlling corporation of the merged corporation) is considered not to 
be outstanding immediately before the transaction. For effect on 
``substantially all'' test of consideration furnished by the surviving 
corporation, see paragraph (j)(3)(iii) of this section.
    (ii) Except as provided in paragraph (k) of this section, the 
controlling corporation must control the surviving corporation 
immediately after the transaction.
    (iii) After the transaction, the surviving corporation must hold 
substantially all of its own properties and substantially all of the 
properties of the merged corporation (other than stock of the 
controlling corporation distributed in the transaction). The surviving 
corporation may transfer such properties as provided in paragraph (k) of 
this section. After the transaction, except as provided in paragraph 
(k)(2) of this section, the surviving corporation must hold 
substantially all of its own properties and substantially all of the 
properties of the merged corporation (other than stock of the 
controlling corporation distributed in the transaction). The term 
substantially all has the same meaning as in section 368(a)(1)(C). The 
``substantially all'' test applies separately to the merged corporation 
and to the surviving corporation. In applying the ``substantially all'' 
test to the surviving corporation, consideration furnished in the 
transaction by the surviving corporation in exchange for its stock is 
property of the surviving corporation which it does not hold after the 
transaction. In applying the ``substantially all'' test to the merged 
corporation, assets transferred from the controlling corporation to the 
merged corporation in pursuance of the plan of reorganization are not 
taken into account. Thus, for example, money transferred from the 
controlling corporation to the merged corporation to be used for the 
following purposes is not taken into account for purposes of the 
``substantially all'' test:
    (A) To pay additional consideration to shareholders of the surviving 
corporation;
    (B) To pay dissenting shareholders of the surviving corporation;
    (C) To pay creditors of the surviving corporation;
    (D) To pay reorganization expenses; or
    (E) To enable the merged corporation to satisfy state minimum 
capitalization requirements (where the money is returned to the 
controlling corporation as part of the transaction).
    (iv) Paragraph (j)(3)(ii) and the first two sentences of paragraph 
(j)(3)(iii) of this section apply to transactions occurring on or after 
October 25, 2007, except that they do not apply to any transaction 
occurring pursuant to a written agreement which is binding before 
October 25, 2007, and at all times thereafter. The remainder of 
paragraph (j)(3)(iii) of this section applies to transactions occurring 
after January 28, 1998, except that it does not apply to any transaction 
occurring pursuant to a written agreement which is binding

[[Page 548]]

on January 28, 1998, and at all times after that.
    (4) The controlling corporation may assume liabilities of the 
surviving corporation without disqualifying the transaction under 
section 368(a)(2)(E). An assumption of liabilities of the surviving 
corporation by the controlling corporation is a contribution to capital 
by the controlling corporation to the surviving corporation. If, in 
pursuance of the plan of reorganization, securities of the surviving 
corporation are exchanged for securities of the controlling corporation, 
or for other securities of the surviving corporation, see sections 354 
and 356.
    (5) In applying section 368(a)(2)(E), it makes no difference if the 
merged corporation is an existing corporation, or is formed immediately 
before the merger, in anticipation of the merger, or after preliminary 
steps have been taken to otherwise acquire control of the surviving 
corporation.
    (6) The following examples illustrate the application of this 
paragraph (j). In each of the examples, Corporation P owns all of the 
stock of Corporation S and, except as otherwise stated, Corporation T 
has outstanding 1,000 shares of common stock and no shares of any other 
class. In each of the examples, it is also assumed that the transaction 
qualifies under section 368(a)(1)(A) if the conditions of section 
368(a)(2)(E) are satisfied.

    Example 1. P owns no T stock. On January 1, 1981, S merges into T. 
In the merger, T's shareholders surrender 950 shares of common stock in 
exchange for P voting stock. The holders of the other 50 shares (who 
dissent from the merger) are paid in cash with funds supplied by P. 
After the transaction, T holds all of its own assets and all of S's 
assets. Based on these facts, the transaction qualifies under section 
368(a)(1)(A) by reason of the application of section 368(a)(2)(E). In 
the transaction, former shareholders of T surrender, in exchange for P 
voting stock, an amount of T stock (950/1,000 shares or 95 percent) 
which constitutes control of T.
    Example 2. The facts are the same as in Example (1) except that 
holders of 100 shares in corporation T, who dissented from the merger, 
are paid in cash with funds supplied by T (and not by P or S) and in the 
merger, T's remaining shareholders surrender 720 shares of common stock 
in exchange for P voting stock and 180 shares of common stock for cash 
supplied by P. The requirements of section 368(a)(2)(E)(ii) are 
satisfied since, in the transaction, former shareholders of T surrender, 
in exchange for P voting stock, an amount of T stock (720/900 shares or 
80 percent) which constitutes control of T. The T stock surrendered in 
exchange for consideration furnished by T is not considered outstanding 
for purposes of determining whether the amount of T stock surrendered by 
T shareholders for P stock constitutes control of T.
    Example 3. T has outstanding 1,000 shares of common stock, 100 
shares of nonvoting preferred stock, and no shares of any other class. 
On January 1, 1981, S merges into T. Prior to the merger, as part of the 
transaction, T distributes its own cash in redemption of the 100 shares 
of preferred stock. In the transaction, T's remaining shareholders 
surrender their 1,000 shares of common stock in exchange for P voting 
stock. The requirements of section 368(a)(2)(E)(ii) are satisfied since, 
in the transaction, former shareholders of T surrender, in exchange for 
P voting stock, an amount of T stock (1,000/1,000 shares or 100 percent) 
which constitutes control of T. The preferred stock surrendered in 
exchange for consideration furnished by T is not considered outstanding 
for purposes of determining whether the amount of T stock surrendered by 
T shareholders for P stock constitutes control of T. However, the 
consideration furnished by T for its stock is property of T which T does 
not hold after the transaction for purposes of the substantially all 
test in paragraph (j)(3)(iii) of this section.
    Example 4. On January 1, 1971, P purchased 201 shares of T's stock. 
On January 1, 1981, S merges into T. In the merger, T's shareholders 
(other than P) surrender 799 shares of T stock in exchange for P voting 
stock. Based on these facts, in the transaction, former shareholders of 
T do not surrender, in exchange for P voting stock, an amount of T stock 
which constitutes control of T (799/1,000 shares being less than 80 
percent). Therefore, the transaction does not qualify under section 
368(a)(1)(A). However, if S is a transitory corporation, formed solely 
for purposes of effectuating the transaction, the transaction may 
qualify as a reorganization described in section 368(a)(1)(B) provided 
all of the applicable requirements are satisfied.
    Example 5. On January 1, 1971, P purchased 200 shares of T's stock. 
On January 1, 1981, S merges into T. Prior to the merger, as part of the 
transaction, T distributes its own cash in redemption of 1 share of T 
stock from a T shareholder other than P. In the merger, T's remaining 
shareholders (other than P) surrender 799 shares of T stock in exchange 
for P voting stock. Based on these facts, in the transaction, former 
shareholders of T do not surrender, in exchange for P voting stock, an 
amount of T stock which constitutes control of T (799/999 shares being 
less than 80 percent). Therefore, the transaction does not

[[Page 549]]

qualify under section 368(a)(1)(A). However, if S is a transitory 
corporation, formed for purposes of effectuating the transaction, the 
transaction may qualify as a reorganization described in section 
368(a)(1)(B) provided all of the applicable requirements are satisfied.
    Example 6. The stock of S has a value of $25,000. The stock of T has 
a value of $75,000. On January 1, 1984, S merges into T. In the merger, 
T's shareholders surrender all of their T stock in exchange for P voting 
stock. After the transaction, T holds all of its own assets and all of 
S's assets. Based on these facts, the transaction qualifies under 
section 368(a)(1)(A) by reason of the application of section 
368(a)(2)(E). In the transaction, former shareholders of T surrender, in 
exchange for P voting stock, an amount of T stock (1,000/1,000 shares or 
100 percent) which constitutes control of T. The stock of T received by 
P in exchange for P's prior interest in S is not taken into account for 
purposes of section 368(a)(2)(E)(ii) since the amount of T stock 
constituting control of T is measured before the transaction.
    Example 7. The stock of T has a value of $75,000. On January 1, 
1984, S merges into T. In the merger, T's shareholders surrender all of 
their T stock in exchange for P voting stock. As part of the 
transaction, P contributes $25,000 to T in exchange for new shares of T 
stock. None of the cash received by T is distributed or otherwise paid 
out to former T shareholders. After the transaction, T holds all of its 
own assets and all of S's assets. Based on these facts, the transaction 
qualifies under section 368(a)(1)(A) by reason of the application of 
section 368(a)(2)(E). In the transaction, former shareholders of T 
surrender, in exchange for P voting stock, an amount of T stock (1,000/
1,000 shares or 100 percent) which constitutes control of T. The T stock 
received by P in exchange for its contribution to T is not taken into 
account for purposes of section 368(a)(2)(E)(ii) since the amount of T 
stock constituting control of T is measured before the transaction.
    Example 8. The facts are the same as in Example (7) except that, as 
part of the transaction, corporation R, instead of P, contributes 
$25,000 to T in exchange for T stock. Based on these facts, the 
transaction does not qualify under section 368(a)(1)(A) by reason of 
section 368(a)(2)(E) since P does not control T immediately after the 
transaction.
    Example 9. T stock has a value of $75,000. P owns 500 shares (\1/2\) 
of that stock with a value of $37,500. The stock of S has a value of 
$125,000. On January 1, 1984, S merges into T. In the merger, T's 
shareholders (other than P) surrender their T stock in exchange for P 
voting stock. Based on these facts, in the transaction, former 
shareholders of T do not surrender, in exchange for P voting stock, an 
amount of T stock which constitutes control of T (500/1,000 shares being 
less than 80 percent). Therefore, the transaction does not qualify under 
section 368(a)(1)(A). The stock of T received by P in exchange for P's 
prior interest in S does not contribute to satisfaction of the 
requirement of section 368(a)(2)(E)(ii).

    (k) Certain transfers of assets or stock in reorganizations--(1) 
General rule. A transaction otherwise qualifying as a reorganization 
under section 368(a) shall not be disqualified or recharacterized as a 
result of one or more subsequent transfers (or successive transfers) of 
assets or stock, provided that the requirements of Sec. 1.368-1(d) are 
satisfied and the transfer(s) are described in either paragraph 
(k)(1)(i) or (k)(1)(ii) of this section. However, this paragraph (k) 
shall not apply to a transfer to the former shareholders of the acquired 
corporation (other than a former shareholder that is also the acquiring 
corporation) or the surviving corporation, as the case may be, to the 
extent it constitutes the receipt of consideration for a proprietary 
interest in the acquired corporation or the surviving corporation, as 
the case may be. Similarly, this paragraph (k) shall not apply to a 
transfer by the former shareholders of the acquired corporation (other 
than a former shareholder that is also the acquiring corporation) or the 
surviving corporation, as the case may be, of consideration initially 
received in the potential reorganization to the issuing corporation or a 
person related to the issuing corporation (see definition of ``related 
person'' in Sec. 1.368-1(e)).
    (i) Distributions. One or more distributions to shareholders 
(including distribution(s) that involve the assumption of liabilities) 
are described in this paragraph (k)(1)(i) if--
    (A) The property distributed consists of--
    (1) Assets of the acquired corporation, the acquiring corporation, 
or the surviving corporation, as the case may be, or an interest in an 
entity received in exchange for such assets in a transfer described in 
paragraph (k)(1)(ii) of this section;
    (2) Stock of the acquired corporation provided that such 
distribution(s) of stock do not cause the acquired corporation to cease 
to be a member of the qualified group (as defined in Sec. 1.368-
1(d)(4)(ii)); or

[[Page 550]]

    (3) A combination thereof; and
    (B) The aggregate of such distributions does not consist of--
    (1) An amount of assets of the acquired corporation, the acquiring 
corporation (disregarding assets held prior to the potential 
reorganization), or the surviving corporation (disregarding assets of 
the merged corporation), as the case may be, that would result in a 
liquidation of such corporation for Federal income tax purposes; or
    (2) All of the stock of the acquired corporation that was acquired 
in the transaction.
    (ii) Transfers Other Than Distributions. One or more other transfers 
are described in this paragraph (k)(1)(ii) if--
    (A) The transfer(s) do not consist of one or more distributions to 
shareholders;
    (B) The property transferred consists of--
    (1) Part or all of the assets of the acquired corporation, the 
acquiring corporation, or the surviving corporation, as the case may be;
    (2) Part or all of the stock of the acquired corporation, the 
acquiring corporation, or the surviving corporation, as the case may be, 
provided that such transfer(s) of stock do not cause such corporation to 
cease to be a member of the qualified group (as defined in Sec. 1.368-
1(d)(4)(ii)); or
    (3) A combination thereof; and
    (C) The acquired corporation, the acquiring corporation, or the 
surviving corporation, as the case may be, does not terminate its 
corporate existence for Federal income tax purposes in connection with 
the transfer(s).
    (2) Examples. The following examples illustrate the application of 
this paragraph (k). Except as otherwise noted, P is the issuing 
corporation, and T is an unrelated target corporation. All corporations 
have only one class of stock outstanding. T operates a bakery that 
supplies delectable pastries and cookies to local retail stores. The 
acquiring corporate group produces a variety of baked goods for 
nationwide distribution. Except as otherwise noted, P owns all of the 
stock of S-1 and 80 percent of the stock of S-4, S-1 owns 80 percent of 
the stock of S-2 and 50 percent of the stock of S-5, S-2 owns 80 percent 
of the stock of S-3, and S-4 owns the remaining 50 percent of the stock 
of S-5. The examples are as follows:

    Example 1. Transfers of acquired assets to members of the qualified 
group after a reorganization under section 368(a)(1)(C). (i) Facts. 
Pursuant to a plan of reorganization, T transfers all of its assets to 
S-1 solely in exchange for P stock, which T distributes to its 
shareholders, and S-1's assumption of T's liabilities. In addition, 
pursuant to the plan, S-1 transfers all of the T assets to S-2, and S-2 
transfers all of the T assets to S-3.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(C), is 
not disqualified by the successive transfers of all of the T assets to 
S-2 and from S-2 to S-3 because the transfers are not one or more 
distributions to shareholders, the transfers consist of part or all of 
the assets of the acquiring corporation, the acquiring corporation does 
not terminate its corporate existence for Federal income tax purposes in 
connection with the transfers, and the transaction satisfies the 
requirements of Sec. 1.368-1(d).
    Example 2. Distribution of acquired assets to a member of the 
qualified group after a reorganization under section 368(a)(1)(C). (i) 
Facts. Pursuant to a plan of reorganization, T transfers all of its 
assets to S-1 solely in exchange for P stock, which T distributes to its 
shareholders, and S-1's assumption of T's liabilities. In addition, 
pursuant to the plan, S-1 distributes half of the T assets to P, and P 
assumes half of the T liabilities.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(C), is 
not disqualified by the distribution of half of the T assets from S-1 to 
P, or P's assumption of half of the T liabilities from S-1, because the 
distribution consists of assets of the acquiring corporation, the 
distribution does not consist of an amount of S-1's assets that would 
result in a liquidation of S-1 for Federal income tax purposes 
(disregarding S-1's assets held prior to the acquisition of T), and the 
transaction satisfies the requirements of Sec. 1.368-1(d).
    Example 3. Indirect distribution of acquired assets to a member of 
the qualified group after a reorganization under section 368(a)(1)(C). 
(i) Facts. The facts are the same as Example 2, except that, instead of 
S-1 distributing half of the T assets to P and having P assume half of 
the T liabilities, S-1 contributes half of the T assets to newly formed 
S-6, S-6 assumes half of the T liabilities, and S-1 distributes all of 
the S-6 stock to P.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(C), is 
not disqualified by the transfer of half of the T assets to S-6 and the 
distribution of the S-

[[Page 551]]

6 stock to P because the transfer of half of the T assets to S-6 is 
described in paragraph (k)(1)(ii) of this section, the distribution of 
the S-6 stock to P is an indirect distribution of assets of the 
acquiring corporation, the distribution does not consist of an amount of 
S-1's assets that would result in a liquidation of S-1 for Federal 
income tax purposes (disregarding S-1's assets held prior to the 
acquisition of T), and the transaction satisfies the requirements of 
Sec. 1.368-1(d).
    Example 4. Distribution of acquired stock to a controlled 
partnership after a reorganization under section 368(a)(1)(B). (i) 
Facts. P owns 80 percent of the stock of S-1, and an 80-percent interest 
in PRS, a partnership. S-4 owns the remaining 20-percent interest in 
PRS. PRS owns the remaining 20 percent of the stock of S-1. Pursuant to 
a plan of reorganization, the T shareholders transfer all of their T 
stock to S-1 solely in exchange for P stock. In addition, pursuant to 
the plan, S-1 distributes 90 percent of the T stock to PRS in redemption 
of 5 percent of the stock of S-1 owned by PRS.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(B), is 
not disqualified by the distribution of 90 percent of the T stock from 
S-1 to PRS because the distribution consists of less than all of the 
stock of the acquired corporation that was acquired in the transaction, 
the distribution does not cause T to cease to be a member of the 
qualified group (as defined in Sec. 1.368-1(d)(4)(ii)), and the 
transaction satisfies the requirements of Sec. 1.368-1(d).
    Example 5. Transfer of acquired stock to a non-controlled 
partnership. (i) Facts. Pursuant to a plan, the T shareholders transfer 
all of their T stock to S-1 solely in exchange for P stock. In addition, 
as part of the plan, T distributes half of its assets to S-1, S-1 
assumes half of the T liabilities, and S-1 transfers the T stock to S-2. 
S-2 and U, an unrelated corporation, form a new partnership, PRS. 
Immediately thereafter, S-2 transfers all of the T stock to PRS in 
exchange for a 50 percent interest in PRS, and U transfers cash to PRS 
in exchange for a 50 percent interest in PRS.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(B), is 
not disqualified by the distribution of half of the T assets from T to 
S-1, or S-1's assumption of half of the T liabilities from T, because 
the distribution consists of assets of the acquired corporation, the 
distribution does not consist of an amount of T's assets that would 
result in a liquidation of T for Federal income tax purposes, and the 
transaction satisfies the requirements of Sec. 1.368-1(d). Further, 
this paragraph (k) describes the transfer of the acquired stock from S-1 
to S-2, but does not describe the transfer of the acquired stock from S-
2 to PRS because such transfer causes T to cease to be a member of the 
qualified group (as defined in Sec. 1.368-1(d)(4)(ii)). Therefore, the 
characterization of this transaction must be determined under the 
relevant provisions of law, including the step transaction doctrine. See 
Sec. 1.368-1(a). The transaction fails to meet the control requirement 
of a reorganization described in section 368(a)(1)(B) because 
immediately after the acquisition of the T stock, the acquiring 
corporation does not have control of T.
    Example 6. Transfers of acquired assets to members of the qualified 
group after a reorganization under section 368(a)(1)(D). (i) Facts. P 
owns all of the stock of T. Pursuant to a plan of reorganization, T 
transfers all of its assets to S-1 solely in exchange for S-1 stock, 
which T distributes to P, and S-1's assumption of T's liabilities. In 
addition, pursuant to the plan, S-1 transfers all of the T assets to S-
2, and S-2 transfers all of the T assets to S-3.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(D), is 
not disqualified by the successive transfers of all the T assets from S-
1 to S-2 and from S-2 to S-3 because the transfers are not one or more 
distributions to shareholders, the transfers consist of part or all of 
the assets of the acquiring corporation, the acquiring corporation does 
not terminate its corporate existence for Federal income tax purposes in 
connection with the transfers, and the transaction satisfies the 
requirements of Sec. 1.368-1(d).
    Example 7. Transfer of stock of the acquiring corporation to a 
member of the qualified group after a reorganization under section 
368(a)(1)(A) by reason of section 368(a)(2)(D). (i) Facts. Pursuant to a 
plan of reorganization, S-1 acquires all of the T assets in the merger 
of T into S-1. In the merger, the T shareholders receive solely P stock. 
Also, pursuant to the plan, P transfers all of the S-1 stock to S-4.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(A) by 
reason of section 368(a)(2)(D), is not disqualified by the transfer of 
all of the S-1 stock to S-4 because the transfer is not a distribution 
to shareholders, the transfer consists of part or all of the stock of 
the acquiring corporation, the transfer does not cause S-1 to cease to 
be a member of the qualified group (as defined in Sec. 1.368-
1(d)(4)(ii)), the acquiring corporation does not terminate its corporate 
existence for Federal income tax purposes in connection with the 
transfer, and the transaction satisfies the requirements of Sec. 1.368-
1(d).
    Example 8. Transfer of acquired assets to a partnership after a 
reorganization under section 368(a)(1)(A) by reason of section 
368(a)(2)(D). (i) Facts. Pursuant to a plan of reorganization, S-1 
acquires all of the T assets in the merger

[[Page 552]]

of T into S-1. In the merger, the T shareholders receive solely P stock. 
In addition, pursuant to the plan, S-1 transfers all of the T assets to 
PRS, a partnership in which S-1 owns a 33\1/3\-percent interest. PRS 
continues T's historic business. S-1 does not perform active and 
substantial management functions as a partner with respect to PRS' 
business.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(A) by 
reason of section 368(a)(2)(D), is not disqualified by the transfer of T 
assets from S-1 to PRS because the transfer is not a distribution to 
shareholders, the transfer consists of part or all of the assets of the 
acquiring corporation, the acquiring corporation does not terminate its 
corporate existence for Federal income tax purposes in connection with 
the transfers, and the transaction satisfies the requirements of Sec. 
1.368-1(d).
    Example 9. Sale of acquired assets to a member of the qualified 
group after a reorganization under section 368(a)(1)(C). (i) Facts. 
Pursuant to a plan of reorganization, T transfers all of its assets to 
S-1 in exchange for P stock, which T distributes to its shareholders, 
and S-1's assumption of T's liabilities. In addition, pursuant to the 
plan, S-1 sells all of the T assets to S-5 for cash equal to the fair 
market value of those assets.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(C), is 
not disqualified by the sale of all of the T assets from S-1 to S-5 
because the transfer is not a distribution to shareholders, the transfer 
consists of part or all of the assets of the acquiring corporation, the 
acquiring corporation does not terminate its corporate existence for 
Federal income tax purposes in connection with the transfer, and the 
transaction satisfies the requirements of Sec. 1.368-1(d).

    (3) Effective/applicability dates. This paragraph (k) applies to 
transactions occurring on or after May 9, 2008, except that it does not 
apply to any transaction occurring pursuant to a written agreement which 
is binding before May 9, 2008, and at all times after that.
    (l) Certain transactions treated as reorganizations described in 
section 368(a)(1)(D)--(1) General rule. In order to qualify as a 
reorganization under section 368(a)(1)(D), a corporation (transferor 
corporation) must transfer all or part of its assets to another 
corporation (transferee corporation) and immediately after the transfer 
the transferor corporation, or one or more of its shareholders 
(including persons who were shareholders immediately before the 
transfer), or any combination thereof, must be in control of the 
transferee corporation; but only if, in pursuance of the plan, stock or 
securities of the transferee are distributed in a transaction which 
qualifies under section 354, 355, or 356.
    (2) Distribution requirement--(i) In general. For purposes of 
paragraph (l)(1) of this section, a transaction otherwise described in 
section 368(a)(1)(D) will be treated as satisfying the requirements of 
sections 368(a)(1)(D) and 354(b)(1)(B) notwithstanding that there is no 
actual issuance of stock and/or securities of the transferee corporation 
if the same person or persons own, directly or indirectly, all of the 
stock of the transferor and transferee corporations in identical 
proportions. In cases where no consideration is received or the value of 
the consideration received in the transaction is less than the fair 
market value of the transferor corporation's assets, the transferee 
corporation will be treated as issuing stock with a value equal to the 
excess of the fair market value of the transferor corporation's assets 
over the value of the consideration actually received in the 
transaction. In cases where the value of the consideration received in 
the transaction is equal to the fair market value of the transferor 
corporation's assets, the transferee corporation will be deemed to issue 
a nominal share of stock to the transferor corporation in addition to 
the actual consideration exchanged for the transferor corporation's 
assets. The nominal share of stock in the transferee corporation will 
then be deemed distributed by the transferor corporation to the 
shareholders of the transferor corporation, as part of the exchange for 
the stock of such shareholders. Where appropriate, the nominal share 
will be further transferred through chains of ownership to the extent 
necessary to reflect the actual ownership of the transferor and 
transferee corporations. Similar treatment to that of the preceding two 
sentences shall apply where the transferee corporation is treated as 
issuing stock with a value equal to the excess of the fair market value 
of the transferor corporation's assets over the

[[Page 553]]

value of the consideration actually received in the transaction.
    (ii) Attribution. For purposes of paragraph (l)(2)(i) of this 
section, ownership of stock will be determined by applying the 
principles of section 318(a)(2) without regard to the 50 percent 
limitation in section 318(a)(2)(C). In addition, an individual and all 
members of his family described in section 318(a)(1) shall be treated as 
one individual.
    (iii) De minimis variations in ownership and certain stock not taken 
into account. For purposes of paragraph (l)(2)(i) of this section, the 
same person or persons will be treated as owning, directly or 
indirectly, all of the stock of the transferor and transferee 
corporations in identical proportions notwithstanding the fact that 
there is a de minimis variation in shareholder identity or 
proportionality of ownership. Additionally, for purposes of paragraph 
(l)(2)(i) of this section, stock described in section 1504(a)(4) is not 
taken into account.
    (iv) Exception. Paragraph (l)(2) of this section does not apply to a 
transaction otherwise described in Sec. 1.358-6(b)(2).
    (3) Examples. The following examples illustrate the principles of 
paragraph (l) of this section. For purposes of these examples, each of 
A, B, C, and D is an individual, T is the acquired corporation, S is the 
acquiring corporation, P is the parent corporation, and each of S1, S2, 
S3, and S4 is a direct or indirect subsidiary of P. Further, all of the 
requirements of section 368(a)(1)(D) other than the requirement that 
stock or securities be distributed in a transaction to which section 354 
or 356 applies are satisfied. The examples are as follows:

    Example 1. A owns all the stock of T and S. The T stock has a fair 
market value of $100x. T sells all of its assets to S in exchange for 
$100x of cash and immediately liquidates. Because there is complete 
shareholder identity and proportionality of ownership in T and S, under 
paragraph (l)(2)(i) of this section, the requirements of sections 
368(a)(1)(D) and 354(b)(1)(B) are treated as satisfied notwithstanding 
the fact that no S stock is issued. Pursuant to paragraph (l)(2)(i) of 
this section, S will be deemed to issue a nominal share of S stock to T 
in addition to the $100x of cash actually exchanged for the T assets, 
and T will be deemed to distribute all such consideration to A. The 
transaction qualifies as a reorganization described in section 
368(a)(1)(D).
    Example 2. The facts are the same as in Example 1 except that C, A's 
son, owns all of the stock of S. Under paragraph (l)(2)(ii) of this 
section, A and C are treated as one individual. Accordingly, there is 
complete shareholder identity and proportionality of ownership in T and 
S. Therefore, under paragraph (l)(2)(i) of this section, the 
requirements of sections 368(a)(1)(D) and 354(b)(1)(B) are treated as 
satisfied notwithstanding the fact that no S stock is issued. Pursuant 
to paragraph (l)(2)(i) of this section, S will be deemed to issue a 
nominal share of S stock to T in addition to the $100x of cash actually 
exchanged for the T assets, and T will be deemed to distribute all such 
consideration to A. A will be deemed to transfer the nominal share of S 
stock to C. The transaction qualifies as a reorganization described in 
section 368(a)(1)(D).
    Example 3. P owns all of the stock of S1 and S2. S1 owns all of the 
stock of S3, which owns all of the stock of T. S2 owns all of the stock 
of S4, which owns all of the stock of S. The T stock has a fair market 
value of $70x. T sells all of its assets to S in exchange for $70x of 
cash and immediately liquidates. Under paragraph (l)(2)(ii) of this 
section, there is indirect, complete shareholder identity and 
proportionality of ownership in T and S. Accordingly, the requirements 
of sections 368(a)(1)(D) and 354(b)(1)(B) are treated as satisfied 
notwithstanding the fact that no S stock is issued. Pursuant to 
paragraph (l)(2)(i) of this section, S will be deemed to issue a nominal 
share of S stock to T in addition to the $70x of cash actually exchanged 
for the T assets, and T will be deemed to distribute all such 
consideration to S3. S3 will be deemed to distribute the nominal share 
of S stock to S1, which, in turn, will be deemed to distribute the 
nominal share of S stock to P. P will be deemed to transfer the nominal 
share of S stock to S2, which, in turn, will be deemed to transfer such 
share of S stock to S4. The transaction qualifies as a reorganization 
described in section 368(a)(1)(D).
    Example 4. A, B, and C own 34%, 33%, and 33%, respectively, of the 
stock of T. The T stock has a fair market value of $100x. A, B, and C 
each own 33% of the stock of S. D owns the remaining 1% of the stock of 
S. T sells all of its assets to S in exchange for $100x of cash and 
immediately liquidates. For purposes of determining whether the 
distribution requirement of sections 368(a)(1)(D) and 354(b)(1)(B) is 
met, under paragraph (l)(2)(iii) of this section, D's ownership of a de 
minimis amount of stock of S is disregarded and the transaction is 
treated as if there is complete shareholder identity and proportionality 
of ownership in T and S. Because there is complete shareholder identity 
and proportionality of ownership in T and S, under paragraph (l)(2)(i) 
of this section, the requirements of sections 368(a)(1)(D) and

[[Page 554]]

354(b)(1)(B) are treated as satisfied notwithstanding the fact that no S 
stock is issued. Pursuant to paragraph (l)(2)(i) of this section, S will 
be deemed to issue a nominal share of S stock to T in addition to the 
$100x of cash actually exchanged for the T assets, T will be deemed to 
distribute all such consideration to A, B, and C, and the nominal S 
stock will be deemed transferred among the S shareholders to the extent 
necessary to reflect their actual ownership of S. The transaction 
qualifies as a reorganization described in section 368(a)(1)(D).
    Example 5. The facts are the same as in Example 4 except that A, B, 
and C own 34%, 33%, and 33%, respectively, of the common stock of T and 
S. D owns preferred stock in S described in section 1504(a)(4). For 
purposes of determining whether the distribution requirement of sections 
368(a)(1)(D) and 354(b)(1)(B) is met, under paragraph (l)(2)(iii) of 
this section, D's ownership of S stock described in section 1504(a)(4) 
is ignored and the transaction is treated as if there is complete 
shareholder identity and proportionality of ownership in T and S. 
Because there is complete shareholder identity and proportionality of 
ownership in T and S, under paragraph (l)(2)(i) of this section, the 
requirements of sections 368(a)(1)(D) and 354(b)(1)(B) are treated as 
satisfied notwithstanding the fact that no S stock is issued. Pursuant 
to paragraph (l)(2)(i) of this section, S will be deemed to issue a 
nominal share of S stock to T in addition to the $100x of cash actually 
exchanged for the T assets, and T will be deemed to distribute all such 
consideration to A, B, and C. The transaction qualifies as a 
reorganization described in section 368(a)(1)(D).
    Example 6. A and B each own 50% of the stock of T. The T stock has a 
fair market value of $100x. B and C own 90% and 10%, respectively, of 
the stock of S. T sells all of its assets to S in exchange for $100x of 
cash and immediately liquidates. Because complete shareholder identity 
and proportionality of ownership in T and S does not exist, paragraph 
(l)(2)(i) of this section does not apply. The requirements of sections 
368(a)(1)(D) and 354(b)(1)(B) are not satisfied, and the transaction 
does not qualify as a reorganization described in section 368(a)(1)(D).

    (4) Effective/applicability date--(i) In general. This section 
applies to transactions occurring on or after December 18, 2009. For 
rules regarding transactions occurring before December 18, 2009, see 
section 1.368-2T(l) as contained in 26 CFR part 1.
    (ii) Transitional rule. A taxpayer may apply the provisions of these 
regulations to transactions occurring before December 18, 2009. However, 
the transferor corporation, the transferee corporation, any direct or 
indirect transferee of transferred basis property from either of the 
foregoing, and any shareholder of the transferor or transferee 
corporation may not apply the provisions of these regulations unless all 
such taxpayers apply the provisions of the regulations.
    (m) Qualification as a reorganization under section 368(a)(1)(F)--
(1) Mere change. To qualify as a reorganization under section 
368(a)(1)(F), a transaction must result in a mere change in identity, 
form, or place of organization of one corporation, however effected (a 
mere change). A mere change can consist of a transaction that involves 
an actual or deemed transfer of property from one corporation (a 
transferor corporation) to one other corporation (a resulting 
corporation). Such a transaction is a mere change and qualifies as a 
reorganization under section 368(a)(1)(F) only if all the requirements 
set forth in paragraphs (m)(1)(i) through (vi) of this section are 
satisfied. For purposes of this paragraph (m), a transaction or a series 
of related transactions that can be tested against the requirements set 
forth in paragraphs (m)(1)(i) through (vi) of this section (a potential 
F reorganization) begins when the transferor corporation begins 
transferring (or is deemed to begin transferring) its assets, directly 
or indirectly, to the resulting corporation, and it ends when the 
transferor corporation has distributed (or is deemed to have 
distributed) to its shareholders the consideration it receives (or is 
deemed to receive) from the resulting corporation and has completely 
liquidated for federal income tax purposes. For purposes of this 
paragraph (m), deemed transfers include, for example, those provided in 
Sec. 301.7701-3(g)(1)(iv) of this chapter (when an entity disregarded 
as separate from its owner elects under paragraph Sec. 301.7701-
3(c)(1)(i) of this chapter to be classified as an association, the owner 
of the entity is deemed to transfer all of the assets and liabilities of 
the entity to the association in exchange for stock of the association). 
Deemed transfers also include those resulting from the application of 
step transaction principles. For example,

[[Page 555]]

step transaction principles may disregard a transitory holding of 
property by an individual after a liquidation of the transferor 
corporation and before a subsequent transfer of the transferor 
corporation's property to the resulting corporation. Step transaction 
principles may also treat a contribution of all the stock of the 
transferor corporation to the resulting corporation, followed by a 
liquidation (or deemed liquidation) of the transferor corporation, as a 
deemed transfer of the transferor corporation's property to the 
resulting corporation, followed by a distribution of stock of the 
resulting corporation in complete liquidation of the transferor 
corporation.
    (i) Resulting corporation stock distributed in exchange for 
transferor corporation stock. Immediately after the potential F 
reorganization, all the stock of the resulting corporation, including 
any stock of the resulting corporation issued before the potential F 
reorganization, must have been distributed (or deemed distributed) in 
exchange for stock of the transferor corporation in the potential F 
reorganization. However, for purposes of this paragraph (m)(1)(i) and 
paragraph (m)(1)(ii) of this section, a de minimis amount of stock 
issued by the resulting corporation other than in respect of stock of 
the transferor corporation to facilitate the organization of the 
resulting corporation or maintain its legal existence is disregarded.
    (ii) Identity of stock ownership. The same person or persons must 
own all of the stock of the transferor corporation, determined 
immediately before the potential F reorganization, and of the resulting 
corporation, determined immediately after the potential F 
reorganization, in identical proportions. However, this requirement is 
not violated if one or more holders of stock in the transferor 
corporation exchange stock in the transferor corporation for stock of 
equivalent value in the resulting corporation, but having different 
terms from those of the stock in the transferor corporation, or receive 
a distribution of money or other property from either the transferor 
corporation or the resulting corporation, whether or not in exchange for 
stock in the transferor corporation or the resulting corporation.
    (iii) Prior assets or attributes of resulting corporation. The 
resulting corporation may not hold any property or have any tax 
attributes (including those specified in section 381(c)) immediately 
before the potential F reorganization. However, this requirement is not 
violated if the resulting corporation holds or has held a de minimis 
amount of assets to facilitate its organization or maintain its legal 
existence, and has tax attributes related to holding those assets, or 
holds the proceeds of borrowings undertaken in connection with the 
potential F reorganization.
    (iv) Liquidation of transferor corporation. The transferor 
corporation must completely liquidate, for federal income tax purposes, 
in the potential F reorganization. However, the transferor corporation 
is not required to dissolve under applicable law and may retain a de 
minimis amount of assets for the sole purpose of preserving its legal 
existence.
    (v) Resulting corporation is the only acquiring corporation. 
Immediately after the potential F reorganization, no corporation other 
than the resulting corporation may hold property that was held by the 
transferor corporation immediately before the potential F 
reorganization, if such other corporation would, as a result, succeed to 
and take into account the items of the transferor corporation described 
in section 381(c).
    (vi) Transferor corporation is the only acquired corporation. 
Immediately after the potential F reorganization, the resulting 
corporation may not hold property acquired from a corporation other than 
the transferor corporation if the resulting corporation would, as a 
result, succeed to and take into account the items of such other 
corporation described in section 381(c).
    (2) Non-application of continuity of interest and continuity of 
business enterprise requirements. A continuity of the business 
enterprise and a continuity of interest are not required for a potential 
F reorganization to qualify as a reorganization under section 
368(a)(1)(F). See Sec. 1.368-1(b).

[[Page 556]]

    (3) Related transactions--(i) Series of transactions. A potential F 
reorganization consisting of a series of related transactions that 
together result in a mere change of one corporation may qualify as a 
reorganization under section 368(a)(1)(F), whether or not certain steps 
in the series, viewed in isolation, could be subject to other Code 
provisions, such as sections 304(a), 331, 332, or 351. However, see 
paragraph (k) of this section for transactions that qualify as 
reorganizations under section 368(a) and will not be recharacterized as 
a mere change as a result of one or more subsequent transfers of assets 
or stock.
    (ii) Mere change within a larger transaction. A potential F 
reorganization that qualifies as a reorganization under section 
368(a)(1)(F) may occur before, within, or after other transactions that 
effect more than a mere change, even if the resulting corporation has 
only transitory existence. Related events that precede or follow the 
potential F reorganization generally will not cause that potential F 
reorganization to fail to qualify as a reorganization under section 
368(a)(1)(F). Qualification of a potential F reorganization as a 
reorganization under section 368(a)(1)(F) will not alter the character 
of other transactions for federal income tax purposes, and step 
transaction principles may be applied to other transactions without 
regard to whether certain steps qualify as a reorganization or part of a 
reorganization under section 368(a)(1)(F).
    (iii) Distributions treated as separate transactions. As provided in 
paragraph (m)(1)(ii) of this section, a potential F reorganization may 
qualify as a mere change even though a holder of stock in the transferor 
corporation receives a distribution of money or other property from 
either the transferor corporation or the resulting corporation. If a 
shareholder receives money or other property (including in exchange for 
its shares) from the transferor corporation or the resulting corporation 
in a potential F reorganization that qualifies as a reorganization under 
section 368(a)(1)(F), then the receipt of money or other property 
(including any exchanged for shares) is treated as an unrelated, 
separate transaction from the reorganization, whether or not connected 
in a formal sense. See Sec. 1.301-1(l).
    (iv) Transactions also qualifying under other provisions of section 
368(a)(1). In certain cases, a potential F reorganization would (but for 
this paragraph (m)(3)(iv)) qualify both as a reorganization under 
section 368(a)(1)(F) and as a reorganization or part of a reorganization 
under another provision of section 368(a)(1). The following rules 
determine which of these overlapping qualifications applies.
    (A) If the potential F reorganization or a step thereof qualifies as 
a reorganization or part of a reorganization under another provision of 
section 368(a)(1), and if a corporation in control (within the meaning 
of section 368(c)) of the resulting corporation is a party to such other 
reorganization (within the meaning of section 368(b)), the potential F 
reorganization will not qualify as a reorganization under section 
368(a)(1)(F).
    (B) Except as provided in paragraph (m)(3)(iv)(A) of this section, 
if, but for this paragraph (m)(3)(iv)(B), the potential F reorganization 
would qualify as a reorganization under both section 368(a)(1)(F) and 
one or more of sections 368(a)(1)(A), 368(a)(1)(C), or 368(a)(1)(D), 
then for all federal income tax purposes the potential F reorganization 
will qualify as a reorganization only under section 368(a)(1)(F).
    (4) Examples. The following examples illustrate the application of 
this paragraph (m). Unless the facts otherwise indicate, A, B, and C are 
domestic individuals; P, S, T, X, Y, and Z (and similar designations) 
are domestic corporations; each transaction is entered into for a valid 
business purpose; all persons and transactions are unrelated; and all 
other relevant facts are set forth in the examples.

    Example 1. Cash contribution and redemption--no mere change. C owns 
all of the stock of X, a State A corporation. The net value of X's 
assets and liabilities is $1,000,000. Y, a State B corporation, seeks to 
acquire the assets of X for cash. To effect the acquisition, Y and X 
enter into an agreement under which Y will contribute $1,000,000 to Z, a 
newly formed corporation of which Y is the sole shareholder, in exchange 
for Z stock and X will merge into Z. In the merger, C surrenders all of 
the X stock and receives the

[[Page 557]]

$1,000,000 Y contributed to Z. C receives no Z stock in the transaction. 
After the merger, Y holds all of the Z stock, and Z holds all of the 
assets and liabilities previously held by X. Z stock is not distributed 
to the shareholders of X in exchange for their stock in X as required by 
paragraph (m)(1)(i) of this section, and the transaction results in a 
change in the ownership of X that does not result from an exchange or 
distribution described in paragraph (m)(1)(ii) of this section. 
Therefore, the merger of X into Z is not a mere change of X and does not 
qualify as a reorganization under section 368(a)(1)(F).
    Example 2. Cash redemption--mere change. A owns 75%, and B owns 25%, 
of the stock of X, a State A corporation. The management of X determines 
that it would be in the best interest of X to reorganize under the laws 
of State B. Accordingly, X forms Y, a State B corporation, and X and Y 
enter into an agreement under which X will merge into Y. A does not wish 
to own stock in Y. In the merger, A surrenders A's X stock and receives 
cash, and B surrenders all of B's X stock and receives all the stock of 
Y. The change in ownership caused by A's surrender of X stock results 
from a distribution and exchange described in paragraph (m)(1)(ii) of 
this section. Therefore, the merger of X into Y is a mere change of X 
and qualifies as a reorganization under section 368(a)(1)(F). Under 
paragraph (m)(3)(iii) of this section, A's surrender of X stock for cash 
is treated as a transaction, separate from the reorganization, to which 
section 302(a) applies.
    Example 3. Pre-transaction de minimis stock issuance--mere change--
other provisions of section 368(a)(1). P owns all of the stock of S, a 
Country A corporation. The management of P determines that it would be 
in the best interest of S to change its place of incorporation to 
Country B. Under Country B law, a corporation must have at least two 
shareholders to enjoy limited liability. P is advised by its Country B 
advisors that the new corporation should issue 1% of its stock to a 
shareholder that is not P's nominee to assure satisfaction of the two-
shareholder requirement. As part of an integrated plan, C, an officer of 
S, organizes Y, a Country B corporation with 1,000 shares of common 
stock authorized, and contributes cash to Y in exchange for ten of the 
common shares. S then merges into Y under the laws of Country A and 
Country B. Pursuant to the plan of merger, P surrenders its shares of S 
stock and receives 990 shares of Y common stock. The ten shares of Y 
stock issued to C not in respect of the S stock are de minimis and are 
used to facilitate the organization of Y within the meaning of paragraph 
(m)(1)(i) of this section. Therefore, the issuance of this stock to a 
new shareholder does not prevent the merger of S into Y from qualifying 
as a mere change of S. Accordingly, the merger is a reorganization under 
section 368(a)(1)(F). Without regard to the merger's qualification under 
section 368(a)(1)(F), the merger would also qualify as a reorganization 
under both section 368(a)(1)(A) and section 368(a)(1)(D). Under 
paragraph (m)(3)(iv)(B) of this section, if a potential F reorganization 
qualifies as a reorganization under section 368(a)(1)(F), and would also 
qualify under one or more of sections 368(a)(1)(A) or 368(a)(1)(D), the 
potential F reorganization qualifies only as a reorganization under 
368(a)(1)(F), and neither section 368(a)(1)(A) nor section 368(a)(1)(D) 
will apply.
    Example 4. Pre-transaction assets, attributes--no mere change. A 
owns all of the stock of P, and P owns all of the stock of S, which is 
engaged in a manufacturing business. P has owned the stock of S for many 
years. P owns no assets other than the stock of S. A decides to 
eliminate the holding company structure by merging P into S. Because it 
operates a manufacturing business, the potential resulting corporation, 
S, holds property and has tax attributes immediately before the 
potential F reorganization. Therefore, under paragraph (m)(1)(iii) of 
this section, the merger of P into S is not a mere change of P and does 
not qualify as a reorganization under section 368(a)(1)(F). The same 
result would occur under paragraph (m)(1)(iii) of this section if, 
instead of P merging into S, S merged into P, because P, the potential 
resulting corporation, holds property (the stock of S) and has tax 
attributes immediately before the potential F reorganization.
    Example 5. Series of related transactions--mere change. P owns all 
of the stock of S1, a State A corporation. The management of P 
determines that it would be in the best interest of S1 to change its 
place of incorporation to State B. Accordingly, under an integrated 
plan, P forms S2, a new State B corporation; P contributes the S1 stock 
to S2; and S1 merges into S2 under the laws of State A and State B. 
Under paragraph (m)(3)(i) of this section, a series of transactions that 
together result in a mere change of one corporation may qualify as a 
reorganization under section 368(a)(1)(F). The contribution of S1 stock 
to S2 and the merger of S1 into S2 together constitute a mere change of 
S1. Therefore, the potential F reorganization qualifies as a 
reorganization under section 368(a)(1)(F). Without regard to its 
qualification under section 368(a)(1)(F), the potential F reorganization 
would also qualify as a reorganization under both section 368(a)(1)(A) 
and section 368(a)(1)(D). Under paragraph (m)(3)(iv)(B) of this section, 
if a potential F reorganization qualifies as a reorganization under 
section 368(a)(1)(F) and would also qualify under one or more of 
sections 368(a)(1)(A) or 368(a)(1)(D), it qualifies only as a 
reorganization under 368(a)(1)(F), and neither section 368(a)(1)(A) nor 
section 368(a)(1)(D) will apply. The result would be

[[Page 558]]

the same with respect to qualification under section 368(a)(1)(F) if, 
instead of merging into S2, S1 completely liquidates or is deemed to 
liquidate by reason of a conversion in an entity disregarded as separate 
from its owner under Sec. 301.7701-3 of this chapter.
    Example 6. Post-transaction stock sale--mere change. P owns all of 
the stock of S1, a State A corporation. The management of P determines 
that it would be in the best interest of S1 to change its place of 
incorporation to State B. Accordingly, P forms S2, a new State B 
corporation. S1 then merges into S2 under the laws of State A and State 
B. Immediately thereafter, and as part of the same plan, P sells all of 
its stock in S2 to an unrelated party. Without regard to P's sale of S2 
stock, the merger of S1 into S2 is a potential F reorganization that 
qualifies as a mere change of S1 within the meaning of paragraph (m)(1) 
of this section. Under paragraph (m)(3)(ii) of this section, related 
events that occur before or after a potential F reorganization that 
qualifies as a mere change generally do not cause that potential F 
reorganization to fail to qualify as a reorganization under section 
368(a)(1)(F). Therefore, P's sale of the S2 stock is disregarded in 
determining whether the merger of S1 into S2 is a mere change of S1. 
Accordingly, the merger of S1 into S2 qualifies as a reorganization 
under section 368(a)(1)(F). The result would be the same if, instead of 
the S2 stock being sold by P, S2 merges into a previously unrelated 
corporation and terminates its separate existence.
    Example 7. Post-transaction redemption--mere change. A owns all of 
the stock of T. P owns all of the stock of S. Each of T and S is a State 
A corporation engaged in a manufacturing business. The following 
transactions occur pursuant to a single plan. Each of T, P, and S is a 
State A corporation engaged in a manufacturing business. Second, P 
changes its state of incorporation to State B by merging into newly 
incorporated New P under the laws of State A and State B. Third, New P 
redeems all the New P stock issued to A in respect of A's P stock 
(initially issued to A in respect of A's T stock) for cash. Without 
regard to the other steps, the merger of P into New P is a potential F 
reorganization that qualifies as a reorganization under section 
368(a)(1)(F). Under paragraph (m)(3)(ii) of this section, related events 
that occur before or after a potential F reorganization that qualifies 
as a mere change generally do not prevent that potential F 
reorganization from qualifying as a reorganization under section 
368(a)(1)(F). Therefore, the merger of P into New P qualifies as a 
reorganization under section 368(a)(1)(F). Under paragraph (m)(3)(ii) of 
this section, the qualification of the merger of P into New P as a 
reorganization under section 368(a)(1)(F) does not alter the tax 
treatment of the merger of T into S. Because the P shares received by A 
in respect of the T shares (exchanged for New P shares in the mere 
change of P into New P) are redeemed for cash pursuant to the plan, the 
merger of T into S does not satisfy the continuity of interest 
requirement of Sec. 1.368-1(e) and therefore does not qualify as a 
reorganization under section 368(a).
    Example 8. Series of related transactions--mere change. P owns all 
of the stock of S, a State A corporation. The management of P determines 
that it would be in the best interest of S to change its form from a 
State A corporation to a State A limited partnership but to continue to 
be treated as a corporation for federal tax purposes. Accordingly, P 
contributes 1% of the S stock to newly formed LLC, a limited liability 
company, in exchange for all of the membership interests in LLC. P is 
the sole member of LLC. Under Sec. 301.7701-3 of this chapter, LLC is 
disregarded as an entity separate from its owner, P. Then, under a State 
A statute, S converts to a State A limited partnership. In the 
conversion, P's interest as a 99% shareholder of S is converted into a 
99% limited partner interest, and LLC's interest as a 1% shareholder of 
S is converted into a 1% general partner interest. S also elects, under 
Sec. 301.7701-3(c) of this chapter, to be classified as a corporation 
for federal income tax purposes, effective on the same day as the 
conversion. Under paragraph (m)(3)(i) of this section, the conversion of 
S from a State A corporation to a State A limited partnership, together 
with the election to treat S as a corporation for federal tax purposes, 
results in a mere change of S and qualifies as a reorganization under 
section 368(a)(1)(F).
    Example 9. Other acquiring corporation--no mere change. P owns 80%, 
and A owns 20%, of the stock of S. A and the management of P determine 
that it would be in the best interest of S to completely liquidate while 
A continues to operate part of the business of S in corporate form. 
Accordingly, S distributes 80% of its assets to P and 20% of its assets 
to A; S dissolves; and A contributes the assets it receives from S to 
newly incorporated New S in exchange for all of the stock of New S. S's 
distribution of 80% of its property to P as part of the complete 
liquidation of S meets the requirements of section 332. Thus, section 
381(a)(1) applies to P's acquisition of 80% of the property held by S 
immediately before the transaction. Under paragraph (m)(1)(v) of this 
section, the potential F reorganization in which 20% of the property 
held by S immediately before the transaction is transferred to New S 
cannot be a mere change of S, because section 381(a) applies to P's 
acquisition of property held by S immediately before the potential F 
reorganization. Accordingly, sections 331 and 336 apply to A's 
acquisition of property from S and S's distribution of property to A, 
and section 351

[[Page 559]]

applies to A's contribution of that property to New S.
    Example 10. Other acquiring corporation--no mere change. P owns all 
of the stock of S1. The management of P determines that it would be in 
the best interest of S1 to merge S1 into P. Accordingly, pursuant to a 
state merger statute, S1 merges into P. Immediately afterward and as 
part of the same plan, P contributes 50% of the former assets of S1 to 
newly incorporated S2 in exchange for all of the stock of S2. The 
transaction does not qualify as a complete liquidation of S1 under 
section 332 (because of the reincorporation of some of S1's assets) but 
does qualify as a reorganization under section 368(a)(1)(A) by reason of 
section 368(a)(2)(C) and paragraph (k) of this section. Under paragraph 
(m)(1)(v) of this section, the potential F reorganization in which some 
of the former assets of S1 are transferred (in form) first to P, and 
then to S2, is not a mere change of S1, because section 381(a) applies 
to P's acquisition of property held by S1 immediately before the 
potential F reorganization. Furthermore, under paragraph (m)(3)(iv)(A) 
of this section, P, the corporation in control of S2 within the meaning 
of section 368(c), is a party to the reorganization within the meaning 
of section 368(b). Thus, the indirect transfer of property from S1 to S2 
does not qualify under section 368(a)(1)(F).
    Example 11. Other acquiring corporation--mere change. P owns all of 
the stock of S1. S1's only asset is all of the equity interest in LLC2, 
a domestic limited liability company. Under Sec. 301.7701-3 of this 
chapter, LLC2 is disregarded as an entity separate from its owner, S1. 
Pursuant to an integrated plan to undergo a reorganization under 
368(a)(1)(F), S1 and LLC2 undergo the following two state law 
conversions. First, under state law LLC2 converts into S2, a 
corporation. Second, under state law S1 converts into LLC1, a domestic 
limited liability company. Under Sec. 301.7701-3 of this chapter, LLC1 
is disregarded as an entity separate from its owner, P. As a result of 
the two conversions, S1 is deemed to transfer its assets to S2 in 
exchange for all of the stock in S2 and then distribute the S2 stock to 
P in complete liquidation of S1. The two conversions, viewed as a 
potential F reorganization, constitute a mere change of S1, and that 
potential F reorganization qualifies as a reorganization under section 
368(a)(1)(F). The result would be the same if, instead of converting 
into S2 pursuant to state law, LLC2 elected under Sec. 301.7701-3(c) to 
change its classification for federal tax purposes and be treated as an 
association taxable as a corporation, provided the effective date of the 
election (and its resulting deemed transactions) occurs before the 
conversion of S1.
    Example 12. Other acquiring corporation--no mere change. The facts 
are the same facts as in Example 11, except that S1 converts into LLC1 
prior to the conversion of LLC2 into S2. As a result of these 
conversions, S1 is deemed to distribute all of its assets to P in 
exchange for all of P's S1 stock, and P is deemed to transfer all of 
those assets to S2 in exchange for all of the stock in S2. The 
transaction does not qualify as a complete liquidation of S1 under 
section 332 (because of the reincorporation of S1's assets), but does 
qualify as a reorganization under section 368(a)(1)(C) by reason of 
section 368(a)(2)(C) and paragraph (k) of this section. Under paragraph 
(m)(1)(v) of this section, the potential F reorganization in which the 
former assets of S1 are deemed transferred, first by S1 to P, and then 
by P to S2, is not a mere change of S1 because section 381(a) applies to 
P's acquisition of property held by S1 immediately before the potential 
F reorganization. Furthermore, the corporation in control of S2, within 
the meaning of section 368(c), is a party to the reorganization within 
the meaning of section 368(b). Thus, the indirect transfer of property 
from S1 to S2 does not qualify under section 368(a)(1)(F).
    Example 13. Series of related transactions--no mere change. X owns 
all of the stock of T. P acquires all of the stock of T in exchange for 
consideration consisting of $50 cash and P voting stock with $50 value. 
No election is made under section 338. Immediately thereafter and as 
part of the same plan, P forms S as a wholly-owned subsidiary, and T is 
merged into S. Viewed in isolation as a potential F reorganization, the 
merger of T into S appears to constitute a mere change of T. However, 
the acquisition of the T stock by P and the merger of T into S, viewed 
together, qualify as a reorganization under section 368(a)(1)(A) by 
reason of section 368(a)(2)(D). The step transaction doctrine is applied 
treat the transaction as a statutory merger of T into S in exchange for 
$50 cash and $50 of P's voting stock (and S's assumption of T's 
liabilities), P's momentary ownership of T stock is disregarded. Under 
paragraph (m)(3)(iv)(A) of this section, P, the corporation in control 
of S, is a party to the reorganization within the meaning of section 
368(b). Thus, the transfer of property from T to S does not qualify 
under section 368(a)(1)(F).
    Example 14. Multiple transferor corporations--no mere change. P owns 
all the stock of S1 and S2. The management of P determines it would be 
in the best interest of S1 and S2 to operate as a single corporation. P 
forms S3 and, under applicable corporate law, S1 and S2 simultaneously 
merge into S3. Immediately after the merger, P owns all the stock of S3. 
Each of the mergers can be tested as a potential F reorganization. 
However, immediately after the simultaneous mergers, the resulting 
corporation, S3, holds property acquired from a corporation other than 
the transferor corporation, and section

[[Page 560]]

381(a) would apply to the acquisition of such property. Therefore, under 
paragraph (m)(1)(vi) of this section, neither potential F reorganization 
is a mere change, and neither merger into S3 qualifies as a 
reorganization under section 386(a)(1)(F). The result would be different 
if the mergers were not simultaneous. If S1 completed its merger into S3 
before S2 began its merger into S3, the merger of S1 into S3 would 
qualify as a reorganization under section 368(a)(1)(F), but the merger 
of S2 into S3 would not so qualify (although it would qualify as a 
reorganization under sections 368(a)(1)(A) and 368(a)(1)(D)).

    (5) Effective/Applicability Date. This paragraph (m) applies to 
transactions occurring on or after September 21, 2015.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960]

    Editorial Note: For Federal Register citations affecting Sec. 
1.368-2, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.govinfo.gov.



Sec. 1.368-3  Records to be kept and information to be filed with
returns.

    (a) Parties to the reorganization. The plan of reorganization must 
be adopted by each of the corporations that are parties thereto. Each 
such corporation must include a statement entitled, ``STATEMENT PURSUANT 
TO Sec. 1.368-3(a) BY [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER 
(IF ANY) OF TAXPAYER], A CORPORATION A PARTY TO A REORGANIZATION,'' on 
or with its return for the taxable year of the exchange. If any such 
corporation is a controlled foreign corporation (within the meaning of 
section 957), each United States shareholder (within the meaning of 
section 951(b)) with respect thereto must include this statement on or 
with its return. However, it is not necessary for any taxpayer to 
include more than one such statement on or with the same return for the 
same reorganization. The statement must include--
    (1) The names and employer identification numbers (if any) of all 
such parties;
    (2) The date of the reorganization;
    (3) The value and basis of the assets, stock or securities of the 
target corporation transferred in the transaction, determined 
immediately before the transfer and aggregated as follows--
    (i) Importation property transferred in a loss importation 
transaction, as defined in Sec. 1.362-3(c)(2) and (3), respectively;
    (ii) Loss duplication property as defined in Sec. 1.362-4(g)(1);
    (iii) Property with respect to which any gain or loss was recognized 
on the transfer (without regard to whether such property is also 
identified in paragraph (a)(3)(i) or (ii) of this section);
    (iv) Property not described in paragraph (a)(3)(i), (ii), or (iii) 
of this section; and
    (4) The date and control number of any private letter ruling(s) 
issued by the Internal Revenue Service in connection with this 
reorganization.
    (b) Significant holders. Every significant holder, other than a 
corporation a party to the reorganization, must include a statement 
entitled, ``STATEMENT PURSUANT TO Sec. 1.368-3(b) BY [INSERT NAME AND 
TAXPAYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A SIGNIFICANT 
HOLDER,'' on or with such holder's return for the taxable year of the 
exchange. If a significant holder is a controlled foreign corporation 
(within the meaning of section 957), each United States shareholder 
(within the meaning of section 951(b)) with respect thereto must include 
this statement on or with its return. The statement must include--
    (1) The names and employer identification numbers (if any) of all of 
the parties to the reorganization;
    (2) The date of the reorganization; and
    (3) The value and basis of all the stock or securities of the target 
corporation held by the significant holder that is transferred in the 
transaction and such holder's basis in that stock or securities, 
determined immediately before the transfer and aggregated as follows--
    (i) Stock and securities with respect to which an election is made 
under section 362(e)(2)(C); and
    (ii) Stock and securities not described in paragraph (b)(3)(i) of 
this section.
    (c) Definitions. For purposes of this section:
    (1) Significant holder means--

[[Page 561]]

    (i) A holder of stock of the target corporation that receives stock 
or securities in an exchange described in section 354 (or so much of 
section 356 as relates to section 354) if, immediately before the 
exchange, such holder--
    (A) Owned at least five percent (by vote or value) of the total 
outstanding stock of the target corporation if the stock owned by such 
holder is publicly traded; or
    (B) Owned at least one percent (by vote or value) of the total 
outstanding stock of the target corporation if the stock owned by such 
holder is not publicly traded; or
    (ii) A holder of securities of the target corporation that receives 
stock or securities in an exchange described in section 354 (or so much 
of section 356 as relates to section 354) if, immediately before the 
exchange, such holder owned securities in such target corporation with a 
basis of $1,000,000 or more.
    (2) Publicly traded stock means stock that is listed on--
    (i) A national securities exchange registered under section 6 of the 
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
    (ii) An interdealer quotation system sponsored by a national 
securities association registered under section 15A of the Securities 
Exchange Act of 1934 (15 U.S.C. 78o-3).
    (d) Substantiation information. Under Sec. 1.6001-1(e), taxpayers 
are required to retain their permanent records and make such records 
available to any authorized Internal Revenue Service officers and 
employees. In connection with the reorganization described in this 
section, these records should specifically include information regarding 
the amount, basis, and fair market value of all transferred property, 
and relevant facts regarding any liabilities assumed or extinguished as 
part of such reorganization.
    (e) Effective/applicability date. This section applies to any 
taxable year beginning on or after May 30, 2006. However, taxpayers may 
apply this section to any original Federal income tax return (including 
any amended return filed on or before the due date (including 
extensions) of such original return) timely filed on or after May 30, 
2006. For taxable years beginning before May 30, 2006, see Sec. 1.368-3 
as contained in 26 CFR part 1 in effect on April 1, 2006. Paragraphs 
(a)(3) and (b)(3) of this section apply with respect to reorganizations 
occurring on or after March 28, 2016, and also with respect to 
reorganizations occurring before such date as a result of an entity 
classification election under Sec. 301.7701-3 of this chapter filed on 
or after March 28, 2016, unless such reorganization is pursuant to a 
binding agreement that was in effect prior to March 28, 2016 and at all 
times thereafter.

[T.D. 9329, 72 FR 32800, June 14, 2007, as amended by T.D. 9759, 81 FR 
17083, Mar. 28, 2016]

                       Insolvency Reorganizations

                               Carryovers



Sec. 1.381(a)-1  General rule relating to carryovers in certain 
corporate acquisitions.

    (a) Allowance of carryovers. Section 381 provides that a corporation 
which acquires the assets of another corporation in certain liquidations 
and reorganizations shall succeed to, and take into account, as of the 
close of the date of distribution or transfer, the items described in 
section 381(c) of the distributor or transferor corporation. These items 
shall be taken into account by the acquiring corporation subject to the 
conditions and limitations specified in sections 381, 382(b), and 383 
and the regulations thereunder.
    (b) Determination of transactions and items to which section 381 
applies--(1) Qualified transactions. Except to the extent provided in 
section 381(c)(20), relating to the carryover of unused pension trust 
deductions in certain liquidations, the items described in section 
381(c) are required by section 381 to be carried over to the acquiring 
corporation (as defined in subparagraph (2) of this paragraph) only in 
the following liquidations and reorganizations:
    (i) The complete liquidation of a subsidiary corporation upon which 
no gain or loss is recognized in accordance with the provisions of 
section 332;
    (ii) A statutory merger or consolidation qualifying under section 
368(a)(1)(A) to which section 361 applies;

[[Page 562]]

    (iii) A reorganization qualifying under section 368(a)(1)(C);
    (iv) A reorganization qualifying under section 368(a)(1)(D) if the 
requirements of section 354(b)(1)(A) and (B) are satisfied; and
    (v) A mere change in identity, form, or place of organization 
qualifying under section 368(a)(1)(F).
    (2) Acquiring corporation defined. (i) Only a single corporation may 
be an acquiring corporation for purposes of section 381 and the 
regulations thereunder. The corporation which acquires the assets of its 
subsidiary corporation in a complete liquidation to which section 
381(a)(1) applies is the acquiring corporation for purposes of section 
381. In a transaction to which section 381(a)(2) applies, the acquiring 
corporation is the corporation that, pursuant to the plan of 
reorganization, directly acquires the assets transferred by the 
transferor corporation, even if that corporation ultimately retains none 
of the assets so transferred.
    (ii) The application of this subparagraph may be illustrated by the 
following examples:

    Example 1. Y Corporation, a wholly-owned subsidiary of X 
Corporation, directly acquired all the assets of Z Corporation solely in 
exchange for voting stock of X Corporation in a transaction qualifying 
under section 368(a)(1)(C). Y Corporation is the acquiring corporation 
for purposes of section 381.
    Example 2. X Corporation acquired all the assets of Z Corporation 
solely in exchange for voting stock of X Corporation in a transaction 
qualifying under section 368(a)(1)(C). Thereafter, pursuant to the plan 
of reorganization X Corporation transferred all the assets so acquired 
to Y Corporation, its wholly-owned subsidiary (see section 
368(a)(2)(C)). X Corporation is the acquiring corporation for purposes 
of section 381.
    Example 3. X Corporation acquired all the assets of Z Corporation 
solely in exchange for the voting stock of X Corporation in a 
transaction qualifying under section 368(a)(1)(C). Thereafter, pursuant 
to the plan of reorganization X Corporation transferred one-half of the 
assets so acquired to Y Corporation, its wholly-owned subsidiary, and 
retained the other half of such assets. X Corporation is the acquiring 
corporation for purposes of section 381.
    Example 4. X Corporation acquired all the assets of Z Corporation 
solely in exchange for voting stock of X Corporation in a transaction 
qualifying under section 368(a)(1)(C). Thereafter, pursuant to the plan 
of reorganization X Corporation transferred one-half of the assets so 
acquired to Y Corporation, its wholly-owned subsidiary, and the other 
half of such assets to M Corporation, another wholly-owned subsidiary of 
X Corporation. X Corporation is the acquiring corporation for purposes 
of section 381.

    (3) Transactions and items not covered by section 381. Section 381 
does not apply to partial liquidations, divisive reorganizations, or 
other transactions not described in subparagraph (1) of this paragraph. 
Moreover, section 381 does not apply to the carryover of an item or tax 
attribute not specified in subsection (c) thereof. In a case where 
section 381 does not apply to a transaction, item, or tax attribute by 
reason of either of the preceding sentences, no inference is to be drawn 
from the provisions of section 381 as to whether any item or tax 
attribute shall be taken into account by the successor corporation.
    (c) Foreign corporations. For additional rules involving foreign 
corporations, see Sec. Sec. 1.367(b)-7 through 1.367(b)-9.
    (d) Internal Revenue Code of 1939. Any reference in the regulations 
under section 381 to any provision of the Internal Revenue Code of 1954 
shall, where appropriate, be deemed also to refer to the corresponding 
provision of the Internal Revenue Code of 1939.
    (e) Effective/applicability date. The rules of paragraph (b)(1)(i) 
of this section apply to corporate reorganizations and tax-free 
liquidations described in section 381(a) that occur on or after August 
31, 2011. The last sentence of paragraph (b)(2)(i) of this section and 
Example 2 of paragraph (b)(2)(ii) of this section apply to transactions 
occurring on or after November 10, 2014.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7343, 40 FR 
1698, Jan. 9, 1975; T.D. 9273, 71 FR 44914, Aug. 8, 2006; T.D. 9534, 76 
FR 45675, Aug. 1, 2011; T.D. 9700; 79 FR 66617, Nov. 10, 2014]



Sec. 1.381(b)-1  Operating rules applicable to carryovers in certain
corporate acquisitions.

    (a) Closing of taxable year--(1) In general. Except in the case of 
certain reorganizations qualifying under section 368(a)(1)(F), the 
taxable year of the distributor or transferor corporation shall end with 
the close of the date of distribution or transfer. With regard to

[[Page 563]]

the closing of the taxable year of the transferor corporation in certain 
reorganizations under section 368(a)(1)(F) involving a foreign 
corporation after December 31, 1986, see Sec. Sec. 1.367(a)-1(e) and 
1.367(b)-2(f).
    (2) Reorganizations under section 368(a)(1)(F). In the case of a 
reorganization qualifying under section 368(a)(1)(F) (whether or not 
such reorganization also qualifies under any other provision of section 
368(a)(1)), the acquiring corporation shall be treated (for purposes of 
section 381) just as the transferor corporation would have been treated 
if there had been no reorganization. Thus, the taxable year of the 
transferor corporation shall not end on the date of transfer merely 
because of the transfer; a net operating loss of the acquiring 
corporation for any taxable year ending after the date of transfer shall 
be carried back in accordance with section 172(b) in computing the 
taxable income of the transferor corporation for a taxable year ending 
before the date of transfer; and the tax attributes of the transferor 
corporation enumerated in section 381(c) shall be taken into account by 
the acquiring corporation as if there had been no reorganization.
    (b) Date of distribution or transfer. (1) The date of distribution 
or transfer shall be that day on which are distributed or transferred 
all those properties of the distributor or transferor corporation which 
are to be distributed or transferred pursuant to a liquidation or 
reorganization described in paragraph (b)(1) of Sec. 1.381(a)-1. If the 
distribution or transfer of all such properties is not made on one day, 
then, except as provided in subparagraph (2) of this paragraph, the date 
of distribution or transfer shall be that day on which the distribution 
or transfer of all such properties is completed.
    (2) If the distributor or transferor and acquiring corporations file 
the statements described in subparagraph (3) of this paragraph, the date 
of distribution or transfer shall be that day as of which (i) 
substantially all of the properties to be distributed or transferred 
have been distributed or transferred, and (ii) the distributor or 
transferor corporation has ceased all operations (other than liquidating 
activities). Such day also shall be the date of distribution or transfer 
if the completion of the distribution or transfer is unreasonably 
postponed beyond the date as of which substantially all the properties 
to be distributed or transferred have been distributed or transferred 
and the distributor or transferor corporation has ceased all operations 
other than liquidating activities. A corporation shall be considered to 
have distributed or transferred substantially all of its properties to 
be distributed or transferred even though it retains money or other 
property in a reasonable amount to pay outstanding debts or preserve the 
corporation's legal existence. A corporation shall be considered to have 
ceased all operations, other than liquidating activities, when it ceases 
to be a going concern and its activities are merely for the purpose of 
winding up its affairs, paying its debts, and distributing any remaining 
balance of its money or other properties to its shareholders.
    (3) Election--(i) Content of statements. The statements referred to 
in paragraph (b)(2) of this section must be entitled, ``ELECTION OF DATE 
OF DISTRIBUTION OR TRANSFER PURSUANT TO Sec. 1.381(b)-1(b)(2),'' and 
must include: [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER (IF ANY) 
OF DISTRIBUTOR OR TRANSFEROR CORPORATION] AND [INSERT NAME AND EMPLOYER 
IDENTIFICATION NUMBER (IF ANY) OF ACQUIRING CORPORATION] ELECT TO 
DETERMINE THE DATE OF DISTRIBUTION OR TRANSFER UNDER Sec. 1.381(b)-
1(b)(2). SUCH DATE IS [INSERT DATE (mm/dd/yyyy)].
    (ii) Filing of statements. One statement must be included on or with 
the timely filed Federal income tax return of the distributor or 
transferor corporation for its taxable year ending with the date of 
distribution or transfer. An identical statement must be included on or 
with the timely filed Federal income tax return of the acquiring 
corporation for its first taxable year ending after that date. If the 
distributor or transferor corporation, or the acquiring corporation, is 
a controlled foreign corporation (within the meaning of section 957), 
each United

[[Page 564]]

States shareholder (within the meaning of section 951(b)) with respect 
thereto must include this statement on or with its return.
    (4) If--
    (i) The last day of the acquiring corporation's taxable year is a 
Saturday, Sunday, or legal holiday, and
    (ii) The day specified in subparagraph (1) or (2) of this paragraph 
as the date of distribution or transfer is the last business day before 
such Saturday, Sunday, or holiday,

then the last day of the acquiring corporation's taxable year shall be 
the date of distribution or transfer for purposes of section 381(b) and 
this section. For purposes of this subparagraph, the term business day 
means a day which is not a Saturday, Sunday, or legal holiday, and also 
means a Saturday, Sunday, or legal holiday if the date of distribution 
or transfer determined under subparagraph (1) or (2) of this paragraph 
is such Saturday, Sunday, or holiday.
    (c) Return of distributor or transferor corporation. The distributor 
or transferor corporation shall file an income tax return for the 
taxable year ending with the date of distribution or transfer described 
in paragraph (b) of this section. If the distributor or transferor 
corporation remains in existence after such date of distribution or 
transfer, it shall file an income tax return for the taxable year 
beginning on the day following the date of distribution or transfer and 
ending with the date on which the distributor or transferor 
corporation's taxable year would have ended if there had been no 
distribution or transfer.
    (d) Carryback of net operating losses. For provisions relating to 
the carryback of net operating losses of the acquiring corporation, see 
paragraph (b) of Sec. 1.381(c)(1)-1.
    (e) Effective/applicability date. Paragraph (b)(3) of this section 
applies to any taxable year beginning on or after May 30, 2006. However, 
taxpayers may apply paragraph (b)(3) of this section to any original 
Federal income tax return (including any amended return filed on or 
before the due date (including extensions) of such original return) 
timely filed on or after May 30, 2006. For taxable years beginning 
before May 30, 2006, see Sec. 1.381(b)-1 as contained in 26 CFR part 1 
in effect on April 1, 2006.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended at T.D. 8280, 55 FR 
1417, Jan. 16, 1990; T.D. 8862, 65 FR 3609, Jan. 24, 2000; T.D. 9264, 71 
FR 30598, May 30, 2006; T.D. 9329, 72 FR 32801, June 14, 2007; T.D. 
9739, 80 FR 56915, Sept. 21, 2015]



Sec. 1.381(c)(1)-1  Net operating loss carryovers in certain
corporate acquisitions.

    (a) Carryover requirement. (1) Section 381(c)(1) requires the 
acquiring corporation to succeed to, and take into account, the net 
operating loss carryovers of the distributor or transferor corporation. 
To determine the amount of these carryovers as of the close of the date 
of distribution or transfer, and to integrate them with any carryovers 
and carrybacks of the acquiring corporation for purposes of determining 
the taxable income of the acquiring corporation for taxable years ending 
after the date of distribution or transfer, it is necessary to apply the 
provisions of section 172 in accordance with the conditions and 
limitations of section 381(c)(1) and this section. See also section 
382(b) and the regulations thereunder.
    (2) The net operating loss carryovers and carrybacks of the 
acquiring corporation determined as of the close of the date of 
distribution or transfer shall be computed without reference to any net 
operating loss of a distributor or transferor corporation. The net 
operating loss carryovers of a distributor or transferor corporation as 
of the close of the date of distribution or transfer shall be determined 
without reference to any net operating loss of the acquiring 
corporation.
    (3) For purposes of the tax imposed under section 56, the acquiring 
corporation succeeding to and taking into account any net operating loss 
carryovers of the distributor or transferor corporation shall also 
succeed to and take into account along with such net operating loss 
carryforward any deferred tax liability under section 56(b) and the 
regulations thereunder attributable to such net operating loss 
carryover.

[[Page 565]]

    (b) Carryback of net operating losses. A net operating loss of the 
acquiring corporation for any taxable year ending after the date of 
distribution or transfer shall not be carried back in computing the 
taxable income of a distributor or transferor corporation. However, a 
net operating loss of the acquiring corporation for any such taxable 
year shall be carried back in accordance with section 172(b) in 
computing the taxable income of the acquiring corporation for a taxable 
year ending on or before the date of distribution or transfer. If a 
distributor or transferor corporation remains in existence after the 
date of distribution or transfer, a net operating loss sustained by it 
for any taxable year beginning after such date shall be carried back in 
accordance with section 172(b) in computing the taxable income of such 
corporation for a taxable year ending on or before that date, but may 
not be carried back or over in computing the taxable income of the 
acquiring corporation. This paragraph may be illustrated by the 
following examples:

    Example 1. On December 31, 1954, X Corporation merged into Y 
Corporation in a statutory merger to which section 361 applies, and the 
charter of Y Corporation continued after the merger. Y Corporation 
sustained a net operating loss for the calendar year 1955. Y 
Corporation's net operating loss for 1955 may not be carried back in 
computing the taxable income of X Corporation but shall be carried back 
in computing the taxable income of Y Corporation.
    Example 2. On December 31, 1954, X Corporation and Y Corporation 
transferred all their assets to Z Corporation in a statutory 
consolidation to which section 361 applies. Z Corporation sustained a 
net operating loss for the calendar year 1955. Z Corporation's net 
operating loss for 1955 may not be carried back in computing the taxable 
income of X Corporation or Y Corporation.
    Example 3. On December 31, 1954, X Corporation ceased all operations 
(other than liquidating activities) and transferred substantially all 
its properties to Y Corporation in a reorganization qualifying under 
section 368(a)(1)(C). Such properties comprised all of X Corporation's 
properties which were to be transferred pursuant to the reorganization. 
In the process of liquidating its assets and winding up its affairs, X 
Corporation sustained a net operating loss for its taxable year 
beginning on January 1, 1955. This net operating loss of X Corporation 
shall be carried back in computing the taxable income of that 
corporation but may not be carried back or over in computing the taxable 
income of Y Corporation.

    (c) First taxable year to which carryovers apply. (1) The net 
operating loss carryovers available to the distributor or transferor 
corporation as of the close of the date of distribution or transfer 
shall first be carried to the first taxable year of the acquiring 
corporation ending after that date. This rule applies irrespective of 
whether the date of distribution or transfer is on the last day, or any 
other day, of the acquiring corporation's taxable year. Thus, such net 
operating loss carryovers shall first be used by the acquiring 
corporation with respect to the computation of its net operating loss 
deduction under section 172(a), and its taxable income determined under 
the provisions of section 172(b)(2), for such first taxable year. 
However, see paragraph (f) of this section.
    (2) The net operating loss carryovers available to the distributor 
or transferor corporation as of the close of the date of distribution or 
transfer shall be carried to the acquiring corporation without 
diminution by reason of the fact that the acquiring corporation does not 
acquire 100 percent of the assets of the distributor or transferor 
corporation. Thus, if a parent corporation owning 80 percent of all 
classes of stock of its subsidiary corporation were to acquire its share 
of the assets of the subsidiary corporation upon a complete liquidation 
described in paragraph (b)(1)(i) of Sec. 1.381(a)-1, then, subject to 
the conditions and limitations of this section, 100 percent of the net 
operating loss carryovers available to the subsidiary corporation as of 
the close of the date of distribution would be carried over to the 
parent corporation.
    (d) Limitation on net operating loss deduction for first taxable 
year ending after date of distribution or transfer. (1) That part of the 
acquiring corporation's net operating loss deduction, determined in 
accordance with sections 172(a) and 381(c)(1), for its first taxable 
year ending after the date of distribution or transfer which is 
attributable to the net operating loss carryovers of the distributor or 
transferor corporation, is limited by section 381(c)(1)(B) and this 
paragraph to an amount equal to

[[Page 566]]

the acquiring corporation's postacquisition part year taxable income. 
Such postacquisition part year taxable income is the amount which bears 
the same ratio to the acquiring corporation's taxable income for the 
first taxable year ending after the date of distribution or transfer 
(determined under section 63 without regard to any net operating loss 
deduction but taking into account other items to which the acquiring 
corporation succeeds under section 381) as the number of days in such 
first taxable year which follow the date of distribution or transfer 
bears to the total number of days in such taxable year. Thus, if the 
date of distribution or transfer is the last day of the acquiring 
corporation's taxable year, the net operating loss carryovers of the 
distributor or transferor are allowed in full in computing under section 
172(a) the net operating loss deduction of the acquiring corporation for 
its first taxable year ending after that date. In such instance, the 
number of days in the first taxable year which follow the date of 
distribution or transfer is the total number of days in such taxable 
year.
    (2) The limitation provided by section 381(c)(1)(B) applies solely 
for the purpose of computing the net operating loss deduction of the 
acquiring corporation under section 172(a) for the acquiring 
corporation's first taxable year ending after the date of distribution 
or transfer. The limitation does not apply for purposes of determining 
the portion of any net operating loss (whether of the distributor, 
transferor, or acquiring corporation) which may be carried to any 
taxable year of the acquiring corporation following its first taxable 
year ending after the date of distribution or transfer since such 
determination is made pursuant to section 172(b) and section 
381(c)(1)(C). See paragraphs (e) and (f) of this section.
    (3) The limitation provided by section 381(c)(1)(B) shall be applied 
to the aggregate of the allowable net operating loss carryovers of the 
distributor or transferor corporation without reference to the taxable 
years in which the net operating losses were sustained by such 
corporation. If the acquiring corporation has acquired the assets of two 
or more distributor or transferor corporations on the same date of 
distribution or transfer, then the limitation provided by section 
381(c)(1)(B) shall be applied to the aggregate of the net operating loss 
carryovers from all of such distributor or transferor corporations.
    (4) If the acquiring corporation succeeds to the net operating loss 
carryovers of two or more distributor or transferor corporations on two 
or more different dates of distribution or transfer within one taxable 
year of the acquiring corporation, the limitation to be applied under 
section 381(c)(1)(B) to the aggregate of such carryovers shall be 
governed by the rules prescribed in paragraph (b) of Sec. 1.381(c)(1)-
2.
    (5) Illustrations. The application of this paragraph may be 
illustrated by the following examples:

    Example 1. (i) X Corporation and Y Corporation were organized on 
January 1, 1956, and make their returns on the calendar year basis. On 
December 16, 1957, X Corporation transferred all its assets to Y 
Corporation in a statutory merger to which section 361 applies. The net 
operating losses and taxable income (computed without the net operating 
loss deduction) of the two corporations are as follows, the assumption 
being made that none of the modifications specified in section 
172(b)(2)(A) apply to any taxable year:

------------------------------------------------------------------------
                                                     X            Y
                 Taxable year                   Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1956.........................................    ($35,000)      ($5,000)
Ending 12-16-57..............................     (30,000)           xxx
1957.........................................          xxx        36,500
------------------------------------------------------------------------

    (ii) The aggregate of the net operating loss carryovers of X 
Corporation carried under section 381(c)(1)(A) to Y Corporation's 
taxable year ending December 31, 1957, is $65,000; but pursuant to 
section 381(c)(1)(B), only $1,500 of such aggregate amount ($36,500 x 
15/365) may be used in computing the net operating loss deduction of Y 
Corporation for such taxable year under section 172(a). This limitation 
applies even though Y Corporation's own net operating loss carryover to 
such year is only $5,000, with the result that Y Corporation has taxable 
income under section 63 of $30,000 for its taxable year ending December 
31, 1957, that is, $36,500 less the sum of $5,000 and $1,500.
    (iii) For rules determining the portion of any given loss of X 
Corporation or Y Corporation which may be carried to a taxable year of Y 
Corporation following its taxable year ending December 31, 1957, see 
sections

[[Page 567]]

172(b)(2) and 381(c)(1)(C) and paragraph (f) of this section.
    Example 2. (i) X Corporation was organized on January 1, 1954, and Y 
Corporation was organized on January 1, 1956. Each corporation makes its 
return on the basis of the calendar year. On December 31, 1956, X 
Corporation transferred all its assets to Y Corporation in a statutory 
merger to which section 361 applies. The net operating losses and the 
taxable income (computed without any net operating loss deduction) of 
the two corporations are as follows, the assumption being made that none 
of the modifications specified in section 172(b)(2)(A) apply to any 
taxable year:

------------------------------------------------------------------------
                                                     X            Y
                 Taxable year                   Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1954.........................................     ($5,000)           xxx
1955.........................................     (15,000)           xxx
1956.........................................     (10,000)       $20,000
1957.........................................          xxx        40,000
------------------------------------------------------------------------

    (ii) The aggregate of the net operating loss carryovers of X 
Corporation carried under section 381(c)(1)(A) to Y Corporation's 
taxable year 1957 is $30,000, and the full amount of such carryovers is 
allowed in such taxable year to Y Corporation as a deduction under 
section 172(a), since such amount does not exceed the limitation 
($40,000 x 365/365) for such taxable year under section 381(c)(1)(B).
    Example 3. (i) X Corporation, Y Corporation, and Z Corporation were 
organized on January 1, 1954, and each corporation makes its return on 
the basis of the calendar year. On September 30, 1956, X Corporation and 
Y Corporation transferred all their assets to Z Corporation in a 
statutory merger to which section 361 applies. The net operating losses 
and the taxable income (computed without any net operating loss 
deduction) of the three corporations are as follows, the assumption 
being made that none of the modifications specified in section 
172(b)(2)(A) apply to any taxable year:

------------------------------------------------------------------------
                                       X             Y            Z
          Taxable year            Corporation   Corporation  Corporation
                                 (transferor)  (transferor)   (acquirer)
------------------------------------------------------------------------
1954...........................     ($5,000)      ($3,000)     ($40,000)
1955...........................      (4,000)       (2,000)        10,000
Ending 9-30-56.................      (1,000)       (9,000)           xxx
1956...........................          xxx           xxx        73,200
------------------------------------------------------------------------

    (ii) The aggregate of the net operating loss carryovers of X 
Corporation and Y Corporation carried under section 381(c)(1)(A) to Z 
Corporation's taxable year 1956 is $24,000; but, pursuant to section 
381(c)(1)(B), only $18,400 of such aggregate amount ($73,200 x 92/366) 
may be used in computing the net operating loss deduction of Z 
Corporation for such taxable year under section 172(a). For this 
purpose, Z Corporation may not use the total of the aggregate carryovers 
($10,000) from X Corporation plus the aggregate carryovers ($14,000) 
from Y Corporation, even though each such aggregate of carryovers is 
separately less than the limitation ($18,400) applicable under section 
381(c)(1)(B) and this section.
    (iii) For rules determining the portion of any given loss of X 
Corporation, Y Corporation, or Z Corporation which may be carried to a 
taxable year of Z Corporation following its taxable year ending December 
31, 1956, see sections 172(b)(2) and 381(c)(1)(C) and paragraph (f) of 
this section.

    (e) Computation of carryovers and carrybacks; general rule--(1) 
Sequence for applying losses and computation of taxable income. The 
portion of any net operating loss which is carried back or carried over 
to any taxable year is the excess, if any, of the amount of the loss 
over the sum of the taxable income for each of the prior taxable years 
to which the loss may be carried under sections 172(b)(1) and 381. In 
determining the taxable income for each such prior taxable year for this 
purpose, the various net operating loss carryovers and carrybacks to 
such prior taxable year are considered to be applied in reduction of the 
taxable income in the order of the taxable years in which the net 
operating losses are sustained, beginning with the loss for the earliest 
taxable year. The application of this rule to the taxable income of the 
acquiring corporation for any taxable year ending after the date of 
distribution or transfer involves the use of carryovers of the 
distributor or transfer corporation, and of carryovers and carrybacks of 
the acquiring corporation. In such instance, the sequence for the use of 
loss years remains the same, and the requirement is to begin with the 
net operating loss of the earliest taxable year, whether or not it is a 
loss of the distributor, transferor, or acquiring corporation. The 
taxable income of the acquiring corporation for any taxable year ending 
after the date of distribution or transfer shall be determined in the 
manner prescribed by section 172(b)(2), except that, if the date of 
distribution or transfer is on a day other than the last day of a 
taxable year of the acquiring corporation, the taxable income of such 
corporation for the taxable year which includes such date shall be 
computed in the special manner prescribed

[[Page 568]]

by section 381(c)(1)(C) and paragraph (f) of this section.
    (2) Loss year of transferor or distributor considered prior taxable 
year. Section 381(c)(1)(C) provides that, for the purpose of determining 
the net operating loss carryovers under section 172(b)(2), a net 
operating loss for a loss year of a distributor or transferor 
corporation which ends on or before the last day of a loss year of the 
acquiring corporation shall be considered to be a net operating loss for 
a year prior to such loss year of the acquiring corporation. In a case 
where the acquiring corporation has acquired the assets of two or more 
distributor or transferor corporations on the same date of distribution 
or transfer, the loss years of the distributor or transferor 
corporations shall be taken into account in the order in which such loss 
years terminate; if any one of the loss years of a distributor or 
transferor corporation ends on the same day as the loss year of another 
distributor or transferor corporation, either loss year may be taken 
into account before the other.
    (3) Years to which losses may be carried. The taxable years to which 
a net operating loss shall be carried back or carried over are 
prescribed by section 172(b)(1). Since the taxable year of the 
distributor or transferor corporation ends with the close of the date of 
distribution or transfer, such taxable year and the first taxable year 
of the acquiring corporation which ends after that date shall be 
considered two separate taxable years to which a net operating loss of 
the distributor or transferor corporation for any taxable year ending 
before that date may be carried over. This rule applies even though the 
taxable year of the distributor or transferor corporation which ends on 
the date of distribution or transfer is a period of less than twelve 
months. However, for the purpose of determining under section 172(b)(1) 
the taxable years to which a net operating loss of the acquiring 
corporation is carried over or carried back, the first taxable year of 
the acquiring corporation which ends after the date of distribution or 
transfer shall be treated as only one taxable year even though such 
taxable year is considered under section 381(c)(1)(C) and paragraph 
(f)(2) of this section as two taxable years. The application of this 
subparagraph may be illustrated by the following example:

    Example. X Corporation was organized on January 1, 1954, and 
thereafter it sustained net operating losses in its calendar years 1954, 
1955, and 1956. On June 30, 1957, X Corporation transferred all its 
assets to Y Corporation, which was organized on January 1, 1955, in a 
statutory merger to which section 361 applies. In its taxable year 
ending June 30, 1957, X Corporation sustained a net operating loss. Y 
Corporation sustained net operating losses in its calendar years 1955, 
1956, and 1958, but had taxable income for the year 1957. The years to 
which these losses of X Corporation and Y Corporation shall be carried, 
and the sequence in which carried, are as follows:

------------------------------------------------------------------------
                Loss year
------------------------------------------------------------------------
X 1954..................................  X 1955, X 1956, X 6/30/57, Y
                                           1957, Y 1958.
X 1955..................................  X 1954, X 1956, X 6/30/57, Y
                                           1957, Y 1958, Y 1959.
Y 1955..................................  Y 1956, Y 1957, Y 1958, Y
                                           1959, Y 1960.
X 1956..................................  X 1954, X 1955, X 6/30/57, Y
                                           1957, Y 1958, Y 1959, Y 1960.
Y 1956..................................  Y 1955, Y 1957, Y 1958, Y
                                           1959, Y 1960, Y 1961.
X 6-30-57...............................  X 1955, X 1956, Y 1957, Y
                                           1958, Y 1959, Y 1960, Y 1961.
Y 1958..................................  Y 1955, Y 1956, Y 1957, Y
                                           1959, Y 1960, Y 1961, Y 1962,
                                           Y 1963.
------------------------------------------------------------------------


    (4) Computation of carryovers in a case where the date of 
distribution or transfer occurs on last day of acquiring corporation's 
taxable year. The computation of the net operating loss carryovers from 
the distributor or transferor corporation and from the acquiring 
corporation in a case where the date of distribution or transfer occurs 
on the last day of a taxable year of the acquiring corporation may be 
illustrated by the following example:
    Example. X Corporation and Y Corporation were organized on January 
1, 1955, and each corporation makes its return on the basis of the 
calendar year. On December 31, 1956, X Corporation transferred all its 
assets to Y Corporation in a statutory merger to which section 361 
applies. The net operating losses and the taxable income (computed 
without any net operating loss deduction) of the two corporations are as 
follows, the assumption being made that none of the modifications 
specified in section 172(b)(2)(A) apply to any taxable year:

[[Page 569]]



------------------------------------------------------------------------
                                                     X            Y
                 Taxable year                   Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1955.........................................     ($2,000)     ($11,000)
1956.........................................      (3,000)        10,000
1957.........................................          xxx      (15,000)
------------------------------------------------------------------------


The sequence in which the losses of X Corporation and Y Corporation are 
applied, and the computation of the carryovers to Y Corporation's 
calendar year 1958, may be illustrated as follows:
    (i) X Corporation's 1955 loss. The carryover to 1958 is $2,000, 
computed as follows:

Net operating loss..........................................      $2,000
Less:
  X's 1956 taxable income........................          0
  Y's 1957 taxable income........................          0
                                                  ------------
                                                   .........           0
                                                             -----------
 Carryover..................................................       2,000
 

    (ii) Y Corporation's 1955 loss. The carryover to 1958 is $1,000, 
computed as follows:

Net operating loss..........................................    $11,000
Less:
  Y's 1956 taxable income.......................     $10,000
  Y's 1957 taxable income.......................           0
                                                 -------------
                                                  ..........      10,000
                                                             -----------
 Carryover..................................................       1,000
 

    (iii) X Corporation's 1956 loss. The carryover to 1958 is $3,000, 
computed as follows:

Net operating loss...........................................     $3,000
Less:
  X's 1955 taxable income.........................          0
  Y's 1957 taxable income.........................          0
                                                   ------------
                                                    .........          0
                                                              ----------
 Carryover...................................................      3,000
 

    (iv) Y Corporation's 1957 loss. The carryover to 1958 is $15,000, 
computed as follows:

Net operating loss..........................................    $15,000
Less:
  Y's 1955 taxable income..........................        0
  Y's 1956 taxable income before net        $10,000
   operating loss deduction............
  Minus Y's 1956 net operating loss          11,000        0
   deduction (i.e., Y's 1955 carryover)
                                        -------------
                                         ..........        0
                                                    ----------
 Carryover..................................................      15,000
 

    (v) Summary of carryovers to 1958. The aggregate of the net 
operating loss carryovers to 1958 is $21,000, computed as follows:

X's 1955 loss................................................     $2,000
Y's 1955 loss................................................      1,000
X's 1956 loss................................................      3,000
Y's 1957 loss................................................     15,000
                                                              ----------
 Total.......................................................     21,000
 

    (f) Computation of carryovers and carrybacks when date of 
distribution or transfer is not on last day of acquiring corporation's 
taxable year--(1) General rule. Pursuant to the provisions of section 
381(c)(1)(C), the taxable income of the acquiring corporation for its 
taxable year which is a prior taxable year for purposes of section 
172(b)(2) and paragraph (e) of this section shall be determined in the 
manner prescribed in this paragraph, if the date of distribution or 
transfer occurs within, but not on the last day of, such taxable year.
    (2) Taxable year considered as two taxable years. Such taxable year 
of the acquiring corporation shall be considered as though it were two 
taxable years, but only for the limited purpose of applying section 
172(b)(2). The first of such two taxable years shall be referred to in 
this section as the preacquisition part year; the second, as the 
postacquisition part year. For purposes of section 172(b)(2), a net 
operating loss of the acquiring corporation shall be carried to the 
preacquisition part year and then to the postacquisition part year, 
whereas a net operating loss of a distributor or transferor corporation 
shall be carried to the postacquisition part year and then to the 
acquiring corporation's subsequent taxable years. In determining under 
section 172(b)(2) and this paragraph the portion of any net operating 
loss of a distributor or transferor corporation which is carried to any 
taxable year of the acquiring corporation ending after the 
postacquisition part year, the taxable income (as determined under this 
paragraph) of the postacquisition part year shall be taken into account 
but the taxable income of the preacquisition part year (as so 
determined) shall not be taken into account. Though considered as two 
separate taxable years for purposes of section 172(b)(2), the 
preacquisition part year and the postacquisition part year are treated 
as one taxable year in determining the years to which a net operating 
loss is carried under section 172(b)(1). See paragraph (e)(3) of this 
section.
    (3) Preacquisition part year. The preacquisition part year shall 
begin with the beginning of such taxable year of the acquiring 
corporation and shall

[[Page 570]]

end with the close of the date of distribution or transfer.
    (4) Postacquisition part year. The postacquisition part year shall 
begin with the day following the date of distribution or transfer and 
shall end with the close of such taxable year of the acquiring 
corporation.
    (5) Division of taxable income. The taxable income for such taxable 
year (computed with the modifications specified in section 172(b)(2)(A) 
but without any net operating loss deduction) of the acquiring 
corporation shall be divided between the preacquisition part year and 
the postacquisition part year in proportion to the number of days in 
each. Thus, if in a statutory merger to which section 361 applies Y 
Corporation acquires the assets of X Corporation on June 30, 1960, and Y 
Corporation has taxable income (computed in the manner so prescribed) of 
$36,600 for its calendar year 1960, then the preacquisition part year 
taxable income would be $18,200 ($36,600 x 182/366) and the 
postacquisition part year taxable income would be $18,400 ($36,600 x 
184/366).
    (6) Net operating loss deduction. After obtaining the taxable income 
of the preacquisition part year and of the postacquisition part year in 
the manner described in subparagraph (5) of this paragraph, it is 
necessary to compute the net operating loss deduction for each such part 
year. This deduction shall be determined in the manner prescribed by 
section 172(b)(2)(B) but subject to the provisions of this subparagraph. 
The net operating loss deduction for the preacquisition part year shall, 
for purposes of section 172(b)(2) only, be determined in the same manner 
as that prescribed by section 172(b)(2)(B) but shall be computed without 
taking into account any net operating loss of the distributor or 
transferor corporation. Therefore, only net operating loss carryovers 
and carrybacks of the acquiring corporation to the preacquisition part 
year shall be taken into account in computing the net operating loss 
deduction for such part year. The net operating loss deduction for the 
post- acquisition part year shall, for purposes of section 172(b)(2) 
only, be determined in the same manner as that prescribed by section 
172(b)(2)(B) and shall be computed by taking into account all the net 
operating loss carryovers available to the distributor or transferor 
corporation as of the close of the date of distribution or transfer, as 
well as the net operating loss carryovers and carrybacks of the 
acquiring corporation to the postacquisition part year. The sequence in 
which the net operating losses of the two corporations shall be applied 
for purposes of this subparagraph shall be determined in the manner 
prescribed in paragraph (e) of this section.
    (7) Limitation on taxable income. In no case shall the taxable 
income of the preacquisition part year or the postacquisition part year, 
as computed under this paragraph, be considered to be less than zero.
    (8) Cross reference. If the acquiring corporation succeeds to the 
net operating loss carryovers of two or more distributors or transferor 
corporations on two or more dates of distribution or transfer during the 
same taxable year of the acquiring corporation, the determination of the 
taxable income of the acquiring corporation for such year pursuant to 
section 381(c)(1)(C) shall be governed by the rules prescribed in 
paragraph (c) of Sec. 1.381(c)(1)-2.
    (9) Illustration. The application of this paragraph may be 
illustrated by the following example:

    Example. (i) Facts. X Corporation was organized on January 1, 1955, 
and Y Corporation was organized on January 1, 1954. Each corporation 
makes its return on the basis of the calendar year. On June 30, 1956, X 
Corporation transferred all its assets to Y Corporation in a statutory 
merger to which section 361 applies. The net operating losses and the 
taxable income (computed without any net operating loss deduction) of 
the two corporations are as follows, the assumption being made that none 
of the modifications specified in section 172(b)(2)(A) apply to any 
taxable year:

------------------------------------------------------------------------
                                                     X            Y
                 Taxable year                   Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1954.........................................          xxx      ($5,000)
1955.........................................    ($65,000)      (20,000)
Ending June 30, 1956.........................        1,000           xxx
1956.........................................          xxx        36,600
------------------------------------------------------------------------

    (ii) Y Corporation's 1954 loss. The carryover to 1957 is $0, 
computed as follows:

Net operating loss...........................................     $5,000

[[Page 571]]

 
Less:
  Y's 1955 taxable income....................................          0
                                                  -------------
    Carryover to Y's preacquisition part year................      5,000
Less:
  Y's preacquisition part year taxable income         $18,200
   computed under subparagraph (5) of this
   paragraph ($36,600 x 182/366).................
  Minus Y's net operating loss deduction for              xxx     18,200
   preacquisition part year......................
                                                  ----------------------
    Carryover to Y's postacquisition part year and also to Y           0
     1957....................................................
 

    (iii) X Corporation's 1955 loss. The carryover to 1957 is $45,600, 
computed as follows:

Net operating loss..........................................     $65,000
Less:
  X's 6/30/56 year taxable income...........................       1,000
                                                 -------------
    Carryover to Y's postacquisition part year..............     64,000
Less:
  Y's postacquisition part year taxable income       $18,400
   computed under subparagraph (5) of this
   paragraph ($36,600 x 184/366)................
  Minus Y's net operating loss deduction for      ..........     $18,400
   postacquisition part year (i.e., Y's 1954
   carryover of $0 to such part year)...........
                                                             -----------
    Carryover to Y 1957.....................................      45,600
 

    (iv) Y Corporation's 1955 loss. The carryover to 1957 is $6,800, 
computed as follows:

Net operating loss..........................................     $20,000
Less:
  Y's 1954 taxable income...................................           0
                                                 -------------
    Carryover to Y's preacquisition part year...............     20,000
Less:
  Y's preacquisition part year taxable income        $18,200
   computed under subparagraph (5) of this
   paragraph....................................
  Minus Y's net operating loss deduction for           5,000
   preacquisition part year (i.e., Y's 1954
   carryover to such part year).................
                                                 ------------
                                                  ..........      13,200
                                                             -----------
    Carryover to Y's postacquisition part year..............      6,800
Less:
  Y's postacquisition part year taxable income       $18,400
   computed under subparagraph (5) of this
   paragraph....................................
  Minus Y's net operating loss deduction for          64,000
   postacquisition part year (i.e., Y's 1954
   carryover of $0, and X's 1955 carryover of
   $64,000, to such part year)..................
                                                 ------------
                                                  ..........           0
                                                             -----------
    Carryover to Y 1957.....................................       6,800
 

    (v) Summary of carryovers to 1957. The aggregate of the net 
operating loss carryovers to 1957 is $52,400, determined as follows:

Y's 1954 loss...............................................           0
X's 1955 loss...............................................     $45,600
Y's 1955 loss...............................................       6,800
                                                             -----------
 Total......................................................      52,400
 

    (g) Successive acquiring corporations. An acquiring corporation 
which, in a distribution or transfer to which section 381(a) applies, 
acquires the assets of a distributor or transferor corporation which 
previously acquired the assets of another corporation in a transaction 
to which section 381(a) applies, shall succeed to and take into account, 
subject to the conditions and limitations of sections 172 and 381, the 
net operating loss carryovers available to the first acquiring 
corporation under sections 172 and 381.
    (h) Illustration. The application of this section may be further 
illustrated by the following example:

    Example. (1) Facts. X Corporation was organized on January 1, 1954, 
and Y Corporation was organized on January 1, 1955. Each corporation 
makes its return on the basis of the calendar year. On August 31, 1957, 
X Corporation transferred all its assets to Y Corporation in a statutory 
merger to which section 361 applies. The net operating losses and the 
taxable income of the two corporations for the taxable years involved 
are set forth in the tabulation below. The taxable income so shown is 
computed without the modifications required by section 172(b)(2)(A) and 
without the benefit of any net operating loss deduction. In its calendar 
year 1957, Y Corporation had a deduction of $365 which is disallowed by 
section 172(b)(2)(A).

------------------------------------------------------------------------
                                                     X            Y
                 Taxable year                   Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1954.........................................     ($7,000)           xxx
1955.........................................     (10,000)     ($10,000)
1956.........................................     (25,000)      (15,000)
Ending 8-31-57...............................        1,000           xxx
1957.........................................          xxx        54,750
1958.........................................          xxx       (5,000)
1959.........................................          xxx        50,000
------------------------------------------------------------------------

    (2) Computation of carryovers and carrybacks. The sequence in which 
the losses of X Corporation and Y Corporation are applied and the 
computation of the carryovers to Y Corporation's calendar year 1959 may 
be illustrated as follows:
    (i) X Corporation's 1954 loss. The carryover to 1958, which is the 
last year to which this

[[Page 572]]

loss may be carried, is $0, computed as follows:

Net operating loss..........................................      $7,000
Less:
  X's 1955 taxable income.......................           0
  X's 1956 taxable income.......................           0
                                                 ------------
                                                  ..........           0
                                                             -----------
    Carryover to X's 8/31/57-year...........................       7,000
Less:
  X's 8/31/57-year taxable income...........................       1,000
                                                 -------------
    Carryover to Y's postacquisition part year..............       6,000
Less:
  Y's postacquisition part year taxable income       $18,422
   computed under paragraph (f)(5) of this
   section (($54,750 + $365) x 122/365).........
  Minus Y's net operating loss deduction for             xxx
   postacquisition part year....................
                                                 ------------
                                                  ..........      18,422
                                                             -----------
    Carryover to Y 1958.....................................           0
 

    (ii) X Corporation's 1955 loss. The carryover to 1959 is $0, 
computed as follows:

Net operating loss..........................................     $10,000
Less:
  X's 1954 taxable income.......................           0
  X's 1956 taxable income.......................           0
                                                 ------------
                                                  ..........           0
                                                             -----------
    Carryover to X's 8/31/57-year...........................      10,000
Less:
  X's 8/31/57-year taxable income before net          $1,000
   operating loss deduction.....................
  Minus X's net operating loss deduction for 8/        7,000
   31/57-year (i.e., X's 1954 carryover)........
                                                 ------------
                                                  ..........           0
                                                             -----------
    Carryover to Y's postacquisition part year..............      10,000
Less:
  Y's postacquisition part year taxable income       $18,422
   computed under paragraph (f)(5) of this
   section......................................
  Minus Y's net operating loss deduction for           6,000
   postacquisition part year (i.e., X's 1954
   carryover to such part year).................
                                                 ------------
                                                  ..........      12,422
                                                             -----------
    Carryover to Y 1958 and Y 1959..........................           0
 

    (iii) Y Corporation's 1955 loss. The carryover to 1959 is $0, 
computed as follows:

Net operating loss..........................................     $10,000
Less:
  Y's 1956 taxable income...................................           0
                                                 -------------
    Carryover to Y's preacquisition part year...............      10,000
Less:
  Y's preacquisition part year taxable income        $36,693
   computed under paragraph (f)(5) of this
   section (($54,750 + $365) x 243/365).........
  Minus Y's net operating loss deduction for             xxx
   preacquisition part year.....................
                                                 ------------
                                                  ..........      36,693
                                                             -----------
    Carryover to Y's postacquisition part year, to Y 1958,             0
     and to Y 1959..........................................
 

    (iv) X Corporation's 1956 loss. The carryover to 1959 is $22,578, 
computed as follows:

Net operating loss.........................................      $25,000
Less:
  X's 1954 taxable income.......................          0
  X's 1955 taxable income.......................          0
  X's 8/31/57-year taxable income         $1,000
   before net operating loss
   deduction........................
  Minus X's net operating loss           $17,000          0            0
   deduction for 8/31/57-year (i.e.,
   X's 1954 carryover of $7,000 and
   X's 1955 carryover of $10,000)...
                                     -----------------------------------
    Carryover to Y's postacquisition part year.............      $25,000
Less:
  Y's postacquisition part year taxable income      $18,422
   computed under paragraph (f)(5) of this
   section......................................
  Minus Y's net operating loss deduction for         16,000
   postacquisition part year (i.e., X's 1954
   carryover of $6,000, X's 1955 carryover of
   $10,000 and Y's 1955 carryover of $0, to such
   part year)...................................
                                     ------------
                                                  .........        2,422
                                                 ------------
    Carryover to Y 1958....................................       22,578
Less:
  Y's 1958 taxable income..................................            0
                                     -------------
    Carryover to Y 1959....................................       22,578
 

    (v) Y Corporation's 1956 loss. The carryover to 1959 is $0, computed 
as follows:

Net operating loss..........................................     $15,000
Less:
  Y's 1955 taxable income...................................           0
                                                 -------------
    Carryover to Y's preacquisition part year...............      15,000
Less:
  Y's preacquisition part year taxable income        $36,693
   computed under paragraph (f)(5) of this
   section......................................
  Minus Y's net operating loss deduction for          10,000
   preacquisition part year (i.e., Y's 1955
   carryover to such part year).................
                                                 ------------

[[Page 573]]

 
                                                  ..........      26,693
                                                             -----------
    Carryover to Y's postacquisition part year, to Y 1958,             0
     and to Y 1959..........................................
 

    (vi) Y Corporation's 1958 loss. The carryover to 1959 is $0, 
computed as follows:

Net operating loss...........................................     $5,000
Less:
  Y's 1955 taxable income \1\....................           0
  Y's 1956 taxable income........................           0
                                                  ------------
                                                   ..........          0
                                                              ----------
    Carryback to Y's preacquisition part year................    $5,000
Less:
  Y's preacquisition part year taxable income         $36,693
   computed under paragraph (f)(5) of this
   section.......................................
  Minus Y's net operating loss deduction for           25,000
   preacquisition part year (i.e., Y's 1955
   carryover of $10,000, and Y's 1956 carryover
   of $15,000, to such part year)................
                                                  -------------
                                                   ..........    11,693
    Carryback to Y's postacquisition part year and carryover           0
     to Y 1959...............................................
 
\1\ Three-year carryback in case of loss years ending after December 31,
  1957.

    (vii) Summary of carryovers to 1959. The aggregate of the net 
operating loss carryovers to 1959 is $22,578, computed as follows:

X's 1955 loss...............................................           0
Y's 1955 loss...............................................           0
X's 1956 loss...............................................     $22,578
Y's 1956 loss...............................................           0
Y's 1958 loss...............................................           0
                                                             -----------
 Total......................................................      22,578
 

    (3) Net operating loss deduction for 1957. (i) The net operating 
loss deduction available to Y Corporation under section 172(a) for the 
calendar year 1957, determined in accordance with paragraph (d) of this 
section, is $48,300, computed as follows:

Aggregate of the net operating loss carryovers
 available to the transferor corporation as of
 the close of August 31, 1957, but limited by
 paragraph (d) of this section to $18,300 (Y's
 1957 taxable income of $54,750, computed
 without any net operating loss deduction,
 multiplied by 122/365)
  Carryover of X's 1954 loss....................      $6,000
  Carryover of X's 1955 loss....................      10,000
  Carryover of X's 1956 loss....................      25,000
                                                 -------------
                                                    $41,000
Aggregate of carryovers, limited as above...................     $18,300
Carryover of Y's 1955 loss..................................      10,000
Carryover of Y's 1956 loss..................................      15,000
Carryback of Y's 1958 loss..................................       5,000
                                                 -------------
 Net operating loss deduction...............................      48,800
 

    (ii) The taxable income under section 63 for 1957 is $6,450, 
computed as follows:

Taxable income determined without any net operating loss         $54,750
 deduction..................................................
Less:
  Net operating loss deduction for 1957, as determined under     $48,300
   subdivision (i) of this subparagraph.....................
                                                             -----------
 Taxable income under section 63............................       6,450
 

    (4) Net operating loss deduction for 1959. The taxable income under 
section 63 for 1959 is $27,422, computed as follows:

Taxable income determined without any net operating loss         $50,000
 deduction..................................................
Less:
  Net operating loss deduction for 1959 (i.e., the aggregate      22,578
   carryovers determined under subparagraph (2)(vii) of this
   paragraph)...............................................
                                                             -----------
 Taxable income under section 63............................      27,422
 

    (5) Years to which losses may be carried. The taxable years to which 
the losses of X Corporation and Y Corporation may be carried, and the 
sequence in which carried, are as follows:

------------------------------------------------------------------------
             Loss year                           Carried to
------------------------------------------------------------------------
X 1954............................  X 1955, X 1956, X 8/31/57, Y 1957, Y
                                     1958.
X 1955............................  X 1954, X 1956, X 8/31/57, Y 1957, Y
                                     1958, Y 1959.
Y 1955............................  Y 1956, Y 1957, Y 1958, Y 1959, Y
                                     1960.
X 1956............................  X 1954, X 1955, X 8/31/57, Y 1957, Y
                                     1958, Y 1959, Y 1960.
Y 1956............................  Y 1955, Y 1957, Y 1958, Y 1959, Y
                                     1960, Y 1961.
Y 1958............................  Y 1955, Y 1956, Y 1957, Y 1959, Y
                                     1960, Y 1961, Y 1962, Y 1963.
------------------------------------------------------------------------


[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7564, 43 FR 
40493, Sept. 12, 1978]



Sec. 1.381(c)(1)-2  Net operating loss carryovers; two or more dates
of distribution or transfer in the taxable year.

    (a) In general. If the acquiring corporation succeeds to the net 
operating loss carryovers of two or more distributor or transferor 
corporations on two or more dates of distribution or transfer within one 
taxable year of the acquiring corporation, the limitation to be applied 
under section 381(c)(1)(B) to the aggregate of the net operating loss 
carryovers to that taxable year from all of the distributor or 
transferor corporations shall be determined by applying the rules 
prescribed in paragraph (b) of this section, and the taxable income of 
the acquiring corporation for that taxable year under sections 
381(c)(1)(C) and 172(b)(2) shall be determined by applying the rules 
prescribed in paragraph (c) of this section. For purposes of this 
section, the term postacquisition income means

[[Page 574]]

postacquisition part year taxable income determined under paragraph 
(d)(1) of Sec. 1.381(c)(1)-1 by treating the first date of distribution 
or transfer as though it were the only date of distribution or transfer 
during the taxable year of the acquiring corporation.
    (b) Determination of limitation under section 381(c)(1)(B)--(1) In 
general. If the acquiring corporation succeeds to the net operating loss 
carryovers of two or more distributor or transferor corporations on two 
or more dates of distribution or transfer during the same taxable year 
of the acquiring corporation, and if the amount of the net operating 
loss carryovers acquired on the first date of distribution or transfer 
equals or exceeds the postacquisition income, then the limitation under 
section 381(c)(1)(B) shall be an amount equal to such postacquisition 
income. If the amount of the net operating loss carryovers acquired on 
the first date of distribution or transfer is less than such 
postacquisition income, then the limitation under section 381(c)(1)(B) 
shall be determined as provided in subparagraphs (2) through (5) of this 
paragraph.
    (2) Allocation of postacquisition income among partial 
postacquisition years. That part of the taxable year of the acquiring 
corporation beginning on the day following the first date of 
distribution or transfer and ending with the close of the taxable year 
of the acquiring corporation shall be divided into the same number of 
partial postacquisition years as the number of dates of distribution or 
transfer on which the acquiring corporation succeeds to net operating 
loss carryovers during its taxable year. The first partial 
postacquisition year shall begin with the day following the first date 
of distribution or transfer and shall end with the close of the second 
date of distribution or transfer. The second and succeeding partial 
postacquisition years shall begin with the day following the close of 
the preceding such partial year and shall end with the close of the 
succeeding date of distribution or transfer, or, if there is no such 
succeeding date, then with the close of the taxable year of the 
acquiring corporation. The postacquisition income of the acquiring 
corporation shall be allocated among the partial postacquisition years 
in proportion to the number of days in each such partial year.
    (3) Two dates of distribution or transfer. If the acquiring 
corporation succeeds to the net operating loss carryovers of two 
distributor or transferor corporations on two dates of distribution or 
transfer during the same taxable year of the acquiring corporation, and 
if the amount of the net operating loss carryovers acquired on the first 
date equals or exceeds the income for the first partial postacquisition 
year, the limitation provided by section 381(c)(1)(B) shall be the 
amount of the postacquisition income. If the income for the first 
partial postacquisition year exceeds the net operating loss carryovers 
acquired on the first date of distribution or transfer, the limitation 
provided by section 381(c)(1)(B) shall be the amount of the 
postacquisition income reduced by the amount of such excess. The 
application of this subparagraph may be illustrated by the following 
example:

    Example. (i) X Corporation has taxable income (computed without any 
net operating loss deduction) of $36,500 for its calendar year 1955. 
During 1955, X Corporation acquires the assets of Y and Z Corporations 
in statutory mergers to each of which section 361 applies, the dates of 
transfer being January 1 and December 1, respectively. The net operating 
loss carryovers of each transferor corporation and the income for each 
partial postacquisition year are:

----------------------------------------------------------------------------------------------------------------
                                                                                    Income for
                              Corp.                                 Carryovers     partial years     Reduction
----------------------------------------------------------------------------------------------------------------
Y...............................................................          $1,000         $33,400         $32,400
                                                                                  ($36,500 x 334/
                                                                                            365)
Z...............................................................          50,000           3,000               0
                                                                                  ($36,500 x 30/
                                                                                            365)
                                                                 -----------------------------------------------
                                                                          51,000          36,400          32,400
----------------------------------------------------------------------------------------------------------------

    (ii) The limitation provided by section 381(c)(1)(B) equals the 
postacquisition income of $36,400 reduced by $32,400, the excess of the 
income for the first partial year ($33,400) over the net operating loss 
carryovers acquired on the first date of transfer ($1,000). Accordingly, 
the limitation is $4,000 ($36,400 minus $32,400). Therefore, although X 
Corporation acquired carryovers aggregating $51,000 during 1955, it can 
utilize only $4,000 of such carryovers in computing its net operating 
loss deduction for 1955.


[[Page 575]]


    (4) Three dates of distribution or transfer. If the acquiring 
corporation succeeds to the net operating loss carryovers of three 
distributor or transferor corporations on three dates of distribution or 
transfer during the same taxable year of the acquiring corporation, and 
if the amount of the net operating loss carryovers acquired on the first 
date equals or exceeds the income for the first and second partial 
postacquisition years, the limitation provided by section 381(c)(1)(B) 
shall be the amount of the postacquisition income. If the amount of the 
carryovers acquired on the first date equals or exceeds the income for 
the first partial postacquisition year but does not equal or exceed the 
income for the first and second partial postacquisition years, the 
limitation shall be the amount of the postacquisition income reduced by 
the excess of the income for the first and second partial 
postacquisition years over the amount of carryovers acquired on the 
first and second dates of distribution or transfer. If the income for 
the first partial postacquisition year exceeds the carryovers acquired 
on the first date, the limitation shall be the postacquisition income 
reduced by the sum of the amount of such excess plus the amount, if any, 
by which the income for the second partial postacquisition year exceeds 
the carryovers acquired on the second date. This subparagraph may be 
illustrated by the following examples:

    Example 1. (i) X Corporation has taxable income (computed without 
any net operating loss deduction) of $36,500 for its calendar year 1955. 
During 1955, X Corporation acquires the assets of M, N, and Z 
Corporations in statutory mergers to each of which section 361 applies, 
the dates of transfer being January 1, January 31, and December 1, 
respectively. The net operating loss carryovers of each transferor 
corporation and the income for each partial postacquisition year are:

----------------------------------------------------------------------------------------------------------------
                                                                                    Income for
                              Corp.                                 Carryovers     partial years     Reduction
----------------------------------------------------------------------------------------------------------------
M...............................................................          $4,000          $3,000         $23,400
                                                                                  ($36,500 x 30/
                                                                                            365)
N...............................................................           6,000          30,400
                                                                                  ($36,500 x 304/
                                                                                            365)
Z...............................................................          50,000           3,000               0
                                                                                  ($36,500 x 30/
                                                                                            365)
                                                                 -----------------------------------------------
                                                                          60,000          36,400          23,400
----------------------------------------------------------------------------------------------------------------

    (ii) Since the carryovers of $4,000 acquired on the first date of 
transfer exceed the income for the first partial year ($3,000), the 
limitation provided by section 381(c)(1)(B) is the amount of the 
postacquisition income ($36,400) reduced by the excess of the income for 
the first and second partial years ($33,400) over the carryovers 
acquired on the first and second dates of transfer ($10,000). Therefore, 
the limitation is $13,000 ($36,400 less $23,400).
    Example 2. (i) Assume the same facts as in Example (1) except that 
the amount of the net operating loss carryovers acquired from M 
Corporation is $1,000. The net operating loss carryovers of each 
transferor corporation and the income for each partial postacquisition 
year are:

----------------------------------------------------------------------------------------------------------------
                                                                                    Income for
                              Corp.                                 Carryovers     partial years     Reduction
----------------------------------------------------------------------------------------------------------------
M...............................................................          $1,000          $3,000          $2,000
                                                                                  ($36,500 x 30/
                                                                                            365)
N...............................................................           6,000          30,400          24,400
                                                                                  ($36,500 x 304/
                                                                                            365)
Z...............................................................          50,000           3,000               0
                                                                                  ($36,500 x 30/
                                                                                            365)
                                                                 -----------------------------------------------
                                                                          57,000          36,400          26,400
----------------------------------------------------------------------------------------------------------------

    (ii) Since the income for the first partial year ($3,000) exceeds 
the $1,000 of carryovers acquired on the first date by $2,000, the 
limitation provided by section 381(c)(1)(B) is the postacquisition 
income of $36,400 reduced by such excess and also reduced by the excess 
of the income for the second partial year ($30,400) over the carryovers 
acquired on the second date of transfer ($6,000). Therefore, the 
limitation is $10,000 ($36,400 less the sum of $2,000 and $24,400).
    Example 3. (i) Assume the same facts as in Example (2) except that 
the carryovers acquired from N Corporation are $75,000. The net 
operating loss carryovers of each transferor corporation and the income 
for each partial postacquisition year are:

----------------------------------------------------------------------------------------------------------------
                                                                                    Income for
                              Corp.                                 Carryovers     partial years     Reduction
----------------------------------------------------------------------------------------------------------------
M...............................................................          $1,000          $3,000          $2,000
                                                                                  ($36,500 x 30/
                                                                                            365)
N...............................................................          75,000          30,400               0
                                                                                  ($36,500 x 304/
                                                                                            365)

[[Page 576]]

 
Z...............................................................          50,000           3,000               0
                                                                                  ($36,500 x 30/
                                                                                            365)
                                                                 -----------------------------------------------
                                                                         126,000          36,400           2,000
----------------------------------------------------------------------------------------------------------------

    (ii) Since the income for the first partial year ($3,000) exceeds 
the $1,000 of carryovers acquired on the first date by $2,000, the 
limitation provided by section 381(c)(1)(B) is the postacquisition 
income of $36,400 reduced by $2,000, or $34,400. No further reduction is 
made since the income for the second partial year ($30,400) does not 
exceed the carryovers of $75,000 acquired on the second date of 
transfer.

    (5) Four or more dates of distribution or transfer. If the acquiring 
corporation succeeds to the net operating loss carryovers of four or 
more distributor or transferor corporations on four or more dates of 
distribution or transfer during the same taxable year of the acquiring 
corporation, the limitation provided by section 381(c)(1)(B) shall be 
determined consistently with the methods prescribed in subparagraphs (3) 
and (4) of this paragraph. The application of this subparagraph may be 
illustrated by the following example:

    Example. (i) X Corporation has taxable income (computed without any 
net operating loss deduction) of $36,500 for its calendar year 1955. 
During 1955, X Corporation acquired the assets of M, N, O, Y, and Z 
Corporations in statutory mergers to each of which section 361 applied, 
the dates of transfer being, respectively, January 1, January 31, March 
3, April 2, and December 1. The net operating loss carryovers of each 
transferor corporation and the income for each partial postacquisition 
year are:

----------------------------------------------------------------------------------------------------------------
                                                                                    Income for
                              Corp.                                 Carryovers     partial years     Reduction
----------------------------------------------------------------------------------------------------------------
M...............................................................          $1,000          $3,000          $2,000
                                                                                  ($36,500 x 30/
                                                                                            365)
N...............................................................           4,000           3,100
                                                                                  ($36,500 x 31/
                                                                                            365)
O...............................................................           1,000           3,000           1,100
                                                                                  ($36,500 x 30/
                                                                                            365)
Y...............................................................          10,000          24,300          14,300
                                                                                  ($36,500 x 243/
                                                                                            365)
Z...............................................................          20,000           3,000               0
                                                                                  ($36,500 x 30/
                                                                                            365)
                                                                 -----------------------------------------------
                                                                          36,000          36,400          17,400
----------------------------------------------------------------------------------------------------------------

    (ii) The limitation provided by section 381(c)(1)(B) equals the 
postacquisition income of $36,400 reduced by the sum of (a) the $2,000 
excess of the income for the first partial year ($3,000) over the 
carryovers acquired from M Corporation ($1,000), (b) the $1,100 excess 
of the income for the second and third partial years ($6,100) over the 
carryovers acquired from N and O Corporations ($5,000), and (c) the 
$14,300 excess of the income for the fourth partial year ($24,300) over 
the carryovers acquired from Y Corporation ($10,000). Accordingly, the 
limitation is $19,000 ($36,400 minus $17,400). Therefore, although X 
Corporation acquired carryovers aggregating $36,000 during 1955, it can 
utilize only $19,000 of such carryovers in computing its net operating 
loss deduction for 1955.

    (c) Determination of taxable income of acquiring corporation under 
section 381(c)(1)(C)--(1) In general. If the acquiring corporation 
succeeds to the net operating loss carryovers of two or more distributor 
or transferor corporations on two or more dates of distribution or 
transfer within one taxable year of the acquiring corporation, then 
pursuant to section 381(c)(1)(C) the taxable income of the acquiring 
corporation for its taxable year which is a prior taxable year for 
purposes of section 172(b)(2) and paragraph (e) of Sec. 1.381(c)(1)-1 
shall be determined as provided in this paragraph.
    (2) Division of taxable income. The taxable income of the acquiring 
corporation (computed with the modifications specified in section 
172(b)(2)(A) but without any net operating loss deduction) shall be 
allocated proportionately on a daily basis among a preacquisition part 
year (determined under paragraph (f)(3) of Sec. 1.381(c)(1)-1 by 
treating the first date of distribution or transfer as though it were 
the only date of distribution or transfer during the taxable year of the 
acquiring corporation) and two or more partial postacquisition years 
(determined as provided in paragraph (b)(2) of this section). The 
preacquisition part year and each partial postacquisition year shall be 
considered a separate taxable year, but only for the limited purpose of 
applying sections 172(b)(2) and 381(c)(1)(C).
    (3) Net operating loss deduction. The net operating loss deduction 
of the preacquisition part year and the partial postacquisition years 
shall be determined consistently with the manner

[[Page 577]]

described in paragraph (f)(6) of Sec. 1.381(c)(1)-1 but by taking into 
account, in the case of any partial postacquisition year, only the net 
operating loss carryovers and carrybacks of the acquiring corporation 
and those net operating loss carryovers from a distributor or transferor 
corporation which become available to the acquiring corporation as of 
the close of those dates of distribution or transfer which occur before 
the beginning of that specific partial postacquisition year. The 
sequence in which the net operating losses of the distributor or 
transferor and acquiring corporations shall be applied for this purpose 
shall be determined in the manner described in paragraph (e) of Sec. 
1.381(c)(1)-1. Subject to the preceding sentence, the net operating loss 
carryovers to any specific partial postacquisition year, whether from a 
distributor, transferor, or acquiring corporation, shall be taken into 
account in the order of the taxable years in which the net operating 
losses arose, beginning with the loss for the earliest taxable year.
    (4) Illustration. The application of this paragraph may be 
illustrated by the following example:

    Example. (i) Facts. X Corporation, which was organized on January 1, 
1957, sustained a net operating loss of $20,000 for its calendar year 
1957 and had taxable income (computed without any net operating loss 
deduction) of $36,500 for its calendar year 1958. During 1958, X 
Corporation acquired the assets of Y and Z Corporations in statutory 
mergers to each of which section 361 applied, the dates of transfer 
being June 30 and September 30, respectively. None of the modifications 
specified in section 172(b)(2)(A) apply to any of the corporations for 
any taxable year. The taxable income (computed without any net operating 
loss deduction) and net operating losses of Y and Z Corporations (which 
were organized on January 1, 1957, and January 1, 1954, respectively) 
are set forth below:

------------------------------------------------------------------------
                                    Acquiring    Transferor   Transferor
           Taxable year            corporation  corporation  corporation
                                        X            Y            Z
------------------------------------------------------------------------
1954.............................         xxx          xxx     ($30,000)
1955.............................         xxx          xxx         1,000
1956.............................         xxx          xxx         1,000
1957.............................   ($20,000)    ($25,000)         1,000
Ending 6-30-58...................         xxx        1,000           xxx
Ending 9-30-58...................         xxx          xxx         1,000
1958.............................      36,500          xxx           xxx
------------------------------------------------------------------------


The sequence in which the losses of the acquiring corporation and the 
transferor corporations are applied and the computation of the 
carryovers to X Corporation's calendar year 1959 are illustrated in the 
following subdivisions of this example.
    (ii) Computation of taxable income. X Corporation's taxable income, 
determined in the manner described in subparagraph (2) of this 
paragraph, for the preacquisition part year and for the partial 
postacquisition years is as follows:

------------------------------------------------------------------------
                                            Taxable
                  Year                      income        Computation
------------------------------------------------------------------------
Preacquisition part year................     $18,100   $36,500 x 181/365
Partial No. 1...........................       9,200     36,500 x 92/365
Partial No. 2...........................       9,200     36,500 x 92/365
------------------------------------------------------------------------

    (iii) Z Corporation's 1954 loss. The carryover to 1959 is $0, 
computed as follows:

------------------------------------------------------------------------
 
------------------------------------------------------------------------
Net operating loss.........................................      $30,000
Less:
  Z's 1955, 1956, 1957, and 9/30/58-3 year income..........        4,000
                                                            ------------
Net operating loss carryover to Partial No. 2 year.........       26,000
Less:
  Partial No. 2 year taxable income........................        9,200
                                                            ------------
                                                                  16,800
------------------------------------------------------------------------

The balance of $16,800 is not carried over to 1959 since X Corporation's 
taxable year 1958 is the last of the five years to which Z's 1954 loss 
may be carried under section 172(b)(1).

    (iv) Y Corporation's 1957 loss. The carryover to 1959 is $14,800, 
computed as follows:

Net operating loss...........................................    $25,000
Less:
  Y's 6/30/58-year income....................................      1,000
                                                   ------------
Net operating loss carryover to Partial No. 1 year...........     24,000
Less:
  Partial No. 1 year taxable income..........................      9,200
                                                   ------------
    Carryover to Partial No. 2 year..........................     14,800
Less:
  X's Partial No. 2 year taxable income...........     $9,200
  Minus X's net operating loss deduction for           26,000
   Partial No. 2 year (i.e., Z's 1954 carryover of
   $26,000 to such partial year)..................
                                                   -----------
                                                    .........          0
                                                              ----------
    Carryover to 1959........................................     14,800
 

    (v) X Corporation's 1957 loss. The carryover to 1959 is $1,900, 
computed as follows:

Net operating loss...........................................    $20,000
Less:
  X's preacquisition part year taxable income................     18,100
                                                   ------------
    Carryover to Partial No. 1 year..........................      1,900
Less:
  Partial No. 1 year taxable income...............     $9,200

[[Page 578]]

 
  Minus X's net operating loss deduction for           24,000
   Partial No. 1 year (i.e., Y's 1957 carryover of
   $24,000 to such partial year)..................
                                                   -----------
                                                    .........          0
                                                              ----------
    Carryover to Partial No. 2 year..........................      1,900
Less:
  Partial No. 2 year taxable income...............     $9,200
  Minus X's net operating loss deduction for           40,800
   Partial No. 2 year (i.e., Z's 1954 carryover of
   $26,000, and Y's 1957 carryover of $14,800, to
   such partial year..............................
                                                   -----------
                                                    .........          0
                                                              ----------
    Carryover to 1959........................................     $1,900
 

    (vi) Summary of carryovers to 1959. The aggregate of the net 
operating loss carryovers to 1959 is $16,700, computed as follows:

Z's 1954 loss...............................................         xxx
Y's 1957 loss...............................................     $14,800
X's 1957 loss...............................................      91,900
                                                             -----------
 Total......................................................      16,700
 



Sec. 1.381(c)(2)-1  Earnings and profits.

    (a) In general. (1) Section 381(c)(2) requires the acquiring 
corporation in a transaction to which section 381(a) applies to succeed 
to, and take into account, the earnings and profits, or deficit in 
earnings and profits, of the distributor or transferor corporation as of 
the close of the date of distribution or transfer. In determining the 
amount of such earnings and profits, or deficit, to be carried over, and 
the manner in which they are to be used by the acquiring corporation 
after such date, the provisions of section 381(c)(2) and this section 
shall apply. For purposes of section 381(c)(2) and this section, if the 
distributor or transferor corporation accumulates earnings and profits, 
or incurs a deficit in earnings and profits, after the date of 
distribution or transfer and before the completion of the reorganization 
or liquidation, such earnings and profits, or deficit, shall be deemed 
to have been accumulated or incurred as of the close of the date of 
distribution or transfer.
    (2) If the distributor or transferor corporation has accumulated 
earnings and profits as of the close of the date of distribution or 
transfer, such earnings and profits shall (except as hereinafter 
provided in this section) be deemed to be received by, and to become a 
part of the accumulated earnings and profits of, the acquiring 
corporation as of such time. Similarly, if the distributor or transferor 
corporation has a deficit in accumulated earnings and profits as of the 
close of the date of distribution or transfer, such deficit shall 
(except as hereinafter provided in this section) be deemed to be 
incurred by the acquiring corporation as of such time. In no event, 
however, shall the accumulated earnings and profits, or deficit, of the 
distribution or transferor corporation be taken into account in 
determining earnings and profits of the acquiring corporation for the 
taxable year during which occurs the date of distribution or transfer.
    (3) Any part of the accumulated earnings and profits, or deficit in 
accumulated earnings and profits, of the distributor or transferor 
corporation which consists of earnings and profits, or deficits, 
accumulated before March 1, 1913, shall be deemed to become earnings and 
profits, or deficits, of the acquiring corporation accumulated before 
March 1, 1913, and any part of the accumulated earnings and profits of 
the distributor or transferor corporation which consists of increase in 
value of property accrued before March 1, 1913, shall be deemed to 
become earnings and profits of the acquiring corporation consisting of 
increase in value of property accrued before March 1, 1913.
    (4) If the acquiring corporation and each distributor or transferor 
corporation has accumulated earnings and profits as of the close of the 
date of distribution or transfer, or if each of such corporations has a 
deficit in accumulated earnings and profits as of such time, then the 
accumulated earnings and profits (or deficit) of each such corporation 
shall be consolidated as of the close of the date of distribution or 
transfer in the accumulated earnings and profits account of the 
acquiring corporation. See subparagraph (6) of this paragraph for 
determination of the accumulated earnings and profits (or deficit) of 
the acquiring corporation as of the close of the date of distribution or 
transfer.
    (5) If (i) one or more corporations a party to a distribution or 
transfer has accumulated earnings and profits as of the close of the 
date of distribution or

[[Page 579]]

transfer, and (ii) one or more of such corporations has a deficit in 
accumulated earnings and profits as of such time, the total of any such 
deficits shall be used only to offset earnings and profits accumulated, 
or deemed to have been accumulated under subparagraph (6) of this 
paragraph, by the acquiring corporation after the date of distribution 
or transfer. In such instance, the acquiring corporation will be 
considered as maintaining two separate earnings and profits accounts 
after the date of distribution or transfer. The first such account shall 
contain the total of the accumulated earnings and profits as of the 
close of the date of distribution or transfer of each corporation which 
has accumulated earnings and profits as of such time, and the second 
such account shall contain the total of the deficits in accumulated 
earnings and profits of each corporation which has a deficit as of such 
time. The total deficit in the second account may not be used to reduce 
the accumulated earnings and profits in the first account (although such 
earnings and profits may be offset by deficits incurred, or deemed to 
have been incurred, after the date of distribution or transfer) but 
shall be used only to offset earnings and profits accumulated, or deemed 
to have been accumulated under subparagraph (6) of this paragraph, by 
the acquiring corporation after the date of distribution or transfer.
    (6) In any case in which it is necessary to compute the accumulated 
earnings and profits, or the deficit in accumulated earnings and 
profits, of the acquiring corporation as of the close of the date of 
distribution or transfer and such date is a day other than the last day 
of a taxable year of the acquiring corporation--
    (i) If the acquiring corporation has earnings and profits for its 
taxable year during which occurs the date of distribution or transfer, 
such earnings and profits (a) shall be deemed to have accumulated as of 
the close of such date in an amount which bears the same ratio to the 
undistributed earnings and profits of such corporation for such year as 
the number of days in the taxable year preceding the date following the 
date of distribution or transfer bears to the total number of days in 
the taxable year, and (b) shall be deemed to have accumulated after the 
date of distribution or transfer in an amount which bears the same ratio 
to the undistributed earnings and profits of such corporation for such 
year as the number of days in the taxable year following such date bears 
to the total number of days in such taxable year. For purposes of the 
preceding sentence, the undistributed earnings and profits of the 
acquiring corporation for such taxable year shall be the earnings and 
profits for such taxable year reduced by any distributions made 
therefrom during such taxable year.
    (ii) If the acquiring corporation has an operating deficit for its 
taxable year during which occurs the date of distribution or transfer, 
then, unless the actual accumulated earnings and profits, or deficit, as 
of such date can be shown, such operating deficit shall be deemed to 
have accumulated in a manner similar to that described in subdivision 
(i) of this subparagraph.
    (7) This paragraph may be illustrated by the following examples, in 
which it is assumed that none of the accumulated earnings and profits, 
or deficits, consist of earnings and profits or deficits accumulated, or 
increase in value of property accrued, before March 1, 1913.

    Example 1. (i) M and N Corporations make their returns on the basis 
of the calendar year. On June 30, 1959, M Corporation transfers all its 
assets to N Corporation in a statutory merger to which section 361 
applies. The books of the two corporations reveal the following 
information:

------------------------------------------------------------------------
                                                     M            N
                 Description                    Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
Accumulated earnings and profits at close of      $100,000      $150,000
 calendar year 1958..........................
Earnings and profits of taxable year ending         15,000   ...........
 June 30, 1959...............................
Earnings and profits of calendar year 1959...  ............       36,500
Distributions during calendar year 1959......            0             0
------------------------------------------------------------------------

    (ii) As of the close of June 30, 1959, N acquires from M accumulated 
earnings and profits of $115,000. Since M and N each has accumulated 
earnings and profits as of the close of the date of transfer, M's 
accumulated earnings and profits are added to N's accumulated earnings 
and profits as of such time. However, no part of M's accumulated

[[Page 580]]

earnings and profits is taken into account in determining N's earnings 
and profits for the calendar year 1959. Therefore, N's earnings and 
profits for the calendar year 1959 are $36,500.
    Example 2. (i) X and Y Corporations make their returns on the basis 
of the calendar year. On June 30, 1959, X Corporation transfers all its 
assets to Y Corporation in a statutory merger to which section 361 
applies. The books of the two corporations reveal the following 
information:

------------------------------------------------------------------------
                                                     X            Y
                 Description                    Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
Accumulated earnings and profits at close of       $20,000      $100,000
 calendar year 1958..........................
Deficit in earnings and profits for taxable         80,000   ...........
 year ending June 30, 1959...................
Earnings and profits of calendar year 1959...  ............       36,500
Distributions during calendar year 1959......            0             0
------------------------------------------------------------------------

    (ii) As of the close of June 30, 1959, Y acquires from X a deficit 
in accumulated earnings and profits in the amount of $60,000. This 
deficit may be used only to reduce those earnings and profits of Y which 
are accumulated, or deemed to have accumulated, after June 30, 1959. 
Accordingly, as of December 31, 1959, the accumulated earnings and 
profits of Y amount to $118,100; at such time Y also has a separate 
deficit in accumulated earnings and profits in the amount of $41,600. 
These amounts are determined as follows:

Accumulated earnings and profits of Y as of the close of        $100,000
 1958.......................................................
Add:
  Portion of undistributed earnings and profits of Y for          18,100
   1959 deemed to have accumulated as of close of June 30,
   1959 ($36,500 x 181/365).................................
                                                             -----------
    Accumulated earnings and profits of Y as of close of         118,100
     June 30, 1959, and also as of Dec. 31, 1959............
                                                             ===========
  Portion of undistributed earnings and profits of Y for          18,400
   1959 deemed to have accumulated after June 30, 1959
   ($36,500 x 184/365)......................................
Less:
  Deficit in accumulated earnings and profits acquired by Y       60,000
   from X Corporation as of close of June 30, 1959..........
                                                             -----------
    Separate deficit in accumulated earnings and profits of       41,600
     Y as of Dec. 31, 1959..................................
 

    Example 3. Assume the same facts as in Example (2), except that on 
September 15, 1959, Y Corporation makes a cash distribution of $96,500. 
The entire distribution is a dividend: $36,500 from earnings and profits 
for the taxable year 1959 and $60,000 from earnings and profits 
accumulated as of December 31, 1958. Accordingly, as of December 31, 
1959, Y has accumulated earnings and profits of $40,000, and also has a 
separate deficit in accumulated earnings and profits of $60,000. These 
amounts are determined as follows:

Earnings and profits of Y for calendar year 1959.............    $36,500
Accumulated earnings and profits of Y as of close of 1958....    100,000
                                                              ----------
 Total.......................................................    136,500
Less:
  Distributions during 1959..................................     96,500
                                                              ----------
    Accumulated earnings and profits of Y as of Dec. 31, 1959     40,000
                                                              ==========
Deficit in accumulated earnings and profits acquired from X      $60,000
 as of close of June 30, 1959................................
Less:
  Portion of Y's undistributed earnings and profits for 1959           0
   deemed to have accumulated after June 30, 1959............
                                                              ----------
    Separate deficit in accumulated earnings and profits of Y     60,000
     as of Dec. 31, 1959.....................................
 

    Example 4. (i) M and N Corporations make their returns on the basis 
of the calendar year. On June 30, 1959, M Corporation transfers all its 
assets to N Corporation in a statutory merger to which section 361 
applies. The books of the two corporations reveal the following 
information:

------------------------------------------------------------------------
                                                     M            N
                 Description                    Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
Accumulated earnings and profits at close of      $100,000       $50,000
 calendar year 1958..........................
Earnings and profits for taxable year ending        10,000
 June 30, 1959...............................
Deficit in earnings and profits for calendar   ............      146,000
 year 1959...................................
Distributions during calendar year 1959......            0             0
------------------------------------------------------------------------

    (ii) Assuming that N has not shown its actual accumulated earnings 
and profits, or deficit, as of the close of June 30, 1959, N has a 
deficit in accumulated earnings and profits at such time which amounts 
to $22,400, determined as follows:

------------------------------------------------------------------------
 
------------------------------------------------------------------------
Accumulated earnings and profits of N as of close of 1958....    $50,000
Less:
  Portion of deficit in earnings and profits of N for 1959        72,400
   deemed to have accumulated as of close of June 30, 1959
   ($146,000 x 181/365)......................................
                                                              ----------
    Deficit in accumulated earnings and profits of N as of        22,400
     close of June 30, 1959, and also as of Dec. 31, 1959....
------------------------------------------------------------------------


As of the close of June 30, 1959, N acquires from M accumulated earnings 
and profits in the amount of $110,000, no part of which may be offset by 
N's own deficit of $22,400; however, such earnings and profits may be 
offset by deficits incurred, or deemed incurred, by N after June 30, 
1959. Thus, as of December 31, 1959, N has the above-mentioned deficit 
of

[[Page 581]]

$22,400; at such time N also has accumulated earnings and profits in the 
amount of $36,400, determined as follows:

Accumulated earnings and profits acquired from M as of close    $110,000
 of June 30, 1959...........................................
Less:
  Portion of deficit in earnings and profits of N for 1959        73,600
   deemed to have accumulated after June 30, 1959 ($146,000
   x 184/365)...............................................
                                                             -----------
    Accumulated earnings and profits of N as of Dec. 31,          36,400
     1959...................................................
 

    Example 5. Assume the same facts as in Example (4), except that on 
September 9, 1959, N Corporation makes a cash distribution of $100,000. 
The amount of $82,000 is a dividend from accumulated earnings and 
profits, computed as follows:

Accumulated earnings and profits acquired from M as of close    $110,000
 of June 30, 1959...........................................
Less:
  Deficit in earnings and profits of N for 1959 deemed to         28,000
   have accumulated from June 30 through Sept. 8, 1959
   ($146,000 x 70/365)......................................
                                                             -----------
    Accumulated earnings and profits as of close of Sept. 8,      82,000
     1959...................................................
 


As of December 31, 1959, N Corporation has a deficit in accumulated 
earnings and profits of $68,000, computed as follows:

Deficit in accumulated earnings and profits of N as of close     $22,400
 of June 30, 1959............................................
Add:
  Portion of N's deficit in earnings and profits for 1959         45,600
   deemed to have accumulated after Sept. 8, 1959 ($146,000 x
   114/365)..................................................
                                                              ----------
    Deficit in accumulated earnings and profits of N as of        68,000
     Dec. 31, 1959...........................................
 

    Example 6. (i) X, Y, and Z Corporations make their returns on the 
basis of the calendar year. On June 30, 1959, X Corporation and Y 
Corporation transfer all their assets to Z Corporation in a statutory 
merger to which section 361 applies. The books of the three corporations 
reveal the following information:

----------------------------------------------------------------------------------------------------------------
                                                                               X             Y            Z
                              Description                                 Corporation   Corporation  Corporation
                                                                         (transferor)  (transferor)   (acquirer)
----------------------------------------------------------------------------------------------------------------
Accumulated earnings and profits (or deficit) at close of calendar year       $35,000     ($25,000)    ($20,000)
 1958..................................................................
Earnings and profits (or deficit) for taxable year ended June 30, 1959.         5,000       (5,000)
Earnings and profits for calendar year 1959............................  ............  ............       36,500
Distributions during 1959..............................................             0             0            0
----------------------------------------------------------------------------------------------------------------

    (ii) As of the close of June 30, 1959, Z acquires from Y a deficit 
in accumulated earnings and profits of $30,000. As of such time, Z's own 
deficit in accumulated earnings and profits amounts to $1,900, 
determined as follows:

Deficit in accumulated earnings and profits of Z as of close     $20,000
 of 1958....................................................
Less:
  Portion of undistributed earnings and profits of Z for          18,100
   1959 deemed to have accumulated as of close of June 30,
   1959 ($36,500 x 181/365).................................
                                                             -----------
    Deficit in accumulated earnings and profits as of close        1,900
     of June 30, 1959.......................................
 


The total deficit of $31,900 may be used only to offset earnings and 
profits of Z accumulated, or deemed to have accumulated, after June 30, 
1959; such deficit may not be used to reduce the accumulated earnings 
and profits of $40,000 acquired from X as of the close of June 30, 1959. 
Thus, as of December 31, 1959, the accumulated earnings and profits of Z 
amount to $40,000; at such time Z Corporation also has a separate 
deficit in accumulated earnings and profits in the amount of $13,500, 
determined as follows:

Deficit in accumulated earnings and profits as of close of       $31,900
 June 30, 1959..............................................
Less:
  Portion of undistributed earnings and profits of Z for          18,400
   1959 deemed to have accumulated after June 30, 1959
   ($36,500 x 184/365)......................................
                                                             -----------
    Separate deficit in accumulated earnings and profits as       13,500
     of Dec. 31, 1959.......................................
 

    Example 7. X and Y Corporations make their returns on the basis of 
the calendar year. On December 31, 1954, X transfers all its assets to Y 
in a statutory merger to which section 361 applies. The books of the two 
corporations reveal the following information:

------------------------------------------------------------------------
                                                     X            Y
                 Description                    Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
Accumulated earnings and profits (or deficit)    ($50,000)      $210,000
 at close of calendar year 1954..............
Earnings and profits (or deficit) for
 calendar year:
  1955.......................................  ............        5,000
  1956.......................................  ............     (20,000)
  1957.......................................  ............       70,000
  1958.......................................  ............       60,000
  1959.......................................  ............       55,000
Cash distributions on:
  Sept. 1, 1957..............................  ............       80,000
  Sept. 1, 1958..............................  ............       40,000
  Sept. 1, 1959..............................  ............       30,000
------------------------------------------------------------------------


[[Page 582]]

    The balances in the accumulated earnings and profits account and the 
separate deficit account of Y Corporation at the close of the taxable 
year involved are as follows:

------------------------------------------------------------------------
                                                             Accumulated
                                                  Deficit      earnings
                     Year                         acquired   and profits
                                                   from X        of Y
                                                Corporation  Corporation
------------------------------------------------------------------------
1954..........................................      $50,000     $210,000
1955..........................................       45,000      210,000
1956..........................................       45,000      190,000
1957..........................................       45,000      180,000
1958..........................................       25,000      180,000
1959..........................................         None      180,000
------------------------------------------------------------------------

    (b) Successive acquisitions. (1) If, as of the date of distribution 
or transfer, either the acquiring corporation, or the distributor or 
transferor corporation, or both, is considered under paragraph (a) of 
this section to be maintaining separate earnings and profits accounts as 
the result of a prior transaction or transactions to which section 
381(a) applied, the accumulated earnings and profits, or deficit in 
accumulated earnings and profits, of each such corporation shall be 
combined with the appropriate earnings and profits account of the other 
such corporation. For example, if, as of the date of transfer, the 
acquiring corporation and the transferor corporation are each 
maintaining separate accounts, one containing accumulated earnings and 
profits and the other containing a deficit in accumulated earnings and 
profits, the amounts in the two accumulated earnings and profits 
accounts shall be combined into one account, and the amounts in the two 
deficit accounts shall be combined into a second account, and the amount 
in one combined account may not be used to offset the amount in the 
other combined account.
    (2) This paragraph may be illustrated by the following examples, in 
which it is assumed that none of the accumulated earnings and profits, 
or deficits, consist of earnings and profits or deficits accumulated, or 
increase in value of property accrued, before March 1, 1913.

    Example 1. (i) X, Y, and Z Corporations make their returns on the 
basis of the calendar year. On June 30, 1958, X Corporation transfers 
all its assets to Z Corporation in a statutory merger to which section 
361 applies, and on August 31, 1958, Y Corporation transfers all its 
assets to Z Corporation in another statutory merger to which section 361 
applies. The books of the three corporations reveal the following 
information:

----------------------------------------------------------------------------------------------------------------
                                                                               X             Y            Z
                              Description                                 Corporation   Corporation  Corporation
                                                                         (transferor)  (transferor)   (acquirer)
----------------------------------------------------------------------------------------------------------------
Accumulated earnings and profits (deficit) at close of calendar year         ($40,000       $10,000      $60,000
 1957..................................................................
Deficit in earnings and profits for taxable year ending June 30, 1958..       (5,000)  ............  ...........
Earnings and profits for taxable year ending Aug. 31, 1958.............  ............         2,000  ...........
Earnings and profits of calendar year 1958.............................  ............  ............       36,500
Distributions during calendar year 1958................................             0             0            0
----------------------------------------------------------------------------------------------------------------

    (ii) As of the close of June 30, 1958, Z acquires from X a deficit 
in accumulated earnings and profits in the amount of $45,000, which 
deficit may be used only to reduce those earnings and profits of Z which 
are accumulated, or deemed to have been accumulated, after June 30, 
1958. As of the close of August 31, 1958, Z acquires from Y earnings and 
profits of $12,000, no portion of which may be reduced by the deficit 
acquired by Z from X. Accordingly, as of December 31, 1958, Z has 
accumulated earnings and profits of $90,100, and also has a separate 
deficit in accumulated earnings and profits of $26,600. These amounts 
are determined as follows:

Accumulated earnings and profits of Z as of Dec. 31, 1957...     $60,000
Add:
  Portion of undistributed earnings and profits of Z for          18,100
   1958 deemed to have accumulated as of close of June 30,
   1958 ($36,500 x 181/365).................................
                                                             -----------
Accumulated earnings and profits of Z as of June 30, 1958...      78,100
Add:
  Accumulated earnings and profits acquired by Z from Y as        12,000
   of close of Aug. 31, 1958................................
                                                             -----------
Accumulated earnings and profits of Z as of close of Aug.         90,100
 31, 1958, and also as of Dec. 31, 1958.....................
                                                             ===========
Deficit in accumulated earnings and profits acquired by Z         45,000
 from X as of close of June 30, 1958........................

[[Page 583]]

 
Less:
  Portion of undistributed earnings and profits of Z for           6,200
   1958 deemed to have accumulated from June 30 through Aug.
   31, 1958 ($36,500 x 62/365)..............................
                                                             -----------
    Separate deficit in accumulated earnings and profits of       38,800
     Z as of Aug. 31, 1958..................................
Less:
  Portion of undistributed earnings and profits of Z for          12,200
   1958 deemed to have accumulated after Aug. 31, 1958
   ($36,500 x 122/365)......................................
                                                             -----------
    Separate deficit in accumulated earnings and profits of       26,600
     Z as of Dec. 31, 1958..................................
 

    Example 2. (i) Assume the same facts as in Example (1), plus the 
additional fact that on June 30, 1959, Z Corporation transfers all its 
assets to M Corporation (which makes its return on the basis of the 
calendar year) in a statutory merger to which section 361 applies, and 
that as of such time M Corporation is considered to be maintaining 
separate earnings and profits accounts as the result of a previous 
transaction to which section 381(a) applied. The books of the two 
corporations reveal the following information:

------------------------------------------------------------------------
                                                     Z            M
                 Description                    Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
Accumulated earnings and profits as of Dec.        $90,100       $50,000
 31, 1958....................................
Separate deficit in accumulated earnings and        26,600        30,000
 profits as of Dec. 31, 1958.................
Earnings and profits for taxable year ending         5,000   ...........
 June 30, 1959...............................
Earnings and profits of calendar year 1959...  ............       36,500
Distributions during 1959....................            0             0
------------------------------------------------------------------------

    (ii) As of June 30, 1959, M acquires from Z accumulated earnings and 
profits of $90,100, which amount is combined with M's own accumulated 
earnings and profits of $50,000; M also acquires from Z a deficit in 
accumulated earnings and profits of $21,600 ($26,600 minus $5,000), 
which amount is combined with M's own deficit of $11,900. The total 
deficit of $33,500 may be used only to reduce earnings and profits of M 
which are accumulated, or deemed to have accumulated, after June 30, 
1959. Accordingly, as of December 31, 1959, M has accumulated earnings 
and profits of $140,100, and also has a separate deficit in accumulated 
earnings and profits in the amount of $15,100. These amounts are 
determined as follows:

Deficit of M as of Dec. 31, 1958............................     $30,000
Less:
  Portion of M's undistributed earnings and profits for 1959      18,100
   deemed to have accumulated as of close of June 30, 1959
   ($36,500 x 181/365)......................................
                                                             -----------
    Deficit of M as of June 30, 1959........................      11,900
Plus:
  Deficit of Z as of June 30, 1959..........................      21,600
                                                             -----------
    Combined deficit of M as of close of June 30, 1959......      33,500
Less:
  Portion of M's undistributed earnings and profits for 1959      18,400
   deemed to have accumulated after June 30, 1959 ($36,500 x
   184/365).................................................
                                                             -----------
    Separate deficit of M as of Dec. 31, 1959...............      15,100
                                                             ===========
Accumulated earnings and profits of M as of Dec. 31, 1958,        50,000
 and also as of June 30, 1959...............................
Accumulated earnings and profits of Z as of Dec. 31, 1958,        90,100
 and also as of June 30, 1959...............................
                                                             -----------
    Combined accumulated earnings and profits of M as of         140,100
     close of June 30, 1959, and also as of Dec. 31, 1959...
 


    (c) Distribution of earnings and profits pursuant to reorganization 
or liquidation. (1) If, in a reorganization to which section 381(a)(2) 
applies, the transferor corporation pursuant to the plan of 
reorganization distributes to its stockholders property consisting not 
only of property permitted by section 354 to be received without 
recognition of gain, but also of other property or money, then the 
accumulated earnings and profits of the transferor corporation as of the 
close of the date of transfer shall be computed by taking into account 
the amount of earnings and profits properly applicable to the 
distribution, regardless of whether such distribution occurs before or 
after the close of the date of transfer.
    (2) If, in a distribution to which section 381(a)(1) (relating to 
certain liquidations of subsidiaries) applies, the acquiring corporation 
receives less than 100 percent of the assets distributed by the 
distributor corporation, then the accumulated earnings and profits of 
the distributor corporation as of the close of the date of distribution 
shall be computed by taking into account the amount of earnings and 
profits properly applicable to the distributions to minority 
stockholders, regardless of whether such distributions occur before or 
after the close of the date of distribution.

[T.D. 6586, 26 FR 12550, Dec. 28, 1961, as amended by T.D. 6692, 28 FR 
12817, Dec. 3, 1963; T.D. 9700, 79 FR 66617, Nov. 10, 2014]

[[Page 584]]



Sec. 1.381(c)(3)-1  Capital loss carryovers.

    (a) Carryover requirement. (1) Section 381(c)(3) requires the 
acquiring corporation in a transaction to which section 381(a) applies 
to succeed to, and take into account, the capital loss carryovers of the 
distributor or transferor corporation. To determine the amount of these 
carryovers as of the close of the date of distribution or transfer, and 
to integrate them with the capital loss carryovers of the acquiring 
corporation for purposes of determining the taxable income of the 
acquiring corporation for taxable years ending after the date of 
distribution or transfer, it is necessary to apply the provisions of 
section 1212 in accordance with the conditions and limitations of 
section 381(c)(3) and this section.
    (2) The capital loss carryovers of the acquiring corporation as of 
the close of the date of distribution or transfer shall be determined 
without reference to any capital gains or capital losses of the 
distributor or transferor corporation. The capital loss carryovers of a 
distributor or transferor corporation as of the close of the date of 
distribution or transfer shall be determined without reference to any 
capital gains or capital losses of the acquiring corporation.
    (3) This section contains rules applicable to capital loss 
carryovers determined without reference to the amendment of section 
1212(a) made by section 7 of the Act of September 2, 1964 (Public Law 
88-571, 78 Stat. 860) in respect of foreign expropriation capital 
losses. If the distributor, transferor, or acquiring corporation 
sustains a net capital loss in a taxable year ending after December 31, 
1958, any portion of which is attributable to a foreign expropriation 
capital loss, such portion shall be carried over to each of the ten 
succeeding taxable years consistently with the rules prescribed in this 
section and paragraph (a)(2) of Sec. 1.1212-1.
    (b) First taxable year to which carryovers apply. (1) The capital 
loss carryovers available to the distributor or transferor corporation 
as of the close of the date of distribution or transfer shall first be 
carried to the first taxable year of the acquiring corporation ending 
after that date. This rule applies irrespective of whether the date of 
distribution or transfer is on the last day, or any other day, of the 
acquiring corporation's taxable year.
    (2) The capital loss carryovers available to the distributor or 
transferor corporation as of the close of the date of distribution or 
transfer shall be carried to the acquiring corporation without 
diminution by reason of the fact that the acquiring corporation does not 
acquire 100 percent of the assets of the distributor or transferor 
corporation.
    (c) Limitation on capital loss carryovers for first taxable year 
ending after date of distribution or transfer. (1) Any capital loss 
carryover of a distributor or transferor corporation which is available 
to the acquiring corporation as of the close of the date of distribution 
or transfer shall be a short-term capital loss of the acquiring 
corporation in each of the taxable years to which the net capital loss 
giving rise to such carryover may be carried to the extent provided in 
section 1212 and this section. However, in the first taxable year of the 
acquiring corporation ending after the date of distribution or transfer, 
the total capital loss carryovers of the distributor or transferor 
corporation which may be treated in that year as short-term capital 
losses of the acquiring corporation is limited by section 381(c)(3)(B) 
to an amount which bears the same ratio to the acquiring corporation's 
capital gain net income (net capital gain for taxable years beginning 
before January 1, 1977) for such first taxable year (determined without 
regard to any capital loss carryovers) as the number of days in such 
first taxable year which follow the date of distribution or transfer 
bears to the total number of days in such taxable year. Thus, if the 
date of distribution or transfer is the last day of the acquiring 
corporation's taxable year, there is no limitation under section 
381(c)(3)(B) on the amount of such carryovers which may be treated as 
short-term capital losses of the acquiring corporation for its first 
taxable year ending after that date.
    (2) The limitation provided by section 381(c)(3)(B) shall be applied 
to the aggregate of the capital loss carryovers of the distributor or 
transferor corporation without reference to the taxable years in which 
the net capital losses giving rise to the carryovers

[[Page 585]]

were sustained. If the acquiring corporation has acquired the assets of 
two or more distributor or transferor corporations on the same date of 
distribution or transfer, then the limitation provided by section 
381(c)(3)(B) shall be applied to the aggregate of the capital loss 
carryovers from all of such distributor or transferor corporations.
    (3) If the acquiring corporation succeeds to the capital loss 
carryovers of two or more distributor or transferor corporations on two 
or more dates of distribution or transfer during the same taxable year 
of the acquiring corporation, the limitation to be applied under section 
381(c)(3)(B) to the aggregate of such carryovers shall be determined 
consistently with the rules prescribed in paragraph (b) of Sec. 
1.381(c)(1)-2.
    (4) The application of this paragraph may be illustrated by the 
following example:

    Example. (i) X and Y Corporations are organized on January 1, 1954, 
and make their returns on the basis of the calendar year. On July 4, 
1957, X Corporation transfers all its assets to Y Corporation in a 
statutory merger to which section 361 applies. The net capital losses 
and the net capital gains (capital gain net income for taxable years 
beginning after Dec. 31, 1976), (computed without regard to any capital 
loss carryovers) of the two corporations are as follows:

------------------------------------------------------------------------
                                                     X            Y
                 Taxable year                   Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1954.........................................     ($5,000)             0
1955.........................................     (10,000)        $5,000
1956.........................................     (25,000)       (7,000)
Ending 7-4-57................................      (8,000)   ...........
1957.........................................  ............       36,500
------------------------------------------------------------------------

    (ii) The capital loss carryovers of X Corporation which are 
available to Y Corporation as of the close of July 4, 1957, amount to 
$48,000 in the aggregate; but only $18,000 ($36,500 x 180/365) of such 
amount may be treated as short-term capital losses of Y Corporation for 
1957.

    (d) Computation of carryovers; general rule--(1) Sequence for 
applying losses and determination of capital gain net income. Section 
1212 provides that a net capital loss sustained in any taxable year 
(hereinafter referred to as the ``loss year'') shall be carried over to 
each of the five succeeding taxable years and treated in each of such 
succeeding years as a short-term capital loss to the extent not allowed 
as a deduction against any capital gain net income (net capital gain for 
taxable years beginning before January 1, 1977) of any taxable years 
intervening between the loss year and the taxable year to which such 
loss is carried. For this purpose, the capital gain net income (net 
capital gain for taxable years beginning before January 1, 1977) of any 
intervening taxable year is determined without regard to the net capital 
loss for the loss year or for any taxable year thereafter, and the 
various capital loss carryovers from taxable years preceding the loss 
year to any such intervening taxable year are considered to be applied 
in reduction of the capital gain net income (net capital gain for 
taxable years beginning before January 1, 1977) for such year in the 
order of the taxable years in which the losses were sustained, beginning 
with the loss for the earliest preceding taxable year. The application 
of these rules to the capital gain net income (net capital gain for 
taxable years beginning before January 1, 1977) of the acquiring 
corporation for any taxable year ending after the date of distribution 
or transfer involves the use of carryovers of the distributor or 
transferor corporation and of the acquiring corporation. In determining 
the order in which the capital loss carryovers of the distributor or 
transferor and acquiring corporations from taxable years ending on or 
before the date of distribution or transfer are considered to be applied 
in reduction of the capital gain net income (net capital gain for 
taxable years beginning before January 1, 1977) of the acquiring 
corporation for any intervening taxable year ending after such date, the 
following rules shall apply:
    (i) Each taxable year of the distributor or transferor and acquiring 
corporations which, with respect to the first taxable year of the 
acquiring corporation ending after the date of distribution or transfer, 
constitutes a first preceding taxable year, shall be treated as if each 
such year ended on the same day, whether or not such taxable years 
actually end on the same day. In like manner, each taxable year of the 
distributor or transferor and acquiring corporations which, with respect 
to such first taxable year of the

[[Page 586]]

acquiring corporation ending after the date of distribution or transfer, 
constitutes a second preceding taxable year, shall be treated as if each 
such year ended on the same day (whether or not such taxable years 
actually end on the same day), and a similar rule shall be applied with 
respect to those taxable years of the distributor or transferor and 
acquiring corporations which constitute third, fourth, and fifth 
preceding taxable years;
    (ii) If in the same preceding taxable year both the distributor or 
transferor and acquiring corporations incurred a net capital loss which 
is a carryover to an intervening taxable year of the acquiring 
corporation ending after the date of distribution or transfer, then in 
applying such losses in reduction of the capital gain net income (net 
capital gain for taxable years beginning before January 1, 1977) for 
such an intervening year, either such loss may be taken into account 
before the other; and
    (iii) The rules of subdivisions (i) and (ii) of this subparagraph 
shall apply regardless of the number of distributor or transferor 
corporations the assets of which are acquired by the acquiring 
corporation on the same date of distribution or transfer.
    (2) Cross reference. If the date of distribution or transfer is a 
day other than the last day of a taxable year of the acquiring 
corporation, then in determining the capital gain net income (net 
capital gain for taxable years beginning before January 1, 1977) of the 
acquiring corporation for its first taxable year ending after the date 
of distribution or transfer, section 1212 and this paragraph shall be 
applied in the special manner set forth in paragraph (e) of this 
section.
    (3) Years to which losses may be carried. The taxable years to which 
a net capital loss shall be carried are prescribed by section 1212. 
Since the taxable year of a distributor or transferor corporation ends 
with the close of the date of distribution or transfer, such taxable 
year and the first taxable year of the acquiring corporation which ends 
after that date are considered two separate taxable years to which a net 
capital loss of the distributor or transferor corporation for any 
taxable year ending before that date shall be carried. This rule applies 
even though the taxable year of the distributor or transferor 
corporation which ends on the date of distribution or transfer is a 
period of less than twelve months. However, the distribution or transfer 
has no effect in determining under section 1212 the taxable years to 
which a net capital loss of the acquiring corporation is carried. For 
this purpose, the first taxable year of the acquiring corporation which 
ends after the date of distribution or transfer constitutes only one 
taxable year even though such taxable year is considered under paragraph 
(e) of this section as two taxable years for certain purposes. The 
application of this subparagraph may be illustrated by the following 
example:

    Example. R and S Corporations are organized on January 1, 1954, and 
both corporations make their returns on the basis of the calendar year. 
R Corporation has net capital losses for its years 1954, 1955, and 1957, 
and S Corporation has net capital losses for its years 1954 and 1956. On 
June 30, 1958, R Corporation transfers all its assets to S Corporation 
in a statutory merger to which section 361 applies. The taxable years to 
which these losses of R and S Corporations may be carried are as 
follows:

------------------------------------------------------------------------
             Loss year                           Carried to
------------------------------------------------------------------------
R1954.............................  R1955, R1956, R1957, R6/30/58,
                                     S1958.
S1954.............................  S1955, S1956, S1957, S1958, S1959.
R1955.............................  R1956, R1957, R6/30/58, S1958,
                                     S1959.
S1956.............................  S1957, S1958, S1959, S1960, S1961.
R1957.............................  R6/30/58, S1958, S1959, S1960,
                                     S1961.
------------------------------------------------------------------------

    (4) Computation of carryovers in case where date of distribution or 
transfer occurs on last day of acquiring corporation's taxable year. The 
computation of the capital loss carryovers from the distributor or 
transferor corporation and from the acquiring corporation in a case 
where the date of distribution or transfer occurs on the last day of a 
taxable year of the acquiring corporation may be illustrated by the 
following example:

    Example. X and Y Corporations are organized on January 1, 1955, and 
make their returns on the basis of the calendar year. On December 31, 
1956, X Corporation transfers all its assets to Y Corporation in a 
statutory merger to which section 361 applies. The net capital losses 
and the net capital gains (capital gain net income for taxable years 
beginning after December 31, 1976), (computed without regard to any 
capital loss

[[Page 587]]

carryovers) of the two corporations are as follows:

------------------------------------------------------------------------
                                                     X            Y
                 Taxable year                   Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1955.........................................    ($20,000)      ($2,000)
1956.........................................     (10,000)       (8,000)
1957.........................................  ............       25,000
1958.........................................  ............       10,000
------------------------------------------------------------------------


The sequence in which the net capital losses of X and Y Corporations are 
applied, and the computation of the capital loss carryovers to Y 
Corporation's taxable year 1959, may be illustrated as follows. (For 
purposes of this example, the carryover from a preceding taxable year of 
the transferor corporation will be applied before the carryover from the 
same preceding taxable year of the acquiring corporation):
    (i) X Corporation's 1955 loss. The carryover to 1959 is $0, computed 
as follows:

Net capital loss............................................     $20,000
Less: Y's 1957 net capital gain (computed without regard to       25,000
 any capital loss carryovers)...............................
                                                             -----------
  Carryover to Y 1958 and Y 1959............................           0
 

    (ii) Y Corporation's 1955 loss. The carryover to 1959 is $0, 
computed as follows:

Net capital loss.............................................     $2,000
Less:
  Y's 1957 net capital gain (computed without         $25,000
   regard to any capital loss carryovers)........
  Minus capital loss carryovers to Y 1957 (i.e.,       20,000
   carryover of $20,000 from X 1955).............
                                                  ------------
                                                   ..........      5,000
                                                              ----------
    Carryover to Y 1958 and Y 1959...........................          0
 

    (iii) X Corporation's 1956 loss. The carryover to 1959 is $0, 
computed as follows:

Net capital loss............................................     $10,000
Less:
  Y's 1957 net capital gain (computed without        $25,000
   regard to any capital loss carryovers).......
  Minus capital loss carryovers to Y 1957 (i.e.,      22,000
   carryovers of $20,000 from X 1955 and $2,000
   from Y 1955).................................
                                                 ------------
                                                  ..........       3,000
                                                             -----------
    Carryover to Y 1958.....................................       7,000
Less:
  Y's 1958 net capital gain (computed without        $10,000
   regard to any capital loss carryovers).......
  Minus capital loss carryovers to Y 1958.......           0
                                                 ------------
                                                  ..........      10,000
                                                             -----------
    Carryover to Y 1959.....................................           0
 

    (iv) Y Corporation's 1956 loss. The carryover to 1959 is $5,000, 
computed as follows:

Net capital loss.............................................     $8,000
Less:
  Y's 1957 net capital gain (computed without         $25,000
   regard to any capital loss carryovers)........
  Minus capital loss carryovers to Y 1957 (i.e.,       32,000
   carryovers of $20,000 from X 1955, $2,000 from
   Y 1955, and $10,000 from X 1956)..............
                                                  ------------
                                                   ..........          0
                                                              ----------
    Carryover to Y 1958......................................      8,000
Less:
  Y's 1958 net capital gain (computed without         $10,000
   regard to any capital loss carryovers)........
  Minus capital loss carryovers to Y 1958 (i.e.,        7,000
   carryover of $7,000 from X 1956)..............
                                                  ------------
                                                   ..........      3,000
                                                              ----------
    Carryover to Y 1959......................................      5,000
 

    (e) Computation of carryovers when date of distribution or transfer 
is not on last day of acquiring corporation's taxable year--(1) General 
rule. If, in determining under paragraph (d) of this section the portion 
of a net capital loss for any taxable year which is carried over to a 
succeeding taxable year, an intervening taxable year is a taxable year 
of the acquiring corporation which includes, but does not end on, the 
date of distribution or transfer, the capital gain net income (net 
capital gain for taxable years beginning before January 1, 1977) of such 
intervening year shall be determined by applying section 1212 in the 
special manner provided by this paragraph.
    (2) Taxable year considered as two taxable years. Such intervening 
taxable year of the acquiring corporation shall be considered as though 
it were two taxable years, but only for the limited purpose of computing 
capital loss carryovers to subsequent taxable years. The first of such 
two taxable years shall be referred to in this paragraph as the 
preacquisition part year; the second, as the postacquisition part year. 
Though considered as two separate taxable years for purposes of this 
paragraph, the preacquisition part year and the postacquisition part 
year are treated as one taxable year in determining the years to which a 
net capital loss is carried under section 1212. See paragraph (d)(3) of 
this section.
    (3) Preacquisition part year. The preacquisition part year shall 
begin with the beginning of such taxable year

[[Page 588]]

of the acquiring corporation and shall end with the close of the date of 
distribution or transfer.
    (4) Postacquisition part year. The postacquisition part year shall 
begin with the day following the date of distribution or transfer and 
shall end with the close of such taxable year of the acquiring 
corporation.
    (5) Division of capital gain net income. The capital gain net income 
(net capital gain for taxable years beginning before January 1, 1977) 
for such intervening taxable year (computed without regard to any 
capital loss carryovers) of the acquiring corporation shall be divided 
between the preacquisition part year and the postacquisition part year 
in proportion to the number of days in each. Thus, if in a statutory 
merger to which section 361 applies Y Corporation acquires the assets of 
X Corporation on June 30, 1956, and Y Corporation has net capital gain 
(computed in the manner so prescribed) of $36,600 for its calendar year 
1956, then the preacquisition part year capital gain net income (net 
capital gain for taxable years beginning before January 1, 1977) would 
be $18,200 ($36,600 x 182/366) and the postacquisition part year capital 
gain net income (net capital gain for taxable years beginning before 
January 1, 1977) would be $18,400 ($36,600 x 184/366).
    (6) Application of capital loss carryovers. After obtaining the 
capital gain net income (net capital gain for taxable years beginning 
before January 1, 1977) of the preacquisition part year and 
postacquisition part year in the manner described in subparagraph (5) of 
this paragraph, it is necessary to determine the capital loss carryovers 
which are taken into account with respect to each such part year. The 
carryovers to be taken into account and the sequence in which such 
carryovers are applied, shall be determined in accordance with paragraph 
(d)(1) of this section but subject to the provisions of this 
subparagraph. With respect to the preacquisition part year, no capital 
loss carryovers of the distributor or transferor corporation shall be 
taken into account; that is, only capital loss carryovers of the 
acquiring corporation shall be taken into account. With respect to the 
postacquisition part year, capital loss carryovers of both the 
distributor or transferor corporation and the acquiring corporation 
shall be taken into account.
    (7) Cross reference. If an intervening taxable year is a taxable 
year of the acquiring corporation during which the acquiring corporation 
succeeds to the capital loss carryovers of two or more distributor or 
transferor corporations on two or more dates of distribution or 
transfer, the capital gain net income (net capital gain for taxable 
years beginning before January 1, 1977) of the acquiring corporation for 
such intervening taxable year shall be determined consistently with the 
rules prescribed in paragraph (c) of Sec. 1.381(c)(1)-2, except that 
the sequence in which the capital loss carryovers of the distributor or 
transferor and acquiring corporations shall be applied shall be 
determined under paragraph (d)(1) of this section.
    (8) Illustration. The application of this paragraph may be 
illustrated as follows:

    Example. X Corporation is organized on April 1, 1959, and makes its 
return on the basis of the fiscal year ending March 31. Y Corporation is 
organized on January 1, 1959, and makes its return on the basis of the 
calendar year. On June 30, 1961, X Corporation transfers all its assets 
to Y Corporation in a statutory merger to which section 361 applies. The 
net capital losses and the net capital gains (capital gain net income 
for taxable years beginning after December 31, 1976) (computed without 
regard to any capital loss carryovers) of the two corporations are as 
follows:

------------------------------------------------------------------------
                                                     X            Y
                 Taxable year                   Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1959.........................................  ............    ($24,000)
Ending 3-31-60...............................    ($19,000)
1960.........................................  ............      (6,000)
Ending 3-31-61...............................      (5,000)
Ending 6-30-61...............................            0
1961.........................................  ............       36,500
1962.........................................  ............       12,000
------------------------------------------------------------------------


The following table shows those taxable years of the transferor and 
acquiring corporations which, with respect to Y Corporation's calendar 
year 1961, are first, second, and third preceding taxable years:

[[Page 589]]


------------------------------------------------------------------------
                                                                  Y
            Taxable year                  X Corporation      Corporation
                                          (transferor)        (acquirer)
------------------------------------------------------------------------
First preceding year...............  Ending June 30, 1961..        1960
Second preceding year..............  Ending March 31, 1961.        1959
Third preceding year...............  Ending March 31, 1960.
------------------------------------------------------------------------

The sequence in which the net capital losses of X and Y Corporations are 
applied, and the computation of the capital loss carryovers to Y 
Corporation's calendar year 1963, may be illustrated as follows. (For 
purposes of this example, the carryover from a preceding taxable year of 
the acquiring corporation will be applied before the carryover from the 
same preceding taxable year of the transferor corporation):
    (i) X Corporation's 3/31/60 loss. The carryover to 1963 is $0, 
computed as follows:

Net capital loss............................................     $19,000
Less: Y's postacquisition part year net capital gain              18,400
 computed under subparagraph (5) of this paragraph ($36,500
 x 184/365).................................................
                                                             -----------
  Carryover to Y 1962.......................................         600
Less: Y's 1962 net capital gain (computed without regard to       12,000
 any capital loss carryovers)...............................
                                                             -----------
  Carryover to Y 1963.......................................           0
 

    (ii) Y Corporation's 1959 loss. The carryover to 1963 is $0, 
computed as follows:

Net capital loss............................................     $24,000
Less: Y's preacquisition part year net capital gain computed      18,100
 under subparagraph (5) of this paragraph ($36,500 x 181/
 365).......................................................
                                                 -------------
  Carryover to Y's postacquisition part year................       5,900
Less:
  Y's postacquisition part year net capital gain     $18,400
   computed under subparagraph (5) of this
   paragraph....................................
  Minus capital loss carryovers to                    19,000           0
   postacquisition part year (i.e., carryover of
   $19,000 from X 3/31/60)......................
                                                 -----------------------
    Carryover to Y 1962.....................................       5,900
Less:
  Y's 1962 net capital gain (computed without        $12,000
   regard to any capital loss carryovers).......
  Minus capital loss carryovers to Y 1962 (i.e.,         600      11,400
   carryover of $600 from X 3/31/60)............
                                                 -----------------------
    Carryover to Y 1963.....................................           0
 

    (iii) X Corporation's 3/31/61 loss. The carryover to 1963 is $0, 
computed as follows:

Net capital loss.............................................     $5,000
Less:
  Y's postacquisition part year net capital gain      $18,400
   computed under subparagraph (5) of this
   paragraph.....................................
  Minus capital loss carryovers to                     24,900
   postacquisition part year (i.e., carryovers of
   $19,000 from X 3/31/60 and $5,900 from Y 1959)
                                                  ------------
                                                   ..........          0
                                                              ----------
    Carryover to Y 1962......................................      5,000
Less:
  Y's 1962 net capital gain (computed without         $12,000
   regard to any capital loss carryovers)........
  Minus capital loss carryovers to Y 1962 (i.e.,        6,500
   carryovers of $600 from X 3/31/60 and $5,900
   from Y 1959)..................................
                                                  ------------
                                                   ..........      5,500
                                                              ----------
    Carryover to Y 1963......................................          0
 

    (iv) Y Corporation's 1960 loss. The carryover to 1963 is $5,500, 
computed as follows:

Net capital loss.............................................     $6,000
Less:
  Y's preacquisition part year net capital gain       $18,100
   computed under subparagraph (5) of this
   paragraph.....................................
  Minus capital loss carryovers to preacquisition      24,000
   part year (i.e., carryover of $24,000 from Y
   1959).........................................
                                                  ------------
                                                   ..........          0
                                                              ----------
    Carryover to Y's postacquisition part year...............      6,000
Less:
  Y's postacquisition part year net capital gain      $18,400
   computed under subparagraph (5) of this
   paragraph.....................................
  Minus capital loss carryovers to                     29,900          0
   postacquisition part year (i.e., carryovers of
   $19,000 from X 3/31/60, $5,900 from Y 1959,
   and $5,000 from X 3/31/61)....................
                                                              ----------
                                                   ..........          0
                                                              ----------
    Carryover to Y 1962......................................      6,000
Less:
  Y's 1962 net capital gain (computed without         $12,000
   regard to any capital loss carryovers)........
  Minus capital loss carryovers to Y 1962 (i.e.,      11,5000
   carryovers of $600 from X 3/31/60, $5,900 from
   Y 1959, and $5,000 from X 3/31/61)............
                                                  ------------
                                                   ..........       $500
                                                              ----------
    Carryover to Y 1963......................................      5,500
 

    (f) Successive acquiring corporations. An acquiring corporation 
which, in a transaction to which section 381(a) applies, acquires the 
assets of a distributor or transferor corporation which previously 
acquired the assets of another corporation in a transaction to which 
section 381(a) applies, shall succeed to and take into account, subject 
to the conditions and limitations of sections 1212 and 381, the capital 
loss

[[Page 590]]

carryovers available to the first acquiring corporation under sections 
1212 and 381.

[T.D. 6552, 26 FR 1985, Mar. 8, 1961, as amended by T.D. 6867, 30 FR 
15094, Dec. 12, 1965; T.D. 7728, 45 FR 72650, Nov. 3, 1980]



Sec. 1.381(c)(4)-1  Method of accounting.

    (a) Introduction--(1) Purpose. This section provides guidance 
regarding the method of accounting or combination of methods (other than 
inventory and depreciation methods) an acquiring corporation must use 
following a distribution or transfer to which sections 381(a) and 
381(c)(4) apply and how to implement any associated change in method of 
accounting. See Sec. 1.381(c)(5)-1 for guidance regarding the inventory 
method an acquiring corporation must use following a distribution or 
transfer to which sections 381(a) and 381(c)(5) apply. See Sec. 
1.381(c)(6)-1 for guidance regarding the depreciation method an 
acquiring corporation must use following a distribution or transfer to 
which sections 381(a) and 381(c)(6) apply.
    (2) Carryover method requirement for separate and distinct trades or 
businesses. In a transaction to which section 381(a) applies, if an 
acquiring corporation continues to operate a trade or business of the 
parties to the section 381(a) transaction as a separate and distinct 
trade or business after the date of distribution or transfer, the 
acquiring corporation must use a carryover method as defined in 
paragraph (b)(5) of this section for each continuing trade or business, 
unless either the carryover method is impermissible and must be changed 
under paragraph (a)(4) of this section or the acquiring corporation 
changes the carryover method in accordance with paragraph (a)(5) of this 
section. The carryover method requirement applies to the overall method 
of accounting (for example, an accrual method of accounting) and any 
special method of accounting (for example, the percentage of completion 
method of accounting described in section 460) as defined in paragraph 
(b)(2) of this section used by each trade or business after the date of 
distribution or transfer. The acquiring corporation need not secure the 
Commissioner's consent to continue a carryover method.
    (3) Principal method requirement for trades or businesses not 
operated as separate and distinct trades or businesses. In a transaction 
to which section 381(a) applies, if an acquiring corporation does not 
operate the trades or businesses of the parties to the section 381(a) 
transaction as separate and distinct trades or businesses after the date 
of distribution or transfer, the acquiring corporation must use a 
principal method determined under paragraph (c) of this section, unless 
either the principal method is impermissible and must be changed under 
paragraph (a)(4) of this section or the acquiring corporation changes 
the principal method in accordance with paragraph (a)(5) of this 
section. The principal method requirement applies to the overall method 
of accounting (for example, the cash receipts and disbursements method 
of accounting) and any special method of accounting (for example, the 
installment method under section 453) as defined in paragraph (b)(2) of 
this section used by each integrated trade or business after the date of 
distribution or transfer. The acquiring corporation must change to a 
principal method in accordance with paragraph (d)(1) of this section for 
each integrated trade or business and need not secure the Commissioner's 
consent to use a principal method.
    (4) Carryover method or principal method not a permissible method. 
If a carryover method or principal method is not a permissible method of 
accounting, the acquiring corporation must secure the Commissioner's 
consent to change to a permissible method of accounting as provided in 
paragraph (d)(2) of this section. If the acquiring corporation must use 
a single method of accounting for a particular item after the date of 
distribution or transfer regardless of the number of separate and 
distinct trades or businesses operated on that date, the acquiring 
corporation must use the principal method for that item as determined 
under paragraph (c) of this section, unless either the principal method 
is impermissible and must be changed under this paragraph (a)(4) or the 
acquiring corporation changes the

[[Page 591]]

principal method in accordance with paragraph (a)(5) of this section.
    (5) Voluntary change. Any party to a section 381(a) transaction may 
request permission under section 446(e) to change a method of accounting 
for the taxable year in which the transaction occurs or is expected to 
occur. For trades or businesses that will not operate as separate and 
distinct trades or businesses after the date of distribution or 
transfer, a change in method of accounting for the taxable year that 
includes that date will be granted only if the requested method is the 
method that the acquiring corporation must use after the date of 
distribution or transfer. The time and manner of obtaining the 
Commissioner's consent to change to a different method of accounting is 
described in paragraph (d)(2) of this section.
    (6) Examples. The following examples illustrate the rules of this 
paragraph (a). Unless otherwise noted, the carryover method is a 
permissible method of accounting.

    Example (1). Carryover method for separate and distinct trades or 
businesses after the date of distribution or transfer. (i) Facts. X 
Corporation operates an employment agency that uses the overall cash 
receipts and disbursements method of accounting. T Corporation operates 
an educational institution that uses an overall accrual method of 
accounting. X Corporation acquires the assets of T Corporation in a 
transaction to which section 381(a) applies. After the date of 
distribution or transfer, X Corporation operates the employment agency 
as a trade or business that is separate and distinct from the 
educational institution.
    (ii) Conclusion. Because after the date of distribution or transfer 
X Corporation operates the employment agency as a separate and distinct 
trade or business, under paragraph (a)(2) of this section X Corporation 
must use the carryover method for each continuing trade or business, 
unless either the carryover method is impermissible and must be changed 
under paragraph (a)(4) of this section or X Corporation changes the 
carryover method in accordance with paragraph (a)(5) of this section. As 
defined in paragraph (b)(5) of this section, the carryover method for 
the employment agency is the cash receipts and disbursements method of 
accounting and the carryover method for the educational institution is 
the accrual method of accounting used by T Corporation immediately prior 
to the date of distribution or transfer. There is no change in method of 
accounting, and X Corporation need not secure the Commissioner's consent 
to use either carryover method.
    Example (2). Carryover method for a special method of accounting. 
(i) Facts. X Corporation provides personal grooming consulting and T 
Corporation provides weight management consulting. Both X Corporation 
and T Corporation use the same overall accrual method of accounting. X 
Corporation has elected to use the recurring item exception under Sec. 
1.461-5. T Corporation does not use the recurring item exception. X 
Corporation acquires the assets of T Corporation in a transaction to 
which section 381(a) applies. After the date of distribution or 
transfer, X Corporation operates the personal grooming consulting 
business as a trade or business that is separate and distinct from the 
weight management consulting business.
    (ii) Conclusion. Because after the date of distribution or transfer, 
X Corporation operates the personal grooming consulting business as a 
separate and distinct trade or business, under paragraph (a)(2) of this 
section X Corporation must use a carryover method for each continuing 
trade or business, unless either the carryover method is impermissible 
and must be changed under paragraph (a)(4) of this section or X 
Corporation changes the carryover method in accordance with paragraph 
(a)(5) of this section. As defined in paragraph (b)(5) of this section, 
the carryover method for the overall method of accounting for each trade 
or business is the accrual method used immediately prior to the date of 
distribution or transfer. The carryover method for the special method of 
accounting for the personal grooming consulting business is the 
recurring item exception under Sec. 1.461-5 while the carryover method 
for the weight management consulting business is not to use the 
recurring item exception under Sec. 1.461-5. There is no change in 
method of accounting, and X Corporation need not secure the 
Commissioner's consent to use the carryover methods of accounting.
    Example (3). Carryover method for a special method of accounting not 
permissible. (i) Facts. X Corporation is an engineering firm that uses 
the overall cash receipts and disbursements method of accounting and has 
elected under section 171 to amortize bond premium with respect to its 
taxable bonds acquired at a premium. T Corporation is a manufacturer 
that uses an overall accrual method of accounting and has not made a 
section 171 election to amortize bond premium with respect to its 
taxable bonds acquired at a premium. X Corporation acquires the assets 
of T Corporation in a transaction to which section 381(a) applies. After 
the date of distribution or transfer, X Corporation operates the 
engineering firm as a trade or business that is separate and distinct 
from the manufacturing business.

[[Page 592]]

    (ii) Conclusion. Because after the date of distribution or transfer 
X Corporation operates the engineering firm as a separate and distinct 
trade or business, under paragraph (a)(2) of this section X Corporation 
must use a carryover method for each continuing trade or business, 
unless either the carryover method is impermissible and must be changed 
under paragraph (a)(4) of this section or X Corporation changes the 
carryover method in accordance with paragraph (a)(5) of this section. As 
defined in paragraph (b)(5) of this section, the carryover method for 
the overall method of accounting for the engineering firm is the cash 
receipts and disbursements method used by X Corporation immediately 
prior to the date of distribution or transfer, and the carryover method 
for the overall method of accounting for the manufacturing business is 
the accrual method used by T Corporation immediately prior to the date 
of distribution or transfer. There is no change in method of accounting, 
and X Corporation need not secure the Commissioner's consent to use 
either carryover method. Notwithstanding that after the date of 
distribution or transfer X Corporation has two separate and distinct 
trades or businesses, X Corporation is permitted only one method of 
accounting for amortizable bond premium under section 171. Because after 
the date of distribution or transfer X Corporation must use a single 
method of accounting for bond premium for all trades or businesses, X 
Corporation must use the principal method for that item as determined 
under paragraph (c) of this section, unless either the principal method 
is impermissible and must be changed under paragraph (a)(4) of this 
section or X Corporation changes that method in accordance with 
paragraph (a)(5) of this section. X Corporation must change to the 
principal method in accordance with paragraph (d)(1) of this section. If 
amortizing bond premium is not the principal method, X Corporation may 
make an election to amortize bond premium to the extent permitted by 
section 171. See paragraph (e)(2) of this section for rules on making 
elections.

    (b) Definitions. For purposes of this section--
    (1) Method of accounting. A method of accounting has the same 
meaning as provided in section 446 and any applicable Income Tax 
Regulations.
    (2) Special method of accounting. A special method of accounting is 
a method expressly permitted or required by the Internal Revenue Code, 
Income Tax Regulations, or administrative guidance published in the 
Internal Revenue Bulletin that deviates from the normal application of 
the cash receipts and disbursements method or an accrual method of 
accounting. The installment method under section 453, the mark-to-market 
method under section 475, the amortization of bond premium under section 
171, the percentage of completion method under section 460, the 
recurring item exception of Sec. 1.461-5, and the income deferral 
method under section 455 are examples of special methods of accounting. 
See Sec. 1.446-1(c)(1)(iii).
    (3) Adoption of a method of accounting. Adoption of a method of 
accounting has the same meaning as provided in Sec. 1.446-1(e)(1).
    (4) Change in method of accounting. A change in method of accounting 
has the same meaning as provided in Sec. 1.446-1(e)(2).
    (5) Carryover method. A carryover method for the overall method of 
accounting is the overall method of accounting that each party to a 
section 381(a) transaction uses for each separate and distinct trade or 
business immediately prior to the date of distribution or transfer. The 
carryover method for a special method of accounting for an item is the 
special method of accounting for that item that each party to a section 
381(a) transaction uses for each separate and distinct trade or business 
immediately prior to the date of distribution or transfer.
    (6) Principal method. A principal method is an overall or special 
method of accounting that is determined under paragraph (c) of this 
section.
    (7) Permissible method of accounting. A permissible method of 
accounting is a method of accounting that is proper or permitted under 
the Internal Revenue Code or any applicable Income Tax Regulations.
    (8) Acquiring corporation. An acquiring corporation has the same 
meaning as provided in Sec. 1.381(a)-1(b)(2).
    (9) Distributor corporation. A distributor corporation means the 
corporation, foreign or domestic, that distributes its assets to another 
corporation described in section 332(b) in a distribution to which 
section 332 (relating to liquidations of subsidiaries) applies.
    (10) Transferor corporation. A transferor corporation means the 
corporation, foreign or domestic, that transfers its assets to another 
corporation

[[Page 593]]

in a transfer to which section 361 (relating to nonrecognition of gain 
or loss to corporations) applies, but only if--
    (i) The transfer is in connection with a reorganization described in 
section 368(a)(1)(A), (a)(1)(C), or (a)(1)(F), or
    (ii) The transfer is in connection with a reorganization described 
in section 368(a)(1)(D) or (a)(1)(G), provided the requirements of 
section 354(b) are met.
    (11) Parties to the section 381(a) transaction. Parties to the 
section 381(a) transaction means the acquiring corporation and the 
distributor or transferor corporation that participate in a transaction 
to which section 381(a) applies.
    (12) Date of distribution or transfer. The date of distribution or 
transfer has the same meaning as provided in section 381(b)(2) and Sec. 
1.381(b)-1(b).
    (13) Separate and distinct trades or businesses. Separate and 
distinct trades or businesses has the same meaning as provided in Sec. 
1.446-1(d).
    (14) Gross receipts. Gross receipts means all the receipts, 
including amounts that are excludible from gross income, that must be 
taken into account under the method of accounting used in a 
representative period (determined without regard to this section) for 
federal income tax purposes. For example, gross receipts includes income 
from investments, amounts received for services, rents, total sales (net 
of returns and allowances), and both taxable and tax-exempt interest. 
See paragraph (e)(5) of this section for rules on determining the 
representative period.
    (15) Audit protection. Audit protection means, for purposes of 
paragraph (d)(1) of this section, that the IRS will not require an 
acquiring corporation that is required to change a method of accounting 
under paragraph (a)(3) of this section to change that method for a 
taxable year ending prior to the taxable year that includes the date of 
distribution or transfer.
    (16) Section 481(a) adjustment. The section 481(a) adjustment means 
an adjustment that must be taken into account as required under section 
481(a) to prevent amounts from being duplicated or omitted when the 
taxable income of an acquiring corporation is computed under a method of 
accounting different from the method used to compute taxable income for 
the preceding taxable year.
    (17) Cut-off basis. A cut-off basis means a manner in which a change 
in method of accounting is made without a section 481(a) adjustment and 
under which only the items arising after the beginning of the year of 
change (or, in the case of a change made under paragraph (d)(1) of this 
section, after the date of distribution or transfer) are accounted for 
under the new method of accounting.
    (18) Adjustment period. The adjustment period means the number of 
taxable years for taking into account the section 481(a) adjustment 
required as a result of a change in method of accounting.
    (19) Component trade or business. A component trade or business is a 
trade or business of a party to the section 381(a) transaction that will 
be combined and integrated with a trade or business of the other party 
to the section 381 transaction. See paragraph (e)(4)(ii) of this section 
for the determination of whether a trade or business is operated as a 
separate and distinct trade or business after the date of distribution 
or transfer.
    (c) Principal method--(1) In general. For each integrated trade or 
business, the principal method is generally the method of accounting 
used by the component trade or business of the acquiring corporation 
immediately prior to the date of distribution or transfer. If, however, 
the component trade or business of the distributor or transferor 
corporation is larger than the component trade or business of the 
acquiring corporation on the date of distribution or transfer, the 
principal method is the method used by the component trade or business 
of the distributor or transferor corporation immediately prior to that 
date. If the larger component trade or business does not have a special 
method of accounting for a particular item immediately prior to the date 
of distribution or transfer, the principal method for that item is the 
method of accounting used by the component trade or business that does 
have a special method of accounting for that

[[Page 594]]

item. See paragraph (e)(9) of this section for special rules concerning 
methods of accounting that are elected on a project-by-project, job-by-
job, or other similar basis. For each integrated trade or business, the 
component trade or business of the distributor or transferor corporation 
is larger than the component trade or business of the acquiring 
corporation on the date of distribution or transfer if--
    (i) The aggregate of the adjusted bases of the assets held by each 
component trade or business of the distributor or transferor corporation 
(determined under section 1011 and any applicable Income Tax 
Regulations) exceeds the aggregate of the adjusted bases of the assets 
of each component trade or business of the acquiring corporation 
immediately prior to the date of distribution or transfer, and
    (ii) The aggregate of the gross receipts for a representative period 
of each component trade or business of the distributor or transferor 
corporation exceeds the aggregate of the gross receipts for the same 
period of each component trade or business of the acquiring corporation. 
See paragraph (e)(5) of this section for rules on determining the 
representative period.
    (2) Multiple component trades or businesses with different principal 
methods. If a party to the section 381(a) transaction has multiple 
component trades or businesses and more than one principal overall 
method of accounting or more than one principal special method of 
accounting for an item, then the acquiring corporation may choose which 
of the principal methods of accounting used by such component trades or 
businesses will be the principal methods of the integrated trade or 
business. The acquiring corporation must choose a principal method that 
is a permissible method of accounting. In general, a change to a 
principal method in a transaction to which section 381(a) and paragraph 
(a)(3) of this section applies is made under paragraph (d)(1) of this 
section.
    (3) Examples. The following examples illustrate the rules of this 
paragraph (c). Unless otherwise noted, the principal method is a 
permissible method of accounting.

    Example (1). Principal method is the method used by the acquiring 
corporation. (i) Facts. X Corporation and T Corporation each operate an 
employment agency. X Corporation uses the overall cash receipts and 
disbursements method of accounting, and T Corporation uses an overall 
accrual method of accounting. X Corporation acquires the assets of T 
Corporation in a transaction to which section 381(a) applies. The 
adjusted bases of the assets in X Corporation's employment agency 
immediately prior to the date of distribution or transfer exceed the 
adjusted bases of the assets in T Corporation's employment agency, and 
the gross receipts in X Corporation's employment agency for the 
representative period exceed the gross receipts of T Corporation's 
employment agency for the period. After the date of distribution or 
transfer, X Corporation's employment agency will not be operated as a 
trade or business that is separate and distinct from T Corporation's 
employment agency.
    (ii) Conclusion. Because after the date of distribution or transfer 
X Corporation will not operate its employment agency as a separate and 
distinct trade or business, X Corporation must use a principal method 
under paragraph (a)(3) of this section, unless either the principal 
method is impermissible and must be changed under paragraph (a)(4) of 
this section or X Corporation changes the principal method in accordance 
with paragraph (a)(5) of this section. Because on the date of 
distribution or transfer T Corporation's employment agency is not larger 
than X Corporation's employment agency, the principal method for the 
overall method of accounting is the cash receipts and disbursements 
method used by X Corporation's employment agency. X Corporation need not 
secure the Commissioner's consent to use this method of accounting. 
However, in accordance with paragraph (d)(1) of this section, X 
Corporation must change the method of accounting for the employment 
agency acquired from T Corporation to the cash receipts and 
disbursements method.
    Example (2). Principal method is the method used by the acquiring 
corporation. (i) Facts. The facts are the same as in Example (1), except 
that the gross receipts of T Corporation's employment agency for the 
representative period exceed the gross receipts of X Corporation's 
employment agency for the period.
    (ii) Conclusion. The result is the same as in Example (1). Although 
the gross receipts of T Corporation's employment agency exceed the gross 
receipts of X Corporation's employment agency, T Corporation's 
employment agency is not larger than X Corporation's employment agency 
because the adjusted bases of the assets of T Corporation's employment 
agency do not exceed the adjusted

[[Page 595]]

bases of the assets of X Corporation's employment agency. Thus, the 
principal method for the overall method of accounting is the cash 
receipts and disbursements method of accounting used by X Corporation's 
employment agency immediately prior to the date of distribution or 
transfer. X Corporation need not secure the Commissioner's consent to 
use this method of accounting. However, in accordance with paragraph 
(d)(1) of this section, X Corporation must change the method of 
accounting for the employment agency business acquired from T 
Corporation to the cash receipts and disbursements method.
    Example (3). Principal method is the method used by the distributor 
or transferor corporation. (i) Facts. The facts are the same as in 
Example (2), except that the adjusted bases of the assets held by T 
Corporation's employment agency immediately prior to the date of 
distribution or transfer exceed the adjusted bases of the assets held by 
X Corporation's employment agency.
    (ii) Conclusion. The principal method for the overall method of 
accounting is the accrual method of accounting used by T Corporation's 
employment agency immediately prior to the date of distribution or 
transfer because on the date of distribution or transfer T Corporation's 
employment agency is larger than X Corporation's employment agency. The 
adjusted bases of the assets of T Corporation's employment agency exceed 
the adjusted bases of the assets of X Corporation's employment agency, 
and the gross receipts of T Corporation's employment agency exceed the 
gross receipts of X Corporation's employment agency. X Corporation need 
not secure the Commissioner's consent to use this method of accounting. 
However, in accordance with paragraph (d)(1) of this section, X 
Corporation must change the method of accounting for the employment 
agency business it operated prior to the date of distribution or 
transfer to the accrual method of accounting used by T Corporation's 
employment agency immediately prior to the date of distribution or 
transfer.
    Example (4). Impermissible principal method. (i) Facts. The facts 
are the same as in Example (1), except that X Corporation is prohibited 
under section 448 from using the cash receipts and disbursements method 
of accounting after the date of distribution or transfer.
    (ii) Conclusion. Because section 448 prohibits X Corporation from 
using the cash receipts and disbursements method of accounting, X 
Corporation is not permitted to use the principal method for the overall 
method of accounting as determined in Example (1). Because after the 
date of distribution or transfer that method is not a permissible 
method, under paragraph (a)(4) of this section X Corporation must secure 
the Commissioner's consent to change to a permissible method in 
accordance with the procedures set forth in paragraph (d)(2) of this 
section.
    Example (5). Voluntary change not allowable. (i) Facts. The facts 
are the same as in Example (4), except that T Corporation wants to 
discontinue using the overall accrual method of accounting for its 
employment agency and change to the cash receipts and disbursements 
method for the taxable year in which the section 381(a) transaction 
occurs or is expected to occur.
    (ii) Conclusion. Under paragraph (a)(5) of this section, the 
Commissioner will grant a request to change a method of accounting for 
the taxable year that includes the date of distribution or transfer only 
if the requested method is the method that the acquiring corporation 
must use after the date of distribution or transfer. The Commissioner 
will not consent to a request by T Corporation to change to the cash 
receipts and disbursements method for the taxable year in which the 
section 381(a) transaction occurs or is expected to occur because X 
Corporation cannot use the cash receipts and disbursements method after 
the date of distribution or transfer.
    Example (6). Principal methods are the acquiring corporation's 
methods. (i) Facts. X Corporation and T Corporation each publishes 
magazines. X Corporation acquires the assets of T Corporation in a 
transaction to which section 381(a) applies. Both X Corporation and T 
Corporation use an overall accrual method of accounting. X Corporation 
has elected to defer income from its subscription sales under section 
455. T Corporation has not elected to defer income from its subscription 
sales under section 455 and instead has recognized the income from these 
sales in accordance with section 451. The adjusted bases of the assets 
in X Corporation's publication business immediately prior to the date of 
distribution or transfer exceed the adjusted bases of the assets in T 
Corporation's publication business, and the gross receipts in X 
Corporation's publication business for the representative period exceed 
the gross receipts in T Corporation's publication business for the 
representative period. After the date of distribution or transfer, X 
Corporation will not operate its publication business as a trade or 
business that is separate and distinct from T Corporation's publication 
business.
    (ii) Conclusion. Because after the date of distribution or transfer 
X Corporation will not operate its publication business as a separate 
and distinct trade or business, X Corporation must use the principal 
method under paragraph (a)(3) of this section, unless either the 
principal method is impermissible and must be changed under paragraph 
(a)(4) of this section or X Corporation changes the principal method in 
accordance with paragraph (a)(5) of this section. The adjusted

[[Page 596]]

bases of the assets in T Corporation's publication business do not 
exceed the adjusted bases of the assets in X Corporation's publication 
business, and the gross receipts in T Corporation's publication business 
do not exceed the gross receipts in X Corporation's publication 
business. Because on the date of distribution or transfer T 
Corporation's publication business is not larger than X Corporation's 
publication business, the principal method for the overall method of 
accounting is the accrual method used by X Corporation's publication 
business immediately prior to the date of distribution or transfer. The 
principal method for subscription sales is the section 455 deferral 
method used by X Corporation immediately prior to the date of 
distribution or transfer. X Corporation need not secure the 
Commissioner's consent to use the principal method for either the 
overall method of accounting or the special method of accounting. 
However, in accordance with paragraph (d)(1) of this section, X 
Corporation must change both the overall method of accounting and the 
special method of accounting for the publication business acquired from 
T Corporation to the accrual method and the section 455 deferral method 
used by X Corporation immediately prior to the date of distribution or 
transfer.
    Example (7). Principal methods are the acquiring corporation's 
methods. (i) Facts. The facts are the same as in Example (6), except 
that the adjusted bases of the assets in T Corporation's publication 
business immediately prior to the date of distribution or transfer 
exceed the adjusted bases of the assets in X Corporation's business.
    (ii) Conclusion. The result is the same as in Example (6). Because 
on the date of distribution or transfer T Corporation's publication 
business is not larger than X Corporation's publication business, the 
principal method for the overall method of accounting is the accrual 
method used by X Corporation's publication business immediately prior to 
the date of distribution or transfer. The principal method for 
subscription sales is the section 455 deferral method used by X 
Corporation immediately prior to the date of distribution or transfer. X 
Corporation need not secure the Commissioner's consent to use the 
principal method for either the overall method of accounting or the 
special method of accounting. However, in accordance with paragraph 
(d)(1) of this section, X Corporation must change both the overall 
method of accounting and the special method of accounting for the 
publication business acquired from T Corporation to the accrual method 
and the section 455 deferral method used by X Corporation immediately 
prior to the date of distribution or transfer.
    Example (8). Principal method determination when larger component 
trade or business does not have a special method of accounting. (i) 
Facts. X Corporation and T Corporation both install ice skating rinks. 
Both X Corporation and T Corporation use an overall accrual method of 
accounting for their respective businesses. X Corporation completes its 
installation contracts within the contracting year and uses an accrual 
method of accounting to recognize the revenue from its installation 
contracts. T Corporation's installation contracts are subject to section 
460, and T Corporation recognizes the revenue from such contracts under 
the percentage-of-completion method. X Corporation acquires the assets 
of T Corporation in a transaction to which section 381(a) applies. The 
adjusted bases of the assets in X Corporation's installation business 
immediately prior to the date of distribution or transfer exceed the 
adjusted bases of the assets in T Corporation's installation business, 
and the gross receipts in X Corporation's installation business for the 
representative period exceed the gross receipts in T Corporation's 
installation business for the representative period. After the date of 
distribution or transfer, X Corporation will not operate its 
installation business as a trade or business that is separate and 
distinct from T Corporation's installation business.
    (ii) Conclusion. Because after the date of distribution or transfer 
X Corporation will not operate its installation business as a separate 
and distinct trade or business, X Corporation must use a principal 
method under paragraph (a)(3) of this section, unless either the 
principal method is impermissible and must be changed under paragraph 
(a)(4) of this section or X Corporation changes the principal method in 
accordance with paragraph (a)(5) of this section. The adjusted bases of 
the assets in T Corporation's installation business do not exceed the 
adjusted bases of the assets in X Corporation's installation business, 
and the gross receipts in T Corporation's installation business do not 
exceed the gross receipts in X Corporation's installation business. 
Because on the date of distribution or transfer T Corporation's 
installation business is not larger than X Corporation's installation 
business, the principal method for the overall method of accounting is 
the accrual method used by X Corporation's installation business 
immediately prior to the date of distribution or transfer. X Corporation 
need not secure the Commissioner's consent to use the principal method 
for the overall method of accounting. However, in accordance with 
paragraph (d)(1) of this section, X Corporation must change the overall 
method of accounting for the installation business acquired from T 
Corporation to the accrual method used by X Corporation. Under paragraph 
(c) of this section, the principal method for T Corporation's long-term 
contracts is the percentage-of-completion method used by T Corporation 
immediately prior to the date of distribution

[[Page 597]]

or transfer because X Corporation's installation business does not have 
a method of accounting for long-term contracts. There is no change in 
method of accounting, and X Corporation need not secure the 
Commissioner's consent to use T Corporation's percentage-of-completion 
method.
    Example (9). Principal method determination with a combined trade or 
business and a separate and distinct trade or business. (i) Facts. X 
Corporation operates a tennis academy as a trade or business that is 
separate and distinct from its trade or business of operating a golf 
academy. X Corporation uses the overall cash receipts and disbursements 
method of accounting for the tennis academy and an overall accrual 
method of accounting for the golf academy. T Corporation operates a 
tennis academy and uses an accrual method of accounting for the overall 
method. X Corporation acquires the assets of T Corporation in a 
transaction to which section 381(a) applies. After the date of 
distribution or transfer, X Corporation will not operate its tennis 
academy as a trade or business that is separate and distinct from T 
Corporation's tennis academy. X Corporation will continue to operate its 
golf academy as a trade or business that is separate and distinct from 
the operation of the tennis academy. The adjusted bases of the assets in 
T Corporation's tennis academy exceed the adjusted bases of the assets 
in X Corporation's tennis academy immediately prior to the date of 
distribution or transfer. The gross receipts of T Corporation's tennis 
academy for the representative period exceed the gross receipts of X 
Corporation's tennis academy for that period.
    (ii) Conclusion. Because after the date of distribution or transfer 
X Corporation will not operate its tennis academy as a separate and 
distinct trade or business, X Corporation must use a principal method 
under paragraph (a)(3) of this section, unless either the principal 
method is impermissible and must be changed under paragraph (a)(4) of 
this section or X Corporation changes the principal method in accordance 
with paragraph (a)(5) of this section. Because on the date of 
distribution or transfer the tennis academy operated by T Corporation is 
larger than the tennis academy operated by X Corporation, the principal 
method for the overall method of accounting for the combined tennis 
academy business is the accrual method used by T Corporation's tennis 
academy immediately prior to the date of distribution or transfer. X 
Corporation need not secure the Commissioner's consent to use the 
principal method for the overall method of accounting. However, in 
accordance with paragraph (d)(1) of this section, X Corporation must 
change the method of accounting for its tennis academy to the accrual 
method. Because X Corporation will operate the golf academy as a 
separate trade or business, under paragraph (a)(2) of this section X 
Corporation must continue to use the accrual method that it used 
immediately prior to the date of distribution or transfer as the 
carryover method for the golf academy. There is no change in method of 
accounting, and X Corporation need not secure the Commissioner's consent 
to use the carryover method.
    Example (10). Principal method determination with multiple component 
trades or businesses. (i) Facts. The facts are the same as in Example 
(9), except that after the date of distribution or transfer X 
Corporation will not operate its golf academy as a trade or business 
that is separate and distinct from the tennis academy. In addition, X 
Corporation's component trades or businesses are larger than T 
Corporation's component trade or business: (1) the adjusted bases of the 
assets of X Corporation's tennis academy and golf academy businesses, in 
the aggregate, exceed the adjusted bases of the assets held by T 
Corporation's tennis academy; and (2) the gross receipts for the 
representative period of X Corporation's tennis academy and golf academy 
businesses, in the aggregate, exceed the gross receipts in T 
Corporation's tennis academy.
    (ii) Conclusion. Because on the date of distribution or transfer T 
Corporation's tennis academy is not larger than X Corporation's combined 
tennis academy and golf academy, the principal method for the overall 
method of accounting is the method of accounting used by the component 
trades or businesses of X Corporation that will be combined with T 
Corporation's component trade or business on that date. Because on the 
date of distribution or transfer X Corporation operates two component 
trades or businesses with different overall methods of accounting that 
will be integrated after the date of distribution or transfer, X 
Corporation may choose under paragraph (c)(2) of this section which 
overall method (and any special method of accounting) used by its 
component trades or businesses will be the principal method. X 
Corporation may choose to use either the accrual method used by the golf 
academy or the cash receipts and disbursements method used by its tennis 
academy as the principal method after the date of distribution or 
transfer, if either method is a permissible method. In accordance with 
paragraph (d)(1) of this section, X Corporation must change T 
Corporation's overall method of accounting to the principal method. 
Under paragraph (a)(3) of this section, X Corporation also must change 
either its golf academy business or its tennis academy business, 
depending on which principal method X Corporation selects, to the 
principal method.

    (d) Procedures for changing a method of accounting--(1) Change made 
to principal method under paragraph (a)(3) of this section--(i) Section 
481(a) adjustment--(A) In general. An acquiring corporation

[[Page 598]]

that changes its method of accounting or the distributor or transferor 
corporation's method of accounting under paragraph (a)(3) of this 
section does not need to secure the Commissioner's consent to use the 
principal method. To the extent the use of a principal method 
constitutes a change in method of accounting, the change in method is 
treated as a change initiated by the acquiring corporation for purposes 
of section 481(a)(2). Any change to a principal method, whether the 
change relates to a trade or business of the acquiring corporation or a 
trade or business of the distributor or transferor corporation, must be 
reflected on the acquiring corporation's federal income tax return for 
the taxable year that includes the date of distribution or transfer. The 
amount of the section 481(a) adjustment and the adjustment period, if 
any, necessary to implement a change to the principal method are 
determined under Sec. 1.446-1(e) and the applicable administrative 
procedures that govern voluntary changes in methods of accounting under 
section 446(e). If the Internal Revenue Code, the Income Tax 
Regulations, or administrative procedures require that a method of 
accounting be implemented on a cut-off basis, the acquiring corporation 
must implement the change on a cut-off basis as of the date of 
distribution or transfer on its federal income tax return for the 
taxable year that includes the date of distribution or transfer. If the 
Internal Revenue Code, the Income Tax Regulations, or administrative 
procedures require a section 481(a) adjustment, the acquiring 
corporation must determine the section 481(a) adjustment and include the 
appropriate amount of the section 481(a) adjustment on its federal 
income tax return for the taxable year that includes the date of 
distribution or transfer and subsequent taxable year(s), as necessary. 
This adjustment is determined by the acquiring corporation as of the 
beginning of the day that is immediately after the date of distribution 
or transfer.
    (B) Example. The following example illustrates the rules of this 
paragraph (d)(1)(i):

    Example. X Corporation uses the overall cash receipts and 
disbursements method of accounting, and T Corporation uses an overall 
accrual method of accounting. X Corporation acquires the assets of T 
Corporation in a transaction to which section 381(a) applies. X 
Corporation determines that under the rules of paragraph (c)(1) of this 
section X Corporation must change the method of accounting for the 
business acquired from T Corporation to the cash receipts and 
disbursements method. X Corporation will determine the section 481(a) 
adjustment pertaining to the change to the cash receipts and 
disbursements method by consolidating the adjustments (whether the 
amounts thereof represent increases or decreases in items of income or 
deductions) arising with respect to balances in the various accounts, 
such as accounts receivable, as of the beginning of the day that 
immediately follows the day on which X Corporation acquires the assets 
of T Corporation. X Corporation will reflect this adjustment, or an 
appropriate part thereof, on its federal income tax return for the 
taxable year that includes the date of distribution or transfer.

    (ii) Audit protection. Notwithstanding any other provision in any 
other Income Tax Regulation or administrative procedure, no audit 
protection is provided for any change in method of accounting under 
paragraph (d)(1) of this section.
    (iii) Other terms and conditions. Except as otherwise provided in 
this section, other terms and conditions provided in Sec. 1.446-1(e) 
and the applicable administrative procedures for voluntary changes in 
method of accounting under section 446(e) apply to a change in method of 
accounting under this section. Thus, for example, if the administrative 
procedures for a particular change in method of accounting have a term 
and condition that provides for the acceleration of the section 481(a) 
adjustment period, this term and condition applies to a change made 
under this paragraph (d)(1). However, any scope limitation in the 
applicable administrative procedures will not apply for purposes of 
making a change under this paragraph (d)(1). For example, if the 
administrative procedures provide as a limitation that an identical 
change in method of accounting is barred for a period of years, this 
limitation will not bar a change to the principal method made under this 
section.
    (2) Change made to a method of accounting under paragraph (a)(4) or 
(a)(5) of this section--(i) In general. A party to

[[Page 599]]

a section 381(a) transaction that changes a method of accounting under 
either paragraph (a)(4) or paragraph (a)(5) of this section must follow 
the provisions of Sec. 1.446-(1)(e) and the applicable administrative 
procedures, including scope limitations, for voluntary changes in method 
of accounting under section 446(e), except as provided in paragraphs 
(d)(2)(ii) and (d)(2)(iii) of this section. An application on Form 3115, 
``Application for Change in Accounting Method,'' filed with the IRS to 
change a method of accounting under this paragraph (d)(2) should be 
labeled ``Filed under section 381(c)(4)'' at the top.
    (ii) Final year limitation. Any scope limitation relating to the 
final year of a trade or business will not apply to a taxpayer that 
changes its method of accounting in the final year of a trade or 
business that is terminated as the result of a section 381(a) 
transaction.
    (iii) Time to file. Under the authority of Sec. 1.446-1(e)(3)(ii), 
for a change in method of accounting requiring advance consent, the 
application for a change in method of accounting (for example, Form 
3115) must be filed with the IRS on or before the later of--
    (A) The due date for filing a Form 3115 as specified in Sec. 1.446-
1(e), for example, the last day of the taxable year in which the 
distribution or transfer occurred, or
    (B) The earlier of--
    (1) The day that is 180 days after the date of distribution or 
transfer, or
    (2) The day on which the acquiring corporation files its federal 
income tax return for the taxable year in which the distribution or 
transfer occurred.
    (e) Rules and procedures--(1) No method of accounting. If a party to 
a section 381(a) transaction is not using a method of accounting, does 
not have a method of accounting for a particular item, or came into 
existence as a result of the transaction, the party will not be treated 
as having a method of accounting different from that used by another 
party to the section 381(a) transaction.
    (2) Elections and adoptions allowed. If an election does not require 
the Commissioner's consent, an acquiring corporation or a distributor or 
transferor corporation is not precluded from making any election that is 
otherwise permissible for the taxable year that includes the date of 
distribution or transfer. For purposes of this section, a corporation 
shall be deemed as having made any election as of the first day of the 
taxable year that includes the date of distribution or transfer. 
Similarly, where adoption is permissible, an acquiring corporation or a 
distributor or transferor corporation may adopt any permissible method 
of accounting for the taxable year that includes the date of 
distribution or transfer.
    (3) Elections continue after section 381(a) transaction--(i) General 
rule. An acquiring corporation is not required to renew any election not 
otherwise requiring renewal and previously made by it or by a 
distributor or transferor corporation for a carryover method or a 
principal method if the acquiring corporation uses the method after the 
section 381(a) transaction. If the acquiring corporation uses a method 
after the date of distribution or transfer, an election made by the 
acquiring corporation or by a distributor or transferor corporation for 
that method that was in effect on the date of distribution or transfer 
continues after the section 381(a) transaction as though the 
distribution or transfer had not occurred.
    (ii) Example. The following example illustrates the rules of this 
paragraph (e)(3):

    Example. The acquiring corporation, X Corporation, previously 
elected to amortize bond premium under section 171. X Corporation 
acquires the assets of T Corporation in a transaction to which section 
381(a) applies. X Corporation determines under the rules of paragraph 
(c)(1) of this section that X Corporation's method of amortizing bond 
premium is the principal method. After the date of distribution or 
transfer, X Corporation is not required to renew its bond premium 
amortization election and is bound by it. Additionally, X Corporation 
would not be required to renew its election to amortize bond premium if 
the method were the carryover method under paragraph (a)(2) of this 
section.

    (4) Appropriate times for certain determinations--(i) Determining 
the method of accounting. The method of accounting used by a party to a 
section 381(a) transaction on the date of distribution or transfer is 
the method of accounting used by that party as of the end of the

[[Page 600]]

day that is immediately prior to the date of distribution or transfer.
    (ii) Determining whether there are separate and distinct trades or 
businesses after the date of distribution or transfer. Whether an 
acquiring corporation will operate the trades or businesses of the 
parties to a section 381(a) transaction as separate and distinct trades 
or businesses after the date of distribution or transfer will be 
determined as of the date of distribution or transfer based upon the 
facts and circumstances. Intent to combine books and records of the 
trades or businesses may be demonstrated by contemporaneous records and 
documents or by other objective evidence that reflects the acquiring 
corporation's ultimate plan of operation, even though the actual 
combination of the books and records may extend beyond the end of the 
taxable year that includes the date of distribution or transfer.
    (5) Representative period for aggregating gross receipts. The 
representative period for measuring gross receipts is generally the 12 
consecutive months preceding the date of distribution or transfer. If a 
component trade or business was not in existence for the 12 consecutive 
months preceding the date of distribution or transfer, then all 
component trades or businesses of each integrated trade or business will 
compare their gross receipts for the period that such trade or business 
was in existence. For example, if the acquiring corporation's component 
trade or business was formed in August and the date of distribution or 
transfer occurred in December of the same year, the gross receipts for 
those five months will be compared with the gross receipts of the other 
component trades or businesses for the same period.
    (6) Establishing a method of accounting. A method of accounting used 
by the distributor or transferor corporation immediately prior to the 
date of distribution or transfer that continues to be used by the 
acquiring corporation after the date of distribution or transfer is an 
established method of accounting for purposes of section 446(e), whether 
or not such method is proper or is permitted under the Internal Revenue 
Code or any applicable Income Tax Regulations.
    (7) Other applicable provisions. This section does not preempt any 
other provision of the Internal Revenue Code or the Income Tax 
Regulations that is applicable to the acquiring corporation's 
circumstances. For example, income, deductions, credits, allowances, and 
exclusions may be allocated among the parties to a section 381(a) 
transaction and other taxpayers under sections 269 and 482, if 
appropriate. Similarly, transfers of contracts accounted for using a 
long-term contract method of accounting are governed by the rules 
provided in Sec. 1.460-4(k). Further, if other paragraphs of section 
381(c) apply for purposes of determining the methods of accounting to be 
used following the date of distribution or transfer, section 381(c)(4) 
and this Sec. 1.381(c)(4)-1 will not apply to the tax treatment of the 
items. For example, this section does not apply to inventories that an 
acquiring corporation obtains in a transaction to which section 381(a) 
applies. Instead, the rules of section 381(c)(5) govern the inventory 
method to be used by the acquiring corporation after the distribution or 
transfer. Similarly, if the acquiring corporation assumes an obligation 
of the distributor or transferor corporation that gives rise to a 
liability after the date of distribution or transfer and to which Sec. 
1.381(c)(16)-1 applies, the deductibility of the item is determined 
under this section only after the rules of section 381(c)(16) are 
applied.
    (8) Character of items of income and deduction. After the date of 
distribution or transfer, items of income and deduction have the same 
character in the hands of the acquiring corporation as they would have 
had in the hands of the distributor or transferor corporation if no 
distribution or transfer had occurred.
    (9) Method of accounting selected by project or job. If other 
sections of the Internal Revenue Code, Income Tax Regulations, or other 
administrative guidance permit an acquiring corporation to elect a 
method of accounting on a project-by-project, job-by-job, or other 
similar basis, then for purposes of this section the method elected with 
respect to each project or job is the established method only for that 
project or job. For example, the election under

[[Page 601]]

section 460 to classify a contract to perform both manufacturing and 
construction activities as a long-term construction contract if at least 
95 percent of the estimated total allocable contract costs are 
reasonably allocated to the construction activities is made on a 
contract-by-contract basis. Accordingly, the method of accounting 
previously elected for a project or job generally continues after the 
date of distribution or transfer. However, if the trades or businesses 
of the parties to a section 381(a) transaction are not operated as 
separate and distinct trades or businesses after the date of 
distribution or transfer, and two or more of the parties to the section 
381(a) transaction previously worked on the same project or job and used 
different methods of accounting for the project or job immediately 
before the distribution or transfer, then the acquiring corporation must 
determine the principal method for that project or job under paragraph 
(c) of this section and make changes, if necessary, to the principal 
method in accordance with paragraph (d)(1) of this section.
    (10) Impermissible method of accounting. This section does not limit 
the Commissioner's ability under section 446(b) to determine whether a 
taxpayer's method of accounting is an impermissible method or otherwise 
fails to clearly reflect income. For example, an acquiring corporation 
may not use the method of accounting determined under paragraph (a)(2) 
of this section if the method fails to clearly reflect the acquiring 
corporation's income within the meaning of section 446(b).
    (f) Effective/applicability date. This section applies to corporate 
reorganizations and tax-free liquidations described in section 381(a) 
that occur on or after August 31, 2011.

[T.D. 9534, 76 FR 45675, Aug. 1, 2011, as amended by T.D. 9870, 84 FR 
33692, July 15, 2019]



Sec. 1.381(c)(5)-1  Inventory method.

    (a) Introduction--(1) Purpose. This section provides guidance 
regarding the inventory method an acquiring corporation must use 
following a distribution or transfer to which sections 381(a) and 
381(c)(5) apply and how to implement any associated change in method of 
accounting. See Sec. 1.381(c)(4)-1 for guidance regarding the method of 
accounting or combination of methods (other than inventory and 
depreciation methods) an acquiring corporation must use following a 
distribution or transfer to which sections 381(a) and 381(c)(4) apply. 
See Sec. 1.381(c)(6)-1 for guidance regarding the depreciation method 
an acquiring corporation must use following a distribution or transfer 
to which sections 381(a) and 381(c)(6) apply.
    (2) Carryover method requirement for separate and distinct trades or 
businesses. In a transaction to which section 381(a) applies, if an 
acquiring corporation continues to operate a trade or business of the 
parties to the section 381(a) transaction as a separate and distinct 
trade or business after the date of distribution or transfer, the 
acquiring corporation must use a carryover method as defined in 
paragraph (b)(4) of this section for each continuing trade or business, 
unless either the carryover method is impermissible and must be changed 
under paragraph (a)(4) of this section or the acquiring corporation 
changes the carryover method in accordance with paragraph (a)(5) of this 
section. The acquiring corporation need not secure the Commissioner's 
consent to continue a carryover method.
    (3) Principal method requirement for trades or businesses not 
operated as separate and distinct trades or businesses. In a transaction 
to which section 381(a) applies, if an acquiring corporation does not 
operate the trades or businesses of the parties to the section 381(a) 
transaction as separate and distinct trades or businesses after the date 
of distribution or transfer, the acquiring corporation must use a 
principal method determined under paragraph (c) of this section, unless 
either the principal method is impermissible and must be changed under 
paragraph (a)(4) of this section or the acquiring corporation changes 
the principal method in accordance with paragraph (a)(5) of this 
section. The acquiring corporation must change to a principal method in 
accordance with paragraph (d)(1) of this section for each integrated 
trade or business and need not secure the Commissioner's consent to use 
a principal method.

[[Page 602]]

    (4) Carryover method or principal method not a permissible method. 
If a carryover method or principal method is not a permissible inventory 
method, the acquiring corporation must secure the Commissioner's consent 
to change to a permissible inventory method as provided in paragraph 
(d)(2) of this section. If the acquiring corporation must use a single 
inventory method for a particular type of goods after the date of 
distribution or transfer regardless of the number of separate and 
distinct trades or businesses operated on that date, the acquiring 
corporation must use the principal method for that type of goods as 
determined under paragraph (c) of this section, unless either the 
principal method is impermissible and must be changed under this 
paragraph (a)(4) or the acquiring corporation changes the principal 
method in accordance with paragraph (a)(5) of this section.
    (5) Voluntary change. Any party to a section 381(a) transaction may 
request permission under section 446(e) to change an inventory method 
for the taxable year in which the transaction occurs or is expected to 
occur. For trades or businesses that will not operate as separate and 
distinct trades or businesses after the date of distribution or 
transfer, a change in method of accounting for the taxable year that 
includes that date will be granted only if the requested inventory 
method is the method that the acquiring corporation must use after the 
date of distribution or transfer. The time and manner of obtaining the 
Commissioner's consent to change to a different inventory method is 
described in paragraph (d)(2) of this section.
    (6) Examples. The following examples illustrate the rules of this 
paragraph (a). Unless otherwise noted, the carryover method is a 
permissible inventory method.
    (i) Example (1). Carryover method for separate and distinct trades 
or businesses after the date of distribution or transfer.
    (A) Facts. X Corporation manufactures radios and television sets. X 
Corporation uses the first-in, first-out (FIFO) method of inventory 
identification, the cost method of valuing its inventories, and 
capitalizes inventory costs in accordance with section 263A. T 
Corporation manufactures washing machines and dryers. T Corporation uses 
the last-in, first-out (LIFO) method of inventory identification, the 
cost method of valuing its inventories, and capitalizes inventory costs 
under section 263A using methods other than those used by X Corporation. 
X Corporation acquires the inventory of T Corporation in a transaction 
to which section 381(a) applies. After the date of distribution or 
transfer, X Corporation operates its radio and television manufacturing 
business as a trade or business that is separate and distinct from its 
washing machines and dryers manufacturing business.
    (B) Conclusion. Because after the date of distribution or transfer X 
Corporation operates its manufacturing businesses as separate and 
distinct trades or businesses, under paragraph (a)(2) of this section X 
Corporation must use the carryover methods for each continuing trade or 
business, unless either the carryover methods are impermissible and must 
be changed under paragraph (a)(4) of this section or X Corporation 
changes the carryover methods in accordance with paragraph (a)(5) of 
this section. As defined in paragraph (b)(4) of this section, the 
carryover methods for the radios and television sets manufacturing 
business are the FIFO method, the cost basis of valuation, and X 
Corporation's methods of accounting for section 263A costs immediately 
prior to the date of distribution or transfer. The carryover methods for 
the washing machines and dryers manufacturing business are the LIFO 
method, the cost basis of valuation, and T Corporation's methods of 
accounting for section 263A costs immediately prior to the date of 
distribution or transfer. There is no change in method of accounting, 
and X Corporation need not secure the Commissioner's consent to use any 
carryover method.
    (ii) Example (2). Carryover method not permissible.
    (A) Facts. X Corporation manufactures food and beverages and uses 
the

[[Page 603]]

FIFO method of inventory identification, the cost method of valuing its 
inventories, and capitalizes costs in accordance with section 263A. T 
Corporation sells sporting equipment. T Corporation uses the FIFO method 
of inventory identification and the cost method of valuing its 
inventories. T Corporation does not capitalize costs under section 263A 
because it meets the small business taxpayer exception under section 
263A. X Corporation acquires the inventory of T Corporation in a 
transaction to which section 381(a) applies. After the date of 
distribution or transfer, X Corporation operates the food and beverages 
business as a trade or business that is separate and distinct from the 
sporting equipment business, and X Corporation does not qualify for the 
small business taxpayer exception under section 263A for its sporting 
equipment business.
    (B) Conclusion. Because after the date of distribution or transfer X 
Corporation operates the food and beverages business as a separate and 
distinct trade or business, under paragraph (a)(2) of this section X 
Corporation must use the carryover methods for each continuing trade or 
business, unless either the carryover methods are impermissible and must 
be changed under paragraph (a)(4) of this section or X Corporation 
changes the carryover methods in accordance with paragraph (a)(5) of 
this section. As defined in paragraph (b)(4) of this section, the 
carryover methods for the food and beverages business are the FIFO 
method, the cost basis of valuation, and X Corporation's methods of 
capitalizing costs under section 263A immediately prior to the date of 
distribution or transfer. The carryover methods for the sporting 
equipment business are the FIFO method and the cost basis of valuation. 
There is no change in method of accounting, and X Corporation need not 
secure the Commissioner's consent to use any carryover method. However, 
because X Corporation does not qualify for the small business taxpayer 
exception under section 263A for its sporting equipment business, X 
Corporation's method of not capitalizing additional section 263A costs 
is an impermissible carryover method under paragraph (a)(4) of this 
section. X Corporation must secure the Commissioner's consent to change 
to a permissible method of capitalizing costs under section 263A for the 
sporting equipment business as provided in paragraph (d)(2) of this 
section.
    (b) Definitions. For purposes of this section--
    (1) Inventory method. An inventory method is a method of accounting 
used to account for merchandise on hand (including finished goods, work 
in process, and raw materials) at the beginning of a year for purposes 
of computing taxable income for that year. The term includes not only 
the method for identifying inventory, for example, the FIFO inventory 
method or the LIFO inventory method, but also all other methods 
necessary to account for merchandise.
    (2) Adoption of a method of accounting. Adoption of a method of 
accounting has the same meaning as provided in Sec. 1.446-1(e)(1).
    (3) Change in method of accounting. A change in method of accounting 
has the same meaning as provided in Sec. 1.446-1(e)(2).
    (4) Carryover method. A carryover method is an inventory method that 
each party to a section 381(a) transaction uses for each separate and 
distinct trade or business immediately prior to the date of distribution 
or transfer.
    (5) Principal method. A principal method is an inventory method that 
is determined under paragraph (c) of this section.
    (6) Permissible method of accounting. A permissible method of 
accounting is a method of accounting that is proper or permitted under 
the Internal Revenue Code or any applicable Income Tax Regulations.
    (7) Acquiring corporation. An acquiring corporation has the same 
meaning as provided in Sec. 1.381(a)-1(b)(2).
    (8) Distributor corporation. A distributor corporation means the 
corporation, foreign or domestic, that distributes its assets to another 
corporation described in section 332(b) in a distribution to which 
section 332 (relating to liquidations of subsidiaries) applies.

[[Page 604]]

    (9) Transferor corporation. A transferor corporation means the 
corporation, foreign or domestic, that transfers its assets to another 
corporation in a transfer to which section 361 (relating to 
nonrecognition of gain or loss to corporations) applies, but only if--
    (i) The transfer is in connection with a reorganization described in 
section 368(a)(1)(A), (a)(1)(C), or (a)(1)(F), or
    (ii) The transfer is in connection with a reorganization described 
in section 368(a)(1)(D) or (a)(1)(G), provided the requirements of 
section 354(b) are met.
    (10) Parties to the section 381(a) transaction. Parties to the 
section 381(a) transaction means the acquiring corporation and the 
distributor or transferor corporation that participate in a transaction 
to which section 381(a) applies.
    (11) Date of distribution or transfer. The date of distribution or 
transfer has the same meaning as provided in section 381(b)(2) and Sec. 
1.381(b)-1(b).
    (12) Separate and distinct trades or businesses. Separate and 
distinct trades or businesses has the same meaning as provided in Sec. 
1.446-1(d).
    (13) Audit protection. Audit protection means, for purposes of 
paragraph (d)(1) of this section, that the IRS will not require an 
acquiring corporation that is required to change a method of accounting 
under paragraph (a)(3) of this section to change that method for a 
taxable year ending prior to the taxable year that includes the date of 
distribution or transfer.
    (14) Section 481(a) adjustment. The section 481(a) adjustment means 
an adjustment that must be taken into account as required under section 
481(a) to prevent amounts from being duplicated or omitted when the 
taxable income of an acquiring corporation is computed under a method of 
accounting different from the method used to compute taxable income for 
the preceding taxable year.
    (15) Cut-off basis. A cut-off basis means a manner in which a change 
in method of accounting is made without a section 481(a) adjustment and 
under which only the items arising after the beginning of the year of 
change (or, in the case of a change made under paragraph (d)(1) of this 
section, after the date of distribution or transfer) are accounted for 
under the new method of accounting. When it implements the change on a 
cut-off basis, a taxpayer using the LIFO inventory method to identify 
its inventory goods that makes a change in method of accounting within 
the LIFO inventory method from one LIFO method or sub-method to another 
LIFO method or sub-method uses the new LIFO inventory method to 
determine its current-year cost and base-year cost of ending inventories 
for the year of change, but does not recompute the cost of beginning 
inventories for the year of change using the new LIFO inventory method.
    (16) Adjustment period. The adjustment period means the number of 
taxable years for taking into account the section 481(a) adjustment 
required as a result of a change in method of accounting.
    (17) Component trade or business. A component trade or business is a 
trade or business of a party to the section 381(a) transaction that will 
be combined and integrated with a trade or business of the other party 
to the section 381 transaction. See paragraph (e)(7)(ii) of this section 
for the determination of whether a trade or business is operated as a 
separate and distinct trade or business after the date of distribution 
or transfer.
    (c) Principal method--(1) In general. For each integrated trade or 
business, the principal method for a particular type of goods is 
generally the inventory method used by the component trade or business 
of the acquiring corporation immediately prior to the date of 
distribution or transfer for that type of goods. If, however, on the 
date of distribution or transfer the component trade or business of the 
distributor or transferor corporation holds more inventory of a type of 
goods than the component trade or business of the acquiring corporation, 
the principal method for such goods is the inventory method used by the 
component trade or business of the distributor or transferor corporation 
immediately prior to that date. For each integrated trade or business, 
the component trade or business of the distributor or transferor 
corporation holds more inventory if, for a particular type of goods, the 
aggregate of the fair market value of the

[[Page 605]]

goods held by each component trade or business of the distributor or 
transferor corporation exceeds the aggregate of the fair market value of 
the goods held by each component trade or business of the acquiring 
corporation immediately prior to the date of distribution or transfer. 
Alternatively, as a simplifying convention, the acquiring corporation 
may elect to apply the preceding sentence to the aggregate fair market 
value of the entire inventories, held by each component trade or 
business of the acquiring corporation and each component trade or 
business of the distributor or transferor corporation, that will be 
integrated after the date of distribution or transfer. If the component 
trade or business with the larger aggregate fair market value of the 
entire inventories does not have an inventory method for a particular 
type of goods immediately prior to the date of distribution or transfer, 
the principal method for that type of goods is the inventory method used 
by the component trade or business that does have an inventory method 
for that type of goods.
    (2) Multiple component trades or businesses with different principal 
methods. If a party to the section 381(a) transaction has multiple 
component trades or businesses and more than one principal inventory 
method for a particular type of goods, then the acquiring corporation 
may choose which of the inventory methods used by such component trades 
or businesses will be the principal method of the integrated trade or 
business. The acquiring corporation must choose a principal method that 
is a permissible method of accounting. In general, a change to a 
principal method in a transaction to which section 381(a) and paragraph 
(a)(3) of this section apply is made under paragraph (d)(1) of this 
section.
    (3) Examples. The following examples illustrate the rules of this 
paragraph (c). Unless otherwise noted, the principal method is a 
permissible inventory method.

    Example (1). Principal methods are the methods used by the acquiring 
corporation. (i) Facts. X Corporation and T Corporation each manufacture 
tennis equipment. X Corporation's manufacturing business uses the FIFO 
method of inventory identification, the cost method of valuing 
inventories, and allocates indirect costs to the property produced using 
the burden rate method provided in Sec. 1.263A-1(f)(3)(i). T 
Corporation's manufacturing business uses the LIFO method of inventory 
identification, the cost method of valuing its inventories, and 
allocates indirect costs to the property it produces using the standard 
cost method provided in Sec. 1.263A-1(f)(3)(ii). X Corporation acquires 
the inventory of T Corporation in a transaction to which section 381(a) 
applies. The fair market value of each particular type of goods held by 
X Corporation's manufacturing business immediately prior to the date of 
distribution or transfer exceeds the fair market value of each 
particular type of goods held by T Corporation's manufacturing business 
on that date. After the date of distribution or transfer, X Corporation 
will not operate its manufacturing business as a trade or business that 
is separate and distinct from T Corporation's manufacturing business.
    (ii) Conclusion. Because after the date of distribution or transfer 
X Corporation will not operate its manufacturing business as a separate 
and distinct trade or business, X Corporation must use the principal 
methods under paragraph (a)(3) of this section, unless either the 
principal methods are impermissible and must be changed under paragraph 
(a)(4) of this section or X Corporation changes the principal methods in 
accordance with paragraph (a)(5) of this section. The fair market value 
of each particular type of goods held by T Corporation's manufacturing 
business immediately prior to the date of distribution or transfer does 
not exceed the fair market value of each particular type of goods held 
by X Corporation's manufacturing business on that date. Because on the 
date of distribution or transfer T Corporation's manufacturing business 
does not hold more inventory than X Corporation's manufacturing 
business, the principal methods are the FIFO method of inventory 
identification, the cost method of valuation, and X Corporation's method 
of allocating indirect costs under section 263A using the burden rate 
method. X Corporation need not secure the Commissioner's consent to use 
these methods. However, in accordance with paragraph (d)(1) of this 
section, X Corporation must change the inventory methods for the 
manufacturing business acquired from T Corporation to the principal 
methods.
    Example (2). Principal methods are the methods used by the acquiring 
corporation. (i) Facts. The facts are the same as in Example (1), except 
that the fair market value of each particular type of goods held by X 
Corporation's manufacturing business immediately prior to the date of 
distribution or transfer is identical to the fair market value of each 
particular type of goods held by T Corporation's manufacturing business 
on that date.

[[Page 606]]

    (ii) Conclusion. The result is the same as in Example (1). The 
principal methods are the FIFO method of inventory identification, the 
cost method of valuation, and X Corporation's method of allocating 
indirect costs under section 263A using the burden rate method. X 
Corporation need not secure the Commissioner's consent to use the 
principal methods. However, in accordance with paragraph (d)(1) of this 
section, X Corporation must change the inventory methods for the 
manufacturing business acquired from T Corporation to the principal 
methods.
    Example (3). Principal methods are the methods used by the 
distributor or transferor corporation. (i) Facts. The facts are the same 
as in Example (1), except that the fair market value of each particular 
type of goods held by T Corporation's manufacturing business immediately 
prior to the date of distribution or transfer exceeds the fair market 
value of each particular type of goods held by X Corporation's 
manufacturing business on that date.
    (ii) Conclusion. Because after the date of distribution or transfer 
X Corporation will not operate its manufacturing business as a separate 
and distinct trade or business, X Corporation must use the principal 
methods under paragraph (a)(3) of this section, unless either the 
principal methods are impermissible and must be changed under paragraph 
(a)(4) of this section or X Corporation changes the principal methods in 
accordance with paragraph (a)(5) of this section. The fair market value 
of each particular type of goods held by T Corporation's manufacturing 
business immediately prior to the date of distribution or transfer 
exceeds the fair market value of each particular type of goods held by X 
Corporation's manufacturing business on that date. Because on the date 
of distribution or transfer T Corporation's manufacturing business holds 
more inventory than X Corporation's manufacturing business, the 
principal methods are the LIFO method of inventory identification, the 
cost method of valuation, and T Corporation's method of allocating 
indirect costs under section 263A using the standard cost method. X 
Corporation need not secure the Commissioner's consent to use the 
principal methods. However, in accordance with paragraph (d)(1) of this 
section, X Corporation must change the inventory methods for the 
manufacturing business operated by X Corporation prior to the date of 
distribution or transfer to the principal methods.
    Example (4). Voluntary change allowable. (i) Facts. The facts are 
the same as in Example (1), except that T Corporation wants to 
discontinue using the LIFO method for its manufacturing business and 
change to the FIFO method for the taxable year in which the section 
381(a) transaction occurs or is expected to occur.
    (ii) Conclusion. Under paragraph (a)(5) of this section, the 
Commissioner will grant a request to change a method of accounting for 
the taxable year that includes the date of distribution or transfer only 
if the requested method is the method that the acquiring corporation 
must use after the date of distribution or transfer. The Commissioner 
will consent to a request by T Corporation to change to the FIFO method 
for the taxable year in which the section 381(a) transaction occurs or 
is expected to occur because X Corporation will use this method after 
the date of distribution or transfer.
    Example (5). Principal method determination when larger component 
trade or business does not have a method of accounting for a particular 
type of goods. (i) Facts. The facts are the same as in Example (1), 
except that T Corporation's manufacturing business has a particular type 
of goods that is not held by X Corporation's manufacturing business.
    (ii) Conclusion. The result is similar to Example (1). In general, 
the principal methods are the FIFO method of inventory identification, 
the cost method of valuation, and X Corporation's method of allocating 
indirect costs to the property produced using the burden rate method. X 
Corporation need not secure the Commissioner's consent to use the 
principal methods. However, in accordance with paragraph (d)(1) of this 
section, X Corporation must change the inventory methods for the 
manufacturing business acquired from T Corporation to the principal 
methods. Under paragraph (c) of this section, the principal methods for 
the particular type of goods held only by T Corporation's manufacturing 
business are the LIFO method of inventory identification, the cost 
method of valuation, and T Corporation's method of allocating indirect 
costs to the property it produces using the standard cost method. X 
Corporation must determine whether the principal methods for the type of 
goods previously held by T Corporation are permissible given that such 
methods are different than the principal methods that must be used by X 
for all other goods. If X Corporation's use of the standard cost method 
would be impermissible after the date of distribution or transfer, X 
Corporation must change to a permissible method under section 263A for 
those goods in accordance with paragraph (a)(4) of this section.
    Example (6). Inventory convention elected. (i) Facts. X Corporation 
manufactures planes and T Corporation manufactures planes and 
communications satellites. X Corporation's manufacturing business uses 
the FIFO method of inventory identification and values its inventories 
at cost or market, whichever is lower, while T Corporation's 
manufacturing business uses the LIFO method of inventory identification 
and values its inventories at cost. X Corporation's manufacturing 
business and T Corporation's manufacturing

[[Page 607]]

business use the same methods to capitalize costs under section 263A. X 
Corporation acquires the inventory of T Corporation in a transaction to 
which section 381(a) applies. In lieu of determining the fair market 
value of each particular type of goods held on the date of distribution 
or transfer, X Corporation elects to value the entire inventories of its 
manufacturing business and the entire inventories of T Corporation's 
manufacturing business in accordance with paragraph (c)(1) of this 
section. The fair market value of the inventory held by T Corporation's 
manufacturing business immediately prior to the date of distribution or 
transfer does not exceed the fair market value of the inventory held by 
X Corporation's manufacturing business on that date. After the date of 
distribution or transfer, X Corporation will not operate its 
manufacturing business as a trade or business that is separate and 
distinct from T Corporation's manufacturing business.
    (ii) Conclusion. Because after the date of distribution or transfer 
X Corporation will not operate its manufacturing business as a separate 
and distinct trade or business, X Corporation must use the principal 
methods under paragraph (a)(3) of this section, unless either the 
principal methods are impermissible and must be changed under paragraph 
(a)(4) of this section or X Corporation changes the principal methods in 
accordance with paragraph (a)(5) of this section. The fair market value 
of the entire inventory held by T Corporation's manufacturing business 
immediately prior to the date of distribution or transfer does not 
exceed the fair market value of the entire inventory of X Corporation's 
manufacturing business on that date. Because on the date of distribution 
or transfer T Corporation's manufacturing business does not hold more 
inventory than X Corporation's manufacturing business, the principal 
methods are the FIFO method, the cost or market, whichever is lower, 
method of valuation, and X Corporation's method of capitalizing costs 
under section 263A on the date of distribution or transfer. X 
Corporation need not secure the Commissioner's consent to use the 
principal methods. However, in accordance with paragraph (d)(1) of this 
section, X Corporation must change the inventory methods for the 
manufacturing business acquired from T Corporation to the principal 
methods.
    Example (7). Principal method determination with a combined trade or 
business and a separate and distinct trade or business. (i) Facts. X 
Corporation manufactures tennis equipment in a trade or business that is 
separate and distinct from its trade or business of manufacturing golf 
equipment. X Corporation uses the FIFO method of inventory 
identification for its tennis equipment and the LIFO method of inventory 
identification for its golf equipment. X Corporation values the goods in 
both inventories at cost and allocates indirect costs to the property 
produced using the burden rate method provided in Sec. 1.263A-
1(f)(3)(i). T Corporation manufactures tennis equipment. T Corporation's 
manufacturing business uses the FIFO method of inventory identification, 
values inventories at cost, and allocates indirect costs to the property 
it produces using the standard cost method provided in Sec. 1.263A-
1(f)(3)(ii). X Corporation acquires the inventory of T Corporation in a 
transaction to which section 381(a) applies. Immediately prior to the 
date of distribution or transfer, the fair market value of T 
Corporation's inventories in the tennis equipment manufacturing business 
exceeds the fair market value of the inventories held by X Corporation's 
tennis equipment manufacturing business. After the date of distribution 
or transfer, X Corporation will not operate its tennis equipment 
manufacturing business as a trade or business that is separate and 
distinct from T Corporation's tennis equipment manufacturing business, 
but X Corporation will operate its golf equipment manufacturing business 
as a trade or business that is separate and distinct from the tennis 
equipment manufacturing business.
    (ii) Conclusion. Because after the date of distribution or transfer 
X Corporation will not operate its tennis equipment manufacturing 
business as a separate and distinct trade or business, X Corporation 
must use the principal methods under paragraph (a)(3) of this section, 
unless either the principal methods are impermissible and must be 
changed under paragraph (a)(4) of this section or X Corporation changes 
the principal methods in accordance with paragraph (a)(5) of this 
section. Under paragraph (c)(1) of this section, X Corporation elects to 
compare the fair market values of the entire inventories of the 
component trades or businesses on the date of distribution or transfer 
to determine whether T Corporation holds more inventory than X 
Corporation. The fair market value of the inventory held by T 
Corporation's tennis equipment manufacturing business exceeds the fair 
market value of the tennis equipment held by X Corporation's tennis 
equipment manufacturing business. Because on the date of distribution or 
transfer T Corporation's tennis equipment manufacturing business holds 
more inventory than X Corporation's tennis equipment manufacturing 
business, the principal methods for the combined tennis equipment 
business are the FIFO method of inventory identification, the cost basis 
of valuation, and T Corporation's methods of allocating indirect costs 
under section 263A using the standard cost method provided in Sec. 
1.263A-1(f)(3)(ii). X Corporation need not secure the Commissioner's 
consent to use the principal methods. However, in accordance with 
paragraph (d)(1) of this section, X Corporation must change the methods 
of accounting for its tennis equipment manufacturing business to the 
principal

[[Page 608]]

methods. Under paragraph (a)(2) of this section, because X Corporation 
will operate the golf equipment manufacturing business as a separate 
trade or business, for the inventories held by the golf equipment 
manufacturing business X Corporation must continue to use the LIFO 
method of inventory identification, use the cost basis of valuation, and 
allocate indirect costs under section 263A using the burden rate method 
provided in Sec. 1.263A-1(f)(3)(i). There are no changes in method of 
accounting for the golf manufacturing business, and X Corporation need 
not secure the Commissioner's consent to use these carryover methods.
    Example (8). Principal method determination with multiple component 
trades or businesses. (i) Facts. The facts are the same as in Example 
(7), except that after the date of distribution or transfer X 
Corporation will not operate the golf equipment manufacturing business 
as a trade or business that is separate and distinct from the tennis 
equipment manufacturing business. In addition, the fair market value of 
the inventories of X Corporation's tennis equipment manufacturing 
business and golf equipment manufacturing business, in the aggregate, 
exceed the fair market value of the inventories of T Corporation's 
tennis equipment manufacturing business.
    (ii) Conclusion. Because on the date of distribution or transfer T 
Corporation's tennis equipment manufacturing business does not hold more 
inventory than X Corporation's tennis equipment manufacturing business 
and golf equipment manufacturing business, in the aggregate, the 
principal method for identifying inventory is the method used by X 
Corporation's component trade or business on the date of distribution or 
transfer. However, because on the date of distribution or transfer X 
Corporation operates two separate and distinct trades or businesses with 
different inventory identification methods that will be combined after 
the date of distribution or transfer, X Corporation may choose under 
paragraph (c)(2) of this section which method used by its component 
trades or businesses will be the principal method. After the date of 
distribution or transfer, X Corporation may use either the FIFO method 
of inventory identification used by the tennis equipment manufacturing 
business or the LIFO method of inventory identification used by the golf 
equipment manufacturing business as the principal method of 
identification, if either method is a permissible method. For the 
integrated trade or business, X Corporation will use the cost method of 
valuation and allocate indirect costs under section 263A using the 
burden rate method provided in Sec. 1.263A-1(f)(3)(i). In accordance 
with paragraph (d)(1) of this section, X Corporation must change the 
inventory methods of T Corporation's manufacturing business to the 
principal methods. Under paragraph (a)(3) of this section, X Corporation 
also must change either its golf equipment manufacturing business or its 
tennis equipment manufacturing business, depending on which principal 
method X Corporation selects, to the principal method.

    (d) Procedures for changing a method of accounting--(1) Change made 
to principal method under paragraph (a)(3) of this section--(i) Section 
481(a) adjustment--(A) In general. An acquiring corporation that changes 
its method of accounting or the distributor or transferor corporation's 
method of accounting under paragraph (a)(3) of this section does not 
need to secure the Commissioner's consent to use a principal method. To 
the extent the use of a principal method constitutes a change in method 
of accounting, the change in method is treated as a change initiated by 
the acquiring corporation for purposes of section 481(a)(2). Any change 
to a principal method, whether the change relates to a trade or business 
of the acquiring corporation or a trade or business of the distributor 
or transferor corporation, must be reflected on the acquiring 
corporation's federal income tax return for the taxable year that 
includes the date of distribution or transfer. The amount of the section 
481(a) adjustment and the adjustment period, if any, necessary to 
implement a change to the principal method are determined under Sec. 
1.446-1(e) and the applicable administrative procedures that govern 
voluntary changes in methods of accounting under section 446(e). If the 
Internal Revenue Code, the Income Tax Regulations, or administrative 
procedures require that a method of accounting be implemented on a cut-
off basis, the acquiring corporation must implement the change, on a 
cut-off basis as of the date of distribution or transfer, on its federal 
income tax return for the taxable year that includes the date of 
distribution or transfer. If the Internal Revenue Code, the Income Tax 
Regulations, or administrative procedures require a section 481(a) 
adjustment, the acquiring corporation must determine the section 481(a) 
adjustment and include the appropriate amount of the section 481(a) 
adjustment on its federal income

[[Page 609]]

tax return for the taxable year that includes the date of distribution 
or transfer and subsequent taxable year(s), as necessary. This 
adjustment is determined by the acquiring corporation as of the 
beginning of the day that is immediately after the date of distribution 
or transfer.
    (B) Example. The following example illustrates the rules of this 
paragraph (d)(1)(i):

    Example. X Corporation uses the FIFO method of inventory 
identification, and T Corporation uses the LIFO method of inventory 
identification. X Corporation acquires the inventory of T Corporation in 
a transaction to which section 381(a) applies. X Corporation determines 
that under the rules of paragraph (c)(1) of this section, X Corporation 
must change the inventory method for the business acquired from T 
Corporation to the FIFO method. X Corporation will determine the section 
481(a) adjustment pertaining to the change to the FIFO method (whether 
the amounts thereof represent increases or decreases in income) as of 
the beginning of the day that immediately follows the day on which X 
Corporation acquires the inventory of T Corporation. X Corporation will 
reflect this adjustment, or an appropriate part thereof, on its federal 
income tax return for the taxable year that includes the date of 
distribution or transfer.

    (ii) Audit protection. Notwithstanding any other provision in any 
other Income Tax Regulation or administrative procedure, no audit 
protection is provided for any change in method of accounting under 
paragraph (d)(1) of this section.
    (iii) Other terms and conditions. Except as otherwise provided in 
this section, other terms and conditions provided in Sec. 1.446-1(e) 
and the applicable administrative procedures for voluntary changes in 
method of accounting under section 446(e) apply to a change in method of 
accounting under this section. Thus, for example, if the administrative 
procedures for a particular change in method of accounting have a term 
and condition that provides for the acceleration of the section 481(a) 
adjustment period, this term and condition applies to a change made 
under this paragraph (d)(1). However, any scope limitation in the 
applicable administrative procedures will not apply for purposes of 
making a change under this paragraph (d)(1). For example, if the 
administrative procedures provide as a limitation that an identical 
change in method of accounting is barred for a period of years, this 
limitation will not bar a change to the principal method made under this 
section.
    (2) Change made to a method of accounting under paragraph (a)(4) or 
(a)(5) of this section--(i) In general. A party to a section 381(a) 
transaction that changes a method of accounting under either paragraph 
(a)(4) or paragraph (a)(5) of this section must follow the provisions of 
Sec. 1.446-(1)(e) and the applicable administrative procedures, 
including scope limitations, for voluntary changes in method of 
accounting under section 446(e), except as provided in paragraphs 
(d)(2)(ii) and (d)(2)(iii) of this section. An application on Form 3115, 
``Application for Change in Accounting Method,'' filed with the IRS to 
change a method of accounting under this paragraph (d)(2) should be 
labeled ``Filed under section 381(c)(5)'' at the top.
    (ii) Final year limitation. Any scope limitation relating to the 
final year of a trade or business will not apply to a taxpayer that 
changes its method of accounting in the final year of a trade or 
business that is terminated as the result of a section 381(a) 
transaction.
    (iii) Time to file. Under the authority of Sec. 1.446-1(e)(3)(ii), 
for a change in method of accounting requiring advance consent, the 
application for a change in method of accounting (for example, Form 
3115), must be filed with the IRS on or before the later of--
    (A) The due date for filing a Form 3115 as specified in Sec. 1.446-
1(e), for example, the last day of the taxable year in which the 
distribution or transfer occurred, or
    (B) The earlier of--
    (1) The day that is 180 days after the date of distribution or 
transfer, or
    (2) The day on which the acquiring corporation files its federal 
income tax return for the taxable year in which the distribution or 
transfer occurred.
    (e) Rules and procedures--(1) Inventory method selected for a 
particular type of goods. If other sections of the Internal Revenue Code 
or Income Tax Regulations allow a taxpayer to elect an inventory method 
for a particular type of goods, the method elected with respect

[[Page 610]]

to those goods is the established inventory method only for those goods. 
For example, an election to use the LIFO inventory method to identify 
specified goods in inventory, such as certain products in finished 
goods, is the inventory method only for those products.
    (2) No method of accounting. If a party to a section 381(a) 
transaction is not using an inventory method, does not have an inventory 
method for a particular type of goods, or came into existence as a 
result of the transaction, the party will not be treated as having an 
inventory method different from that used by another party to the 
section 381(a) transaction.
    (3) Elections and adoptions allowed. If an election does not require 
the Commissioner's consent, an acquiring corporation or a distributor or 
transferor corporation is not precluded from making any election that is 
otherwise permissible for the taxable year that includes the date of 
distribution or transfer. For example, an acquiring corporation may 
elect to identify its inventory using the LIFO inventory method in the 
year of the distribution or transfer. For purposes of this section, a 
corporation shall be deemed as having made any election as of the first 
day of the taxable year that includes the date of distribution or 
transfer. Similarly, where adoption is permissible, an acquiring 
corporation or a distributor or transferor corporation may adopt any 
permissible method of accounting for the taxable year that includes the 
date of distribution or transfer.
    (4) Elections continue after section 381(a) transaction--(i) General 
rule. An acquiring corporation is not required to renew any election not 
requiring renewal and previously made by it or by a distributor or 
transferor corporation for a carryover method or a principal method if 
the acquiring corporation uses the method after the section 381(a) 
transaction. If the acquiring corporation uses a method after the date 
of distribution or transfer, an election made by the acquiring 
corporation or by a distributor or transferor corporation for that 
method that was in effect on the date of distribution or transfer 
continues after the section 381(a) transaction as though the 
distribution or transfer had not occurred.
    (ii) Example. The following example illustrates the rules of 
paragraph (e)(4):

    Example. Since its incorporation in 1982, X Corporation elected to 
use the LIFO inventory method under section 472 to identify its 
inventory of tennis balls. Since its incorporation in 2002, T 
Corporation elected to use the FIFO inventory method to identify its 
inventory of tennis balls. X Corporation acquires the assets of T 
Corporation in a transaction to which section 381(a) applies. 
Immediately prior to the date of distribution or transfer, the fair 
market value of X Corporation's inventory in its tennis balls exceeds 
the fair market value of the tennis balls inventory held by T 
Corporation. After the date of distribution or transfer, X Corporation 
will not operate its business as a trade or business that is separate 
and distinct from T Corporation's business. Because on the date of 
distribution or transfer T Corporation does not hold more inventory than 
X Corporation, the principal method for identifying inventory is the 
method used by X Corporation on the date of distribution or transfer. 
After the date of distribution or transfer, X Corporation need not renew 
its election to identify inventory using the LIFO inventory method, and 
X Corporation is bound by the election.

    (5) Adopting the LIFO inventory method. A party to a section 381(a) 
transaction will be deemed to be using the LIFO inventory method for a 
particular type of goods on the date of distribution or transfer if that 
party elects under section 472 to adopt that inventory method with 
respect to those goods for its taxable year within which the date of 
distribution or transfer occurs. See section 472 for the requirements to 
adopt the LIFO inventory method.
    (6) Inventory layers treatment--(i) Adjustments required after a 
section 381(a) transaction. An acquiring corporation that determines the 
principal method of taking an inventory after a section 381(a) 
transaction under paragraphs (a)(3) and (c) of this section after the 
date of distribution or transfer may need to integrate inventories and 
make appropriate adjustments as provided in paragraphs (e)(6)(ii) and 
(e)(6)(iii) of this section.
    (ii) LIFO inventory method used after the section 381(a) 
transaction--(A) LIFO inventory method used by the acquiring

[[Page 611]]

corporation and the distributor or transferor corporation--(1) Principal 
method is the dollar-value LIFO method. If, under paragraphs (a)(3) and 
(c) of this section, the acquiring corporation changes its inventory 
method or the inventory method of the distributor or transferor 
corporation from the specific goods LIFO method of pricing inventories 
to the dollar-value LIFO method of pricing inventories (dollar-value 
LIFO method) for a particular type of goods, the inventory accounted for 
under the specific goods method shall be placed on the dollar-value 
method as provided in Sec. 1.472-8(f), and then the inventory shall be 
integrated with the inventory previously accounted for under the dollar-
value LIFO method. If pools of each corporation are permitted or 
required to be combined, the pools must be combined as provided in Sec. 
1.472-8(g)(2). For purposes of combining pools, all base year 
inventories or layers of increment that occur in taxable years including 
the same December 31 shall be combined. A base year inventory or layer 
of increment occurring in any short taxable year of a distributor or 
transferor corporation shall be merged with and considered a layer of 
increment of its immediately preceding taxable year.
    (2) Principal method is the specific goods LIFO method. If, under 
paragraphs (a)(3) and (c) of this section, the acquiring corporation 
changes its inventory method or the inventory method of the distributor 
or transferor corporation from the dollar-value LIFO method of pricing 
inventories to the specific goods LIFO method of pricing inventories, 
the acquiring corporation shall treat the inventory being changed to the 
specific goods LIFO method as having the same acquisition dates and 
costs as such inventory had under the dollar-value LIFO method.
    (B) Change from the FIFO inventory method to either the specific 
goods LIFO method or the dollar-value LIFO method. If, under paragraphs 
(a)(3) and (c) of this section, the acquiring corporation changes its 
inventory method or the inventory method of the distributor or 
transferor corporation from the FIFO inventory method to either the 
specific goods LIFO method or the dollar-value method of pricing LIFO 
inventories, the inventory accounted for under the FIFO inventory method 
shall be treated by the acquiring corporation as having been acquired at 
their average unit cost in a single transaction on the date of the 
distribution or transfer. Thus, if an inventory of a particular type of 
goods is combined in an existing dollar-value pool, the goods shall be 
treated as if they were purchased by the acquiring corporation at the 
average unit cost on the date of the distribution or transfer with 
respect to such pool. Alternatively, if the goods are not combined in an 
existing pool, the goods will be treated as if they were purchased by 
the acquiring corporation at the average unit cost on the date of the 
distribution or transfer with respect to a new pool, with the base-year 
being the year of the section 381(a) transaction. Adjustments resulting 
from a restoration to cost of any write-down to market value of the 
inventories shall be taken into account by the acquiring corporation 
ratably in each of the three taxable years beginning with the taxable 
year that includes the date of the distribution or transfer. See section 
472(d).
    (iii) FIFO inventory method used after the section 381(a) 
transaction--(A) FIFO inventory method used by the acquiring corporation 
and the distributor or transferor corporation. If, under paragraphs 
(a)(3) and (c) of this section, the FIFO inventory method is the 
principal method and the component trades or businesses of both the 
acquiring corporation and the distributor or transferor corporation use 
the FIFO method immediately prior to the distribution or transfer, the 
acquiring corporation must treat the inventory that must change to the 
principal method as having the same acquisition dates and costs as such 
inventory had immediately prior to the date of distribution or transfer. 
However, if the principal method of valuing inventories is the cost or 
market, whichever is lower, method, the acquiring corporation must treat 
the inventories that must change to the principal method as having been 
acquired at cost or market, whichever is lower.
    (B) Change from either the specific goods LIFO method or the dollar-
value LIFO method to the FIFO inventory

[[Page 612]]

method. If, under paragraphs (a)(3) and (c) of this section, the 
acquiring corporation changes its inventory method or the inventory 
method of the distributor or transferor corporation from either the 
specific goods LIFO method or the dollar-value LIFO method to the FIFO 
inventory method, the acquiring corporation must treat the inventory 
accounted for under the LIFO method as having the same acquisition dates 
and costs that the inventory would have had if the FIFO inventory method 
had been used on the date of distribution or transfer. However, if the 
principal method of valuing inventories is the cost or market, whichever 
is lower, method, the acquiring corporation must treat the inventories 
accounted for under the LIFO method as having been acquired at cost or 
market, whichever is lower.
    (7) Appropriate times for certain determinations--(i) Determining 
the inventory method. The inventory method used by a party to a section 
381(a) transaction on the date of distribution or transfer is the method 
used by that party as of the end of the day that is immediately prior to 
the date of distribution or transfer.
    (ii) Determining whether there are separate and distinct trades or 
businesses after the date of distribution or transfer. Whether an 
acquiring corporation will operate the trades or businesses of the 
parties to a section 381(a) transaction as separate and distinct trades 
or businesses after the date of distribution or transfer will be 
determined as of the date of distribution or transfer based upon the 
facts and circumstances. Intent to combine books and records of the 
trades or businesses may be demonstrated by contemporaneous records and 
documents or by other objective evidence that reflects the acquiring 
corporation's ultimate plan of operation, even though the actual 
combination of the books and records may extend beyond the end of the 
taxable year that includes the date of distribution or transfer.
    (8) Establishing an inventory method. An inventory method used by 
the distributor or transferor corporation immediately prior to the date 
of distribution or transfer that continues to be used by the acquiring 
corporation after the date of distribution or transfer is an established 
method of accounting for purposes of section 446(e), whether or not such 
method is proper or is permitted under the Internal Revenue Code or any 
applicable Income Tax Regulations.
    (9) Other applicable provisions. This section does not preempt any 
other provision of the Internal Revenue Code or the Income Tax 
Regulations that is applicable to the acquiring corporation's 
circumstances. Section 381(c)(5) and this Sec. 1.381(c)(5)-1 determine 
only the inventory method to be used after a section 381(a) transaction. 
If other paragraphs of section 381(c) apply for purposes of determining 
the methods of accounting to be used following the date of distribution 
or transfer, section 381(c)(5) and this Sec. 1.381(c)(5)-1 will not 
apply to the tax treatment of the items. Specifically, section 381(c)(5) 
and this Sec. 1.381(c)(5)-1 do not apply to assets other than inventory 
that an acquiring corporation obtains in a transaction to which section 
381(a) applies.
    (10) Use of the cash receipts and disbursements method of 
accounting. If immediately prior to the date of distribution or 
transfer, an acquiring corporation or a distributor or transferor 
corporation uses the cash receipts and disbursements method of 
accounting within the meaning of section 446(c)(1) and Sec. 1.446-
1(c)(1)(i), or is not required to use an inventory method for its goods, 
section 381(c)(5) and Sec. 1.381(c)(5)-1 do not apply. Instead, section 
381(c)(4) and Sec. 1.381(c)(4)-1 must be applied to determine the 
methods of accounting that continue after the transaction.
    (11) Character of items of income and deduction. After the date of 
distribution or transfer, items of income and deduction have the same 
character in the hands of the acquiring corporation as they would have 
had in the hands of the distributor or transferor corporation if no 
distribution or transfer had occurred.
    (12) Impermissible inventory method. This section does not limit the 
Commissioner's ability under section 446(b) to determine whether a 
taxpayer's inventory method is an impermissible

[[Page 613]]

method or otherwise fails to clearly reflect income. For example, an 
acquiring corporation may not use the method of accounting determined 
under paragraph (a)(2) of this section if the method fails to clearly 
reflect the acquiring corporation's income within the meaning of section 
446(b).
    (f) Effective/applicability date. This section applies to corporate 
reorganizations and tax-free liquidations described in section 381(a) 
that occur on or after August 31, 2011. The designations of paragraphs 
(a)(6)(ii)(A) and (B) of this section and removal of the term ``small 
reseller'' and replacement with the term ``small business taxpayer'' 
apply to taxable years beginning on or after January 5, 2021.

[T.D. 9534, 76 FR 45682, Aug. 1, 2011; 76 FR 53820, Aug. 30, 2011; T.D. 
9942, 86 FR 268, Jan. 5, 2021]



Sec. 1.381(c)(6)-1  Depreciation method.

    (a) Carryover requirement--(1) Distributions in taxable years ending 
before July 25, 1969. (i) Section 381(c)(6) provides that if, in a 
transaction in a taxable year which ends before July 25, 1969, to which 
section 381(a) applies, an acquiring corporation acquires depreciable 
property from a distributor or transferor corporation which computes its 
allowance for the depreciation of the property under section 167(b)(2), 
(3), or (4), the acquiring corporation shall compute its depreciation 
allowance by the same method used by the distributor or transferor 
corporation with respect to such property. Thus, if the distributor or 
transferor corporation used the sum of the years-digits method under 
section 167(b)(3) with respect to an asset distributed or transferred to 
an acquiring corporation, the acquiring corporation will be required to 
use the sum of the years-digits method with respect to such asset 
acquired. The computation of the depreciation allowance with respect to 
the property acquired shall be made under the provisions of section 167 
and the regulations thereunder.
    (ii) The rules provided in section 381(c)(6) and subdivision (i) of 
this subparagraph will apply only with respect to that part or all of 
the basis of the property in the hands of the acquiring corporation 
immediately after the date of distribution or transfer as does not 
exceed the basis of the property in the hands of the distributor or 
transferor corporation on the date of the distribution or transfer. For 
this purpose, the basis of the property in the hands of the distributor 
or transferor corporation shall be the adjusted basis provided in 
section 1011 for the purpose of determining gain on the sale or other 
disposition of such property. For provisions defining the date of 
distribution or transfer see Sec. 1.381(b)-1(b).
    (2) Distributions in taxable years ending after July 24, 1969. (i) 
Section 381(c)(6) provides that if, in a transaction in a taxable year 
ending after July 24, 1969, to which section 381(a) applies, an 
acquiring corporation acquires depreciable property from a distributor 
or transferor corporation which computes its allowances for the 
depreciation of the property under subsection (b), (j), or (k) of 
section 167, the acquiring corporation shall compute its depreciation 
allowance by the same method used by the distributor or transferor 
corporation with respect to such property. Thus, if the distributor or 
transferor corporation used the straight line method under section 
167(b)(1) with respect to an asset distributed or transferred to an 
acquiring corporation, the acquiring corporation will be required to use 
the straight line method with respect to such asset. Similarly, if the 
distributor or transferor corporation elected to compute depreciation 
under section 167(k) with respect to property attributable to 
rehabilitation expenditures, and such property is transferred to an 
acquiring corporation, the acquiring corporation will be required to 
compute depreciation under section 167(k) with respect to the property 
acquired. The computation of the depreciation allowance with respect to 
the property acquired shall be made under the provisions of section 167 
and the regulations thereunder.
    (ii) The rules provided in section 381(c)(6) and subdivision (i) of 
this subparagraph shall apply only with respect to that part or all of 
the basis of the property in the hands of the acquiring corporation 
immediately after the date of distribution or transfer as does not 
exceed the basis of the property in

[[Page 614]]

the hands of the distributor or transferor corporation on the date of 
the distribution or transfer. For this purpose, the basis of the 
property in the hands of the distributor or transferor corporation shall 
be the adjusted basis provided in section 1011 for the purpose of 
determining gain on the sale or other disposition of such property. For 
provisions defining the date of distribution or transfer see Sec. 
1.38(b)-1(b).
    (b) Portion in excess of distributor or transferor corporation's 
basis--(1) General rule. With respect to that part of the basis of the 
depreciable property (other than certain section 1250 property described 
in subparagraph (2) of this paragraph) which in the hands of the 
acquiring corporation exceeds the adjusted basis to the distributor or 
transferor corporation, the acquiring corporation may use any reasonable 
method of computing depreciation, other than the methods provided in 
section 167(b)(2), (3), or (4). See paragraph (b) of Sec. 1.167(b)-0 
for methods which are acceptable under section 167(a) with respect to 
such property. See also sections 334(b)(1) and 362(b) for the 
determination of basis of property in the hands of the acquiring 
corporation in connection with a transaction to which section 381(a) 
applies.
    (2) Section 1250 property. With respect to that part of the basis of 
section 1250 property acquired after July 24, 1969, which in the hands 
of the acquiring corporation exceeds the adjusted basis to the 
distributor or transferor corporation, the acquiring corporation shall 
be subject to the limitations contained in section 167(j)(4) (relating 
to used section 1250 property) or 167(j)(5) (relating to used 
residential rental property). Thus, for example, if section 1250 
property which is not residential rental property is acquired in a 
section 381(a) transaction after July 24, 1969, the straight line method 
of depreciation (or other method allowable under section 167(j)(4)(B)) 
is the only acceptable method with respect to that portion of the basis 
of the property which, in the hands of the acquiring corporation, 
exceeds the adjusted basis to the transferor or distributor corporation.
    (c) Records required. Records shall be maintained in sufficient 
detail to identify any depreciable property to which this section 
applies, and to establish the basis thereof.
    (d) Agreement under section 167(d). To the extent not inconsistent 
with paragraph (b) of this section, an acquiring corporation shall be 
treated as the distributor or transferor corporation in the case of an 
agreement between the distributor or transferor corporation and the 
district director under section 167(d) and Sec. 1.167(d)-1 with respect 
to property to which section 381(c)(6) and this section apply. Thus, in 
the case where the basis of an asset in the hands of an acquiring 
corporation exceeds the basis of such asset in the hands of the 
distributor or the transferor corporation, such an agreement will not 
have the effect of permitting the acquiring corporation to compute its 
depreciation allowance with respect to such excess basis under the 
methods provided in section 167(b)(2), (3), or (4). However, the 
provisions of the agreement will continue to apply with respect to the 
useful life of the asset.
    (e) Change of method of depreciation. Although the acquiring 
corporation is required to use the method of computing depreciation used 
by the distributor or transferor with respect to depreciable property to 
which this section applies, such acquiring corporation may use another 
method with respect to such property if consent of the Commissioner is 
obtained in accordance with paragraph (e) of Sec. 1.446-1. Further, 
subject to the provisions of paragraph (b) of Sec. 1.167(e)-1 the 
acquiring corporation may change from the declining balance method 
described in section 167(b)(2) to the straight line method without 
consent of the Commissioner.
    (f) Successive transactions to which section 381(a) applies. The 
provisions of this section shall apply in the case of successive 
transactions to which section 381(a) applies. Thus, for example, if X 
Corporation, a transferor corporation, used the sum of the years-digits 
method under section 167(b)(3) with respect to an asset transferred to Y 
Corporation, an acquiring corporation, in a transaction to which section 
381(a) applies, and subsequently Y Corporation, using the same method, 
transfers

[[Page 615]]

such asset to Z Corporation in a transaction to which section 381(a) 
also applies, then Z Corporation shall be required to use the sum of the 
years-digits method with respect to such asset.
    (g) Illustration. The application of this section may be illustrated 
by the following example:

    Example. M and N Corporations compute their taxable incomes on the 
basis of the calendar year. On December 31, 1959, M Corporation 
transfers all of its assets to N Corporation in a transaction to which 
section 381(a) applies. Included among these assets is an item of 
depreciable property which on that date has an adjusted basis (for 
determining gain) of $800,000 after M Corporation takes into account for 
1959 its allowance for depreciation under section 167(b)(2). The basis 
attributable to the asset under section 362(b) is determined to be 
$900,000 in the hands of N Corporation. Under the provisions of section 
381(c)(6) and paragraph (a) of this section, N Corporation is required 
to compute its allowance for the depreciation of the asset under section 
167(b)(2) for 1960 and subsequent years but only in respect of $800,000 
of its basis. N Corporation may use any reasonable method other than the 
methods provided in section 167(b)(2), (3), or (4) in computing its 
depreciation allowance of the remaining $100,000.

[T.D. 6559, 26 FR 2983, Apr. 7, 1961, as amended by T.D. 7166, 37 FR 
5246, Mar. 11, 1972; 37 FR 6400, Mar. 29, 1972]



Sec. 1.381(c)(8)-1  Installment method.

    (a) Carryover requirement. (1) Section 381(c)(8) provides that if, 
in a transaction to which section 381(a) applies, an acquiring 
corporation acquires installment obligations, the income from which the 
distributor or transferor corporation has elected under section 453 and 
the regulations thereunder to report on the installment method, then the 
acquiring corporation shall be treated as the distributor or transferor 
corporation would have been treated under section 453 had it not 
transferred the installment obligations. Thus, if the distributor or 
transferor corporation had properly elected to return income from the 
sale or other disposition of property giving rise to the obligations on 
the installment method, then the acquiring corporation shall be required 
to return the income from all such installment obligations in the same 
manner and to the same extent as the distributor or transferor 
corporation, unless consent of the Commissioner to use another method is 
obtained in accordance with paragraph (e) of Sec. 1.446-1. Amounts 
received by the acquiring corporation on or after the date of 
distribution or transfer with respect to an installment sale made by the 
distributor or transferor corporation will not be taken into account in 
applying the limitation under section 453(b)(2) with respect to the 
amount of payments received in the year of sale or other disposition.
    (2) Section 381(c)(8) and this section have no application to sales 
or other dispositions of property made by the acquiring corporation on 
or after the date of distribution or transfer. For provisions defining 
the date of distribution or transfer, see Sec. 1.381(b)-1(b). See 
section 381(c)(4) and the regulations thereunder for rules relating to 
the proper method or combination of methods of accounting to be used by 
the acquiring corporation.
    (b) Basis of obligations. The basis in the hands of an acquiring 
corporation of installment obligations described in section 381(c)(8) 
and paragraph (a) of this section shall be the same as in the hands of 
the distributor or transferor corporation.
    (c) Repossession of property sold in prior years. If the acquiring 
corporation repossesses property, previously sold by the distributor or 
transferor corporation, by reason of default by the purchaser in payment 
of the acquired installment obligations, then the acquiring corporation 
shall be treated as though it were the vendor corporation for purposes 
of determining, under section 453 and the regulations thereunder, the 
gain, loss, income, or deduction with respect to the property 
repossessed.

[T.D. 6559, 26 FR 2983, Apr. 7, 1961]



Sec. 1.381(c)(9)-1  Amortization of bond discount or premium.

    (a) Carryover requirement. If, in a transaction to which section 
381(a) applies, the acquiring corporation assumes liability for the 
payment of bonds of a distributor or transferor corporation which were 
issued at a discount or premium, then under the provisions of section 
381(c)(9) the acquiring corporation is to be treated as the

[[Page 616]]

distributor or transferor corporation after the date of distribution or 
transfer for purposes of determining the amount of amortization 
allowable, or includible, with respect to such discount or premium in 
computing taxable income. Thus, if subsequent to February 28, 1913, a 
distributor or transferor corporation issues bonds at a premium and the 
liability for them is assumed by the acquiring corporation in a 
transaction to which section 381(a) applies, then the net amount of the 
premium is income which should be prorated or amortized over the life of 
the bonds, including the period during which the acquiring corporation 
is liable upon the obligations assumed. On the other hand, if a 
distributor or transferor corporation issues bonds at a discount and the 
liability for them is assumed by the acquiring corporation in a 
transaction to which section 381(a) applies, then the net amount of the 
discount is deductible in computing taxable income but should be 
prorated or amortized over the life of the bonds, including the period 
during which the acquiring corporation is liable upon the obligations 
assumed.
    (b) Expense incurred upon issuance of bonds. If, in a transaction to 
which section 381(a) applies, the acquiring corporation assumes 
liability for bonds of a distributor or transferor corporation which 
were issued at a discount or premium, the acquiring corporation shall be 
treated as the distributor or transferor corporation after the date of 
distribution or transfer with respect to the expense incurred upon the 
issuance of such bonds.
    (c) Purchase of bonds. If, in a transaction to which section 381(a) 
applies, the acquiring corporation assumes liability for bonds of a 
distributor or transferor corporation which were issued at a discount or 
premium and if the acquiring corporation subsequently purchases such 
bonds, then the acquiring corporation shall be treated as the 
distributor or transferor corporation for the purpose of determining the 
amount of any income or deduction resulting from the purchase. See 
paragraph (c) of Sec. 1.61-12. For rules relating to the exchange or 
substitution of bonds issued by the acquiring corporation for bonds of a 
distributor or transferor corporation, see paragraph (d) of this 
section.
    (d) Exchange of new for old bonds. Notwithstanding any other 
provision of this section, if--
    (1) In a transaction to which section 381(a) applies, bonds of the 
acquiring corporation are exchanged or substituted for bonds of a 
distributor or transferor corporation which were issued at a discount or 
premium, or
    (2) Bonds of the acquiring corporation are exchanged or substituted 
for bonds of a distributor or transferor corporation which were issued 
at a discount or premium and in respect of which the acquiring 
corporation has assumed the liability in a transaction to which section 
381(a) applies,

then, with respect to any unamortized discount, premium, or expense of 
issuance attributable to such bonds of the distributor or transferor 
corporation, the acquiring corporation shall be treated as the 
distributor or transferor corporation.
    (e) Bonds of a distributor or transferor corporation. For purposes 
of applying section 381(c)(9), the term bonds of a distributor or 
transferor corporation includes not only bonds issued by the distributor 
or transferor corporation but also bonds for which the distributor or 
transferor corporation has assumed liability. Thus, if the distributor 
or transferor corporation has assumed liability for bonds in a 
transaction in which any unamortized discount or premium attributable to 
such bonds carried over to such corporation, then the acquiring 
corporation assuming liability for the bonds shall be treated as the 
distributor or transferor corporation after the date of distribution or 
transfer for purposes of determining the amount of amortization 
allowable, or includible, with respect to such discount or premium. On 
the other hand, if the distributor or transferor corporation has assumed 
liability for bonds in a transaction in which any unamortized discount 
or premium attributable to such bonds did not carry over to such 
corporation, then there can be no carryover to the acquiring corporation 
under this section.

[T.D. 6532, 26 FR 405, Jan. 19, 1961]

[[Page 617]]



Sec. 1.381(c)(10)-1  Deferred exploration and development expenditures.

    (a) Carryover requirement. (1) If for any taxable year a distributor 
or transferor corporation has elected under section 615 or section 616 
(or corresponding provisions of prior law) to defer and deduct on a 
ratable basis any exploration or development expenditures made in 
connection with any ore, mineral, mine, or other natural deposit 
transferred to the acquiring corporation in a transaction described in 
section 381(a), then under the provisions of section 381(c)(10) the 
acquiring corporation shall be entitled to deduct such expenditures on a 
ratable basis in the same manner, and to the same extent, as they would 
have been deductible by the distributor or transferor corporation in the 
absence of the distribution or transfer. For this purpose, the acquiring 
corporation shall be treated as though it were the distributor or 
transferor corporation. The principles set forth in paragraph (e) of 
Sec. 1.615-3 and paragraph (f) of Sec. 1.616-2 are applicable in 
computing the amount of the deduction allowable to the acquiring 
corporation in respect of expenditures deferred by a distributor or 
transferor corporation.

    Example. X and Y Corporations are both organized on January 1, 1955, 
and both corporations compute their taxable income on the basis of the 
calendar year. During 1955, X Corporation purchases a mineral property 
which it begins to develop in 1956. During 1956, X Corporation incurs 
development expenditures of $500,000 in respect of such property which 
it elects to defer under section 616(b). On December 31, 1956, Y 
Corporation acquires all of the assets of X Corporation in a 
reorganization to which section 381(a) applies, no gain being recognized 
to X Corporation on the transfer. In 1957, Y Corporation sells 150,000 
units of produced ore benefited by the development expenditures incurred 
and deferred by X Corporation, and the number of units remaining as of 
the end of 1957, plus the number of units sold during that year, is 
estimated to be 1,000,000. In addition to its deduction for depletion, Y 
Corporation is, in 1957, entitled to a deduction under sections 616(b) 
and 381(c)(10) of $75,000 of the development expenditures previously 
deferred by X Corporation, that is, $500,000 x 150,000/1,000,000.

    (2) If a distributor or transferor corporation has elected under 
section 615 or section 616 (or corresponding provisions of prior law) to 
defer exploration or development expenditures in respect of a mine or 
other natural deposit which it subsequently disposes of except for a 
retained economic interest therein, such as the right to royalty income 
or in-ore payments, and such retained economic interest is transferred 
to the acquiring corporation in a transaction to which section 381(a) 
applies, then the acquiring corporation shall be entitled to deduct such 
deferred expenditures attributable to the economic interest retained on 
a ratable basis to the same extent they would have been deductible by 
the distributor or transferor corporation in the absence of the 
distribution or transfer. See paragraph (c) of Sec. 1.615-3 and 
paragraph (c) of Sec. 1.616-2.
    (3) For purposes of this section, the terms exploration expenditures 
and development expenditures shall have the same meaning as that 
ascribed to them in the regulations under sections 615 and 616 of the 
Internal Revenue Code of 1954, or under sections 23(cc) and 23(ff) of 
the Internal Revenue Code of 1939, whichever applies. See, for example, 
paragraph (a) of Sec. 1.615-1 and paragraph (a) of Sec. 1.616-1.
    (b) Effect and identification of election previously made. (1) The 
election made by a distributor or transferor corporation under the 
provisions of section 615 or section 616 (or corresponding provisions of 
prior law) to defer exploration or development expenditures in respect 
of any taxable year may not be revoked by the acquiring corporation for 
any reason whatsoever.
    (2) When filing its return for the first taxable year for which it 
deducts exploration or development expenditures which were deferred 
under section 615 or section 616 (or corresponding provisions of prior 
law) by a distributor or transferor corporation, the acquiring 
corporation shall attach thereto a statement properly identifying the 
taxable year for which the election to defer was made by the distributor 
or transferor corporation, the name of the corporation which made the 
election, and the district director with whom the election was filed.
    (3) It is unnecessary for an acquiring corporation to renew an 
election to

[[Page 618]]

defer exploration or development expenditures which was made by a 
distributor or transferor corporation.
    (c) Successive transactions to which section 381(a) applies. If, by 
virtue of section 381(c)(10), the acquiring corporation is entitled to 
deduct exploration or development expenditures deferred by a distributor 
or transferor corporation, then such acquiring corporation shall be 
deemed to have made the election to defer such expenditures for purposes 
of applying section 381(c)(10) to any subsequent transaction in which 
such acquiring corporation is a distributor or transferor corporation.
    (d) Carryover of limitation requirements. (1) If a distributor or 
transferor corporation transfers any mineral property to the acquiring 
corporation in a transaction described in section 381(a) and the 
acquiring corporation pays or incurs exploration expenditures in a 
taxable year ending after the date of the distribution or transfer, then 
in applying the 4-year or $400,000 limitations described in section 
615(c) and paragraphs (a) and (b) of Sec. 1.615-4, whichever is 
applicable, the acquiring corporation shall be deemed to have been 
allowed any deduction which, for any taxable year ending on or before 
the date of distribution or transfer, was allowed to the distributor or 
transferor corporation under section 615(a), or under section 23(ff)(1) 
of the Internal Revenue Code of 1939, or to have made any election 
which, for any such preceding year, was made by the distributor or 
transferor corporation under section 615(b), or under section 23(ff)(2) 
of the Internal Revenue Code of 1939. Thus, in such instance, the 
acquiring corporation shall take into account the years in which the 
distributor or transferor corporation exercised the election to deduct 
or defer exploration expenditures and any amounts so deducted or 
deferred. For this purpose, it is immaterial whether the deduction has 
been allowed to, or the election has been made by, the distributor or 
transferor corporation with respect to the specific mineral property 
transferred by that corporation to the acquiring corporation.
    (2) Generally, for purposes of applying the 4-year limitation 
described in paragraph (a) of Sec. 1.615-4, if there are two or more 
distributor or transferor corporations that transfer any mineral 
property to the acquiring corporation, each taxable year of any such 
corporation ending on or before the date of distribution or transfer in 
which exploration expenditures were deducted or deferred shall be 
treated as a separate taxable year regardless of the fact that the 
taxable years of two or more such corporations normally end on the same 
date. However, if the date of distribution or transfer is the same with 
respect to more than one distributor or transferor corporation, then the 
taxable years of such corporations ending on the same date of 
distribution or transfer shall be considered as one taxable year for 
purposes of applying the 4-year limitation even though more than one 
such corporation deducted or deferred exploration expenditures for such 
taxable years.
    (3) For purposes of applying the $400,000 limitation described in 
paragraph (b) of Sec. 1.615-4, if there are two or more distributor or 
transferor corporations that transfer any mineral property to the 
acquiring corporation, any exploration expenditures which were deducted 
or treated as deferred expenses by such corporations for taxable years 
ending after December 31, 1950, shall be taken into account by the 
acquiring corporation.
    (4) If a distributor or transferor corporation that transfers any 
mineral property to the acquiring corporation was required to take into 
account any taxable years or amounts of its transferor, as provided by 
paragraph (e) of Sec. 1.615-4, for purposes of either the 4-year 
limitation described in paragraph (a) of Sec. 1.615-4 or the $400,000 
limitation described in paragraph (b) of Sec. 1.615-4, then the 
acquiring corporation shall also take these taxable years and amounts 
into account in applying the same limitations.
    (5) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. M and N Corporations were organized on January 1, 1956, 
and each corporation computes its taxable income on the basis of the 
calendar year. For each of its taxable years 1956 and 1957, M 
Corporation expended $60,000 for exploration expenditures and exercised 
the option to deduct such amounts under section 615(a). N Corporation

[[Page 619]]

made no exploration expenditures during its taxable years 1956 and 1957. 
On December 31, 1957, M Corporation transferred all of its assets to N 
Corporation in a transaction to which section 381(a) applies, no gain 
being recognized to the transferor corporation on the transfer. N 
Corporation made exploration expenditures of $100,000, $120,000, 
$110,000, and $100,000 for the years 1958, 1959, 1960, and 1961, 
respectively, which expenditures it desired to deduct under section 
615(a) to the extent allowable. On the basis of these facts, N 
Corporation may deduct up to $100,000 for each of the years 1958 and 
1959. No deduction or deferral is allowable for 1960 since the benefits 
of section 615(c) were previously availed of for 4 taxable years. 
However, N Corporation may deduct $80,000 for 1961 (the 4-year 
limitation not applying to such year) but, if such deduction is made, N 
Corporation will not be allowed any further deductions or deferrals 
since the $400,000 limitation of paragraph (b) of Sec. 1.615-4 will 
have been reached.
    Example 2. R and S Corporations were organized on January 1, 1955, 
and each corporation computes its income on the basis of the calendar 
year. For the 1955 taxable year neither corporation made any exploration 
expenditures under section 615(a). On June 30, 1956, R Corporation 
transferred all its assets to S Corporation in a transaction to which 
section 381(a) applies, no gain being recognized to the transferor 
corporation on the transfer. During its short taxable year ending June 
30, 1956, R Corporation made exploration expenditures of $60,000 which 
it elected to deduct under section 615. For its taxable year ending 
December 31, 1956, S Corporation may deduct or defer exploration 
expenditures up to $100,000 since this is a separate election for 
purposes of utilizing section 615 and is not affected by the $60,000 
previously deducted by R Corporation. Assuming S Corporation exercises 
an election under section 615 for its taxable year ending December 31, 
1956, S Corporation may elect to apply the benefits of section 615 to 
exploration expenditures for two more taxable years. However, for 
taxable years beginning after July 6, 1960 (the 4-year limitation not 
applying), S Corporation is entitled under section 615 to deduct or 
defer exploration expenditures made in such years to the extent that the 
combined deductions and deferrals by R and S Corporations in prior years 
did not exceed $400,000.
    Example 3. O and P Corporations were organized on January 1, 1955, 
and each corporation computes its taxable income on the basis of the 
calendar year. For their taxable years 1955, 1956, and 1957, each 
corporation deducted exploration expenditures made in such years under 
section 615(a). On June 30, 1958, O Corporation transferred all its 
assets to P Corporation in a transaction to which section 381(a) 
applies, no gain being recognized to the transferor corporation on the 
transfer. If, during its short taxable year ending June 30, 1958, O 
Corporation made additional exploration expenditures, it may deduct or 
defer such expenditures (up to $100,000) under section 615 since O 
Corporation has utilized section 615 in only three previous taxable 
years. For its taxable years ending after June 30, 1958, and beginning 
before July 7, 1960, P Corporation may not deduct or defer exploration 
expenditures under section 615, since the benefits of that section were 
utilized by O and P Corporations for 4 taxable years. However, for 
taxable years beginning after July 6, 1960 (the 4-year limitation not 
applying), P is entitled under section 615 to deduct or defer 
exploration expenditures made in such years to the extent that the 
combined deductions and deferrals by O and P Corporations in prior years 
do not exceed $400,000. See paragraph (b) of Sec. 1.615-4.
    Example 4. X, Y, and Z Corporations were organized on January 1, 
1955, and each corporation computes its taxable income on the basis of 
the calendar year. For their taxable years ending December 31, 1955, X 
and Y Corporations each deferred $100,000 for exploration expenditures 
made in such taxable years under section 615(b). Z Corporation made no 
exploration expenditures during its taxable year ending December 31, 
1955. On March 31, 1956, X and Y Corporations transferred all their 
assets to Z Corporation in a transaction to which section 381(a) 
applies, no gain being recognized to the transferor corporations on the 
transfer. X and Y Corporations each made exploration expenditures of 
$75,000 during their short taxable years ending March 31, 1956, which 
they deducted under section 615(a). For purposes of taxable years 
beginning before July 7, 1960, Z Corporation must take into account the 
taxable years in which X and Y Corporations deducted or deferred 
exploration expenditures. In so doing, each taxable year in which 
exploration expenditures were deducted or deferred must be taken into 
account except that the taxable years of X and Y Corporations ending on 
March 31, 1956, shall be considered as one taxable year. Therefore, Z 
Corporation may deduct or defer exploration expenditures in accordance 
with section 615 for any one taxable year ending after March 31, 1956, 
and beginning before July 7, 1960. However, for taxable years beginning 
after July 6, 1960 (the 4-year limitation not applying), Z Corporation 
must take into account for purposes of the $400,000 limitation all of 
the $350,000 of exploration expenditures deducted or deferred by X, Y, 
and Z Corporations during taxable years ending after December 31, 1950. 
Therefore, Z Corporation, assuming it has not deducted or deferred any 
exploration expenditures, is entitled under section 615 to deduct or 
defer in taxable years beginning after July 6, 1960, up to

[[Page 620]]

$50,000 for exploration expenditures made in such years.
    Example 5. For purposes of this example, assumethat each taxpayer 
computes taxable income on the basis of the calendar year. Taxpayer A, 
an individual who has deducted exploration expenditures of $75,000 under 
section 23(ff) of the Internal Revenue Code of 1939 for each of his 
taxable years 1952 and 1953, transferred a mineral property to K 
Corporation on January 1, 1954, in a transaction in which the basis of 
the mineral property in the hands of K Corporation is determined under 
section 362(a). For its taxable year 1954 and pursuant to section 
615(a)., K Corporation deducted exploration expenditures of $100,000 
which it made in such year. K Corporation had made no exploration 
expenditures in any preceding taxable year. On December 31, 1954, K 
Corporation transferred all its assets to L Corporation in a 
reorganization to which section 381(a) applies, no gain being recognized 
to the transferor corporation on the transfer. Assuming that L 
Corporation has not deducted or deferred exploration expenditures in any 
preceding taxable year, L Corporation may deduct or defer exploration 
expenditures (up to $100,000) in accordance with section 615 for any one 
taxable year ending after December 31, 1954, and beginning before July 
7, 1960, in view of the 4-year limitation. However, if L Corporation 
does not deduct or defer exploration expenditures in that period, then 
for taxable years beginning after July 6, 1960 (the 4-year limitation 
not applying), L Corporation is entitled to deduct or defer up to 
$150,000 (but not to exceed $100,000 per year) for exploration 
expenditures made in such years. See paragraph (b) of Sec. 1.615-4.

[T.D. 6552, 26 FR 1988, Mar. 8, 1961, as amended by T.D. 6685, 28 FR 
11406, Oct. 24, 1963]



Sec. 1.381(c)(11)-1  Contributions to pension plan, employees'
annuity plans, and stock bonus and profit-sharing plans.

    (a) Carryover requirement. Section 381(c)(11) provides that, for 
purposes of determining amounts deductible under section 404 for any 
taxable year, the acquiring corporation shall be considered after the 
date of distribution or transfer to be the distributor or transferor 
corporation in respect of any pension, annuity, stock bonus, or profit-
sharing plan.
    (b) Nature of carryover. (1) Primarily, section 381(c)(11) and this 
section apply to the amount of any unused deductions or excess 
contributions carryovers which, in the absence of the transaction 
causing section 381 to apply, would have been available to the 
distributor or transferor corporation under section 404. Thus, for 
example, this section applies to unused deductions under a profit-
sharing or stock bonus trust which, in accordance with the second 
sentence of section 404(a)(3)(A), would have been available in 
succeeding taxable years to the transferor corporation if the transfer 
of assets to the acquiring corporation had not occurred.
    (2) Section 381(c)(11) also permits or requires the acquiring 
corporation to be treated as though it were the distributor or 
transferor corporation for the purpose of satisfying any conditions 
which would have been required of the distributor or transferor 
corporation in the absence of the distribution or transfer, so that it 
may be determined whether the distributor or transferor corporation, or 
the acquiring corporation, is entitled to take a deduction under section 
404 in respect of a trust or plan established by the distributor or 
transferor corporation. Thus, for example, in a case when the taxable 
year of the transferor corporation ends on the date of transfer pursuant 
to section 381(b)(1), that corporation is entitled, pursuant to the 
provisions of section 404(a)(6) and paragraph (c) of Sec. 1.404(a)-1, 
to a deduction in such taxable year for a payment to a qualified trust 
of that corporation made by the acquiring corporation after the close of 
such taxable year but within the time specified in section 404(a)(6). In 
further illustration, if the transferor corporation were to establish a 
qualified plan, and if the plan were maintained as a qualified plan by 
the acquiring corporation, then any contributions paid under the plan by 
the acquiring corporation (other than those which are deductible by the 
transferor corporation by reason of section 404(a)(6)) would be 
deductible under section 404 by the acquiring corporation even though 
the plan were exclusively for the benefit of former employees of the 
transferor corporation. Also, for example, if the transferor corporation 
were to adopt an annuity plan during its taxable year ending on the date 
of transfer, the acquiring corporation would be entitled, subject to the 
provisions of section 401(b), to amend the

[[Page 621]]

plan so as to make it retroactively satisfy the requirements of section 
401(a)(3), (4), (5), and (6) for the period beginning with the date on 
which the plan was put into effect.
    (c) Taxable year of deduction. The first taxable year of the 
acquiring corporation in which any amount shall be allowed as a 
deduction to that corporation by reason of section 381(c)(11) and this 
section shall be its first taxable year ending after the date of 
distribution or transfer.
    (d) Requirements for deductions. (1) In order for any amount paid by 
the acquiring corporation (other than amounts deductible under section 
404(a)(5)) to be deductible by the acquiring corporation by reason of 
this section in respect of a trust or nontrusteed annuity plan which is 
established by a distributor or transferor corporation and maintained by 
the acquiring corporation, the contributions must be paid (or deemed to 
have been paid under section 404(a)(6)) by the acquiring corporation in 
a taxable year of that corporation which ends with or within a year of 
the trust for which it is exempt under section 501(a), or, in the case 
of a nontrusteed annuity plan, for which it meets the requirements of 
section 404(a)(2). See, however, section 404(a)(4) and Sec. 1.404(a)-11 
for rules relating to deductions for contributions to foreign-situs 
trusts. The trust or plan which is established by the distributor or 
transferor corporation and maintained by the acquiring corporation may 
separately satisfy the requirements of section 401(a) or section 
404(a)(2) or may, together with other trusts or plans of the acquiring 
corporation, constitute a single plan which qualifies under section 
401(a) or meets the requirements of section 404(a)(2).
    (2) Excess contributions paid under a qualified trust or plan 
established by the transferor or distributor corporation may be carried 
over and, subject to the applicable limitations, deducted by the 
acquiring corporation in a taxable year ending after the date of 
distribution or transfer regardless of whether the trust is exempt, or 
the plan meets the requirements of section 404(a)(2), during such 
taxable year. There are, however, special rules for computing the 
limitations on the amount of excess contributions which are deductible 
in a taxable year ending after the trust or plan has terminated (see 
paragraph (a) of Sec. 1.404(a)-13). For this purpose, the pension, 
annuity, stock bonus, or profit-sharing plan of the distributor or 
transferor corporation under which the excess contributions were made 
shall be considered continued (and not terminated) by the acquiring 
corporation if, after the date of distribution or transfer, the 
acquiring corporation continues the plan as a separate and distinct plan 
of its own which continues to qualify under section 401(a), or to meet 
the requirements of section 404(a)(2), or consolidates or replaces that 
plan with a comparable plan. See subparagraph (4) of this paragraph for 
rules relating to what constitutes a ``comparable'' plan.
    (3) In order for any amount paid by the acquiring corporation to be 
deductible by the acquiring corporation as an unused deduction carried 
over from a qualified profit-sharing or stock bonus trust established by 
a distributor or transferor corporation, the acquiring corporation must 
continue such trust established by the distributor or transferor 
corporation as a separate and distinct trust of its own which continues 
to qualify under section 401(a), or must consolidate or replace that 
trust with a comparable trust. In addition, the amount paid by the 
acquiring corporation will be deductible as an unused deduction carried 
over from the transferor or distributor corporation only if it is paid 
into the profit-sharing or stock bonus trust established by the 
transferor or distributor corporation, or the comparable trust, in a 
taxable year of the acquiring corporation which ends with or within a 
year of such trust (or such comparable trust) for which it meets the 
requirements of section 401(a) and is exempt under section 501(a). See 
subparagraph (4) of this paragraph for rules relating to what 
constitutes a ``comparable'' trust.
    (4) For purposes of subparagraphs (2) and (3) of this paragraph, a 
plan under which deductions are determined pursuant to paragraph (1) or 
(2) of section 404(a) shall be considered comparable

[[Page 622]]

to another plan under which deductions are determined pursuant to either 
of those paragraphs, and a plan under which deductions are determined 
pursuant to paragraph (3) of section 404(a) shall be considered 
comparable to another plan under which deductions are determined 
pursuant to such paragraph (3). Thus, a profit-sharing plan (which 
qualifies under section 401(a)) established by the transferor or 
distributor corporation shall, for purposes of subparagraphs (2) and (3) 
of this paragraph, be considered terminated if, after the date of 
distribution or transfer, the acquiring corporation transfers the funds 
accumulated under the profit-sharing plan into a pension plan covering 
the same employees. In such a case, excess contributions paid under the 
profit-sharing plan by the distributor or transferor corporation may be 
carried over and deducted by the acquiring corporation in a taxable year 
ending after the date of distribution or transfer subject to the 
limitations in section 404(a)(3)(A). On the other hand, unused 
deductions attributable to the profit sharing plan may not be carried 
over and used by the acquiring corporation as a basis for deducting 
amounts contributed by it to the pension plan.
    (e) Effect of consolidation or replacement of plan on prior 
contributions. If a pension, annuity, stock bonus, or profit-sharing 
plan which was established by a distributor or transferor corporation is 
terminated after the date of distribution or transfer because of 
consolidation or replacement with a comparable plan of the acquiring 
corporation, then the contributions paid to or under its plan by the 
distributor or transferor corporation on or before the date of 
distribution or transfer shall not be disallowed under section 404 
merely because of the termination of the plan which was established by 
that corporation, provided that the termination does not cause the plan 
to fail to qualify under section 401(a).
    (f) Amounts deductible under section 404. Section 381(c)(11) and 
this section apply only to amounts which are otherwise deductible under 
section 404 and the regulations thereunder. See Sec. Sec. 1.404(a)-1 
through 1.404(d)-1. Thus, to be deductible by reason of this section, 
contributions paid by the acquiring corporation must be expenses which 
otherwise satisfy the conditions of section 162 (relating to trade or 
business expenses). No deduction shall be allowed by reason of section 
381(c)(11) and this section for a contribution which is allowable under 
section 162 but is not allowable under section 404. Thus, the acquiring 
corporation shall not be allowed a deduction by reason of this section 
in respect of a plan established by a distributor or transferor 
corporation if the contribution would not otherwise be deductible under 
section 404 by reason of section 404(c) and Sec. 1.404(c)-1. On the 
other hand, any unused deductions or excess contributions of a 
distributor or transferor corporation which are carried over from 1939 
Code years shall be deductible by the acquiring corporation if the 
requirements of this section, section 404(d), and Sec. 1.404(d)-1 are 
satisfied.
    (g) Cost of past service credits. In computing the cost of past 
service credits under a plan with respect to employees of the 
distributor or transferor corporation, the acquiring corporation may 
include the cost of credits for periods during which the employees were 
in the service of the distributor or transferor corporation.
    (h) Separate carryovers required. The excess contributions which are 
available to a distributor or transferor corporation under the 
provisions of section 404(a)(1)(D) and section 404(a)(3)(A) at the close 
of the date of distribution or transfer and are carried over to the 
acquiring corporation under this section shall be kept separate and 
distinct from each other and from any excess contributions which are 
available to the distributor or transferor corporation at that time 
under the provisions of section 404(a)(7) and are carried over to the 
acquiring corporation under this section. If there are excess 
contributions carried over to the acquiring corporation from more than 
one transferor or distributor corporation, the excess contributions of 
each transferor or distributor corporation shall be kept separate and 
distinct from those of the other transferor or distributor corporations 
and, with respect to each such transferor or distributor corporation, 
shall be kept separate and distinct as

[[Page 623]]

provided in the preceding sentence. See, however, paragraph (i) of this 
section for rules for applying the provisions of section 404(a)(3)(A) 
when the acquiring corporation maintains two or more profit-sharing or 
stock bonus trusts, one or more of which was established by a 
distributor or transferor corporation. The requirements in this 
paragraph shall apply with respect to any excess contributions which are 
carried over to the acquiring corporation from a distributor or 
transferor corporation under the provisions of section 404(d) and this 
section.
    (i) Limitations applicable to profit-sharing or stock bonus trusts. 
When contributions are paid by the acquiring corporation after the date 
of distribution or transfer to two or more profit-sharing or stock bonus 
trusts, and one or more of such trusts was established by a distributor 
or transferor corporation, such trusts shall be considered as a single 
trust in applying the provisions of section 404(a)(3)(A) under this 
section. Accordingly, in determining its secondary limitation, and its 
excess contributions carryover, under section 404(a)(3)(A) in any 
taxable year ending after the date of distribution or transfer, the 
acquiring corporation shall take into accounts its primary limitations, 
and the deductions allowed or allowable to it, for all prior years under 
the limitations provided in those sections, and also the primary 
limitations of, and deductions allowed or allowable to, the distributor 
or transferor corporation or corporations for all prior years under the 
limitations provided in those sections.
    (j) Successive carryovers. The provisions of section 381(c)(11) and 
this section shall apply to an acquiring corporation which, in a 
distribution or transfer to which section 381(a) applies acquires the 
assets of a distributor or transferor corporation which has previously 
acquired the assets of another corporation in a transaction to which 
section 381(a) applies, even though, in computing an unused deductions 
or excess contributions carryover to the second acquiring corporation, 
it is necessary to take into account contributions paid by, and 
limitations applicable to, the first distributor or transferor 
corporation.
    (k) Information to be furnished by acquiring corporation. The 
acquiring corporation shall furnish such information with respect to a 
plan established by a distributor or transferor corporation as will, 
consistently with the principles of section 404, establish that the 
provisions of such section and this section apply. For purposes of this 
section, the district director may require any other information that he 
considers necessary to determine deductions allowable under section 404 
and this section or qualification under section 401. Any unused 
deductions or excess contributions carried over from a distributor or 
transferor corporation pursuant to this section shall be properly 
identified with the corporation which would have been permitted to use 
those deductions or contributions in the absence of the transaction 
causing section 381 to apply.
    (l) Illustration. The application of this section may be illustrated 
by the following example:

    Example. In 1955, X Corporation, which makes its return on the basis 
of the calendar year, paid $400,000 to completely fund past service 
credits under a qualified pension plan and deducted 10 percent ($40,000) 
of that cost in each of the taxable years 1955, 1956, and 1957. The 
pension plan established by X Corporation had an anniversary date of 
January 1. On December 31, 1957, on which date the undeducted part of 
the cost amounted to $280,000, X Corporation transferred all its assets 
to Y Corporation in a statutory merger to which section 361 applies. Y 
Corporation, which also makes its return on the basis of the calendar 
year, had a qualified pension plan and trust which also had an 
anniversary date of January 1. Since Y Corporation had many more 
employees than X Corporation on the date of transfer, it covered the 
former employees of X Corporation under its own plan. Y Corporation is 
entitled to deductions under section 404(a)(1)(D) and this section in 
1958 and succeeding taxable years, in order of time, with respect to the 
undeducted balance of $280,000, to the extent of the difference between 
the amount paid and deductible by that corporation in each such taxable 
year and the maximum amount deductible by that corporation for such 
taxable year in accordance with the applicable limitations of section 
404(a)(1). In computing the maximum amount deductible by Y Corporation 
for 1958 and 1959 under section 404(a)(1)(C), that corporation may 
include $40,000 for each year, the amount that X Corporation could have 
included for each of those years in computing the maximum amount that 
would

[[Page 624]]

have been deductible by X Corporation under section 404(a)(1)(C) if the 
merger had not occurred. Thus, assuming that Y Corporation's appropriate 
limitation so computed under section 404(a)(1)(C) is $1,000,000 
(including the $40,000 carried over from X Corporation under this 
section) for each of those taxable years, and that Y Corporation 
contributed $925,000 to its trust in 1958 and $975,000 in 1959, then Y 
Corporation is entitled under section 404(a)(1)(D) and this section to 
deduct in 1958 $75,000, and in 1959 $25,000, of the amount ($280,000) 
carried over from X Corporation. The undeducted balance of such amount 
($180,000) available to Y Corporation on December 31, 1959, would be 
deductible by that corporation in succeeding taxable years in accordance 
with section 404(a)(1)(D) and this section.

[T.D. 6556, 26 FR 2405, Mar. 22, 1961, as amended by T.D. 7168, 37 FR 
5024, Mar. 9, 1972; T.D. 9849, 84 FR 9233, Mar. 14, 2019]



Sec. 1.381(c)(12)-1  Recovery of bad debts, prior taxes, 
or delinquency amounts.

    (a) Carryover requirement. (1) If, as a result of a distribution or 
transfer to which section 381(a) applies, the acquiring corporation is 
entitled to the recovery of a bad debt, prior tax, or delinquency amount 
on account of which a deduction or credit was allowed to a distributor 
or transferor corporation for a prior taxable year, and such debt, tax, 
or amount is recovered by the acquiring corporation after the date of 
distribution or transfer, then under the provisions of section 
381(c)(12) the acquiring corporation is required to include in its gross 
income for the taxable year of recovery the same amount of income 
attributable to the recovery as the distributor or transferor 
corporation would have been required to include under section 111 and 
the regulations thereunder had the distribution or transfer not 
occurred.
    (2) The rule prescribed by paragraph (a)(1) of this section and by 
section 381(c)(12) with respect to bad debts, prior taxes, and 
delinquency amounts applies equally with respect to the recovery by the 
acquiring corporation of all other losses, expenditures, and accruals 
made on the basis of deductions from the gross income of a distributor 
or transferor corporation for prior taxable years, including war losses 
referred to in section 127 of the Internal Revenue Code of 1939, but not 
including deductions with respect to depreciation, depletion, 
amortization, or amortizable bond premiums. An item which is not a 
``section 111 item'' for purposes of the regulations under section 111 
is not subject to the provisions of section 381(c)(12). The provisions 
of section 111(c) shall be applied with respect to a recovery by the 
acquiring corporation in the same manner as they would have been applied 
by the distributor or transferor corporation.
    (b) Amount of recovery exclusion allowable for year of recovery. For 
the year of any recovery by the acquiring corporation, the amount of the 
recovery exclusion for the original taxable year shall be determined in 
accordance with paragraph (b) of Sec. 1.111-1. For the purpose of this 
paragraph and section 381(c)(12), the recovery exclusion for any year 
with respect to section 111 items of the acquiring corporation shall be 
kept separate from the recovery exclusion for any year with respect to 
section 111 items of each distributor or transferor corporation. The 
recovery by the acquiring corporation of any section 111 item of such 
corporation after the date of the distribution or transfer shall be 
considered separately from recoveries by the acquiring corporation of 
any such item which was deducted or credited by a distributor or 
transferor corporation. Any recovery by the acquiring corporation of a 
section 111 item shall be excluded from the gross income of the 
acquiring corporation to the extent of the recovery exclusion (1) 
determined for the original year for which that item was deducted or 
credited by the specific corporation which claimed the deduction or 
credit and (2) reduced by the excludable recoveries (whether made by the 
acquiring corporation, or by the distributor or transferor corporation) 
in intervening years with respect to the recovery exclusion of such 
corporation for such original year. There shall be taken into account 
the effect of net operating loss carryovers and carrybacks or capital 
loss carryovers.
    (c) Illustration of carryover of recovery exclusion--(1) Facts. (i) 
The application of section 381(c)(12) may be illustrated

[[Page 625]]

by the following example. M and N Corporations are both organized on 
January 1, 1957, and both corporations compute their taxable income on 
the basis of the calendar year. On December 31, 1959, M Corporation 
transfers all its assets to N Corporation in a reorganization to which 
section 381(a) applies.
    (ii) The section 111 items of the two corporations for the following 
taxable years are as follows, identification of such items being made by 
an appropriate letter:

------------------------------------------------------------------------
                                                     M            N
     Taxable year of deduction or credit        Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1957.........................................      $500(g)       $200(h)
1958.........................................       300(i)        400(j)
1959.........................................       600(k)        100(m)
------------------------------------------------------------------------

    (iii) The recovery exclusions in respect of such taxable years, 
computed in accordance with Sec. 1.111-1(b)(2), are assumed to be as 
follows:

------------------------------------------------------------------------
                                                     M            N
                 Taxable year                   Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1957.........................................         $400          $150
1958.........................................          200           300
1959.........................................          500            75
------------------------------------------------------------------------

    (iv) The recoveries of the above-mentioned section 111 items by the 
two corporations are as follows:

------------------------------------------------------------------------
                                                     M            N
           Taxable year of recovery             Corporation  Corporation
                                               (transferor)   (acquirer)
------------------------------------------------------------------------
1958.........................................      $25 (g)       $50 (h)
1959.........................................       50 (g)        20 (h)
                                                    30 (i)        15 (j)
1960.........................................  ............      350 (g)
                                                                 225 (i)
                                                                 550 (k)
                                                                 100 (h)
                                                                 350 (j)
                                                                  85 (m)
------------------------------------------------------------------------

    (2) M Corporation's 1958 recovery.

Total recovery of section 111 items for 1957.....................    $25
  Less: Recovery exclusion for 1957..............................    400
                                                                  ------
    Amount included in gross income of M Corporation for 1958....      0
                                                                  ------
 

    (3) M Corporation's 1959 recoveries.

(i) Total recovery of section 111 items for 1957.................   $50
  Less: Recovery exclusion for 1957.......................   $400
  Minus excludable recovery...............................     25
                                                           -------
                                                            .....    375
    Amount included in gross income of M Corporation for 1959....      0
(ii) Total recovery of section 111 items for 1958................     30
  Less: Recovery exclusion for 1958..............................    200
                                                           --------
    Amount included in gross income of M Corporation for 1959....      0
 

    (4) N Corporation's 1958 recovery.

Total recovery of section 111 items for 1957.....................    $50
  Less: Recovery exclusion for 1957..............................    150
                                                                  ------
    Amount included in gross income of N Corporation for 1958....      0
 

    (5) N Corporation's 1959 recoveries.

(i) Total recovery of section 111 items for 1957.................   $20
  Less: Recovery exclusion for 1957.......................   $150
  Minus excludable recovery in 1958.......................     50
                                                           -------
                                                            .....    100
    Amount included in gross income of N Corporation for 1959....      0
(ii) Total recovery of section 111 items for 1958................     15
  Less: Recovery exclusion for 1958..............................    300
                                                           --------
    Amount included in gross income of N Corporation for 1959....      0
 

    (6) N Corporation's 1960 recoveries.

(i) Total recovery of section 111 items of M Corporation for 1957   $350
  Less: Recovery exclusion of M Corporation for 1957.............  $400
    Minus:
      Excludable recovery in 1959..................    $50
      Excludable recovery in 1958..................     25
                                                    -------
                                                     .....     75
                                                     .....  .....    325
      Amount included in gross income of N Corporation for 1960..     25
(ii) Total recovery of section 111 items of M Corporation for       225
 1958............................................................
  Less: Recovery exclusion of M Corporation for 1958......   $200
    Minus excludable recovery in 1959.....................     30
                                                    -------
                                                            .....   170
      Amount included in gross income of N Corporation for 1960..     55
(iii) Total recovery of section 111 items of M Corporation for       550
 1959............................................................
  Less: Recovery exclusion of M Corporation for 1959.............    500
                                                    --------
      Amount included in gross income of N Corporation for 1960..     50
(iv) Total recovery of section 111 items of N Corporation for       100
 1957............................................................
  Less: Recovery exclusion of N Corporation for 1957......  $150
    Minus:
      Excludable recovery in 1959..................    $20
      Excludable recovery in 1958..................     50
                                                    -------
                                                     .....     70
                                                     .....  .....    80
        Amount included in gross income of N Corporation for 1960     20
(v) Total recovery of section 111 items of N Corporation for 1958  $350
  Less: Recovery exclusion of N Corporation for 1958......   $300
  Minus excludable recovery in 1959.......................     15
                                                    -------

[[Page 626]]

 
                                                            .....   285
    Amount included in gross income of N Corporation for 1960....     65
(vi) Total recovery of section 111 items of N Corporation for         85
 1959............................................................
  Less: Recovery exclusion of N Corporation for 1959.............     75
                                                    --------
    Amount included in gross income of N Corporation for 1960....     10
 

    (7) Summary of recoveries included in gross income of N Corporation 
for 1960.

(i) Recovery of M Corporation items for:
  1957....................................................    $25
  1958....................................................     55
  1959....................................................     50
                                                           --------
                                                            .....   $130
                                                                  ------
(ii) Recovery of N corporation items for:
  1957....................................................     20
  1958....................................................     65
  1959....................................................     10
                                                           --------
                                                            .....     95
                                                                  ------
    Total amount included in gross income........................    225
 


[T.D. 6559, 26 FR 2984, Apr. 7, 1961]



Sec. 1.381(c)(13)-1  Involuntary conversions.

    (a) Carryover requirement--(1) General rule. Section 381(c)(13) 
requires that after the date of distribution or transfer the acquiring 
corporation, in a transaction to which section 381(a) applies, shall be 
treated as the distributor or transferor corporation for purposes of 
applying section 1033, relating to involuntary conversions. This rule 
shall apply even though the property similar or related in service or 
use to the property converted, or the stock of a corporation owning such 
similar property, is purchased by the acquiring corporation after the 
date of distribution or transfer and is not received from the 
distributor or transferor corporation in the transaction to which 
section 381(a) applies. Accordingly, if any factor essential to the 
application of section 1033 occurs on or before the date of distribution 
or transfer and any other such factor also occurs after that date, then, 
in accordance with section 381(c)(13) and this section, the provisions 
of section 1033 shall apply to the acquiring corporation in the same 
manner that they would have applied to the distributor or transferor 
corporation in the absence of the distribution or transfer. For purposes 
of this section, the terms involuntary conversion and disposition of the 
converted property shall have the meaning ascribed to them by the 
regulations under section 1033.
    (2) Application to other transactions. The provisions of this 
section shall apply to any transaction which, under provisions of the 
Internal Revenue Code of 1954, is treated as though it were an 
involuntary conversion within the meaning of section 1033. See, for 
example, section 1071, relating to gain from a sale or exchange to 
effectuate the policies of the Federal Communications Commission; and 
sections 1332(b)(3) and 1333(3), relating to war loss recoveries.
    (b) Conversion into similar property. Section 1033(a)(1) provides 
that no gain shall be recognized if property is involuntarily converted 
only into property which is similar or related in service or use to the 
property so converted. If there is a disposition of property of a 
distributor or transferor corporation and, subsequent to the date of 
distribution or transfer, property similar or related in service or use 
to the property disposed of is received by the acquiring corporation as 
compensation for the property so disposed of, then no gain shall be 
recognized to the acquiring corporation, provided that no gain would 
have been recognized under section 1033(a)(1) if the similar property 
had been received directly by the distributor or transferor corporation.

    Example. Property of S Corporation with an adjusted basis of $100 is 
condemned by the local government. Shortly after the property is so 
condemned, S Corporation liquidates and distributes its assets to P 
Corporation in a distribution to which section 381(a) applies. 
Subsequent to the date of distribution, P Corporation receives from the 
government (in settlement of the condemnation proceedings) property with 
a market value of $500 which is similar or related in service or use to 
the property so condemned. No gain is recognized to either corporation 
upon P Corporation's receipt of the similar property, and the property 
so received has a basis of $100 in the hands of P Corporation on the 
date of its acquisition.

    (c) Conversion into money or dissimilar property when disposition 
occurs after December 31, 1950--(1) General rule. Section 1033(a)(3) and 
Sec. 1.1033(a)-2 provide rules for involuntary conversions of property 
into money or dissimilar property where the disposition of the

[[Page 627]]

converted property occurs after December 31, 1950. In such a case, the 
gain on the conversion, if any, shall be recognized, at the election of 
the taxpayer, only to the extent that the amount realized on the 
conversion exceeds the cost of other property purchased by the taxpayer 
which is similar or related in service or use to the property so 
converted, or exceeds the cost of stock purchased by the taxpayer in the 
acquisition of control of a corporation owning such other property, 
provided (i) the taxpayer purchases such other property or stock for the 
purpose of replacing the property so converted and (ii) the purchase 
occurs during the period of time specified in section 1033(a)(3)(B). The 
provisions of this paragraph shall apply to involuntary conversions 
where the disposition of the property occurs after December 31, 1950, 
and where the election to have section 1033(a)(3) apply to the treatment 
of the gain upon the conversion is contingent upon activities of both 
the distributor or transferor corporation and the acquiring corporation. 
For purposes of section 381(c)(13), the period of time specified in 
section 1033(a)(3)(B) shall be determined by taking into account taxable 
years of, and extensions of time granted to, both the distributor or 
transferor corporation and the acquiring corporation.
    (2) Replacement period. The period during which the purchase of 
similar property or stock must be made in order to prevent the 
recognition of gain on the involuntary conversion terminates 2 years 
(or, in the case of a disposition occurring before Dec. 31, 1969, 1 
year) after the close of the first taxable year in which any part of the 
gain upon the conversion is realized, or at the close of such later date 
as may be designated pursuant to an application of the taxpayer. See 
paragraph (c)(3) of Sec. 1.1033(a)-2. Therefore, if, in a case to which 
this subparagraph applies, the first taxable year in which gain is 
realized is the taxable year of the distributor or transferor 
corporation ending with the close of the date of distribution or 
transfer, the acquiring corporation will have a maximum of only 2 years 
(or, in the case of a disposition occurring before Dec. 31, 1969, 1 
year) after that date in which to purchase the similar property or 
stock, unless an extension of time has been granted upon application by 
the distributor, transferor, or acquiring corporation within the time 
prescribed. See paragraph (a) of Sec. 1.381(b)-1 as to the termination 
of the taxable year of the distributor or transferor corporation. See 
paragraph (c)(3) of Sec. 1.1033(a)-2 as to applications to extend the 
period within which to replace the converted property. In addition to 
the information otherwise required under paragraph (c)(3) of Sec. 
1.1033(a)-2, the application shall contain sufficient detail in 
connection with the distribution or transfer to establish that section 
381(c)(13) applies to the involuntary conversion involved.
    (3) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example 1. A and B Corporations compute their taxable income on the 
basis of the calendar year, and both corporations use the cash method of 
accounting. During 1970 property of A Corporation is destroyed by fire, 
and in January 1971, A Corporation receives $15,000 from an insurance 
company as compensation for its loss of property. The adjusted basis of 
the property on the date of destruction is $10,000; as a consequence, A 
Corporation realizes a gain of $5,000 on the involuntary conversion. On 
June 30, 1971, B Corporation acquires all of the assets of A Corporation 
in a reorganization to which section 381(a) applies. In accordance with 
paragraph (c)(2) of Sec. 1.1033(a)-2, A Corporation reports in its 
return for the short taxable year ending June 30, 1971, all the details 
in connection with the involuntary conversion but does not include the 
realized gain in gross income, thereby electing to have the gain 
recognized only to the extent provided in section 1033(a)(3). On June 
15, 1973, B Corporation purchases for $20,000 property which is similar 
or related in service or use to the property previously destroyed. In 
its return for 1973, B Corporation reports all of the details in 
connection with its replacement of the property, as required by 
paragraph (c)(2) of Sec. 1.1033(a)-2. As a result of this replacement 
by B Corporation, none of the gain realized by A Corporation is 
recognized. The replacement property which is purchased by B Corporation 
has a basis to that corporation of $15,000 on the date of its purchase, 
that is, the cost of such property ($20,000) decreased by the amount of 
gain not recognized to A Corporation on the involuntary conversion 
($5,000).
    Example 2. Assume the same facts as in Example (1), except that B 
Corporation does not

[[Page 628]]

purchase similar property on or before June 30, 1973, and does not apply 
on or before that date (in accordance with paragraph (c)(3) of Sec. 
1.1033(a)-2) for an extension of time in which to make a replacement. In 
such event, the gain realized by A Corporation is recognized to that 
corporation for its taxable year ending June 30, 1971. A Corporation's 
tax liability for such taxable year must be recomputed in accordance 
with paragraph (c)(2) of Sec. 1.1033(a)-2 in order to reflect this 
additional income.
    Example 3. Assume the same facts as in Example (1), except that the 
property of A Corporation is destroyed in 1968, A Corporation receives 
the $15,000 from an insurance company in January 1969, B Corporation 
acquires all of the assets of A Corporation on June 30, 1969, and A 
Corporation's return is filed for the short taxable year ending June 30, 
1969. B Corporation would have to purchase property which is similar or 
related in service or use to the property previously destroyed by June 
30, 1970, in order to take advantage of the provisions of section 1033.
    Example 4. M and N Corporations compute their taxable income on the 
basis of the calendar year, and both corporations use the cash method of 
accounting. During 1970, property of M Corporation is destroyed by fire. 
The adjusted basis of the property on the date of destruction is 
$10,000. The property is insured against loss by fire, but the insurance 
claim is not satisfied on or before June 30, 1971, the date on which N 
Corporation acquires all of the assets (including the insurance claim) 
of M Corporation in a reorganization to which section 381(a) applies. On 
September 1, 1972, N Corporation receives $15,000 from the insurance 
company as compensation for the fire loss suffered by M Corporation. 
Upon receipt of the insurance proceeds, N Corporation realizes a gain of 
$5,000 upon the involuntary conversion; however, in its return for 1972, 
N Corporation elects under the provisions of paragraph (c)(2) of Sec. 
1.1033(a)-2 to have the gain recognized only to the extent provided by 
section 1033(a)(3). On December 30, 1974, N Corporation purchases for 
$20,000 property which is similar or related in service or use to the 
property previously destroyed in the hands of M Corporation. As a result 
of this replacement by N Corporation, none of the gain realized by N 
Corporation in 1972 is recognized. The replacement property which is 
purchased by N Corporation has a basis to that corporation of $15,000 on 
the date of its purchase, that is, the cost of such property ($20,000) 
decreased by the amount of gain not recognized to N Corporation on the 
involuntary conversion ($5,000).
    Example 5. R and S Corporations compute their taxable income on the 
basis of the calendar year, and both corporations use the cash method of 
accounting. During 1970 property of R Corporation is destroyed by fire. 
The adjusted basis of the property on the date of destruction is 
$10,000. In anticipation of taking the benefit of section 1033(a)(3), R 
Corporation purchases for $20,000 on June 1, 1971, property which is 
similar or related in service or use to the destroyed property. In its 
return for 1971, R Corporation reports all of the details in connection 
with the replacement of the property, as required by paragraph (c)(2) of 
Sec. 1.1033(a)-2. The property destroyed in 1970 is insured against 
loss by fire, but the insurance claim is not satisfied on or before 
March 1, 1972, the date on which S Corporation acquires all of the 
assets (including the insurance claim) of R Corporation in a 
reorganization to which section 381(a) applies. On October 1, 1972, S 
Corporation receives $12,000 from the insurance company as compensation 
for the fire loss suffered by R Corporation. Upon receipt of the 
insurance proceeds, S Corporation realizes a gain of $2,000 upon the 
involuntary conversion; however, in its return for 1972, S Corporation 
elects under the provisions of paragraph (c)(2) of Sec. 1.1033(a)-2 to 
have the gain recognized only to the extent provided by section 
1033(a)(3). As a result of the replacement by R Corporation, none of the 
gain realized by S Corporation in 1972 is recognized. Assuming there are 
no adjustments for depreciation, the replacement property has a basis on 
October 1, 1972, of $18,000, that is, the cost of such property 
($20,000) decreased by the amount of gain not recognized to S 
Corporation on the involuntary conversion ($2,000)

    (d) Conversion into money when disposition occurs before January 1, 
1951. Section 1033(a)(2) provides that, if property is disposed of in an 
involuntary conversion before January 1, 1951, and money is received as 
compensation for the conversion, no gain shall be recognized if such 
money is forthwith expended in the acquisition of other property similar 
or related in service or use to the property so converted, or in the 
acquisition of control of a corporation owning such other property, or 
in the establishment of a replacement fund. That section also provides 
that, if any part of the money is not so expended, the gain, if any, 
shall be recognized to the extent of the money which is not so expended. 
For example, if, pursuant to section 381(c)(13) and section 1033(a)(2), 
property of a distributor or transferor corporation is disposed of 
before January 1, 1951, in an involuntary conversion, and the proceeds 
from the conversion are received by the acquiring corporation so that 
the gain on the conversion is realized by that corporation,

[[Page 629]]

the acquiring corporation may avoid recognition of the gain if it 
complies with the provisions of section 1033(a)(2) for nonrecognition of 
gain. Thus, the acquiring corporation must forthwith expend the proceeds 
in the acquisition of similar property or stock, or in the establishment 
of a replacement fund, in order to avoid recognition of the gain, if the 
disposition occurred before January 1, 1951. See the provisions of 
Sec. Sec. 1.1033(a)-3 and 1.1033(a)-4 relating to involuntary 
conversions and replacement funds when disposition of the converted 
property occurred before January 1, 1951.
    (e) Successive acquiring corporations. An acquiring corporation 
which, in a transaction to which section 381(a) applies, acquires the 
assets of a corporation which previously acquired the assets of another 
corporation in a transaction to which section 381(a) applies, shall be 
treated as such other corporation for purposes of applying sections 
381(c)(13) and 1033 (relating to involuntary conversions). Thus, for 
example, if any factor essential to the application of section 1033 
occurs on or before the date of distribution or transfer in one 
transaction to which section 381(a) applies, and any other such factor 
occurs after the date of distribution or transfer in a subsequent 
transaction to which section 381(a) applies, then the acquiring 
corporation in such subsequent transaction shall be treated as the first 
distributor or transferor corporation subject to the rules and 
limitations of this section for purposes of sections 381(c)(13) and 
1033.

[T.D. 6552, 26 FR 1989, Mar. 8, 1961, as amended by T.D. 7075, 35 FR 
17995, Nov. 24, 1970]



Sec. 1.381(c)(14)-1  Dividend carryover to personal holding company.

    (a) Carryover requirement. Section 381(c)(14) provides that an 
acquiring corporation shall succeed to and take into account the 
dividend carryover (described in section 564) of a distributor or 
transferor corporation in computing its dividends paid deduction under 
section 561 for taxable years ending after the date of distribution or 
transfer for which the acquiring corporation is a personal holding 
company under section 542. To determine the amount of such dividend 
carryover and to integrate it with the dividend carryover of the 
acquiring corporation in computing the dividends paid deduction for 
taxable years ending after the date of distribution or transfer, it is 
necessary to apply the provisions of section 564 and Sec. 1.564-1 in 
accordance with this section.
    (b) Manner of computing dividend carryover--(1) Preceding taxable 
years. If the acquiring corporation is a personal holding company under 
section 542 for its first taxable year ending after the date of 
distribution or transfer, the taxable year of the distributor or 
transferor corporation ending with such date is a first preceding 
taxable year for purposes of section 564, and the taxable year of the 
distributor or transferor corporation immediately preceding such first 
preceding year is a second preceding taxable year for purposes of 
section 564. If the acquiring corporation is a personal holding company 
for its second taxable year ending after the date of distribution or 
transfer, the taxable year of the distributor or transferor corporation 
ending with such date is a second preceding taxable year for purposes of 
section 564.
    (2) Determination of dividends paid deduction and taxable income. 
The dividends paid deduction of any distributor or transferor 
corporation (determined under section 561 but without regard to any 
dividend carryover) and the taxable income of any such corporation 
(adjusted as provided in section 545(b)) for any taxable year ending on 
or before the date of distribution or transfer shall be determined 
without reference to any dividends paid deduction, or taxable income, of 
the acquiring corporation or any other distributor or transferor 
corporation; in like manner, the dividends paid deduction and the 
taxable income of the acquiring corporation for any such taxable year 
shall be determined without reference to any dividends paid deduction, 
or taxable income, of a distributor or transferor corporation.
    (3) Computation of dividend carryover. (i) For the purpose of 
determining the dividend carryover to the first taxable year of the 
acquiring corporation ending after the date of distribution or transfer, 
the amount of the dividend carryover from the distributor or

[[Page 630]]

transferor corporation shall be determined under section 564 without 
reference to the dividends paid deduction or taxable income of the 
acquiring corporation or any other corporation. If two or more 
transactions to which section 381(a) applies have the same date of 
distribution or transfer, or if a particular taxable year of the 
acquiring corporation is the first taxable year ending after the dates 
of distribution or transfer of two or more such transactions occurring 
on different dates, the amount of the dividend carryover from each 
distributor or transferor corporation shall be determined separately as 
provided in the preceding sentence. Except as provided in subdivision 
(iii) of this subparagraph, the aggregate of the dividend carryovers 
from each distributor or transferor corporation and the dividend 
carryover of the acquiring corporation (computed without regard to this 
section) shall constitute the dividend carryover under section 561(a)(3) 
of the acquiring corporation for its first taxable year ending after the 
date (or dates) of distribution or transfer.
    (ii) For the purpose of determining the dividend carryover to the 
second taxable year of the acquiring corporation ending after the date 
(or dates) of distribution or transfer, the excess, if any, of the 
dividends paid deduction (determined under section 561 without regard to 
any dividend carryover) over the taxable income (adjusted as provided in 
section 545(b)) for the taxable year of each distributor or transferor 
corporation and the acquiring corporation referred to as a second 
preceding taxable year shall be determined separately without reference 
to the dividends paid deduction or taxable income of any other of such 
corporations. The excesses thus determined shall be aggregated, and such 
aggregate shall be--
    (a) Increased by the excess of the dividends paid deduction 
(determined without regard to any dividend carryover) over the taxable 
income (adjusted as provided in section 545(b)), or
    (b) Reduced by the excess of the taxable income (adjusted as 
provided in section 545(b)) over the dividends paid deduction 
(determined without regard to any dividend carryover),

for the first preceding taxable year of the acquiring corporation. 
Except as provided in subdivision (iii) of this subparagraph, the amount 
thus determined shall constitute the dividend carryover under section 
561(a)(3) of the acquiring corporation for its second taxable year 
ending after the date (or dates) of distribution or transfer.
    (iii) If a particular taxable year of the acquiring corporation is 
its first taxable year ending after the date (or dates) of distribution 
or transfer of one or more transactions to which section 381(a) applies, 
and if the same taxable year of the acquiring corporation is also its 
second taxable year ending after the date (or dates) of distribution or 
transfer of one or more other transactions to which section 381(a) 
applies, then, for the purpose of determining the dividend carryover to 
such taxable year of the acquiring corporation, the rules contained in 
both subdivisions (i) and (ii) of this subparagraph shall be applied. 
Insofar as such taxable year constitutes the first taxable year ending 
after the date (or dates) of distribution or transfer of any 
transaction, the amount of the dividend carryover from any distributor 
or transferor corporation involved in such transaction shall be 
determined separately as provided in subdivision (i) of this 
subparagraph. Insofar as such taxable year constitutes the second 
taxable year ending after the date (or dates) of distribution or 
transfer of any transaction, the amount of the dividend carryover from 
any distributor or transferor corporation involved in the transaction 
and the acquiring corporation shall be determined as provided in 
subdivision (ii) of this subparagraph. The aggregate of the dividend 
carryovers thus determined shall constitute the dividend carryover under 
section 561(a)(3) of the acquiring corporation for such taxable year. 
See Example (4) in paragraph (c) of this section.
    (c) Illustrations. The rules set forth in paragraphs (a) and (b) of 
this section may be illustrated by the following examples:

    Example 1. (i) Facts. N Corporation acquired on June 30, 1960, all 
the assets of M Corporation in a reorganization to which section 381(a) 
applies. Both corporations compute taxable income on the basis of the 
calendar

[[Page 631]]

year. N Corporation is a personal holding company for its taxable years 
ending December 31, 1960, and December 31, 1961.
    (ii) Dividend carryover to N Corporation's taxable year ending 
December 31, 1960. With respect to N Corporation's taxable year ending 
December 31, 1960, the taxable years referred to as first preceding 
taxable years and second preceding taxable years are--
    (a) M Corporation's taxable years ending June 30, 1960, and December 
31, 1959, respectively; and
    (b) N Corporation's taxable years ending December 31, 1959, and 
December 31, 1958, respectively.


The dividend carryover to N Corporation's taxable year ending December 
31, 1960, is $22,000 computed as follows, assuming the dividends paid 
deduction before dividend carryovers, and the taxable income after 
section 545(b) adjustments, to be as stated in the computation:

----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                                          M Corporation N Corporation
Second preceding taxable year:
  Dividends paid deduction..................................      $25,000  ...........      $12,000
  Taxable income............................................       15,000  ...........       13,000
                                                             =============             -------------
  Excess dividends paid deduction........................................      $10,000
First preceding taxable year:
  Dividends paid deduction..................................       23,000  ...........       20,000
  Taxable income............................................       21,000  ...........       10,000
                                                             =============             -------------
  Excess dividends paid deduction...........................        2,000  ...........      $10,000
Separate dividend carryovers................................       12,000  ...........       10,000
----------------------------------------------------------------------------------------------------------------

The aggregate dividend carryover of $22,000 is the sum of $12,000 (the 
separate dividend carryover from M Corporation) and $10,000 (the 
separate dividend carryover from N Corporation's own preceding taxable 
years).
    (iii) Dividend carryover to N Corporation's taxable year ending 
December 31, 1961. With respect to N Corporation's taxable year ending 
December 31, 1961, the first preceding taxable year is N Corporation's 
taxable year ending December 31, 1960; and the taxable years referred to 
as second preceding taxable years are M Corporation's taxable year 
ending June 30, 1960, and N Corporation's taxable year ending December 
31, 1959. The dividend carryover to N Corporation's taxable year ending 
December 31, 1961, is $17,000 computed as follows, assuming the 
dividends paid deduction before dividend carryovers, and the taxable 
income after section 545(b) adjustments, to be as stated in the 
computation:

------------------------------------------------------------------------
                                                     M            N
         Second preceding taxable year          Corporation  Corporation
------------------------------------------------------------------------
Dividends paid deduction......................      $23,000      $20,000
Taxable income................................       21,000       10,000
                                               -------------------------
Separate excess of dividends paid deduction           2,000       10,000
 over taxable income..........................
------------------------------------------------------------------------

The aggregate excess of dividends paid deduction over taxable income for 
the second preceding taxable year is $12,000, the sum of $2,000 
(separate excess from N Corporation) and $10,000 (separate excess from N 
Corporation). Such aggregate excess is increased by the excess dividends 
paid deduction, or is reduced by the excess of taxable income, for the 
first preceding taxable year as follows:

------------------------------------------------------------------------
 
------------------------------------------------------------------------
Aggregate excess of dividends paid deduction for  ..........     $12,000
 second preceding taxable year..................
Dividends paid deduction of N Corporation for        $50,000
 first preceding taxable year...................
Taxable income of N Corporation for first             45,000
 preceding taxable year.........................
                                                 ------------
                                                  ..........      $5,000
Dividend carryover to N Corporation's taxable     ..........      17,000
 year ending December 31, 1961..................
------------------------------------------------------------------------

    Example 2. (i) Facts. X Corporation is organized on May 1, 1956, and 
computes its taxable income on the basis of the fiscal year ending April 
30. Y Corporation and Z Corporation are both organized on January 1, 
1955, and both compute their taxable income on the basis of the calendar 
year. On July 31, 1957, X Corporation and Y Corporation transfer all 
their assets to Z Corporation in a statutory merger to which section 
381(a) applies. For its taxable years ending December 31, 1957, and 
December 31, 1958, Z Corporation is a personal holding company.
    (ii) Dividend carryover to Z Corporation's taxable year ending 
December 31, 1957. With respect to Z Corporation's taxable year ending 
December 31, 1957, the taxable years referred to as first preceding 
taxable years and second preceding taxable years are--
    (a) X Corporation's taxable years ending July 31, 1957, and April 
30, 1957, respectively;
    (b) Y Corporation's taxable years ending July 31, 1957, and December 
31, 1956, respectively; and
    (c) Z Corporation's taxable years ending December 31, 1956, and 
December 31, 1955, respectively.


[[Page 632]]



The dividend carryover to Z Corporation's taxable year ending December 
31, 1957, is $40,000 computed as follows, assuming the dividends paid 
deduction before dividend carryovers, and the taxable income after 
section 545(b) adjustments, to be as stated in the computation:

----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                      X Corporation Y Corporation Z Corporation
Second preceding taxable year:
  Dividends paid deduction........      $56,000  ...........      $19,000  ...........       $6,000
  Taxable income..................       24,000  ...........       17,000  ...........        5,000  ...........
                                   -------------             -------------             -------------
    Excess.....................................      $32,000  ...........       $2,000  ...........      $1,000
First preceding taxable year:
  Dividends paid deduction........        9,000  ...........        4,000  ...........       10,000
  Taxable income..................        7,000  ...........        8,000  ...........        5,000
                                   -------------             -------------             -------------
    Excess.....................................        2,000  ...........      (4,000)  ...........        5,000
                                   -------------             -------------             --------------
Separate dividend carryovers...................       34,000  ...........            0  ...........       6,000
----------------------------------------------------------------------------------------------------------------
The aggregate dividend carryover of $40,000 is the sum of $34,000 (the separate dividend carryover from X
  Corporation) and $6,000 (the separate dividend carryover from Z Corporation's own preceding taxable years).

    (iii) Dividend carryover to Z Corporation's taxable year ending 
December 31, 1958. With respect to Z Corporation's taxable year ending 
December 31, 1958, the first preceding taxable year is Z Corporation's 
taxable year ending December 31, 1957; and the taxable years referred to 
as second preceding taxable years are X Corporation's taxable year 
ending July 31, 1957, Y Corporation's taxable year ending July 31, 1957, 
and Z Corporation's taxable year ending December 31, 1956. The dividend 
carryover to Z Corporation's taxable year ending December 31, 1958, is 
$1,000 computed as follows, assuming the dividends paid deduction before 
dividend carryovers, and the taxable income after section 545(b) 
adjustments, to be as stated in the computation:

------------------------------------------------------------------------
                                        X            Y            Z
                                   Corporation  Corporation  Corporation
------------------------------------------------------------------------
Second preceding taxable year:
  Dividends paid deduction.......       $9,000       $4,000      $10,000
  Taxable income.................        7,000        8,000        5,000
                                  --------------------------------------
Separate excess of dividends paid        2,000            0        5,000
 deduction over taxable income...
 
------------------------------------------------------------------------

The aggregate excess of dividends paid deduction over taxable income for 
the second preceding taxable year is $7,000, the sum of $2,000 (separate 
excess from X Corporation) and $5,000 (separate excess from Z 
Corporation). Such aggregate excess is increased by the excess dividends 
paid deduction, or is reduced by the excess of taxable income, for the 
first preceding taxable year as follows:

Aggregate excess of dividends paid deduction for     ..........   $7,000
 second preceding taxable year.....................
Dividends paid deduction of Z Corporation for first    $102,000
 preceding taxable year............................
Taxable income of Z Corporation for first preceding     108,000  (6,000)
 taxable year......................................
                                                    --------------------
Dividend carryover to Z Corporation's taxable year   ..........    1,000
 ending December 31, 1958..........................
 

    Example 3. Assume the facts stated in Example (2), except that Y 
Corporation transferred all its assets to Z Corporation on May 31, 1957. 
Assume also that the facts for Y Corporation's taxable year ending May 
31, 1957, are otherwise the same as those stated for its taxable year in 
Example (2) ending July 31, 1957. In such case, the dividend carryovers 
to Z Corporation's taxable years ending on December 31, 1957, and 
December 31, 1958, are the same as in Example (2) notwithstanding the 
fact that the transfers from X Corporation and Y Corporation occurred on 
the different dates.
    Example 4. (i) Facts. T Corporation acquired on June 30, 1960, all 
the assets of U Corporation in a statutory merger to which section 
381(a) applies, and in a like transaction acquired on June 30, 1961, all 
the assets of V Corporation. Such corporations all compute taxable 
income on the basis of the calendar year. T Corporation is a personal 
holding company for its taxable years 1960 and 1961.
    (ii) Dividend carryover to T Corporation's taxable year 1960. With 
respect to T Corporation's taxable year ending December 31, 1960, the 
taxable years referred to as first preceding taxable years and second 
preceding taxable years are--

[[Page 633]]

    (a) U Corporation's taxable years ending June 30, 1960, and December 
31, 1959, respectively; and
    (b) T Corporation's taxable years ending December 31, 1959, and 
December 31, 1958, respectively.


The dividend carryover to T Corporation's taxable year ending December 
31, 1960, is $7,000 computed as follows, assuming the dividends paid 
deduction before dividend carryovers, and the taxable income after 
section 545(b) adjustments, to be as stated in the computation:

----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                                          U Corporation T Corporation
Second preceding taxable year:
  Dividends paid deduction..................................      $16,000  ...........      $10,000
  Taxable income............................................       12,000  ...........       13,000
                                                             -------------             -------------
    Excess...............................................................       $4,000  ...........           0
First preceding taxable year:
  Dividends paid deduction..................................        7,000  ...........       17,000
  Taxable income............................................        5,000  ...........       16,000
                                                             -------------             -------------
    Excess...............................................................        2,000  ...........       $1,000
                                                             -------------             --------------
Separate dividend carryovers.............................................        6,000  ...........        1,000
----------------------------------------------------------------------------------------------------------------

The aggregate dividend carryover of $7,000 is the sum of $6,000 (the 
separate dividend carryover from U Corporation) and $1,000 (the separate 
dividend carryover from T Corporation's own first preceding taxable 
year).
    (iii) Dividend carryover to T Corporation's taxable year 1961. 
Inasmuch as T Corporation's taxable year 1961 is the second taxable year 
ending after the date of distribution or transfer from U Corporation, 
paragraph (b)(3)(ii) of this section governs the determination of the 
dividend carryover from taxable years of T Corporation and U 
Corporation. On the other hand, inasmuch as T Corporation's taxable year 
1961 is the first taxable year ending after the date of distribution or 
transfer from V Corporation, paragraph (b)(3)(i) governs the 
determination of the dividend carryover from taxable years of V 
Corporation.
    (a) Application of paragraph (b)(3)(ii) of this section. With 
respect to T Corporation's taxable year 1961, the first preceding 
taxable year is T Corporation's taxable year ending December 31, 1960; 
and the taxable years referred to as second preceding taxable year are T 
Corporation's taxable year ending December 31, 1959, and U Corporation's 
taxable year ending June 30, 1960. The dividend carryover from taxable 
years of T Corporation and U Corporation is $1,500 computed as follows, 
assuming the dividends paid deduction before dividend carryovers, and 
the taxable income after section 545(b) adjustments, to be as stated in 
the computation:

------------------------------------------------------------------------
                                                     U            T
         Second preceding taxable year          Corporation  Corporation
------------------------------------------------------------------------
Dividends paid deduction......................       $7,000      $17,000
Taxable income................................        5,000       16,000
                                               -------------------------
Separate excess of dividends paid deduction           2,000        1,000
 over taxable income..........................
------------------------------------------------------------------------

The aggregate excess of dividends paid deduction over taxable income for 
the second preceding taxable year is $3,000, the sum of $2,000 (separate 
excess from U Corporation) and $1,000 (separate excess from T 
Corporation). Such aggregate is increased by the excess dividends paid 
deduction, or is reduced by the excess of taxable income, for the first 
preceding taxable year as follows:

 
                                                                  T
                                                             Corporation
 
Aggregate excess of dividends paid deduction for second           $3,000
 preceding taxable year....................................
First preceding taxable year:
  Dividends paid deduction of T Corporation....     $21,000
  Taxable income of T Corporation..............      22,500
  Excess taxable income....................................      (1,500)
                                                -------------
Separate dividend carryover (without regard to V                   1,500
 Corporation)..............................................
 

    (b) Application of paragraph (b)(3)(i) of this section. With respect 
to T Corporation's taxable year 1961, V Corporation's taxable year 
ending June 30, 1961, is a first preceding taxable year, and its taxable 
year ending December 31, 1960, is a second preceding taxable year. The 
separate dividend carryover from V Corporation is $8,000 computed as 
follows, assuming the dividends paid deduction before dividend 
carryovers, and the taxable income after section 545(b) adjustments, to 
be as stated in the computation:

 
                                                       V Corporation
          Second preceding taxable year
 
 
Dividends paid deduction.........................     $11,000
Taxable income...................................       6,000
  Excess.........................................  ..........     $5,000
First preceding taxable year:
  Dividends paid deduction.......................      $9,000
  Taxable income.................................       6,000
                                                  ------------

[[Page 634]]

 
  Excess.........................................       3,000
                                                              ----------
Separate dividend carryover from V Corporation...  ..........      8,000
 

    (c) Dividend carryover. The dividend carryover to T Corporation's 
taxable year 1961 is $9,500, the sum of $8,000 (the separate dividend 
carryover from V Corporation) and $1,500 (the aggregate dividend 
carryover from T Corporation and U Corporation).

    (d) Successive carryovers. The provisions of this section shall 
apply for the purpose of determining a dividend carryover to an 
acquiring corporation which, in a distribution or transfer to which 
section 381(a) applies, acquires the assets of a distributor or 
transferor corporation which has previously acquired the assets of 
another corporation in a transaction to which section 381(a) applies; 
even though, in computing the dividend carryover to such second 
acquiring corporation, it is necessary to take into account the 
deduction for dividends paid, and the adjusted taxable income, of the 
first distributor or transferor corporation.
    (e) Acquiring corporation not receiving all the assets. The dividend 
carryover acquired from a distributor or transferor corporation by an 
acquiring corporation in a transaction to which section 381(a) applies 
is not reduced by reason of the fact that the acquiring corporation does 
not acquire 100 percent of the assets of the distributor or transferor 
corporation.
    (f) Dividends paid after the close of taxable year. A transaction to 
which section 381(a) applies does not prevent the application of section 
563(b) to a dividend paid by a distributor or transferor corporation 
after the close of its taxable year ending with the date of distribution 
or transfer but on or before the 15th day of the third month following 
the close of such taxable year. However, dividends paid by the acquiring 
corporation may not be taken into account under section 563(b) for the 
purpose of determining the dividends paid deduction of the distributor 
or transferor corporation for its taxable year ending with the date of 
distribution or transfer.

[T.D. 6532, 26 FR 406, Jan. 19, 1961]



Sec. 1.381(c)(15)-1  Indebtedness of certain personal holding companies.

    (a) Qualified indebtedness--(1) Carryover requirement. If, in a 
transaction to which section 381(a) applies, the acquiring corporation 
assumes liability for any indebtedness which was qualified indebtedness 
(as defined in section 545(c) and Sec. 1.545-3) in the hands of the 
distributor or transferor corporation immediately before the assumption 
of such indebtedness, then, under section 381(c)(15), in computing its 
undistributed personal holding company income for any taxable year 
beginning after December 31, 1963, and ending after the date of 
distribution or transfer, the acquiring corporation shall be considered 
the distributor or transferor corporation for purposes of computing the 
deduction under section 545(c) and Sec. 1.545-3. Such deduction shall 
be allowed to the acquiring corporation in accordance with section 
545(c) and Sec. 1.545-3.
    (2) Successive transactions to which section 381(a) applies. If in a 
transaction to which section 381(a) applies, an acquiring corporation 
assumes liability for qualified indebtedness, such acquiring corporation 
shall be deemed to have incurred such qualified indebtedness for the 
purpose of applying section 381(c)(15) to any subsequent transaction in 
which such acquiring corporation is the distributor or transferor 
corporation.
    (b) Pre-1934 indebtedness--(1) Carryover requirement. If, in a 
transaction to which section 381(a) applies, the acquiring corporation 
assumes liability for any indebtedness incurred, or assumed, before 
January 1, 1934, by a distributor or transferor corporation, then under 
section 381(c)(15) the acquiring corporation shall be allowed, in 
computing its undistributed personal holding company income for any 
taxable year ending after the date of distribution or transfer, a 
deduction under section 545(b)(7) for amounts used or irrevocably set 
aside to pay or to retire such indebtedness. Such deduction shall be 
allowed to the acquiring corporation in accordance with section 
545(b)(7) and paragraph (g) of Sec. 1.545-2 as though the indebtedness 
had been incurred, or assumed, by the acquiring corporation before 
January 1, 1934.

[[Page 635]]

    (2) Successive transactions to which section 381(a) applies. If, in 
a transaction to which section 381(a) applies, an acquiring corporation 
assumes liability for indebtedness described in subparagraph (1) of this 
paragraph, such acquiring corporation shall be deemed to have incurred 
the indebtedness before January 1, 1934, for the purpose of applying 
section 381(c)(15) to any subsequent transaction in which such acquiring 
corporation is the distributor or transferor corporation.
    (c) Special rule. For purposes of this section, if, in a transaction 
otherwise described in this section, an acquiring corporation acquires 
real estate--(1) of which the distributor or transferor corporation is 
the legal or equitable owner immediately before the acquisition, and (2) 
which is subject to indebtedness that, with respect to the distributor 
or transferor corporation, is indebtedness described in this section 
immediately before the acquisition, then the acquiring corporation will 
be treated as having assumed such indebtedness, provided it shows to the 
satisfaction of the Commissioner that under all the facts and 
circumstances it bears the burden of discharging such indebtedness.

[T.D. 6949, 33 FR 5524, Apr. 9, 1968; 33 FR 6091, Apr. 20, 1968]



Sec. 1.381(c)(16)-1  Obligations of distributor or transferor 
corporation.

    (a) Deduction allowed to acquiring corporation. (1) If, in a 
transaction to which section 381(a) applies, the acquiring corporation 
assumes an obligation of a distributor or transferor corporation which 
gives rise to a liability after the date of distribution or transfer and 
if the distributor or transferor corporation would be entitled to deduct 
such liability in computing taxable income were it paid or accrued after 
that date by such corporation, then, under the provisions of section 
381(c)(16) and this section, the acquiring corporation shall be entitled 
to deduct such liability as if it were the distributor or transferor 
corporation. However, in the case of a transaction to which section 
381(a)(2) applies, section 381(c)(16) shall not apply to an obligation 
which is reflected in the amount of consideration, that is, the stock, 
securities, or other property, transferred by the acquiring corporation 
to a transferor corporation or its shareholders in exchange for the 
property of that transferor corporation. An obligation which is so 
reflected in the amount of consideration will be treated as an item or 
tax attribute not specified in section 381(c)(16). Such an obligation is 
subject to section 381(c)(4). See subparagraph (2) of this paragraph. 
Any deduction allowed under section 381(c)(16) to the acquiring 
corporation shall be taken by that corporation in the taxable year 
ending after the date of distribution or transfer in which the liability 
is paid or accrued by that corporation, as the case may be.
    (2) In order to determine whether, in the case of obligations of a 
distributor or transferor corporation assumed by an acquiring 
corporation, section 381(c)(16) and this section, or section 381(c)(4) 
and the regulations thereunder, apply, the following rules shall govern:
    (i) If the obligation gave rise to a liability before the date of 
distribution or transfer, see section 381(c)(4) and the regulations 
thereunder.
    (ii) If the obligation gives rise to a liability after the date of 
distribution or transfer, and the obligation was not reflected in the 
amount of consideration transferred by the acquiring corporation to the 
distributor or transferor corporation or its shareholders in exchange 
for the property of the distributor or transferor corporation, then 
section 381(c)(16) and this section shall apply.
    (iii) In the case of a transaction to which section 381(a)(1) 
applies, if the obligation gives rise to a liability after the date of a 
distribution, and the obligation was reflected in the amount of 
consideration transferred by the acquiring corporation to the 
distributor corporation or its shareholders in exchange for the property 
of the distributor corporation, then section 381(c)(16) and this section 
shall apply.
    (iv) In the case of a transaction to which section 381(a)(2) 
applies, if the obligation gives rise to a liability after the date of a 
transfer, and the obligation was reflected in the amount of 
consideration transferred by the acquiring corporation to the transferor

[[Page 636]]

corporation or its shareholders in exchange for the property of the 
transferor corporation, then see section 381(c)(4) and the regulations 
thereunder.
    (3) The rules of this section apply to obligations assumed by 
agreement of the parties as well as by operation of law.
    (4) For purposes of this section, an obligation of a distributor or 
transferor corporation gives rise to a liability when the liability 
would be accruable by a taxpayer using the accrual method of accounting 
notwithstanding the fact that the distributor or transferor corporation 
is not using the accrual method of accounting. See paragraph (a)(2) of 
Sec. 1.461-1.
    (5) In the case of a transaction to which section 381(a)(2) applies, 
the determination as to whether or not an obligation was reflected in 
the amount of consideration transferred by the acquiring corporation to 
the transferor corporation or its shareholders in exchange for the 
property of the transferor corporation shall be made on the basis of all 
the facts of each particular transfer. Where, on the date of 
distribution or transfer, the parties were aware of the existence of a 
specific obligation and reduced the amount of consideration to be 
transferred by the acquiring corporation by a specific amount because of 
the existence of such obligation, then such obligation shall be 
considered to have been reflected in the amount of consideration 
transferred. In the absence of such facts, it shall be presumed that the 
obligation was not reflected in the amount of consideration transferred.
    (b) Distribution or transfer occurring under the Internal Revenue 
Code of 1939. Subject to the provisions of section 381(c)(16) and this 
section, a corporation which would have been an acquiring corporation 
(under the provisions of paragraph (b) of Sec. 1.381(a)-1) in a 
transaction to which section 381(a) applies if the date of distribution 
or transfer had occurred on or after the effective date of the 
provisions of subchapter C, chapter 1 of the Internal Revenue Code of 
1954, applicable to a liquidation or reorganization, as the case may be, 
shall be entitled to take a deduction for amounts paid or accrued in any 
taxable year beginning after December 31, 1953, in respect of any 
obligation which it has assumed from a corporation which would have been 
a distributor or transferor corporation in such transaction. However, 
this paragraph shall have no application to a situation described in 
paragraph (a)(2)(iv) of this section.
    (c) Examples. The application of the foregoing rules may be 
illustrated by the following examples:

    Example 1. X Corporation and Y Corporation compute their taxable 
income on the basis of the calendar year, and both corporations use an 
accrual method of accounting. On December 31, 1954, Y Corporation 
acquires the assets of X Corporation in a transfer to which section 
381(a)(2) applies. By reason of State law, Y Corporation assumes 
responsibility for all of the obligations for which X Corporation is 
then, or may become, liable. The parties have no knowledge of any 
specific obligations of X Corporation which are not yet fixed and 
ascertainable, but it is agreed to reduce the amount of consideration 
that Y Corporation is to transfer in exchange for the assets of X 
Corporation by $5,000 to reflect any unforeseen contingent liabilities 
of X Corporation for which Y Corporation might subsequently become 
liable. After the date of the transfer, a claim for damages on account 
of the alleged negligence of an alleged agent of X Corporation is filed. 
After commencement of legal action by the claimant and in order to 
eliminate the possibility of injury to its business, Y Corporation 
settles the claim in 1955 by paying the claimant the amount of $3,000. 
Assuming that such sum would have been deductible under section 162 if 
paid by X Corporation, Y Corporation is entitled to deduct such sum in 
accordance with the provisions of section 381(c)(16) and this section in 
computing its taxable income for 1955, since the claim gave rise to a 
liability after the date of transfer, the parties were not aware of a 
specific obligation, and the specific obligation was not reflected in 
the consideration transferred by Y Corporation in exchange for the 
assets of X Corporation.
    Example 2. Assume the same facts as in Example (1), except that the 
claim for damages was filed prior to the transfer of X Corporation's 
assets to Y Corporation, but the parties considered the chances for 
recovery by the claimant so remote that no specific amount other than 
the $5,000 reduction in consideration for all contingent liabilities as 
a whole is reflected in the consideration transferred by Y Corporation 
in exchange for the assets of X Corporation. Assuming that such sum 
would have been deductible under section 162 if paid by X Corporation, 
the

[[Page 637]]

$3,000 paid by Y Corporation in 1955 is deductible in accordance with 
the provisions of section 381(c)(16) and this section in 1955.
    Example 3. Assume the same facts as in Example (1), except that the 
parties consider the chances of recovery by the claimant of sufficient 
probability that Y Corporation reduces the amount of consideration it 
transfers in exchange for the assets of X Corporation by $1,000 in 
addition to the $5,000 reduction for all other contingent liabilities. 
The $3,000 paid by Y Corporation in 1955 is not deductible under section 
381(c)(16) and this section, since the specific obligation was reflected 
in the consideration transferred by Y Corporation in exchange for the 
assets of X Corporation. The deductibility of the payment is accordingly 
governed by the provisions of section 381(c)(4) and the regulations 
thereunder. Similarly, if in this case Y Corporation had transferred 
$10,000 less in consideration for the assets of X Corporation because of 
this particular claim, Y Corporation would not be entitled to any 
deduction for the $3,000 paid in 1955 under section 381(c)(16) and this 
section, and the deductibility of the payment would be governed by the 
provisions of section 381(c)(4) and the regulations thereunder. If the 
date of transfer of X Corporation's assets had occurred prior to the 
effective date of subchapter C, chapter 1 of the Internal Revenue Code 
of 1954, applicable to a reorganization, no deduction would be allowed 
to Y Corporation under that section.

[T.D. 6750, 29 FR 11267, Aug. 5, 1964]



Sec. 1.381(c)(17)-1  Deficiency dividend of personal holding company.

    (a) Carryover requirement. If a determination (as defined in section 
547(c)) establishes that a distributor or transferor corporation in a 
transaction to which section 381(a) applies is liable for personal 
holding company tax imposed by section 541 (or by a corresponding 
provision of prior income tax law) for any taxable year ending on or 
before the date of distribution or transfer, then in computing such tax 
the deduction described in section 547 shall be allowed pursuant to 
section 381(c)(17) to such corporation for the amount of deficiency 
dividends paid by the acquiring corporation with respect to the 
distributor or transferor corporation. Except as otherwise provided in 
this section, the provisions of section 547 and the regulations 
thereunder apply with respect to a deficiency dividend deduction 
allowable pursuant to section 381(c)(17).
    (b) Deficiency dividends paid by the acquiring corporation with 
respect to the distributor or transferor corporation. A deficiency 
dividend paid by the acquiring corporation with respect to the 
distributor or transferor corporation is a distribution that would 
satisfy the definition of a deficiency dividend under section 547(d)(1) 
if paid by the distributor or transferor corporation to its own 
shareholders except that it shall be paid by the acquiring corporation 
to its own shareholders and shall be paid after the date of distribution 
or transfer and on, or within 90 days after, the date of the 
determination but before the acquiring corporation files claim under 
paragraph (c) of this section.
    (c) Claim for deduction. A claim for a deduction under this section 
shall be made by the acquiring corporation on Form 976, and shall be 
filed within 120 days after the date of the determination. The form 
shall contain, or be accompanied by, the information required under 
paragraph (b)(2) of Sec. 1.547-2 in sufficient detail to properly 
identify the facts with the distributor or transferor corporation and 
the acquiring corporation. The statement required with respect to the 
shareholders on the date of payment of the deficiency dividend shall 
relate to the shareholders of the acquiring corporation, and the 
required certified copy of the resolution authorizing the payment of the 
dividend shall be that of the board of directors, or other authority, of 
the acquiring corporation. Necessary changes may be made in Form 976 in 
order to carry out the provisions of this paragraph. The claim shall be 
filed with the district director for the internal revenue district in 
which the return of the distributor or transferor corporation to which 
such claim relates was filed.
    (d) Effect on dividends paid deduction. A deficiency dividend paid 
by the acquiring corporation, which is allowable as a deduction to a 
distributor or transferor corporation pursuant to section 381(c)(17), 
shall not become a part of the dividends paid deduction of the acquiring 
corporation under section 561 for any taxable year.
    (e) Successive transactions to which section 381(a) applies. The 
provisions of this section shall apply in the case of

[[Page 638]]

successive transactions to which section 381(a) applies. Thus, if X 
Corporation transfers its assets to Y Corporation in a transaction to 
which section 381(a) applies and if Y Corporation transfers its assets 
to Z Corporation in a subsequent transaction to which section 381(a) 
applies, then, subject to the provisions of this section, X Corporation 
may take a deficiency dividend deduction for the amount of deficiency 
dividends paid by Z Corporation with respect to X Corporation.
    (f) Example. The provisions of this section may be illustrated by 
the following example:

    Example. M Corporation, a personal holding company, computes its 
taxable income on the basis of the calendar year. On December 31, 1956, 
N Corporation acquires the assets of M Corporation in a transaction to 
which section 381(a) applies. On July 31, 1958, a determination (as 
defined in section 547(c)) establishes that M Corporation is liable for 
the taxable year 1955 for personal holding company tax in the amount of 
$35,500 based on undistributed personal holding company income of 
$42,000 for such taxable year. N Corporation complies with the 
provisions of this section and on September 30, 1958, distributes 
$42,000 to its shareholders as deficiency dividends with respect to M 
Corporation's taxable year 1955. The distribution of $42,000 by N 
Corporation is a taxable dividend under section 316(b)(2) regardless of 
whether N Corporation is a personal holding company for the taxable year 
1958 or whether it had any current or accumulated earnings and profits. 
See Example (3) in paragraph (e) of Sec. 1.316-1. Because N Corporation 
has paid deficiency dividends of $42,000 in accordance with this 
section, M Corporation is entitled to a deficiency dividend deduction of 
$42,000 for the taxable year 1955 and is thus relieved of its liability 
for personal holding company tax of $35,500 for such taxable year. To 
prevent a duplication of deductions, the amount distributed by N 
Corporation in 1958 does not become a part of N Corporation's dividends 
paid deduction under section 561 for any taxable year.

[T.D. 6532, 26 FR 409, Jan. 19, 1961, as amended by T.D. 7604, 44 FR 
18661, Mar. 29, 1979; T.D. 7767, 45 FR 11264, Feb. 6, 1981]



Sec. 1.381(c)(18)-1  Depletion on extraction of ores or minerals from
the waste or residue of prior mining.

    (a) Carryover requirement. Section 381(c)(18) provides that the 
acquiring corporation in a transaction described in section 381(a) shall 
be considered as though it were the distributor or transferor 
corporation after the date of distribution or transfer for the purpose 
of determining the applicability of section 613(c)(3) (relating to 
extraction of ores or minerals from the ground). Thus, an acquiring 
corporation which has acquired the waste or residue of prior mining from 
a distributor or transferor corporation in a transaction described in 
section 381(a) shall be entitled, after the date of distribution or 
transfer, to an allowance for depletion under section 611 in respect of 
ores or minerals extracted from such waste or residue if the distributor 
or transferor corporation would have been entitled to such an allowance 
for depletion in the absence of the distribution or transfer. See 
paragraph (f) of Sec. 1.613-4 to determine whether a distributor or 
transferor corporation is entitled to an allowance for depletion with 
respect to the waste or residue of prior mining.
    (b) Application of section 614 to waste or residue of prior mining. 
If, in a transaction described in section 381(a), the acquiring 
corporation acquires waste or residue of prior mining from a distributor 
or transferor corporation, then the acquiring corporation shall be 
considered as though it were the distributor or transferor corporation 
for the purpose of applying section 614 and the regulations thereunder 
to the waste or residue so acquired. Thus, if the distributor or 
transferor corporation was required under paragraph (c) of Sec. 1.614-1 
to treat the waste or residue as part of the mineral deposit from which 
it was extracted and if the acquiring corporation acquires both the 
waste or residue and the mineral deposit from which it was extracted in 
a transaction described in section 381(a), then such waste or residue 
shall be treated as a part of such mineral deposit in the hands of the 
acquiring corporation. On the other hand, if the waste or residue was 
required to be treated as a separate mineral deposit in the hands of the 
distributor or transferor corporation, such waste or residue shall be 
treated as a separate mineral deposit in the hands of the acquiring 
corporation.

[T.D. 6552, 26 FR 1991, Mar. 8, 1961, as amended by T.D. 7170, 37 FR 
5373, Mar. 15, 1972]

[[Page 639]]



Sec. 1.381(c)(19)-1  Charitable contribution carryovers in certain 
acquisitions.

    (a) Carryover requirement. Section 381(c)(19) provides that, in 
computing taxable income for its taxable years which begin after the 
date of distribution or transfer to which section 381(a) applies, the 
acquiring corporation shall take into account any charitable 
contributions made by a distributor or transferor corporation during the 
taxable year ending on the date of distribution or transfer, and in 
certain immediately preceding taxable years, which are in excess of the 
maximum amount deductible for those taxable years under section 
170(b)(2) in the following manner:
    (1) If the taxable year of the distributor or transferor corporation 
ending on the date of distribution or transfer begins before January 1, 
1962, the acquiring corporation shall, in computing taxable income for 
its first 2 taxable years which begin after the date of such 
distribution or transfer, take into account the excess contributions 
made by the distributor or transferor corporation in the taxable year 
ending on the date of distribution or transfer and in the immediately 
preceding taxable year;
    (2) If the taxable year of the distributor or transferor corporation 
ending on the date of distribution or transfer begins after December 31, 
1961, the acquiring corporation shall, in computing taxable income for 
certain taxable years which begin after the date of distribution or 
transfer, take into account the excess contributions made by the 
distributor or transferor corporation in the taxable year ending on such 
date of distribution or transfer and in any of the four taxable years 
immediately preceding such taxable year but excluding any taxable year 
beginning before January 1, 1962 (see paragraph (c)(3) of this section). 
Notwithstanding the preceding sentence, if the taxable year of the 
distributor or transferor corporation ending on the date of distribution 
or transfer begins after December 31, 1961, and before January 1, 1963, 
the acquiring corporation shall, in computing taxable income for its 
first taxable year which begins after the date of distribution or 
transfer, also take into account the excess contributions made by the 
distributor or transferor corporation in the taxable year immediately 
preceding the taxable year of the distributor or transferor corporation 
ending on the date of distribution or transfer (see paragraph (c)(2) of 
this section).

To determine the amount of excess contributions made by a distributor or 
transferor corporation and to integrate them with contributions made by 
the acquiring corporation for the purpose of determining the charitable 
contributions deductible by the acquiring corporation for its taxable 
years beginning immediately after the date of distribution or transfer, 
it is necessary to apply the provisions of section 170(b)(2) and Sec. 
1.170-3 (or, if applicable, section 170(b)(2) and (d)(2) and Sec. 
1.170A-11) in accordance with the conditions and limitations of section 
381(c)(19) and this section. For taxable years beginning before January 
1, 1970, see section 170 for provisions of section 170(b)(2) as referred 
to in this section. For taxable years beginning after December 31, 1969, 
see section 170A for provisions of section 170(b)(2) or (d)(2) as 
referred to in this section. For special rules for applying section 
170(d)(2) with respect to contributions paid, or treated as paid, in 
taxable years beginning before January 1, 1970, see paragraph (d) of 
Sec. 1.170A-11.
    (b) Manner of computing excess charitable contribution carryovers. 
(1) The amount of any charitable contribution made by a distributor or 
transferor corporation in any taxable year ending on or before the date 
of distribution or transfer, or made by the acquiring corporation in any 
taxable year before its taxable year beginning after the date of 
distribution or transfer, in excess of the amount allowable as a 
deduction to such corporation for such taxable year under section 
170(b)(2) shall be determined by taking into account the taxable income 
of, and the contributions made by, that corporation only.
    (2) An acquiring corporation which, in a distribution or transfer to 
which section 381(a) applies, acquires the assets of a distributor or 
transferor corporation which previously acquired the assets of another 
corporation in a

[[Page 640]]

transaction to which section 381(a) applies, shall succeed to and take 
into account, subject to the conditions and limitations of sections 170 
and 381, the charitable contribution carryovers available to the first 
acquiring corporation under sections 170 and 381, including those 
derived by such first acquiring corporation from its distributor or 
transferor corporation.
    (3) The excess charitable contributions made by a distributor or 
transferor corporation in its taxable year ending on the date of 
distribution or transfer and in certain immediately preceding taxable 
years (see paragraph (c) of this section) which are not deductible by 
the distributor or transferor corporation because of the 5-percent 
limitation of section 170(b)(2) shall be available to the acquiring 
corporation without diminution by reason of the fact that the acquiring 
corporation does not acquire 100 percent of the assets of the 
distributor or transferor corporation. Thus, if a parent corporation 
owning 80 percent of all classes of stock of its subsidiary corporation 
were to acquire its share of the assets of the subsidiary corporation 
upon a complete liquidation described in paragraph (b)(1)(i) of Sec. 
1.381(a)-1, then, subject to the conditions and limitations of this 
section, 100 percent of the excess contributions made by the subsidiary 
corporation would be available to the acquiring corporation.
    (c) Taxable years to which carryovers apply and amount deductible--
(1) Taxable years beginning before January 1, 1962. If the taxable year 
of the distributor or transferor corporation ending on the date of 
distribution or transfer begins before January 1, 1962:
    (i) The excess charitable contributions made by a distributor or 
transferor corporation in its taxable year immediately preceding that 
ending on the date of distribution or transfer, to the extent not 
deductible by it because of the limitations of section 170(b)(2) in its 
taxable year ending on that date, shall be deductible by the acquiring 
corporation to the extent prescribed by section 170(b)(2) in its first 
taxable year beginning after the date of distribution or transfer. Any 
portion of such excess which is not deductible under this section by the 
acquiring corporation in such first taxable year shall not be deducted 
by that corporation in any other taxable year.
    (ii) The excess charitable contributions made by a distributor or 
transferor corporation in its taxable year ending on the date of 
distribution or transfer shall first be deductible by the acquiring 
corporation to the extent prescribed by section 170(b)(2) and this 
section in its first taxable year beginning after that date and then, to 
the extent prescribed by section 170(b)(2) and this section, in its 
second taxable year beginning after that date. Any portion of such 
excess which is not deductible under this section by the acquiring 
corporation in such first and second taxable years shall not be deducted 
by that corporation in any other taxable year.
    (2) Taxable years beginning in 1962. If the taxable year of the 
distributor or transferor corporation ending on the date of distribution 
or transfer begins after December 31, 1961, and before January 1, 1963:
    (i) The excess charitable contributions made by a distributor or 
transferor corporation in its taxable year immediately preceding that 
ending on the date of distribution or transfer, to the extent not 
deductible by it because of the limitations of section 170(b)(2) in its 
taxable year ending on that date, shall be deductible by the acquiring 
corporation to the extent prescribed by section 170(b)(2) in its first 
taxable year beginning after the date of distribution or transfer. Any 
portion of such excess which is not deductible under this section by the 
acquiring corporation in such first year shall not be deducted by that 
corporation in any other taxable year.
    (ii) The excess charitable contributions made by a distributor or 
transferor corporation in its taxable year ending on the date of 
distribution or transfer and beginning after December 31, 1961, and 
before January 1, 1963, shall first be deductible by the acquiring 
corporation to the extent prescribed by section 170(b)(2) and this 
section in its first taxable year beginning after that date and then, to 
the extent prescribed by section 170(b)(2) and this section, in its 
second, third, fourth, and fifth taxable year, in order of time,

[[Page 641]]

beginning after that date. Any portion of such excess which is not 
deductible under this section by the acquiring corporation in such 5 
taxable years shall not be deducted by that corporation in any other 
taxable year.
    (3) Taxable years beginning after December 31, 1962. (i) If the 
taxable year of the distributor or transferor corporation ending on the 
date of distribution or transfer begins after December 31, 1962, the 
excess charitable contributions made by a distributor or transferor 
corporation in its taxable year ending on the date of distribution or 
transfer and in each of its four immediately preceding taxable years 
(excluding any taxable year beginning before January 1, 1962), to the 
extent not deductible by it because of the limitations of section 
170(b)(2) in its taxable year ending on the date of distribution or 
transfer or its prior taxable years, shall be deductible by the 
acquiring corporation to the extent prescribed by section 170(b)(2) (or, 
if applicable, section 170(d)(2)) and subdivision (ii) of this 
subparagraph, in its taxable years which begin after the date of 
distribution or transfer. However, any portion of the excess charitable 
contributions made by a distributor or transferor corporation in a 
particular taxable year, to which this subparagraph is applicable, which 
is not deductible under this section within the 5 taxable years 
immediately following the taxable year in which the contribution was 
paid by the distributor or transferor corporation shall not be 
deductible by the acquiring corporation in any other taxable year.
    (ii) For purposes of determining the 5 taxable years in which the 
excess contributions may be deducted, all taxable years of the 
distributor or transferor corporation subsequent to the taxable year in 
which the excess contribution was made, including the taxable year 
ending on the date of distribution or transfer shall be treated as 
taxable years of the acquiring corporation.
    (iii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. X Corporation and Y Corporation both compute taxable income 
on the calendar year basis. X Corporation has excess charitable 
contributions for 1962 and 1964. On December 31, 1966, X Corporation 
distributes all its assets to Y Corporation in a complete liquidation to 
which section 381(a) applies. The excess 1962 charitable contributions 
of X Corporation (to the extent not deductible by X because of the 
limitations of section 170(b)(2) in its taxable years 1963 through 1966) 
may be deducted by Y Corporation only in 1967. Y Corporation's taxable 
year 1967 is the fifth taxable year succeeding the taxable year 1962 
(the year in which the excess contributions were made), and the portion 
of such excess contributions which is not deductible in the 5 taxable 
years immediately succeeding 1962 (1963 through 1967) is not deductible 
by Y Corporation in any other taxable year. Any excess charitable 
contributions for 1964 to which Y Corporation may be entitled must be 
deducted by Y Corporation (if deductible at all) in 1967, 1968, and 1969 
since such years are the third, fourth, and fifth taxable years 
succeeding the taxable year 1964 (the year in which the excess 
contributions were paid).

    (4) General rules. No excess charitable contributions made by a 
distributor or transferor corporation shall be deductible by the 
acquiring corporation in its taxable year which includes the date of 
distribution or transfer. In addition, an excess charitable contribution 
made by a distributor or transferor corporation in a taxable year prior 
to the taxable year of the transfer is only deductible by the 
distributor or transferor corporation, subject to the limitations of 
section 170(b)(2) (or, if applicable, section 170(d)(2)), in its 
subsequent taxable years which begin on or before the date of 
distribution or transfer, and by the acquiring corporation in its 
taxable year or years beginning after the date of distribution or 
transfer.
    (d) Rules governing amounts deductible by acquiring corporations. 
(1) In applying the provisions of section 170(b)(2) (or, if applicable, 
section 170(d)(2)) for the purpose of determining the amount of excess 
charitable contributions which are deductible by the acquiring 
corporation in its taxable years beginning after the date of 
distribution or transfer, all taxable years of the distributor or 
tranferor and acquiring corporations which, with respect to a particular 
taxable year beginning after the date of distribution or transfer, 
constitute the same numbered preceding taxable year shall together be 
considered as a 1 taxable year even though the taxable years involved 
may not end on the

[[Page 642]]

same date. Thus, for example, all taxable years of the distributor or 
transferor and acquiring corporations which, with respect to the first 
taxable year of the acquiring corporation beginning after the date of 
distribution or transfer, constitutes the second preceding taxable year 
shall together be considered as 1 taxable year even though the taxable 
years involved may not end on the same date. Any excess charitable 
contributions carried over from preceding taxable years which are 
considered as 1 taxable year shall be taken into account by the 
acquiring corporation as one amount, without regard to the extent to 
which the contributions were made by a distributor or transferor 
corporation or the acquiring corporation.
    (2) For purposes of this paragraph, each taxable year of the 
distributor or transferor corporation beginning on or before the date of 
distribution or transfer shall be treated as a preceding taxable year 
with reference to the acquiring corporation's taxable years beginning 
after such date. For example, the taxable year of a distributor or 
transferor corporation which ends on the date of distribution or 
transfer shall be considered a first preceding taxable year with 
reference to the acquiring corporation's first taxable year beginning 
after that date, a second preceding taxable year with reference to the 
acquiring corporation's second taxable year beginning after that date, 
and so forth with respect to succeeding taxable years of the acquiring 
corporation. Also, for example, the taxable year of a distributor or 
transferor corporation which immediately precedes its taxable year 
ending on the date of distribution or transfer shall be considered a 
second preceding taxable year with reference to the acquiring 
corporation's first taxable year beginning after that date.
    (e) Illustration. The application of this section may be illustrated 
by the following example:

    Example. (i) X Corporation is organized on April 1, 1956, and 
computes its taxable income on the basis of the fiscal year ending March 
31. Y Corporation is organized on July 1, 1955, and computes its taxable 
income on the basis of the fiscal year ending June 30. Z Corporation is 
organized on January 1, 1956, and computes its taxable income on the 
basis of the calendar year. On June 30, 1957, X Corporation distributes 
all its assets to Y Corporation in a complete liquidation to which 
section 381(a) applies. On November 30, 1957, Y Corporation transfers 
all its assets to Z Corporation in a statutory merger to which section 
381(a) applies.
    (ii) The 5-percent limitation (computed in the manner prescribed by 
section 170(b)(2)), the charitable contributions actually paid, and the 
excess contributions with respect to each such corporation during the 
taxable years involved are as follows:

          Name of corporation                   X          X
          Taxable year ending              3-31-57    6-30-57
5-percent limitation...................    $20,000     $9,000
Current contributions..................     32,000     15,000
                                        ----------------------
  (Excess contributions)...............   (12,000)    (6,000)
------------------------------------------------------------------------
          Name of corporation                   Y          Y          Y
          Taxable year ending              6-30-56    6-30-57   11-30-57
5-percent limitation...................    $15,000    $10,000    $18,000
Current contributions..................     29,000          0     17,000
                                        -----------
  (Excess contributions)...............   (14,000)  .........  .........
                                                   ---------------------
  Balance of 5-percent limitation......  .........     10,000      1,000
------------------------------------------------------------------------
          Name of corporation                   Z          Z          Z
          Taxable year ending             12-31-56   12-31-57   12-31-58
5-percent limitation...................    $10,000    $30,000    $58,000
Current contributions..................     40,000     28,000     92,000
                                        -----------
  (Excess contributions)...............   (30,000)  .........  .........
                                                   ---------------------
  Balance of 5-percent limitation......  .........      2,000     56,000
 

    (iii) X Corporation was in existence for two taxable years, in each 
of which it made charitable contributions in excess of the maximum 
amount deductible for those years under section 170(b)(2). The excess 
contributions made in the year ending March 31, 1957, of $12,000, are 
deductible by X Corporation in its short taxable year ending June 30, 
1957, and then by Y Corporation in its short taxable year ending 
November 30, 1957, in each instance in the manner and to the extent 
prescribed by section 170(b)(2) and this section. The excess 
contributions made by X Corporation in the year ending June 30, 1957, of 
$6,000, are deductible by Y Corporation in its short taxable year ending 
November 30, 1957, and then by Z Corporation in its taxable year 1958, 
in each instance in the manner and to the extent prescribed by section 
170(b)(2) and this section.
    (iv) Y Corporation was in existence for three taxable years. In the 
year ended June 30, 1956, its contributions in excess of the amount 
deductible for that year under section 170(b)(2) amounted to $14,000. 
Such excess is deductible by Y Corporation in its taxable year ending 
June 30, 1957, and, together with X Corporation's excess contributions 
of $18,000, in its short taxable year ending November 30, 1957, in each 
instance in the manner and to the extent prescribed by

[[Page 643]]

section 170(b)(2) and this section. Accordingly, since Y Corporation 
made no contributions in its taxable year ending June 30, 1957, its 
deduction for that year on account of excess contributions carried over 
is $10,000, an amount equal to the 5-percent limitation of section 
170(b)(2). The deduction is attributable to excess contributions made by 
Y Corporation in the taxable year ended June 30, 1956; thus, the excess 
of those contributions over $10,000, namely, $4,000, is deductible by Y 
Corporation in its short taxable year ending November 30, 1957, in the 
manner and to the extent prescribed by section 170(b)(2) and this 
section. With respect to the short taxable year ending November 30, 
1957, the excess contributions of the second preceding year are X 
Corporation's excess contributions of $12,000 made in the year ending 
March 31, 1957, and Y Corporation's excess contributions of $4,000 made 
in the year ending June 30, 1956, which were not deductible by Y 
Corporation in the taxable year ending June 30, 1957, because of the 5-
percent limitation prescribed by section 170(b)(2), an aggregate of 
$16,000. Inasmuch as Y Corporation's limitation for the short taxable 
year ended November 30, 1957, exceeds the contributions made in that 
year by $1,000, the excess contributions of the second preceding taxable 
year are deductible in the taxable year ending November 30, 1957, to the 
extent of $1,000 and the remainder ($15,000) is not deductible by any 
corporation in any taxable year. The excess contributions of the first 
preceding taxable year, namely, X Corporation's excess contributions 
made in the short taxable year ending June 30, 1957, are deductible by Z 
Corporation in its taxable year 1958, in the manner and to the extent 
prescribed in section 170(b)(2) and this section.
    (v) Z Corporation has been in existence for 3 taxable years. The 
contributions made in 1956 in excess of the amount deductible for that 
year under section 170(b)(2) amounted to $30,000. Such excess is 
deductible by Z Corporation in its taxable year 1957 and, together with 
X Corporation's excess contributions of $6,000 (derived through Y 
Corporation) made in the taxable year ending June 30, 1957, in the 
taxable year 1958, in each instance in the manner and to the extent 
prescribed by section 170(b)(2) and this section. Thus, $2,000 of the 
$30,000 excess contributions made in the year 1956 are deducted in 1957 
and the remainder ($28,000), together with X Corporation's excess 
contributions of $6,000 made in the short taxable year ending June 30, 
1957, are deducted in 1958 since the aggregate of such amounts plus the 
contributions actually made in that year does not exceed the 5-percent 
limitation prescribed by section 170(b)(2).

[T.D. 6552, 26 FR 1992, Mar. 8, 1961, as amended by T.D. 6900, 31 FR 
14642, Nov. 17, 1966; T.D. 7207, 37 FR 20795, Oct. 5, 1972]



Sec. 1.381(c)(20)-1  Carryforward of disallowed business interest.

    (a) Carryover requirement. Section 381(c)(20) provides that the 
acquiring corporation in a transaction described in section 381(a) will 
succeed to and take into account the carryover of disallowed business 
interest described in section 163(j)(2) to taxable years ending after 
the date of distribution or transfer.
    (b) Carryover of disallowed business interest described in section 
163(j)(2). For purposes of section 381(c)(20) and this section, the term 
carryover of disallowed business interest described in section 163(j)(2) 
means the disallowed business interest expense carryforward (as defined 
in Sec. 1.163(j)-1(b)(11)), including any disallowed disqualified 
interest (as defined in Sec. 1.163(j)-1(b)(12)), and including the 
distributor or transferor corporation's disallowed business interest 
expense from the taxable year that ends on the date of distribution or 
transfer. For the application of section 382 to disallowed business 
interest expense described in section 163(j)(2), see the regulations in 
this part under section 382 of the Code, including but not limited to 
Sec. 1.382-2.
    (c) Limitation on use of disallowed business interest expense 
carryforwards in the acquiring corporation's first taxable year ending 
after the date of distribution or transfer--(1) In general. In 
determining the extent to which the acquiring corporation may use 
disallowed business interest expense carryforwards in its first taxable 
year ending after the date of distribution or transfer, the principles 
of Sec. Sec. 1.381(c)(1)-1 and 1.381(c)(1)-2 apply with appropriate 
adjustments, including but not limited to the adjustments described in 
paragraphs (c)(2) and (3) of this section.
    (2) One date of distribution or transfer within the acquiring 
corporation's taxable year. If the acquiring corporation succeeds to the 
disallowed business interest expense carryforwards of one or more 
distributor or transferor corporations on a single date of distribution 
or transfer within one taxable year of the acquiring corporation, then, 
for the acquiring corporation's first taxable year ending after the date 
of distribution or

[[Page 644]]

transfer, that part of the acquiring corporation's business interest 
expense deduction (if any) that is attributable to the disallowed 
business interest expense carryforwards of the distributor or transferor 
corporation is limited under this paragraph (c) to an amount equal to 
the post-acquisition portion of the acquiring corporation's section 
163(j) limitation, as defined in paragraph (c)(4) of this section.
    (3) Two or more dates of distribution or transfer in the taxable 
year. If the acquiring corporation succeeds to the disallowed business 
interest expense carryforwards of two or more distributor or transferor 
corporations on two or more dates of distribution or transfer within one 
taxable year of the acquiring corporation, the limitation to be applied 
under this paragraph (c) is determined by applying the principles of 
Sec. 1.381(c)(1)-2(b) to the post-acquisition portion of the acquiring 
corporation's section 163(j) limitation, as defined in paragraph (c)(4) 
of this section.
    (4) Definition. For purposes of this paragraph (c), the term post-
acquisition portion of the acquiring corporation's section 163(j) 
limitation means the amount that bears the same ratio to the acquiring 
corporation's section 163(j) limitation (within the meaning of Sec. 
1.163(j)-1(b)(31)) (or, if the acquiring corporation is a member of a 
consolidated group, the consolidated group's section 163(j) limitation) 
for the first taxable year ending after the date of distribution or 
transfer (taking into account items to which the acquiring corporation 
succeeds under section 381, other than disallowed business interest 
expense carryforwards) as the number of days in that year after the date 
of distribution or transfer bears to the total number of days in that 
year.
    (5) Examples. For purposes of this paragraph (c)(5), unless 
otherwise stated, X, Y, and Z are taxable domestic C corporations that 
were incorporated on January 1, 2021 and that file their tax returns on 
a calendar-year basis; none of X, Y, or Z is a member of a consolidated 
group; the small business exemption in Sec. 1.163(j)-2(d) does not 
apply; interest expense is deductible except to the extent of the 
potential application of section 163(j); and the facts set forth the 
only corporate activity. The principles of this paragraph (c) are 
illustrated by the following examples.
    (i) Example 1: Transfer before last day of acquiring corporation's 
taxable year--(A) Facts. On October 31, 2022, X transferred all of its 
assets to Y in a statutory merger to which section 361 applies. For the 
2021 taxable year, X had $400x of disallowed business interest expense, 
and Y had $0 of disallowed business interest expense. For the taxable 
year ending October 31, 2022, X had an additional $350x of disallowed 
business interest expense (X did not deduct any of its 2021 
carryforwards in its 2022 taxable year). For the taxable year ending 
December 31, 2022, Y had business interest expense of $100x, business 
interest income of $200x, and ATI of $1,000x. Y's section 163(j) 
limitation for the 2022 taxable year was $500x ($200x + (30 percent x 
$1,000x) = $500x).
    (B) Analysis. Pursuant to Sec. 1.163(j)-5(b)(2), Y deducts its 
$100x of current-year business interest expense (as defined in Sec. 
1.163(j)-1(b)(9)) before any disallowed business interest expense 
carryforwards (including X's carryforwards) from a prior taxable year 
are deducted. The aggregate disallowed business interest expense of X 
carried forward under section 381(c)(20) to Y's taxable year ending 
December 31, 2022, is $750x. However, pursuant to paragraph (c)(2) of 
this section, for Y's first taxable year ending after the date of 
distribution or transfer, the maximum amount of X's disallowed business 
interest expense carryforwards that Y can deduct is equal to the post-
acquisition portion of Y's section 163(j) limitation. Pursuant to 
paragraph (c)(4) of this section, the post-acquisition portion of Y's 
section 163(j) limitation means Y's section 163(j) limitation times the 
ratio of the number of days in the taxable year after the date of 
distribution or transfer to the total number of days in that year. 
Therefore, only $84x of the aggregate amount ($500x x (61/365) = $84x) 
may be deducted by Y in that year, and the remaining $666x ($750x-$84x = 
$666x) is carried forward to the succeeding taxable year.
    (C) Transfer on last day of acquiring corporation's taxable year. 
The facts are the same as in Example 1 in paragraph (c)(5)(i)(A) of this 
section, except that

[[Page 645]]

X's transfer of its assets to Y occurred on December 31, 2022. For the 
taxable year ending December 31, 2022, X had an additional $350x of 
disallowed business interest expense (X did not deduct any of its 2021 
carryforwards in its 2022 taxable year). For the taxable year ending 
December 31, 2023, Y had business interest expense of $100x, business 
interest income of $200x, and ATI of $1,000x. Y's section 163(j) 
limitation for the 2023 taxable year was $500x ($200x + (30 percent x 
$1,000x) = $500x). The aggregate disallowed business interest expense of 
X carried under section 381(c)(20) to Y's taxable year ending December 
31, 2023, is $750x. Paragraph (c)(2) of this section does not limit the 
amount of X's disallowed business interest expense carryforwards that 
may be deducted by Y in the 2023 taxable year. Since the amount of Y's 
section 163(j) limit for the 2023 taxable year was $500x, Y may deduct 
the full amount ($100x) of its own business interest expense for the 
2023 taxable year, along with $400x of X's disallowed business interest 
expense carryforwards.
    (ii) Example 2: Multiple transferors on same date--(A) Facts. On 
October 31, 2022, X and Y transferred all of their assets to Z in 
statutory mergers to which section 361 applies. For the 2021 taxable 
year, X had $300x of disallowed business interest expense, Y had $200x, 
and Z had $0. For the taxable year ending October 31, 2022, each of X 
and Y had an additional $125x of disallowed business interest expense 
(neither X nor Y deducted any of its 2021 carryforwards in 2022). For 
the taxable year ending December 31, 2022, Z had business interest 
expense of $100x, business interest income of $200x, and ATI of $1,000x. 
Z's section 163(j) limitation for the 2022 taxable year was $500x ($200x 
+ (30 percent x $1,000x) = $500x).
    (B) Analysis. The aggregate disallowed business interest expense of 
X and Y carried under section 381(c)(20) to Z's taxable year ending 
December 31, 2022, is $750x. However, pursuant to paragraph (c)(2) of 
this section, only $84x of the aggregate amount ($500x x (61/365) = 
$84x) may be deducted by Z in that year. Moreover, under paragraph 
(b)(2) of this section, this amount only may be deducted by Z in that 
year after Z has deducted its $100x of current-year business interest 
expense (as defined in Sec. 1.163(j)-1(b)(9)).
    (d) Applicability date. This section applies to taxable years 
beginning on or after November 13, 2020. However, taxpayers and their 
related parties, within the meaning of sections 267(b) and 707(b)(1), 
may choose to apply the rules of this section to ta axable year 
beginning after December 31, 2017, so long as the taxpayers and their 
related parties consistently apply the rules of the section 163(j) 
regulations (as defined in Sec. 1.163(j)-1(b)(37)), and, if applicable, 
Sec. Sec. 1.263A-9, 1.263A-15, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 
1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-
3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of 
Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to 
that taxable year.

[T.D. 9905, 85 FR 56832, Sept. 14, 2020]



Sec. 1.381(c)(21)-1  Pre-1954 adjustments resulting from change 
in method of accounting.

    (a) Carryover requirement. Section 381(c)(21) provides that, in a 
transaction to which section 381(a) applies, an acquiring corporation 
shall take into account the net amount of any adjustments described in 
section 481(b)(4) (relating to adjustments arising from changes in 
accounting methods initiated by the taxpayer attributable to pre-1954 
Code years) of the distributor or transferor corporation to the extent 
that such net amount of such adjustments has not been taken into account 
in any taxable year, including a short taxable year, by the distributor 
or transferor corporation. The acquiring corporation shall take into 
account in each taxable year beginning with the taxable year ending 
after the date of distribution or transfer the net amount of such 
adjustments in the same manner and at the same time as such net amount 
would have been taken into account by the distributor or transferor 
corporation. Thus, the amount of any such adjustment which the acquiring 
corporation shall take into account in each taxable year shall be the 
same amount that would have been taken into account in each taxable year 
by

[[Page 646]]

the distributor or transferor corporation.
    (b) This section may be illustrated by the following example:

    Example. On January 1, 1960, X Corporation, a calendar year 
taxpayer, voluntarily changed its method of accounting giving rise to a 
$50,000 adjustment under section 481(a), of which $20,000 is 
attributable to pre-1954 Code years. Under section 481(b)(4) the $20,000 
adjustment is to be spread over 1960 and the following 9 years at the 
rate of $2,000 each year. On November 1, 1963, all the assets of X 
Corporation are acquired by Y Corporation in a transaction to which 
section 381(a) applies. Y Corporation reports its income on a fiscal 
year ending June 30. X and Y Corporations must take into account the 
$20,000 adjustment at the rate of $2,000 in each taxable year in the 
following time and manner:

                              X Corporation
Calendar years 1960-62 ($2,000 x 3)...............     $6,000
Short taxable year ending Nov. 1, 1963 ($2,000 x        2,000     $8,000
 1)...............................................
                                                   -----------
                              Y Corporation
Fiscal years ending:
  June 30, 1964 ($2,000 x 1)......................      2,000
  June 30, 1965-69 ($2,000 x 5)...................     10,000     12,000
                                                   ---------------------
                                                    .........     20,000
 

    (c) Successive transactions to which section 381(a) applies. The 
provisions of this section shall apply in the case of successive 
transactions to which section 381(a) applies. Thus, if R Corporation, 
which was taking into account adjustments described in section 
481(b)(4), distributes or transfers its assets to S Corporation in a 
transaction to which section 381(a) applies, and S Corporation was 
required to take into account any remaining portion of such adjustments 
under section 381(c)(21) and this section, and if subsequently S 
Corporation distributes or transfers its assets to T Corporation in a 
transaction to which section 381(a) applies, then T Corporation, under 
section 381(c)(21) and this section, shall take into account any 
remaining portion of such adjustments not previously taken into account 
by R and S Corporations.
    (d) Acquiring corporation not receiving all the assets. The 
adjustments described in this section acquired from a distributor or 
transferor corporation by an acquiring corporation in a transaction to 
which section 381(a) applies is not reduced by reason of the fact that 
the acquiring corporation does not acquire 100 percent of the assets of 
the distributor or transferor corporation.

[T.D. 6553, 26 FR 2171, Mar. 15, 1961]



Sec. 1.381(c)(22)-1  Successor life insurance company.

    (a) Carryover requirement. If in a taxable year beginning after 
December 31, 1957, a distributor or transferor corporation which is an 
insurance company is acquired by a corporation which is an insurance 
company in a transaction to which section 381(a) applies, section 
381(c)(22) provides that the acquiring corporation shall take into 
account the appropriate items which the distributor or transferor 
corporation was required to take into account for purposes of part I, 
subchapter L, chapter 1 of the Internal Revenue Code. Furthermore, 
except as otherwise provided by this section, the acquiring corporation 
shall take into account the items described in paragraphs (2) through 
(21), other than paragraphs (14), (15), and (17), of section 381(c) and 
the regulations thereunder. For example, the acquiring corporation shall 
take into account the reserves described in section 810(c) distributed 
or transferred to it as of the close of the date of distribution or 
transfer by the distributor or transferor corporation in accordance with 
the provisions of section 381(c)(4) and the regulations thereunder. For 
provisions defining the date of distribution or transfer, see paragraph 
(b) of Sec. 1.381(b)-1.
    (b) Items required to be taken into account by acquiring 
corporation. If a transaction meets the requirements of paragraph (a) of 
this section, the acquiring corporation shall, except as otherwise 
provided, take into account as of the close of the date of distribution 
or transfer the following items of the distributor or transferor 
corporation:
    (1) The operations loss carryovers (as determined under section 
812), subject to conditions and limitations consistent with the 
conditions and limitations prescribed in section 381(c)(1) and the 
regulations thereunder. For example, a loss from operations for a loss 
year of a distributor or transferor corporation which ends on or before 
the last day of a loss year of the acquiring corporation shall be 
considered to be a

[[Page 647]]

loss from operations for a year prior to such loss year of the acquiring 
corporation. All references in section 381(c)(1) and the regulations 
thereunder to section 172 shall be construed as referring to the 
appropriate corresponding provisions of section 812. Thus, a reference 
to section 172(b) shall be construed as referring to section 812 (b) and 
(d). In determining the span of years for which a loss from operations 
may be carried, the number of taxable years for which the distributor or 
transferor corporation was authorized to do business as an insurance 
company shall be taken into account. For purposes of this determination, 
the taxable year of the distributor or transferor corporation which ends 
on the date of distribution or transfer shall be taken into account even 
though such taxable year is a period of less than 12 months.
    (2)(i) The investment yield and the beginning of the year asset 
balance for the distributor or transferor corporation's taxable year 
ending with the close of the date of distribution or transfer. Such 
items shall be integrated with the investment yield and beginning of the 
year asset balance of the acquiring corporation for its first taxable 
year ending after such date of distribution or transfer for purposes of 
determining the current earnings rate of the acquiring corporation for 
such taxable year. Furthermore, for purposes of determining the average 
earnings rate of the acquiring corporation, the investment yield and 
mean of the assets of the distributor or transferor corporation for its 
4 taxable years immediately preceding its taxable year which closes with 
the date of distribution or transfer shall be integrated with the 
investment yield and mean of the assets of the acquiring corporation for 
such corresponding taxable years.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. X qualified as a life insurance company in 1949. Y 
qualified as a life insurance company in 1951. On June 30, 1961, at 
which time both X and Y were life insurance companies (as defined in 
section 801(a)), X transferred all its assets to Y in a statutory merger 
to which section 361 applies. For its taxable year ending on June 30, 
1961, X had investment yield of $15 and assets at the beginning of such 
taxable year of $450. For purposes of determining its current earnings 
rate for its taxable year ending on December 31, 1961, Y had investment 
yield of $45 (including the $15 of investment yield of X), assets at the 
beginning of such taxable year of $1,250 (including the $450 of X's 
assets at the beginning of its taxable year 1961), and assets at the end 
of such taxable year of $1,750 (after the application of section 
806(a)). Under the provisions of subdivision (i) of this subparagraph, 
the current earnings rate of Y for the taxable year 1961 would be 3 
percent, determined by dividing the investment yield of Y, $45, by the 
mean of the assets of Y, $1,500 ($1,250 + $1,750 / 2). In order to 
determine its average earnings rate and adjusted reserves rate for the 
taxable year 1961, Y would make up the following schedule:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                          Investment yield                                                        Mean of assets               Current
--------------------------------------------------------------------------------------------------------------------------------------------   earnings
                                                                                           Column 3                               Column 6    rate of Y
                                                                                          (Col. 1 +                              (Col. 4 +  ------------
                                                                                           Col. 2)                                Col. 5)
                         Taxable year                          Column 1--X  Column 2--Y   integrated  Column 4--X  Column 5--Y   integrated    Column 7
                                                                                          investment                              means of    (Col. 3 /
                                                                                            yield                                  assets      Col. 6)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1960.........................................................          $16          $26          $42         $400         $800       $1,200          3.5
1959.........................................................           16           24           40          500          750        1,250          3.2
1958.........................................................           17           22           39          650          650        1,300          3.0
1957.........................................................           19           21           40          700          500        1,200          3.3
--------------------------------------------------------------------------------------------------------------------------------------------------------


For the taxable year 1961, Y would have an average earnings rate of 3.2 
percent, computed by taking into account the current earnings rates for 
the taxable year 1961 and each of the 4 taxable years immediately 
preceding such taxable year. The adjusted reserves rate for such taxable 
year would be 3 percent since the current earnings rate of 3 percent for 
1961 is lower than the average earnings rate of 3.2 percent.
    Example 2. The facts are the same as in Example (1), except that the 
taxable year in issue is 1962, and the current earnings rate of Y for 
such taxable year was 3.8 percent. For the taxable year 1962, Y would 
have an average earnings rate of 3.3 percent, computed by taking into 
account only the current earnings rates for the taxable year 1962 and 
each of the 4 taxable years immediately preceding such taxable year. The 
adjusted reserves rate

[[Page 648]]

for such taxable year would be 3.3 percent since the average earnings 
rate of 3.3 percent is lower than the 1962 current earnings rate of 3.8 
percent.

    (3) To the extent there are any amounts accrued for discounts in the 
nature of interest which have not been included as interest paid under 
section 805(e)(3), the acquiring corporation shall be treated as the 
distributor or transferor corporation for purposes of including such 
amounts as interest paid.
    (4) Any adjustment required by section 806(b) with respect to an 
item described in section 810(c) shall be made by the acquiring 
corporation in its first taxable year which begins after the date of 
distribution or transfer.
    (5) The amount of the deduction provided by section 809(d)(6), as 
limited by section 809(f), for all taxable years of the distributor or 
transferor corporation which end on and before the date of distribution 
or transfer (irrespective of whether or not the distributor or 
transferor corporation claimed this deduction for such taxable years) 
for the purpose of determining the limitation under section 809(d)(6).
    (6) [Reserved]
    (7)(i) The dollar balances in the shareholders surplus account, 
policyholders surplus account, and other accounts provided, however, 
that the acquiring corporation is a stock life insurance company. The 
dollar balance in the policyholders surplus account shall reflect the 
amount (if any) treated as a subtraction from such account by reason of 
the application of the limitation provided under section 815(d)(4) 
immediately prior to the close of the date of distribution or transfer. 
To the extent that any amount must be added to the shareholders surplus 
account as a result of the application of the limitation provided under 
section 815(d)(4), the acquiring corporation shall be treated as the 
distributor or transferor corporation as of its first taxable year which 
begins after the date of distribution or transfer. However, any amounts 
attributable to money or other property not permitted to be received 
without the recognition of gain (i.e., boot) distributed to a person 
other than the acquiring corporation under section 381(a) shall be 
treated as a distribution under section 815.
    (ii) Notwithstanding paragraph (b)(7)(i) of this section, if the 
distributor or transferor corporation distributes or transfers less than 
50 percent of its insurance business to the acquiring corporation, then 
the acquiring corporation shall succeed to a ratable portion of the 
dollar balances in the distributor's or transferor's shareholders 
surplus account, policyholders surplus account, and other accounts. The 
percentage of the accounts to which the acquiring corporation succeeds 
is determined by the ratio of the distributor's or transferor's 
insurance reserves for the contracts transferred to the acquiring 
corporation, as maintained under section 816(b), to the distributor's or 
transferor's reserves for all of its contracts maintained under section 
816(b) immediately before the earlier of the distribution or transfer or 
the adoption of the plan of liquidation or reorganization. For 
transactions in which the distributor liquidates pursuant to an election 
under section 338(h)(10), see Sec. 1.338-11(f) for the treatment of its 
remaining policyholders surplus account. For all other transactions 
subject to this paragraph, the distributor or transferor must take into 
account as income its remaining policyholders surplus account to the 
extent the fair market value of its assets (net of liabilities) 
distributed or transferred to the acquiring corporation or to the 
transferor's shareholders pursuant to the plan of liquidation or 
reorganization exceeds the distributor's or transferor's remaining 
shareholders surplus account.
    (iii) If, pursuant to a plan in existence at the time of the 
liquidation or reorganization, the acquiring corporation transfers any 
insurance or annuity contract it received in the liquidation or 
reorganization to another person, then, for purposes of paragraph 
(b)(7)(ii) of this section, that contract shall be deemed to have been 
transferred by the transferor to that other person after the adoption of 
the plan of liquidation or reorganization. If the transferor is an old 
target within the meaning of Sec. 1.338(h)(10)-1(d)(2), any transfer by 
the acquiring corporation

[[Page 649]]

to the purchasing corporation (as defined in Sec. 1.338-2(c)(11)) or to 
any person related to the purchasing corporation within the meaning of 
section 197(f)(9)(C) within two years of the transfer described in 
section 381(a) will be presumed to have been pursuant to a plan in 
existence at the time of the liquidation or reorganization.
    (iv) If the acquiring corporation is a mutual life insurance 
company, the dollar balances in the shareholders surplus account, 
policyholders surplus account, and other accounts shall not be taken 
into account by such acquiring corporation and the distributor or 
transferor corporation shall be subject to the provisions of section 
815(d)(2)(A) as of the close of the date of distribution or transfer.
    (v) The provisions of this paragraph (b)(7) are illustrated by the 
following examples:

    Example 1. P buys the stock of insurance company target, T, from S 
for $16, and P and S make a section 338(h)(10) election for T. T 
transfers no insurance contracts to S, or any related party, in 
connection with the transaction. Further, assume that T had $10 in its 
policyholders surplus account and no balance in its shareholders surplus 
account or other accounts. Immediately before the deemed asset sale, old 
T is required to include as ordinary income the $10 in the policyholders 
surplus account.
    Example 2. Assume the same facts as in Example 1, except that T 
holds a block of life insurance contracts P does not wish to acquire, 
and, immediately before the sale of T stock, S causes T to distribute 
the unwanted block of insurance contracts to S. Further, assume that S 
is an insurance company, that the distribution of contracts is one of 
series of distributions in complete cancellation or redemption of all of 
its stock (the others occurring under Sec. 1.338(h)(10)-1(d)(4)(i)) 
that qualifies as a complete liquidation under section 332, and that old 
T's tax reserves with respect to the distributed contracts represent 
one-tenth of old T's tax reserves with respect to all of its life 
insurance contracts. Because T transfers less than 50 percent of its 
life insurance business to S in a transaction to which section 381(a) 
applies, S succeeds to a ratable portion of old T's policyholders 
surplus account ($1), and old T includes as ordinary income the 
remaining $9 of that account.
    Example 3. Assume the same facts as in Example 2, except that 14 
months after the deemed asset sale, S and X, a person related to new T 
under section 197(f)(9)(C), engage in an indemnity reinsurance 
transaction involving the contracts transferred to S from old T. Because 
X is related to the purchasing corporation (P) under section 
197(f)(9)(C), and X receives contracts from the acquiring corporation 
(S) that S acquired from old T within two years of the transfer from old 
T to S, the contracts are presumed to have been transferred pursuant to 
a plan in existence at the time of old T's liquidation. If S cannot 
establish otherwise, old T is treated as having distributed the 
remainder of its policyholders surplus account. In that case, in the 
taxable year of the indemnity reinsurance transaction, S takes into 
account as ordinary income the portion of the old T's accounts ($1) that 
old T or S has not previously taken into account as income.

    (8) To the extent that any amount must be added to the shareholders 
surplus account as a result of an election made under section 815(d)(1) 
by the distributor or transferor corporation, the acquiring corporation 
shall be treated as the distributor or transferor corporation as of its 
first taxable year which begins after the date of distribution or 
transfer.
    (9) The amount of the life insurance reserves at the end of 1958, 
but only for the purpose of applying the limitation provided under 
section 815(d)(4)(B).
    (10) To the extent there are amounts subject to the provisions of 
section 817(d), the acquiring corporation shall be treated as the 
distributor or transferor corporation.
    (11) To the extent there are any installments of tax imposed by 
section 818(e)(3)(A) remaining to be paid, the acquiring corporation 
shall be treated as the distributor or transferor corporation for the 
purpose of paying such installments.
    (12) The capital loss carryovers, subject to conditions and 
limitations consistent with the conditions and limitations prescribed in 
section 381(c)(3) and the regulations thereunder, except that any net 
capital loss of the distributor or transferor corporation for a taxable 
year beginning before January 1, 1959, shall not be taken into account. 
See section 817(c).
    (13)(i) The transferor's unamortized policy acquisition expenses or 
positive or negative capitalization requirements on its specified 
insurance contracts.
    (ii) Notwithstanding paragraph (b)(13)(i) of this section, if the 
distributor or transferor corporation

[[Page 650]]

transfers less than 50 percent of its insurance business to the 
acquiring corporation, then the acquiring corporation shall succeed to a 
ratable portion of the transferor's unamortized policy acquisition 
expenses or positive or negative capitalization requirements on its 
specified insurance contracts. The percentage of such acquisition 
expenses or positive or negative capitalization requirements to which 
the acquiring corporation succeeds is determined by the ratio of the 
distributor's or transferor's insurance reserves for the contracts 
transferred to the acquiring corporation, as maintained under section 
816(b), to the distributor's or transferor's reserves for all of its 
contracts maintained under section 816(b) immediately before the earlier 
of the distribution or transfer or the adoption of the plan of 
liquidation or reorganization. For amounts of the distributor's or 
transferor's unamortized policy acquisition expenses or positive or 
negative capitalization requirements on its specified insurance 
contracts to which the acquirer does not succeed to under this 
paragraph, and, for transactions in which the transferor liquidates 
pursuant to an election under section 338(h)(10), see Sec. 1.338-11(f) 
for the treatment of its capitalized amounts under section 848.
    (iii) If, pursuant to a plan in existence at the time of the 
liquidation or reorganization, the acquiring corporation transfers any 
insurance or annuity contract it received in the liquidation or 
reorganization to another person, then, for purposes of paragraph 
(b)(13)(ii) of this section, that contract shall be deemed to have been 
transferred by the transferor to that other person after the adoption of 
the plan of liquidation or reorganization. If the transferor is an old 
target within the meaning of Sec. 1.338(h)(10)-1(d)(2), any transfer by 
the acquiring corporation to the purchasing corporation (as defined in 
Sec. 1.338-2(c)(11)) or to any person related to the purchasing 
corporation within the meaning of section 197(f)(9)(C) within two years 
of the transfer described in section 381(a) will be presumed to have 
been pursuant to a plan in existence at the time of the liquidation or 
reorganization.
    (14) The special loss discount account, provided, however, that the 
acquiring corporation will succeed to the special loss discount account 
only to the extent that it is attributable to the portion of the 
transferor's insurance business acquired by the acquiring corporation in 
the section 381 transaction.
    (c) Effective dates--(1) In general. This section applies to the 
acquisition of assets of an insurance company by another insurance 
company in a transaction to which section 381 applies for taxable years 
beginning after December 31, 1957.
    (2) Special rules for section 381 transactions. Paragraphs (a), 
(b)(7), (b)(13), and (b)(14) of this section apply to the acquisition of 
assets of an insurance company by another insurance company in a 
transaction to which section 381 applies on or after April 10, 2006.
    (3) Joint retroactive election. The distributor or transferor and 
the acquiring corporation may jointly make an irrevocable election to 
apply paragraphs (a), (b)(7), (b)(13), and (b)(14) of this section to a 
transaction to which section 381 applies occurring before April 10, 2006 
provided that the taxable year that includes the acquisition and all 
subsequent affected taxable years of both the distributor or transferor 
and the acquiring corporation are years for which an assessment of 
deficiency or a refund for overpayment is not prevented by any law or 
rule of law.
    (4) Time and manner of making the joint election. The distributor or 
transferor and the acquiring corporation may make an election described 
in paragraph (c)(2) of this section by each attaching a statement to its 
original or amended income tax return for the taxable year that includes 
the acquisition of assets in a transaction to which section 381 applies. 
The statement must be entitled ``Election to retroactively apply the 
rules of section 1.381(c)(22)-1 to a transaction completed before April 
10, 2006'' and must include the following information--
    (i) The name and EIN of the distributor or transferor and the 
acquiring corporation; and
    (ii) The following declaration (or a substantially similar 
declaration): The distributor or transferor and the acquiring 
corporation have each amended

[[Page 651]]

its income tax returns for the taxable year that includes the 
acquisition of assets in a transaction to which section 381 applies and 
for all affected subsequent years to reflect the rules in paragraphs 
(a), (b)(7), (b)(13), and (b)(14) of section 1.381(c)(22)-1.

[T.D. 6625, 27 FR 12541, Dec. 19, 1962, as amended by T.D. 9257, 71 FR 
18004, Apr. 10, 2006; T.D. 9377, 73 FR 3873, Jan. 23, 2007; T.D. 9911, 
85 FR 64392, Oct. 13, 2020]



Sec. 1.381(c)(23)-1  Investment credit carryovers in certain corporate
acquisitions.

    (a) Carryover requirement. (1) Section 381(c)(23) requires the 
acquiring corporation in a transaction to which section 381 applies to 
succeed to and take into account under such regulations as may be 
prescribed by the Secretary or his delegate, the investment credit 
carryovers of the distributor or transferor corporation. To determine 
the amount of these carryovers as of the close of the date of 
distribution or transfer, and to integrate them with any carryovers and 
carrybacks of the acquiring corporation for purposes of determining the 
amount of credit allowed by section 38 to the acquiring corporation for 
taxable years ending after the date of distribution or transfer, it is 
necessary to apply the provisions of sections 46, 47, and 48 in 
accordance with the conditions and limitations of this section.
    (2) The investment credit carryovers and carrybacks of the acquiring 
corporation determined as of the close of the date of distribution or 
transfer shall be computed without reference to any unused credit of a 
distributor or transferor corporation. The investment credit carryovers 
of a distributor or transferor corporation as of the close of the date 
of distribution or transfer shall be determined without reference to any 
unused credit of the acquiring corporation.
    (b) Carryback of unused credits. An unused credit of the acquiring 
corporation for any taxable year ending after the date of distribution 
or transfer shall not be carried back in computing the credit allowed by 
section 38 to a distributor or transferor corporation. However, an 
unused credit of the acquiring corporation for any such taxable year 
shall be carried back in accordance with section 46(b)(1) in computing 
the credit allowed to the acquiring corporation for a taxable year 
ending on or before the date of distribution or transfer. If a 
distributor or transferor corporation remains in existence after the 
date of distribution or transfer, an unused credit sustained by it for 
any taxable year beginning after such date shall be carried back in 
accordance with section 46(b)(1) in computing the credit allowed by 
section 38 to such corporation for a taxable year ending on or before 
that date, but may not be carried back or over in computing the credit 
allowed by section 38 to the acquiring corporation.
    (c) Computation of carryovers and carrybacks. (1) Subject to the 
modifications set forth in this paragraph, the provisions of Sec. 1.46-
2 shall apply in computing carryovers and carrybacks of unused credits 
to taxable years of the acquiring corporation.
    (2)(i) The investment credit carryovers available to the distributor 
or transferor corporation as of the close of the date of distribution or 
transfer shall first be carried to the first taxable year of the 
acquiring corporation ending after that date. This rule applies whether 
the date of distribution or transfer is on the last day, or any other 
day, of the acquiring corporation's taxable year.
    (ii) The investment credit carryovers available to the distributor 
or transferor corporation as of the close of the date of distribution or 
transfer shall be carried to the acquiring corporation without 
diminution by reason of the fact that the acquiring corporation does not 
acquire 100 percent of the assets of the distributor or transferor 
corporation.
    (3) An unused credit of a distributor or transferor corporation for 
a taxable year which ends on or before the last day of a taxable year of 
the acquiring corporation shall be considered to be an unused credit for 
a year prior to such taxable year of the acquiring corporation. If the 
acquiring corporation has acquired the assets of two or more distributor 
or transferor corporations on the same date of distribution or transfer, 
the unused credit years of the distributor or transferor corporations

[[Page 652]]

shall be taken into account in the order in which such years terminate. 
If any one of the unused credit years of a distributor or transferor 
corporation ends on the same day as the unused credit year of another 
distributor or transferor corporation, either unused credit year may be 
taken into account before the other.
    (4) The extent to which an investment credit carryover of a 
distributor or transferor corporation or of an acquiring corporation 
from an unused credit year ending before January 1, 1971, may be taken 
into account by the acquiring corporation for a taxable year beginning 
after December 31, 1970, shall be determined without regard to the 
credit earned by the acquiring corporation for such year. Thus, in such 
a case, the amount of unused credit from such unused credit years which 
may be taken into account in a taxable year of the acquiring corporation 
beginning after December 31, 1970, shall be determined solely with 
reference to the limitation based on amount of tax for such taxable year 
(without reduction for the credit earned for such year).
    (d) Computation of carryovers when date of distribution or transfer 
occurs on last day of acquiring corporation's taxable year. The 
computation of the investment credit carryovers from the distributor or 
transferor corporation and from the acquiring corporation in a case 
where the date of distribution or transfer occurs on the last day of a 
taxable year of the acquiring corporation may be illustrated by the 
following example:

    Example. X Corporation and Y Corporation were organized on January 
1, 1971, and each corporation files its return on the calendar year 
basis. On December 31, 1972, X transfers all its assets to Y in a 
statutory merger to which section 361 applies. X's credit earned and its 
limitation based on amount of tax for its taxable years 1971 and 1972 
are as follows:

------------------------------------------------------------------------
                                                            Limitation
     X Corporation's taxable year        Credit earned   based on amount
                                                              of tax
------------------------------------------------------------------------
1971..................................          $10,000           $5,000
1972..................................            5,000            3,000
------------------------------------------------------------------------


Y's credit earned and its limitation based on amount of tax for its 
taxable years 1971 through 1973 are as follows:

------------------------------------------------------------------------
                                                            Limitation
            Y Corporation's              Credit earned   based on amount
                                                              of tax
------------------------------------------------------------------------
1971..................................           $6,000           $5,000
1972..................................            5,000            3,000
1973..................................            3,000           10,000
------------------------------------------------------------------------

The sequence for the allowance of unused credits of X Corporation and Y 
Corporation, and the computation of the carryovers to Y Corporation's 
calendar year 1974, may be illustrated as follows:
    (1) X Corporation's 1971 unused credit. The carryover to Y 1974 is 
$0, computed as follows:

Unused credit................................................     $5,000
  Excess of X's 1972 limitation based on tax over credit               0
   earned....................................................
                                                              ----------
Carryover to Y's year 1973...................................      5,000
  Excess of Y's 1973 limitation based on tax over credit           7,000
   earned....................................................
                                                              ----------
Carryover to Y's year 1974...................................          0
 

    (2) Y Corporation's 1971 unused credit. The carryover to Y 1974 is 
$0, computed as follows:

Unused credit................................................     $1,000
  Excess of Y's 1972 limitation based on tax over credit               0
   earned....................................................
                                                              ----------
Carryover to Y's year 1973...................................      1,000
                                                              ==========
  Excess of Y's 1973 limitation based on tax over credit           7,000
   earned....................................................
  Less: X's $5,000 carryover from 1971.......................      5,000
                                                              ----------
                                                                   2,000
                                                              ==========
Carryover to Y's year 1974...................................          0
 

    (3) X Corporation's 1972 unused credit. The carryover to Y 1974 is 
$1,000, computed as follows:

Unused credit................................................     $2,000
                                                              ==========
  Excess of Y's 1973 limitation based on tax over credit           7,000
   earned....................................................
  Less: X's $5,000 carryover from 1971 and Y's $1,000              6,000
   carryover from 1971.......................................
                                                              ----------
                                                                   1,000
                                                              ==========
  Carryover to Y's year 1974.................................      1,000
 

    (4) Y Corporation's 1972 unused credit. The carryover to Y 1974 is 
$2,000, computed as follows:

Unused credit................................................     $2,000
                                                              ==========
Excess of Y's 1973 limitation based on tax over credit earned      7,000
Less: X's $5,000 carryover from 1971 Y's $1,000 carryover          7,000
 from 1971 and X's $1,000 carryover from 1972................
                                                              ----------
                                                                       0
                                                              ==========
Carryover to Y's year 1974...................................      2,000
 

    (5) The aggregate of the investment credit carryovers to Y's year 
1974 is $3,000, computed as follows:

[[Page 653]]



X's 1972 unused credit.......................................     $1,000
Y's 1972 unused credit.......................................      2,000
                                                              ----------
    Total....................................................      3,000
 


    (e) Computation of carryovers when date of distribution or transfer 
is not on last day of acquiring corporation's taxable year. (1) If the 
date of distribution or transfer occurs on any day other than the last 
day of a taxable year of the acquiring corporation, the amount which may 
be added to the amount allowable as a credit by section 38 for the first 
taxable year of the acquiring corporation ending after the date of 
distribution or transfer (hereinafter called the ``year of 
acquisition'') shall be determined in the following manner. The year of 
acquisition shall be considered as though it were 2 taxable years. The 
first of such 2 taxable years shall be referred to in this paragraph as 
the preacquisition part year and shall begin with the beginning of the 
year of acquisition and end with the close of the date of distribution 
or transfer. The second of such 2 taxable years shall be referred to in 
this paragraph as the postacquisition part year and shall begin with the 
day following the date of distribution or transfer and shall end with 
the close of the year of acquisition.
    (2) The excess limitation for the year of acquisition (i.e., the 
excess of the limitation based on the amount of tax for such year over 
the amount of credit earned for such year) shall be divided between the 
preacquisition part year and the postacquisition part year in proportion 
to the number of days in each. Thus, if in a statutory merger to which 
section 361 applies Y Corporation, a calendar year taxpayer, acquires 
the assets of X Corporation on June 30, 1975, and Y Corporation has an 
excess limitation of $36,500 for its calendar year 1975, then the excess 
limitation for the preacquisition part year would be $18,100 ($36,500 x 
181/365) and the excess limitation for the postacquisition part year 
would be $18,400 ($36,500 x 184/365).
    (3) An unused credit of the acquiring corporation shall be carried 
to and applied against the excess limitation for the preacquisition part 
year and then carried to and applied against the excess limitation for 
the postacquisition part year, whereas an unused credit of the 
distributor or transferor corporation shall not be carried to the 
preacquisition part year but shall only be carried to and applied 
against the excess limitation for the postacquisition part year. For 
special rule relating to carryovers from taxable years ending before 
January 1, 1971, to taxable years beginning after December 31, 1970, see 
subparagraph (6) of this paragraph.
    (4) Though considered as two separate taxable years for purposes of 
this paragraph, the preacquisition part year and the postacquisition 
part year are treated as one taxable year in determining the years to 
which an unused credit is carried under section 46(b)(1).
    (5) The preceding subparagraphs may be illustrated by the following 
example:

    Example. X Corporation and Y Corporation were organized on January 
1, 1971, and each corporation files its return on the calendar year 
basis. On May 1, 1972, X transfers all its assets to Y in a statutory 
merger to which section 361 applies. X's credit earned and its 
limitation based on amount of tax for its taxable years 1971 and ending 
May 1, 1972, are as follows:

------------------------------------------------------------------------
                                                            Limitation
     X Corporation's taxable year        Credit earned   based on amount
                                                              of tax
------------------------------------------------------------------------
1971..................................          $11,000           $5,000
Ending 5-1-72.........................            3,000            6,000
------------------------------------------------------------------------


Y's credit earned and its limitation based on amount of tax for its 
taxable years 1971 and 1972 are as follows:

------------------------------------------------------------------------
                                                            Limitation
     Y Corporation's taxable year        Credit earned   based on amount
                                                              of tax
------------------------------------------------------------------------
1971..................................           $7,000           $3,000
1972..................................            3,000            9,000
------------------------------------------------------------------------

The sequence for the allowance of unused credits of X Corporation and Y 
Corporation, and the computation of carryovers to Y Corporation's 
calendar year 1973, may be illustrated as follows:
    (i) X Corporation's 1971 unused credit. The carryover to Y 1973 is 
$0, computed as follows:

Unused credit................................................     $6,000
  Excess of X's 5-1-72 limitation based on tax over credit         3,000
   earned....................................................
                                                              ----------
Carryover to Y's postacquisition part year 1972..............      3,000
  Excess limitation for Y's postacquisition part year ($6,000      4,000
   x 244/366)................................................
                                                              ==========

[[Page 654]]

 
Carryover to Y's year 1973...................................          0
 

    (ii) Y Corporation's 1971 unused credit. The carryover to Y 1973 is 
$1,000, computed as follows:

Unused credit................................................     $4,000
  Excess limitation for Y's preacquisition part year ($6,000       2,000
   x 122/ 366)...............................................
                                                              ----------
Carryover to Y's postacquisition part year...................      2,000
                                                              ==========
  Excess limitation for Y's postacquisition part year ($6,000      4,000
   x 244/366)................................................
  Less: X's $3,000 carryover from 1971.......................      3,000
                                                              ----------
                                                                   1,000
                                                              ==========
  Carryover to Y's year 1973.................................      1,000
 

    (iii) The aggregate of the investment credit carryovers to Y's year 
1973 is $1,000, computed as follows:

X's 1971 unused credit.......................................          0
Y's 1971 unused credit.......................................     $1,000
                                                              ----------
    Total....................................................      1,000
 

    (6) If the year of acquisition is a taxable year beginning after 
December 31, 1970, and if there is an unused credit of the distributor 
or transferor corporation or of the acquiring corporation arising in an 
unused credit year ending before January 1, 1971, which may be carried 
to such year of acquisition (see paragraph (c)(4) of this section), then 
in applying subparagraphs (1), (2), and (3) of this paragraph, in lieu 
of dividing the excess limitation for the year of acquisition between 
the preacquisition and postacquisition part years, only the limitation 
based on the amount of tax for such year (i.e., without reduction for 
the credit earned) shall be divided between the preacquisition and 
postacquisition part years. If there is also an unused credit arising in 
an unused credit year ending after December 31, 1970, which may be 
carried to the year of acquisition, then for the purpose of determining 
the amount of such unused credit which may be taken into account for 
such year of acquisition, the credit earned for the year of acquisition 
shall first be applied against the limitation based on amount of tax for 
the preacquisition part year (reduced by any investment credit 
carryovers to such part year from unused credit years ending before 
January 1, 1971) and the excess, if any, shall then be applied against 
the limitation based on amount of tax for the postacquisition part year 
(also reduced by any investment credit carryovers to such part year from 
unused credit years ending before January 1, 1971).
    (7) Subparagraph (6) of this paragraph may be illustrated by the 
following example:

    Example. X Corporation and Y Corporation were organized on January 
1, 1970, and each corporation files its return on the calendar year 
basis. On May 1, 1972, X transfers all its assets to Y in a statutory 
merger to which section 361 applies. X's credit earned and its 
limitation based on amount of tax for its taxable years 1970, 1971, and 
ending May 1, 1972, are as follows:

------------------------------------------------------------------------
                                                            Limitation
     X Corporation's taxable year        Credit earned   based on amount
                                                              of tax
------------------------------------------------------------------------
1970..................................             $300
1971..................................              100
Ending 5-1-72.........................              200
------------------------------------------------------------------------


Y's credit earned and its limitation based on amount of tax for its 
taxable years 1970 through 1972 are as follows:

------------------------------------------------------------------------
                                                            Limitation
     Y Corporation's taxable year        Credit earned   based on amount
                                                              of tax
------------------------------------------------------------------------
1970..................................             $100
1971..................................              200
1972..................................              300             $900
------------------------------------------------------------------------

The sequence for the allowance of unused credits of X Corporation and Y 
Corporation, and the computation of carryovers to Y Corporation's 
calendar year 1973, may be illustrated as follows:
    (i) X Corporation's 1970 unused credit. The carryover to Y 1973 is 
$0, computed as follows:

Unused credit................................................       $300
                                                              ==========
  X Corporation's 1971 limitation based on tax...............          0
  X Corporation's 5-1-72 limitation based on tax.............          0
                                                              ----------
  Carryover to Y's postacquisition part year 1972............        300
                                                              ==========
  Limitation based on tax for Y's postacquisition part year          600
   1972 ($900 x 244/366).....................................
                                                              ==========
Carryover to Y's year 1973...................................          0
 

    (ii) Y Corporation's 1970 unused credit. The carryover to Y 1973 is 
$0, computed as follows:

Unused credit................................................       $100
  Y Corporation's 1971 limitation based on tax...............          0
                                                              ----------
Carryover to Y's preacquisition part year 1972...............        100
                                                              ==========
  Limitation based on tax for Y's preacquisition part year           300
   1972 ($900 x 122/366).....................................
                                                              ==========
Carryover to Y's postacquisition part year 1972..............          0
 


[[Page 655]]

    (iii) Y Corporation's credit earned for 1972. The carryover to Y 
1973 is $0, computed as follows:

Credit earned................................................       $300
                                                              ==========
  Limitation based on tax for preacquisition part year 1972          300
   ($900 x 122/366)..........................................
  Less: Y's $100 carryover from 1970.........................        100
                                                              ----------
                                                                    $200
                                                              ==========
Carryover to Y's postacquisition part year 1972..............        100
                                                              ==========
  Limitation based on tax for postacquisition part year 1972         600
   ($900 x 244/366)..........................................
  Less: X's $300 carryover from 1970.........................       $300
                                                              ----------
                                                                     300
                                                              ==========
Carryover to Y's year 1973...................................          0
 

    (iv) X Corporation's 1971 unused credit. The carryover to Y 1973 is 
$0, computed as follows:

Unused credit................................................       $100
  Excess of X's 1972 limitation based on tax over credit               0
   earned....................................................
                                                              ----------
Carryover to Y's postacquisition part year 1972..............        100
  Limitation based on tax for postacquisition part year 1972         600
   ($900 x 244/366)..........................................
                                                              ==========
  Less:
    X's $300 carryover from 1970.............................        300
    Y's 1972 credit earned for postacquisition part year.....        100
                                                              ----------
                                                                     400
                                                              ==========
                                                                     200
                                                              ==========
Carryover to Y's year 1973...................................          0
 

    (v) Y Corporation's 1971 unused credit. The carryover to Y 1973 is 
$100, computed as follows:

Unused credit................................................       $200
                                                              ==========
  Limitation based on tax for preacquisition part year 1972          300
   ($900 x 122/366)..........................................
                                                              ==========
  Less:
    Y's $100 carryover from 1970.............................        100
                                                              ----------
    Y's 1972 credit earned for preacquisition part year 1972.        200
                                                              ----------
                                                                     300
                                                              ==========
                                                                       0
                                                              ==========
Carryover to Y's postacquisition part year...................        200
                                                              ==========
  Limitation based on tax for postacquisition part year 1972         600
   ($900 x 244/366)..........................................
                                                              ==========
  Less:
    X's $300 carryover from 1970.............................        300
    Y's 1972 credit earned for postacquisition part year 1972        100
    X's $100 carryover from 1971.............................        100
                                                              ----------
                                                                     500
                                                              ==========
                                                                     100
                                                              ==========
Carryover to Y's year 1973...................................        100
 

    (vi) X Corporation's 5-1-72 unused credit. The carryover to Y 1973 
is $200, computed as follows:

Unused credit................................................       $200
                                                              ==========
  Limitation based on tax for postacquisition part year 1972         600
   ($900 x 244/366)..........................................
                                                              ==========
  Less:
    X's $300 carryover from 1970.............................        300
    Y's 1972 credit earned for postacquisition part year 1972        100
    X's $100 carryover from 1971, and Y's $100 carryover from        200
     1971....................................................
                                                              ----------
                                                                     600
                                                              ==========
                                                                       0
                                                              ==========
Carryover to Y's year 1973...................................        200
 

    (vii) The aggregate of the investment credit carryovers to Y 1973 is 
$300, computed as follows:

Y's 1971 unused credit.......................................       $100
X's 1972 unused credit.......................................        200
                                                              ----------
    Total....................................................        300
 

    (8) If the year of acquisition is a taxable year to which the 
limitation provided in Sec. 1.46-2(b)(2) (relating to 20- percent 
limitation on carryovers and carrybacks to certain taxable years) 
applies, then for purposes of applying such limitation the 
preacquisition part year and the postacquisition part year shall each be 
considered a fractional part of a year, but, if the date of distribution 
or transfer is not on the last day of a month, the entire month in which 
the date of distribution or transfer occurs shall be considered as 
included in the preacquisition part year and no portion thereof shall be 
considered as included in the postacquisition part year.
    (9) If the acquiring corporation succeeds to the investment credit 
carryovers of two or more distributor or transferor corporations on two 
or more dates of distribution or transfer during the same taxable year 
of the acquiring corporation, the manner in which the unused credits of 
the distributor or transferor corporations shall be applied shall be 
determined consistently with the rules prescribed in paragraph (c) of 
Sec. 1.381(c)(1)-2.
    (f) Successive acquiring corporations. An acquiring corporation 
which, in a distribution or transfer to which section 381(a) applies, 
acquires the assets

[[Page 656]]

of a distributor or transferor corporation which previously acquired the 
assets of another corporation in a transaction to which section 381(a) 
applies, shall succeed to and take into account, subject to the 
conditions and limitations of Sec. 1.46-2 and this section, the 
investment credit carryovers available to the first acquiring 
corporation under Sec. 1.46-2 and this section.
    (g) Recomputation of credit allowed by section 38 on certain 
property of acquiring corporation. If section 38 property acquired by an 
acquiring corporation in a transaction to which section 381(a) applies 
is disposed of, or otherwise ceases to be section 38 property (or 
becomes public utility property) with respect to the acquiring 
corporation, before the close of the estimated useful life which was 
taken into account in computing the distributor or transferor 
corporation's qualified investment, see paragraph (e) of Sec. 1.47-3.
    (h) Electing small business corporation. An unused credit of a 
distributor or transferor corporation arising in an unused credit year 
for which such corporation is not an electing small business corporation 
(as defined in section 1371(b)) may not be carried over in a transaction 
to which section 381 applies to a taxable year of the acquiring 
corporation for which such corporation is an electing small business 
corporation and may not be added to the amount allowable as a credit 
under section 38 to the shareholders of the acquiring corporation for 
such taxable year. However, in such a case, a taxable year for which the 
acquiring corporation is an electing small business corporation shall be 
counted as a taxable year for purposes of determining the taxable years 
to which such unused credit may be carried.
    (i) [Reserved]
    (j) Carryover of operating capacity for qualified intercity bus. For 
rules for determining an acquiring corporation's qualified investment 
for the energy credit for a qualified intercity bus, see Sec. 1.48-
9(q)(11).

(Sec. 38(b) (76 Stat. 963, 26 U.S.C. 38(b)), 48(l)(16) (94 Stat. 264, 26 
U.S.C. 48(l)(16)), and 7805 (68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7289, 38 FR 30554, Nov. 6, 1973, as amended by T.D. 7982, 49 FR 
39544, Oct. 9, 1984; 49 FR 41246, Oct. 22, 1984]



Sec. 1.381(c)(24)-1  Work incentive program credit carryovers 
in certain corporate acquisitions.

    The computation of carryovers and carrybacks of unused WIN credits 
in a transaction to which section 381 applies shall be made under the 
principles of Sec. 1.381(c)(23)-1 (relating to the computation of 
carryovers and carrybacks of unused investment credits), except that the 
provisions of paragraph (c)(4) and paragraph (e)(6), (7), and (8) of 
such section shall not apply.

(Secs. 381(c)(23), 76 Stat. 971 (26 U.S.C. 381(c)(23), 381(c)(24)) 85 
Stat. 557 (26 U.S.C. 381(c)(24)), 7805, 68A Stat. 917 (26 U.S.C. 7805))

[T.D. 7289, 38 FR 30557, Nov. 6, 1973]



Sec. 1.381(c)(25)-1  Deficiency dividend of a qualified investment
entity.

    (a) Carryover requirement. If a distributor or transferor 
corporation in a transaction to which section 381(a) applies--
    (1) Was a qualified investment entity (within the meaning of section 
860(b)) for any taxable year ending on or before the date of 
distribution or transfer, and
    (2) A determination (as defined in section 860(e)) establishes that 
the transferor or distributor corporation is liable for the tax imposed 
by section 11(a), 56(a), 852(b), 857(b)(1), 857(b)(3)(A), or 1201(a) for 
such taxable year,then in determining the liability for such tax the 
deduction described in section 860 shall be allowed pursuant to section 
381(c)(25) to such corporation for the amount of deficiency dividends 
paid by the acquiring corporation with respect to the distributor or 
transferor corporation. Except as otherwise provided in this section, 
the provisions of section 860 and the regulations thereunder apply with 
respect to a deficiency dividend deduction allowable pursuant to section 
381(c)(25).
    (b) Deficiency dividends paid by the acquiring corporation with 
respect to the distributor or transferor corporation. A deficiency 
dividend paid by the acquiring corporation with respect to the 
distributor or transferor corporation must be a distribution that would 
satisfy the definition of a deficiency dividend under section 860(f) if 
paid by the distributor or transferor corporation to

[[Page 657]]

its own shareholders. The distribution, however, shall be paid by the 
acquiring corporation to its own shareholders. The distribution also 
shall be paid after the date of distribution or transfer and on, or 
within 90 days after, the date of the determination but before the 
acquiring corporation files a claim under paragraph (c) of this section.
    (c) Claim for deduction. A claim for deduction under this section 
shall be made by the acquiring corporation on Form 976 and shall be 
filed within 120 days after the date of the determination. The form 
shall contain, or be accompanied by, the information required under 
Sec. 1.860-2(b)(2) in sufficient detail to properly identify the facts 
with respect to the distributor or transferor corporation and the 
acquiring corporation. The required certified copy of the resolution 
authorizing the payment of the dividend shall be that of the trustees, 
board of directors, or other authority, of the acquiring corporation. 
Necessary changes may be made in Form 976 in order to carry out the 
provisions of this paragraph. The claim shall be filed with the district 
director, or director of the internal revenue service center, with whom 
the return of the distributor or transferor corporation to which the 
claim relates was filed.
    (d) Effect on dividends paid deduction. A deficiency dividend paid 
by the acquiring corporation that is allowable as a deduction to a 
distributor or transferor corporation pursuant to section 381(c)(25) 
shall not become a part of the dividends paid deduction of the acquiring 
corporation under section 561 for any taxable year.
    (e) Successive transactions to which section 381(a) applies. The 
provisions of this section shall apply in the case of successive 
transactions to which section 381(a) applies. Thus, if X corporation 
transfers its assets to Y corporation in a transaction to which section 
381(a) applies and if Y corporation transfers its assets to Z 
corporation in a subsequent transaction to which section 381(a) applies, 
then, subject to the provisions of this section, X corporation may take 
a deficiency dividend deduction for the amount of deficiency dividends 
paid by Z corporation with respect to X corporation.

(Sec. 860(l) (92 Stat. 2849, 26 U.S.C. 860(l)); sec. 860(g) (92 Stat. 
2850, 26 U.S.C. 860(g)); and sec. 7805 (68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7767, 46 FR 11264, Feb. 6, 1981, as amended by T.D. 7936, 49 FR 
2106, Jan. 18, 1984]



Sec. 1.381(c)(26)-1  Credit for employment of certain new employees.

    (a) Carryovers and carrybacks. For taxable years beginning before 
January 1, 1984, the computation of carryovers and carrybacks of unused 
targeted jobs credit (new jobs credit in the case of wages paid before 
1979) under section 44B (as in effect prior to enactment of the Tax 
Reform Act of 1984) in a transaction to which section 381(a) applies 
shall be made under the principles of Sec. 1.381(c)(23)-1 (relating to 
the computation of carryovers and carrybacks of unused investment 
credit), except that the provisions of paragraph (c)(4) and paragraph 
(e)(6), (7) and (8) of such section shall not apply.
    (b) Other items. See Sec. 1.51-1(h) for a rule that applies to 
certain transfers of a trade or business in which a member of a targeted 
group is employed.

[T.D. 8062, 50 FR 46003, Nov. 6, 1985]



Sec. 1.381(d)-1  Operations loss carryovers of life insurance 
companies.

    For the application of part V, subchapter C, chapter 1 of the Code 
to operations loss carryovers of life insurance companies, see section 
812(f) and Sec. 1.812-7 and section 381(c)(22) and Sec. 1.381(c)(22)-
1.

[T.D. 6625, 27 FR 12543, Dec. 19, 1962]



Sec. 1.382-1  Table of contents.

    This section lists the captions that appear in the regulations for 
Sec. Sec. 1.382-2 through 1.382-12.

            Sec. 1.382-2 General rules for ownership change.

    (a) Certain definitions for purposes of sections 382 and 383 and the 
regulations thereunder.
    (1) Loss corporation.
    (i) In general.
    (ii) Distributor of transferor loss corporation in a transaction 
under section 381.
    (iii) Separate accounting required for losses and credits of an 
acquiring corporation and a distributor or transferor loss corporation.

[[Page 658]]

    (iv) End of separate accounting for losses and credits of 
distributor or transferor corporation.
    (v) Application to other successor corporations.
    (vi) Any section 382 disallowed business interest carryforward.
    (2) Pre-change loss.
    (3) Stock.
    (i) In general.
    (ii) Convertible stock.
    (4) Testing date.
    (i) In general.
    (ii) Exceptions.
    (5) Successor corporation.
    (6) Predecessor corporation.
    (7) Section 382 disallowed business interest carryforward.
    (8) Testing period.
    (b) Effective dates.
    (1) In general. [Reserved]
    (2) Rules provided in paragraph (a)(3)(ii) of this section.
    (i) In general.
    (ii) Certain convertible preferred stock.
    (3) Rules provided in paragraphs (a)(1)(i)(A), (a)(1)(ii), (iv), and 
(v), (a)(2)(iv) through (vi), (a)(3)(i), and (a)(4) through (8) of this 
section.

Sec. 1.382-3 Definitions and rules relating to a 5-percent shareholder.

    (a) Definitions.
    (1) Entity.
    (i) In general.
    (ii) Examples.
    (iii) Effective date.
    (A) In general
    (B) Special rule.
    (C) Example.
    (2) [Reserved]
    (b)-(i) [Reserved]
    (j) Modification of the segregation rules of Sec. 1.382-
2T(j)(2)(iii) in the case of certain issuances of stock.
    (1) Introduction.
    (2) Small issuance exception.
    (i) In general.
    (ii) Small issuance defined.
    (iii) Small issuance limitation.
    (A) In general.
    (B) Class of stock defined.
    (C) Adjustments for stock splits and similar transactions.
    (D) Exception.
    (iv) Short taxable years.
    (3) Other issuances of stock for cash.
    (i) In general.
    (ii) Solely for cash.
    (A) In general.
    (B) Related issuances.
    (iii) Coordination with paragraph (j)(2) of this section.
    (4) Limitation on exempted stock.
    (5) Proportionate acquisition of exempted stock.
    (i) In general.
    (ii) Actual knowledge of greater overlapping ownership.
    (6) Exception for equity structure shifts.
    (7) Transitory ownership by underwriter disregarded.
    (8) Certain related issuances.
    (9) Application to options.
    (10) Issuance of stock pursuant to the exercise of certain options.
    (11) Application to first tier and higher tier entities.
    (12) Certain non-stock ownership interests.
    (13) Examples.
    (14) Effective date.
    (i) In general.
    (ii) Effective date for paragraph (j)(10) of this section.
    (iii) Election to apply this paragraph (j) retroactively.
    (A) Election.
    (B) Amended returns.
    (C) Revised information statements.
    (k) Special rules for certain regulated investment companies.
    (1) In general.
    (2) Effective date.
    (i) General rule.
    (ii) Election to apply prospectively.

             Sec. 1.382-4 Constructive ownership of stock.

    (a) In general. [Reserved]
    (b) Attribution from corporations, partnerships, estates and trusts.
    (1) [Reserved]
    (2) Limitation.
    (c) Attribution to corporations, partnerships, estates and trusts. 
[Reserved]
    (d) Treatment of options as exercised.
    (1) General rule.
    (2) Options treated as exercised.
    (i) Issuance or transfer.
    (ii) Subsequent testing dates.
    (3) The ownership test.
    (4) The control test.
    (i) In general.
    (ii) Operating rules.
    (A) Person and related persons.
    (B) Indirect ownership interest.
    (5) The income test.
    (6) Application of the ownership, control, and income tests.
    (i) In general.
    (ii) Application of ownership test.
    (iii) Application of control test.
    (iv) Application of income test.
    (7) Safe harbors.
    (i) Contracts to acquire stock.
    (ii) Escrow, pledge, or other security agreements.
    (iii) Compensatory options.
    (iv) Options exercisable only upon death, disability, mental 
incompetency or retirement.
    (v) Rights of first refusal.
    (vi) Options designated in the Internal Revenue Bulletin.
    (8) Additional rules.

[[Page 659]]

    (i) Contracts to acquire stock.
    (ii) Indirect transfer of an option.
    (iii) Options related to interests in non-corporate entities.
    (iv) Puts.
    (9) Definition of option.
    (i) In general.
    (ii) Convertible stock.
    (iii) Series of options.
    (iv) General principles of tax law.
    (10) Subsequent treatment of options treated as exercised on a 
change date.
    (i) In general.
    (ii) Alternative look-back rule for options exercised within 3 years 
after change date.
    (11) Transfers not subject to deemed exercise.
    (12) Certain rules regarding non-stock interests as stock.
    (e) Stock transferred under certain agreements. [Reserved]
    (f) Family attribution. [Reserved]
    (g) Definitions.
    (h) Effective date.
    (1) In general. [Reserved]
    (2) Option attribution rules.
    (i) General rule.
    (ii) Special rule for control test.
    (iii) Convertible stock issued prior to July 20, 1988.
    (A) In general.
    (B) Exceptions.
    (1) Nonvoting convertible preferred stock.
    (2) Other convertible stock.
    (iv) Convertible stock issued on or after July 20, 1988, and before 
November 5, 1992.
    (v) Certain options in existence immediately before and after an 
ownership change.
    (vi) Election to apply Sec. 1.382-2T(h)(4).
    (A) In general.
    (B) Additional consequences of election.
    (C) Time and manner of making the election.
    (D) Amended returns.
    (3) Special rule for options subject to attribution under Sec. 
1.382-2T(h)(4).

                  Sec. 1.382-5 Section 382 limitation.

    (a) Scope.
    (b) Computation of value.
    (c) Short taxable year.
    (d) Successive ownership changes and absorption of a section 382 
limitation.
    (1) In general.
    (2) Recognized built-in gains and losses.
    (3) Effective date.
    (e) Controlled groups.
    (f) Effective date.

Sec. 1.382-6 Allocation of income and loss to periods before and after 
              the change date for purposes of section 382.

    (a) General rule.
    (1) In general.
    (2) Allocation of business interest expense.
    (i) Scope.
    (ii) Deductibility of business interest expense.
    (b) Closing-of-the-books election.
    (1) In general.
    (2) Making the closing-of-the-books election.
    (i) Time and manner.
    (ii) Election irrevocable.
    (3) Special rules relating to consolidated and controlled groups.
    (i) Consolidated groups.
    (ii) Controlled groups.
    (4) Allocation of business interest expense.
    (i) Scope.
    (ii) Deductibility of business interest expense.
    (iii) Example.
    (c) Operating rules for determining net operating loss, taxable 
income, net capital loss, modified capital gain net income, and special 
allocations.
    (1) In general.
    (2) Adjustment to net operating loss.
    (i) Determination of remaining capital gain.
    (ii) Reduction of net operating loss by remaining capital gain.
    (d) Coordination with rules relating to the allocation of income 
under Sec. 1.1502-76(b).
    (e) Allocation of certain credits.
    (f) Examples.
    (g) Definitions and nomenclature.
    (1) Change year.
    (2) Pre-change period.
    (3) Post-change period.
    (4) Modified capital gain net income.
    (h) Applicability date.
    (1) In general.
    (2) Paragraphs (a) and (b)(1) and (4) of this section.

                Sec. 1.382-7 Built-in gains and losses.

    (a) Treatment of prepaid income.
    (b) Effective/applicability dates.
    (c) [Reserved]
    (d) Special rules.
    (1)-(4) [Reserved]
    (5) Section 382 disallowed business interest carryforwards.
    (e)-(f) [Reserved]
    (g) Applicability dates.
    (1)-(3) [Reserved]
    (4) Paragraph (d)(5) of this section.

                    Sec. 1.382-8 Controlled groups.

    (a) Introduction.
    (b) Controlled group loss and controlled group with respect to a 
controlled group loss.
    (1) In general.
    (2) Presumption regarding net unrealized built-in loss.
    (c) Computation of value.
    (1) Reduction in value by the amount restored.

[[Page 660]]

    (2) Restoration of value.
    (3) Reduction in value by the amount restored.
    (4) Appropriate adjustments.
    (5) Certain reductions in the value of members of a controlled 
group.
    (d) No double reduction.
    (e) Definitions and nomenclature.
    (1) Definitions in Section 382 and the regulations thereunder.
    (2) Controlled group.
    (3) Component member.
    (4) Foreign component member.
    (i) In general.
    (ii) Exception.
    (5) Predecessor and successor corporation.
    (f) Coordination between consolidated groups and controlled groups.
    (g) Examples.
    (h) Time and manner of filing election to restore.
    (1) Statements required.
    (i) Filing by loss corporation.
    (ii) Filing by electing member.
    (iii) Agreement.
    (2) Special rule for foreign component members.
    (i) Deemed election to restore full value.
    (ii) Election not to restore full value.
    (iii) Agreement.
    (3) Revocation of election.
    (i) [Reserved]
    (j) Effective date.
    (1) In general.
    (2) Transition rule.
    (i) In general.
    (ii) Special transition rules for controlled groups that had 
ownership changes before January 29, 1991.
    (3) Amended returns.
    (4) Effective/applicability date.

Sec. 1.382-9 Special rules under section 382 for corporations under the 
         jurisdiction of a court in a title 11 or similar case.

    (a) Introduction.
    (b) Application of section 382(1)(5).
    (c) [Reserved]
    (d) Rules for determining whether stock of the loss corporation is 
owned as a result of being a qualified creditor.
    (1) Qualified creditor.
    (2) General rules for determining whether indebtedness is qualified 
indebtedness.
    (i) Definition.
    (ii) Determination of beneficial ownership.
    (iii) Duty of inquiry.
    (iv) Ordinary course indebtedness.
    (3) Treatment of certain indebtedness as continuously owned by the 
same owner.
    (i) In general.
    (ii) Operating rules.
    (iii) Indebtedness owned by beneficial owner who becomes a 5-percent 
shareholder or 5-percent entity.
    (iv) Example.
    (4) Special rule if indebtedness is a large portion of creditor's 
assets.
    (i) In general.
    (ii) Applicable period.
    (iii) Determination of ownership change.
    (iv) Reliance on statement.
    (5) Tacking of ownership periods.
    (i) Transferee treated as owning indebtedness for period owned by 
transferor.
    (ii) Qualified transfer.
    (iii) Exception.
    (iv) Debt-for-debt exchanges.
    (6) Effective date.
    (i) In general.
    (ii) Elections and amended returns.
    (A) Election to apply this paragraph (d) retroactively.
    (B) Election to revoke section 382(l)(5)(H) election.
    (C) Amended returns.
    (e) Option attribution for purposes of determining stock ownership 
under section 382(1)(5)(A)(ii).
    (1) In general.
    (2) Special rules.
    (i) Lapse or forfeiture of options deemed exercised.
    (ii) Actual exercise of options not deemed exercised.
    (iii) Amended returns.
    (3) Examples.
    (4) Effective dates.
    (i) In general.
    (ii) Special rule for interest or dividends.
    (f)-(h) [Reserved]
    (i) Election not to apply section 382(l)(5).
    (j) Value of the loss corporation in an ownership change to which 
section 382(l)(6) applies.
    (k) Rules for determining the value of the stock of the loss 
corporation.
    (1) Certain ownership interests treated as stock.
    (2) Coordination with section 382(e)(2).
    (3) Coordination with section 382(e)(3).
    (4) Coordination with section 382(l)(1).
    (5) Coordination with section 382(l)(4).
    (6) Special rule for stock not subject to the risk of corporate 
business operations.
    (i) In general.
    (ii) Coordination of special rule and other rules affecting value.
    (7) Limitation on value of stock.
    (l) Rules for determining the value of the loss corporation's pre-
change assets.
    (1) In general.
    (2) Coordination with section 382(e)(2).
    (3) Coordination with section 382(e)(3).
    (4) Coordination with section 382(l)(1).
    (5) Coordination with section 382(l)(4).
    (m) Continuity of business requirement.
    (1) Under section 382(1)(5).
    (2) Under section 382(l)(6).
    (n) Ownership change in a title 11 or similar case succeeded by 
another ownership change within two years.

[[Page 661]]

    (1) Section 382(l)(5) applies to the first ownership change.
    (2) Section 382(l)(6) applies to the first ownership change.
    (o) Options not subject to attribution.
    (p) Effective date for rules relating to section 382(l)(6).
    (1) In general.
    (2) Ownership change to which section 382(l)(6) applies occurring 
before March 17, 1994.

    Sec. 1.382-10 Special rules for determining time and manner of 
            acquisition of an interest in a loss corporation.

                 Sec. 1.382-11 Reporting requirements.

    (a) Information statement required.
    (b) Effective/applicability date.

    Sec. 1.382-12 Determination of adjusted Federal long-term rate.

    (a) In general.
    (b) Adjusted Federal long-term rate.
    (c) Adjustment factor.
    (d) Effective/applicability date.

[T.D. 8149, 52 FR 29674, Aug. 11, 1987. Redesignated by T.D. 8440, 57 FR 
45711, Oct. 5, 1992]

    Editorial Note: For Federal Register citations affecting Sec. 
1.382-1, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.govinfo.gov.



Sec. 1.382-1T  Table of contents (temporary).

    This section lists the captions that appear in the regulations for 
Sec. 1.382-2T.

1.382-2T Definition of ownership change under section 382, as amended by 
                 the Tax Reform Act of 1986 (temporary).

    (a) Ownership change.
    (1) In general.
    (2) Events requiring a determination of whether an ownership change 
has occurred.
    (i) Testing dates prior to November 5, 1992.
    (ii) [Reserved]
    (iii) Records to be maintained by loss corporation.
    (b) Nomenclature and assumptions.
    (c) Computing the amount of increases in percentage ownership.
    (1) In general.
    (2) Example.
    (3) Related and unrelated increases in percentage stock ownership.
    (4) Example.
    (d) Testing period.
    (1) In general.
    (2) Effect of a prior ownership change.
    (3) Commencement of the testing period.
    (i) In general.
    (ii) Exception for corporations with net unrealized built-in loss.
    (4) Disregarding testing dates.
    (5) Example.
    (e) Owner shift and equity structure shift.
    (1) Owner shift.
    (i) Defined.
    (ii) Transactions between persons who are not 5-percent shareholders 
disregarded.
    (iii) Examples.
    (2) Equity structure shift.
    (i) Tax-free reorganizations.
    (ii) Transactions designated under section 382(g)(3)(B) treated as 
equity structure shifts.
    (iii) Overlap of owner shift and equity structure shift.
    (iv) Examples.
    (f) Definitions.
    (1) Loss corporation.
    (2) Old loss corporation.
    (3) New loss corporation.
    (4) Successor corporation.
    (5) Predecessor corporation.
    (6) Shift.
    (7) Entity.
    (8) Direct ownership interest.
    (9) First tier entity.
    (10) 5-percent owner.
    (11) Public shareholder.
    (12) Public owner.
    (13) Public group.
    (14) Higher tier entity.
    (15) Indirect ownership interest.
    (16) Highest tier entity.
    (17) Next lower tier entity.
    (18) Stock.
    (i) In general.
    (ii) Treating stock as not stock.
    (iii) Treating interests not constituting stock as stock.
    (iv) Stock of the loss corporation.
    (19) Change date.
    (20) Year.
    (21) Old section 382.
    (22) Pre-change loss.
    (23) Unrelated.
    (24) Percentage ownership interest.
    (g) 5-percent shareholder.
    (1) In general.
    (2) Determination of whether a person is a 5-percent shareholder.
    (3) Determination of the percentage stock ownership interest of a 5-
percent shareholder.
    (4) Examples.
    (5) Stock ownership presumptions in connection with certain 
acquisitions and dispositions of loss corporation stock.
    (i) In general.
    (ii) Example.
    (h) Constructive ownership of stock.
    (1) In general.
    (2) Attribution from corporations, partnerships, estates and trusts.
    (i) In general.
    (ii) Limitation on attribution from entities with respect to certain 
interests.

[[Page 662]]

    (iii) Limitation on attribution from certain entities.
    (iv) Examples.
    (3) Attribution to corporations, partnerships, estates and trusts.
    (4) Option attribution.
    (i) In general.
    (ii) Examples.
    (iii) Contingencies.
    (iv) Series of options.
    (v) Interests that are similar to options.
    (vi) Actual exercise of options.
    (A) In general.
    (B) Actual exercise within 120 days of deemed exercise.
    (vii) Effect of deemed exercise of options on the outstanding stock 
of the loss corporation.
    (A) Right of obligation to issue stock.
    (B) Right or obligation to acquire outstanding stock by the loss 
corporation.
    (C) Effect on value of old loss corporation.
    (viii) Options that lapse or are forfeited.
    (ix) Option rule inapplicable if pre-change losses are de minimis.
    (x) Options not subject to attribution
    (A) Long-held options with respect to actively traded stock.
    (B) Right to receive or obligation to issue a fixed dollar amount of 
value of stock upon maturity of certain debt.
    (C) Right or obligation to redeem stock of the loss corporation.
    (D) Options exercisable only upon death, disability or mental 
incompetency.
    (E) Right to receive or obligation to issue stock as interest or 
dividends.
    (F) Options outstanding following an ownership change.
    (1) In general.
    (2) Example.
    (G) Right to acquire loss corporation stock pursuant to a default 
under loan agreement.
    (H) Agreement to acquire or sell stock owned by certain shareholders 
upon retirement.
    (I) [Reserved]
    (J) Title 11 of similar case.
    (K)-(Y) [Reserved]
    (xi) Certain transfers of options disregarded.
    (xii) Exercise of an option that has not been treated as stock.
    (xiii) Effective date.
    (5) Stock transferred under certain agreements.
    (6) Family attribution.
    (i) [Reserved]
    (j) Aggregation and segregation rules.
    (1) Aggregation of public shareholders and public owners into public 
groups.
    (i) Public group.
    (ii) Treatment of public group that is a 5-percent shareholder.
    (iii) Presumption of no cross-ownership.
    (iv) Identification of the public groups treated as 5-percent 
shareholders.
    (A) Analysis of highest tier entities.
    (B) Analysis of other higher tier entities and first tier entities.
    (C) Aggregation of the public shareholders.
    (v) Appropriate adjustments.
    (vi) Examples.
    (2) Segregation rules applicable to transactions involving the loss 
corporation.
    (i) In general.
    (ii) Direct public group.
    (iii) Transactions to which segregation rules apply.
    (A) In general.
    (B) Certain equity structure shifts and transactions to which 
section 1032 applies.
    (1) In general.
    (2) Examples.
    (C) Redemption-type transactions.
    (1) In general.
    (2) Examples.
    (D) Acquisition of loss corporation stock as the result of the 
ownership of a right to acquire stock.
    (1) In general.
    (2) Example.
    (E) Transactions identified in the Internal Revenue Bulletin.
    (F) Issuance of rights to acquire loss corporation stock.
    (1) In general.
    (2) Example.
    (iv) Combination of de minimis public groups.
    (A) In general.
    (B) Example.
    (v) Multiple transactions.
    (A) In general.
    (B) Example.
    (vi) Acquisitions made by either a 5-percent shareholder or the loss 
corporation following application of the segregation rules.
    (3) Segregation rules applicable to transactions involving first 
tier entities or higher tier entities.
    (i) Dispositions.
    (ii) Example.
    (iii) Other transactions affecting direct public groups of a first 
tier entity or higher tier entity.
    (iv) Examples.
    (v) Acquisitions made by a 5-percent shareholder, a higher tier 
entity, or a first tier entity following application of the segregation 
rules.
    (k) Operating rules.
    (1) Presumptions regarding stock ownership.
    (i) Stock subject to regulation by the Securities and Exchange 
Commission.
    (ii) Statements under penalties of perjury.
    (2) Actual knowledge regarding stock ownership.
    (3) Duty to inquire as to actual stock ownership in the loss 
corporation.
    (4) Ownership interests structured to avoid the section 382 
limitation.
    (5) Example.

[[Page 663]]

    (6) First tier entity or higher tier entity that is a foreign 
corporation or entity. [Reserved]
    (l) Changes in percentage ownership which are attributable to 
fluctuations in value. [Reserved]
    (m) Effective date.
    (1) In general.
    (2) Plan of reorganization.
    (3) Earliest commencement of the testing period.
    (4) Transitional rules.
    (i) Rules provided in paragraph (j) of this section for testing 
dates before September 4, 1987.
    (ii) Example.
    (iii) Rules provided in paragraph (j) of this section for testing 
dates on or after September 4, 1987.
    (iv) Rules provided in paragraphs (f)(18)(ii) and (iii) of this 
section.
    (v) Rules provided in paragraph (a)(2)(ii) of this section.
    (vi) Rules provided in paragraph (h)(4) of this section.
    (vii) Rules provided in paragraph (a)(2)(i) of this section.
    (5) Bankruptcy proceedings.
    (i) In general.
    (ii) Example.
    (6) Transactions of domestic building and loan associations.
    (7) Transactions not subject to section 382.
    (i) Application of old section 382.
    (ii) Effect on testing period.
    (iii) Termination of old section 382. [Reserved]
    (8) Options issued or transferred before January 1, 1987.
    (i) Options issued before May 6, 1986.
    (ii) Options issued on or after May 6, 1986 and before September 18, 
1986.
    (iii) Options issued on or after September 18, 1986 and before 
January 1, 1987.
    (9) Examples.

[T.D. 9487, 75 FR 33991, June 16, 2010]



Sec. 1.382-2  General rules for ownership change.

    (a) Certain definitions for purposes of sections 382 and 383 and the 
regulations thereunder. The following definitions apply for purposes of 
sections 382 and 383 and the regulations thereunder.
    (1) Loss corporation--(i) In general. The term loss corporation 
means a corporation which--
    (A) Is entitled to use a net operating loss carryforward, a capital 
loss carryover, a carryover of excess foreign taxes under section 
904(c), a carryforward of a general business credit under section 39, a 
carryover of a minimum tax credit under section 53, or a section 382 
disallowed business interest carryforward described in paragraph (a)(7) 
of this section;
    (B) For the taxable year that includes a testing date, as defined in 
paragraph (a)(4) of this section or Sec. 1.382-2T(a)(2)(i), whichever 
is applicable (determined for purposes of this paragraph (a)(1) without 
regard to whether the corporation is a loss corporation), has a net 
operating loss, a net capital loss, excess foreign taxes under section 
904(c), unused general business credits under section 38, or an unused 
minimum tax credit under section 53; or
    (C) Has a net unrealized built-in loss (determined for purposes of 
this paragraph (a)(1) by treating the date on which such determination 
is made as the change date). See section 382(h)(3) for the definition of 
net unrealized built-in loss.

See section 383 and Sec. 1.383-1 for rules relating to a loss 
corporation that has an ownership change and has capital losses, excess 
foreign taxes, general business credits or minimum tax credits. Any 
predecessor or successor to a loss corporation described in this 
paragraph (a)(1) is also a loss corporation.
    (ii) Distributor or transferor loss corporation in a transaction 
under section 381. Notwithstanding that a loss corporation ceases to 
exist under state law, if its disallowed business interest expense 
carryforwards, net operating loss carryforwards, excess foreign taxes, 
or other items described in section 381(c) are succeeded to and taken 
into account by an acquiring corporation in a transaction described in 
section 381(a), such loss corporation will be treated as continuing in 
existence until--
    (A) Any pre-change losses (excluding pre-change credits described in 
Sec. 1.383-1(c)(3)), determined as if the date of such transaction were 
the change date, are fully utilized or expire under section 163(j), 172, 
or 1212;
    (B) Any net unrealized built-in losses, determined as if the date of 
such transaction were the change date, may no longer be treated as pre-
change losses; and
    (C) Any pre-change credits (described in Sec. 1.383-1(c)(3)), 
determined as if the date of such transaction were the

[[Page 664]]

change date, are fully utilized or expire under sections 39, 53, or 
904(c).

Following a transaction described in the preceding sentence, the stock 
of the acquiring corporation shall be treated as the stock of the loss 
corporation for purposes of determining whether an ownership change 
occurs with respect to the pre-change losses and net unrealized built-in 
losses that may be treated as pre-change losses of the distributor or 
transferor corporation.
    (iii) Separate accounting required for losses and credits of an 
acquiring corporation and a distributor or transferor loss corporation. 
Except as provided in paragraph (a)(1)(iv) of this section, pre-change 
losses (determined as if the testing date were the change date and 
treating the amount of any net unrealized built-in loss as a pre-change 
loss), that are succeeded to and taken into account by an acquiring 
corporation in a transaction to which section 381(a) applies must be 
accounted for separately from losses and credits of the acquiring 
corporation for purposes of applying this section. See Example (2) of 
Sec. 1.382-2T(e)(2)(iv) of this section.
    (iv) End of separate accounting for losses and credits of 
distributor or transferor loss corporation. The separate tracking of 
owner shifts of the stock of an acquiring corporation required by 
paragraph (a)(1)(iii) of this section with respect to the net operating 
loss carryovers and other attributes described in paragraph (a)(1)(ii) 
of this section ends when a fold-in event occurs. A fold-in event is 
either an ownership change of the distributor or transferor corporation 
in connection with, or after, the transaction to which section 381(a) 
applies, or a period of 5 consecutive years following the section 381(a) 
transaction during which the distributor or transferor corporation has 
not had an ownership change. Starting on the day after the earlier of 
the change date (but not earlier than the day of the section 381(a) 
transaction) or the last day of the 5 consecutive year period, the 
losses and other attributes of the distributor or transferor corporation 
are treated as losses and attributes of the acquiring corporation for 
purposes of determining whether an ownership change occurs with respect 
to such losses. Also, for purposes of determining the beginning of the 
acquiring corporation's testing period, such losses are considered to 
arise either in a taxable year that begins not earlier than the later of 
the day following the change date or the day of the section 381(a) 
transaction, or in a taxable year that begins 3 years before the end of 
the 5 consecutive year period. Pre-change losses of a distributor or 
transferor corporation that are subject to a limitation under section 
382 continue to be subject to the limitation notwithstanding the 
occurrence of a fold-in event. Any ownership change that occurs in 
connection with, or subsequent to, the section 381 transaction may 
result in an additional, lesser limitation with respect to such pre-
change losses.
    (v) Application to other successor corporations. This paragraph 
(a)(1) also applies, as the context may require, to successor 
corporations other than successors in section 381(a) transactions. For 
example, if a corporation receives assets from the loss corporation that 
have basis in excess of value, the recipient corporation's basis for the 
assets is determined, directly or indirectly, in whole or in part, by 
reference to the loss corporation's basis, and the amount by which basis 
exceeds value is material, the recipient corporation is a successor 
corporation subject to this paragraph (a)(1).
    (2) Pre-change loss. The term pre-change loss means--
    (i) Any net operating loss carryforward of the old loss corporation 
to the taxable year ending on the change date or in which the change 
date occurs;
    (ii) Any net operating loss of the old loss corporation for the 
taxable year in which the ownership change occurs to the extent such 
loss is allocable to the period in such year on or before the change 
date;
    (iii) Any recognized built-in loss for any recognition period 
taxable year (within the meaning of 382(h));
    (iv) Any pre-change capital losses described in Sec. 1.383-
1T(c)(2)(i) and (ii);
    (v) Any pre-change credits described in 1.383-1T(c)(3); and
    (vi) Any section 382 disallowed business interest carryforward.

[[Page 665]]

    (3) Stock--(i) In general. Except as provided in this paragraph 
(a)(3)(i) and Sec. 1.382-2T(f)(18)(ii) and (iii), the term stock means 
stock other than stock described in section 1504(a)(4). Notwithstanding 
the preceding sentence, stock that is not described in section 
1504(a)(4) solely because it is entitled to vote as a result of dividend 
arrearages shall be treated as so described and thus shall not be 
considered stock. Stock described in section 1504(a)(4), however, is not 
excluded for purposes of determining the value of the loss corporation 
under section 382(e). The determination of the percentage of stock of 
any corporation owned by any person shall be made on the basis of the 
relative fair market value of the stock owned by such person to the 
total fair market value of the outstanding stock of the corporation. 
Solely for purposes of determining the percentage of stock owned by a 
person, each share of all the outstanding shares of stock that have the 
same material terms is treated as having the same value. Thus, for 
example, a control premium or blockage discount is disregarded in 
determining the percentage of stock owned by any person.
    (ii) Convertible stock. The term stock includes any convertible 
stock. For rules regarding the treatment of certain convertible stock as 
an option, see Sec. 1.382-4(d)(9)(ii).
    (4) Testing date--(i) In general. Except as provided in paragraph 
(a)(4)(ii) of this section, a loss corporation is required to determine 
whether an ownership change has occurred immediately after any owner 
shift, or issuance or transfer (including an issuance or transfer 
described in Sec. 1.382-4(d)(8)(i) or (ii)) of an option with respect 
to stock of the loss corporation that is treated as exercised under 
Sec. 1.382-4(d)(2). Each date on which a loss corporation is required 
to make a determination of whether an ownership change has occurred is 
referred to as a testing date. All computations of increases in 
percentage ownership are to be made as of the close of the testing date 
and any transactions described in this paragraph (a)(4) that occur on 
that date are treated as occurring simultaneously at the close of the 
testing date. See Sec. 1.382-2T(e)(1) for the definition of owner 
shift. The term option, as used in this paragraph (a)(4), includes 
interests that are treated as options under Sec. 1.382-4(d)(9).
    (ii) Exceptions. A loss corporation is not required to determine 
whether an ownership change has occurred immediately after--
    (A) Any transfer of stock, or an option with respect to stock, of 
the loss corporation in any of the circumstances described in section 
382(l)(3)(B) (death, gift, divorce, etc.); or
    (B) The transfer of an option described in Sec. 1.382-4(d)(11)(i) 
or (ii) (relating to transfers between persons who are not 5-percent 
shareholders or between members of certain public groups).
    (5) Successor corporation. A successor corporation is a distributee 
or transferee corporation that succeeds to and takes into account items 
described in section 381(c) from a corporation as the result of an 
acquisition of assets described in section 381(a). A successor 
corporation also includes, as the context may require, a corporation 
which receives an asset or assets from another corporation if the 
corporation's basis for the asset(s) is determined, directly or 
indirectly, in whole or in part, by reference to the other corporation's 
basis and the amount by which basis differs from value is, in the 
aggregate, material.
    (6) Predecessor corporation. A predecessor corporation is a 
distributor or transferor corporation that distributes or transfers its 
assets to an acquiring corporation in a transaction described in section 
381(a). A predecessor corporation also includes, as the context may 
require, a corporation which transfers an asset or assets to another 
corporation if the transferee's basis for the asset(s) is determined, 
directly or indirectly, in whole or in part, by reference to the 
corporation's basis and the amount by which basis differs from value is, 
in the aggregate, material.
    (7) Section 382 disallowed business interest carryforward. The term 
section 382 disallowed business interest carryforward includes the 
following items:
    (i) The loss corporation's disallowed business interest expense 
carryforwards (as defined in Sec. 1.163(j)-

[[Page 666]]

1(b)(11)), including disallowed disqualified interest (as defined in 
Sec. 1.163(j)-1(b)(12)), as of the date of the ownership change.
    (ii) The loss corporation's current-year business interest expense 
(as defined in Sec. 1.163(j)-1(b)(9)) in the change year (as defined in 
Sec. 1.382-6(g)(1)) that is allocable to the pre-change period (as 
defined in Sec. 1.382-6(g)(2)) under Sec. 1.382-6(a) or (b) and that 
becomes disallowed business interest expense (as defined in Sec. 
1.163(j)-1(b)(10)).
    (8) Testing period. Notwithstanding the temporal limitations 
provided in Sec. 1.382-2T(d)(3)(i), the testing period for a loss 
corporation can begin as early as the first day of the first taxable 
year from which there is a section 382 disallowed business interest 
carryforward to the first taxable year ending after the testing date.
    (b) Effective dates--(1) In general. [Reserved]
    (2) Rules provided in paragraph (a)(3)(ii) of this section--(i) In 
general. Except as provided in paragraph (b)(2)(ii) of this section, the 
rules provided in paragraph (a)(3)(ii) of this section apply with 
respect to any convertible stock.
    (ii) Certain convertible preferred stock. Convertible stock that, 
when issued, would be described in section 1504(a)(4) by disregarding 
subparagraph (D) thereof and by ignoring the potential participation in 
corporate growth that the conversion feature may offer is treated as 
stock described in that section (and thus is not treated as stock for 
the purpose of determining whether an ownership change occurs, but is 
taken into account for the purpose of determining the value of the loss 
corporation immediately before an ownership change; see sections 
382(e)(1) and 382(k)(6)(A)) if--
    (A) The stock was issued on or after July 20, 1988, and prior to 
November 5, 1992; or
    (B) The stock was issued prior to July 20, 1988, and the loss 
corporation makes the election described in Notice 88-67, 1988-1 C.B. 
555, (see Sec. 601.601(d)(2)(ii)(b) of this chapter for availability of 
Cumulative Bulletins (C.B.)) on or before the earlier of the date 
prescribed in the Notice or December 7, 1992.
    (3) Rules provided in paragraphs (a)(1)(i)(A), (a)(1)(ii), (iv), and 
(v), (a)(2)(iv) through (vi), (a)(3)(i), and (a)(4) through (8) of this 
section. The rules provided in paragraphs (a)(1)(i)(A), (a)(1)(ii), 
(iv), and (v), (a)(2)(iv) through (vi), (a)(3)(i), and (a)(4) through 
(8) of this section apply to testing dates occurring on or after 
November 13, 2020. For loss corporations that have testing dates 
occurring before November 13, 2020, see Sec. 1.382-2 as contained in 26 
CFR part 1, revised April 1, 2019. However, taxpayers and their related 
parties, within the meaning of sections 267(b) and 707(b)(1), may choose 
to apply the rules of this section to testing dates occurring during a 
taxable year beginning after December 31, 2017, and before November 13, 
2020, so long as the taxpayers and their related parties consistently 
apply the rules of this section, the section 163(j) regulations (as 
defined in Sec. 1.163(j)-1(b)(37)), Sec. Sec. 1.382-1, 1.382-5, 1.382-
6, 1.382-7, 1.383-0, and 1.383-1, and, if applicable, Sec. Sec. 1.263A-
9, 1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 
1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-
79, 1.1502-91 through 1.1502-99 (to the extent they effectuate the rules 
of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to 
that taxable year.

[T.D. 8352, 56 FR 29434, June 27, 1991, as amended by T.D. 8405, 57 FR 
10740, Mar. 30, 1992; 57 FR 24188, June 8, 1992; T.D. 8531, 59 FR 12836, 
Mar. 18, 1994; T.D. 8679, 61 FR 33315, June 27, 1996; T.D. 8825, 64 FR 
36177, 36178, July 2, 1999; T.D. 9905, 85 FR 56834, Sept. 14, 2020]



Sec. 1.382-2T  Definition of ownership change under section 382, 
as amended by the Tax Reform Act of 1986 (temporary).

    (a) Ownership change--(1) In general. A corporation is a new loss 
corporation and thus subject to limitation under section 382 only if an 
ownership change has occurred with respect to such corporation. An 
ownership change occurs with respect to a corporation if it is a loss 
corporation on a testing date and, immediately after the close of the 
testing date, the percentage of stock of the corporation owned by one or 
more 5-percent shareholders has increased by more than 50 percentage 
points over the lowest percentage of stock of such

[[Page 667]]

corporation owned by such shareholders at any time during the testing 
period. See paragraph (a)(2)(i) of this section for the definition of 
testing date. See paragraph (d) of this section for the definition of 
testing period. See Sec. 1.382-2(a)(1) and paragraph (f)(3) of this 
section for the respective definition of loss corporation and new loss 
corporation. See paragraph (g) of this section for the definition of 5-
percent shareholder. See section 383 and Sec. 1.383-1 for rules 
relating to loss corporations that have an ownership change and have 
capital loss carryovers, excess foreign taxes carried over under section 
904(c), carryovers of general business credits under section 39, or 
unused minimum tax credits under section 53.
    (2) Events requiring a determination of whether an ownership change 
has occurred--(i) Testing dates prior to November 5, 1992. Except as 
otherwise provided in this paragraph (a)(2)(i), a loss corporation is 
required to determine whether an ownership change has occurred 
immediately after any owner shift, any equity structure shift, or any 
transaction in which an option with respect to stock of the loss 
corporation is--
    (A) Transferred to (or by) a 5-percent shareholder (or a person who 
would be 5-percent shareholder if the option were treated as exercised), 
or
    (B) Issued by the loss corporation, a first tier entity, or a higher 
tier entity that owns five percent or more of the loss corporation 
(determined without regard to the application of paragraph (h)(2)(i)(A) 
of this section). Notwithstanding the preceding sentence, any transfer 
of stock of the loss corporation (or an option with respect to such 
stock) in any of the circumstances described in section 382(l)(3)(B), or 
any equity structure shift that is not also an owner shift, is not an 
event that requires the loss corporation to make a determination of 
whether an ownership change has occurred. For purposes of this section, 
each date on which a loss corporation is required to make a 
determination of whether an ownership change has occurred is referred to 
as a testing date, all computations of increases in percentage ownership 
are to be made as of the close of the testing date, and any transactions 
described in this paragraph (a)(2)(i) that occur on that date are 
treated as occurring simultaneously at the close of the testing date. 
See paragraphs (e)(1) and (2) of this section for the respective 
definitions of owner shift and equity structure shift. See paragraphs 
(f)(9) and (14) of this section for the respective definitions of first 
tier entity and higher tier entity. See paragraph (m)(4)(vii) of this 
section for special rules regarding the effective date of the provisions 
of this paragraph (a)(2)(i).
    (ii) [Reserved]. For further guidance, see Sec. 1.382-11(a).
    (iii) Records to be maintained by loss corporation. A loss 
corporation shall keep such records as are necessary to determine: (A) 
The identity of its 5-percent shareholders, (B) the percentage of its 
stock owned by each such 5-percent shareholder, and (C) whether the 
section 382 limitation is applicable. Such records shall be retained so 
long as they may be material in the administration of any internal 
revenue law.
    (b) Nomenclature and assumptions. For purposes of the example in 
this section--
    (1) L is a loss corporation, and, if there is more than one loss 
corporation, they are designated as L1, L2, 
L3, etc.
    (2) P is a corporation that is not a loss corporation, and, if there 
is more than one such corporation, they are designated as P1, 
P2, P3, etc.
    (3) HC is a corporation whose assets consist solely of the stock of 
other corporations.
    (4) E is an entity other than a corporation (e.g., a partnership), 
and, if there is more than one such entity, they are designated as 
E1, E2, E3, etc.
    (5) Unless otherwise stated--
    (i) A, B, C, D, AA, BB, CC, and DD are unrelated individuals who own 
interests in corporations or other entities only to the extent expressly 
stated,
    (ii) All corporations have one class of stock outstanding and each 
share of stock has the same fair market value as each other share,
    (iii) The capital structure of the loss corporation and its business 
do not change over time, and
    (iv) The rules of paragraphs (k)(2) and (4) of this section are not 
applicable.

[[Page 668]]

    (6) Public L represents a group of unrelated individuals and 
entities that own direct (and not indirect) stock ownership interests in 
loss corporation L, each of whom owns less than five percent of the 
stock of the loss corporation, and, if there is more than one loss 
corporation, such groups are designated as Public L1, Public 
L2, Public L3, etc.
    (7) Public P represents a group of unrelated individuals and 
entities that own direct (and not indirect) stock ownership interests in 
corporation P, each of whom owns less than five percent of the stock of 
the corporation, and, if there is more than one corporation, such groups 
are designated as Public P1, P2, P3, 
etc.
    (8) Public E represents a group of unrelated individuals and 
entities that own direct (and not indirect) ownership interests in 
entity E, each of whom owns less than five percent of the entity, and, 
if there is more than one entity, such groups are designated as Public 
E1, Public E2, Public E3, etc.
    (c) Computing the amount of increases in percentage ownership--(1) 
In general. In order to determine whether an ownership change has 
occurred on a testing date, the loss corporation must identify each 5-
percent shareholder whose percentage of stock ownership in the loss 
corporation immediately after the close of the testing date has 
increased, compared to such shareholder's lowest percentage of stock 
ownership in such corporation at any time during the testing period. The 
amount of the increase in the percentage of stock ownership in the loss 
corporation of each 5-percent shareholder must be computed separately by 
comparing the percentage ownership of each such 5-percent shareholder 
immediately after the close of the testing date to such shareholder's 
lowest percentage ownership at any time during the testing period. Each 
such increase in the percentage ownership of a 5-percent shareholder is 
then added together with any other such increases of other 5-percent 
shareholders to determine whether an ownership change has occurred. 
Because only those 5-percent shareholders whose percentages of stock 
ownership have increased are taken into account, a 5-percent shareholder 
is disregarded if his percentage of stock ownership, immediately after 
the close of the testing date, has decreased (or has remained the same), 
compared to his lowest percentage ownership interest on any previous 
date during the testing period.
    (2) Example.

    Example. (i) A and B each own 40 percent of the outstanding L stock. 
The remaining 20 percent of the L stock is owned by 100 unrelated 
individuals, none of whom own as much as five percent of L stock 
(``Public L''). C negotiates with A and B to purchase all their stock in 
L.
    (ii) The acquisitions from both A and B are completed on September 
13, 1990. C's acquisition of 80 percent of L stock results in an 
ownership change because C's percentage ownership has increased by 80 
percentage points as of the testing date, compared to his lowest 
percentage ownership in L at any time during the testing period (0 
percent).

    (3) Related and unrelated increases in percentage stock ownership. 
The determination whether an ownership change has occurred is made 
without regard to whether the changes in stock ownership of the loss 
corporation (by one or more 5-percent shareholders) result from related 
or unrelated events.
    (4) Example.

    Example. (i) L has outstanding 200 shares of common stock. A, B and 
C respectively own 100, 50 and 50 shares of the L stock. On January 2, 
1988, A sells 60 shares of L stock to B. Thus, B's percentage ownership 
interest in L increases by 30 percentage points, from 50 shares to 110 
shares. On January 1, 1989, A purchases C's entire interest in L. Thus, 
A's percentage ownership interest in L increases by 25 percentage 
points, compared to his lowest percentage ownership interest in L, from 
40 shares immediately following the January 2, 1988 sale to B to 90 
shares. Even though A's ownership interest in L as of January 1, 1989 
has decreased, compared to his 50 percent ownership interest at the 
beginning of the testing period, A is a 5-percent shareholder who must 
be taken into account for purposes of the computation required under 
paragraph (c)(1) of this section because his interest in L on that 
testing date (45 percent) has increased, compared to his lowest 
percentage ownership interest in L at any time during the testing period 
(20 percent following the sale to B).
    (ii) Accordingly, although A and B jointly have increased their 
aggregate total ownership interest in L between January 2, 1988 and 
January 1, 1989 by only 25 percentage points (i.e., the total ownership 
interest in L held by A and B at all times is not less than

[[Page 669]]

a 75 percent interest), the total of their separate increases in the 
percentage stock ownership of L, compared to their respective lowest 
percentage ownership interests at any time during the testing period, is 
55 percentage points. Thus, an ownership change occurs as a result of 
A's acquisition of L stock on January 1, 1989.

    (d) Testing period--(1) In general. Except as otherwise provided in 
paragraphs (d) and (m) of this section, the testing period for any 
testing date is the three-year period ending on the testing date. See 
paragraph (a)(2)(i) of this section for the definition of testing date.
    (2) Effect of a prior ownership change. Following an ownership 
change, the testing period for determining whether a subsequent 
ownership change has occurred shall begin no earlier than the first day 
following the change date of the most recent ownership change. See 
paragraph (f)(19) of this section for the definition of change date.
    (3) Commencement of the testing period--(i) In general. Except as 
otherwise provided in paragraph (d)(3)(ii) of this section, the testing 
period for any loss corporation shall not begin before the earlier of 
the first day of either--
    (A) The first taxable year from which there is a loss or excess 
credit carryforward to the first taxable year ending after the testing 
date, or
    (B) The taxable year in which the testing date occurs.
    (ii) Exception for corporations with net unrealized built-in loss. 
Paragraph (d)(3)(i) of this section shall not apply if the corporation 
has a net unrealized built-in loss (determined after application of 
section 382(h)(3)(B)) on the testing date, unless the loss corporation 
establishes the taxable year in which the net unrealized built-in loss 
first accrued.


In that event, the testing period shall not begin before the earlier 
of--
    (A) The first day of the taxable year in which the net unrealized 
built-in loss first accrued, or
    (B) The day described in paragraph (d)(3)(i) of this section. See 
section 382(h) for the definition of net unrealized built-in loss.
    (4) Disregarding testing dates. Any testing date that occurs before 
the beginning of the testing period shall be disregarded for purposes of 
this section.
    (5) Example.

    Example. (i) A owns all 100 outstanding shares of L stock. A sells 
40 shares to B on January 1, 1988. C purchases 20 shares of L stock from 
A on July 1, 1991. In determining if an ownership change occurs on the 
July 1, 1991 testing date, B's acquisition of L stock is disregarded 
because it occurred before the testing period that ends on such testing 
date. Thus, B's ownership interest in L does not increase during the 
testing period, and no ownership change results from C's acquisition.
    (ii) The facts are the same as in (i), except that throughout the 
period during which B negotiated his stock purchase transaction with A, 
B knew that C intended to attempt to acquire a significant stock 
interest in L. Also, B and C have been partners in a number of 
significant business ventures. The result is the same as in (i).

    (e) Owner shift and equity structure shift--(1) Owner shift--(i) 
Defined. For purposes of this section, an owner shift is any change in 
the ownership of the stock of a loss corporation that affects the 
percentage of such stock owned by any 5-percent shareholder. See 
paragraph (g) of this section for the definition of a 5-percent 
shareholder. An owner shift includes, but is not limited to, the 
following transactions:
    (A) A purchase of disposition of loss corporation stock by a 5-
percent shareholder,
    (B) A section 351 exchange that affects the percentage of stock 
owned by a 5-percent shareholder,
    (C) A redemption or a recapitalization that affects the percentage 
of stock owned by a 5-percent shareholder,
    (D) An issuance of loss corporation stock that affects the 
percentage of stock owned by a 5-percent shareholder, and
    (E) An equity structure shift that affects the percentage of stock 
owned by a 5-percent shareholder.
    (ii) Transactions between persons who are not 5-percent shareholders 
disregarded. Transfers of loss corporation stock between persons who are 
not 5-percent shareholders of such corporation (and between members of 
separate public groups resulting from the application of the segregation 
rules of paragraphs (j)(2) and (3)(iii) of this section) are not owner 
shifts and thus are not

[[Page 670]]

taken into account. See paragraph (h)(4)(xi) of this section for a 
similar rule applicable to transfers of options.
    (iii) Examples.

    Example 1. A has owned all 1000 shares of outstanding L stock for 
more than three years. On June 15, 1988, A sells 300 of his L shares to 
B. This transaction is an owner shift. No other 5-percent shareholder 
has increased his percentage ownership of L stock during the testing 
period. Thus, the owner shift resulting from B's acquisition does not 
result in an ownership change, because B has increased his stock 
ownership in L by only 30 percentage points.
    Example 2. The facts are the same as in Example (1). In addition, on 
June 15, 1989, L issues 100 shares to each of C, D and AA. The stock 
issuance is an owner shift. The transaction, however, does not result in 
an ownership change, because B, C, D and AA (the 5-percent shareholders 
whose stock ownership has increased as of the testing date, compared to 
any other time during the testing period) have increased their 
percentage of stock ownership in L by a total of only 46.2 percentage 
points during the testing period (by 23.1 percentage points [300 shares/
1300 shares] for B, and 7.7 percentage points [100 shares/1300 shares] 
for each of C, D and AA).
    Example 3. All 1000 shares of L stock are owned by a group of 100 
unrelated individuals, none of whom own as much as five percent of L 
stock (``Public L''). Several of the members of Public L sell their L 
stock, amounting to a 30 percent ownership interest in L, to B on June 
15, 1988. The sale of stock to B is an owner shift. Between June 16, 
1988 and June 15, 1989, each of the remaining individuals in Public L 
sells his stock to another person who is not a 5-percent shareholder. 
Under paragraph (e)(1)(ii) of this section, trading activity among the 
members of Public L is disregarded and does not result in an owner 
shift. On June 15, 1989, L issues 100 shares to each of C, D and AA. The 
only sale transactions by members of Public L that are taken into 
account in determining whether an ownership change occurs on June 15, 
1989 are the sales to B on June 15, 1988. Because B, C, D and AA 
together have increased their percentage ownership of L stock as a 
result of B's purchase and the stock issuance by an amount not in excess 
of 50 percentage points during the testing period ending on June 15, 
1988, an ownership change does not occur on that date.
    Example 4. The facts are the same as in Example (2). In addition, on 
December 15, 1989, L redeems 200 of the L shares from A. The redemption 
is an owner shift that results in an ownership change, because B, C, D 
and AA are 5-percent shareholders whose percentage ownership of L 
increase by a total of 54.6 percentage points during the testing period 
(by 27.3 percentage points [300 shares/1100 shares] for B and 9.1 
percentage points [100 shares/1100 shares] for each of C, D and AA).
    Example 5. L is owned entirely by 10,000 unrelated shareholders, 
none of whom owns as much as five percent of the stock of L (``Public 
L''). Accordingly, Public L is L's only 5-percent shareholder. See 
paragraph (j)(1) of this section. There are one million shares of common 
stock outstanding. On December 1, 1988, L issues two million new shares 
of its common stock to members of the public, none of whom owned any L 
stock prior to the issuance. Following the public offering, no 
shareholder of L owns, directly or indirectly, five percent or more of L 
stock. Under paragraph (j)(2) of this section, however, all of the newly 
issued stock is treated as acquired by a 5-percent shareholder (``Public 
NL'') that is unrelated to Public L. Therefore, the public offering 
constitutes an owner shift that results in an ownership change because 
Public NL's percentage of stock ownership in L increased by 66\2/3\ 
percentage points (two million shares acquired in the public offering/
three million shares outstanding following the offering) over its lowest 
percentage ownership during the testing period (0 percent prior to the 
offering).
    Example 6. The facts are the same as in Example (5), except that L 
issues only 500,000 new shares of L stock on December 1, 1988, and 
Public NL's percentage ownership interest in L increases by only 33\1/3\ 
percentage points (500,000 shares acquired in the public offering/1.5 
million shares outstanding following the offering). During the two years 
following December 2, 1988, 14 percent of the stock outstanding on that 
date is sold over a public stock exchange. On December 3, 1990, A 
purchases five percent of L stock (75,000 shares) over a public stock 
exchange. The purchase of five percent of L stock by A is an owner shift 
and is presumed to have been made proportionately from Public L and 
Public NL under paragraph (j)(1)(vi) of this section. Under paragraph 
(e)(1)(ii) of this section, transfers of L stock in transactions not 
involving A (i.e., in transactions among or between members of separate 
public groups resulting from the application of paragraphs (j)(2) and 
(3) of this section) are not taken into account, and do not constitute 
owner shifts. (Transfers between members of Public NL and Public L, 
which are treated as separate 5-percent shareholders solely by virtue of 
paragraph (j)(2) of this section, are disregarded even if L has actual 
knowledge of any such transfers.) A and Public NL, the only 5-percent 
shareholders whose interests in L have increased during the testing 
period, have increased their respective stock ownership by only 36\2/3\ 
percentage points--five percentage points for A [75,000 shares/1.5 
million shares outstanding] and 31\2/3\ percentage points for Public NL 
[((500,000 shares issued in the public offering)-(5 percent x

[[Page 671]]

500,000 shares presumed to have been acquired by A)) /1.5 million shares 
outstanding]. Accordingly, there is no ownership change with respect to 
L notwithstanding that, taking into account the public trading, a change 
of more than 50 percentage points in the ultimate beneficial ownership 
of L stock occurred during the three-year period ending on the December 
3, 1990 testing date.
    Example 7. The facts are the same as in Example 6, except that five 
percent of the L stock has always been owned by P which, in turn, has 
always been owned by Public P. On December 6, 1990, P sells all of its L 
stock over a public stock exchange. Although the trading of P stock 
among persons that are not 5-percent share-holders (without regard to 
the segregation rules of paragraph (j) of this section) are disregarded 
under paragraph (e)(1)(ii) of this section, the disposition of the L 
stock by P is not disregarded because the L stock is transferred in a 
transaction that is subject to paragraph (j)(3)(i) of this section.

    (2) Equity structure shift--(i) Tax-free reorganizations. An equity 
structure shift is any reorganization within the meaning of section 368 
with respect to which the loss corporation is a party to the 
reorganization, except that such term does not include a reorganization 
described in--
    (A) Section 368(a)(1)(D) or (G) unless the requirements of section 
354(b)(1) are met, or
    (B) Section 368(a)(1)(F).
    (ii) Transactions designated under section 382(g)(3)(B) treated as 
equity structure shifts. [Reserved]
    (iii) Overlap of owner shift and equity structure shift. Any equity 
structure shift that affects the percentage of loss corporation stock 
owned by a 5-percent shareholder also constitutes an owner shift. See 
paragraph (e)(i)(E) of this section
    (iv) Examples.

    Example 1. A owns all of the stock of L and B owns all of the stock 
of P. On October 13, 1988, L merges into P in a reorganization described 
in section 368a(1)(A). As a result of the merger, A and B own 25 and 75 
percent, respectively, of the stock of P. The merger is an equity 
structure shift (and, because it affects the percentage of L stock owned 
by 5-percent shareholders, it also constitutes an owner shift). On the 
October 13, 1988 testing date, B is a 5-percent shareholder whose stock 
ownership in the loss corporation following the merger has increased by 
75 percentage points over his lowest percentage of stock ownership in L 
at any time during the testing period (0 percent prior to the merger). 
Accordingly, an ownership change occurs as a result of the merger. P is 
thus a new loss corporation and L's pre-change losses are subject to 
limitation under section 382.
    Example 2. (i) A owns 100 percent of L1 stock and B owns 
100 percent of L2 stock. On January 1, 1988, L1 
merges into L2 in a reorganization described in section 
368(a)(1)(A). Immediately after the merger, A and B own 40 percent and 
60 percent, respectively, of the L2 stock. There is an equity 
structure shift (as well as an owner shift) with respect to both 
L1 and L2 on January 1, 1988.
    (ii) Because the percentage of L2 stock owned by B 
immediately after the merger (60 percent) increases by more than 50 
percentage points over the lowest percentage of the stock of 
L1 owned by B during the testing period (0 percent prior to 
the merger), there is an ownership change with respect to L1. 
L2 is a new loss corporation and thus, under Sec. 1.382-
2(a)(1)(iii) of this section, the pre-change losses of L1 
must be accounted for separately by L2 from the losses of 
L2 (immediately before the ownership change) and are subject 
to limitation under section 382. See Sec. 1.382-2(a)(1)(iv) of this 
section for rules that end separate accounting for L1's pre-
change losses on any testing date occurring on or after January 29, 
1991.
    (iii) L2 is a new loss corporation because it is a 
successor corporation to L1. There is no ownership change 
with respect to L2, however, because A's stock ownership in 
L2 increased by only 40 percentage points (to 40 percent) 
over the amount owned by A prior to the merger (0 percent). Therefore, 
the pre-change losses of L2 are not limited under section 382 
as a result of the merger.
    Example 3. The result in Example (2) would be the same if 
L1 had survived the merger (i.e., L2 merged into 
L1) with A and B owning 40 and 60 percent, respectively, of 
L1 stock. L1's pre-change losses would be 
accounted for separately and limited under section 382 and the pre-
change losses of L2 would be accounted for separately under 
Sec. 1.382-2(a)(1)(iii) of this section, but would not be limited under 
section 382. See Sec. 1.382-2(a)(1)(ii) for the treatment of 
L2 following the transaction.
    Example 4. The facts are the same as Example (2), except, instead of 
acquiring L1 in a merger, L2 acquires all of the 
L1 stock from A on January 1, 1988, solely in exchange for 
stock representing a 40 percent interest in L2, in a 
reorganization described in section 368(a)(1)(B). The acquisition of 
stock by L2 is an equity structure shift (as well as an owner 
shift) with respect to L1 that results in an ownership change 
with respect to L1 because the percentage of L1 
stock owned by B immediately after the reorganization (60 percent, by 
virtue of B's ownership of L2, through the operation of the 
constructive ownership

[[Page 672]]

rules of paragraph (h) of this section) increases by more than 50 
percentage points over the lowest percentage of L1 stock 
owned by B at any time during the testing period (0 percent prior to the 
reorganization). The acquisition also results in an equity structure 
shift and an owner shift with respect to L2, but 
L2 incurs no ownership change, because A's stock ownership in 
L2 increased by only 40 percentage points over the percentage 
of L2 stock owned by A prior to the reorganization (0 
percent).

    (f) Definitions. For purposes of this section--
    (1) Loss corporation. See section 382 and Sec. 1.382-2(a)(1) for 
the definition of a loss corporation.
    (2) Old loss corporation. The term old loss corporation means any 
corporation with respect to which there is an ownership change and that 
was a loss corporation immediately before the ownership change.
    (3) New loss corporation. The term new loss corporation means a 
corporation with respect to which there is an ownership change if, 
immediately after such change, it is a loss corporation. A successor 
corporation to the corporation described in the preceding sentence also 
is a new loss corporation.
    (4) Successor corporation. See Sec. 1.382-2(a)(5) for the 
definition of successor corporation.
    (5) Predecessor corporation. See Sec. 1.382-2(a)(6) for the 
definitions of predecessor corporation.
    (6) Shift. As the context may require, a shift means an equity 
structure shift, an owner shift or both.
    (7) Entity. See Sec. 1.382-3(a)(1) for the definition of an entity.
    (8) Direct ownership interest. A direct ownership interest means the 
interest a person owns in an entity, including a loss corporation, 
without regard to the constructive ownership rules of paragraph (h) of 
this section.
    (9) First tier entity. A first tier entity is an entity that, at any 
time during the testing period, owns a five percent or more direct 
ownership interest in the loss corporation.
    (10) 5-percent owner. A 5-percent owner is any individual that, at 
any time during the testing period, owns a five percent or more direct 
ownership interest in a first tier entity or a higher tier entity. See 
paragraph (g) of this section for rules to determine whether, as a 
result of the constructive ownership rules of paragraph (h) of this 
section, a 5-percent owner is a 5-percent shareholder.
    (11) Public shareholder. A public shareholder is any individual, 
entity, or other person with a direct ownership interest in a loss 
corporation of less than five percent at all times during the testing 
period.
    (12) Public owner. A public owner is any individual, entity, or 
other person that, at all times during the testing period, owns less 
than a five percent direct ownership interest in a first tier entity or 
any higher tier entity.
    (13) Public group. A public group is a group of individuals, 
entities, or other persons each of whom owns, directly or 
constructively, less than five percent of the loss corporation. See 
paragraphs (g) and (j) of this section for the rules applicable to 
identify public groups and to determine whether a public group is a 5-
percent shareholder.
    (14) Higher tier entity. A higher tier entity is any entity that, at 
any time during the testing period, owns a five percent or more direct 
ownership interest in a first tier entity or in any higher tier entity.
    (15) Indirect ownership interest. An indirect ownership is an 
interest a person owns in an entity determined solely as a result of the 
application of the constructive ownership rules of paragraph (h) of this 
section and without regard to any direct ownership interest (or other 
beneficial ownership interest) in the entity.
    (16) Highest tier entity. A highest tier entity is a first tier 
entity or a higher tier entity that is not owned, in whole or in part, 
at any time during the testing period by a higher tier entity.
    (17) Next lower tier entity. The next lower tier entity with respect 
to a first tier entity is the loss corporation. The next lower tier 
entity with respect to a higher tier entity is any first tier entity or 
other higher tier entity in which the higher tier entity owns, at any 
time during the testing period, a five percent or more direct ownership 
interest.
    (18) Stock--(i) In general. For further guidance, see Sec. 1.382-
2(a)(3)(i).
    (ii) Treating stock as not stock. Any ownership interest that 
otherwise

[[Page 673]]

would be treated as stock under paragraph (f)(18)(i) of this section 
shall not be treated as stock if--
    (A) As of the time of its issuance or transfer to (or by) a 5-
percent shareholder, the likely participation of such interest in future 
corporate growth is disproportionately small when compared to the value 
of such stock as a proportion of the total value of the outstanding 
stock of the corporation,
    (B) Treating the interest as not constituting stock would result in 
an ownership change, and
    (C) The amount of the pre-change loss (determined as if the testing 
date were the change and treating the amount of any net unrealized 
built-in loss as a pre-change loss) is more than twice the amount 
determined by multiplying
    (1) the value of the loss corporation (as determined under section 
382(e)) on the testing date, by
    (2) the long-term tax exempt rate (as defined in section 382(f)) for 
the calendar month in which the testing date occurs.

Stock that is not treated as stock under this paragraph (f)(18)(ii), 
however, is taken into account for purposes of determining the value of 
the loss corporation under section 382(e).
    (iii) Treating interests not constituting stock as stock. Any 
ownership interest that would not be treated as stock under paragraph 
(f)(18)(i) of this section (other than an option that is subject to 
paragraph (h)(4) of this section) shall be treated as constituting stock 
if--
    (A) As of the time of its issuance or transfer to (or by) a 5-
percent shareholder (or a person who would be a 5-percent shareholder if 
the interest not constituting stock were treated as stock), such 
interest offers a potential significant participation in the growth of 
the corporation,
    (B) Treating the interest as constituting stock would result in an 
ownership change, and
    (C) The amount of the pre-change losses (determined as if the 
testing date were the change date and treating the amount of any net 
unrealized built-in loss as a pre-change loss) is more than twice the 
amount determined by multiplying
    (1) The value of the loss corporation (as determined under section 
382(e)) on the testing date, by
    (2) The long-term tax exempt rate (as defined in section 382(f)) for 
the calendar month in which the testing date occurs.

An ownership interest is that treated as stock under this paragraph 
(f)(18)(iii) is taken into account for purposes of determining the value 
of the loss corporation under section 382(e). See Sec. 1.382-4(d)(12) 
for rules that apply with respect to options and this paragraph 
(f)(18)(iii).
    (iv) Stock of the loss corporation. The stock of the loss 
corporation means stock of such corporation within the meaning of this 
paragraph (f)(18) and, as the context may require, includes any indirect 
ownership interest in the loss corporation.
    (19) Change date. The change date means the date on which a shift 
(or any other transaction described in paragraph (a)(2)(i) of this 
section) that is the last component of an ownership change occurs.
    (20) Year. A year, or any multiple thereof, means a 365-day period 
(or a 366-day period in the case of a leap year), or any multiple 
thereof, unless the year is specifically identified as a taxable year.
    (21) Old section 382. ``Old section 382'' means section 382, as in 
effect prior to the effective date of section 382 in the Tax Reform Act 
of 1986 (the ``Act''), but taking into account section 621(f)(2) of the 
Act.
    (22) Pre-change loss. See section 382 and Sec. 1.382-2(a)(2) for 
the definition of pre-change loss.
    (23) Unrelated. Any two persons are unrelated if the constructive 
ownership rules of paragraph (h) of this section do not apply to treat 
either person as owning stock that is owned, directly or constructively, 
by the other person.
    (24) Percentage ownership interest. A person's percentage ownership 
interest in--
    (i) A corporation shall be determined under the rules of this 
section that are applicable to the determination of a shareholder's 
percentage stock ownership interest in a loss corporation (see 
paragraphs (f)(18)(i) through (iii) of this section),

[[Page 674]]

    (ii) A partnership shall be equal to the relative fair market value 
of such person's partnership interest to the total fair market value of 
all outstanding partnership interests, determined without regard to any 
limited and preferred partnership interest that is described in 
paragraph (h)(2)(ii)(C) of this section,
    (iii) A trust shall be determined in accordance with the principles 
of section 318(a)(2)(B) for determining the constructive ownership of 
stock,
    (iv) An estate shall be determined in accordance with the principles 
of section 318(a)(2)(A) for determining the constructive ownership of 
stock, and
    (v) All other entities shall be determined by reference to the 
person's relative economic interest in the entity, taking into account 
all of the relevant facts and circumstances.
    (g) 5-percent shareholder--(1) In general. Subject to the rules of 
paragraphs (k)(2) and (4) of this section, the term 5-percent 
shareholder means--
    (i) An individual that owns, at any time during the testing period,
    (A) A direct ownership interest in the stock of the loss corporation 
of five percent or more or
    (B) An indirect ownership interest in the stock of the loss 
corporation of five percent or more by virtue of an ownership interest 
in any one first tier entity or higher tier entity,
    (ii) A public group, of either a first tier entity or a higher tier 
entity, identified as a 5-percent shareholder under paragraph 
(j)(1)(iv)(A) or (B) of this section,
    (iii) A public group of the loss corporation identified as a 5-
percent shareholder under paragraph (j)(1)(iv)(C) of this section, and
    (iv) A public group, of the loss corporation, a first tier entity or 
a higher tier entity, identified as a 5-percent shareholder under 
paragraph (j)(2) or (3) of this section. An individual owning five 
percent or more of the stock of the loss corporation at any time during 
the testing period is a 5-percent shareholder notwithstanding that the 
individual may own less than five percent of the stock of the loss 
corporation on the testing date. See paragraph (g)(5)(i)(B) of this 
section for rules permitting a loss corporation to make an adjustment in 
cases described in the preceding sentence.
    (2) Determination of whether a person is a 5-percent shareholder. 
Except as provided in paragraphs (k)(2) and (4) of this section, a 
person shall be treated as constructively owning stock of the loss 
corporation pursuant to paragraph (h)(2) of this section only if the 
loss corporation stock is attributed to such person in the person's 
capacity as a higher tier entity or a 5-percent owner of the first tier 
entity or higher tier entity from which such stock is attributed. See 
paragraph (k)(3) of this section for rules explaining the extent of the 
obligation of the loss corporation to determine the identity of its 5-
percent shareholders. Nothing in this paragraph (g)(2), however, shall 
limit the attribution of loss corporation stock under section 318(a)(2) 
and paragraph (h) of this section to a public owner.
    (3) Determination of the percentage stock ownership interest of a 5-
percent shareholder. Subject to the rules of paragraphs (k)(2) and (4) 
of this section, in determining a 5-percent shareholder's percentage 
ownership interest in the loss corporation, the shareholder's direct 
ownership interest, if any, and each indirect ownership interest that he 
may have in the loss corporation in his capacity as a 5-percent owner of 
any one first tier entity or higher tier entity, if any, are required to 
be added together and taken into account with respect to such 
shareholder only to the extent that each such direct or indirect 
ownership interest constitutes five percent or more of the stock of the 
loss corporation.
    (4) Examples.

    Example 1. (i) Twenty percent of L stock is owned by A, 10 percent 
is owned by P1, 20 percent is owned by E, a joint venture, 
and the remaining 50 percent of L stock is owned by Public L. 
P1 is owned 15 percent by B and 85 percent by Public 
P1. E is owned 30 percent by P2 and 70 percent by 
P3, which, in turn, are owned by Public P2 and 
Public P3, respectively.
    (ii) The ownership structure of L is illustrated by the following 
chart:

[[Page 675]]

[GRAPHIC] [TIFF OMITTED] TC17OC91.002

    (iii) P1 and E, each of which has a direct ownership 
interest in L of five percent or more, are first tier entities. The 
shareholders with direct ownership interests in L who individually own 
less than five percent of L are public shareholders (Public L). B, who 
has a direct ownership interest of five percent or more in 
P1, is a 5-percent owner of P. P2 and 
P3, and P3, each of which has a direct ownership 
interest in a first tier entity (E) of five percent or more, are higher 
tier entities with respect to L and, because neither entity is owned at 
any time during the testing period by a higher tier entity, they also 
are highest tier entities. The shareholders of P2 and 
P3 (Public P2 and Public P3, 
respectively) are public owners of such entities, because none of those 
shareholders own five percent or more of either entity at any time 
during the testing period.
    (iv) A, who has a 20 percent direct ownership interest in L, is a 5-
percent shareholder of L. Because, by application of the constructive 
ownership rules of paragraph (h) of this section, B owns only 1.5 
percent of L stock in his capacity as a 5-percent owner of P1 
(15 percent ownership of P1 x 10 percent ownership of L), B 
is not a 5-percent shareholder of L, even though he is a 5-percent owner 
of P1. Under the rules of paragraph (j) of this section, 
therefore, B is treated as a member of Public P1. See Example 
(3) of paragraph (j)(1)(vi) of this section for a determination of which 
public owners and public shareholders constitute public groups that are 
treated as 5-percent shareholders of L.
    Example 2. (i) The facts are the same as in Example (1), except that 
P3 is owned 60 percent by C, 30 percent by P4, and 
10 percent by Public P3. The stock of P4 is owned 
by a group of persons (Public P4), none of whom own five 
percent or more of the stock of P4.
    (ii) The ownership structure of L is illustrated by the following 
chart:

[[Page 676]]

[GRAPHIC] [TIFF OMITTED] TC17OC91.003

    (iii) The defined terms are the same as in Example (1), except that 
P3 is a higher tier entity, not a highest tier entity, 
because five percent or more of P3 is, in turn, owned by 
another entity (P4). P4, which owns five percent 
or more of a higher tier entity (P3), also is a higher tier 
entity and, because it is not owned at any time during any testing 
period by any entity that is also a higher tier entity, P4 is 
a highest tier entity. All of the shareholders of P4, none of 
which own a direct ownership interest of five percent or more in 
P4, are public owners of P4.
    (iv) C is a 5-percent owner of P3 and, under the 
constructive ownership rules of paragraph (h) of this section, C 
indirectly owns 8.4 percent of L ([60 percent ownership of 
P3] x [70 percent ownership of E] x [20 percent ownership of 
L]), in his capacity as a 5-percent owner of P3. B is a 5-
percent owner of P1 and, under the constructive ownership 
rules of paragraph (h) of his section, B owns 1.5 percent of L ([15 
percent ownership of P1] x [10 percent ownership of L]) in 
his capacity as a 5-percent owner of P1. Therefore, C is a 5-
percent shareholder of L, but B is not a 5-percent shareholder of L, 
even though he is a 5-percent owner of P1. See Example (4) of

[[Page 677]]

paragraph (j)(1)(vi) of this section for a determination of which public 
owners and public shareholders constitute public groups that are treated 
as separate 5-percent shareholders of L.
    Example 3. (i) L is owned 30 percent by A and 70 percent by P. A 
owns six percent of P stock and the balance (94 percent) is owned 
equally by 500 unrelated shareholders (``Public P'').
    (ii) A is a 5-percent shareholder because he directly owns 30 
percent of L. Even though A is a 5-percent owner of P, A's 4.2 percent 
indirect ownership interest in L (six percent ownership interest in P x 
P's 70 percent ownership of L) is generally not taken into account in 
determining A's ownership interest, because such indirect ownership 
interest is less than five percent. Instead, A's 4.2 percent indirect 
interest is treated under paragraph (j)(1)(iv) of this section as owned 
by Public P. If, however, L has actual knowledge of A's less-than-five-
percent indirect ownership interest in L and is thus subject to 
paragraph (k)(2) of this section, or paragraph (k)(4) of this section 
otherwise applies, L must take A's total 34.2 percent ownership interest 
into account in determining A's percentage ownership in L.
    Example 4. The facts are the same as in Example (3), except that A 
owns ten percent of P's stock. Because A's indirect ownership interest 
in L in his capacity as a 5-percent owner of P is five percent or more, 
both A's 30 percent direct ownership interest in L and his seven percent 
indirect ownership interest in L (10 percent ownership interest in P x 
P's 70 percent ownership of L) are taken into account in determining his 
ownership interest in L, without regard to L's actual knowledge or 
whether paragraph (k)(4) of this section applies.
    Example 5. See Sec. 1.382-3(a)(1)(ii) for additional examples with 
respect to the definition of an entity.

    (5) Stock ownership presumptions in connection with certain 
acquisitions, and dispositions of loss corporation stock--(i) In 
general. For purposes of this section--
    (A) If an individual owns less than five percent of the stock of a 
loss corporation during the testing period (excluding the testing date) 
and acquires an amount of such stock so that the individual becomes a 5-
percent shareholder on the testing date, the loss corporation may treat 
any interest in the loss corporation owned by such individual prior to 
that acquisition as owned by a public group during the period of such 
individual's ownership of that interest and as not owned by the 5-
percent shareholder during the same period, and
    (B) If a 5-percent shareholder's percentage ownership interest in 
the loss corporation is reduced to less than five percent, the loss 
corporation may presume that the remaining stock owned by such 5-percent 
shareholder immediately after such reduction is the stock owned by such 
shareholder for each subsequent testing date having a testing period 
that includes the date on which the reduction occurred as long as such 
shareholder continues to own less than five percent of the stock of the 
loss corporation. In that event, such ownership interest shall be 
treated as owned by a separate public group for purposes of the rules of 
paragraph (j)(2)(vi) of this section.
    (ii) Example.

    Example. L has 100,000 shares of stock outstanding. All of the L 
stock is owned equally by 40 unrelated, individual shareholders, 
including A (who owns 2.5 percent of L stock). Because no person owns as 
much as five percent of L stock, Public L is the only 5-percent 
shareholder of L. See paragraph (j)(1) of this section. A purchases 
5,000 shares of L stock over a public stock exchange on June 8, 1989. 
The purchase is an owner shift. When added to his ownership interest 
before that date (the testing date), A owns 7,500 shares of L stock (7.5 
percent). Under paragraph (g)(5)(i)(A) of this section, L may treat A 
and Public L as having owned 0 percent and 100 percent, respectively, at 
all times prior to June 8, 1989 (rather than having owned 2.5 percent by 
A and 97.5 percent by Public L, even if L has actual knowledge of A's 
less than five percent ownership interest). The increase in A's stock 
ownership of L as of June 8, 1989 thus would be 7.5 percentage points, 
rather than 5.0 percentage points, for purposes of determining whether 
an ownership change occurs on that testing date and any subsequent 
testing date.

    (h) Constructive ownership of stock--(1) In general. Subject to 
certain modifications set forth in this section and section 382(l)(3), 
the constructive ownership rules of section 318(a) generally apply for 
purposes of determining ownership of loss corporation stock.
    (2) Attribution from corporations, partnerships, estates and 
trusts--(i) In general. Stock owned (directly or indirectly) by an 
entity shall be attributed to its owners--

[[Page 678]]

    (A) Except as otherwise provided in this section, by treating the 
stock attributed pursuant to section 318(a)(2) as no longer being owned 
by the entity from which it is attributed, and
    (B) If attribution is from a corporation, without regard to the 50 
percent stock ownership limitation contained in section 318(a)(2)(C).
    (ii) Limitation on attribution from entities with respect to certain 
interests. Section 318(a)(2) shall not apply to treat the stock of the 
loss corporation that is owned directly by a first tier entity (or 
indirectly by any higher tier entity) as being indirectly owned by any 
person that has an ownership interest in the first tier entity (or any 
higher tier entity) to the extent that such interest is (or is 
attributable to)--
    (A) Stock of any such entity that is described in section 
1504(a)(4),
    (B) Any ownership interest in any such entity that does not 
constitute stock under paragraph (f)(18)(ii) of this section, or
    (C) If the entity is not a corporation, any ownership interest in 
any such entity that has characteristics similar to the interests 
described in paragraph (h)(2)(ii)(A) or (B) of this section.

The ownership interests described in this paragraph (h)(2)(ii) shall not 
be taken into account in determining a person's percentage ownership 
interest in an entity under paragraph (f)(24) of this section.
    (iii) Limitation on attribution from certain entities. For purposes 
of this section, except as provided in paragraphs (k)(2) and (4) of this 
section, each of the following shall be treated as an individual who is 
unrelated to any other owner (direct or indirect) of the loss 
corporation--
    (A) Any entity other than a higher tier entity that owns five 
percent or more of the loss corporation stock (determined without regard 
to paragraph (h)(2)(i)(A) of this section) on a testing date, a first 
tier entity or the loss corporation,
    (B) A qualified trust described in section 401(a),
    (C) Any State, any possession of the United States, the District of 
Columbia, the United States (or any agency or instrumentality thereof), 
any foreign government, or any political subdivision of any of the 
foregoing, and
    (D) Any other person designated by the Internal Revenue Service in 
the Internal Revenue Bulletin.

Stock of a loss corporation that is owned by any such person shall thus 
not be attributed to any other person for purposes of this section. See 
paragraph (g)(2) of this section limiting attribution from a first tier 
entity or a higher tier entity to any person that is not a 5-percent 
owner or a higher tier entity.
    (iv) Examples.

    Example 1. All the stock of L is owned by A. B and C respectively 
own 70 and 30 percent of the outstanding P stock. P acquires 60 percent 
of the outstanding L stock from A on July 1, 1988 (a testing date). 
After the acquisition, P is a first tier entity and a higher tier entity 
of L. B and C are each 5-percent owners of P and also are 5-percent 
shareholders of L having a 42 percent and 18 percent stock ownership 
interest in L, respectively, through the operation of the constructive 
ownership rules of paragraph (h) of this section. Because B and C 
together have increased their ownership in L by more than 50 percentage 
points during the testing period ending on the testing date (60 percent 
on the testing date and 0 percent prior thereto), an ownership change 
occurs with respect to L on July 1, 1988.
    Example 2. The facts are the same as in Example (1), except that B 
and C are not shareholders in a corporation, but instead are partners in 
a general partnership, E. B and C respectively own 70 percent and 30 
percent of E. E acquires 60 percent of the L stock on July 1, 1988. The 
results are the same as in Example (1).
    Example 3. The facts are the same as in Example (1), except that the 
acquisition is accomplished in a transaction that qualifies under 
section 351(a). In that transaction, HC is formed through (i) a 
contribution of money by P in exchange for 60 shares of HC common stock 
and (ii) a contribution of all the outstanding shares of L stock plus 
cash by A in exchange for 40 shares of HC common stock and 30 shares of 
HC preferred stock that is described in section 1504(a)(4). The 
respective values of each share of HC stock, common and preferred, are 
equal. The stock of L is attributed to A through his interest in HC 
common stock, but not through his interest in HC preferred stock (see 
paragraph (h)(2)(ii)(A) of this section). Thus, A is treated as owning 
indirectly only 40 percent of L. B and C are 5-percent shareholders of L 
having indirect ownership interests in L of 42 percent and 18 percent, 
respectively, through their ownership of HC common stock. The

[[Page 679]]

results are therefore the same as in Example (1).

    (3) Attribution to corporations, partnerships, estates and trusts. 
Except as otherwise provided by regulation under section 382 or by the 
Internal Revenue Service in the Internal Revenue Bulletin, the rules of 
section 318(a)(3) shall not apply in determining the ownership of stock 
under this section.
    (4) Option attribution--(i) In general. Solely for the purpose of 
determining whether there is an ownership change on any testing date, 
stock of the loss corporation that is subject to an option shall be 
treated as acquired on any such date, pursuant to an exercise of the 
option by its owner on that date, if such deemed exercise would result 
in an ownership change. The preceding sentence shall be applied 
separately with respect to--
    (A) Each class of options (i.e., options with terms that are 
identical, issued by the same issuer, and issued on the same date) owned 
by each 5-percent shareholder (or person who would be a 5-percent 
shareholder if the option were treated as exercised), and
    (B) Each 5-percent shareholder, each owner of an option who would be 
a 5-percent shareholder if the option were treated as exercised, and 
each combination of such persons.
    (ii) Examples.

    Example 1. (i) A owns all of the 100 shares of outstanding L stock. 
A grants options for the purchase of his L stock, exercisable for 10 
years from the date of issuance, in the following transactions: An 
option to B for four shares (issued January 1, 1988), an option to C for 
six shares (issued June 1, 1989), and an option to D for 15 shares 
(issued July 30, 1989). On July 30, 1990, A sells 41 shares of his L 
stock to BB.
    (ii) Pursuant to paragraph (a)(2)(i) of this section, the date on 
which each option is acquired is a testing date. The issuance of options 
to acquire L stock to each of B, C, and D is not treated as an 
acquisition of the underlying stock on any such testing date since such 
treatment with respect to any one of the option owners (or any 
combination thereof) would not have resulted in an ownership change on 
any of those testing dates.
    (iii) The date on which BB acquires 41 shares also is a testing 
date. BB's acquisition of 41 percent of the L stock, taken together with 
the shift in ownership that would result if the options held by B, C and 
D were exercised, would result in an ownership change, because the stock 
owned or treated as owned by Public L (a group including only B, the 
sole shareholder who owns less than five percent of L stock), C, D and 
BB would have increased by 66 percentage points (four, six, 15, and 41 
percentage points, respectively) during the testing period. Subject to 
paragraph (h)(4)(ix) of this section, the options are treated as 
exercised and an ownership change occurs on July 30, 1990, pursuant to 
paragraph (h)(4)(i) of this section. Accordingly, no new testing period 
can begin before July 31, 1990. Under paragraph (h)(4)(x)(F) of this 
section, the option attribution rules of paragraph (h)(4)(i) of this 
section shall not be applicable with respect to any of the options owned 
by B, C, and D immediately before the ownership change until such time, 
if any, that such options are transferred to (or by) 5-percent 
shareholder (or a person who would be a 5-percent shareholder if such 
option were exercised). In addition, the subsequent exercise of any of 
those options by A, B, or C (the persons owning such options immediately 
before the ownership change) is disregarded. See paragraph (h)(4)(vi) of 
this section. Also see paragraph (h)(4)(viii) of this section for the 
treatment of options that lapse or are forfeited.
    (iv) The facts are the same as in (i), except that the sale of A's 
41 shares of L stock to BB occurs on July 30, 1995. Because the options 
are treated as exercised and the related stock is treated as acquired on 
the July 30, 1995 testing date, the results are the same as described in 
(iii).
    Example 2. (i) A owns all of the outstanding 100 shares of the stock 
of L. On July 22, 1988, the value of A's stock in L is $500 and the 
following agreements are entered into: (i) A sells 40 shares of his L 
stock to B for $200, (ii) in exchange for $10, A grants B an option to 
acquire the balance of his L stock for $305 at any time before July 22, 
1992, and (iii) L grants A an option to acquire 100 shares of L stock at 
a price of $600 exercisable until such time as B's option is no longer 
outstanding.
    (ii) If the stock subject to the options owned by both A and B were 
treated as acquired on the July 22, 1988 testing date, B would have 
increased his ownership interest in L by only 50 percentage points to 50 
percent ([40 shares purchased + 60 shares acquired pursuant to the 
option]/200 outstanding shares of L stock, including 100 shares deemed 
outstanding pursuant to the option issued to A by L) as compared with 0 
percent prior to July 22, 1988. In determining whether the options with 
respect to the stock of L would, if exercised, result in an ownership 
change, paragraph (h)(4)(i)(B) of this section requires that such 
options be treated as exercised separately with respect to each 5-
percent shareholder, each person who would be a 5-percent shareholder if 
the option were treated as exercised or each combination of such 
persons. Therefore, by

[[Page 680]]

treating the option owned by A as not having been exercised and the 
option owned by B as having been exercised, B's interest in L increases 
by 100 percentage points during the testing period. An ownership change 
with respect to L therefore results from the transactions occurring on 
July 22, 1988.

    (iii) Contingencies. Except as provided in paragraph (h)(4)(x)(D) of 
this section, the extent to which an option is contingent or otherwise 
not currently exercisable shall be disregarded for purposes of this 
section.
    (iv) Series of options. For purposes of this section, an option to 
acquire an option with respect to the stock of the loss corporation, and 
each one of a series of such options, shall be considered as an option 
to acquire such stock.
    (v) Interests that are similar to options. For purposes of this 
section,
    (A) An interest that is similar to an option includes, but is not 
limited to, a warrant, a convertible debt instrument, an instrument 
other than debt that is convertible into stock, a put, a stock interest 
subject to risk of forfeiture, and a contract to acquire or sell stock, 
and
    (B) Any such interest shall be treated as an option.
    (vi) Actual exercise of options--(A) In general. The actual exercise 
of any option in existence immediately before and after an ownership 
change, whether or not the option was treated as exercised in connection 
with the ownership change under paragraph (h)(4)(i) of this section, 
shall be disregarded for purposes of this section, but only if the 
option is exercised by the 5-percent shareholder (or person who would 
have been a 5-percent shareholder if the options owned by such person 
had been exercised immediately before the ownership change) who owned 
the option immediately before and after such ownership change.
    (B) Actual exercise within 120 days of deemed exercise. If the 
actual exercise of an option occurs on or before the end of the period 
which is 120 days after the date on which the option is treated as 
exercised under paragraph (h)(4)(i) of this section, the loss 
corporation may elect to treat paragraphs (h)(4)(i) and (vi)(A) of this 
section as not applying to such option and take into account only the 
acquisition of loss corporation stock resulting from the actual exercise 
of the option. An election under this paragraph (h)(4)(vi)(B) shall have 
no effect on the determination of whether an ownership change occurs, 
but shall apply only for the purpose of determining the date on which 
the change date occurs. An election under this paragraph (h)(4)(vi)(B) 
shall be made in the statement described in Sec. 1.382-11(a).
    (vii) Effect of deemed exercise of options on the outstanding stock 
of the loss corporation--(A) Right or obligation to issue stock. Solely 
for purposes of determining whether an ownership change has occurred 
under paragraph (h)(4)(i) of this section, the deemed exercise of an 
option with respect to unissued stock (or treasury stock) of a 
corporation shall result in a corresponding increase in the amount of 
its total outstanding stock.
    (B) Right or obligation to acquire outstanding stock by the loss 
corporation. Solely for purposes of determining whether an ownership 
change has occurred under paragraph (h)(4)(i) of this section, the 
deemed exercise of a right to transfer outstanding stock to the issuing 
corporation (or a right of the issuing corporation to acquire its stock) 
shall result in a corresponding decrease in the amount of its total 
outstanding stock.
    (C) Effect on value of old loss corporation. The deemed exercise of 
an option with respect to unissued stock (or treasury stock) under 
paragraph (h)(4)(i) of this section shall have no effect on the 
determination of the value of the old loss corporation and the 
computation of the section 382 limitation. See section 382(l)(1)(B) 
disregarding capital contributions made during the two-year period 
preceding the change date for purposes of computing the section 382 
limitation.
    (viii) Options that lapse or are forfeited. If an option that is 
treated as exercised under paragraph (h)(4)(i) of this section lapses 
unexercised or the owner of such option irrevocably forfeits his right 
to acquire stock pursuant to the option, the option shall be treated for 
purposes of this section as if it never had been issued. In that case, 
the loss corporation may file an amended return for prior years (subject 
to any applicable statute of limitations) if the

[[Page 681]]

section 382 limitation was thus inapplicable. If paragraph (h)(4)(i) of 
this section applied to an option (or options) with respect to a taxable 
year for which an income tax return has not been filed by the date that 
the option (or options) lapses or is irrevocably forfeited, the loss 
corporation may treat paragraph (h)(4)(i) of this section as 
inapplicable to such option (or options).
    (ix) Option rule inapplicable if pre-change losses are de minimis. 
Paragraph (h)(4)(i) of this section shall not apply to treat the stock 
of the loss corporation as acquired by the owner of an option if, on a 
testing date, the amount of pre-change losses (determined as if the 
testing date were a change date and treating the amount of any net 
unrealized built-in loss as a pre-change loss) is less than twice the 
amount determined by multiplying.
    (A) The value of the loss corporation (as determined under section 
382(e)) on the testing date, by
    (B) The long-term tax exempt rate (as defined in section 382(f)) for 
the calendar month in which the testing date occurs.
    (x) Options not subject to attribution. Paragraph (h)(4)(i) of this 
section shall not apply to--
    (A) Long-held options with respect to actively traded stock. Any 
option with respect to stock of the loss corporation which stock is 
actively traded on an established securities market (within the meaning 
of section 1273(b)) for which market quotations are readily available, 
if such option has been continuously owned by the same 5-percent 
shareholder (or a person who would be a 5-percent shareholder if such 
option were exercised) for at least three years, but only until the 
earlier of such time as--
    (1) The option is transferred by or to a 5-percent shareholder (or a 
person who would be a 5-percent shareholder if such option were 
exercised), or
    (2) The fair market value of the stock that is subject to the option 
exceeds the exercise price for such stock on the testing date. For 
purposes of this paragraph (h)(4)(x)(A), options with respect to the 
stock of a loss corporation that are assumed (or substituted) in a 
reorganization and converted into options with respect to the stock of 
another party to the reorganization shall not be treated as transferred, 
provided that there are no changes in the terms of the options, other 
than that the stock that may be acquired pursuant to the option is that 
of another party to the reorganization and that the amount of stock 
subject to the option is adjusted only to reflect the exchange ratio for 
the exchange of stock of the loss corporation in the reorganization.
    (B) Right to receive or obligation to issue a fixed dollar amount of 
value of stock upon maturity of certain debt. Any right to receive or 
obligation to issue stock pursuant to the terms of a debt instrument 
that, in economic terms, is equivalent to nonconvertible debt because 
the right to receive stock of the issuer of a fixed dollar amount is 
based upon the fair market value for such stock determined at or about 
the date the stock is transferred pursuant to such right or obligation 
(i.e., the amount of the stock transferred pursuant to the option is 
equal to a fixed dollar amount, divided by the value of each share of 
such stock at or about the date of the stock transfer). This paragraph 
(h)(4)(x)(B) shall not apply if the method for determining the fair 
market value of the stock of the issuer is intended to or, in fact, 
provides the owner of the debt instrument with a participation in any 
appreciation of any stock of the issuer.
    (C) Right or obligation to redeem stock of the loss corporation. Any 
right or obligation of the loss corporation to redeem any of its stock 
at the time such stock is issued, but only to the extent such stock is 
issued to persons who are not 5-percent shareholders immediately before 
the issuance.
    (D) Options exercisable only upon death, disability or mental 
incompetency. Any option entered into between owners of the same entity 
(or an owner and the entity in which the owner has a direct ownership 
interest) with respect to such owner's ownership interest in the entity 
that is exercisable only upon the death, complete disability or mental 
incompetency of such owner.
    (E) Right to receive or obligation to issue stock as interest or 
dividends. Any right to receive or obligation to issue stock of a 
corporation in payment of interest or dividends by the issuing

[[Page 682]]

corporation. (For an example illustrating this exception, see paragraph 
(j)(2)(iv)(B) of this section.)
    (F) Options outstanding following an ownership change--(1) In 
general. Any option in existence immediately before and after an 
ownership change, whether or not the option was treated as exercised in 
connection with the ownership change under paragraph (h)(4)(i) of this 
section, but only so long as the option continues to be owned by the 5-
percent shareholder (or person who was treated as a 5-percent 
shareholder) who owned the option immediately before and after such 
ownership change.
    (2) Example (i) A, B, C and D own all of the outstanding stock of L. 
A owns 70 shares of L stock and each of B, C and D own 10 shares of L 
stock. On July 12, 1988, L issues warrants to each of its shareholders 
entitling them to acquire an additional 8.5 shares of L stock for each 
share of stock owned.
    (ii) If B, C and D, but not A, each exercise their respective rights 
to acquire an additional 85 shares of L stock (10 shares x 8.5 shares 
that may be acquired for each share owned) on July 12, 1988, their 
combined ownership interest in L on that date would exceed 80 percent 
(255 shares deemed to be acquired + 30 shares actually owned)/355 shares 
outstanding (actual and deemed)). B, C and D thus would increase their 
ownership interest in L by 50.3 percentage points during the testing 
period, causing an ownership change, because, under paragraph 
(h)(4)(i)(B) of this section, the options are treated as exercised if 
the exercise would cause an ownership change.
    (iii) Following the ownership change, paragraph (h)(4)(i) of this 
section applies to prevent A's right to acquire 595 shares of L stock 
(70 shares x 8.5 shares that may be acquired for each share owned) or 
the rights held by B, C, or D, to be treated as exercised on any 
subsequent testing date, except to the extent that those rights are 
transferred. To the extent any of those options are transferred 
following the ownership change, paragraph (h)(4)(i) of this section will 
apply to any such options on the date of the transfer and on any 
subsequent testing date.
    (G) Right to acquire loss corporation stock pursuant to a default 
under a loan agreement. Any right to acquire stock of a corporation by a 
bank (as that term is defined in section 581), an insurance company (as 
that term is defined in Sec. 1.801-3(a)), or a trust qualified under 
section 401(a) solely as the result of a default under a loan agreement 
entered into in the ordinary course of the trade or business of such 
bank, life insurance company or qualified trust.
    (H) Agreement to acquire or sell stock owned by certain shareholders 
upon retirement. Any option entered into between noncorporate owners of 
the same entity (or a noncorporate owner and the entity in which the 
owner has a direct ownership interest) with respect to such owner's 
ownership interest in the entity, but only if each of such owners 
actively participate in the management of the entity's trade or 
business, the option is issued at a time that the loss corporation is 
not a loss corporation and the option is exercisable solely upon the 
retirement of such owner. An option with terms described in both this 
paragraph (h)(4)(x)(H) and in paragraph (h)(4)(x)(D) of this section 
shall also not be subject to paragraph (h)(4)(i) of this section.
    (I) [Reserved]
    (J) Title 11 or similar case. See Sec. 1.382-9(o) which excepts 
certain options created by or under a plan of reorganization in a title 
11 or similar case from the operation of paragraph (h)(4)(i) of this 
section.
    (K)-(Y) [Reserved]
    (xi) Certain transfers of options disregarded. Transfers of options 
between persons who are not 5-percent shareholders (and between members 
of separate public groups resulting from the application of the 
segregation rules of paragraphs (j)(2) and (3)(iii) of this section) are 
not taken into account. Transfers of options in any of the circumstances 
described in section 382(l)(3)(B) are also disregarded and the 
transferee shall be treated as having owned the option for the period 
that it was owned by the transferor.
    (xii) Exercise of an option that has not been treated as stock. The 
acquisition of stock pursuant to the actual exercise of an option (other 
than an option described in paragraph (h)(4)(vi)(A) of this section) 
shall not be disregarded.

[[Page 683]]

    (xiii) Effective date. See paragraph (m)(4)(vi) of this section for 
special rules regarding the effective date of the provisions of this 
paragraph (h)(4).
    (5) Stock transferred under certain agreements. Notwithstanding 
paragraph (h)(4) of this section, no shift results solely because under 
section 1058(a)--
    (i) A shareholder transfers stock of a corporation pursuant to an 
agreement that meets the requirements of section 1058(b), or
    (ii) A person having rights under such an agreement exchanges those 
rights for stock identical to the stock transferred pursuant to the 
agreement.
    (6) Family attribution. For purposes of this section--
    (i) Paragraphs (1) and (5)(B) of section 318(a) shall not apply,
    (ii) An individual and all members of his family described in 
section 318(a)(1) shall be treated as one individual,
    (iii) Subject to paragraph (k)(2) of this section, paragraph 
(h)(6)(ii) of this section shall not apply to members of a family who, 
without regard to that paragraph (h)(6)(ii), would not be 5-percent 
shareholders, and
    (iv) If under paragraph (h)(6)(ii) of this section, an individual 
may be treated as a member of more than one family, and each family that 
is treated as one individual is a 5-percent shareholder (or would be 
treated as a 5-percent shareholder if such individual were treated as a 
member of such family), then such individual shall be treated only as a 
member of the family that results in the smallest increase in the total 
percentage stock ownership of the 5-percent shareholders on the testing 
date and shall not be treated as the member of any other family.
    (i) [Reserved]
    (j) Aggregation and segregation rules. For purposes of this section, 
except as provided in paragraphs (k)(2) and (4) of this section--
    (1) Aggregation of public shareholders and public owners into public 
groups--(i) Public group. Under this paragraph (j), a loss corporation 
or other entity can be treated as owned, in whole or in part, by one or 
more public groups. A public group can include public shareholders, 
public owners, and 5-percent owners who are not 5-percent shareholders 
of the loss corporation.
    (ii) Treatment of a public group that is a 5-percent shareholder. 
Each public group that is treated as a 5-percent shareholder under 
paragraph (g)(1)(ii), (iii) or (iv) of this section shall be treated as 
one individual. See paragraph (j)(2)(iv) for a rule combining certain de 
minimis public groups.
    (iii) Presumption of no cross-ownership. The public owners, 5-
percent owners who are not 5-percent shareholders and public 
shareholders in any public group, subject to paragraphs (j)(2)(iii), 
(k)(2) and (k)(4) of this section, are presumed not to be members of any 
other public group. It also is presumed that each such person is 
unrelated to all other shareholders (direct and indirect) of the loss 
corporation. See paragraph (h)(6)(iii) of this section. The members of a 
public group that exists by virtue of its direct ownership interest in 
an entity are presumed not to be members (and not to be related to a 
member) of any other public group that exists at any time by virtue of 
its direct ownership interest in any other entity. To the extent that 
the presumptions adopted in this paragraph (j)(1)(iii) are not 
applicable because the loss corporation has actual knowledge of facts to 
the contrary and is thus subject to paragraph (k)(2) of this section, 
public shareholders, public owners and 5-percent owners who are not 5-
percent shareholders may be aggregated into additional public groups.
    (iv) Identification of the public groups treated as 5-percent 
shareholders--(A) Analysis of highest tier entities. The loss 
corporation must identify first tier entities and higher tier entities 
in order to identify any highest tier entities that must be identified 
under paragraph (k)(3) of this section. The loss corporation must then 
identify any 5-percent owners of each such highest tier entity who 
indirectly own, at any time during the testing period, five percent or 
more of the loss corporation through the ownership interest in such 
highest tier entity. Under paragraph (g)(1)(i)(B) of this section, any 
such 5-percent owner is a 5-percent shareholder. See paragraph (k)(3) of 
this section for rules explaining the extent of the obligation of the 
loss corporation

[[Page 684]]

to determine the identity of its shareholders. Each person who has an 
ownership interest in any highest tier entity and who is not treated as 
a 5-percent shareholder (i.e., persons who are public owners or 5-
percent owners who are not 5-percent shareholders) is a member of the 
public group of that highest tier entity. A public group, so identified, 
that indirectly owns five percent or more of the loss corporation on the 
testing date is treated under paragraph (g)(1)(ii) of this section as a 
5-percent shareholder. If the public group so identified owns less than 
five percent of the loss corporation on the testing date, such public 
group is treated as part of the public group of the next lower tier 
entity.
    (B) Analysis of other higher tier entities and first tier entities. 
The analysis and aggregation of public groups described in paragraph 
(j)(1)(iv)(A) of this section is repeated for any next lower tier entity 
and successively for any next lower tier entity of any entity described 
in this paragraph (j)(1)(iv)(B) until applied to each first tier entity.
    (C) Aggregation of the public shareholders. The public shareholders 
are aggregated and, under paragraph (g)(1)(iii) of this section, are 
treated as a public group that is a 5-percent shareholder without regard 
to whether such group, at any time during the testing period, owns five 
percent or more of the loss corporation. For this purpose, if the public 
group of any first tier entity indirectly owns less than five percent of 
the loss corporation on the testing date, and is thus not treated as a 
5-percent shareholder, but is treated as part of the public group of the 
loss corporation under paragraph (j)(1)(iv)(A) or (B) of this section, 
the ownership interest of that group is included in the public group of 
the loss corporation referred to in the preceding sentence.
    (v) Appropriate adjustments. A loss corporation may apply the 
principles of paragraph (g)(5) of this section with respect to--
    (A) Any public group that is treated as a 5-percent shareholder on 
the testing date if such public group, at any time during the testing 
period, was treated as part of the public group of the next lower tier 
entity, or
    (B) Any public group that is treated as part of the public group of 
a next lower tier entity if such public group, at any time during the 
testing period, was part of the public group of a higher tier entity 
that was treated as a 5-percent shareholder and had a direct or indirect 
ownership interest in such lower tier entity.
    (vi) Examples.

    Example 1. (i) All of the stock of L is owned by 1,000 shareholders, 
none of whom own as much as five percent of L stock (``Public L''). All 
of the stock of P is owned by 150,000 shareholders, none of whom own as 
much as five percent of P stock (``Public P''). Between July 12, 1988 
and August 13, 1988, P purchases all of the L stock through a series of 
transactions on the public stock exchange. P's percentage of direct 
stock ownership in L increases from 4.9 percent to five percent on July 
15, 1988, and from 50 percent to 51 percent on July 30, 1988.
    (ii) Before July 15, 1988, P is a public shareholder of L. On and 
after July 15, 1988, P is a first tier entity (and a highest tier 
entity) of L. Accordingly, under the rules of paragraph (j)(1) of this 
section, Public P, on and after July 15, 1988, is treated as a public 
group that is a 5-percent shareholder. Each acquisition by P on and 
after such date affects the percentage of L stock that is owned by 
Public P and thus constitutes an owner shift.
    (iii) Immediately after the transaction on July 30, 1988, P owns 51 
percent of L stock. Under paragraph (j)(1)(iv)(A) of this section, 
Public P thus owns 51 percent of L. Under paragraph (j)(1)(iv)(C) of 
this section, Public L, the public group that includes the public 
shareholders of L, is treated as a 5-percent shareholder that owns 49 
percent of L. Under paragraph (j)(1)(iii) of this section, Public L and 
Public P are presumed not to have any common members and it is also 
presumed that no member of either public group is related to any other 
member of either of the two public groups.
    (iv) Assuming that the presumption provided in paragraph (j)(1)(iii) 
of this section (i.e., that no person owns stock in both P and L) is not 
rebutted to any extent, Public P is treated as a 5-percent shareholder 
whose stock ownership in L, as of the July 30, 1988 testing date, has 
increased by 51 percentage points over its lowest percentage of stock 
ownership in L at any time during the testing period (0 percent prior to 
July 12, 1988). Accordingly, an ownership change with respect to L 
occurs as a result of P's acquisition on July 30, 1988. L is thus a new 
loss corporation and its pre-change losses are subject to limitation 
under section 382.
    Example 2. (i) All of the stock of P is owned by 1,000 unrelated 
shareholders, none of

[[Page 685]]

whom owns as much as five percent of P stock. L1 is a wholly 
owned subsidiary of P. On January 2, 1988, P distributes all of the 
L1 stock pro rata to its shareholders.
    (ii) Prior to the stock distribution, the public owners of P are 
members of a public group (``Public P'') that is treated as a 5-percent 
shareholder owning 100 percent of the stock of L1.
    See paragraph (j)(1)(iv)(A) of this section. Following the stock 
distribution to the P shareholders, L1 is owned by 1,000 
public shareholders that are members of a public group (``Public 
L1'') that is treated as a 5-percent shareholder owning 100 
percent of the stock of L1. See paragraph (j)(1)(iv)(C) of 
this section.
    (iii) Public P and Public L1 are treated as unrelated, 
individual 5-percent shareholders under paragraph (j)(1)(iii) of this 
section. Although the members of one public group are presumed not to be 
members of any other public group under paragraph (j)(1)(iii) of this 
section, L1 has actual knowledge that all of its public 
shareholders immediately following the distribution (Public 
L1) received L1 stock pro rata in respect to the 
outstanding P stock and thus were also members of Public P. Applying 
paragraph (k)(2) of this section, the loss corporation may take into 
account the identity of ownership interests between Public L1 
and Public P to establish that Public L1 did not increase its 
percentage ownership in L1. Accordingly, the transaction 
would not constitute an owner shift.
    Example 3. (i) The facts are the same as in Example 1 of paragraph 
(g)(4) of this section. Thus, 20 percent of L stock is owned by A, 10 
percent is owned by P1, 20 percent is owned by E, a joint 
venture, and the remaining 50 percent of L stock is owned by Public L. 
P1 is owned 15 percent by B and 85 percent by Public 
P1. E is owned 30 percent by P2 and 70 percent by 
P3, which are owned by Public P2 and Public 
P3, respectively. See Example (1)(ii) of paragraph (g)(4) of 
this section for a chart illustrating this ownership structure.
    (ii) The public owners of P2 and P3 (Public 
P2 and Public P3, respectively), are public groups 
that are treated as 5-percent shareholders of L, because each such 
public group indirectly owns five percent or more of L stock (six 
percent by Public P2 [(30 percent ownership of E) x (20 
percent ownership of L)] and 14 percent by Public P3 [(70 
percent ownership of E) x (20 percent ownership of L)]). The public 
owners of P1 (``Public P1''), who indirectly own 
8.5 percent of L stock [(85 percent ownership of P1) x (10 
percent ownership of L)] and B, who indirectly owns 1.5 percent of L and 
is thus included in Public P1 under paragraph (j)(1)(iv)(A) 
of this section, are members of a public group that is treated as a 5-
percent shareholder of L that owns ten percent of L stock. Finally, the 
public group of L (``Public L'') is a 5-percent shareholder that owns 50 
percent of L. Accordingly, A, Public L, Public P1 (including 
B), Public P2, and Public P3 are the only 5-
percent shareholders of L.
    Example 4. (i) The facts are the same as Example 3 above, except 
that P3 is owned 60 percent by C, 30 percent by 
P4, and 10 percent by P3. The stock of 
P4 is publicly traded and is owned by Public P4. 
The facts are thus the same as in Example (2) in paragraph (g)(4) of 
this section. See Example (2)(ii) of paragraph (g)(4) of this section 
for a chart illustrating this ownership structure.
    (ii) The public owners of P4 (a highest tier entity) are 
members of a public group that indirectly owns 4.2 percent of L ([30 
percent ownership of P3] x [70 percent ownership of E] x [20 
percent ownership of L]). For purposes of identifying public groups that 
are 5-.percent shareholders, L is not required to identify P4 
as a highest tier entity under paragraph (k)(3) of this section because 
P4 does not own five percent or more of L stock. Moreover, 
under paragraph (h)(2)(iii) of this section, P4 generally is 
treated as an individual from which there is no attribution of loss 
corporation stock. The public group of P3 (including 
P4) indirectly owns 5.6 percent of L ([40 percent of 
P3] x [70 percent ownership of E] x [20 percent of L]), and 
is thus a 5-percent shareholder of L. The public groups of P2 
and P1 (both Public P1 and B), respectively, also 
own five percent or more of L stock and are thus 5-percent shareholders 
of L. In addition, the public group of L is a 5-percent shareholder 
regardless of whether it owns five percent of L stock. Accordingly, A, 
Public L, Public P3 (including P4), Public 
P2, and Public P1 (including B), are the only 5-
percent shareholders of L.
    Example 5(i) On September 4, 1987, L is owned 14 percent by each of 
A and B, 30 percent by each of P1 and P2, four 
percent by each of C and P3, and two percent by each of D and 
AA. P1 is owned 30 percent by each of A, B, and P4 
and 10 percent by D. P2 is owned 70 percent by A, 10 percent 
by each of B and D, six percent by DD and four percent by C. AA owns 100 
percent of the stock of P3. P4 is owned 60 percent 
by C and 20 percent by each of BB and CC.
    (ii) The ownership structure of L is illustrated by the following 
chart:

[[Page 686]]

[GRAPHIC] [TIFF OMITTED] TC17OC91.004

    (iii) In order to identify L's 5-percent shareholders and their 
respective ownership interests in L on September 4, 1987, the rules of 
paragraph (j)(1) of this section apply to identify the public groups 
that are treated as separate 5-percent shareholders. Analysis begins 
with any highest tier entity, such as P4. Each of 
P4's shareholders is a 5-percent owner of P4. 
C4 owns 5.4 percent of L in his capacity as a 5-percent owner 
of P4 and therefore is a 5-percent shareholder. 
Notwithstanding that C actually owns, directly and by attribution, 10.6 
percent of L (four percent directly, 5.4 percent indirectly through 
P4, and 1.2 percent through P2), C's ownership 
interest in L as a 5-percent shareholder is presumed to include only the 
5.4 percent indirect ownership through P4. (Under paragraphs 
(g) and (k)(2) of this section, however, L must account for C's direct 
and indirect ownership interests in determining whether an ownership 
change occurs on any testing date if it has actual knowledge of such 
ownership on or berfore the date that its income tax return is filed for 
the taxable year that includes the testing date). Although BB and CC are 
each 5-percent owners of P4, they are not 5-percent 
shareholders and therefore are members of the public group of 
P4. Because the public group of P4 indirectly owns 
only 3.6 percent of L, it is treated under paragraph (j)(1)(iv)(A) of 
this section as part of the public group of the next lower tier entity, 
P1.
    (iv) With respect to P1, a first tier entity, each of its 
shareholders are 5-percent owners. Because A and B each indirectly own 
nine percent of L as 5-percent owners of P1 and A indirectly 
owns 21 percent of L as a 5-percent owner of P2, they are 
each 5-percent shareholders without regard to their direct

[[Page 687]]

ownership interests in L. A's ownership interest in L as a 5-percent 
shareholder is 44 percent (14 percent directly, nine percent in his 
capacity as a 5-percent owner of P1, and 21 percent in his 
capacity as a 5-percent owner of P2). B's ownership interest 
in L as a 5-percent shareholder is 23 percent (14 percent directly and 
nine percent in his capacity as a 5-percent and nine percent in his 
capacity as a 5-percent owner of P1). B's ownership interest 
as a 5-percent shareholder does not include the three percent interest 
he owns indirectly through P2. (Under paragraphs (g) and 
(k)(2) of this section, however, L must account for B's direct and 
indirect ownership interests, including his three percent interest 
through P2, in determining whether an ownership change occurs 
on any testing date if L has actual knowledge of such ownership on or 
before the date that its income tax return is filed for the taxable year 
that includes the testing date.) D is a 5-percent owner of 
P1. Although D owns eight percent of L (two percent directly, 
three percent indirectly through P1, and three percent 
indirectly through P2), he is not a 5-percent shareholder 
because he does not own five percent or more of L stock either directly 
or in his capacity as a 5-percent owner of either P1 or 
P2. (Under paragraphs (g) and (k)(2) of this section, 
however, L must account for D's direct and indirect ownership interests 
in determining whether an ownership change occurs on any testing date to 
the extent L has actual knowledge of such ownership amounting to five 
percent or more of L stock before the date that its income tax return is 
filed for the taxable year that includes the testing date.) The public 
group of P1 (comprised of the public group of P4 
and D's direct ownership interest in P1) has a 6.6 percent 
interest in L and is therefore treated as a separate 5-percent 
shareholder.
    (v) With respect to highest tier entity P2, D is a 5-
percent owner who is not a 5-percent shareholder for the reason 
described in the preceding subdivision. DD is a 5-percent owner of 
P2, who is not a 5-percent shareholder, because DD indirectly 
owns only 1.8 percent of L. Assuming that L does not have actual 
knowledge of B's and C's direct ownership interest in P2, 
those interests are accounted for in computing the ownership interest 
are accounted for in computing the ownership interest of the public 
group of P2. Therefore, each of P2's shareholders, 
except A who is a 5-percent shareholder in his capacity as a 5-percent 
owner of P2, are treated as members of the public group of 
P2 that owns nine percent of L and is thus treated as a 
separate 5-percent shareholder.
    (vi) Because the direct ownership interest of P3 is less 
than five percent, it is a public shareholder. Therefore, assuming that 
L does not have actual knowledge of C's, D's, or AA's direct and/or 
indirect ownership interests in L, the public group of L is a separate 
5-percent shareholder owning 12 percent of L (comprised of the direct 
ownership interests of C, D, AA and P3).

    (2) Segregation rules applicable to transactions involving the loss 
corporation--(i) In general. For purposes of this section, if--
    (A) A transaction is described in paragraph (j)(2)(iii) of this 
section, and
    (B) The loss corporation has one or more direct public groups 
immediately before and after the transaction,


the stock owned by such direct public group or groups is subject to the 
segregation rules described in paragraph (j)(2)(iii) of this section for 
purposes of determining whether an ownership change has occurred on the 
date of the transaction (and on any subsequent testing date with a 
testing period that includes the date of such transaction). See 
paragraph (j)(3) of this section for the application of the rules of 
this paragraph (j)(2) to transactions involving first tier entities or 
higher tier entities.
    (ii) Direct public group. For purposes of this section, a direct 
public group is any public group of the loss corporation described in 
paragraph (j)(1)(iv)(C) of this section or any public group of the loss 
corporation resulting from the application of paragraph (j)(2)(iii) or 
(j)(3)(i) of this section.
    (iii) Transactions to which segregation rules apply--(A) In general. 
The segregation rules of this paragraph (j)(2)(iii) apply to any 
transaction described in paragraph (j)(2)(iii)(B), (C), (D), (E), or (F) 
of this section in the manner specified. The presumptions adopted by 
this paragraph (j)(2)(iii) shall not apply only if, and to the extent 
that, the loss corporation either has actual knowledge of facts to the 
contrary regarding its stock ownership and is thus subject to paragraph 
(k)(2) of this section, or is subject to paragraph (k)(4) of this 
section. Any direct public group that is required to be identified as a 
result of a transaction described in paragraph (j)(2)(iii) of this 
section shall be treated as a 5-percent shareholder under paragraph 
(g)(1)(iv) of this section without regard to whether such group, at any 
time during the testing period, owns five percent or more of the loss 
corporation stock. To the extent that the presumptions are rebutted, the 
public

[[Page 688]]

shareholders, public owners and 5-percent owners who are not 5-percent 
shareholders may be aggregated into additional public groups. For an 
exception applicable to certain regulated investment companies, see 
Sec. 1.382-3(k)(1).
    (B) Certain equity structure shifts and transactions to which 
section 1032 applies--(1) In general. In the case of--
    (i) A transaction that is an equity structure shift that also is 
described in section 381(a)(2) and in which the loss corporation is a 
party to the reorganization, or
    (ii) A transfer of the stock of the loss corporation (including 
treasury stock) by the loss corporation in any other transaction to 
which section 1032 applies,

each direct public group that exists immediately after such transaction 
shall be segregated so that each direct public group that existed 
immediately before the transaction is treated separately from the direct 
public group that acquires stock of the loss corporation in the 
transaction. The direct public group that acquires stock of the loss 
corporation in the transaction is presumed not to include any members of 
any direct public group that existed immediately before the transaction. 
For purposes of this paragraph (j)(2)(iii)(B), a person is treated as 
acquiring stock of the loss corporation in a reorganization as the 
result of the person's ownership interest in another corporation that 
succeeds to the loss corporation's pre-change losses (determined as if 
the testing date were the change date and treating the amount of any net 
unrealized built-in loss as a pre-change loss) in a transaction to which 
section 381(a)(2) applies. In determining whether a transaction is 
described in section 1032 for purposes of this paragraph (j)(2)(iii)(B), 
the transfer by the loss corporation of any interest not constituting 
stock that is treated as stock under paragraph (f)(18)(iii) of this 
section shall be treated as the transfer of stock. See Sec. 1.382-3(j) 
for exceptions to the segregation rules of this paragraph 
(j)(2)(iii)(B)(1).
    (2) Examples.

    Example 1. (i) P1 owns 60 percent of the stock of L. The 
remaining L stock (40 percent) is owned by Public L. A owns 40 percent 
of the P1 stock. The remaining P1 stock (60 
percent) is owned by Public P1. P2 is a publicly 
traded corporation owned by shareholders who each own less than five 
percent of P2 stock (Public P2).
    (ii) On May 22, 1988, L merges into P2 in a transaction 
described in section 368(a)(1)(A), with the shareholders of L receiving 
an amount of P2 stock equal to 70 percent of the value of 
P2 immediately after the reorganization.
    (iii) Immediately before the merger, L's 5-percent shareholders were 
Public L (40 percent), Public P1 (36 percent), and A (24 
percent). Although the shareholders of P2 (immediately before 
the merger) do not acquire any stock in the merger, they are treated as 
acquiring a direct ownership interest in the loss corporation in the 
reorganization because P2 succeeds to the pre-change losses 
of L in a transaction to which section 381(a)(2) applies. As a result of 
the merger, which constitutes a transaction described in 
(j)(2)(iii)(B)(1) of this section, L's direct public group, Public L, 
must be segregated from the direct public group that would otherwise 
exist after the transaction (Public L and Public P2). Public 
L, the direct public group that exists before the merger, has a 
continuing 28 percent interest in the loss corporation [70 percent of 
P2 shares received in the merger x 40 percent shares of L 
owned prior to the merger] that must be segregated from the interests 
acquired by Public P2.
    (iv) In addition, Public P1, which owns five percent or 
more of the stock of P2 through P1's ownership 
interest in P2, also is segregated from any other public 
group (i.e., both Public L and Public P2) under paragraph 
(j)(1) of this section. Therefore, under paragraphs (j)(1) and (2) of 
this section, Public P2 (excluding the members of Public L 
and Public P1 immediately before the merger) is treated as a 
separate public group and 5-percent shareholder.
    (v) The only 5-percent shareholder whose interest in the loss 
corporation, P2, has increased during the testing period is 
Public P2. Its interest has increased by 30 percentage 
points. Accordingly, no ownership change results from the merger. For 
purposes of measuring the shift in ownership of P2 on any 
subsequent testing date with a testing period that includes May 22, 1988 
(the date on which L merged into P2), Public P2 
will continue to be treated as a direct public group, separate from 
Public L (the members of which own P2 stock as a result of 
the merger) and Public P1.
    Example 2. (i) P and L are each owned by 21 equal shareholders. Each 
of 14 of the shareholders of P and L are owners of both corporations 
(``common owners''). L has actual knowledge of this cross ownership. 
therefore, as a group, these persons own 66\2/3\ percent of each of P 
and L. P stock has a value of $600 and L stock has a value of $400.

[[Page 689]]

    (ii) P merges into L under section 368(a)(1)(A) on June 10, 1988. 
Ordinarily, the direct public group of L that exists immediately before 
the transaction would be segregated from the direct public group that 
acquires stock in the merger (the public group of P immediately before 
the merger). In view of the common ownership of P and L, however, a 
third group may be created under paragraph (j)(2)(iii)(A) of this 
section so that L's owners following the merger would be: The common 
owners (66\2/3\ percent), Public L, less the common owners, 13\1/3\ 
percent), and Public P, less the common owners (20 percent). 
Accordingly, the only 5-percent shareholder increasing its ownership 
interest by 20 percentage points and no ownership change occurs as a 
result of the merger.
    Example 3. (i) L is entirely owned by Public L. L commences and 
completes a public offering of common stock on January 22, 1988, with 
the result that its outstanding stock increases from 100,000 shares to 
300,000 shares. No person owns as much as five percent of L stock 
following the public offering.
    (ii) The public offering of L stock is a transaction to which 
section 1032 applies. Immediately before the public offering, L's only 
5-percent shareholder was Public L, a direct public group. Therefore, 
Public L (as in existence immediately before the transaction) must be 
segregated from the direct public group that would otherwise exist 
immediately after the transaction. Under paragraph (j)(2)(iii)(B)(1) of 
this section, the acquisition of 200,000 shares of L stock in the public 
offering must be treated as acquired by a direct public group (``New 
Public L'') that is separate from Public L. Each such public group is 
treated as an individual that is a separate 5-percent shareholder. See 
paragraphs (g)(1)(iv) and (j)(1)(ii) of this section.
    (iii) As a result of the public offering, L has two 5-percent 
shareholders, Public L and New Public L, which own 33\1/3\ percent and 
66\2/3\ percent of the stock of L, respectively. Because the members of 
New Public L are presumed not to be members of Public L (and not to be 
related to any such members), the ownership interest of New Public L 
immediately prior to the offering of stock was 0 percent.
    (iv) New Public L is a 5-percent shareholder that has increased its 
ownership interest in L by more than 50 percentage points during the 
testing period (by 66\2/3\ percentage points). Thus, there is an 
ownership change with respect to L. For purposes of subsequent 
transactions, Public L and New Public L will not be segregated into two 
public groups because a new testing period commences on the day 
following the change date, January 23, 1988 (i.e., any subsequent 
testing date will not have a testing period that includes the date of 
the public offering).
    Example 4. The facts are the same as in Example 3, but L establishes 
that 60,000 shares of the newly issued L stock were acquired by its 
shareholders of record on the date of the stock issuance (i.e., members 
of Public L, referred to as Acquiring Public L) by persons owning 27 
percent of the L stock immediately before the stock issuance. 
Accordingly, L has actual knowledge that New Public L acquired no more 
than 140,000 shares of L stock in the public offering. Under paragraphs 
(j)(2)(iii) and (k)(2) of this section, New Public L may be treated as 
having increased its ownership interest in L by 46\2/3\ percentage 
points (140,000 shares acquired in the offering/300,000 shares 
outstanding). L also has actual knowledge that the members of Public L 
owning 27 percent of L stock immediately before the stock issuance 
(27,000 shares/100,000 shares outstanding) own 29 percent of L stock 
immediately after such issuance ([27,000 shares + 60,000 shares acquired 
in the offering]/300,000 shares outstanding). Assuming that L chooses to 
take its actual knowledge into account for purposes of determining 
whether an ownership change occurred on January 22, 1988, Public L is 
segregated into two direct public groups immediately before the stock 
issuance so that the two percentage point increase in the ownership 
interest in L by Acquiring Public L is taken into account. The total 
increased ownership interest in L by New Public L and Acquiring Public L 
on the testing date over their lowest ownership interest during the 
testing period is 48\2/3\ percent. Thus, no ownership change occurs with 
respect to L.
    Example 5. (i) L is owned entirely by 10,000 unrelated individuals, 
none of whom own as much as five percent of L stock (``Public L''). P is 
owned entirely by 1,500 unrelated individuals, none of whom own as much 
as five percent of P stock (``Public P''). On December 22, 1988, L 
acquires all of the P stock from Public P in exchange for L stock 
representing 25 percent of the value of L, in a transaction described in 
section 368(a)(1)(B).
    (ii) Under paragraph (j)(2)(iii)(B)(1) of this section, Public L, 
the direct public group that owns L stock immediately before and after 
the transaction to which section 1032 applies, is treated separately 
from Public P, the direct public group that acquires L stock in the 
transaction. Because Public P's percentage ownership interest in L 
increases to only 25 percent (as compared with 0 percent before the 
acquisition), no ownership change occurs. For purposes of determining 
whether an ownership change occurs on any testing date with a testing 
period that includes December 22, 1988, Public L and Public P will 
continue to be treated as separate 5-percent shareholders.
    (iii) See Example (4) in paragraph (j)(3)(iv) of this section for 
the application of paragraph (j)(2)(iii)(B) of this section to a 
reorganization under section 368(a)(1)(B) in which the loss corporation 
is acquired.


[[Page 690]]


    (C) Redemption-type transactions--(1) In general. In the case of a 
transaction in which the loss corporation acquires its stock in exchange 
for property, each direct public group that exists immediately before 
the transaction shall be segregated at that time (and thereafter) so 
that the stock that is acquired in the transaction is treated as owned 
by a separate public group from each public group that owns the stock 
that is not acquired. For purposes of the preceding sentence, the term 
property shall include stock described in section 1504(a)(4) and stock 
described in paragraph (f)(18)(ii) of this section. Each direct public 
group that owned the stock that is acquired in the transaction is 
presumed not to own any such stock immediately after the transaction.

    (2) Examples.

    Example 1. L is entirely owned by Public L. There are 500,000 shares 
of L stock outstanding. On July 12, 1988, L acquires 150,000 shares of 
its stock for cash. Because L's acquisition is a redemption, Public L is 
segregated into two different public groups immediately before the 
transaction (and thereafter) so that the redeemed interests (``Public 
RL'') are treated as part of a public group that is separate from the 
ownership interests that are not redeemed (``Public CL''). Therefore, as 
a result of the redemption, Public CL's interest in L increases by 30 
percentage points (from 70 percent (350,000/500,000) to 100 percent) on 
the July 12, 1988 testing date. Because the resulting increase is not 
more than 50 percentage points, no ownership change occurs. For purposes 
of determining whether an ownership change occurs on any subsequent 
testing date having a testing period that includes such redemption, 
Public CL is treated as a 5-percent shareholder whose percentage 
ownership interests in L increased by 30 percentage points as a result 
of the redemption.
    Example 2. L is entirely owned by Public L. There are 250,000 shares 
of L common stock outstanding. On April 22, 1988, L acquires 100,000 
shares of its outstanding common stock in exchange for 100,000 shares of 
preferred stock described in section 1504(a)(4). (The transaction thus 
constitutes a recapitalization within the meaning of section 
368(a)(1)(E).) As a result of the recapitalization, which is a 
transaction described in paragraph (j)(2)(iii)(C) of this section, 
Public L is segregated into two different public groups immediately 
before the transaction (and thereafter) so that the stock acquired by L 
is treated as owned by a public group (``Public RL'') that is separate 
from the public group that owns the stock that is not so acquired 
(``Public CL''). Therefore, as a result of the transaction, Public CL's 
interest in L increases by 40 percentage points (from 60 percent to 100 
percent). Because the resulting increase is not more than 50 percentage 
points, no ownership change occurs. For purposes of determining whether 
an ownership change occurs on any subsequent testing date with a testing 
period that includes the date of the recapitalization, Public CL is 
treated as a separate 5-percent shareholder whose percentage ownership 
interest increased by 40 percentage points as a result of the redemption 
type transaction.

    (D) Acquisition of loss corporation stock as the result of the 
ownership of a right to acquire stock--(1) In general. In the case of a 
deemed acquisition of stock of the loss corporation as the result of the 
ownership of a right issued by the loss corporation to acquire such 
stock (see paragraph (h)(4) of this section), each direct public group 
that exists immediately after such acquisition shall be segregated so 
that each direct public group that existed immediately before the 
transaction is treated separately from the direct public group that is 
deemed to acquire stock of the loss corporation as a result of the 
ownership of the right to acquire such stock. The direct public group 
that is treated as acquiring stock of the loss corporation in the 
transaction is presumed not to include any members of any direct public 
group that existed immediately before the transaction. In applying the 
rules of paragraph (h)(4) of this section, the segregation rules of this 
paragraph (j)(2)(iii)(D) shall apply before making the determination 
required under that paragraph (h)(4) of this section. See Sec. 1.382-
3(j)(9) for rules relating to this paragraph (j)(2)(iii)(D).
    (2) Example.

    Example. (i) L has 700,000 shares of common stock outstanding. 
Public L owns all of the outstanding L common stock. On May 20, 1988, L 
issues a class of debentures to the public that, in the aggregate, may 
be converted into 300,000 shares of L common stock. On September 7, 
1988, P1 acquires 210,000 shares of L common stock over a 
public stock exchange. None of the L debentures have been converted as 
of that date.
    (ii) By virtue of L's issuance of convertible debentures, May 20, 
1988 is a testing date. See paragraph (a)(2)(i) of this section. 
Immediately before the issuance of the convertible debentures, L's only 
5-percent shareholder

[[Page 691]]

was Public L, a direct public group. Therefore, under paragraph 
(j)(2)(iii)(D) of this section, Public L must be segregated from the 
direct public group that would otherwise exist immediately after the 
transaction for the purpose of applying paragraph (h)(4) of this 
section, so that any acquisition of L stock through the conversion of 
L's debentures is treated as made by a public group other than Public L 
(``New Public L''). Assuming the largest increase in the total 
percentage stock ownership of New Public L on the testing date (see 
paragraph (h)(4) of this section), New Public L would have increased its 
ownership interest in L by 30 percentage points. Therefore, the stock of 
L would not be treated as acquired pursuant to a deemed conversion of 
the L debentures on May 20, 1988, under paragraph (h)(4) of this 
section, because the conversion would not cause an ownership change.
    (iii) P1's acquisition of L common stock results in 
second testing date. For the purpose of applying paragraph (h)(4) of 
this section, Public L must again be segregated from the direct public 
group that would otherwise result from conversion of the debentures, so 
that a deemed acquisition of L stock through the conversion of L's 
debentures on September 7, 1988 is treated as made by a public group 
other than Public L (``New Public L''). As on the previous testing date, 
New Public L would have increased its ownership interest in L by 30 
percentage points if it were treated as having acquired L common stock 
pursuant to the conversion of the L debentures. The increase in New 
Public L's ownership, taken together with P1's 21 percentage 
point ownership increase in L during the testing period [210,000 shares 
deemed converted/(700,000 (actual) + 300,000 (deemed) shares 
outstanding)], results in an ownership change.

    (E) Transactions identified in the Internal Revenue Bulletin. Any 
transaction that is designated by the International Revenue Service in 
the Internal Revenue Bulletin shall be subject to the rules, as provided 
in such bulletin, similar to the rules described in this paragraph 
(j)(2)(iii).
    (F) Issuance of rights to acquire loss corporation stock--(1) In 
general. In the case of any transaction that is described in paragraph 
(j)(2)(iii)(B), (D) or (E) of this section in which the loss corporation 
issues rights to acquire its stock to the members of more than one 
public group, those rights shall be presumed to be exercised pro rata by 
each such public group as those rights are actually exercised. See Sec. 
1.382-3(j)(10) for an exception to the application of the rule of this 
paragraph (j)(2)(iii)(F)(1) to stock issued on the exercise of a 
transferable option.
    (2) Example.

    Example. (i) L, which has six million shares outstanding, is owned 
entirely by Public L and P is owned entirely by Public P. On November 
30, 1988, P merges into L in a transaction qualifying under section 
368(a)(1)(A) with Public P receiving four million shares of L stock as a 
result of the reorganization. Under paragraph (j)(2)(iii)(B) of this 
section, Public L and Public P continue to be treated as separate public 
groups following the merger. Pursuant to the plan of reorganization, L 
also issues an amount of warrants in L stock pro rata to Public L and 
Public P that, if exercised, would result in the issuance of an 
additional two million shares of L stock. On November 30, 1989, when 
only one-half of the outstanding warrants have been exercised, A 
acquires all of the unexercised warrants.
    (ii) Without regard to the warrants distributed in reorganization, 
Public P's ownership interest in L increases by 40 percentage points on 
November 30, 1988, relative to its lowest ownership interest in L at any 
time during the testing period (0 percent prior to the merger). For 
purposes of determining whether an ownership change occurs on November 
30, 1988, the segregation rules of paragraphs (j)(2)(iii)(B) and (D) of 
this section does not require that a third direct public group be 
separately identified and treated as acquiring the warrants, because L 
has actual knowledge that Public L and Public P acquired the distributed 
warrants in proportion to their respective ownership interests in L 
stock. Because the largest increase in the ownership of L on the testing 
date results from treating only Public P as exercising the distributing 
warrants, in which event, its ownership interest would increase by 44.4 
percentage points ([four million shares acquired in the merger + 800,000 
shares deemed acquired]/10.8 million (actual and deemed) shares 
outstanding), the issuance of the warrants by L does not cause an 
ownership change on November 30, 1988.
    (iii) Under paragraph (j)(2)(iii)(F)(1) of this section, each actual 
exercise of warrants to acquire one million shares of L stock between 
November 30, 1988 and November 30, 1989 is treated as made pro rata by 
Public L and Public P (600,000 shares to Public L and 400,000 shares to 
Public P). Accordingly, as a result of the actual exercises of warrants 
during that period the ownership interests of the only 5-percent 
shareholders, Public L and Public P, are proportionately increased.
    (iv) A's acquisition of the all of the outstanding warrants on 
November 30, 1989 requires the determination whether there has been an 
ownership change with respect to L, because A would be 5-percent 
shareholder

[[Page 692]]

under paragraph (g)(1)(i) of this section owning 8\1/3\ percent of the L 
stock if the acquired warrants were exercised (one million shares deemed 
acquired/12 million (actual and deemed) shares outstanding). See 
paragraph (a)(2)(i) of this section. Under paragraph (h)(4)(i) of this 
section, A is not treated as having exercised those warrants, because an 
ownership change would not results. (Public P's 36\2/3\ percentage point 
increase [(four million shares acquired in the merger + 400,000 shares 
deemed acquired)/12 million (actual and deemed) shares outstanding] and 
A's 8\1/3\ percentage point increase is not greater than 50 percentage 
points).

    (iv) Combination of de minimis public groups--(A) In general. 
Notwithstanding paragraph (j)(2)(iii)(A) of this section, any public 
group first identified during a taxable year, as a result of any 
transaction described in paragraph (j)(2)(iii)(B), (D), (E), or (F) of 
this section, that owns less than five percent of loss corporation stock 
may be combined, at the option of the loss corporation, with any other 
such groups also first identified as a result of any such transaction 
that occurs during such taxable year.
    (B) Example.

    Example. (i) L is widely held with no person owning as much as five 
percent of the L stock at any time (``Public L''). L's taxable year ends 
on December 31. On January 1, 1989, L issues a class of debt maturing on 
December 31, 2019 (``Class A Debentures'') with respect to which it will 
semi-annually issue L stock in discharge of its interest obligation. In 
addition, L issues an amount of L stock to the public in two separate 
transactions during 1989. As a percentage of the L stock outstanding at 
the close of L's taxable year on December 31, 1989, L issued .45 percent 
of its stock on each of two dates in payment of interest with respect to 
the Class A Debentures, 4.5 percent of its stock in the first stock 
offering and six percent of its stock in the second stock offering. 
During 1990, L did not issue stock other than in payment of interest 
with respect to the Class A Debentures. As a percentage of L stock 
outstanding on December 31, 1990, L issued .41 percent of its stock on 
each of two dates during 1990 with respect to its outstanding debt.
    (ii) Under paragraph (h)(4)(x)(E) of this section, L's obligation to 
issue stock in satisfaction of the interest with respect to the Class A 
Debentures until December 31, 2019, is not subject to paragraph 
(h)(4)(i) of this section and thus is taken into account only as such 
stock is issued.
    (iii) The application of the segregation rules of paragraphs 
(j)(2)(iii)(B) and (iv) of this section require the identification of at 
least two additional, separate direct public groups during 1989. First, 
the persons who acquire six percent of L stock in a public offering to 
which section 1032 applies must be treated as a separate 5-percent 
shareholder (``Public 1L''). See paragraph (j)(2)(iii)(B) of this 
section. Even though this group was first identified in 1989, it may not 
be combined with other public groups also first identified in 1989 
because it owns five percent or more of L stock. Second, although each 
of the three other issuances of L stock during the year ordinarily 
result in the identification of an additional, separate direct public 
group, each such direct public group may be combined with the two other 
such groups into a single public group (``Public 2L''). As of the end of 
1989, Public 2L would own a total of 5.4 percent of the stock of L.
    (iv) The application of the segregation rules of paragraphs 
(j)(2)(iii)(B) and (iv) of this section require the identification of at 
least one additional, direct public group during 1990. Because each 
additional, direct public group first identified in 1990 acquires less 
than five percent of L stock, they may be combined into a single public 
group (``Public 3L'') owning .82 percent of the stock of L. Public 3L is 
treated as a five percent shareholder even though it owns less than five 
percent of the stock of L. See paragraph (j)(2)(iv)(A) of this section.

    (v) Multiple transactions--(A) In general. If a transaction (or any 
part thereof) is described by more than one subdivision of paragraph 
(j)(2)(iii) of this section, each such subdivision shall apply to the 
transaction (or each part of the transaction) in the manner that results 
in the largest increase in the percentage stock ownership by the 5-
percent shareholders.
    (B) Example.

    Example. (i) All of the common stock of L is owned by 1,000 
unrelated persons, none of whom owns as much as five percent of the L 
stock (``Public CL''). L has outstanding a class of preferred stock 
described in section 1504(a)(4) that is owned in equal amounts by 500 
unrelated persons (``Public PL'').
    (ii) On September 4, 1988, L rearranges its capital structure by 
redeeming 70 percent of the common stock owned by 700 of the 
shareholders in exchange for cash. In addition, all of the preferred 
stock is exchanged for a new class of common stock (nonvoting) 
representing 40 percent of the value of L.
    (iii) With respect to the part of the transaction that is treated as 
a redemption under paragraph (j)(2)(iii)(C) of this section (the 
exchange of common stock for cash), Public CL is segregated into two 
different public groups immediately before the transaction (and

[[Page 693]]

thereafter) so that the owners of the redeemed stock (``Public RCL'') 
are treated as part of a public group that is separate from the public 
group comprised of the owners of the stock that is not redeemed 
(``Public CCL''). As a result of the redemption, Public CCL's percentage 
ownership interest in L thus increases by 30 percentage points from 30 
percent to 60 percent (taking into account all transactions occurring on 
the testing date, because the change in ownership is measured under 
paragraph (a)(1)(i) of this section by reference to each 5-percent 
shareholder's ownership interest immediately after the testing date). In 
addition, the exchange of preferred stock for nonvoting common stock is 
a transaction to which section 1032 applies. Under paragraph (j)(2)(v) 
of this section, the part of the transaction to which section 1032 
applies is also subject to the segregation rules in the manner specified 
in paragraph (j)(2)(iii)(B) of this section. Accordingly, Public PL, the 
direct public group that acquires L nonvoting common stock in exchange 
for L preferred stock, must be treated as a separate public group from 
the other direct public groups, Public CCL and Public RCL. As a separate 
public group, Public PL's percentage stock ownership in L increases by 
40 points (as compared to 0 percent prior to the transaction).
    (iv) In summary, Public CCL increases its percentage ownership in L 
by 30 percentage points and Public PL increases its percentage ownership 
by 40 percentage points. Consequently, an ownership change occurs with 
respect to L on September 4, 1988.

    (vi) Acquisitions made by either a 5-percent shareholder or the loss 
corporation following application of the segregation rules. Unless a 
different proportion is established by either the loss corporation or 
the Internal Revenue Service, the acquisition of loss corporation stock 
by either a 5-percent shareholder or the loss corporation on any date on 
which more than one public group of the loss corporation exists by 
virtue of the application of the rules of this paragraph (j)(2) shall be 
treated as being made proportionately from each public group existing 
immediately before such acquisition. See paragraph (g)(5)(i)(B) of this 
section for the application of this paragraph to the ownership interest 
of a 5-percent shareholder that owns less than five percent of the stock 
of the loss corporation on the testing date.
    (3) Segregation rules applicable to transactions involving first 
tier entities or higher tier entities--(i) Dispositions. If a loss 
corporation is owned, in whole or in part, by a public group (or 
groups), the rules of paragraphs (j)(2)(iii)(B) and (iv) of this section 
shall apply to any transaction in which a first tier entity or an 
individual that owns a direct ownership interest in the loss corporation 
of five percent or more transfers a direct ownership interest in the 
loss corporation to public shareholders. Therefore, each direct public 
group that exists immediately after such a disposition shall be 
segregated so that the ownership interests of each public group that 
existed immediately before the transaction are treated separately from 
the public group that acquires stock of the loss corporation as a result 
of the disposition by the individual or first tier entity. The 
principles of this paragraph (j)(3)(i) shall also apply to transactions 
in which an ownership interest in a higher tier entity that owns five 
percent or more of the loss corporation (determined without regard to 
the application of paragraph (h)(2)(i)(A) of this section) or a first 
tier entity is transferred to a public owner or 5-percent owner who is 
not a 5-percent shareholder.
    (ii) Example.

    Example. (A) L is owned equally by Public L, P and E. Public L 
consists of 150 equal, unrelated shareholders. P is owned by Public P, a 
group consisting of 1,500 equal, unrelated shareholders. E is a 
partnership and none of its partners are 5-percent owners. On October 
22, 1988, E sells its entire interest in L over a public stock exchange. 
No individual or entity acquires as much as five percent of L's stock as 
the result of E's disposition of the L stock.
    (B) The disposition of the L stock by E is a transaction that causes 
the segregation of L's direct public group that exists immediately 
before the transaction (Public L) from the direct public group that 
acquires L stock in the transaction (Public EL). As a result, L has 
three 5-percent shareholders, Public L, Public P (through the 
application of paragraph (j)(1) of this section) and Public EL, each of 
which owns 33\1/3\ percent of L stock. Therefore, Public EL is a 5-
percent shareholder that has increased its ownership interest in L by 
33\1/3\ percentage points during the testing period. For purposes of 
subsequent transactions, Public L and Public EL will continue to be 
treated as separate direct public groups until any subsequent testing 
date that does not have a testing period that includes E's disposition 
of L stock.


[[Page 694]]


    (iii) Other transactions affecting direct public groups of a first 
tier entity or higher tier entity. The rules of paragraphs (j)(2)(i), 
(iii), (iv) and (v) of this section shall apply to transactions 
described in such paragraphs that involve either a higher tier entity 
that owns five percent or more of the loss corporation (determined 
without regard to the application of paragraph (h)(2)(i)(A) of this 
section) or a first tier entity. In applying those rules for purposes of 
this paragraph (j)(3)(iii), each direct public group of a first tier 
entity or a higher tier entity is any public group of any such entity 
identified in paragraph (j)(1)(iv)(A) or (B) of this section or 
resulting from the application of this paragraph (j)(3)(iii). The 
principles of paragraph (j)(2)(iii)(C) of this section also shall apply 
to any transaction that has the effect of a redemption-type transaction 
(e.g., an acquisition by the loss corporation of stock in a first tier 
entity).
    (iv) Examples.

    Example 1. The facts are the same as in Example 1 of paragraph 
(j)(2)(iii)(B)(2) of this section, except that Public L and 
P1 own 40 percent and 60 percent, respectively, of the stock 
of HC which, in turn, owns 100 percent of L and HC merges into 
P2. Under paragraph (j)(3)(iii) of this section, the rules of 
paragraph (j)(2)(iii)(B) of this section apply to segregate HC's direct 
public group (Public L) immediately before the merger from the direct 
public group (Public P2) that acquires loss corporation stock 
in the merger. The consequences of the merger of HC into P2 
are thus the same as in Example (1) of paragraph (j)(2)(iii)(B)(2) of 
this section.
    Example 2. (i) Twenty-five individual shareholders each own four 
percent of L (``Public L''). Public L is therefore the only 5-percent 
shareholder of L. Each of the shareholders of L contribute their L stock 
to a newly formed corporation, HC. In exchange for their contribution of 
L stock, HC issues 100 percent of each of its two classes of common 
stock (voting and nonvoting).
    (ii) The formation of HC, a first tier entity of L, is a transaction 
to which section 1032 applies. Under paragraph (j)(3)(iii) of this 
section, the rules of paragraphs (j)(1)(iii) and (j)(2)(iii)(B) of this 
section are applied to this transaction with the result that the 
shareholders of HC, immediately after the issuance of HC stock, are 
presumed not to include any persons that previously had a direct or 
indirect ownership interest in L. The presumption underlying those 
rules, however, is rebutted by establishing that all of the HC stock 
outstanding immediately after the transaction was issued solely in 
exchange for L stock. Thus, Public HC (immediately after the 
transaction) and Public L (immediately before the transaction) would be 
treated owned by the same direct public group.
    Example 3. (i) All of the stock of L is owned by unrelated 
shareholders, none of whom owns as much as five percent of L stock. P 
also is owned by unrelated shareholders, none of whom owns as much as 
five percent of P stock. On November 22, 1988, P incorporates 
P1 with a contribution of P stock. Immediately thereafter, 
P1 acquires all of the properties of L in exchange for its P 
stock in a forward triangular merger qualifying under sections 368 
(a)(1)(A) and (a)(2)(D). The P stock transferred by P1 equals 
45 percent of the total outstanding P stock.
    (ii) Immediately before the merger of L into P1, P's only 
5-percent shareholder was Public P, a direct public group of P. The 
rules of paragraph (j)(2)(iii)(B) of this section thus apply to the 
transaction under paragraph (j)(3)(i) of this section since P, a first 
tier entity, is a party to the reorganization described in such 
paragraph. Although Public P does not acquire any stock in the merger, 
it is treated as acquiring stock in the loss corporation, P1, 
because such corporation succeeds to the pre-change losses of L in a 
transaction to which 381(a) applies. As a result of the merger, Public 
P, the direct public group of P that exists immediately before the 
merger, must be segregated from the direct public groups acquiring P 
stock in the reorganization. Public P is, therefore, treated as 
acquiring 55 percent of the outstanding stock of the loss corporation, 
P1, in the transaction. The transaction, therefore, results 
in an ownership change for P1.
    Example 4. (i) L is owned 20 percent by A and 80 percent by 1,000 
unrelated individuals and entities, none of whom owns as much as five 
percent of L stock (``Public L''). P is owned 10 percent by B, 40 
percent by E, and 50 percent by 5,000 unrelated individuals, none of 
whom owns as much as five percent of P stock (``Public P''). E is owned 
30 percent by C and 70 percent by 30 unrelated individuals, none of whom 
owns as much as five percent of E (``Public E'').
    (ii) On October 31, 1987, P acquires all of the L stock from A and 
Public L in exchange for P stock representing 20 percent of the value of 
P (determined immediately after the acquisition) in a transaction 
described in section 368(a)(1)(B). After the acquisition, P is owned 
eight percent by B, 32 percent by E, four percent by A, and 56 percent 
by 6,000 unrelated individuals, none of whom owns as much as five 
percent of P. Because L is wholly owned by P immediately after the 
acquisition, L, under paragraph (j)(1) of this section, is treated as 
owned as follows: Eight percent by B, 9.6 percent by C (through C's 
ownership

[[Page 695]]

interest in E, a highest tier entity, and E's ownership interest in P, a 
first tier entity), 22.4 percent by Public E (through its ownership 
interest in E and E's ownership interest in P), four percent by A, and 
56 percent by the shareholders who each own less than five percent of L 
through their ownership interest in P.
    (iii) Under paragraph (j)(3)(iii) of this section, the rules of 
paragraph (j)(2)(iii)(B) of this section apply to the reorganization 
since the transaction involved a first tier entity of L. Thus, the 
direct public group of P that exists immediately after the transaction 
must be segregated into two public groups--the direct public group of P 
that existed immediately before the acquisition (Public P) is treated 
separately from the direct public group consisting of the persons who 
acquire P stock in the transaction (Public L). Accordingly, immediately 
after the reorganization, Public P and Public L own 40 percent and 16 
percent of L, respectively. See paragraph (h) of this section. (Under 
paragraph (g)(5)(ii)(B) of this section, L may treat the four percent of 
L stock owned by A immediately after the reorganization as the amount of 
L stock owned by A for each subsequent testing date having a testing 
period that includes the reorganization.)
    (iv) In summary, after applying the rules of paragraphs (j)(1) and 
(3) of this section, L is treated as owned as follows:

------------------------------------------------------------------------
                                                             Percentage
                   5-percent shareholder                      ownership
                                                              interest
------------------------------------------------------------------------
A.........................................................           4.0
B.........................................................           8.0
C.........................................................           9.6
Public E..................................................          22.4
Public P..................................................          40.0
Public L..................................................          16.0
------------------------------------------------------------------------

    (v) The reorganization results in an ownership change, because B, C, 
Public E and Public P, all of whom are 5-percent shareholders, together 
have increased their percentage ownership in L by 80 percentage points 
as compared to their lowest percentage ownership in L at any time during 
the testing period (0 percent prior to the acquisition).

    (v) Acquisitions made by a 5-percent shareholder, a higher tier 
entity, or a first tier entity following application of the segregation 
rules. The rules of paragraph (j)(2)(vi) of this section shall apply to 
the acquisition of an ownership interest in a first tier entity (or 
higher tier entity) if more than one direct public group of any such 
entity are segregated under the rules of this paragraph (j)(3). 
Accordingly, an acquisition by such an entity or a 5-percent shareholder 
of any ownership interest in such an entity shall be treated as made 
proportionately from the direct public groups resulting from the 
application of this paragraph (j)(3).
    (k) Operating rules--(1) Presumptions regarding stock ownership. 
Subject to paragraphs (k)(2) and (4) of this section, for purposes of 
applying paragraphs (f), (g), (h), and (j)(1) of this section--
    (i) Stock subject to regulation by the Securities and Exchange 
Commission. With respect to loss corporation stock that is described in 
Rule 13d-1(d) of Regulation 13D-G (or any rule or regulation to 
generally the same effect), promulgated by the Securities and Exchange 
Commission under the Securities and Exchange Act of 1934 (``registered 
stock''), a loss corporation may rely on the existence and absence of 
filings of Schedules 13D and 13G (or any similar schedules) as of any 
date to identify all of the corporation's shareholders who have a direct 
ownership interest of five percent or more (both individuals and first 
tier entities) on such date. A loss corporation may similarly rely on 
the existence and absence of such filings as of any date with respect to 
registered stock of any first tier entity or any higher tier entity to 
identify the 5-percent owners of any such entities on such date who 
indirectly own five percent or more of the loss corporation stock, and 
are thus 5-percent shareholders, and to identify any higher tier 
entities of such entities.
    (ii) Statements under penalties of perjury. A loss corporation may 
rely on a statement, signed under penalties of perjury, by an officer, 
director, partner, trustee, executor or similar responsible person, on 
behalf of a first tier entity or a higher tier entity to establish the 
extent, if any, to which the ownership interests of any 5-percent owners 
or higher tier entities with respect to such entities have changed 
during a testing period. A loss corporation may not rely on such a 
statement (A) that it knows to be false or (B) that is made by either a 
first tier entity or higher tier entity that owns 50 percent or more of 
the stock of the loss corporation. For purposes of the preceding 
sentence, any first tier entities and higher tier entities that are 
known by the loss corporation to be members of

[[Page 696]]

the same controlled group (within the meaning of section 267(f)) shall 
be treated as one corporation.
    (2) Actual knowledge regarding stock ownership. For purposes of this 
section (other than paragraphs (g)(5) and (j)(1)(v) of this section), to 
the extent that the loss corporation has actual knowledge of stock 
ownership on any testing date (or acquires such knowledge before the 
date that the income tax return is filed for the taxable year in which 
the testing date occurs) by--
    (i) An individual who would be a 5-percent shareholder, but for the 
application of paragraphs (h)(2)(iii), (h)(6)(iii) or (g)(2) of this 
section, or
    (ii) A 5-percent shareholder that would be taken into account, but 
for paragraphs (h)(2)(iii), (h)(6)(iii) or (g)(3) of this section,

the loss corporation must take such stock ownership into account for 
purposes of determining whether an ownership change has occurred on that 
testing date. If a loss corporation acquires such knowledge after such 
income tax return is filed, the loss corporation may take such ownership 
into account for purposes of determining whether an ownership change 
occurred on that testing date and, if appropriate, file an amended 
income tax return (subject to any applicable statute of limitations). To 
the extent the loss corporation has actual knowledge on or after any 
testing date regarding the ownership interest in the loss corporation by 
members of one public group (described in paragraphs (g)(1)(ii), (iii) 
or (iv) of this section) and the ownership interest of those members in 
the loss corporation as members in another such public group, the loss 
corporation may take such ownership into account for purposes of 
determining whether an ownership change occurred on that testing date.
    (3) Duty to inquire as to actual stock ownership in the loss 
corporation. For purposes of this section, the loss corporation is 
required to determine the stock ownership on each testing date (and, 
except as otherwise provided in this section, the changes in the stock 
ownership during the testing period) of--
    (i) Any individual shareholder who has a direct ownership interest 
of five percent or more in the loss corporation,
    (ii) Any first tier entity,
    (iii) Any higher tier entity that has an indirect ownership interest 
of five percent or more in the loss corporation (determined without 
regard to paragraph (h)(2)(i)(A) of this section), and
    (iv) Any 5-percent owner who indirectly owns five percent or more of 
the stock of the loss corporation in his capacity as a 5-percent owner 
in any one first tier entity or higher tier entity.

The loss corporation does not have any obligation to inquire or to 
determine facts relating to the stock ownership of any shareholders 
other than those described in the preceding sentence. In addition, the 
loss corporation does not have any obligation to inquire or to determine 
if the actual facts relating to the stock ownership of any shareholder 
are consistent with the ownership interests of the loss corporation as 
determined by applying the presumptions and other rules of paragraphs 
(g), (h), (j) or (k)(1) of this section.
    (4) Ownership interest structured to avoid the section 382 
limitation. For purposes of this section, if the ownership interests in 
a loss corporation are structured by a person with a direct or indirect 
ownership interest in the loss corporation to avoid treating a person as 
a 5-percent shareholder (or to permit the loss corporation to rely on 
the presumption provided in paragraph (g)(5)(i)(B) of this section) for 
a principal purpose of circumventing the section 382 limitation, then--
    (i) Paragraph (h)(2)(iii) of this section shall not apply with 
respect to the ownership interests so structured and the constructive 
ownership rules of paragraph (h)(2)(i) of this section shall thus apply 
to attribute stock from any entity without regard to the amount of stock 
it owns in the loss corporation or any other corporation,
    (ii) Paragraphs (g)(2) and (3) of this section shall be modified 
with respect to the ownership interests so structured so that the 
ownership interest of a person includes all of an individual's direct 
and indirect ownership in the loss corporation, without regard to 
whether each such interest represents five percent or more of the stock 
of the loss corporation, and

[[Page 697]]

    (iii) Paragraph (g)(5)(i)(B) of this section shall not apply with 
respect to the ownership interests so structured so that the ownership 
interest of a person takes into account his actual ownership interest in 
the loss corporation.

This paragraph (k)(4) shall apply, however, only if application would 
result in an ownership change.
    (5) Example.

    Example. L is owned by 25 individuals who each own four percent of 
the outstanding L stock. A purchases 40 percent of L stock from such 
shareholders on August 13, 1988. Thereafter, B plans to acquire 15 
percent of the L stock. B is advised concerning the potential 
application of section 382 to L. On February 1, 1989, B acquires a 15 
percent interest in L pursuant to a program in which each of four 
corporations, P1 through P4, each of which is 
wholly-owned by B, acquire a 3.75 percent interest in L. A principal 
purpose of acquiring the L stock through four corporations is to avoid 
treating B as owning any ownership interest in L amounting to as much as 
five percent, and thus to circumvent the section 382 limitation by 
avoiding an ownership change. Under paragraph (k)(4) of this section, 
the limitation on the constructive ownership rules of paragraph 
(h)(2)(iii) of this section are disregarded and B is treated as a 5-
percent shareholder owning 15 percent of the stock of L by virtue of his 
ownership interests in P1 through P4, 
notwithstanding paragraph (g)(2) of this section. Accordingly, an 
ownership change occurs with respect to L.

    (6) First tier entity or higher tier entity that is a foreign 
corporation or entity. [Reserved]
    (l) Changes in percentage ownership which are attributable to 
fluctuations in value. [Reserved]
    (m) Effective date--(1) In general. Except as provided in this 
paragraph (m), section 382 shall apply to any ownership change that 
occurs immediately after an owner shift or an equity structure shift 
that occurs after December 31, 1986, or any other event occurring after 
such date that requires the determination of whether an ownership change 
has occurred under paragraph (a)(2)(i) of this section. In the case of 
an equity structure shift (including an equity structure shift that also 
constitutes an owner shift), any equity structure shift completed 
pursuant to a plan of reorganization adopted before January 1, 1987, 
shall be treated as occurring on the date such plan was adopted. 
Therefore, section 382 shall apply to any ownership change occurring 
immediately after--
    (i) An owner shift (excluding an owner shift that also constitutes 
an equity structure shift) that occurs on or after January 1, 1987,
    (ii) An equity structure shift that occurs after December 31, 1986, 
if it is completed pursuant to a plan of reorganization adopted on or 
after January 1, 1987, or
    (iii) Any transfer or issuance of an option, or other interest that 
is similar to an option, that occurs on or after January l, 1987 and 
that is taken into account under paragraph (a)(2)(i) of this section.

With respect to equity structure shifts completed pursuant to plans 
adopted before January 1, 1987, section 382 shall be inapplicable only 
if the equity structure shift that is treated as occurring on the date 
the plan of reorganization for such shift was adopted (or other event 
occurring after the adoption of such plan) results in an ownership 
change before January 1, 1987. In that event, a new testing period for 
the loss corporation shall begin on the day after such ownership change.
    (2) Plan of reorganization. For purposes of paragraph (m)(1) of this 
section, a plan of reorganization shall be treated as adopted on the 
earlier of--
    (i) The first date that the boards of directors of all the parties 
to the reorganization have adopted the plan or have recommended adoption 
to their shareholders, or
    (ii) The date the shareholders approve such reorganization.

If there is an ownership change with respect to a subsidiary as the 
result of a reorganization of the parent, the treatment of the 
subsidiary under this paragraph (m)(2) shall be governed by the 
classification of the parent-level transaction. For purposes of the 
preceding sentence, a corporation shall be treated as a subsidiary of 
another corporation only if the other corporation owns stock in that 
corporation meeting the requirements of section 1504(a)(2).
    (3) Earliest commencement of the testing period. For purposes of 
determining if an ownership change has occurred at any time after May 5, 
1986, the testing

[[Page 698]]

period shall begin no earlier than May 6, 1986. Under paragraph (d)(4) 
of this section, therefore, shifts in the ownership of stock of the loss 
corporation prior to May 6, 1986 are disregarded.
    (4) Transitional rules--(i) Rules provided in paragraph (j) of this 
section for testing dates before September 4, 1987. For purposes of 
determining whether an ownership change occurs for any testing date 
before September 4, 1987.
    (A) The rules of paragraph (j)(1) of this section shall apply only 
to stock of the loss corporation acquired after May 5, 1986, by any 
first tier entity or higher tier entity and shall not apply to any stock 
acquired by such an entity on or before that date,
    (B) The rules of paragraph (j)(2) of this section shall apply only 
to equity structure shifts in which more than one corporation is a party 
to the reorganization and shall not apply to any other transactions, and
    (C) The rules of paragraph (j)(3) of this section shall apply only 
to--
    (1) Dispositions of stock acquired by an individual, a first tier 
entity or higher tier entity after May 5, 1986 (and shall not apply to 
dispositions of stock acquired on or before such date), and
    (2) Equity structure shifts in which more than one corporation is a 
party to the reorganization (and shall not apply to any other 
transactions).

For any testing date before September 4, 1987, however, the loss 
corporation is permitted to apply all of the rules of paragraph (j) of 
this section. A loss corporation that applies the rules of paragraph (j) 
of this section under the preceding sentence must apply all of the rules 
of such paragraph in determining whether any ownership change occurs on 
any testing dates after May 5, 1986.
    (ii) Example.

    Example. (i) L is owned entirely by 10,000 unrelated individuals, 
none of whom owns as much as five percent of the stock of L (``Public 
L''). P is owned entirely by 1,000 unrelated individuals, none of whom 
owns as much as five percent of the stock of P (``Public P'').
    (ii) Between March 1, 1987 and June 1, 1987, P acquires 45 percent 
of L stock in a series of transactions. On June 15, 1987, L redeems 20 
percent of the L stock from Public L.
    (iii) Under paragraph (m)(4)(i)(A) of this section, the rules of 
paragraph (j)(1) of this section apply to the acquisitions made by P, 
because they occurred after May 5, 1986. Accordingly, following those 
acquisitions, the stock of L is owned 45 percent by Public P and 55 
percent by Public L. Because the increase in the percentage ownership by 
Public P as a result of P's stock purchases is not more than 50 percent, 
no ownership change occurs as the result of P's purchases.
    (iv) On or after September 4, 1987, the rules of paragraph 
(j)(2)(iii)(C) of this section apply to treat any L stock that is 
redeemed as owned by a public group that is separate from the public 
group owning the stock that is not redeemed. (Under paragraph 
(j)(2)(iii)(C) of this section, the continuing shareholders of Public L, 
who owned 35 percent of the stock of L before the redemption ([55 
percent--20 percent]/100 percent) increase their ownership interest in L 
by 8.8 percentage points as a result of such redemption (43.8 percent--
35 percent)). Those rules, however, do not apply to the June 15, 1987 
redemption because it occurs before the date that paragraph (j)(2)(iii) 
of this section generally is effective. (Until September 4, 1987, 
paragraph (j)(2)(iii) of this section generally is effective only for 
equity structure shifts in which more than one corporation is a party to 
the reorganization.) Solely because of the application of paragraph 
(j)(1) of this section to P's acquisitions of L stock, Public P's 
ownership interest in L as a result of the redemption has increased from 
45 percentage points to 56.2 percentage points which, compared to its 
lowest percentage ownership interest at any time during the testing 
period (0 percent prior to March 1, 1987), is a more than 50 percentage 
point increase thus causing an ownership change with respect to L on 
June 15, 1987.

    (iii) Rules provided in paragraph (j) of this section for testing 
dates on or after September 4, 1987. For purposes of determining whether 
an ownership change occurs for any testing date on or after September 4, 
1987, the rules of paragraphs (j)(2) and (3) of this section shall not 
apply to identify any public group resulting from--
    (A) Any transaction described in such paragraphs (j)(2) and (3), 
unless that transaction is also described in paragraph (m)(4)(i)(B) or 
(C) of this section, or
    (B) Any disposition of stock acquired on or before May 5, 1986, but 
only if such disposition or other transaction occurs before September 4, 
1987. Thus, for example, the rules of paragraph (j)(2)(iii)(D) of this 
section shall apply only to rights to acquire stock of the loss 
corporation issued on or after such date.

[[Page 699]]

    (iv) Rules provided in paragraphs (f)(18)(ii) and (iii) of this 
section. For purposes of determining whether an ownership change occurs 
for any testing date, the rules of paragraphs (f)(18)(ii) and (iii) of 
this section apply only to stock (or any other ownership interest) that 
is--
    (A) Issued on or after September 4, 1987, or
    (B) Transferred to (or by) a person who is a 5-percent shareholder 
(or would be a 5-percent shareholder if paragraph (f)(18)(iii) of this 
section were applicable) on or after September 4, 1987.
    (v) Rules provided in paragraph (a)(2)(ii) of this section. The 
information statement required under paragraph (a)(2)(ii) of this 
section is not required to be filed with respect to any taxable year for 
which the due date (including extensions) of the income tax return of 
the loss corporation is on or before October 5, 1987.
    (vi) Rules provided in paragraph (h)(4) of this section. The rules 
provided in paragraph (h)(4) of this section do not apply on any testing 
date on or after November 5, 1992. The rule provided in paragraph 
(h)(4)(viii) of this section applies to the lapse or forfeiture of any 
option treated as exercised under paragraph (h)(4)(i) of this section. 
If an option is treated as exercised under paragraph (h)(4)(i) of this 
section, and the option is actually exercised on a day that is within 
120 days after the date on which the option is treated as exercised, the 
rule provided in paragraph (h)(4)(vi)(B) of this section applies (even 
if the actual exercise of the option occurs on a date on which the rules 
of paragraph (h)(4) of this section would not otherwise apply). Thus, in 
such a case, the loss corporation may elect to treat paragraphs 
(h)(4)(i) and (vi)(A) of this section as not applying to the option and 
take into account only the acquisition of loss corporation stock 
resulting from the actual exercise of the option.
    (vii) Rules provided in paragraph (a)(2)(i) of this section. The 
rules provided in paragraph (a)(2)(i) of this section apply to determine 
whether dates prior to November 5, 1992, are testing dates. For rules 
regarding the determination of whether dates on or after November 5, 
1992, are testing dates, see Sec. 1.382-2(a)(4).
    (5) Bankruptcy proceedings--(i) In general. In the case of a 
reorganization described in section 368(a)(1)(G) or an exchange of debt 
for stock in a title 11 or similar case (within the meaning of section 
368(a)(3)), section 382 shall not apply to any ownership change 
resulting from such a reorganization or proceeding if a petition in such 
case was filed with the court before August 14, 1986. Accordingly, any 
shift in ownership in the loss corporation arising out of such 
reorganization or proceeding shall not be taken into account for 
purposes of determining whether an ownership change occurs on any 
testing date that occurs after December 31, 1986.
    (ii) Example.

    Example. (i) L filed a petition in bankruptcy on September 29, 1985. 
As a result of a title 11 bankruptcy reorganization of L that is 
confirmed by a court on February 2, 1988, there is a shift in the 
ownership of L so that JK increased her interest in L by 24 percentage 
points relative to her lowest ownership interest in L during the testing 
period. JK is the only 5-percent shareholder of L following the 
reorganization whose interest in L increased as a result of the 
transaction. On December 25, 1988, GK purchases 42 percent of the 
outstanding stock of L from shareholders other than JK.
    (ii) There is no ownership change on December 25, 1988 because the 
24 percentage point increase in JK's ownership interest in L is not 
taken into account under paragraph (m)(6)(i) of this section.
    (iii) The facts are the same as in (i), except that the acquisitions 
by JK and GK occurred on August 5, 1986 and September 26, 1986, 
respectively. Because paragraph (m)(6)(i) of this section is only 
applicable with respect to the determination of whether an ownership 
change has occurred on any testing date that occurs after December 31, 
1986, there is an ownership change as a result of GK's acquisition on 
September 26, 1986. Accordingly, section 382 is inapplicable to such 
ownership change under paragraph (m)(1) of this section because it 
occurred prior to January 1, 1987. Under paragraph (d)(2) of this 
section, the testing period for determining whether an ownership change 
occurs on any subsequent testing date shall commence no earlier than 
September 27, 1986.

    (6) Transactions of domestic building and loan associations. The 
rules of paragraph (j)(2)(iii)(B) of this section (and the application 
of those rules by virtue

[[Page 700]]

of paragraph (j)(3) of this section) shall not apply to a public 
offering of stock by a domestic building and loan association described 
in section 591 (or any corporation that owns stock in the association 
meeting the requirements of section 1504(a)(2)) prior to January 1, 
1989. In the case of any transaction described in the preceding 
sentence, any transitory ownership of stock by any entity that is an 
underwriter shall be disregarded so that the rules of paragraph (j)(1) 
of this section shall not apply to treat such stock as owned by the 
owners of the underwriter and thus the rules of paragraph (j)(3)(i) of 
this section shall not apply to the disposition of such stock by the 
underwriter. For purposes of this paragraph (m)(7)--
    (i) Ownership shall be considered transitory only with respect to an 
underwriter acquiring stock in a firm commitment underwriting to the 
extent the stock is disposed of pursuant to the offer (but in no event 
later than sixty (60) days after the initial offering) and,
    (ii) To the extent a transaction may be described both by paragraph 
(j)(2)(iii)(B) of this section and any other provision of paragraph 
(j)(2)(iii) or (3) of this section, paragraph (j)(2)(v)(A) of this 
section shall not apply and the transaction shall be treated as 
described solely by paragraph (j)(2)(iii)(B) of this section.
    (7) Transactions not subject to section 382--(i) Application of old 
section 382. Old section 382 shall not apply to a loss corporation on or 
after the date on which an ownership change occurs, but only if such 
ownership change results in the application of the section 382 
limitation (as defined in section 382(b)) with respect to the loss 
corporation.
    (ii) Effect on testing period. The application of old section 382 to 
a transaction is disregarded for purposes of paragraph (d)(2) of this 
section unless the transaction that results in such application is the 
last component of an ownership change after May 5, 1986 that is not 
subject to section 382 under the effective date rules of this paragraph 
(m) (e.g., an ownership change occurring as the result of an 
individual's purchase of more than 50 percent of L stock on any date on 
or before December 31, 1986).
    (iii) Termination of old section 382. [Reserved]
    (8) Options issued or transferred before January 1, 1987--(i) 
Options issued before May 6, 1986. An option issued before May 6, 1986, 
is subject to the rules of paragraph (h)(4) of this section only if it 
is transferred by (or to) a 5-percent shareholder (or a person who would 
be a 5-percent shareholder if the option were treated as exercised) on 
or after such date. In all other cases, such an option shall not be 
subject to paragraph (h)(4)(i) of this section, but shall be subject to 
paragraph (h)(4)(xii) of this section. Thus, for example, a warrant to 
acquire stock of the loss corporation issued before May 6, 1986 shall 
not be subject to paragraph (h)(4) of this section unless the warrant is 
transferred by (or to) a 5-percent shareholder. The exercise of such a 
warrant, however, would be taken into account as required by this 
paragraph (m)(8)(i) and paragraph (h)(4)(xii) of this section.
    (ii) Options issued on or after May 6, 1986 and before September 18, 
1986. An option issued or transferred on or after May 6, 1986, and 
before September 18, 1986, is subject to the rules of paragraph (h)(4) 
of this section.
    (iii) Options issued on or after September 18, 1986 and before 
January 1, 1987. An option issued or transferred on or after September 
18, 1986, and before January 1, 1987, is subject to the rules of 
paragraph (h)(4) of this section, except that the option shall be 
treated for purposes of this section as if it never had been issued in 
the event that either--
    (A) The option lapses unexercised or is irrevocably forfeited by the 
holder thereof, or
    (B) On the date the option was issued, there was no significant 
likelihood that such option would be exercised within the five-year 
period from the date of such issuance and a purpose for the issuance of 
the option was to cause an ownership change prior to January 1, 1987.
    (9) Examples. The rules of this paragraph (m) may be illustrated by 
the following examples.

    Example 1. (i) A owns all 100 outstanding shares of L stock. A sells 
11 shares to B on January 1, 1986. The January 1, 1986 testing

[[Page 701]]

date is disregarded under paragraph (m)(3) of this section. A sells 
another 40 shares to B on January 1, 1988. B's second stock purchase is 
an owner shift that does not result in an ownership change. B's 
percentage ownership interest on the testing date (51 percent) is only 
40 percentage points greater than the lowest percentage of L stock owned 
by B at any time during the testing period (11 percent on and after May 
6, 1986).
    (ii) The facts are the same as in (i). In addition A sells 20 shares 
of his L stock to C on July 1, 1990. C's stock purchase is an owner 
shift. Because B and C together have increased their respective 
ownership interests in L by 40 and 20 percentage points relative to 
their lowest percentage stock ownership interests in L at any time 
during the testing period, C's purchase causes an ownership change. The 
testing period for any subsequent ownership change begins on the first 
day following C's acquisition, July 2, 1990.
    Example 2. (i) C has owned 100 percent of L since March 22, 1980. On 
October 13, 1986, P merges into L. As a result of the merger, 40 percent 
of L stock is acquired by A, the sole shareholder of P. The merger of P 
into L is both an equity structure shift and an owner shift. The 
transaction, however, is not an ownership change with respect to L, 
because A's percentage ownership interest has increased by only 40 
percentage points. On August 22, 1987, B purchases 15 percent of the L 
stock from C. B's purchase constitutes an owner shift resulting in an 
ownership change that is subject to section 382 because the aggregate 
increases in percentage ownership by B and C (respectively 40 percent 
and 15 percent) is more than 50 percentage points.
    (ii) The facts are the same as in (i), except that the plan of 
reorganization is adopted on October 13, 1986, and the merger is 
completed on July 22, 1987. The result is the same as in (i).
    (iii) The facts are the same as in (ii), except that the 
reorganization is completed on August 22, 1987, and B's purchase of the 
L stock occurs one month earlier, on July 22, 1987. Assume that after 
the reorganization on August 22, 1987, A and B own 40 percent and 15 
percent, respectively, of L stock. Although the merger occurred pursuant 
to a plan of reorganization adopted before 1987, L is subject to section 
382 following the equity structure shift, because the merger would not 
have caused an ownership change if it had been completed in 1986 after 
the commencement of the L's testing period.
    (iv) The facts are the same as in (ii), except that B's purchase 
occurs on June 7, 1986. Assume that immediately after the reorganization 
on August 22, 1987, A and B own 40 percent and 15 percent, respectively, 
of L stock. Since the reorganization pursuant to a plan adopted before 
1987, taken together with the other shifts in the ownership of L's stock 
between May 5, 1986, and December 31, 1986, would have caused an 
ownership change, section 382 does not apply as a result of the merger. 
Since an ownership change occurs as a result of the merger, L's testing 
period for purposes of any subsequent ownership change begins on October 
14, 1986.
    (v) The facts are the same as in (iv), except that B makes an 
additional purchase from C of one percent of L's stock on February 14, 
1987. The result is the same as in (iv). B's additional purchase, 
however, is taken into account for the purpose of determining whether 
there is a second ownership change with respect to L.

[T.D. 8149, 52 FR 29675, Aug. 11, 1987]

    Editorial Note: For Federal Register citations affecting Sec. 
1.382-2T, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.govinfo.gov.



Sec. 1.382-3  Definitions and rules relating to a 5-percent 
shareholder.

    (a) Definitions--(1) Entity--(i) In general. An entity is any 
corporation, estate, trust, association, company, partnership or similar 
organization. An entity includes a group of persons who have a formal or 
informal understanding among themselves to make a coordinated 
acquisition of stock. A principal element in determining if such an 
understanding exists is whether the investment decision of each member 
of a group is based upon the investment decision of one or more other 
members. However, the participation by creditors in formulating a plan 
for an insolvency workout or a reorganization in a title 11 or similar 
case (whether as members of a creditors' committee or otherwise) and the 
receipt of stock by creditors in satisfaction of indebtedness pursuant 
to the workout or reorganization do not cause the creditors to be 
considered an entity.
    (ii) Examples. The following examples illustrate the provisions of 
paragraph (a)(1)(i) of this section.

    Example 1. (i) L corporation has 1,000 shares of common stock 
outstanding. For the three-year period ending on October 1, 1992, L's 
stock was owned by unrelated individuals, none of whom owned five 
percent or more of L. A group of 20 individuals who previously owned no 
stock (the ``Group'') agree among themselves to acquire more than 5 
percent of L's stock. The Group is not a corporation, trust, 
association, partnership or company.

[[Page 702]]

On October 1, 1992, pursuant to their understanding, the members of the 
Group purchase 600 shares of L common stock from the old shareholders of 
L (a total of 60 percent of L stock), with each member purchasing 30 
shares.
    (ii) Before the members of the Group acquired L's stock on October 
1, 1992, no individual or entity owned, directly or indirectly, five 
percent or more of the stock of L. As a result, all shareholders were 
aggregated into a public group and L was considered to be owned by a 
single 5-percent shareholder (``Public L'') in accordance with Sec. 
1.382-2T (g)(1) and (j)(1).
    (iii) Under paragraph (a)(1)(i) of this section, the members of the 
Group have a formal or informal understanding among themselves to make a 
coordinated acquisition of stock and, therefore, the Group is an entity. 
Thus, the acquisition of more than five percent of the stock of L on 
October 1, 1992, by members of the Group is not disregarded under Sec. 
1.382-2T(e)(1)(ii). Because no member of the Group owns, directly or 
indirectly, five percent or more of the stock of L, Sec. Sec. 1.382-2T 
(g)(1) and (j)(1) require that the members of the Group be aggregated 
into a separate public group, which will be presumed to consist of 
persons unrelated to the members of Public L. Because there is a shift 
of more than fifty percentage points in the ownership of L stock during 
the three-year testing period ending on October 1, 1992, an ownership 
change occurs on October 1, 1992, as a result of the Group's purchase of 
the 600 shares.
    Example 2. (i) Prior to October 1, 1992, L's 1,000 shares of 
outstanding stock were owned by unrelated individuals, none of whom 
owned five percent or more of the stock of L. L's management is 
concerned that L may become subject to a takeover bid. In separate 
meetings, L's management meets with potential investors who own no stock 
and are friendly to management to convince them to acquire L's stock 
based on an understanding that L will assemble a group that in the 
aggregate will acquire more than 50 percent of L's stock. On October 1, 
1992, 15 of these investors each purchase 4 percent of L's stock.
    (ii) Under paragraph (a)(1)(i) of this section, the 15 investors 
(the ``Group'') are treated as an entity because the members of the 
Group purchase L stock pursuant to a formal or informal understanding 
among themselves to make a coordinated acquisition of stock. Sections 
1.382-2T (g)(1) and (j)(1) require that on October 1, 1992, the Group be 
aggregated into a separate public group, which has increased its 
ownership of L stock by 60 percentage points over its lowest level of 
ownership in the three-year period ending on October 1, 1992. 
Accordingly, an ownership change occurs on that date.
    Example 3. (i) Prior to October 1, 1992, L's 1,000 shares of 
outstanding stock were owned by unrelated individuals, none of whom 
owned five percent or more of the stock of L. On October 1, 1992, an 
investment advisor advises its clients that it believes L's stock is 
undervalued and recommends that they acquire L stock. Acting on the 
investment advisor's recommendation, 20 unrelated individuals purchase 6 
percent of L's stock in aggregate, with each individual purchasing less 
than 5 percent. Each client's decision was not based upon the investment 
decisions made by one or more other clients.
    (ii) Because there is no formal or informal understanding among the 
clients to make a coordinated acquisition of L stock, their purchase of 
stock is not made by an entity under paragraph (a)(1)(i) of this 
section. As a result, they remain part of the public group which owns L 
stock, and no owner shift results upon their purchase of L stock under 
Sec. 1.382-2T(e)(1)(ii).
    (iii) The result in this example would be the same under paragraph 
(a)(3)(i) of this section if the only additional fact was that the 
investment advisor is also the underwriter (without regard to whether it 
is a firm commitment or best efforts underwriting) for a primary or 
secondary offering of L stock.
    (iv) Assume that the facts are the same except that, instead of an 
investment advisor recommending that clients purchase L stock, the 
trustee of several trusts qualified under section 401(a) sponsored by 
unrelated corporations causes each trust to purchase the L stock. In 
this case, the result is the same, so long as the investment decision 
made on behalf of each trust was not based on the investment decision 
made on behalf of one or more of the other trusts.

    (iii) Effective date. (A) In general. The second, third and fourth 
sentences of paragraph (a)(1)(i) of this section and Examples 1, 2 and 3 
of paragraph (a)(1)(ii) of this section apply to testing dates 
(determined by applying such sentence and examples) on or after November 
20, 1990, but with respect to any group of persons that pursuant to a 
formal or informal understanding among themselves makes a coordinated 
acquisition of stock before November 20, 1990, only if the group 
increases or decreases its ownership of stock of the loss corporation 
relative to its percentage ownership interest at the close of November 
19, 1990, by five percentage points or more on or after November 20, 
1990.
    (B) Special rule. If pursuant to a formal or informal understanding 
among themselves a group consisting only of regulated investment 
companies under

[[Page 703]]

section 851, qualified trusts under section 401, common trust funds 
under section 584, or trusts or estates that are clients of a trust 
department of a bank under section 581, make a coordinated acquisition 
of stock before November 20, 1990, the second, third and fourth 
sentences of paragraph (a)(1)(i) of this section and Examples 1, 2, and 
3 of paragraph (a)(1)(ii) of this section apply for testing dates 
(determined by applying such sentences and examples) on or after 
November 20, 1990, only if the group increases its ownership of stock of 
the loss corporation relative to its percentage ownership interest at 
the close of November 19, 1990, by five percentage points or more on or 
after November 20, 1990.
    (C) Example. The following example illustrates the provisions of 
paragraph (a)(1)(iii) of this section.

    Example. Prior to November 1, 1990, L, a loss, corporation, is owned 
entirely by 1,000 unrelated individuals, none of whom owns as much as 5 
percent of the stock of L (``Public L''). On November 1, 1990, 15 
individuals (the ``Group'') each acquired 3 percent, or 45 percent, in 
total, of L stock pursuant to an understanding among themselves to make 
a coordinated acquisition of stock. The Group is not a corporation, 
trust, association, partnership or company. On March 1, 1992, six 
members of the Group each purchased an additional one percent of L 
stock, or 6 percent, in total, pursuant to the understanding. 
Accordingly, the Group increased its ownership in L stock by 51 
percentage points during the three-year testing period ending on March 
1, 1992. As a result, an ownership change of L occurs on March 1, 1992.
    (2) [Reserved]
    (b)-(i) [Reserved]
    (j) Modification of the segregation rules of Sec. 1.382-
2T(j)(2)(iii) and (3)--(1) Introduction. This paragraph (j) exempts, in 
whole or in part, certain transfers of stock from the segregation rules 
of Sec. 1.382-2T(j)(2)(iii) and (3). Terms and nomenclature used in 
this paragraph (j), and not otherwise defined herein, have the same 
meanings as in section 382 and the regulations issued under section 382.
    (2) Small issuance exception--(i) In general. Section 1.382-
2T(j)(2)(iii)(B) does not apply to a small issuance (as defined in 
paragraph (j)(2)(ii) of this section), except to the extent that the 
total amount of stock issued in that issuance and all other small 
issuances previously made in the same taxable year (determined in each 
case on issuance) exceeds the small issuance limitation. This paragraph 
(j)(2) does not apply to an issuance of stock that, by itself, exceeds 
the small issuance limitation.
    (ii) Small issuance defined. ``Small issuance'' means an issuance 
(other than an issuance described in paragraph (j)(6) of this section) 
by the loss corporation of an amount of stock not exceeding the small 
issuance limitation. For purposes of this paragraph (j)(2)(ii), all 
stock issued in the issuance is taken into account, including stock 
owned immediately after the issuance by a 5-percent shareholder that is 
not a direct public group.
    (iii) Small issuance limitation--(A) In general. For each taxable 
year, the loss corporation may, at its option, apply this paragraph 
(j)(2)--
    (1) On a corporation-wide basis, in which case the small issuance 
limitation is 10 percent of the total value of the loss corporation's 
stock outstanding at the beginning of the taxable year (excluding the 
value of stock described in section 1504(a)(4)); or
    (2) On a class-by-class basis, in which case the small issuance 
limitation is 10 percent of the number of shares of the class 
outstanding at the beginning of the taxable year.
    (B) Class of stock defined. For purposes of this paragraph 
(j)(2)(iii), a class of stock includes all stock with the same material 
terms.
    (C) Adjustments for stock splits and similar transactions. 
Appropriate adjustments to the number of shares of a class outstanding 
at the beginning of a taxable year must be made to take into account any 
stock split, reverse stock split, stock dividend to which section 305(a) 
applies, recapitalization, or similar transaction occurring during the 
taxable year.
    (D) Exception. The loss corporation may not apply this paragraph 
(j)(2)(iii) on a class-by-class basis if, during the taxable year, more 
than one class of stock is issued in a single issuance (or in two or 
more issuances that are treated as a single issuance under paragraph 
(j)(8)(ii) of this section).
    (iv) Short taxable years. In the case of a taxable year that is less 
than 365

[[Page 704]]

days, the small issuance limitation is reduced by multiplying it by a 
fraction, the numerator of which is the number of days in the taxable 
year, and the denominator of which is 365.
    (3) Other issuances of stock for cash--(i) In general. If the loss 
corporation issues stock solely for cash, Sec. 1.382-2T(j)(2)(iii)(B) 
does not apply to such stock in an amount equal (as a percentage of the 
total stock issued) to one-half of the aggregate percentage ownership 
interest of direct public groups immediately before the issuance.
    (ii) Solely for cash--(A) In general. A share of stock is not issued 
solely for cash if--
    (1) The acquiror, as a condition of acquiring that share for cash, 
is required to purchase other stock for consideration other than cash; 
or
    (2) The share is acquired upon the exercise of an option that was 
not issued solely for cash or was not distributed with respect to stock.
    (B) Related issuances. Paragraph (j)(8)(i) of this section (relating 
to the treatment of one or more issuances as a single issuance) does not 
apply in determining whether stock is issued solely for cash.
    (iii) Coordination with paragraph (j)(2) of this section. This 
paragraph (j)(3) does not apply to a small issuance exempted in whole 
from Sec. 1.382-2T(j)(2)(iii)(B) under paragraph (j)(2) of this 
section. In the case of a small issuance exempted in part from Sec. 
1.382-2T(j)(2)(iii)(B) under paragraph (j)(2) of this section, this 
paragraph (j)(3) applies only to the portion of the issuance not so 
exempted, and that portion is treated as a separate issuance for 
purposes of this paragraph (j)(3).
    (4) Limitation on exempted stock. The total amount of stock that is 
exempted from the application of Sec. 1.382-2T(j)(2)(iii)(B) under 
paragraphs (j)(2) and (j)(3) of this section cannot exceed the total 
amount of stock issued in the issuance less the amount of that stock 
owned by a 5-percent shareholder (other than a direct public group) 
immediately after the issuance. Except to the extent that the loss 
corporation has actual knowledge to the contrary, any increase in the 
amount of the loss corporation's stock owned by a 5-percent shareholder 
on the day of the issuance is considered to be attributable to an 
acquisition of stock in the issuance.
    (5) Proportionate acquisition of exempted stock--(i) In general. 
Each direct public group that exists immediately before an issuance to 
which paragraph (j)(2) or (j)(3) of this section applies is treated as 
acquiring its proportionate share of the amount of stock exempted from 
the application of Sec. 1.382-2T(j)(2)(iii)(B) under paragraph (j)(2) 
or (j)(3) of this section.
    (ii) Actual knowledge of greater overlapping ownership. Under the 
last sentence of Sec. 1.382-2T(k)(2), the loss corporation may treat 
direct public groups existing immediately before an issuance to which 
paragraph (j)(2) or (j)(3) of this section applies as acquiring in the 
aggregate more stock than the amount determined under paragraph 
(j)(5)(i) of this section, but only if the loss corporation actually 
knows that the aggregate amount acquired by those groups in the issuance 
exceeds the amount so determined.
    (6) Exception for equity structure shifts. This paragraph (j) does 
not apply to any issuance of stock in an equity structure shift, except 
that paragraph (j)(2) of this section applies (if its requirements are 
met) to the issuance of stock in a recapitalization under section 
368(a)(1)(E).
    (7) Transitory ownership by underwriter disregarded. For purposes of 
Sec. 1.382-2T(g)(1) and (j), and this paragraph (j), the transitory 
ownership of stock by an underwriter of the issuance is disregarded.
    (8) Certain related issuances. For purposes of this paragraph (j), 
two or more issuances (including issuances of stock by first tier or 
higher tier entities) are treated as a single issuance if--
    (i) The issuances occur at approximately the same time pursuant to 
the same plan or arrangement; or
    (ii) A principal purpose of issuing the stock in separate issuances 
rather than in a single issuance is to minimize or avoid an owner shift 
under the rules of this paragraph (j).
    (9) Application to options. The principles of this paragraph (j) 
apply for purposes of applying Sec. 1.382-2T(j)(2)(iii)(D) (relating to 
the deemed

[[Page 705]]

acquisition of stock as a result of the ownership of an option).
    (10) Issuance of stock pursuant to the exercise of certain options. 
If stock is issued on the exercise of a transferable option issued by 
the loss corporation, Sec. 1.382-2T(j)(2)(iii)(F) does not apply and, 
in applying the last sentence of Sec. 1.382-2T(k)(2), the loss 
corporation must take into account any transfers of the option 
(including transfers described in Sec. 1.382-2T(h)(4)(xi)). Therefore, 
even if transferable options are distributed pro rata to members of 
existing public groups, the actual knowledge exception of Sec. 1.382-
2T(k)(2) applies only to the extent that the loss corporation actually 
knows that the persons acquiring stock on exercise of the options are 
members of a pre-existing public group. Moreover, if transferable 
options are issued to more than one public group, Sec. 1.382-
2T(j)(2)(iii)(F) does not apply to treat the options as exercised pro 
rata by each such public group as the options are actually exercised.
    (11) Application to first tier and higher tier entities--(i) In 
general. The principles of paragraphs (j)(1) through (10) and paragraph 
(j)(12) apply to issuances of stock by a first tier entity or a higher 
tier entity that owns 5 percent or more of the loss corporation's stock 
(determined without regard to Sec. 1.382-2T(h)(2)(1)(A)).
    (ii) Small issuance limitation. In applying paragraph (j)(2) of this 
section to any issuance of stock by a first tier or higher tier entity, 
the small issuance limitations of paragraph (j)(2)(iii)(A) and (B) of 
this section are computed by reference to the stock value and the stock 
classes of the issuing corporation.
    (12) Certain non-stock ownership interests. As the context may 
require, a non-stock ownership interest in an entity other than a 
corporation is treated as stock for purposes of this paragraph (j).
    (13) Secondary transfer exception. The segregation rules of Sec. 
1.382-2T(j)(3)(i) will not apply to the transfer of a direct ownership 
interest in the loss corporation by a first tier entity or an individual 
that owns five percent or more of the loss corporation to public 
shareholders. Instead, each public group existing at the time of the 
transfer will be treated under Sec. 1.382-2T(j)(3)(i) as acquiring its 
proportionate share of the stock exempted from the application of Sec. 
1.382-2T(j)(3)(i). The segregation rules also will not apply if an 
ownership interest in an entity that owns five percent or more of the 
loss corporation (determined without regard to the application of Sec. 
1.382-2T(h)(2)(i)(A)) is transferred to a public owner or a 5-percent 
owner who is not a 5-percent shareholder of the loss corporation. 
Instead, provided that the transferor is either a 5-percent owner that 
is a 5-percent shareholder of the loss corporation or a higher tier 
entity owning five percent or more of the loss corporation (determined 
without regard to the application of section 1.382-2T(h)(2)(i)(A)), each 
public group of the entity existing at the time of the transfer is 
treated under Sec. 1.382-2T(j)(3)(i) as acquiring its proportionate 
share of the transferred ownership interest. With regard to a transferor 
that is neither a 5-percent shareholder of the loss corporation nor a 
higher tier entity owning five percent or more of the loss corporation 
(determined without regard to the application of Sec. 1.382-
2T(h)(2)(i)(A)), see generally Sec. 1.382-2T(e)(1)(ii) (disregarding 
these transactions if the transferee is not a 5-percent shareholder).
    (14) Small redemption exception--(i) In general. Section 1.382-
2T(j)(2)(iii)(C) does not apply to a small redemption (as defined in 
paragraph (j)(14)(ii) of this section), except to the extent that the 
total amount of stock redeemed in that redemption and all other small 
redemptions previously made in the same taxable year (determined in each 
case on redemption) exceeds the small redemption limitation. This 
paragraph (j)(14) does not apply to a redemption of stock that, by 
itself, exceeds the small redemption limitation.
    (ii) Small redemption defined. Small redemption means a redemption 
of public shareholders by the loss corporation of an amount of stock not 
exceeding the small redemption limitation.
    (iii) Small redemption limitation--(A) In general. For each taxable 
year, the loss corporation may, at its option, apply this paragraph 
(j)(14)--
    (1) On a corporation-wide basis, in which case the small redemption 
limitation is 10 percent of the total value

[[Page 706]]

of the loss corporation's stock outstanding at the beginning of the 
taxable year (excluding the value of stock described in section 
1504(a)(4)); or
    (2) On a class-by-class basis, in which case the small redemption 
limitation is 10 percent of the number of shares of the class redeemed 
that are outstanding at the beginning of the taxable year.
    (B) Class of stock defined. For purposes of this paragraph 
(j)(14)(iii), a class of stock includes all stock with the same material 
terms.
    (C) Adjustments for stock splits and similar transactions. 
Appropriate adjustments to the number of shares of a class outstanding 
at the beginning of a taxable year must be made to take into account any 
stock split, reverse stock split, stock dividend to which section 305(a) 
applies, recapitalization, or similar transaction occurring during the 
taxable year.
    (D) Exception. The loss corporation may not apply this paragraph 
(j)(14)(iii) on a class-by-class basis if, during the taxable year, more 
than one class of stock is redeemed in a single redemption (or in two or 
more redemptions that are treated as a single redemption under paragraph 
(j)(14)(v) of this section).
    (E) Short taxable years. In the case of a taxable year that is less 
than 365 days, the small redemption limitation is reduced by multiplying 
it by a fraction, the numerator of which is the number of days in the 
taxable year, and the denominator of which is 365.
    (iv) Proportionate redemption of exempted stock--(A) In general. 
Each direct public group that exists immediately before a redemption to 
which this paragraph (j)(14) applies is treated as having been redeemed 
of its proportionate share of the amount of stock exempted from the 
application of Sec. 1.382-2T(j)(2)(iii)(C) under this paragraph 
(j)(14).
    (B) Actual knowledge of greater redemption. Under the last sentence 
of Sec. 1.382-2T(k)(2), the loss corporation may treat direct public 
groups existing immediately before a redemption to which this paragraph 
(j)(14) applies as having been redeemed of more stock than the amount 
determined under paragraph (j)(14)(iv)(A) of this section, but only if 
the loss corporation actually knows that the amount redeemed from those 
groups in the redemption exceeds the amount so determined.
    (v) Certain related redemptions. For purposes of this paragraph 
(j)(14), two or more redemptions (including redemptions of stock by 
first tier or higher tier entities) are treated as a single redemption 
if--
    (A) The redemptions occur at approximately the same time pursuant to 
the same plan or arrangement; or
    (B) A principal purpose of redeeming the stock in separate 
redemptions rather than in a single redemption is to minimize or avoid 
an owner shift under the rules of this paragraph (j)(14).
    (vi) Certain non-stock ownership interests. As the context may 
require, a non-stock ownership interest in an entity other than a 
corporation is treated as stock for purposes of this paragraph (j)(14).
    (vii) Application to first tier and higher tier entities--(A) In 
general. The principles of this paragraph (j)(14) apply to redemptions 
of stock by a first tier entity or a higher tier entity that owns 5 
percent of the loss corporation stock (determined without regard to 
Sec. 1.382-2T(h)(2)(i)(A)).
    (B) Small redemption limitation. In applying this paragraph (j)(14) 
to any redemption of stock by a first tier or a higher tier entity, the 
small redemption limitations of paragraph (j)(14)(iii)(A) of this 
section are computed by reference to the stock value and the stock 
classes of the redeeming corporation.
    (15) Exception for first tier and higher tier entities--(i) In 
general. The segregation rules of Sec. 1.382-2T(j)(3)(iii) will not 
apply to a transaction involving stock in a first tier or a higher tier 
entity if, after taking into account the results of such transaction and 
all other transactions occurring on that date, the first tier or higher 
tier entity owns 10 percent or less (by value) of all the outstanding 
stock (without regard to Sec. 1.382-2(a)(3)) of the loss corporation.
    (ii) Anti-avoidance rule. The rules of paragraph (j)(15)(i) of this 
section do not apply to a transaction involving an ownership interest in 
a first tier or higher tier entity if the loss corporation, directly or 
through one or more

[[Page 707]]

persons, has participated in planning or structuring the transaction 
with a view to avoiding the application of the segregation rules. For 
this purpose, a transaction includes any event that would result in 
segregation under Sec. 1.382-2T(j)(3)(iii), absent the application of 
this paragraph (j)(15), and any event (for example, the formation of a 
holding company) occurring as part of the same plan that includes the 
event that would result in segregation (without the application of this 
paragraph (j)(15)). Other anti-avoidance rules continue to be 
applicable. See, for example, Sec. Sec. 1.382-2T(k)(4) and 1.382-
3(a)(1).
    (iii) Special rules. If application of paragraph (j)(15)(i) of this 
section results in the combination of public groups, then--
    (A) The amount of increase in the percentage of stock ownership of 
the continuing public group will be the sum of its increase and a 
proportionate amount of any increase by any public group that is 
combined with the continuing public group (the former public group); and
    (B) The continuing public group's lowest percentage ownership will 
be the sum of its lowest percentage ownership and a proportionate amount 
of the former public group's lowest percentage ownership.
    (iv) Ownership of the loss corporation. In making the determination 
under paragraph (j)(15)(i) of this section--
    (A) The rules of Sec. 1.382-2T(h)(2) will not apply;
    (B) The entity will be treated as owning the loss corporation stock 
that it actually owns, and any other loss corporation stock if that 
other stock would be attributed to the entity under section 318(a) 
(without regard to paragraph (4) thereof) unless an option is treated as 
exercised under Sec. 1.382-4(d)); and
    (C) The operating rules of paragraph (j)(15)(v) of this section will 
apply.
    (v) Operating rules. Subject to the principles of Sec. 1.382-
2T(k)(4), a loss corporation may establish the ownership limitation of 
paragraph (j)(15)(i) of this section through either--
    (A) Actual knowledge; or
    (B) Absent actual knowledge to the contrary, the presumptions 
regarding stock ownership in Sec. 1.382-2T(k)(1).
    (16) Examples. The provisions of this paragraph (j) are illustrated 
by the following examples:

    Example 1. (i) L corporation is a calendar year taxpayer. On January 
1, 1994, L has 1,000 shares of a single class of common stock 
outstanding, all of which are owned by a single direct public group 
(Public L). On February 1, 1994, L issues to employees as compensation 
60 new common shares of the same class. On May 1, 1994, L issues 50 new 
common shares of the same class solely for cash. Following each 
issuance, L's stock is owned entirely by public shareholders. No other 
changes in the ownership of L's stock occur prior to May 1, 1994. L 
chooses to determine its small issuance limitation for 1994 on a class-
by-class basis under paragraph (j)(2)(iii)(A)(2) of this section.
    (ii) The February issuance is a small issuance because the number of 
shares issued (60) does not exceed 100, the small issuance limitation 
(10 percent of the number of common shares outstanding on January 1, 
1994). Under paragraph (j)(2) of this section, the segregation rules of 
Sec. 1.382-2T(j)(2)(iii)(B) do not apply to the February issuance. 
Under paragraph (j)(5) of this section, Public L is treated as acquiring 
all 60 shares issued.
    (iii) The May issuance is a small issuance because the number of 
shares issued (50) does not exceed 100, the small issuance limitation 
(10 percent of the number of common shares outstanding on January 1, 
1994). However, under paragraph (j)(2) of this section, only 40 of the 
50 shares issued are exempted from the segregation rules of Sec. 1.382-
2T(j)(2)(iii)(B) because the total number of shares of common stock 
issued in the February and May issuances exceeds 100, the small issuance 
limitation, by 10. Because the May issuance is solely for cash, 
paragraph (j)(3) of this section exempts 5 of the 10 remaining shares 
from the segregation rules of Sec. 1.382-2T(j)(2)(iii)(B) (10 shares 
multiplied by 50 percent, one-half of Public L's 100 percent ownership 
interest immediately before the May issuance--1,060 shares/1,060 
shares). Accordingly, under paragraph (j)(5) of this section, Public L 
is treated as acquiring 45 shares in the May issuance. Section 1.382-
2T(j)(2)(iii)(B) applies to the remaining 5 shares issued, which are 
treated as acquired by a direct public group separate from Public L. 
Each such public group is treated as an individual who is a separate 5-
percent shareholder. See Sec. 1.382-2T (g)(1)(iv) and (j)(1)(ii).
    (iv) Assume that L actually knows that at least 10 shares of the May 
issuance are acquired by members of Public L. The result is the same. 
See paragraph (j)(5)(ii) of this section.
    (v) Assume instead that L actually knows that all 50 shares of the 
May issuance are acquired by members of Public L. Under paragraph 
(j)(5)(ii) of this section, L may treat

[[Page 708]]

Public L as acquiring 50 shares in the May issuance.
    Example 2. (i) L corporation is a calendar year taxpayer. On January 
1, 1995, L has 1,000 shares of Class A common stock outstanding, the 
aggregate value of which is $1,000. Five hundred shares are owned by one 
direct public group (Public 1), and 500 shares are owned by another 
direct public group (Public 2). On August 1, 1995, L issues 200 shares 
of Class B common stock for $200 cash. A, an individual, acquires 120 
Class B shares in the transaction. The remaining 80 Class B shares are 
acquired by public shareholders. No other changes in ownership of L's 
stock occur prior to August 1, 1995.
    (ii) The August issuance is not a small issuance. The total value of 
the Class B stock issued ($200) exceeds $100, the small issuance 
limitation as calculated under paragraph (j)(2)(iii)(A)(1) of this 
section (10 percent of the value of L's stock on January 1, 1995). The 
total number of Class B shares issued (200) exceeds 0, the small 
issuance limitation as calculated under paragraph (j)(2)(iii)(A)(2) of 
this section (10 percent of the number of Class B shares outstanding on 
January 1, 1995). Accordingly, paragraph (j)(2) of this section does not 
apply to the August issuance.
    (iii) Paragraph (j)(3) of this section, as limited by paragraph 
(j)(4) of this section, exempts 80 Class B shares from the segregation 
rule of Sec. 1.382-2T(j)(2)(iii)(B). Paragraph (j)(3) of this section, 
without regard to paragraph (j)(4) of this section, would exempt 100 
Class B shares: the product of the 200 Class B shares issued and 50 
percent (one-half of the combined 100 percent pre-issuance ownership 
interest of Public 1 and Public 2). Paragraph (j)(4), however, limits 
the total number of Class B shares that may be excluded to 80 Class B 
shares: the difference between the 200 shares issued and the 120 shares 
acquired by A. Under paragraph (j)(5) of this section, Public 1 and 
Public 2 are treated as acquiring the 80 exempted Class B shares. 
Because Public 1 and Public 2 each owned 500 Class A shares prior to the 
issuance, Public 1 and Public 2 are considered to acquire 40 Class B 
shares each.
    Example 3. (i) L has 1,000 shares of a single class of common stock 
outstanding, all of which are owned by a direct public group (Public L). 
At the same time pursuant to the same plan, L issues 500 shares of its 
stock to its creditors in exchange for its outstanding debt and 500 
shares of its stock to the public for cash. Assume that the separate 
issuances of stock for debt and stock for cash do not have a principal 
purpose of minimizing or avoiding an owner shift. L has no individual 5-
percent shareholders immediately after the issuances.
    (ii) The 500 shares of stock issued by L to its former creditors 
were not issued solely for cash. Therefore, paragraph (j)(3) of this 
section does not apply to those 500 shares, which are treated as owned 
by a public group separate from Public L. See Sec. 1.382-
2T(j)(2)(iii)(B)(1)(ii).
    (iii) Paragraph (j)(3) of this section applies to the 500 shares of 
stock issued by L to the public because that stock was issued solely for 
cash. Because the two issuances occur at the same time pursuant to the 
same plan, they are generally treated as a single issuance for purposes 
of this paragraph (j). See paragraph (j)(8)(i) of this section. The 
treatment of the two issuances as a single issuance does not apply, 
however, for the purpose of determining whether the stock issued to the 
public was issued solely for cash. See paragraph (j)(3)(ii)(B) of this 
section.
    (iv) Paragraph (j)(3) of this section applies to exempt 250 of the 
500 shares issued solely for cash from the segregation rules of Sec. 
1.382-2T(j)(2)(iii)(B) (the product of the 500 shares issued for cash 
and 50 percent (one-half of the 100 percent pre-issuance ownership 
interest of Public L)). The creditors that receive stock in exchange for 
their debt would not be treated as acquiring any of the 250 exempted 
shares even if their exchange of debt for stock occurs prior to the cash 
issuance. Paragraph (j)(5)(i) of this section allocates exempted shares 
among the direct public groups that exist immediately before an 
issuance. Because the issuance for cash and the issuance for debt are 
generally treated as a single issuance, the public group comprised of 
the former creditors of L was not a public group that existed 
immediately before the issuance.
    (v) Three public groups owning L stock exist immediately after the 
two issuances. Public L owns 1,250 shares--the 1,000 shares it owned 
prior to the issuances plus the 250 shares it is treated as acquiring in 
the cash issuance. A separate group comprised of the former creditors of 
L owns the 500 shares issued for debt. A third public group owns the 250 
shares that are not treated as acquired by Public L in the cash 
issuance.
    Example 4. (i) L has 1,000 shares of a single class of common stock 
outstanding, all of which are owned by a direct public group (Public L). 
L issues 1,000 shares pursuant to an offer under which 500 shares must 
be acquired in exchange for debt and the remainder may be acquired for 
cash. Under the terms of the offer, only persons that acquire stock for 
debt are eligible to acquire stock for cash. L has no 5-percent 
shareholders other than direct public groups immediately after the 
issuance.
    (ii) As a condition of acquiring shares for cash, the creditors are 
required to purchase stock for debt. Therefore, paragraph (j)(3) of this 
section does not apply to any part of the issuance because it is not an 
issuance of stock solely for cash. The segregation rules of Sec. 1.382-
2T(j)(2)(iii)(B) apply to treat all

[[Page 709]]

1,000 shares as acquired by a new public group separate from Public L.
    Example 5. Secondary transfer exception to segregation rules--no new 
public group. (i) Facts. L is owned 60 percent by one public group 
(Public L1) and 40 percent by another public group (Public 
L2). On July 1, 2014, individual A acquires 10 percent of L's 
stock over a public stock exchange. On December 31, 2014, A sells all of 
his L stock over a public stock exchange. No individual or entity 
acquires as much as five percent of L's stock as a result of A's 
disposition of his L stock. On January 3, 2015, individual B acquires 10 
percent of L's stock over a public stock exchange. On June 30, 2015, B 
sells all of her L stock over a public stock exchange. No individual or 
entity acquires as much as five percent of L's stock as a result of B's 
disposition of her L stock.
    (ii) Analysis. The dispositions of the L stock by A and B are not 
transactions that cause the segregation of L's direct public groups that 
exist immediately before the transaction (Public L1 and 
Public L2). When A and B sell their shares to public 
shareholders over the public stock exchange, the shares are treated as 
being reacquired by Public L1 and Public L2. As a 
result, Public L1's ownership interest is treated as 
increasing from 54 percent to 60 percent during the testing period, and 
Public L2's ownership interest is treated as increasing from 
36 percent to 40 percent during the testing period.
    Example 6. Secondary transfer exception--first tier entity. (i) 
Facts. L has a single class of common stock outstanding that is owned 60 
percent by a direct public group (Public L) and 40 percent by P. P is 
owned 20 percent by individual A and 80 percent by a direct public group 
(Public P). On October 6, 2014, A sells 50 percent of his interest in P 
to B, an individual who is, and remains, a member of Public P.
    (ii) Analysis. P is an entity that owns five percent or more of L. A 
is a 5-percent owner of P that is a 5-percent shareholder of L. Because 
A's sale of the P stock is to a member of Public P, the disposition of 
the P stock by A is not a transaction that causes the segregation of P's 
direct public group that exists immediately before the transaction 
(Public P). See paragraph (j)(13) of this section. When A sells his 
shares to B, the shares are treated as being acquired by Public P. As a 
result, Public P's ownership interest in L is treated as increasing from 
32 percent to 36 percent during the testing period.
    Example 7. Small redemption exception. (i) Facts. L is a calendar 
year taxpayer. On January 1, 2014, L has 1,060 shares of a single class 
of common stock outstanding, all of which are owned by a single direct 
public group (Public L). On July 1, 2014, L acquires 60 shares of its 
stock for cash. On December 31, 2014, in an unrelated redemption, L 
acquires 90 more shares of its stock for cash. Following each 
redemption, L's stock is owned entirely by public shareholders. No other 
changes in the ownership of L's stock occur prior to December 31, 2014.
    (ii) Analysis--(A) July redemption. The July redemption is a small 
redemption because the number of shares redeemed (60) does not exceed 
106, the small redemption limitation (10 percent of the number of common 
shares outstanding on January 1, 2014). Under paragraph (j)(14) of this 
section, the segregation rules of Sec. 1.382-2T(j)(2)(iii)(C) do not 
apply to the July redemption. Under paragraph (j)(14)(iv) of this 
section, Public L is treated as having all 60 shares redeemed.

    (B) December redemption. The December redemption is a small 
redemption because the number of shares redeemed (90) does not exceed 
106, the small redemption limitation (10 percent of the number of common 
shares outstanding on January 1, 2014). However, under paragraph 
(j)(14)(i) of this section, only 46 of the 90 shares redeemed are 
exempted from the segregation rules of Sec. 1.382-2T(j)(2)(iii)(C) 
because the total number of shares of common stock redeemed in the July 
and December redemptions exceeds 106, the small redemption limitation, 
by 44. Accordingly, under paragraph (j)(14)(iv) of this section, Public 
L is treated as having 46 shares redeemed in the December redemption. 
Section 1.382-2T(j)(2)(iii)(C) applies to the remaining 44 shares 
redeemed. Accordingly, Public L is segregated into two different public 
groups immediately before the transaction (and thereafter) so that the 
redeemed interests (Public RL) are treated as part of a public group 
that is separate from the ownership interests that are not redeemed 
(Public CL). Therefore, as a result of the December redemption, Public 
CL's interest in L increases by 4.4 percentage points (from 95.6 percent 
(956/1,000) to 100 percent (910/910)) on the December 31, 2014 testing 
date. For purposes of determining whether an ownership change occurs on 
any subsequent testing date having a testing period that includes the 
December redemption, Public CL is treated as a 5-percent shareholder 
whose percentage ownership interests in L increased by 4.4 percentage 
points as a result of such redemption.

    Example 8. Segregation rules inapplicable--proportionate amount. (i) 
Facts. P1 is a corporation that owns 8 percent of the stock 
of

[[Page 710]]

L. The remaining L stock (92 percent) is owned by Public L. 
P1 is entirely owned by Public P1. P2 
is a corporation owned 90 percent by individual A and 10 percent by a 
public group (Public P2). On May 22, 2014, P1 
merges into P2 with the shareholders of P1 
receiving an amount of P2 stock equal to 25 percent of the 
value of P2 immediately after the reorganization. L was owned 
92 percent by Public L and 8 percent by P1 throughout the 
testing period ending on the date of the merger.
    (ii) Analysis. Assuming L can establish that P2 owns 10 
percent or less (by value) of L on May 22, 2014 pursuant to the 
operating rules of paragraph (j)(15)(v) of this section, the segregation 
rules of Sec. 1.382-2T(j)(3)(iii) will not apply to segregate 
P1's direct public group (Public P1) immediately 
before the merger from P2's direct public group (Public 
P2). Thus, following the merger, P2 is owned 67.5 
percent (90 percent x 75 percent) by A and 32.5 percent (25 percent + 
(10 percent x 75 percent)) by Public P2. Pursuant to 
paragraph (j)(15)(iii)(B) of this section, Public P2's lowest 
percentage of ownership is the sum of its lowest percentage of ownership 
(zero) and a proportionate amount of former Public P1's 
lowest ownership percentage of L of 2.6 percent (32.5 percent x 8 
percent). P2 will be treated as having one public group whose 
ownership interest in L was 2.6 percent before the merger and remains 
2.6 percent after the merger. Because Public P2 owns less 
than 5 percent of L, Public P2 is treated as part of Public 
L. See Sec. 1.382-2T(j)(1)(iv). Thus, pursuant to paragraph 
(j)(15)(iii)(B) of this section, Public L's lowest ownership percentage 
of L during the testing period is 94.6 percent.
    Example 9. Segregation rules inapplicable--prior increase in 
ownership by former public group during testing period. (i) Facts. The 
facts are the same as Example 8, except that P1 acquired its 
8 percent interest in L during the testing period that includes the 
merger.
    (ii)  Analysis. Pursuant to the rules of paragraph (j)(15)(iii)(A) 
of this section, the amount of increase in the percentage of stock 
ownership by Public P2 is the sum of its increase (zero) and 
a proportionate amount of the increase by former Public P1 of 
2.6 percent (32.5 percent x 8 percent). Pursuant to paragraph 
(j)(15)(iii)(B) of this section, Public P2's lowest 
percentage of ownership is zero, because both former Public 
P1 and Public P2 owned no L stock at the beginning 
of the testing period. Accordingly, Public P2, the continuing 
public group, is treated as having increased its ownership interest by 
2.6 percent. Because Public P2 is treated as part of Public 
L, Public L is treated as increasing its ownership interest by 2.6 
percent.
    Example 10. Ownership limitation based upon fair market value. (i) 
Facts. L has one class of common stock and one class of preferred stock 
outstanding. The preferred stock is stock within the meaning of Sec. 
1.382-2(a)(3). Before December 23, 2014, a direct public group (Public 
L) owns all of the common stock of L. On December 23, 2014, P purchases 
all of the preferred stock of L and a portion of the common stock of L. 
On the date of purchase, the value of the L common stock held by P was 
greater than 5 percent of the value of L, and the total value of L 
common and L preferred stock held by P was less than 10 percent of the 
value of all stock of L. P has one class of common stock outstanding, 
all of which is owned by a direct public group (Public P). On October 7, 
2015, P redeems 30 percent of its single outstanding class of common 
stock. On the redemption date of the P stock, due to a decline in the 
relative value of the common stock of L, the preferred stock of L owned 
by P represents 40 percent of the value of all the outstanding stock of 
L. No ownership change of L occurs between December 23, 2014, and 
October 7, 2015.
    (ii) Analysis. The rules of paragraph (j)(15) of this section do not 
apply to the redemption because P owns more than 10 percent of L (by 
value) on that date.
    Example 11. Ownership limitation--fair market value includes 
preferred stock. The facts are the same as in Example 10, except that 
the preferred stock is not stock within the meaning of Sec. 1.382-
2(a)(3). Although the preferred stock is not stock for the purpose of 
determining owner shifts, the value of that stock is taken into account 
in computing the 10-percent limitation of paragraph (j)(15)(i) of this 
section. Therefore, the results are the same as in Example 10.
    Example 12. Ownership limitation--application of attribution rules. 
(i) Facts. Individual A owns all the outstanding stock of X. A also owns 
preferred stock in Y that is not stock within the meaning Sec. 1.382-
2(a)(3), which represents 50 percent of the value of Y. All the Y common 
stock is owned by public owners. Each of X and Y own 6 percent of the 
single class of L stock outstanding. On October 6, 2014, Y redeems 15 
percent of its common stock.
    (ii) Analysis. In determining satisfaction of the ownership 
limitation of paragraph (j)(15)(i) of this section, the attribution 
rules of section 318(a) apply. Pursuant to section 318(a)(2), A is 
treated as owning the L stock owned by X. Pursuant to section 318(a)(3), 
Y is treated as owning the L stock that A indirectly owns. Because Y's 
ownership of L exceeds the 10 percent ownership limitation of paragraph 
(j)(15)(i) of this section, the rules of paragraph (j)(15) of this 
section do not apply.
    Example 13. Anti-avoidance rule. (i) Facts. P1 is a 
corporation that owns 10 percent of the stock of L. P1 is 
owned entirely by a direct public group (Public P). L has had owner 
shifts of 45 percentage points in its current

[[Page 711]]

testing period. P1 is planning to merge into P2, a 
corporation which has a public group. Advisers to L, upon learning of 
the proposed merger, asked the management of P1 for details 
of the proposed merger, including the stock ownership of P2 
after P1 merges into P2. After finding out that 
information, L or L's advisers did not request any changes in the 
planned transaction.
    (ii) Analysis. The anti-avoidance rule of paragraph (j)(15)(ii) of 
this section does not apply because L did not participate in planning or 
structuring the transaction. Pursuant to paragraph (j)(15)(i) of this 
section, Sec. 1.382-2T(j)(3)(iii) does not apply to cause the 
segregation of P1's public group from P2's public 
group.

    (17) Effective/applicability date. This paragraph (j) generally 
applies to issuances or deemed issuances of stock in taxable years 
beginning on or after November 4, 1992. However, paragraphs (j)(11)(ii) 
and (j)(13) through (15) of this section and Examples 5 through 13 of 
paragraph (j)(16) of this section apply to testing dates occurring on or 
after October 22, 2013, other than with respect to the sale of a Program 
Instrument by the Treasury Department. For purposes of this paragraph 
(j)(17), a Program Instrument is an instrument issued pursuant to a 
Program, as defined in Internal Revenue Service Notice 2010-2 (2010-2 
IRB 251 (December 16, 2009)) (see Sec. 601.601(a)(2)(ii)(b) of this 
chapter), or a Covered Instrument, as defined in that Notice. Taxpayers 
may apply paragraphs (j)(11)(ii) and (j)(13) through (15) of this 
section and Examples 5 through 13 of paragraph (j)(16) of this section 
in their entirety (other than with respect to a sale of a Program 
Instrument by the Treasury Department) to all testing dates that are 
included in a testing period beginning before and ending on or after 
October 22, 2013. However, the provisions described in the preceding 
sentence may not be applied to any date on or before the date of any 
ownership change that occurred before October 22, 2013, under the 
regulations in effect before October 22, 2013, and they may not be 
applied as described in the preceding sentence if such application would 
result in an ownership change occurring on a date before October 22, 
2013, that did not occur under the regulations in effect before October 
22, 2013. See Sec. 1.382-3(j)(14)(ii) and (iii), as contained in 26 CFR 
part 1 revised as of April 1, 1994 for the application of paragraph 
(j)(10) of this section to stock issued on the exercise of certain 
options exercised on or after November 4, 1992, and for an election to 
apply paragraphs (j)(1) through (12) of this section retroactively to 
certain issuances and deemed issuances of stock occurring in taxable 
years prior to November 4, 1992.
    (k) Special rules for certain regulated investment companies--(1) In 
general. The segregation rules of Sec. 1.382-2T(j)(2) do not apply to 
the issuance (as described in Sec. 1.382-2T(j)(2)(iii)(B)(1)(ii)) or 
the redemption (as described in Sec. 1.382-2T(j)(2)(iii)(C)) of any 
redeemable security, as defined in 15 U.S.C. 80a-2(a)(32), by a 
regulated investment company in the ordinary course of business.
    (2) Effective date--(i) General rule. Paragraph (k)(1) of this 
section applies to testing dates after December 31, 1986. A corporation 
may file an amended return for taxable years ending before August 21, 
1992 (subject to any applicable statute of limitations) to take into 
account paragraph (k)(1) of this section only if corresponding 
adjustments are made in amended returns for all affected taxable years 
ending after December 31, 1986 (subject to any applicable statute of 
limitations).
    (ii) Election to apply prospectively. A corporation may elect to 
apply paragraph (k)(1) of this section only to testing dates on or after 
October 29, 1991. The election must be made on the first return which is 
filed after October 20, 1992 by stating on such return, ``This is an 
Election To Apply Sec. 1.382-3(k)(1) Only to Testing Dates on or After 
October 29, 1991.''

[T.D. 8428, 57 FR 38282, Aug. 24, 1992. Redesignated by T.D. 8440, 57 FR 
45712, Oct. 5, 1992; 57 FR 52827, Nov. 5, 1992; T.D. 8490, 59 FR 51573, 
Oct. 4, 1993; T.D. 9638, 78 FR 62423, Oct. 22, 2013; T.D. 9685, 79 FR 
44282, July 31, 2014; T.D. 9721, 80 FR 31997, June 5, 2015]



Sec. 1.382-4  Constructive ownership of stock.

    (a) In general. [Reserved]
    (b) Attribution from corporations, partnerships, estates and trusts. 
(1) [Reserved].
    (2) Limitation. Section 1.382-2T(h)(2)(i)(A) applies solely for 
purposes of determining whether a loss corporation has an ownership 
change.

[[Page 712]]

    (c) Attribution to corporations, partnerships, estates and trusts. 
[Reserved]
    (d) Treatment of options as exercised--(1) General rule. Except as 
provided in paragraph (d)(2) of this section, an option is not treated 
as exercised under section 382(l)(3)(A).
    (2) Options treated as exercised--(i) Issuance or transfer. For 
purposes of determining whether an ownership change occurs, an option is 
treated as exercised on the date of its issuance or transfer if, on that 
date, the option satisfies--
    (A) The ownership test of paragraph (d)(3) of this section,
    (B) The control test of paragraph (d)(4) of this section, or
    (C) The income test of paragraph (d)(5) of this section.
    (ii) Subsequent testing dates. Except as provided in paragraph 
(d)(10) of this section, an option that is treated as exercised on the 
date of its issuance or transfer is treated as exercised on any 
subsequent testing date (as defined in Sec. 1.382-2(a)(4)) for purposes 
of determining whether an ownership change occurs.
    (3) The ownership test. An option satisfies the ownership test if a 
principal purpose of the issuance, transfer, or structuring of the 
option (alone or in combination with other arrangements) is to avoid or 
ameliorate the impact of an ownership change of the loss corporation by 
providing the holder of the option, prior to its exercise or transfer, 
with a substantial portion of the attributes of ownership of the 
underlying stock.
    (4) The control test--(i) In general. An option satisfies the 
control test if--
    (A) A principal purpose of the issuance, transfer, or structuring of 
the option (alone or in combination with other arrangements) is to avoid 
or ameliorate the impact of an ownership change of the loss corporation, 
and
    (B) The holder of the option and any persons related to the option 
holder have, in the aggregate, a direct and indirect ownership interest 
in the loss corporation of more than 50 percent (determined as if the 
increase in such persons' percentage ownership interest that would 
result from the exercise of the option in question and any other options 
to acquire stock held by such persons, and any other intended increases 
in such persons' percentage ownership interest, actually occurred on the 
date the option is issued or transferred).
    (ii) Operating rules--(A) Person and related persons. For purposes 
of this paragraph (d)(4)--
    (1) The term person includes an individual or entity, but not a 
public group, as defined in Sec. 1.382-2T(f)(13), and
    (2) Persons are related if they bear a relationship specified in 
section 267(b) or 707(b) or if they have a formal or informal 
understanding among themselves to make a coordinated acquisition of 
stock, within the meaning of Sec. 1.382-3(a)(1)(i).
    (B) Indirect ownership interest. The indirect ownership interest 
that the holder of the option and any persons related to the holder have 
in the loss corporation is determined by applying the constructive 
ownership rules of Sec. 1.382-2T(h), other than Sec. 1.382-
2T(h)(2)(i)(A) (which treats stock attributed pursuant to section 
318(a)(2) as no longer being owned by the entity from which it is 
attributed) and Sec. 1.382-2T(h)(4) (which treats options as exercised 
in certain circumstances). If, however, the application of such 
constructive ownership rules without regard to Sec. 1.382-
2T(h)(2)(i)(A) would result in the same stock of the loss corporation 
being owned by two or more such persons, appropriate adjustments must be 
made so that such stock is not counted more than once in computing the 
aggregate ownership interests of such persons.
    (5) The income test. An option satisfies the income test if a 
principal purpose of the issuance, transfer, or structuring of the 
option (alone or in combination with other arrangements) is to avoid or 
ameliorate the impact of an ownership change of the loss corporation by 
facilitating the creation of income (including accelerating income or 
deferring deductions) or value (including unrealized built-in gains) 
prior to the exercise or transfer of the option.
    (6) Application of the ownership, control, and income tests--(i) In 
general. Whether an option satisfies the ownership, control, or income 
test depends on all the relevant facts and circumstances. Among the 
factors that

[[Page 713]]

are relevant in applying all three tests are any business purposes for 
the issuance, transfer, or structure of the option, the likelihood of 
exercise of the option (taking into account, for example, any 
contingencies to its exercise), transactions related to the issuance or 
transfer of the option, and the consequences of treating the option as 
exercised.
    An option is not treated as exercised under any of the three tests, 
however, if a principal purpose of its issuance, transfer, or 
structuring is to avoid an ownership change by having it treated as 
exercised. Paragraphs (d)(6)(ii), (iii) and (iv) of this section 
describe additional examples of factors that are relevant in applying 
each test. The weight given to any factor depends on all the facts and 
circumstances. The presence or absence of any factor described in this 
paragraph (d)(6) does not create a presumption.
    (ii) Application of ownership test. Among the additional factors 
that are taken into account in applying the ownership test are the 
relationship, at the time of issuance or transfer of the option, between 
the exercise price of the option and the value of the underlying stock, 
whether the option provides its holder or a related person with the 
right to participate in the management of the loss corporation or with 
other rights that ordinarily would be afforded to owners of the 
underlying stock, and the existence of reciprocal options (e.g., a call 
option held by the prospective purchaser and a corresponding put option 
held by the prospective seller). The ability of the holder of an option 
with a fixed exercise price to share in future appreciation of the 
underlying stock is also a relevant factor, but is not sufficient, by 
itself, for the option to satisfy the ownership test. Conversely, the 
fact that the holder of such an option does not bear the risk of loss 
due to declines in value of the underlying stock does not preclude the 
option from satisfying the ownership test.
    (iii) Application of control test. Among the additional factors that 
are taken into account in applying the control test are the economic 
interests in the loss corporation of the option holder or related 
persons and the influence of those persons over the management of the 
loss corporation (in either case, through the option or a related 
arrangement, or through rights in stock).
    (iv) Application of income test. Among the additional factors that 
are taken into account in applying the income test are whether, in 
connection with the issuance or transfer of the option, the loss 
corporation engages in income acceleration transactions or the holder of 
the option or a related person purchases stock (including section 
1504(a)(4) stock) from, or makes a capital contribution or loan to, the 
loss corporation that can reasonably be expected to avoid or ameliorate 
the impact of an ownership change. Examples of income acceleration 
transactions are those outside the ordinary course of the loss 
corporation's business that accelerate income or gain into the period 
prior to the exercise of the option (or defer deductions to the period 
after the exercise of the option). A stock purchase, capital 
contribution, or loan is more probative toward an option satisfying the 
income test the larger the amount received by the loss corporation in 
the transaction or related transactions. A stock purchase, capital 
contribution, or loan is generally not taken into account in applying 
the income test if it is made to enable the loss corporation to continue 
basic operations of its business (e.g., to meet the monthly payroll or 
fund other operating expenses of the loss corporation).
    (7) Safe harbors. Except as provided in paragraph (d)(7)(i) of this 
section, an option described in this paragraph (d)(7) is not treated as 
exercised pursuant to the ownership, control, or income test. The 
failure of an option to be described in this paragraph (d)(7) does not 
affect the determination of whether the option satisfies the ownership, 
income, or control test. The following options are described in this 
paragraph (d)(7):
    (i) Contracts to acquire stock. A stock purchase agreement or a 
similar arrangement, the terms of which are commercially reasonable, in 
which the parties' obligations to complete the transaction are subject 
only to reasonable closing conditions, and which is closed on a change 
date within one year after it is entered into. An option

[[Page 714]]

is not exempt from the income test of paragraph (d)(5) of this section 
solely by reason of its description in this paragraph (d)(7)(i).
    (ii) Escrow, pledge, or other security agreements. An option that is 
part of a security arrangement in a typical lending transaction 
(including a purchase money loan), if the arrangement is subject to 
customary commercial conditions. For this purpose, a security 
arrangement includes, for example, an agreement for holding stock in 
escrow or under a pledge or other security agreement, or an option to 
acquire stock contingent upon a default under a loan.
    (iii) Compensatory options. An option to acquire stock in a 
corporation with customary terms and conditions provided to an employee, 
director, or independent contractor in connection with the performance 
of services for the corporation or a related person (and that is not 
excessive by reference to the services performed) and which--
    (A) Is nontransferable within the meaning of Sec. 1.83-3(d); and
    (B) Does not have a readily ascertainable fair market value as 
defined in Sec. 1.83-7(b) on the date the option is issued.
    (iv) Options exercisable only upon death, disability, mental 
incompetency, or retirement. An option entered into between stockholders 
of a corporation (or a stockholder and the corporation) with respect to 
stock of either stockholder, that is exercisable only upon the death, 
disability, mental incompetency of the stockholder, or, in the case of 
stock acquired in connection with the performance of services for the 
corporation or a related person (and that is not excessive by reference 
to the services performed), the stockholder's retirement.
    (v) Rights of first refusal. A bona fide right of first refusal with 
customary terms, entered into between stockholders of a corporation (or 
between the corporation and a stockholder), and regarding the 
corporation's stock.
    (vi) Options designated in the Internal Revenue Bulletin. An option 
designated by the Internal Revenue Service in the Internal Revenue 
Bulletin as being exempt from one or more of the ownership, control, or 
income tests. See Sec. 601.601(d)(2)(ii) of this chapter (relating to 
the Internal Revenue Bulletin).
    (8) Additional rules--(i) Contracts to acquire stock. For purposes 
of this paragraph (d), a contract is considered to be issued or 
transferred on the date it is entered into or assigned, respectively.
    (ii) Indirect transfer of an option. If an entity is formed or 
availed of for a principal purpose of facilitating an indirect transfer 
of an option by issuing or transferring interests in the entity, an 
issuance or transfer of an interest in the entity will be treated as a 
transfer of the option for purposes of applying the ownership, control, 
and income tests of paragraphs (d)(3) through (5) of this section.
    (iii) Options related to interests in non-corporate entities. The 
rules of this paragraph (d) apply, with appropriate adjustments, to 
options to acquire or transfer interests in non-corporate entities.
    (iv) Puts. In applying the rules of this section to puts, 
appropriate adjustments must be made to take into account that the put 
provides its holder with a right to transfer, instead of acquire, stock.
    (9) Definition of option--(i) In general. Any contingent purchase, 
warrant, convertible debt, put, stock subject to a risk of forfeiture, 
contract to acquire stock, or similar interest is treated as an option 
for purposes of this paragraph (d), regardless of whether it is 
contingent or otherwise not currently exercisable.
    (ii) Convertible stock. Convertible stock is treated as an option 
for purposes of this paragraph (d) (in addition to being treated as 
stock under Sec. 1.382-2(a)(3)(ii)) only if the terms of the conversion 
feature permit or require consideration other than the stock being 
converted.
    (iii) Series of options. For purposes of this paragraph (d), an 
option to acquire an option with respect to the stock of the loss 
corporation, and each one of a series of such options, is treated as an 
option to acquire such stock.
    (iv) General principles of tax law. This paragraph (d) does not 
affect the determination under general principles of tax law (such as 
substance over form) of whether an instrument is an option or stock.

[[Page 715]]

    (10) Subsequent treatment of options treated as exercised on a 
change date--(i) In general. The following rules apply to options that 
are treated as exercised under paragraph (d)(2) of this section on a 
change date:
    (A) The option is not treated as exercised under paragraph (d)(2) of 
this section on any testing date after the change date and prior to a 
transfer of the option that would itself (i.e., without regard to the 
purposes for the issuance or any prior transfers of the option) cause 
the option to satisfy the ownership test of paragraph (d)(3) of this 
section, the control test of paragraph (d)(4) of this section, or the 
income test of paragraph (d)(5) of this section; and
    (B) The exercise of the option, if by the person who owned the 
option immediately after the ownership change (or by a transferee of the 
option who acquired the option, directly or indirectly, from that person 
in one or more transfers described in paragraph (d)(11) of this 
section), does not contribute to another ownership change on any testing 
date on or after the date of exercise.
    (ii) Alternative look-back rule for options exercised within 3 years 
after change date. If a loss corporation, on its return, as originally 
filed, for a taxable year that includes a change date, properly treats 
an option as exercised under paragraph (d)(2) of this section on the 
change date, and the option is actually exercised within three years 
after the change date, the loss corporation may treat the rules of 
paragraph (d)(10)(i) of this section as inapplicable to the option and 
instead treat the option as having been exercised on the change date for 
the purpose of determining whether an ownership change occurs on any and 
all testing dates after the change date (filing such amended returns as 
may be necessary for taxable years ending after the change date and 
before the date of exercise of the option). A transfer after the change 
date of an option to which this paragraph (d)(10)(ii) applies is treated 
as a transfer of the stock subject to the option. The exercise of an 
option to which this paragraph (d)(10)(ii) applies is not taken into 
account for the purpose of determining whether an ownership change 
occurs on or after the date of exercise.
    (11) Transfers not subject to deemed exercise. Paragraph (d)(2) of 
this section does not apply to the transfer of an option (including a 
transfer described in paragraph (d)(8)(i) or (ii) of this section), if--
    (i) Neither the transferor nor the transferee is a 5-percent 
shareholder and neither person would be a 5-percent shareholder if all 
options held by that person to acquire stock were treated as exercised;
    (ii) The transfer is between members of separate public groups 
resulting from the application of the segregation rules of Sec. 1.382-
2T(j)(2) and (3)(iii); or
    (iii) The transfer occurs in any of the circumstances described in 
section 382(l)(3)(B) (relating to stock acquired by reason of death, 
gift, divorce, separation, etc.).
    (12) Certain rules regarding non-stock interests as stock. Section 
1.382-2T(f)(18)(iii) does not apply to treat an option (whether or not 
treated as exercised under this paragraph (d)) as stock.
    (e) Stock transferred under certain agreements. [Reserved]
    (f) Family attribution. [Reserved]
    (g) Definitions. The terms and nomenclature used in this section, 
and not otherwise defined herein, have the same meaning as in section 
382 and the regulations thereunder.
    (h) Effective date--(1) In general. [Reserved]
    (2) Option attribution rules--(i) General rule. The rules of 
paragraph (d) of this section apply, instead of the rules of Sec. 
1.382-2T(h)(4), on any testing date on or after November 5, 1992. See 
paragraph (h)(2)(vi) of this section for an election relating to the 
effective date.
    (ii) Special rule for control test. An option issued on or before 
March 17, 1994, or an option issued within 60 days after that date 
pursuant to a plan existing before that date, is not treated as 
exercised under the control test provided in paragraph (d)(4) of this 
section on any testing date prior to a transfer of the option after 
March 17, 1994 that would itself cause the option to satisfy the control 
test.
    (iii) Convertible stock issued prior to July 20, 1988--(A) In 
general. Except as

[[Page 716]]

provided in paragraph (h)(2)(iii)(B) of this section, convertible stock 
issued prior to July 20, 1988, is not treated as an option subject to 
the rules of Sec. 1.382-2T(h)(4) or paragraph (d)(2) of this section.
    (B) Exceptions--(1) Nonvoting convertible preferred stock. 
Convertible stock issued prior to July 20, 1988, is treated as an option 
subject to the rules of Sec. 1.382-2T(h)(4) or paragraph (d)(2) of this 
section if--
    (i) The stock, when issued, would be described in section 1504(a)(4) 
by disregarding subparagraph (D) thereof and by ignoring the potential 
participation in corporate growth that the conversion feature may offer; 
and
    (ii) The loss corporation makes the election described in Notice 88-
67, 1988-1 C.B. 555 (see Sec. 601.601(d)(2)(ii)(b) of this chapter for 
availability of Cumulative Bulletins (C.B.)), on or before the earlier 
of the date prescribed in Notice 88-67 or December 7, 1992.
    (2) Other convertible stock. Convertible stock issued prior to July 
20, 1988, is treated as an option subject to the rules of Sec. 1.382-
2T(h)(4) or paragraph (d)(2) of this section if--
    (i) The terms of the conversion feature permit or require the tender 
of consideration other than the stock being converted; and
    (ii) The loss corporation makes the election described in Notice 88-
67 on or before the date prescribed in the Notice.
    (iv) Convertible stock issued on or after July 20, 1988, and before 
November 5, 1992. Convertible stock issued on or after July 20, 1988, 
and before November 5, 1992, is treated as an option subject to the 
rules of Sec. 1.382-2T(h)(4) or paragraph (d) of this section only if--
    (A) The stock, when issued, would be described in section 1504(a)(4) 
by disregarding subparagraph (D) thereof and by ignoring the potential 
participation in corporate growth that the conversion feature may offer; 
or
    (B) The terms of the conversion feature permit or require the tender 
of consideration other than the stock being converted.
    (v) Certain options in existence immediately before and after an 
ownership change. If an option existed immediately before and after an 
ownership change occurring on a testing date to which Sec. 1.382-
2T(h)(4) applies--
    (A) The option is not treated as exercised under paragraph (d)(2) of 
this section on any testing date after the change date and prior to a 
transfer of the option that would itself cause the option to satisfy the 
ownership test of paragraph (d)(3) of this section, the control test of 
paragraph (d)(4) of this section, or the income test of paragraph (d)(5) 
of this section; and
    (B) Except as provided in Sec. 1.382-2T(m)(4)(vi) (which relates to 
the effective date of the rules provided in Sec. 1.382-2T(h)(4) and 
includes a special rule related to options that are actually exercised 
within 120 days after they are treated as exercised under that section), 
the actual exercise of the option, if by the person who owned the option 
immediately after the ownership change (or by a transferee of the option 
who acquired the option, directly or indirectly, from that person in one 
or more transfers described in paragraph (d)(11) of this section), will 
not contribute to an ownership change on any testing date on or after 
the date of exercise.
    (vi) Election to apply Sec. 1.382-2T(h)(4)--(A) In general. If a 
loss corporation makes an election under this paragraph (h)(2)(vi), 
Sec. Sec. 1.382-2T(a)(2)(i) and (h)(4) (relating to testing dates and 
option attribution) apply (instead of the definition of testing date in 
Sec. 1.382-2(a)(4) and paragraph (d) of this section) for the purpose 
of determining whether an ownership change occurs--
    (1) On any testing date on or before May 17, 1994, or
    (2) In the case of a loss corporation that is under the jurisdiction 
of a court in a title 11 or similar case filed on or before May 17, 
1994, subject to Sec. 1.382-9(o)(1), on any testing date at or before 
the time the plan of reorganization becomes effective.
    (B) Additional consequences of election. If a loss corporation makes 
an election under this paragraph (h)(2)(vi)--
    (1) In determining whether any convertible preferred stock issued by 
the loss corporation during the period that the election is in effect is 
treated as stock or as an option, the convertible preferred stock is 
treated as if it were issued on November 4, 1992, and

[[Page 717]]

    (2) The special effective date for the control test provided in 
paragraph (h)(2)(ii) of this section does not apply to any option with 
respect to stock of the loss corporation.
    (C) Time and manner of making the election. The election described 
in paragraph (h)(2)(vi)(A) of this section is made by attaching a 
statement to the loss corporation's income tax return for the first 
taxable year ending after November 4, 1992, in which a testing date 
(within the meaning of Sec. 1.382-2T(a)(2)(i)) occurs, or if such 
return is filed on or before May 17, 1994, with its first return filed 
after May 17, 1994. However, a loss corporation that is under the 
jurisdiction of a court in a title 11 or similar case filed on or before 
May 17, 1994, may make the election described in paragraph (h)(2)(vi)(A) 
by attaching a statement to its tax return for its first taxable year 
ending after that date. The statement must say ``THIS IS AN ELECTION 
UNDER Sec. 1.382-4(h)(2)(vi) TO APPLY Sec. 1.382-2T(h)(4) ON OR AFTER 
NOVEMBER 5, 1992.'' Any amended returns required by paragraph 
(h)(2)(vi)(D) of this section must accompany the return with which the 
election is made. An election under paragraph (h)(2)(vi)(A) of this 
section is irrevocable.
    (D) Amended returns. If an election under this paragraph (h)(2)(vi) 
affects the amount of taxable income or loss for a prior taxable year, 
the loss corporation (or the common parent of any consolidated group of 
which the loss corporation was a member for the year) must file an 
amended return for the year that reflects the effect of the election.
    (3) Special rule for options subject to attribution under Sec. 
1.382-2T(h)(4). Section Sec. 1.382-2T(h)(4)(i) does not apply to any 
option designated by the Internal Revenue Service in the Internal 
Revenue Bulletin as being excepted from the operation of Sec. 1.382-
2T(h)(4)(i).

[T.D. 8531, 59 FR 12837, Mar. 18, 1994, as amended by T.D. 8825, 64 FR 
36178, July 2, 1999]



Sec. 1.382-5  Section 382 limitation.

    (a) Scope. Following an ownership change, the section 382 limitation 
for any post-change year is an amount equal to the value of the loss 
corporation multiplied by the long-term tax-exempt rate that applies 
with respect to the ownership change, and adjusted as required by 
section 382 and the regulations thereunder. See, for example, section 
382(b)(2) (relating to the carryforward of unused section 382 
limitation), section 382(b)(3)(B) (relating to the section 382 
limitation for the post-change year that includes the change date), 
section 382(m)(2) (relating to short taxable years), and section 382(h) 
(relating to recognized built-in gains and section 338 gains).
    (b) Computation of value. [Reserved]
    (c) Short taxable year. The section 382 limitation for any post-
change year that is less than 365 days is the amount that bears the same 
ratio to the section 382 limitation determined under section 382(b)(1) 
as the number of days in the post-change year bears to 365. The section 
382 limitation, as so determined, is adjusted as required by section 382 
and the regulations thereunder. This paragraph (c) does not apply to a 
52-53 week taxable year that is less than 365 days unless a return is 
required under section 443 (relating to short periods) for such year.
    (d) Successive ownership changes and absorption of a section 382 
limitation--(1) In general. If a loss corporation has two (or more) 
ownership changes, any losses or section 382 disallowed business 
interest carryforwards ((within the meaning of Sec. 1.382-2(a)(7)) 
attributable to the period preceding the earlier ownership change are 
treated as pre-change losses with respect to both ownership changes. 
Thus, the later ownership change may result in a lesser (but never in a 
greater) section 382 limitation with respect to such pre-change losses. 
In any case, the amount of taxable income for any post-change year that 
can be offset by pre-change losses may not exceed the section 382 
limitation for such ownership change, reduced by the amount of taxable 
income offset by pre-change losses subject to any earlier ownership 
change(s).
    (2) Recognized built-in gains and losses. [Reserved]
    (3) Effective date. This paragraph (d) applies to taxable years of a 
loss corporation beginning on or after January 1, 1997.

[[Page 718]]

    (e) Controlled groups. See Sec. 1.382-8 for rules for determining 
the value of a loss corporation that is a member of a controlled group.
    (f) Effective date. Except as otherwise provided, this section 
applies to a loss corporation that has an ownership change to which 
section 382(a), as amended by the Tax Reform Act of 1986, applies. 
Paragraph (d)(1) of this section applies with respect to an ownership 
change occurring on or after November 13, 2020. For loss corporations 
that have undergone an ownership change before or after November 13, 
2020, see Sec. 1.382-5 as contained in 26 CFR part 1, revised April 1, 
2019. However, taxpayers and their related parties, within the meaning 
of sections 267(b) and 707(b)(1), may choose to apply the rules of this 
section to testing dates occurring during a taxable year beginning after 
December 31, 2017, so long as the taxpayers and their related parties 
consistently apply the rules of this section, the section 163(j) 
regulations (as defined in Sec. 1.163(j)-1(b)(37)), Sec. Sec. 1.382-1, 
1.382-2, 1.382-6, 1.382-7, 1.383-0, and 1.383-1, and, if applicable, 
Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 
1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 
1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they 
effectuate the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and 1.383-
1), and 1.1504-4, to that taxable year.

[T.D. 8679, 61 FR 33316, June 27, 1996, as amended by T.D. 8825, 64 FR 
36178, July 2, 1999; T.D. 9905, 85 FR 56835, Sept. 14, 2020]



Sec. 1.382-6  Allocation of income and loss to periods before and 
after the change date for purposes of section 382.

    (a) General rule--(1) In general. Except as provided in paragraphs 
(b) and (d) of this section, a loss corporation must allocate its net 
operating loss or taxable income (see section 382(k)(4)), and its net 
capital loss (see section 1222(10)) or modified capital gain net income 
(as defined in paragraph (g)(4) of this section), for the change year 
between the pre-change period and the post-change period by ratably 
allocating an equal portion to each day in the year.
    (2) Allocation of business interest expense--(i) Scope. Except as 
provided in paragraph (b)(4) of this section, this paragraph (a)(2) 
applies if a loss corporation has business interest expense (as defined 
in Sec. 1.163(j)-1(b)(3)) in the change year. The rules of this 
paragraph (a)(2) apply to determine the amount of current-year business 
interest expense (as defined in Sec. 1.163(j)-1(b)(9)) that is deducted 
in the change year. These rules also apply to determine the amount of 
any current-year business interest expense that is characterized as 
disallowed business interest expense (as defined in Sec. 1.163(j)-
1(b)(10)) allocable to the pre-change period and the post-change period, 
and to allocate disallowed business interest expense carryforwards (as 
defined in Sec. 1.163(j)-1(b)(11)) to the change year for deduction in 
the pre-change period and the post-change period.
    (ii) Deductibility of business interest expense. The rules of this 
paragraph (a)(2)(ii) apply in the following order.
    (A) First, the loss corporation calculates its section 163(j) 
limitation (as defined in Sec. 1.163(j)-1(b)(36)) for the change year.
    (B) Second, the loss corporation calculates its deductible current-
year BIE and deducts this amount in determining its taxable income or 
net operating loss for the change year. For purposes of this paragraph 
(a)(2)(ii), the term deductible current-year BIE means the loss 
corporation's current-year business interest expense (including its 
floor plan financing interest expense, as defined in Sec. 1.163(j)-
1(b)(19)), to the extent of its section 163(j) limitation.
    (C) Third, if the loss corporation has disallowed business interest 
expense paid or accrued (without regard to section 163(j)) in the change 
year that is carried forward to post-change years, it allocates an equal 
portion of that disallowed business interest expense to each day in the 
change year. Any amount of disallowed business interest expense that is 
allocated to the pre-change period pursuant to this paragraph 
(a)(2)(ii)(C) is carried forward subject to section 382(d)(3). Any 
amount of disallowed business interest expense that is allocated to the 
post-change period pursuant to this paragraph (a)(2)(ii)(C) is carried 
forward and is not subject to section 382(d)(3).
    (D) Fourth, if the loss corporation has excess section 163(j) 
limitation,

[[Page 719]]

then the loss corporation calculates its deductible disallowed business 
interest expense carryforward and allocates an equal portion to each day 
in the change year. For purposes of this paragraph (a)(2)(ii), the term 
excess section 163(j) limitation means the excess, if any, of the loss 
corporation's section 163(j) limitation over its deductible current-year 
BIE, and the term deductible disallowed business interest expense 
carryforward means the loss corporation's disallowed business interest 
expense carryforward to the extent of its excess section 163(j) 
limitation.
    (E) Fifth, the loss corporation deducts its deductible disallowed 
business interest expense carryforward that was allocated to the pre-
change period under paragraph (a)(2)(ii)(D) of this section. Subject to 
the application of sections 382(b)(3)(B) and 382(d)(3), the loss 
corporation deducts its deductible disallowed business interest expense 
carryforward that was allocated to the post-change period under 
paragraph (a)(2)(ii)(D) of this section. Any amount of disallowed 
business interest expense carryforward that is not deducted pursuant to 
this paragraph (a)(2)(ii)(E) is carried forward subject to section 
382(d)(3).
    (b) Closing-of-the-books election--(1) In general. Subject to 
paragraphs (b)(3)(ii), (b)(4), and (d) of this section, a loss 
corporation may elect to allocate its net operating loss or taxable 
income and its net capital loss or modified capital gain net income for 
the change year between the pre-change period and the post-change period 
as if the loss corporation's books were closed on the change date. An 
election under this paragraph (b)(1) does not terminate the loss 
corporation's taxable year as of the change date (e.g., the change year 
is a single tax year for purposes of section 172).
    (2) Making the closing-of-the-books election--(i) Time and manner. A 
loss corporation makes the closing-of-the-books election by including 
the following statement on the information statement required by Sec. 
1.382-11(a) for the change year: ``THE CLOSING-OF-THE-BOOKS ELECTION 
UNDER Sec. 1.382-6(b) IS HEREBY MADE WITH RESPECT TO THE OWNERSHIP 
CHANGE OCCURRING ON [INSERT DATE].'' The election must be made on or 
before the due date (including extensions) of the loss corporation's 
income tax return for the change year.
    (ii) Election irrevocable. An election under this paragraph (b) is 
irrevocable.
    (3) Special rules relating to consolidated and controlled groups--
(i) Consolidated groups. If an election under this paragraph (b) is made 
with respect to an ownership change occurring in a consolidated return 
year, all allocations under this section with respect to that ownership 
change must be consistent with the election.
    (ii) Controlled groups. If paragraph (b)(3)(i) of this section does 
not apply, and if, as part of the same plan or arrangement, two or more 
members of a controlled group (as defined in section 1563(a), determined 
by substituting ``50 percent'' for ``80 percent'' each place that it 
appears, and without regard to section 1563(a)(4)), have ownership 
changes and continue to be members of the controlled group (or become 
members of the same other controlled group), a closing-of-the-books 
election applies only if the election is made by all members having the 
ownership changes.
    (4) Allocation of business interest expense--(i) Scope. This 
paragraph (b)(4) applies if a loss corporation makes a closing-of-the-
books election pursuant to paragraph (b) of this section and has 
business interest expense in the change year. The rules of this 
paragraph (b)(4) apply to determine the amount of deductible current-
year business interest expense that is allocable to the pre-change 
period and the post-change period for purposes of the allocations 
referred to in paragraph (b)(1) of this section. These rules also apply 
to determine the amount of any current-year business interest expense 
that is characterized as disallowed business interest expense allocable 
to the pre-change period and the post-change period, and to allocate 
disallowed business interest expense carryforwards to the change year 
between the pre-change period and the post-change period for deduction.
    (ii) Deductibility of business interest expense. The rules of this 
paragraph (b)(4)(ii) apply in the order provided.
    (A) The loss corporation calculates its ATI limit, which is the 
product of

[[Page 720]]

its ATI (as defined in Sec. 1.163(j)-1(b)(1)) for the change year and 
30 percent. For purposes of this paragraph (b)(4)(ii), the terms pre-
change ATI limit and post-change ATI limit mean the amount of ATI limit 
allocated to the pre-change period or the post-change period, 
respectively, computed by allocating an equal portion of the ATI limit 
to each day in the change year.
    (B) Pursuant to paragraph (b)(1) of this section, the loss 
corporation allocates its current-year business interest expense 
(including its floor plan financing interest expense) and its business 
interest income (as defined in Sec. 1.163(j)-1(b)(4)) to the pre-change 
and post-change periods as if the loss corporation's books were closed 
on the change date. For purposes of this paragraph (b)(4)(ii), the terms 
pre-change BIE and post-change BIE mean the amount of the loss 
corporation's current-year business interest expense that is allocated 
to the pre-change period or the post-change period, respectively, under 
this paragraph (b)(4)(ii)(B).
    (C) The loss corporation deducts its pre-change BIE to the extent of 
its pre-change section 163(j) limit, and the loss corporation deducts 
its post-change BIE to the extent of its post-change section 163(j) 
limit. For purposes of this paragraph (b)(4)(ii), the term pre-change 
section 163(j) limit means the sum of the pre-change ATI and the amount 
of business interest income and floor plan financing interest expense 
allocated to the pre-change period; the term post-change section 163(j) 
limit means the sum of the post-change ATI limit and the amount of 
business interest income and floor plan financing interest expense 
allocated to the post-change period.
    (D) If any pre-change BIE or post-change BIE has not been deducted 
under paragraph (b)(4)(ii)(C) of this section, the loss corporation 
deducts either any pre-change BIE that has not been deducted to the 
extent of its surplus post-change section 163(j) limit or any post-
change BIE that has not been deducted to the extent of its surplus pre-
change section 163(j) limit. For purposes of this paragraph (b)(4)(ii), 
the term surplus pre-change section 163(j) limit means the amount by 
which the pre-change section 163(j) limit exceeds the amount of pre-
change BIE deducted pursuant to paragraph (b)(4)(ii)(C) of this section; 
the term surplus post-change section 163(j) limit means the amount by 
which the post-change section 163(j) limit exceeds the amount of post-
change BIE deducted pursuant to paragraph (b)(4)(ii)(C) of this section.
    (E) If the loss corporation has any excess pre-change section 163(j) 
limit or excess post-change section 163(j) limit, the loss corporation 
allocates its disallowed business interest expense carryforward, if any, 
ratably between the pre-change and post-change periods based upon the 
relative amounts of excess pre-change section 163(j) limit and excess 
post-change section 163(j) limit. For purposes of this paragraph 
(b)(4)(ii), the term excess pre-change section 163(j) limit means the 
amount by which the surplus pre-change section 163(j) limit exceeds the 
amount of post-change BIE deducted pursuant to paragraph (b)(4)(ii)(D) 
of this section; the term excess post-change section 163(j) limit means 
the amount by which the surplus post-change section 163(j) limit exceeds 
the amount of pre-change BIE deducted pursuant to paragraph 
(b)(4)(ii)(D) of this section.
    (F) The loss corporation deducts its disallowed business interest 
expense carryforward that was allocated to the pre-change period under 
paragraph (b)(4)(ii)(E) of this section to the extent of its excess pre-
change section 163(j) limit. Subject to the application of sections 
382(b)(3)(B) and 382(d)(3), the loss corporation deducts its disallowed 
business interest expense carryforward that was allocated to the post-
change period under paragraph (b)(4)(ii)(E) of this section to the 
extent of its excess post-change section 163(j) limit. Any amount of 
disallowed business interest expense carryforward that is not deducted 
pursuant to this paragraph (b)(4)(ii)(F) is subject to section 382(d)(3) 
irrespective of the period to which it was allocated pursuant to 
paragraph (b)(4)(ii)(E) of this section.
    (iii) Example 1--(A) Facts. X is a calendar-year domestic C 
corporation that is not a member of a consolidated group. As of January 
1, 2021, X has no disallowed business interest expense carryforwards. On 
October 19, 2021, X

[[Page 721]]

experiences an ownership change under section 382(g). For calendar year 
2021, X's ATI is $500. For the period beginning on January 1, 2021 and 
ending on October 19, 2021, X pays or accrues $250 of current-year 
business interest expense that is deductible but for the potential 
application of section 163(j), including $50 of floor plan financing 
interest expense, and X has $60 of business interest income. For the 
period beginning on October 20, 2021 and ending on December 31, 2021, X 
pays or accrues $100 of current-year business interest expense that is 
deductible but for the potential application of section 163(j), 
including $40 of floor plan financing interest expense, and X has $70 of 
business interest income. X makes a closing-of-the-books election 
pursuant to paragraph (b) of this section.
    (B) Analysis--(1) Calculation and allocation of ATI limit. For 
purposes of allocating its net operating loss or taxable income for the 
change year between the pre-change period and the post-change period 
under Sec. 1.382-6, X applies paragraph (b)(4) of this section to 
allocate items related to section 163(j). X's ATI for calendar year 2021 
is $500x. Therefore, pursuant to paragraph (b)(4)(ii)(A) of this 
section, X's ATI limit is $150 ($500 x 30 percent). Additionally, 
pursuant to paragraph (b)(4)(ii)(A) of this section, X's pre-change ATI 
limit is $120 ($150 x (292 days/365 days)), and X's post-change ATI 
limit is $30 ($150 x (73 days/365 days)).
    (2) Determination of pre-change BIE and post-change BIE. Pursuant to 
paragraph (b)(4)(ii)(B) of this section, X's pre-change BIE and post-
change BIE are $250 and $100, respectively.
    (3) Determination of pre-change section 163(j) limit and post-change 
section 163(j) limit. Pursuant to paragraph (b)(4)(ii)(C) of this 
section, X's pre-change section 163(j) limit is $230 ($120 (X's pre-
change ATI limit) + $60 (X's business interest income allocated to the 
pre-change period) + $50 (X's floor plan financing interest expense 
allocated to the pre-change period)). Additionally, pursuant to 
paragraph (b)(4)(ii)(C) of this section, X's post-change section 163(j) 
limit is $140 ($30 (X's post-change ATI limit) + $70 (X's business 
interest income allocated to the post-change period) + $40 (X's floor 
plan financing interest expense allocated to the post-change period)).
    (4) Initial deduction of BIE. Pursuant to paragraph (b)(4)(ii)(C) of 
this section, X deducts $230 (its pre-change section 163(j) limit) of 
its $250 pre-change BIE and all $100 (less than its $140 post-change 
section 163(j) limit) of its post-change BIE.
    (5) Deduction of BIE due to surplus post-change section 163(j) 
limit. After applying paragraph (b)(4)(ii)(C) of this section, X has $20 
of pre-change BIE that has not been deducted ($250-$230) and a surplus 
post-change section 163(j) limit of $40 ($140-$100). As a result, 
pursuant to paragraph (b)(4)(ii)(D) of this section, X deducts its 
remaining $20 of pre-change BIE. (If, after applying paragraph 
(b)(4)(ii)(C) of this section, X instead had $20 of post-change BIE that 
had not yet been deducted and a $40 surplus pre-change section 163(j) 
limit, then X would deduct its remaining $20 of post-change BIE pursuant 
to paragraph (b)(4)(ii)(D) of this section.)
    (iv) Example 2--Potential deduction of disallowed business interest 
expense carryforwards. The facts are the same as in paragraph 
(b)(4)(iii)(A) of this section, except that, as of January 1, 2021, X 
has $90 of disallowed business interest expense carryforwards and $150 
(rather than $250) of pre-change BIE. X's pre-change section 163(j) 
limit and post-change section 163(j) limit are the same as in paragraph 
(b)(4)(iii)(B)(3) of this section. Pursuant to paragraph (b)(4)(ii)(C) 
of this section, X deducts all $150 of its pre-change BIE and all $100 
of its post-change BIE. X has no remaining pre-change BIE or post-change 
BIE to deduct under paragraph (b)(4)(ii)(D) of this section. Paragraph 
(b)(4)(ii)(E) of this section applies because X has $80 of excess pre-
change section 163(j) limit ($230-$150) and $40 of excess post-change 
section 163(j) limit ($140-$100). Under paragraph (b)(4)(ii)(E) of this 
section, X allocates $60 of its disallowed business interest expense 
carryforwards to the pre-change period ($90 x ($80/($80 + $40))) and $30 
of its disallowed business interest expense carryforwards to the post-
change period ($90 x ($40/($80 + $40))). As provided in paragraph 
(b)(4)(ii)(F) of

[[Page 722]]

this section, X deducts all $60 of its disallowed business interest 
expense carryforwards that are allocated to the pre-change period; 
subject to the application of section 382, X deducts all $30 of its 
disallowed business interest expense carryforwards that are allocated to 
the post-change period.
    (c) Operating rules for determining net operating loss, taxable 
income, net capital loss, modified capital gain net income, and special 
allocations. For purposes of this section, for the change year--
    (1) In general--(i) Net operating loss or taxable income is 
determined without regard to gains or losses on the sale or exchange of 
capital assets; and
    (ii) Net operating loss or taxable income and net capital loss or 
modified capital gain net income are determined without regard to the 
section 382 limitation and do not include the following items, which are 
allocated entirely to the post-change period--
    (A) Any income, gain, loss, or deduction to which section 
382(h)(5)(A) applies; and
    (B) Any income or gain recognized on the disposition of assets 
transferred to the loss corporation during the post-change period for a 
principal purpose of ameliorating the section 382 limitation.
    (2) Adjustment to net operating loss--(i) Determination of remaining 
capital gain. The amount of modified capital gain net income (defined in 
paragraph (g)(4) of this section) allocated to each period is offset by 
capital losses to which section 382(h)(5)(A) applies and capital loss 
carryovers, subject to the section 382 limitation (in the case of 
modified capital gain net income allocated to the post-change period).
    (ii) Reduction of net operating loss by remaining capital gain. The 
amount of net operating loss allocated to each period is reduced (but 
not below zero) without regard to the section 382 limitation, first by 
the modified capital gain net income remaining in the same period, and 
then by the modified capital gain net income remaining in the other 
period.
    (d) Coordination with rules relating to the allocation of income 
under Sec. 1.1502-76(b). If Sec. 1.1502-76 applies (relating to the 
taxable year of members of a consolidated group), an allocation of items 
under paragraph (a) or (b) of this section is determined after applying 
Sec. 1.1502-76. Thus, if a short taxable year under Sec. 1.1502-76 is 
a change year for which an allocation under this section is to be made, 
the allocation under this section applies only to the items allocated to 
that short taxable year under Sec. 1.1502-76.
    (e) Allocation of certain credits. The principles of this section 
apply for purposes of allocating, under section 383, excess foreign 
taxes under section 904(c), current year business credits under section 
38, and the minimum tax credit under section 53. The loss corporation 
must use the same method of allocation (ratable allocation or closing-
of-the-books) for purposes of sections 382 and 383.
    (f) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1. (i) Assume that the loss corporation, L, a calendar year 
taxpayer with a May 26, 1995, change date, determines a section 382 
limitation under section 382(b)(1) of $100,000. Thus, for the change 
year, its section 382 limitation is $100,000 x (219/365) = $60,000. L 
makes the closing-of-the- books election under paragraph (b) of this 
section.
    (ii) Assume that L has a $150,000 capital loss carryover (from its 
1994 taxable year) and a $300,000 net operating loss carryover (from its 
1994 taxable year) to the change year. L recognizes, in the pre-change 
period, $200,000 of ordinary loss, and, in the post-change period, 
$150,000 of capital gain and $100,000 of ordinary income. Assume that 
section 382(h) does not apply to the capital gain or the ordinary 
income.
    (iii) L has a $100,000 net operating loss for the change year 
($200,000 pre-change loss less $100,000 post-change income), as 
determined under paragraph (c)(1)(i) of this section. Because L has no 
current year capital losses, L's $150,000 capital gain recognized in the 
post-change period is its modified capital gain net income for the 
change year (as defined at paragraph (g)(4) of this section). L 
allocates $100,000 of net operating loss to the pre-change period and 
$150,000 of modified capital gain net income to the post-change period.
    (iv) Under paragraph (c)(2)(i) of this section, L uses its capital 
loss carryover to offset its modified capital gain net income allocated 
to the post-change period, subject to its section 382 limitation. L's 
section 382 limitation is $60,000, so L uses $60,000 of its capital loss 
carryover to offset $60,000 of its $150,000 modified capital gain net 
income. L has absorbed its entire section 382 limitation

[[Page 723]]

for the change year and has $90,000 of modified capital gain net income 
remaining in the post-change period.
    (v) Under paragraph (c)(2)(ii) of this section, L offsets its 
$100,000 net operating loss allocated to the pre-change period by the 
$90,000 of modified capital gain net income remaining in the post-change 
period, without regard to the section 382 limitation, thereby reducing 
its pre-change net operating loss to $10,000.
    (vi) From its 1994 taxable year, L will carry over $90,000 of 
capital loss and $300,000 of net operating loss to its 1996 taxable 
year. From its 1995 taxable year, L will carry over $10,000 of net 
operating loss subject to the section 382 limitation to its 1996 taxable 
year.
    Example 2. (i) Assume the facts of Example 1, except that L does not 
make the closing-of-the-books election under paragraph (b) of this 
section.
    (ii) L ratably allocates its $100,000 net operating loss and its 
$150,000 of modified capital gain net income for the change year. 
$40,000 of net operating loss ($100,000 x (146/365)) and $60,000 of 
modified capital gain net income ($150,000 x (146/365)) are allocated to 
the pre-change period. $60,000 of net operating loss ($100,000 x (219/
365)) and $90,000 of modified capital gain net income ($150,000 x (219/
365)) are allocated to the post-change period.
    (iii) Under paragraph (c)(2)(i) of this section, L uses its capital 
loss carryovers to offset modified capital gain net income. The capital 
loss carryovers offset the $60,000 modified capital gain net income 
allocated to the pre-change period without limitation. Subject to the 
section 382 limitation, the remaining $90,000 of capital loss carryovers 
offset the modified capital gain net income allocated to the post-change 
period. Accordingly, L uses $60,000 of its capital loss carryovers to 
offset $60,000 of its $90,000 modified capital gain net income allocated 
to the post-change period. L has absorbed its entire section 382 
limitation for the change year.
    (iv) Under paragraph (c)(2)(ii) of this section, L's $60,000 net 
operating loss allocated to the post-change period is offset by its 
remaining $30,000 of post-change modified capital gain net income, 
reducing its post-change net operating loss to $30,000.
    (v) From its 1994 taxable year, L will carry over $30,000 of capital 
loss and $300,000 of net operating loss to its 1996 taxable year. From 
its 1995 taxable year, L will carry over $70,000 of net operating loss 
($40,000 pre-change + $30,000 post-change) to its 1996 taxable year. The 
$40,000 pre-change portion of that carryover is subject to the section 
382 limitation.

    (g) Definitions and nomenclature. The terms and nomenclature used in 
this section and not otherwise defined herein have the same meanings as 
in sections 382 and 383 and the regulations thereunder. For purposes of 
this section:
    (1) Change year. A loss corporation's taxable year that includes the 
change date is its change year.
    (2) Pre-change period. The pre-change period is the portion of the 
change year ending on the close of the change date.
    (3) Post-change period. The post-change period is the portion of the 
change year beginning with the day after the change date.
    (4) Modified capital gain net income. A loss corporation's modified 
capital gain net income is the excess of the gains from sales or 
exchanges of capital assets over the losses from such sales or exchanges 
for the change year, determined by excluding any short-term capital 
losses under section 1212.
    (h) Applicability date--(1) In general. This section applies to 
ownership changes occurring on or after June 22, 1994.
    (2) Ownership changes. Paragraphs (a) and (b)(1) and (4) of this 
section apply with respect to an ownership change occurring during a 
taxable year beginning on or after November 13, 2020. For ownership 
changes occurring during a taxable year beginning before November 13, 
2020, see Sec. 1.382-6 as contained in 26 CFR part 1, revised April 1, 
2019. However, taxpayers and their related parties, within the meaning 
of sections 267(b) and 707(b)(1), may choose to apply the rules of this 
section to testing dates occurring during a taxable year beginning after 
December 31, 2017, so long as the taxpayers and their related parties 
consistently apply the rules of this section, the section 163(j) 
regulations (as defined in Sec. 1.163(j)-1(b)(37)), Sec. Sec. 1.382-1, 
1.382-2, 1.382-5, 1.383-0, and 1.383-1, and, if applicable, Sec. Sec. 
1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-
5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 
1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate 
the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, 1.382-7, and 1.383-
1), and 1.1504-4, to taxable years beginning after December 31, 2017.

[T.D. 8546, 59 FR 32080, June 22, 1994, as amended by T.D. 9264, 71 FR 
30607, May 30, 2006; T.D. 9329, 72 FR 32808, June 14, 2007; T.D. 9905, 
85 FR 56835, Sept. 14, 2020]

[[Page 724]]



Sec. 1.382-7  Built-in gains and losses.

    (a) Treatment of prepaid income. For purposes of section 382(h), 
prepaid income is not recognized built-in gain. The term prepaid income 
means any amount received prior to the change date that is attributable 
to performance occurring on or after the change date. Examples to which 
this paragraph (a) will apply include, but are not limited to, income 
received prior to the change date that is deferred under section 455 or 
Rev. Proc. 2004-34 (2004-1 CB 991 (June 1, 2004)) (or any successor 
revenue procedure) (see Sec. 601.601(d)(2)(ii)(b)).
    (b) Effective/applicability dates. This section applies to loss 
corporations that have undergone an ownership change on or after June 
11, 2010. For loss corporations that have undergone an ownership change 
before June 11, 2010, see Sec. 1.382-7T as contained in 26 CFR part 1, 
revised April 1, 2009.
    (c) [Reserved]
    (d) Special rules. This paragraph (d) contains special rules 
regarding the identification of recognized built-in losses.
    (1)-(4) [Reserved]
    (5) Section 382 disallowed business interest carryforwards. Section 
382 disallowed business interest carryforwards are not treated as 
recognized built-in losses.
    (e)-(f) [Reserved]
    (g) Applicability dates.
    (1)-(3) [Reserved]
    (4) Paragraph (d)(5) of this section. Paragraph (d)(5) of this 
section applies with respect to an ownership change occurring on or 
after November 13, 2020. For loss corporations that have undergone an 
ownership change before or after November 13, 2020, see Sec. 1.382-7 as 
contained in 26 CFR part 1, revised April 1, 2019. However, taxpayers 
and their related parties, within the meaning of sections 267(b) and 
707(b)(1), may choose to apply the rules of paragraph (d)(5) of this 
section to testing dates occurring during a taxable year beginning after 
December 31, 2017.

[T.D. 9487, 75 FR 33992, June 16, 2010, as amended by T.D. 9870, 84 FR 
33692, July 15, 2019; T.D. 9905, 85 FR 56837, Sept. 14, 2020]



Sec. 1.382-8  Controlled groups.

    (a) Introduction. This section provides rules to adjust the value of 
a loss corporation that is a member of a controlled group of 
corporations on a change date so that the same value is not included 
more than once in computing the limitations under section 382 for the 
loss corporations that are members of the controlled group. In general, 
the adjustment is made under paragraph (c) of this section by reducing 
the value of the loss corporation by the value of the stock of each 
component member of the controlled group that the loss corporation owns 
immediately after the ownership change. The loss corporation's value 
may, however, be increased under paragraph (c) of this section by any 
amount of value that the other member elects to restore to the loss 
corporation.
    (b)(1) Controlled group loss and controlled group with respect to a 
controlled group loss--(1) In general. A controlled group loss is a pre-
change loss (or a net unrealized built-in loss) of a loss corporation 
that is attributable to a taxable year of the corporation with respect 
to which the corporation is a component member of a controlled group (as 
defined by paragraphs (e)(2) and (3) of this section). The controlled 
group with respect to each controlled group loss is composed of the loss 
corporation and each other corporation that is a component member of a 
controlled group that includes the loss corporation both--
    (1)(i) With respect to the taxable year to which the controlled 
group loss is attributable; and
    (1)(ii) On the date the loss corporation has an ownership change.
    (2) Presumption regarding net unrealized built-in loss. For purposes 
of determining whether a net unrealized built-in loss of a loss 
corporation is attributable to a taxable year (the determination year) 
with respect to which the corporation is a component member of a 
controlled group, the built-in loss in a prior change date asset is 
deemed to be attributable to a period ending before the determination 
year. A prior change date asset is any asset held by the loss 
corporation at all times during the period beginning on

[[Page 725]]

the change date of its most recent ownership change after 1986 (the 
first change date), and ending on the first day of the determination 
year. The built-in loss in a prior change date asset is the amount by 
which the adjusted basis of the asset on the first change date exceeds 
the fair market value of the asset on that date. The principles of this 
paragraph (b)(2) also apply to items described in section 382(h)(6)(B).
    (c) Computation of value. For purposes of computing the limitation 
under section 382 with respect to each controlled group loss, the value 
of the stock of each component member of the controlled group with 
respect to that loss is determined immediately before the ownership 
change, and is adjusted by applying the following rules:
    (1) Reduction in value. The value of the stock of each component 
member is reduced by the value (immediately before the ownership change 
and without regard to any restoration of value or other adjustment under 
this section) of the stock of any other component member directly owned 
by the component member immediately after the ownership change.
    (2) Restoration of value. After the value of the stock of each 
component member is reduced pursuant to paragraph (c)(1) of this 
section, the value of the stock of each component member is increased by 
the amount of value, if any, restored to the component member by another 
component member (the electing member) pursuant to this paragraph 
(c)(2). The electing member may elect (or may be deemed to elect under 
paragraph (h)(2)(i) of this section in the case of a foreign component 
member) to restore value to another component member in an amount that 
does not exceed the lesser of--
    (i) The sum of--
    (A) The value, determined immediately before the ownership change, 
of the electing member's stock (after adjustment under paragraph (c)(1) 
of this section and before any restoration of value under this paragraph 
(c)(2)); plus
    (B) Any amount of value restored to the electing member by another 
component member under this paragraph (c)(2); or
    (ii) The value, determined immediately before any ownership change, 
of the electing member's stock (without regard to any adjustment under 
this section) that is directly owned by the other component member 
immediately after the ownership change.
    (3) Reduction in value by the amount restored. The value of the 
stock of the electing member is reduced by any amount of value that the 
electing member elects to restore under paragraph (c)(2) of this section 
to another component member.
    (4) Appropriate adjustments. Appropriate additional adjustments 
consistent with paragraphs (c)(1), (2), and (3) of this section must be 
made to prevent any duplication of value. Thus, for example, adjustments 
must be made to reflect--
    (i) Any indirect ownership interest in another component member;
    (ii) Any cross ownership of stock by component members of the 
controlled group with respect to the controlled group loss; and
    (iii) Any value used to determine a limitation under section 382 
with respect to controlled group losses from the same period.
    (5) Certain reductions in the value of members of a controlled 
group. A loss corporation that has an ownership change is required to 
make adjustments consistent with this paragraph (c) with respect to its 
stock if the stock of another corporation in which it had a direct or 
indirect ownership interest was disposed of before the ownership change, 
and;
    (i) Both corporations were component members of a controlled group--
    (A) With respect to a taxable year to which a controlled group loss 
of the loss corporation is attributable; and
    (B) At any time during the 2 year period before the ownership 
change; and
    (ii) Both corporations are component members of a controlled group 
at any time during the 2 year period following the ownership change.
    (d) No double reduction. To the extent consistent with the purposes 
of this section, section 382 and this section shall not be applied to 
duplicate a reduction in the value of a loss corporation. Thus, for 
example, if the value of

[[Page 726]]

a loss corporation is reduced under section 382(l)(1) to reflect a 
capital contribution of stock of a component member, it is not again 
reduced by such amount under paragraph (c)(1) of this section. If this 
paragraph (d) applies to prevent a reduction in value from being 
duplicated, the application of the other rules of this section, such as 
those relating to the restoration of value, is correspondingly limited 
in a manner consistent with the principles of this section.
    (e) Definitions and nomenclature--(1) Definitions in section 382 and 
the regulations thereunder. Except as otherwise provided, the 
definitions and nomenclature contained in section 382 and the 
regulations thereunder apply to this section.
    (2) Controlled group. Controlled group has the same meaning as in 
section 1563(a), determined by substituting ``50 percent'' for ``80 
percent'' each place that it appears, and without regard to section 
1563(a)(4).
    (3) Component member. Component member has the same meaning as in 
section 1563(b), determined by substituting ``December 31 (or the change 
date, if earlier)'' for ``December 31'' each place it appears, and 
without regard to section 1563 (b)(2), (b)(3)(C), and (b)(4).
    (4) Foreign component member--(i) In general. Except as provided in 
paragraph (e)(4)(ii) of this section, foreign component member means a 
component member that is a foreign corporation.
    (ii) Exception. A foreign component member shall not include a 
foreign corporation that has items treated as connected with the conduct 
of a trade or business in the United States that it takes into account 
in determining its value pursuant to section 382(e)(3).
    (5) Predecessor and successor corporation. As the context may 
require, a reference to a corporation, or component member includes a 
reference to a predecessor or successor corporation.
    (f) Coordination between consolidated groups and controlled groups. 
Some or all of the component members of a controlled group may also be 
members of a consolidated group, and a controlled group loss may be 
subject to a consolidated section 382 limitation or subgroup section 382 
limitation determined under Sec. 1.1502-93. Except as otherwise 
provided in this paragraph (f) and Sec. Sec. 1.1502-91 through 1.1502-
99, Sec. 1.1502-93 applies instead of this section when both sections, 
by their terms, are otherwise applicable. This section is applicable and 
may require an adjustment to value if a member of a consolidated group, 
a loss group, or loss subgroup (as those terms are defined in Sec. Sec. 
1.1502-1(h) and 1.1502-91) is also a component member of a controlled 
group with respect to a controlled group loss. Solely for purposes of 
applying this section, a consolidated group, loss group, or loss 
subgroup is treated as a single corporation. Thus to determine the 
limitation with respect to any portion of the pre-change consolidated 
attributes or pre-change subgroup attributes of the loss group or loss 
subgroup that is a controlled group loss, the consolidated section 382 
limitation or subgroup section 382 limitation is computed by treating 
the loss group or the loss subgroup as a single corporation, and 
adjusting value in accordance with paragraph (c) of this section. See 
paragraph (g) Example 4 of this section.
    (g) Examples. For purposes of the examples in this section, unless 
otherwise stated, the nomenclature and assumptions of the examples in 
Sec. 1.382-2T(b) apply, all corporations file separate income tax 
returns on a calendar year basis, the only 5-percent shareholder of a 
corporation is a public group, and the facts set forth the only owner 
shifts with respect to the corporations during the testing period.

    Example 1. Controlled group with respect to a controlled group loss. 
(a) Public L owns all of the L stock, L and Public L1 own 30 percent and 
70 percent, respectively, of the L1 stock, and L1 owns all of the 
corporation T stock. L1 has a net operating loss arising in Year 1 that 
is carried over to Year 4. L has a net operating loss arising in Year 2 
that is carried over to Year 4. On August 1, Year 3, L acquires 30 
percent of the stock of L1, thereby increasing its percentage ownership 
interest in L1 to 60 percent. On December 1, Year 3, L1 purchases all of 
the stock of corporation S from Public S. On November 1, Year 4, P 
acquires all of the L stock. The acquisition by P of all of the L stock 
on November 1, Year 4, causes ownership changes of both L

[[Page 727]]

and L1 under the rules of Sec. 1.382-2T. The following is a graphic 
illustration of these facts.
[GRAPHIC] [TIFF OMITTED] TR02JY99.019


[[Page 728]]


    (b)(1) Under paragraph (b) of this section, the Year 1 net operating 
loss carryover of L1 is a controlled group loss because L1 is a 
component member of a controlled group with respect to Year 1, the year 
to which the loss is attributable. L1 and T compose a controlled group 
with respect to the net operating loss carryover because L1 and T are 
component members of a controlled group both--
    (A) With respect to the taxable year to which L1's net operating 
loss carryover is attributable (i.e., Year 1); and
    (B) On November 1, Year 4, L1's change date. Although L and S are 
component members of L1's controlled group on L1's change date, they are 
not component members of the controlled group with respect to the Year 1 
net operating loss carryover because they were not component members 
with respect to the year to which the net operating loss carryover is 
attributable.
    (2) The value of L1's stock must therefore be adjusted in accordance 
with paragraph (c) of this section to take into account an adjustment 
with respect to the T stock (but not the S stock) in computing L1's 
limitation under section 382 with respect to its net operating loss 
carryover.
    (c) Although L is a member of a controlled group composed of L, L1, 
S, and T on November 1, Year 4, L's change date, it is not a component 
member of a controlled group with respect to Year 2, the taxable year to 
which its net operating loss carryover is attributable. Therefore, L's 
Year 2 net operating loss carryover is not a controlled group loss under 
paragraph (b) of this section and the value of L's stock is not adjusted 
in accordance with paragraph (c) of this section to compute L's 
limitation under section 382 with respect to the Year 2 net operating 
loss carryover.
    Example 2. Adjustments to value of the controlled group members. (a) 
Since Year 1, A has owned all of the stock of L, L and B have owned 80 
percent and 20 percent, respectively, of the stock of corporation P, and 
P and C have owned 75 percent and 25 percent, respectively, of the stock 
of L1. L and L1 each has a net operating loss for the Year 6 taxable 
year that is carried over to its respective Year 7 taxable year. On 
December 1, Year 7, A sells all of the L stock to D. The sale results in 
ownership changes of both L and L1. Immediately before the ownership 
changes, the total value of the L1 stock is $40, the total value of the 
P stock (including the value of its L1 stock) is $100, and the total 
value of the L stock (including the value of the P stock) is $200. The 
following is a graphic illustration of these facts.

[[Page 729]]

[GRAPHIC] [TIFF OMITTED] TR02JY99.020

    (b) Under paragraph (b) of this section, the Year 6 net operating 
loss carryovers of each of L and L1 are controlled group losses because 
each of L and L1 is a component member of a controlled group with 
respect to Year 6, the year to which the losses are attributable. L, P, 
and L1 compose controlled groups with respect to both Year 6 net 
operating loss carryovers because L, P, and L1 are component members of 
a controlled group both--
    (1) With respect to the taxable years to which the net operating 
loss carryovers are attributable (i.e., Year 6); and
    (2) On December 1, Year 7, the change date.
    (c) The value of the stock of L1 for purposes of determining its 
limitation under section 382 with respect to its net operating loss 
carryover from Year 6 is $40. L1 does not elect to restore any value to 
P paragraph (c)(2) of this section.
    (d) The value of the stock of P ($100) is reduced under paragraph 
(c)(1) of this section by the value of the stock of L1 that it directly 
owns, $30 (75% x $40). Following the adjustment, the value of the stock 
of P is $70. P elects to restore this entire $70 of value to L.
    (e) The value of the stock of L, $200, is reduced under paragraph 
(c)(1) of this section by the value of the stock of P it directly owns, 
i.e., $80 (80% x $100), and increased paragraph (c)(2) of this section 
by the amount P elects to restore to L, i.e., $70. Thus, the value of 
the L stock for purposes of determining L's limitation under section 382 
with respect to its net operating loss carryover from Year 6 is $190 
($200-$80 + $70).
    Example 3. Limitation on restoration of value. (a) The facts are the 
same as in Example 2, except that L1 elects to restore $20 to P. For 
purposes of determining L1's limitation under section 382 with respect 
to the Year 6 net operating loss carryover, the value of the stock of L1 
is $20 ($40-$20) because the value of its stock is reduced under 
paragraph (c)(3) of this section by the $20 of value it elects to 
restore to P.

[[Page 730]]

    (b) The value of the stock of P ($100) is reduced under paragraph 
(c)(1) of this section by the value of the L1 stock it directly owns 
($30), and is increased paragraph (c)(2) of this section by the value 
that L1 elects to restore to P ($20). Thus, the value of the P stock is 
$90 ($100-$30 + $20).
    (c)(1) P elects to restore to L the maximum value permitted under 
this section. The value of the stock of L, $200, is reduced under 
paragraph (c)(1) of this section by the value of the P stock it directly 
owns ($80), and is increased by the value that P elects to restore to L. 
P may elect to restore to L the lesser of--
    (A) The sum of the value of its stock immediately after adjustment 
under paragraph (c)(1) of this section (i.e., $70) plus the value 
restored to it by L1 (i.e., $20) (a total of $90); or
    (B) The value of the P stock (without regard to the adjustment 
required by paragraph (c)(1) and (2) of this section) that is directly 
owned by L immediately before the ownership change (i.e., $80).
    (2) Thus, $80 is the maximum amount that P may elect to restore to 
L. Following the restoration of value by P, the value of the L stock for 
purposes of determining L's limitation under section 382 is $200 ($200 -
$80 + $80).
    Example 4. Coordination with consolidated return regulations. (a) P 
and its wholly owned subsidiary L file a consolidated return. L owns 79 
percent of the outstanding stock of L1. P acquired the stock of L in 
Year 1 and L acquired the stock of L1 in Year 2. The P consolidated 
group has a consolidated net operating loss arising in the Year 6 
consolidated return year that is carried over to Year 8. L1 has a net 
operating loss arising in its Year 6 taxable year that is also carried 
over to Year 8. On January 1, Year 8, the P consolidated group has an 
ownership change under Sec. 1.1502-92(b)(1)(i) and L1 has an ownership 
change under Sec. 1.382-2T.
    (b)(1) Under paragraph (b) of this section, the Year 6 net operating 
loss carryover of the P group is a controlled group loss because P, L, 
and L1 are component members of a controlled group with respect to Year 
6, the year to which the loss is attributable. P, L, and L1 compose a 
controlled group with respect to the Year 6 net operating loss carryover 
of the P loss group because they are component members of a controlled 
group both--
    (A) With respect to the taxable years to which the net operating 
loss carryover is attributable (i.e., Year 6); and
    (B) On January 1, Year 8, the P group's change date.
    (2) Because P and L compose a loss group (within the meaning of 
Sec. 1.1502-91(c)) with respect to its Year 6 net operating loss 
carryover, the P loss group must compute a consolidated section 382 
limitation with respect to its Year 6 net operating loss carryover as a 
result of the ownership change.
    (c) In computing the consolidated section 382 limitation under Sec. 
1.1502-93 with respect to the Year 6 net operating loss carryover, the 
value of the P stock immediately before the ownership change is reduced 
under paragraphs (c)(1) and (f) of this section by the value immediately 
before the ownership change of the L1 stock directly owned by L 
immediately after the ownership change. L1 may, however, elect to 
restore such value to the P consolidated group to the extent permitted 
under paragraph (c)(2) of this sectionSec. 1.382-8T.
    Example 5. Appropriate adjustments for indirect ownership interest. 
(a) Individual A owns all of the stock of L, L owns an 80 percent 
interest in the capital and profits of partnership PS, and PS owns 75 
percent of the stock of L1. Both L and L1 have net operating losses for 
the Year 1 taxable year that are carried over to their respective Year 2 
taxable years. On December 19, Year 2, A sells all of the L stock to an 
unrelated individual. The sale results in an ownership change of L and 
L1.
    (b) Under paragraph (b) of this section, the Year 1 net operating 
loss carryovers of each of L and L1 are controlled group losses because 
each of L and L1 is a component member of a controlled group with 
respect to Year 1, the year to which the losses are attributable. L and 
L1 compose controlled groups with respect to each corporation's net 
operating loss carryovers because L and L1 are component members of a 
controlled group both--
    (1) With respect to the taxable years to which the net operating 
loss carryovers are attributable (i.e., Year 1); and
    (2) On December 19, Year 2, the change date.
    (c) L has an indirect ownership interest in L1 which, under 
paragraph (c)(4) of this section, must be taken into account in applying 
this section. As a result, the value of the L stock for purposes of 
determining its limitation under section 382 with respect to the Year 1 
net operating loss carryover must be reduced by the value of L's 
indirect ownership interest in the L1 stock (60 percent) that it owns 
through PS immediately before the ownership change, and is increased by 
the amount (if any) that L1 elects to restore to L under paragraph 
(c)(2) of this section. The value of L1 is reduced under paragraph 
(c)(3) of this section to the extent that L1 elects to restore value to 
L.

    (h) Time and manner of filing election to restore--(1) Statements 
required--(i) Filing by loss corporation. The election to restore value 
described in paragraph (c)(2) of this section must be in the form set 
forth in this paragraph

[[Page 731]]

(h)(1)(i). It must be filed by the loss corporation by including a 
statement on or with its income tax return for the taxable year in which 
the ownership change occurs (or with an amended return for that year 
filed on or before the due date (including extensions) of the income tax 
return of any component member with respect to the taxable year in which 
the ownership change occurs). The common parent of a consolidated group 
must make the election on behalf of the group. The election is made in 
the form of a statement entitled, ``STATEMENT PURSUANT TO Sec. 1.382-
8(h)(1) TO ELECT TO RESTORE ALL OR PART OF THE VALUE OF [INSERT NAME AND 
EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF THE ELECTING MEMBER] TO 
[INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF THE 
CORPORATION TO WHICH VALUE IS RESTORED].'' The statement must include 
the amount of the value being restored and must also indicate that an 
agreement signed and dated by both parties, as described in paragraph 
(h)(1)(iii) of this section, has been entered into. Each such party must 
retain either the original or a copy of this agreement as part of its 
records. See Sec. 1.6001-1(e).
    (ii) Filing by electing member. An electing member must include a 
statement identical to the one described in paragraph (h)(1)(i) of this 
section on or with its income tax return (or with an amended return for 
that year filed on or before the due date (including extensions) of the 
income tax return of any component member with respect to the taxable 
year in which the ownership change occurs) (if any) for the taxable year 
which includes the change date in connection with which the election 
described in paragraph (c)(2) of this section is made. If the electing 
member is a controlled foreign corporation (within the meaning of 
section 957), each United States shareholder (within the meaning of 
section 951(b)) with respect thereto must include this statement on or 
with its return. It is not necessary for the electing member (or the 
United States shareholder, as the case may be) to include this statement 
on or with its return if the loss corporation includes an identical 
statement on or with the same return for the same election.
    (iii) Agreement. Both the electing member and the corporation to 
which value is restored must sign and date an agreement. The agreement 
must--
    (A) Identify the change date for the loss corporation in connection 
with which the election is made;
    (B) State the value of the electing member's stock (without regard 
to any adjustment under paragraph (c) of this section) immediately 
before the ownership change;
    (C) State the amount of any reduction required under paragraph 
(c)(1) of this section with respect to stock of the electing member that 
is owned directly or indirectly by the corporation to which value is 
restored;
    (D) State the amount of value that the electing member elects to 
restore to the corporation; and
    (E) State whether the value of either component member's stock was 
adjusted pursuant to paragraph (c)(4) of this section.
    (2) Special rule for foreign component members--(i) Deemed election 
to restore full value. Unless the election described in paragraph 
(h)(2)(ii) of this section is made for a foreign component member, each 
foreign component member of the controlled group is deemed to have 
elected to restore to each other component member the maximum value 
allowable under paragraph (c)(2) of this section, taking into account 
the limitations of this section.
    (ii) Election not to restore full value. (A) A loss corporation may 
elect to reduce the amount of value restored from a foreign component 
member (the electing foreign component member) to another component 
member under paragraph (h)(2)(i) of this section in the form set forth 
in this paragraph (h)(2)(ii). It must be filed by the loss corporation 
by including a statement on or with its income tax return for the 
taxable year in which the ownership change occurs (or with an amended 
return for that year filed on or before the due date (including 
extensions) of the income tax return of any component member with 
respect to the taxable year in which the ownership change occurs). The 
common parent of a consolidated group must make the

[[Page 732]]

election on behalf of the group. The election is made in the form of a 
statement entitled, ``STATEMENT PURSUANT TO Sec. 1.382-8(h)(2)(ii) TO 
ELECT NOT TO RESTORE FULL VALUE OF [INSERT NAME AND EMPLOYER 
IDENTIFICATION NUMBER (IF ANY) OF ELECTING FOREIGN COMPONENT MEMBER] TO 
[INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF THE 
CORPORATION TO WHICH SUCH VALUE IS NOT TO BE RESTORED].'' The statement 
must include the amount of the value not being restored and must also 
indicate that an agreement signed and dated by both parties, as 
described in paragraph (h)(2)(iii) of this section, has been entered 
into. Each such party must retain either the original or a copy of the 
agreement as part of its records. See Sec. 1.6001-1(e).
    (B) An electing foreign component member must include a statement 
identical to the one described in paragraph (h)(2)(ii)(A) of this 
section on or with its income tax return (or with an amended return for 
that year filed on or before the due date (including extensions) of the 
income tax return of any component member with respect to the taxable 
year in which the ownership change occurs) (if any) for the taxable year 
which includes the change date in connection with which the election 
described in paragraph (h)(2)(ii)(A) of this section is made. If the 
electing foreign component member is a controlled foreign corporation 
(within the meaning of section 957), each United States shareholder 
(within the meaning of section 951(b)) with respect thereto must include 
this statement on or with its return. It is not necessary for the 
electing foreign component member (or United States shareholder, as the 
case may be) to include this statement on or with its return if the loss 
corporation includes an identical statement on or with the same return 
for the same election.
    (iii) Agreement. Both the electing foreign component member and the 
corporation to which full value is not restored must sign and date an 
agreement. The agreement must--
    (A) Identify the change date for the loss corporation in connection 
with which the election is made;
    (B) State the value of the electing foreign component member's stock 
(without regard to any adjustment under paragraph (c) of this section) 
immediately before the ownership change;
    (C) State the amount of any reduction required under paragraph 
(c)(1) of this section with respect to stock of the electing foreign 
component member that is owned directly or indirectly by the corporation 
to which value is not restored;
    (D) State the amount of value that the electing foreign component 
member elects not to restore to the corporation; and
    (E) State whether the value of either component member's stock was 
adjusted pursuant to paragraph (c)(4) of this section.
    (3) Revocation of election. An election (other than the deemed 
election described in paragraph (h)(2)(i) of this section) made under 
this section is revocable only with the consent of the Commissioner.
    (i) References to former temporary regulations. As the context 
requires, a reference in this section to Sec. 1.382-8 includes a 
reference to Sec. 1.382-8T in effect prior to June 25, 1999, as 
contained in 26 CFR part 1 revised as of April 1, 1999, a reference to 
Sec. Sec. 1.1502-91, 1.1502-92, 1.1502-93, and Sec. Sec. 1.1502-91 
through 1.1502-99 includes a reference to Sec. Sec. 1.1502-91A, 1.1502-
92A, 1.1502-93A and Sec. Sec. 1.1502-91A through 1.1502-99A.
    (j) Effective date--(1) In general. This section applies to a loss 
corporation that has an ownership change with respect to a controlled 
group loss on or after January 1, 1997.
    (2) Transition rule--(i) In general. The members of a controlled 
group on January 1, 1997, that have had an ownership change with respect 
to a controlled group loss before January 1, 1997, must determine the 
limitations under section 382 for any post-change year with respect to 
controlled group losses by using a reasonable method to preclude the 
value of stock of a component member that was owned directly or 
indirectly by another member immediately after an ownership change from 
being taken into account more than once in determining the limitations 
under section 382 with respect to

[[Page 733]]

controlled group losses. If such a reasonable method was not used for a 
post-change year, subject to the exception in paragraph (j)(3) of this 
section, the members of the controlled group described in the preceding 
sentence must reduce their limitations under section 382 for post-change 
years for which the income tax return is filed after January 1, 1997, to 
recapture, as quickly as possible, any limitation that members took into 
account in excess of the amount that would be allowable under this 
section.
    (ii) Special transition rule for controlled groups that had 
ownership changes before January 29, 1991. For purposes of this section, 
in the case of an ownership change occurring before January 29, 1991, 
the controlled group with respect to a controlled group loss does not 
include a corporation that is not a component member of the controlled 
group on January 29, 1991. Thus, in the case of an ownership change 
occurring before January 29, 1991, paragraph (c) of this section does 
not require that a loss corporation that is a component member of a 
controlled group to disregard the value of stock of another corporation 
directly owned immediately after the ownership change in determining the 
value of its own stock unless the other corporation is a component 
member of the controlled group on January 29, 1991.
    (3) Amended returns. A taxpayer that has had an ownership change 
before January 1, 1997, may file an amended return for any taxable year 
to modify the amount of a limitation under section 382 with respect to a 
controlled group loss only if--
    (i) The modification complies with the rules contained in this 
section for computing a limitation under section 382;
    (ii) Any other component member of the controlled group with respect 
to the controlled group loss who elects to restore value and whose 
taxable income is affected by the election to restore value also files 
amended returns that comply with such rules; and
    (iii) Corresponding adjustments are made in amended returns for all 
taxable years ending after December 31, 1986.
    (4) Effective/applicability date. Paragraphs (c)(2), (e)(4) and (h) 
of this section apply to any taxable year beginning on or after May 30, 
2006. However, taxpayers may apply paragraphs (c)(2), (e)(4) and (h) of 
this section to any original Federal income tax return (including any 
amended return filed on or before the due date (including extensions) of 
such original return) timely filed on or after May 30, 2006. For taxable 
years beginning before May 30, 2006, see Sec. 1.382-8 as contained in 
26 CFR part 1 in effect on April 1, 2006.

[T.D. 8679, 61 FR 33316, June 27, 1996, as amended by T.D. 8825, 64 FR 
36178, July 2, 1999; T.D. 9264, 71 FR 30599, 30607, May 30, 2006; T.D. 
9329, 72 FR 32801, June 14, 2007]



Sec. 1.382-9  Special rules under section 382 for corporations under
the jurisdiction of a court in a title 11 or similar case.

    (a) Introduction. Either section 382(l)(5) or section 382(l)(6) may 
apply to an ownership change which occurs in a title 11 or similar case 
(as defined in section 368(a)(3)(A)) if the transaction resulting in the 
ownership change is ordered by the court or is pursuant to a plan 
approved by the court. Terms and nomenclature used in this section, and 
not otherwise defined herein (including the nomenclature and assumptions 
in Sec. 1.382-2T(b) relating to the examples) have the same respective 
meanings as in section 382 and the regulations thereunder.
    (b) Application of section 382(l)(5). section 382(a) does not apply 
to any ownership change if--
    (1) The old loss corporation is (immediately before the ownership 
change) under the jurisdiction of the court in a title 11 or similar 
case; and
    (2) The pre-change shareholders and qualified creditors of the old 
loss corporation (determined immediately before the ownership change) 
own (after the ownership change and as a result of being pre-change 
shareholders or qualified creditors immediately before the ownership 
change) stock of the new loss corporation (or stock of a controlling 
corporation if also in bankruptcy) that meets the requirements of 
section 1504(a)(2) (determined by substituting ``50 percent'' for ``80 
percent'' each place it appears).

[[Page 734]]

    (c) [Reserved]
    (d) Rules for determining whether stock of the loss corporation is 
owned as a result of being a qualified creditor--(1) Qualified creditor. 
A qualified creditor is the beneficial owner, immediately before the 
ownership change, of qualified indebtedness of the loss corporation. A 
qualified creditor owns stock of the new loss corporation (or a 
controlling corporation) as a result of being a qualified creditor only 
to the extent that the qualified creditor receives stock in full or 
partial satisfaction of qualified indebtedness (including interest 
accrued on such indebtedness) in a transaction that is ordered by the 
court or is pursuant to a plan approved by the court in a title 11 or 
similar case. For purposes of this paragraph (d)(1), ownership of stock 
after the ownership change is determined without applying the 
attribution rules generally applicable under section 382(l)(3)(A) or 
Sec. 1.382-2T(h).
    (2) General rules for determining whether indebtedness is qualified 
indebtedness--(i) Definition. Indebtedness of the loss corporation is 
qualified indebtedness if it--
    (A) Has been owned by the same beneficial owner since the date that 
is 18 months before the date of the filing of the title 11 or similar 
case; or
    (B) Arose in the ordinary course of the trade or business of the 
loss corporation and has been owned at all times by the same beneficial 
owner.
    (ii) Determination of beneficial ownership. For purposes of 
paragraph (d)(2)(i) of this section, beneficial ownership of 
indebtedness is determined without applying attribution rules.
    (iii) Duty of inquiry. The loss corporation must determine that 
indebtedness that the loss corporation treats as qualified indebtedness, 
other than indebtedness to which paragraph (d)(3)(i) of this section 
applies, has been owned for the requisite period by the beneficial owner 
who owns the indebtedness immediately before the ownership change. The 
loss corporation may rely on a statement, signed under penalties of 
perjury, by a beneficial owner regarding the amount of indebtedness the 
beneficial owner owns and the length of time that the beneficial owner 
has owned the indebtedness.
    (iv) Ordinary course indebtedness. For purposes of this paragraph 
(d)(2), indebtedness arises in the ordinary course of the loss 
corporation's trade or business only if the indebtedness is incurred by 
the loss corporation in connection with the normal, usual, or customary 
conduct of business, determined without regard to whether the 
indebtedness funds ordinary or capital expenditures of the loss 
corporation. For example, indebtedness (other than indebtedness acquired 
for a principal purpose of being exchanged for stock) arises in the 
ordinary course of the loss corporation's trade or business if it is 
trade debt; a tax liability; a liability arising from a past or present 
employment relationship, a past or present business relationship with a 
supplier, customer, or competitor of the loss corporation, a tort, a 
breach of warranty, or a breach of statutory duty; or indebtedness 
incurred to pay an expense deductible under section 162 or included in 
the cost of goods sold. A claim that arises upon the rejection of a 
burdensome contract or lease pursuant to the title 11 or similar case is 
treated as arising in the ordinary course of the loss corporation's 
trade or business if the contract or lease so arose.
    (3) Treatment of certain indebtedness as continuously owned by the 
same owner--(i) In general. For purposes of paragraph (d)(2) of this 
section, a loss corporation may treat indebtedness as always having been 
owned by the beneficial owner of the indebtedness immediately before the 
ownership change if the beneficial owner is not, immediately after the 
ownership change, either a 5-percent shareholder or an entity through 
which a 5-percent shareholder owns an indirect ownership interest in the 
loss corporation (a 5-percent entity). This paragraph (d)(3)(i) does not 
apply to indebtedness beneficially owned by a person whose participation 
in formulating a plan of reorganization makes evident to the loss 
corporation (whether or not the loss corporation had previous knowledge) 
that the person has not owned the indebtedness for the requisite period.
    (ii) Operating rules. For purposes of paragraph (d)(3)(i) of this 
section: (A) If

[[Page 735]]

a loss corporation has actual knowledge of a coordinated acquisition of 
its indebtedness by a group of persons, through a formal or informal 
understanding among themselves, for a principal purpose of exchanging 
the indebtedness for stock, the indebtedness (and any stock received in 
exchange therefor) is treated as owned by an entity. A principal element 
in determining if an understanding exists among members of a group is 
whether the investment decision of each member is based upon the 
investment decision of one or more other members.
    (B) If the loss corporation has actual knowledge regarding stock 
ownership described in Sec. 1.382-2T(k)(2), the loss corporation must 
take that ownership into account in determining which beneficial owners 
of indebtedness are, immediately after the ownership change, 5-percent 
shareholders or 5-percent entities. The loss corporation is not required 
to take into account an ownership interest described in Sec. 1.382-
2T(k)(4) unless the loss corporation has actual knowledge of the 
ownership interest.
    (C) The term 5-percent shareholder includes any person who is a 5-
percent shareholder of the loss corporation within the meaning of Sec. 
1.382-2T(g), without regard to the option attribution rules of section 
382(l)(3)(A) or Sec. 1.382-4(d) (or, if applicable, Sec. 1.382-
2T(h)(4)).
    (D) Paragraph (d)(3)(i) of this section does not apply to 
indebtedness if the loss corporation has actual knowledge immediately 
after the ownership change that the exercise of an option to acquire or 
dispose of stock of the loss corporation would cause the beneficial 
owner of the indebtedness immediately before the ownership change to be, 
after the ownership change, either a 5-percent shareholder or a 5-
percent entity. An interest that is treated as an option under Sec. 
1.382-4(d)(9) (or Sec. 1.382-2T(h)(4)(v) if applicable) is treated as 
an option for purposes of this paragraph (d)(3)(ii)(D).
    (iii) Indebtedness owned by beneficial owner who becomes a 5-percent 
shareholder or 5-percent entity. If the beneficial owner of indebtedness 
immediately before the ownership change is a 5-percent shareholder or 5-
percent entity immediately after the ownership change, the general rules 
of paragraph (d)(2) of this section apply to determine whether the 
indebtedness has been owned for the requisite period by the beneficial 
owner.
    (iv) Example. The following example illustrates paragraph (d)(3) of 
this section.

    Example. (A)(1) L is a loss corporation in a title 11 case. The plan 
of reorganization of L approved by the bankruptcy court provides for the 
satisfaction of claims by the issuance of new L common stock to its 
creditors as follows:

A--2 percent
B--7.5 percent
C--2.5 percent
P1--3 percent
P2--10 percent
P3--4.9 percent
P4--4.9 percent
P5--4.9 percent

    (2) P2 is owned by Public P2. B owns 10 percent of the stock of P1 
and L has no actual knowledge of this ownership. L has actual knowledge 
that D owns P3, P4 and P5. In addition, L has actual knowledge, 
immediately after the ownership change, that C owns an option to acquire 
newly-issued stock of L that, if exercised, would increase C's 
percentage ownership of L stock from 2.5 percent to 8 percent. An 
ownership change of L occurs on the date the plan becomes effective.
    (B) Under paragraph (d)(3)(i) of this section, L may treat the 
indebtedness owned by A and P1 immediately before the ownership change 
as always having been owned by A and P1. Neither A nor P1 is a 5-percent 
shareholder immediately after the ownership change. Further, because P1 
owns less than 5 percent of the L stock (and L has no actual knowledge 
of B's ownership interest in P1), P1 is treated as an individual, and 
the L stock owned by P1 is not attributed to any other person, including 
B. See Sec. 1.382-2T(h)(2)(iii). Therefore, P1 is not a 5-percent 
entity.
    (C) Paragraph (d)(3)(i) of this section does not apply to the 
indebtedness owned by B, C, P2, P3, P4, or P5. B is a 5-percent 
shareholder immediately after the ownership change. L has actual 
knowledge immediately after the ownership change that the exercise of 
C's option would cause C to be a 5-percent shareholder immediately after 
the ownership change. (L does not take into account the effect of the 
exercise of the option, however, in determining the percentage stock 
ownership of any person other than C because the deemed exercise would 
not cause any other person to be a 5-percent shareholder or a 5-percent 
entity after the ownership change.) P2 is a 5-percent entity, because 
Public P2, a

[[Page 736]]

5-percent shareholder, owns an indirect ownership interest in L through 
P2. P3, P4, and P5 are 5-percent entities because D, a 5-percent 
shareholder, owns an indirect ownership interest in L through P3, P4, 
and P5. Because L has actual knowledge that D would be a 5-percent 
shareholder but for the application of Sec. 1.382-2T(h)(2)(iii), that 
section does not apply to P3, P4, or P5. See Sec. 1.382-2T(k)(2). Thus, 
under Sec. 1.382-2T(h)(2)(i), the L stock owned by P3, P4, and P5 is 
attributed to D, and D is a 5-percent shareholder. Because paragraph 
(d)(3)(i) of this section does not apply to the indebtedness owned by B, 
C, P2, P3, P4, and P5, L may treat as qualified indebtedness only 
indebtedness that it determines had been owned by such persons for the 
requisite period. See paragraph (d)(2)(iii) of this section.

    (4) Special rule if indebtedness is a large portion of creditor's 
assets--(i) In general. Indebtedness is not qualified indebtedness if--
    (A) The beneficial owner of the indebtedness is a corporation or 
other entity that had an ownership change on any day during the 
applicable period;
    (B) The indebtedness represents more than 25 percent of the fair 
market value of the total gross assets (excluding cash or cash 
equivalents) of the beneficial owner on its change date; and
    (C) The beneficial owner is a 5-percent entity immediately after the 
ownership change of the loss corporation (determined by applying the 
rules of paragraph (d)(3) of this section).
    (ii) Applicable period. For purposes of paragraph (d)(4)(i) of this 
section, the term applicable period means the period beginning on the 
day 18 months before the filing of the title 11 or similar case (or the 
day on which the beneficial owner acquired the indebtedness, if later) 
and ending with the change date of the loss corporation.
    (iii) Determination of ownership change. For purposes of paragraph 
(d)(4)(i) of this section, the determination whether a beneficial owner 
of indebtedness has an ownership change is made under the principles of 
section 382 and the regulations thereunder, without regard to whether 
the beneficial owner is a loss corporation and by beginning the testing 
period no earlier than the latest of the day three years before the 
change date, the day 18 months before the filing of the title 11 or 
similar case, or the day on which the beneficial owner acquired the 
indebtedness.
    (iv) Reliance on statement. Paragraph (d)(4)(i) of this section does 
not apply to indebtedness if the loss corporation obtains a statement, 
signed under penalties of perjury, by the beneficial owner of the 
indebtedness that states that paragraph (d)(4)(i) of this section does 
not apply to the indebtedness.
    (5) Tacking of ownership periods--(i) Transferee treated as owning 
indebtedness for period owned by transferor. To determine whether 
indebtedness transferred in a qualified transfer is qualified 
indebtedness, the transferee is treated as having owned the indebtedness 
for the period that it was owned by the transferor.
    (ii) Qualified transfer. For purposes of paragraph (d)(5)(i) of this 
section, a transfer of indebtedness is a qualified transfer if--
    (A) The transfer is between parties who bear a relationship to each 
other described in section 267(b) or 707(b) (substituting at least 80 
percent for more than 50 percent each place it appears in section 267(b) 
(and section 267(f)(1)) or 707(b));
    (B) The transfer is a transfer of a loan within 90 days after its 
origination, pursuant to a customary syndication transaction;
    (C) The transfer is a transfer of newly incurred indebtedness by an 
underwriter that owned the indebtedness for a transitory period pursuant 
to an underwriting;
    (D) The transferee's basis in the indebtedness is determined under 
section 1014, 1015, or 1022 or with reference to the transferor's basis 
in the indebtedness;
    (E) The transfer is in satisfaction of a right to receive a 
pecuniary bequest;
    (F) The transfer is pursuant to any divorce or separation instrument 
(within the meaning of section 71(b)(2));
    (G) The transfer is pursuant to a subrogation in which the 
transferee acquires a claim against the loss corporation by reason of a 
payment to the claimant pursuant to an insurance policy or a guarantee, 
letter of credit or similar security arrangement; or
    (H) The transfer is a transfer of an account receivable in a 
customary

[[Page 737]]

commercial factoring transaction made within 30 days after the account 
arose to a transferee that regularly engages in such transactions.
    (iii) Exception. A transfer of indebtedness is not a qualified 
transfer for purposes of paragraph (d)(5)(i) of this section if the 
transferee acquired the indebtedness for a principal purpose of 
benefiting from the losses of the loss corporation by--
    (A) Exchanging the indebtedness for stock of the loss corporation 
pursuant to the title 11 or similar case; or
    (B) Selling the indebtedness at a profit that reflects the 
expectation that, by reason of section 382(l)(5), section 382(a) will 
not apply to any ownership change resulting from the title 11 or similar 
case.
    (iv) Debt-for-debt exchanges. If the loss corporation satisfies its 
indebtedness with new indebtedness, either through an exchange of new 
indebtedness for old indebtedness or a change in the terms of 
indebtedness that results in an exchange under section 1001--
    (A) The owner of the new indebtedness is treated as having owned 
that indebtedness for the period that it owned the old indebtedness; and
    (B) The new indebtedness is treated as having arisen in the ordinary 
course of the trade or business of the loss corporation if the old 
indebtedness so arose.
    (6) Effective date--(i) In general. This paragraph (d) applies to 
ownership changes occurring on or after March 17, 1994. The provisions 
of paragraph (d)(5)(ii)(D) of this section relating to section 1022 are 
effective on and after January 19, 2017.
    (ii) Elections and amended returns--(A) Election to apply this 
paragraph (d) retroactively. A loss corporation may elect to apply this 
paragraph (d) to an ownership change occurring prior to March 17, 1994. 
This election must be made by the later of the due date (including any 
extensions of time) of the loss corporation's tax return for the taxable 
year which includes the change date or the date that the loss 
corporation files its first tax return after May 16, 1994. The election 
is made by attaching the following statement to the return: ``This is an 
Election to Apply Sec. 1.382-9(d) Retroactively with Respect to the 
Ownership Change on [Insert Date of Ownership Change] That Occurred in 
Connection with the title 11 or Similar Case filed on [Insert Date of 
Filing].'' This statement must be accompanied by the amended returns 
described in paragraph (d)(6)(ii)(C) of this section. An election under 
this paragraph (d)(6) is irrevocable.
    (B) Election to revoke section 382(l)(5)(H) election. A loss 
corporation may elect to revoke a prior election made under section 
382(l)(5)(H) with respect to an ownership change occurring before March 
17, 1994 by including the following statement with its election to apply 
Sec. 1.382-9(d) retroactively: ``This is an Election to Revoke a Prior 
Election Made Under Section 382(l)(5)(H) With Respect to the Ownership 
Change on [Insert Date of Ownership Change] That Occurred in Connection 
With the title 11 or Similar Case Filed on [Insert Date of Filing].''
    (C) Amended returns. If the retroactive application of this 
paragraph (d) affects the amount of taxable income or loss for a prior 
taxable year, then, except as precluded by the applicable statute of 
limitations, the loss corporation (or the common parent of any 
consolidated group of which the loss corporation was a member for the 
year) must file an amended return for the year that reflects the effects 
of the retroactive application of the rules of this paragraph (d). If 
the statute of limitations precludes the filing of an amended return for 
one or more such prior taxable years, the loss corporation (or the 
common parent) must make appropriate adjustments under the principles of 
section 382(l)(2)(A) in subsequent taxable years to reflect the 
difference between the losses and credits actually used in such prior 
taxable years and the amount that would have been used in those years 
applying the rules of this paragraph (d).
    (e) Option attribution for purposes of determining stock ownership 
under section 382(l)(5)(A)(ii)--(1) In general. Solely for purposes of 
determining whether the stock ownership requirements of section 
382(l)(5)(A)(ii) are satisfied at the time of an ownership change, stock 
of the loss corporation (or of a controlling corporation if also in 
bankruptcy) that is subject to an option is treated

[[Page 738]]

as acquired at that time, pursuant to an exercise of the option by its 
owner, if such deemed exercise would cause the pre-change shareholders 
and qualified creditors of the loss corporation to own (after such 
ownership change and as a result of being pre-change shareholders or 
qualified creditors immediately before such change) less than an amount 
of such stock sufficient to satisfy the ownership requirements of 
section 382(l)(5)(A)(ii). An option that is owned as a result of being a 
pre-change shareholder or qualified creditor and that, if exercised, 
would result in the ownership of stock by a pre-change shareholder or 
qualified creditor is not treated as exercised under this paragraph (e). 
For purposes of this paragraph (e)(1), rules similar to those option 
attribution rules under Sec. 1.382-2T(h)(4)(iii), (iv), (v), (vii), and 
(x)(A), (B) (except with respect to a debt instrument that was issued 
after the filing of the petition in the title 11 or similar case), (D), 
(E) (except with respect to a right to receive or obligation to issue 
stock as interest or dividends on a debt instrument or stock that was 
issued after the filing of the petition in the title 11 or similar 
case), (G), (H), and (Z), apply.
    (2) Special rules--(i) Lapse or forfeiture of options deemed 
exercised. A loss corporation may apply rules similar to the rules of 
Sec. 1.382-2T(h)(4)(viii) with respect to an option except to the 
extent any person owning the option at any time on or after the change 
date acquires additional stock or an option to acquire additional stock 
during the period of time on or after the ownership change and on or 
before the lapse or forfeiture of the option.
    (ii) Actual exercise of options not deemed exercised. In determining 
whether the ownership change pursuant to the plan of reorganization 
qualifies under section 382(l)(5), a loss corporation may take into 
account stock acquired pursuant to the actual exercise of an option 
issued pursuant to the plan of reorganization if that option was not 
deemed exercised under paragraph (e)(1) of this section. However, this 
paragraph (e)(2)(ii) applies only if the option is actually exercised 
within the 3 years of the ownership change by the 5-percent shareholder 
who, as a result of being a pre-change shareholder or qualified 
creditor, acquired the option under the plan.
    (iii) Amended returns. A loss corporation may file an amended return 
for a prior taxable year (subject to any applicable statute of 
limitations) if it determines that section 382(l)(5) applies to an 
ownership change as a result of the operation of paragraph (e)(2)(i) or 
(ii) of this section, but only if the loss corporation makes 
corresponding adjustments on amended returns for all affected taxable 
years (subject to any applicable statute of limitations).
    (3) Examples. In each of the examples in this paragraph (e)(3), 
assume that there is an ownership change of loss corporation L on the 
date the plan of reorganization is effective.

    Example 1. L is a loss corporation in a title 11 case. The plan of 
reorganization of L approved by the bankruptcy court provides for the 
cancellation of all existing L stock, the issuance of 100 shares of new 
L common stock to qualified creditors, and the issuance of an option to 
a new investor to acquire, at any time during the next 3 years, 90 
shares of new L common stock from L at its fair market value on the date 
the plan becomes effective. Under paragraph (e)(1) of this section, on 
the date the plan becomes effective, the option held by the new investor 
is deemed exercised if the exercise would cause the qualified creditors 
of L to own less than 50 percent of the total voting power or value of 
the L stock after the ownership change. Because the qualified creditors 
would receive at least 50 percent of the voting power and value of the 
new L common stock even if the option were deemed exercised, the stock 
ownership requirements of section 382(l)(5)(A)(ii) are satisfied.
    Example 2. The facts are the same as in Example 1, except that L 
issues an option to the new investor to acquire 110 shares of new L 
common stock. This option is deemed exercised under paragraph (e)(1) of 
this section on the date the plan becomes effective, because, as a 
result of the deemed exercise, the qualified creditors would own only 
100 of 210 shares of the new L common stock (approximately 48 percent) 
after the ownership change. Accordingly, the stock ownership 
requirements of section 382(l)(5)(A)(ii) are not satisfied and section 
382(a) applies to the ownership change.
    Example 3. (a) L is a loss corporation in a title 11 case. The plan 
of reorganization of L approved by the bankruptcy court provides for the 
cancellation of all existing L stock, the issuance of new L common stock 
and 5-year options to acquire L common stock as follows:

[[Page 739]]

    (i) To qualified creditors--100 shares of stock and options to 
acquire 50 shares;
    (ii) To a new investor--options to acquire 110 shares.
    (b) Under paragraph (e)(1) of this section, the option held by the 
new investor is deemed exercised on the date the plan becomes effective 
because the exercise would cause the qualified creditors of L to own 
less than 50 percent of the total voting power and value of the L stock 
after the ownership change (100 of 210 shares or approximately 48 
percent). Accordingly, the stock ownership requirements of section 
382(l)(5)(A)(ii) are not satisfied initially and section 382(a) applies 
to the ownership change.
    (c) Assume, however, that the qualified creditors actually exercise 
enough options that were acquired pursuant to the plan of reorganization 
to purchase 30 additional shares during the 3 year period after the plan 
becomes effective. Under paragraph (e)(2)(ii) of this section, L may 
take into account the 30 shares purchased by the qualified creditors by 
the exercise of the options in determining whether the stock ownership 
requirements of section 382(l)(5)(A)(ii) were satisfied on the date the 
plan of reorganization became effective. If L takes such purchases into 
account, the qualified creditors of L are deemed to own as of the date 
of the ownership change more than 50 percent of the total voting power 
or value of the L stock after the ownership change (130 of 240 shares or 
approximately 54 percent), with the result that the stock ownership 
requirements of section 382(l)(5)(A)(ii) are satisfied and section 
382(l)(5) applies to the ownership change as of the effective date of 
the plan.
    (d) Assume instead that the qualified creditors acquire 30 
additional shares by exercise of options more than 3 years after the 
plan becomes effective. Such exercise is not taken into account under 
paragraph (e)(2)(ii) of this section for purposes of determining whether 
the stock ownership requirements of section 382(l)(5)(A)(ii) are 
satisfied as of the effective date of the plan. Thus, the qualified 
creditors are deemed to own less than 50 percent of the total voting 
power and value of the L stock after the ownership change (100 of 210 
shares) and section 382(l)(5) does not apply to the ownership change.
    (e) Assume instead that, during the 3 year period after the plan 
becomes effective, the new investor exercises part of his option and 
purchases 105 shares of stock. The exercise causes a lapse of the rights 
to acquire the remaining 5 shares of stock. Also during that time, the 
qualified creditors exercise part of their options and acquire 6 
additional shares of stock. Under paragraph (e)(2)(i) of this section, L 
may treat the lapse of that part of the new investor's option to acquire 
5 shares of stock as if that part of the option had never been issued 
for purposes of determining whether the stock ownership requirements of 
section 382(l)(5)(A)(ii) are satisfied as of the effective date of the 
plan. Also, under paragraph (e)(2)(ii) of this section, L may take into 
account the 6 shares purchased by the qualified creditors by the 
exercise of the options in determining whether the stock ownership 
requirements of section 382(l)(5)(A)(ii) are satisfied as of the 
effective date of the plan. If L takes all of this information into 
account, the qualified creditors are deemed to own more than 50 percent 
of the total voting power or value of the L stock after the ownership 
change (106 of 211 shares or approximately 50.2 percent) and section 
382(l)(5) applies to the ownership change as of the effective date of 
the plan.

    (4) Effective dates--(i) In general. This paragraph (e) applies to 
ownership changes occurring on or after September 5, 1990.
    (ii) Special rule for interest or dividends. Rules similar to the 
rules of Sec. 1.382-2T(h)(4)(x)(E) (relating to option attribution for 
purposes of determining whether an ownership change occurs) apply to a 
right to receive or obligation to issue stock as interest or dividends 
on a debt instrument or stock that was issued after the filing of the 
petition in the title 11 or similar case for ownership changes occurring 
before April 8, 1992.
    (f)-(h) [Reserved]
    (i) Election not to apply section 382(l)(5). Under section 
382(l)(5)(H), a loss corporation may elect not to have the provisions of 
section 382(l)(5) apply to an ownership change in a title 11 or similar 
case. This election is irrevocable and must be made by the due date 
(including any extensions of time) of the loss corporation's tax return 
for the taxable year which includes the change date. The election is to 
be made by attaching the following statement to the tax return of the 
loss corporation for that taxable year: ``This is an Election Under 
Sec. 1.382-9(i) not to Apply the Provisions of Section 382(l)(5) to the 
Ownership Change Occurring Pursuant to a Plan of Reorganization 
Confirmed by the Court on [Insert Confirmation Date].''
    (j) Value of the loss corporation in an ownership change to which 
section 382(l)(6) applies. Section 382(l)(6) applies to any ownership 
change occurring pursuant to a plan of reorganization in a title 11 or 
similar case to which section 382(l)(5) does not apply. In such case, 
the value of the loss corporation

[[Page 740]]

under section 382(e) is equal to the lesser of--
    (1) The value of the stock of the loss corporation immediately after 
the ownership change (determined under the rules of paragraph (k) of 
this section); or
    (2) The value of the loss corporation's pre-change assets 
(determined under the rules of paragraph (l) of this section).
    (k) Rules for determining the value of the stock of the loss 
corporation--(1) Certain ownership interests treated as stock. For 
purposes of paragraph (j)(1) of this section--
    (i) Stock includes stock described in section 1504(a)(4) and any 
stock that is not treated as stock under Sec. 1.382-2T(f)(18)(ii) for 
purposes of determining whether a loss corporation has an ownership 
change; and
    (ii) Stock does not include an ownership interest that is treated as 
stock under Sec. 1.382-2T(f)(18)(iii) for purposes of determining 
whether a loss corporation has an ownership change.
    (2) Coordination with section 382(e)(2). In the case of a redemption 
or other corporate contraction occurring after and in connection with 
the ownership change, the value of the stock of the loss corporation 
under paragraph (j)(1) of this section is reduced under section 
382(e)(2).
    (3) Coordination with section 382(e)(3). If the loss corporation is 
a foreign corporation, in determining the value of the stock under 
paragraph (j)(1) of this section, only items treated as connected with 
the conduct of a trade or business in the United States are taken into 
account.
    (4) Coordination with section 382(l)(1). Section 382(l)(1) does not 
apply in determining the value of the stock of the loss corporation 
under paragraph (j)(1) of this section.
    (5) Coordination with section 382(l)(4). If, immediately after the 
ownership change, the loss corporation has substantial nonbusiness 
assets (as determined under section 382(l)(4)(B) taking into account 
only those assets the loss corporation held immediately before the 
ownership change), the value of the stock of the loss corporation under 
paragraph (j)(1) of this section is reduced by the excess of the value 
of such nonbusiness assets over those assets' share of the loss 
corporation's indebtedness (determined under section 382(l)(4)(D) taking 
into account the loss corporation's assets and liabilities immediately 
after the ownership change).
    (6) Special rule for stock not subject to the risk of corporate 
business operations--(i) In general. The value of the stock of the loss 
corporation under paragraph (j)(1) of this section is reduced by the 
value of stock that is issued as part of a plan one of the principal 
purposes of which is to increase the section 382 limitation without 
subjecting the investment to the entrepreneurial risks of corporate 
business operations.
    (ii) Coordination of special rule and other rules affecting value. 
If the value of the loss corporation is modified under another rule 
affecting value, appropriate adjustments are to be made so that such 
modification is not duplicated under this paragraph (k)(6).
    (7) Limitation on value of stock. For purposes of paragraph (j)(1) 
of this section, the value of stock of the loss corporation issued in 
connection with the ownership change cannot exceed the cash and the 
value of any property (including indebtedness of the loss corporation) 
received by the loss corporation in consideration for the issuance of 
that stock.
    (l) Rules for determining the value of the loss corporation's pre-
change assets--(1) In general. Except as otherwise provided in this 
paragraph (l), the value of the loss corporation's pre-change assets is 
the value of its assets (determined without regard to liabilities) 
immediately before the ownership change.
    (2) Coordination with section 382(e)(2). Section 382(e)(2) does not 
apply in determining the value of the pre-change assets of the loss 
corporation under paragraph (j)(2) of this section.
    (3) Coordination with section 382(e)(3). If the loss corporation is 
a foreign corporation, in determining the value of the pre-change assets 
under paragraph (j)(2) of this section, only assets treated as connected 
with the conduct of a trade or business in the United States are taken 
into account.
    (4) Coordination with section 382(l)(1). For purposes of paragraph 
(j)(2) of this

[[Page 741]]

section, the value of the pre-change assets of the loss corporation is 
determined without regard to the amount of any capital contribution to 
which section 382(l)(1) applies. For purposes of applying this paragraph 
(l)(4), the receipt of cash or property by the loss corporation in 
exchange for the issuance of indebtedness is considered a capital 
contribution if it is part of a plan one of the principal purposes of 
which is to increase the value of the loss corporation under paragraph 
(j) of this section.
    (5) Coordination with section 382(l)(4). If, immediately after the 
ownership change, the loss corporation has substantial nonbusiness 
assets (as determined under section 382(l)(4)(B) taking into account 
only those assets the loss corporation held immediately before the 
ownership change), the value of the loss corporation's pre-change assets 
is reduced by the value of the nonbusiness assets.
    (m) Continuity of business requirement--(1) Under section 382(l)(5). 
If section 382(l)(5) applies to an ownership change of a loss 
corporation, section 382(c) and the regulations thereunder do not apply 
with respect to the ownership change.
    (2) Under section 382(l)(6). If section 382(l)(6) applies to an 
ownership change of a loss corporation, section 382(c) and the 
regulations thereunder apply to the ownership change.
    (n) Ownership change in a title 11 or similar case succeeded by 
another ownership change within two years--(1) Section 382(l)(5) applies 
to the first ownership change. If section 382(l)(5) applies to an 
ownership change and, within the two-year period immediately following 
such ownership change, a second ownership change occurs, section 
382(l)(5) cannot apply to the second ownership change and the section 
382(a) limitation with respect to the second ownership change is zero.
    (2) Section 382(l)(6) applies to the first ownership change. If the 
value of a loss corporation in an ownership change was determined under 
section 382(l)(6) and a second ownership change occurs within the two-
year period immediately following the first ownership change, the value 
of the loss corporation under section 382(e) with respect to the second 
ownership change is not reduced under section 382(l)(1) for any increase 
in value of the loss corporation previously taken into account under 
section 382(l)(6) with respect to the first ownership change.
    (o) Treatment of certain options for ownership change purposes--(1) 
Neither Sec. 1.382-2T(h)(4)(i) nor Sec. 1.382-4(d) (relating to the 
treatment of options as exercised) applies to the following options to 
acquire stock of a loss corporation reorganized pursuant to a plan of 
reorganization that is confirmed in a title 11 or similar case (within 
the meaning of section 368(a)(3)(A)) but only until the time the plan 
becomes effective--
    (i) Any option created by the solicitation or receipt of acceptances 
to the plan;
    (ii) The option created by the confirmation of the plan; and
    (iii) Any option created under the plan.
    (2) This paragraph (o) generally applies to any testing date 
occurring on or after September 5, 1990. However, this paragraph (o) 
does not apply on any testing date occurring on or after April 8, 1992, 
if, in connection with the plan of reorganization, the loss corporation 
issues stock (including stock described in section 1504(a)(4)) or 
otherwise receives a capital contribution before the effective date of 
the plan for a principal purpose of using before the effective date 
losses and credits that would be subject to limitation under section 
382(a) or would be eliminated under section 382(l)(5)(B) or (C) if this 
paragraph (o) did not apply on the testing date. A loss corporation may 
elect to apply this paragraph (o) to any testing date occurring before 
September 5, 1990, by filing a statement substantially similar to the 
following with its income tax return: ``THIS IS AN ELECTION TO APPLY 
Sec. 1.382-3(o) (OR Sec. 1.382-9(o) AFTER REDESIGNATION) FOR TESTING 
DATES PRIOR TO SEPTEMBER 5, 1990, TO OPTIONS CREATED BY OR UNDER A PLAN 
OF REORGANIZATION CONFIRMED IN A TITLE 11 OR SIMILAR CASE.'' A loss 
corporation may elect to not apply this paragraph (o) to testing dates 
occurring on or after September 5, 1990, to April 8, 1992, by filing a 
statement substantially similar to the following with

[[Page 742]]

its income tax return: ``THIS IS AN ELECTION TO NOT APPLY Sec. 1.382-
3(o) (OR Sec. 1.382-9(o) AFTER REDESIGNATION) FOR TESTING DATES 
OCCURRING ON OR AFTER SEPTEMBER 5, 1990, TO APRIL 8, 1992, TO OPTIONS 
CREATED BY OR UNDER A PLAN OF REORGANIZATION CONFIRMED IN A TITLE 11 OR 
SIMILAR CASE.''
    (p) Effective date for rules relating to section 382(l)(6)--(1) In 
general. Paragraphs (i), (j), (k), (l), (m)(2), and (n)(2) of this 
section apply to any ownership change occurring on or after March 17, 
1994.
    (2) Ownership change to which section 382(l)(6) applies occurring 
before March 17, 1994. In the case of an ownership change occurring 
before March 17, 1994, the loss corporation may elect to apply the rules 
of paragraphs (j), (k), (l), (m)(2), and (n)(2) of Sec. 1.382-9 in 
their entirety. The election must be made by the later of the due date 
(including any extensions of time) of the loss corporation's tax return 
for the taxable year which includes the change date or the date that the 
loss corporation files its first tax return after May 16, 1994. The 
election is made by attaching the following statement to the return: 
``This is an Election to Apply Sec. Sec. 1.382-9 (j), (k), (l), (m)(2), 
and (n)(2) of the Income Tax Regulations to the Ownership Change 
Occurring Pursuant to a Plan of Reorganization Confirmed by the Court on 
[Insert Confirmation Date].'' In connection with making this election, 
on the same return the loss corporation may also elect not to apply 
section 382(l)(5) to the ownership change under paragraph (i) of this 
section (if the loss corporation has not already done so pursuant to 
Sec. 301.9100-7T(a) of this chapter). If, under the applicable statute 
of limitations, the loss corporation may file amended returns for the 
year of the ownership change and all subsequent years (an open year), an 
electing loss corporation must file an amended return for each prior 
affected year to reflect the elections. If, under the applicable statute 
of limitations, the loss corporation may not file an amended return for 
the year of the ownership change or any subsequent year (a closed year), 
an electing loss corporation must file an amended return for each 
affected open year to reflect the elections and the section 382 
limitation resulting from the ownership change must be appropriately 
adjusted for the earliest open year (or years) to reflect the difference 
between the amount of pre-change losses actually used in closed years 
and the amount of pre-change losses that would have been used in such 
years applying the rules of paragraphs (j), (k), (l), (m)(2), (n)(2) of 
this section to the ownership change.

[T.D. 8388, 57 FR 346, Jan. 6, 1992; T.D. 8407, 57 FR 12210, Apr. 9, 
1992. Redesignated by T.D. 8440, 57 FR 45712, 45713, Oct. 5, 1992; 57 FR 
52827, Nov. 5, 1992; T.D. 8531, 59 FR 12840, Mar. 18, 1994; T.D. 8530, 
59 FR 12843, Mar. 18, 1994; T.D. 8529, 59 FR 12846, Mar. 18, 1994; T.D. 
9811, 82 FR 6237, Jan. 19, 2017]



Sec. 1.382-10  Special rules for determining time and manner of
acquisition of an interest in a loss corporation.

    (a) Distributions from qualified trusts--(1) In general. For 
purposes of Sec. 1.382-2T, if a qualified trust described in section 
401(a) (qualified trust) distributes an ownership interest in an entity 
(as defined in Sec. 1.382-3(a)(1)), then for testing dates on or after 
the date of the distribution, the distributed ownership interest is 
treated as having been acquired by the distributee on the date and in 
the manner acquired by the trust and not as having been acquired or 
disposed of by the trust. The distribution does not cause the day of the 
distribution to be a testing date.
    (2) Accounting for dispositions--(i) General rule. For purposes of 
this paragraph (a), in order to determine which ownership interest in an 
entity is distributed from a qualified trust, a loss corporation must 
either specifically identify the ownership interests that are the 
subject of all dispositions by the qualified trust of ownership 
interests in an entity, or apply the first-in, first-out (FIFO) method 
to all such dispositions.
    (ii) Special rules. For purposes of this paragraph (a)(2):
    (A) The FIFO method must be applied on a class-by-class basis; and
    (B) The term dispositions includes distributions, sales, and other 
transfers.

[[Page 743]]

    (3) Examples. The following examples illustrate the principles of 
this paragraph (a). For purposes of these examples, unless otherwise 
stated, the nomenclature and assumptions of the examples in Sec. 1.382-
2T(b) apply, all corporations file separate income tax returns on a 
calendar year basis, the only 5-percent shareholder of a loss 
corporation is a public group, and the facts set forth the only 
acquisitions of stock by any participants in a qualified plan and the 
only owner shifts with respect to the loss corporation during the 
testing period. The examples are as follows:

    Example 1. (i) Facts. In 1994, E, a qualified trust established 
under Plan F, acquires 10 percent of L stock. A is a participant in Plan 
F. On January 1, 2002, A acquires 4 percent of L stock, and B, who is 
not a participant or a beneficiary of a participant in Plan F, acquires 
5 percent of L stock. On January 1, 2004, E distributes 2 percent of L 
stock to A. On July 1, 2004, A acquires 1 percent of L stock.
    (ii) Analysis. January 1, 2002, is a testing date because B's 
acquisition of 5 percent of L stock causes an increase in the percentage 
ownership of B, a 5-percent shareholder. As of the close of that testing 
date, A is treated as owning only 4 percent of L stock. Therefore, A is 
treated as a member of the public group of L. In addition, E is treated 
as owning 10 percent of L stock that it acquired in 1994.
    (iii) As a result of the application of paragraph (a)(1) of this 
section to E's distribution of 2 percent of L stock to A on January 1, 
2004, for testing dates on and after January 1, 2004, A is treated as 
having acquired that 2 percent interest in L in 1994, and E is treated 
as having acquired only 8 percent of L stock in 1994. Because there are 
no owner shifts on January 1, 2004, that date is not a testing date.
    (iv) July 1, 2004, is a testing date because on that date A, a 5-
percent shareholder, acquires 1 percent of L stock. As of the close of 
that testing date, A's percentage of ownership of L stock is 7 percent, 
and A's lowest percentage of ownership of L stock at any time within the 
testing period is 2 percent (deemed acquired in 1994), representing an 
increase of 5 percentage points. In addition, as of the close of July 1, 
2004, B's percentage of ownership of L stock is 5 percent, and B's 
lowest percentage of ownership of L stock at any time within the testing 
period is 0 percent, representing an increase of 5 percentage points. 
Thus, on July 1, 2004, L must take into account an increase of 10 (5 + 
5) percentage points in determining whether it has an ownership change.
    Example 2. (i) Facts. E is a qualified trust established under Plan 
F. L, a publicly traded corporation, has 100x shares of stock 
outstanding. As of January 1, 2006, C owns 5x shares of L stock and is 
not a participant or beneficiary of a participant in Plan F. At all 
times prior to January 1, 2006, E owns no L stock. On January 1, 2006, E 
acquires 10x shares of L stock from members of the public group of L. On 
December 1, 2007, E distributes 5x shares of L stock to some of the 
participants in Plan F. No one participant acquires all 5x shares as a 
result of the distribution. On February 1, 2008, C purchases 1x shares 
of L stock from the public group of L.
    (ii) Analysis. Because E's acquisition of 10x shares of L stock on 
January 1, 2006, is an owner shift, that date is a testing date. As of 
the close of that date, E's percentage of stock ownership in L has 
increased by 10 percentage points.
    (iii) As a result of the application of paragraph (a)(1) of this 
section to E's distribution of 5x shares of L stock to some Plan F 
participants on December 1, 2007, for testing dates on and after 
December 1, 2007, those distributees are treated as having acquired 
those shares of stock on January 1, 2006, from members of the public 
group of L, and E is not treated as having acquired those shares on that 
date. E's distribution of the 5x shares is not an owner shift. 
Therefore, December 1, 2007, is not a testing date.
    (iv) February 1, 2008, is a testing date because on that date an 
owner shift results from C's purchase of 1x shares of L stock. As of the 
close of that testing date, the distributees of 5x shares of L stock are 
treated as members of the public group of L having acquired 5x shares of 
L stock from other members of the public group of L on January 1, 2006. 
Because those acquisitions are not by 5-percent shareholders, L does not 
take them into account. In addition, as of the close of February 1, 
2008, E's percentage of stock ownership in L is 5 percent, and E's 
lowest percentage of stock ownership in L at any time within the testing 
period is 0 percent, representing an increase of 5 percentage points. In 
addition, as of the close of February 1, 2008, C's percentage of stock 
ownership in L is 6 percent, and C's lowest percentage of stock 
ownership in L at any time within the testing period is 5 percent, 
representing an increase of 1 percentage point. Therefore, on February 
1, 2008, L must take into account an increase of 6 (5 + 1) percentage 
points in determining whether it has an ownership change.

    (4) Effective dates. This section applies to all distributions after 
June 23, 2006. For distributions on or before

[[Page 744]]

June 23, 2006, see Sec. 1.382-10T as contained in 26 CFR part 1, 
revised April 1, 2006.
    (b) [Reserved]

[T.D. 9269, 71 FR 36677, June 28, 2006]



Sec. 1.382-11  Reporting requirements.

    (a) Information statement required. A loss corporation must include 
a statement entitled, ``STATEMENT PURSUANT TO Sec. 1.382-11(a) BY 
[INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER OF TAXPAYER], A LOSS 
CORPORATION,'' on or with its income tax return for each taxable year 
that it is a loss corporation in which an owner shift, equity structure 
shift or other transaction described in Sec. 1.382-2T(a)(2)(i) occurs. 
The statement must include the date(s) of any owner shifts, equity 
structure shifts, or other transactions described in Sec. 1.382-
2T(a)(2)(i), the date(s) on which any ownership change(s) occurred, and 
the amount of any attributes described in Sec. 1.382-2(a)(1)(i) that 
caused the corporation to be a loss corporation. A loss corporation may 
also be required to include certain elections on this statement, 
including--
    (1) An election made under Sec. 1.382-2T(h)(4)(vi)(B) to disregard 
the deemed exercise of an option if the actual exercise of that option 
occurred within 120 days of the ownership change; and
    (2) An election made under Sec. 1.382-6(b)(2) to close the books of 
the loss corporation for purposes of allocating income and loss to 
periods before and after the change date for purposes of section 382.
    (b) Effective/applicability date. This section applies to any 
taxable year beginning on or after May 30, 2006. However, taxpayers may 
apply this section to any original Federal income tax return (including 
any amended return filed on or before the due date (including 
extensions) of such original return) timely filed on or after May 30, 
2006. For taxable years beginning before May 30, 2006, see Sec. 1.382-
2T as contained in 26 CFR part 1 in effect on April 1, 2006.

[T.D. 9329, 72 FR 32803, June 14, 2007]



Sec. 1.382-12  Determination of adjusted Federal long-term rate.

    (a) In general. The long-term tax-exempt rate for an ownership 
change is the highest of the adjusted Federal long-term rates in effect 
for any month in the 3-calendar-month period ending with the calendar 
month in which the change date occurs. For purposes of the previous 
sentence, the adjusted Federal long-term rate is the Federal long-term 
rate determined under section 1274(d) (without regard to paragraphs (2) 
and (3) thereof), adjusted for differences between rates on long-term 
taxable and tax-exempt obligations. The Secretary calculates the 
adjusted Federal long-term rate as provided in paragraph (b) of this 
section. The Internal Revenue Service publishes the long-term tax-exempt 
rate and the adjusted Federal long-term rate for each month in the 
Internal Revenue Bulletin (see Sec. 601.601(d)(2)(ii) of this chapter).
    (b) Adjusted Federal long-term rate. The adjusted Federal long-term 
rate for a calendar month is the product of the Federal long-term rate 
determined under section 1274(d) for that month, based on annual 
compounding, multiplied by the adjustment factor described in paragraph 
(c) of this section.
    (c) Adjustment factor. The adjustment factor is a percentage equal 
to--
    (1) The excess of 100 percent, over
    (2) The product of--
    (i) 59 percent, and
    (ii) The sum of the maximum rate in effect under section 1 
applicable to individuals and the maximum rate in effect under section 
1411 applicable to individuals for the month to which the adjusted 
applicable Federal rate applies.
    (d) Effective/applicability date. The rules of this section apply to 
the determination of the long-term tax-exempt rate and the adjusted 
Federal long-term rate beginning with the rates determined during August 
2016 that apply during September 2016.

[T.D. 9763, 81 FR 24483, Apr. 26, 2016]



Sec. 1.383-0  Effective date.

    (a) The regulations in this part under section 383 of the Code 
(other than the regulations described in paragraph (b)

[[Page 745]]

of this section) reflect the amendments made to sections 382 and 383 by 
the Tax Reform Act of 1986 and the amendments made to section 382 by 
Public Law 115-97 (2017). See Sec. 1.383-1(j) for effective date rules.
    (b) Sections 1.383-1A, 1.383-2A, and 1.383-3A do not reflect the 
amendments made to sections 382 and 383 by the Tax Reform Act of 1986.

[T.D. 8352, 56 FR 29434, June 27, 1991, as amended by T.D. 9905, 85 FR 
56837, Sept. 14, 2020]



Sec. 1.383-1  Special limitations on certain capital losses and 
excess credits.

    (a) Outline of topics. In order to facilitate the use of this 
section, this paragraph lists the paragraphs, subparagraphs and 
subdivisions contained in this section.

    (a) Outline of topics.
    (b) In general.
    (c) Definitions.
    (1) Coordination with definitions and nomenclature used in section 
382.
    (2) Pre-change capital loss.
    (3) Pre-change credit.
    (4) Pre-change loss.
    (5) Regular tax liability.
    (6) Section 383 credit limitation.
    (i) Definition.
    (ii) Example.
    (d) Limitation on use of pre-change losses and pre-change credits.
    (1) In general.
    (i) In general.
    (ii) Ordering rule for losses or credits from same taxable year.
    (2) Ordering rules for utilization of pre-change losses and pre-
change credits and for absorption of the section 382 limitation and the 
section 383 credit limitation.
    (3) Coordination with other limitations.
    (i) In general.
    (ii) Examples.
    (e) Carryforward of unused section 382 limitation.
    (1) Computation of carryforward amount.
    (2) Section 383 credit reduction amount.
    (3) [Reserved]
    (4) Special rules for determining the section 383 credit reduction 
amount.
    (i) Ordering rules.
    (ii) Special rule for credits under section 38(a).
    (f) Examples.
    (g) Coordination with section 382 and the regulations thereunder.
    (h) Alternative minimum tax.
    (i) [Reserved]
    (j) Applicability date.
    (1) In general.
    (2) Interaction with section 163(j).

    (b) In general. Under section 383, if an ownership change occurs 
with respect to a loss corporation, the section 382 limitation and the 
section 383 credit limitation (as defined in paragraph (c)(6) of this 
section) for a post-change year shall apply to limit the amount of 
taxable income and regular tax liability, respectively, that can be 
offset by pre-change capital losses and pre-change credits of the new 
loss corporation. The section 383 credit limitation for a post-change 
year bears a direct relationship to the amount, if any, of the section 
382 limitation that remains after taking into account the reduction in 
the loss corporation's taxable income during a post-change year as a 
result of its pre-change losses (as defined in paragraph (c)(4) of this 
section). In general, the section 383 credit limitation is an amount 
equal to the tax liability of the new loss corporation for the post-
change year which is attributable to so much of the corporation's 
taxable income that would be reduced by allowing as a deduction its 
section 382 limitation remaining after accounting for the use of pre-
change losses. As pre-change losses and pre-change credits of a 
corporation are used, they absorb the section 382 limitation and the 
section 383 credit limitation, respectively, in the manner prescribed by 
paragraph (d) of this section. See also section 382 and the regulations 
thereunder.
    (c) Definitions--(1) Coordination with definitions and nomenclature 
used in section 382. Terms and nomenclature used in this section, and 
not otherwise defined herein, shall have the same respective meanings as 
in section 382 and the regulations thereunder, taking into account that 
the limitations of section 383 and this section apply to pre-change 
capital losses and pre-change credits.
    (2) Pre-change capital loss. The term pre-change capital loss 
means--
    (i) Any capital loss carryover under section 1212 of the old loss 
corporation to the taxable year ending on the change date or in which 
the change date occurs,
    (ii) Any net capital loss of the old loss corporation for the 
taxable year in which the ownership change occurs, to

[[Page 746]]

the extent such loss is allocable to the period in such year ending on 
or before the change date, and
    (iii) If the old loss corporation has a net unrealized built-in 
loss, any recognized built-in loss for any recognition period taxable 
year (within the meaning of section 382(h)) that is a capital loss.
    (3) Pre-change credit. The term pre-change credit means--
    (i) Any excess foreign taxes under section 904(c) of the old loss 
corporation--
    (A) carried forward to the taxable year ending on the change date or 
in which the change date occurs, or
    (B) carried forward from the taxable year that includes the change 
date, to the extent such credit is allocable to the period in such year 
ending on or before the change date,
    (ii) Any credit under section 38 of the old loss corporation--
    (A) carried forward to the taxable year ending on the change date or 
in which the change date occurs, or
    (B) carried forward from a taxable year that includes the change 
date to the extent such credit is allocable to the period in such year 
ending on or before the change date, and
    (iii) The available minimum tax credit of the old loss corporation 
under section 53 to the extent attributable to periods ending on or 
before the change date.
    (4) Pre-change loss. Solely for purposes of this section, the term 
prechange loss means any pre-change loss described in Sec. 1.382-
2(a)(2) other than pre-change credits described in paragraph (c)(3) of 
this section.
    (5) Regular tax liability. For purposes of this section, the term 
regular tax liability has the same meaning as provided in section 26(b).
    (6) Section 383 credit limitation--(i) Definition. The section 383 
credit limitation for a post-change year of a new loss corporation is an 
amount equal to the excess of--
    (A) The new loss corporation's regular tax liability for the post-
change year, over
    (B) The new loss corporation's regular tax liability for the post-
change year computed, for this purpose, by allowing as an additional 
deduction an amount equal to the section 382 limitation remaining after 
the application of paragraphs (d)(2)(i) through (v) of this section.
    (ii) Example. L, a new loss corporation, is a calendar-year 
taxpayer. L has an ownership change on December 31, 2021. For 2022, L 
has taxable income (prior to the use of any pre-change losses) of 
$100,000. In addition, L has a section 382 limitation of $25,000, a pre-
change net operating loss carryover of $12,000, a pre-change general 
business credit carryforward under section 39 of $50,000, and no items 
described in Sec. 1.383-1(d)(2)(i) through (iv). L's section 383 credit 
limitation for 2022 is the excess of its regular tax liability computed 
after allowing a $12,000 net operating loss deduction (taxable income of 
$88,000; regular tax liability of $18,480), over its regular tax 
liability computed after allowing an additional deduction in the amount 
of L's section 382 limitation remaining after the application of 
paragraphs (d)(2)(i) through (v) of this section, or $13,000 (taxable 
income of $75,000; regular tax liability of $15,750). L's section 383 
credit limitation is therefore $2,730 ($18,480 minus $15,750).
    (d) Limitation on use of pre-change losses and pre-change credits--
(1) In general--(i) General rule. The amount of taxable income of a new 
loss corporation for any post-change year that may be offset by pre-
change losses shall not exceed the amount of the section 382 limitation 
for the post-change year. The amount of the regular tax liability of a 
new loss corporation for any post-change year that may be offset by pre-
change credits shall not exceed the amount of the section 383 credit 
limitation for the post-change year.
    (ii) Ordering rule for losses or credits from same taxable year. A 
loss corporation's taxable income is offset first by losses subject to a 
section 382 limitation, to the extent the section 382 limitation for 
that taxable year has not yet been absorbed, before being offset by 
losses of the same type from the same taxable year that are not subject 
to a section 382 limitation. For example, assume that Corporation X has 
an ownership change in Year 1 and carries over disallowed business 
interest expense as defined in Sec. 1.163(j)-1(b)(10), some of

[[Page 747]]

which constitutes a section 382 disallowed business interest 
carryforward, from Year 1 to Year 2. To the extent of its section 163(j) 
limitation, as defined in Sec. 1.163(j)-1(b)(36), and its remaining 
section 382 limitation, Corporation X offsets its Year 2 income with the 
section 382 disallowed business interest carryforward before using any 
of the disallowed business interest expense that is not a section 382 
disallowed business interest carryforward. Similar principles apply to 
the use of tax credits.
    (2) Ordering rules for utilization of pre-change losses and pre-
change credits and for absorption of the section 382 limitation and the 
section 383 credit limitation. Pre-change losses described in any 
subdivision of this paragraph (d)(2) can offset taxable income in a 
post-change year only to the extent that the section 382 limitation for 
that year has not been absorbed by pre-change losses described in any 
lower-numbered subdivisions. Pre-change credits described in any 
subdivision of this paragraph (d)(2) can offset regular tax liability in 
a post-change year only to the extent that the section 383 credit 
limitation for that year has not been absorbed by pre-change credits 
described in any lower numbered subdivisions. The section 382 limitation 
is absorbed by one dollar for each dollar of pre-change loss that is 
used to offset taxable income. The section 383 credit limitation is 
absorbed by one dollar for each dollar of pre-change credit that is used 
to offset regular tax liability. For each post-change year, the section 
382 limitation and the section 383 credit limitation of a new loss 
corporation are absorbed by such corporation's pre-change losses and 
pre-change credits in the following order:
    (i) Pre-change capital losses described in paragraph (c)(2)(iii) of 
this section that are recognized and are subject to the section 382 
limitation in such post-change year;
    (ii) Pre-change capital losses described in paragraphs (c)(2)(i) and 
(ii) of this section;
    (iii) Pre-change losses that are described in Sec. 1.382-
2(a)(2)(iii), other than losses that are pre-change capital losses, that 
are recognized and are subject to the section 382 limitation in such 
post-change year;
    (iv)(A) With respect to an ownership change date occurring prior to 
November 13, 2020, but during the taxable year which includes November 
13, 2020, the pre-change loss described in section 382(d)(3);
    (B) With respect to an ownership change date occurring on or after 
November 13, 2020, section 382 disallowed business interest 
carryforwards (within the meaning of Sec. 1.382-2(a)(7));
    (v) Pre-change losses not described in paragraphs (d)(2)(i) through 
(iv) of this section;
    (vi) Pre-change credits described in paragraph (c)(3)(i) of this 
section (excess foreign taxes),
    (vii) Pre-change credits described in paragraph (c)(3)(ii) of this 
section (business credits); and
    (viii) Pre-change credits described in paragraph (c)(3)(iii) of this 
section (minimum tax credit).
    (3) Coordination with other limitations--(i) In general. Paragraphs 
(d)(1) and (2) of this section shall be applied after the application of 
all other limitations contained in subtitle A which are applicable to 
the use of a pre-change loss or pre-change credit in a post-change year. 
Thus, only otherwise currently allowable pre-change losses and pre-
change credits will result in the absorption of the section 382 
limitation and the section 383 credit limitation. The application of 
section 59A is not a limitation contained in subtitle A for purposes of 
this paragraph (d)(3)(i). Therefore, the treatment of pre-change losses 
and pre-change credits in the computation of the base erosion minimum 
tax amount will not affect whether such losses or credits result in 
absorption of the section 382 limitation and the section 383 credit 
limitation.
    (ii) Example. L, a calendar-year taxpayer, has an ownership change 
on December 31, 2021. For 2022, L has taxable income of $300,000 and a 
regular tax liability of $63,000. L has no pre-change losses, but it has 
a business credit carryforward from 2020 of $25,000. L has a section 382 
limitation for 2022 of $50,000. L's section 383 credit limitation is 
$10,500, an amount equal to the excess of L's regular tax liability 
($63,000)

[[Page 748]]

over its regular tax liability calculated by allowing an additional 
deduction of $50,000 ($52,500). Pursuant to the limitation contained in 
section 38(c), however, L is entitled to use only $9,500 (($63,000-
$25,000) x 25 percent) of its business credit carryforward in 2022. The 
unabsorbed portion of L's section 382 limitation, $1,000 (computed 
pursuant to paragraph (e) of this section), is carried forward under 
section 382(b)(2). The unused portion of L's business credit 
carryforward, $14,500, is carried forward to the extent provided in 
section 39.
    (e) Carryforward of unused section 382 limitation--(1) Computation 
of carryforward amount. The section 382 limitation that can be carried 
forward under section 382(b)(2) is the excess, if any, of (i) the 
section 382 limitation for the post-change year remaining after the 
application of paragraphs (d)(2)(i) through (v) of this section, over 
(ii) the section 383 credit reduction amount for that post-change year.
    (2) Section 383 credit reduction amount. The section 383 credit 
reduction amount for a post-change year is equal to the amount of 
taxable income attributable to the portion of the new loss corporation's 
regular tax liability for the year that is offset by pre-change credits. 
Each dollar of regular tax liability that is offset by a dollar of pre-
change credit is divided by the effective marginal rate at which that 
dollar of tax was imposed to determine the amount of taxable income that 
resulted in that particular dollar of regular tax liability. The sum of 
these ``grossed-up'' amounts for the taxable year is the section 383 
credit reduction amount. In determining the effective marginal rate at 
which a dollar of tax was imposed, special rules regarding rates of tax 
(e.g., section 15 or taxable income brackets (e.g., section 1561), or 
both, shall be taken into account.
    (3) [Reserved]
    (4) Special rules for determining the section 383 credit reduction 
amount--(i) Ordering rules. For purposes of this paragraph (e), credits, 
including pre-change credits, are considered to offset regular tax 
liability in the order that such credits are applied under the ordering 
rules of part IV of subchapter A of chapter 1 and section 904. For 
example, for purposes of this paragraph (e), excess foreign taxes 
carried over under section 904(c) (whether or not a pre-change credit) 
are considered (under section 38(c)) to offset regular tax liability 
before the general business credit carryovers to the taxable year are 
considered (under section 39) to offset regular tax liability before 
general business credits arising in the taxable year.
    (ii) Special rule for credits under section 38(a). For purposes of 
applying this paragraph (e), credits under section 38(a) that, under 
section 38(c)(2) as applicable, taking into account amendments made by 
section 11813 of the Revenue Reconciliation Act of 1990, effectively 
offset both regular tax liability and the tax imposed by section 55 
(relating to minimum tax), are considered to offset regular tax 
liability.
    (f) Examples. The following examples illustrate the operation of 
paragraphs (b) through (e) of this section. For purposes of these 
examples, the term modified tax liability means the amount determined 
under paragraph (c)(6)(i)(B) of this section.
    (1) Example 1. (i) L, a calendar year taxpayer, has an ownership 
change on December 31, 1987. Before the application of carryovers, L, a 
new loss corporation, has $60,000 of capital gain, $100,000 of ordinary 
taxable income and a section 382 limitation of $100,000 for its first 
post-change year beginning after the change date. L's only carryovers 
are an $80,000 capital loss carryover and a $100,000 net operating loss 
carryover. Both carryovers are from taxable years ending before the 
change date and thus are pre-change losses.
    (ii) L first uses $60,000 of its pre-change capital loss carryover 
to offset its capital gain. This reduces its section 382 limitation to 
$40,000 (i.e., $100,000-$60,000). L's pre-change net operating loss 
carryover can therefore be used only to the extent of $40,000. L's 
remaining $20,000 pre-change capital loss carryover and remaining 
$60,000 pre-change net operating loss carryover are carried to later 
years to the extent permitted under this section and sections 172, 
382(l)(2) and 1212.
    (2) Example 2--(i) Facts. L, a calendar-year taxpayer, has an 
ownership

[[Page 749]]

change on December 31, 2021. For 2022, L has $750,000 of ordinary 
taxable income (before the application of carryovers) and a section 382 
limitation of $1,500,000. L's only carryovers are from pre-2021 taxable 
years and consist of a $500,000 net operating loss (NOL) carryover, and 
a $200,000 foreign tax credit carryover (all of which may be used under 
the section 904 limitation). The NOL carryover is a pre-change loss, and 
the foreign tax credit carryover is a pre-change credit. L has no other 
pre-change losses or credits that can be used in 2022.
    (ii) Analysis. The following computation illustrates the application 
of this section for 2022:

                     Table 1 to Paragraph (f)(2)(ii)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
1. Taxable income before carryovers........................     $750,000
2. Pre-change NOL carryover................................      500,000
3. Section 382 limitation..................................    1,500,000
4. Amount of pre-change NOL carryover that can be used           500,000
 (least of line 1, 2, or 3)................................
5. Taxable income (line 1 minus line 4)....................      250,000
6. Section 382 limitation remaining (line 3 minus line 4)..    1,000,000
7. Pre-change credit carryover.............................      200,000
8. Regular tax liability (line 5 x section 11 rates).......       52,500
9. Modified tax liability (line 5 minus line 6 (but not                0
 less than zero) x section 11 rates).......................
10. Section 383 credit limitation (line 8 minus line 9)....       52,500
11. Amount of pre-change credits that can be used in 2022         52,500
 (lesser of line 7 or line 10).............................
12. Amount of pre-change credits to be carried over to 2023      147,500
 under section 904(c) (line 7 minus line 11)...............
13. Section 383 credit reduction amount: $52,500/0.21......      250,000
14. Section 382 limitation to be carried to 2023 under           750,000
 section 382(b)(2) (line 6 minus line 13)..................
------------------------------------------------------------------------

    (3) Example 3--(i) Facts. L, a calendar-year taxpayer, has an 
ownership change on December 31, 2021. L has $80,000 of ordinary taxable 
income (before the application of carryovers) and a section 382 
limitation of $25,000 for 2022, a post-change year. L's only carryover 
is from a pre-2021 taxable year and is a general business credit 
carryforward under section 39 in the amount of $10,000 (no portion of 
which is attributable to the investment tax credit under section 46). 
The general business credit carryforward is a pre-change credit. L has 
no other credits which can be used in 2022.
    (ii) Analysis. The following computation illustrates the application 
of this section:

                     Table 2 to paragraph (f)(3)(ii)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
1. Taxable income before carryovers........................      $80,000
2. Section 382 limitation..................................       25,000
3. Pre-change credit carryover.............................       10,000
4. Regular tax liability (line 1 x section 11 rates).......       16,800
5. Modified tax liability ((line 1 minus line 2) x section        11,550
 11 rates).................................................
6. Section 383 credit limitation (line 4 minus line 5).....        5,250
7. Amount of pre-change credits that can be used (lesser of        5,250
 line 3 or line 6).........................................
8. Amount of pre-change credits to be carried over to 2023         4,750
 under sections 39 and 382(l)(2) (line 3 minus line 7).....
9. Regular tax payable (line 4 minus line 7)...............       11,550
10. Section 383 credit reduction amount: $5,250/0.21.......       25,000
11. Section 382 limitation to be carried to 2023 under                 0
 section 382(b)(2) (line 2 minus line 10)..................
------------------------------------------------------------------------


[[Page 750]]

    (g) Coordination with section 382 and the regulations thereunder. 
The rules and principles of section 382 (including, for example, section 
382(b)(3) and section 382(l)(2)) and the regulations thereunder shall 
also apply with respect to section 383 and this section. To the extent 
section 382(h)(6) applies to credits, the principles of this section 
apply to such credits. In applying the rules and principles of section 
382 and the regulations thereunder, appropriate adjustments shall be 
made to take into account that section 383 and this section apply to 
pre-change capital losses and pre-change credits. For example, in 
applying Sec. 1.382-2T (f)(18)(ii)(C), (f)(18)(iii)(C) and (h)(4)(ix), 
any pre-change credits, as defined in paragraph (c)(3) of this section, 
must be converted to a deduction equivalent by dividing the amount of 
such credits by the maximum effective rate of tax provided for under 
section 11.
    (h) Alternative minimum tax. See Sec. 1.383-2T for the application 
of the limitations contained in sections 382 and 383 in computing the 
alternative minimum tax under section 55.
    (i) [Reserved]
    (j) Applicability date--(1) In general. Subject to any exception 
from the application of section 382 or the section 382 limitation with 
respect to a loss corporation, section 383 and this section apply to any 
loss corporation with respect to which an ownership change occurs after 
December 31, 1986. See Sec. 1.382-2T(m) for effective date rules 
relating to ownership changes. If section 383 was not taken into account 
or was applied other than in accordance with this section in a prior 
taxable year with respect to which section 383 applies, the taxpayer 
should, within the period of limitation, file an amended return and pay 
any additional tax due plus interest.
    (2) Interaction with section 163(j). Paragraphs (c)(6)(i)(B) and 
(c)(6)(ii), (d)(1), (d)(2)(iii) through (viii), (d)(3)(ii), (e)(1) 
through (3), (f), and (g) of this section apply with respect to 
ownership changes occurring during a taxable year beginning on or after 
November 13, 2020. For loss corporations that have undergone an 
ownership change during a taxable year beginning before November 13, 
2020, see Sec. 1.383-1 as contained in 26 CFR part 1, revised April 1, 
2019. However, taxpayers and their related parties, within the meaning 
of sections 267(b) and 707(b)(1), may choose to apply the rules of this 
section to an ownership change occurring during a taxable year beginning 
after December 31, 2017, so long as the taxpayers and their related 
parties consistently apply either the rules of this section (except 
paragraph (d)(2)(iv)(B) of this section), the section 163(j) regulations 
(as defined in Sec. 1.163(j)-1(b)(37)), Sec. Sec. 1.382-1, 1.382-2, 
1.382-5, 1.382-6, 1.382-7, and 1.383-0, and, if applicable, Sec. Sec. 
1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-
5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 
1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate 
the rules of Sec. Sec. 1.382-2, Sec. 1.382-5, 1.382-6, and 1.383-1), 
and 1.1504-4; or the rules of this section (except paragraph 
(d)(2)(iv)(A) of this section), the section 163(j) regulations (as 
defined in Sec. 1.163(j)-1(b)(37)) and Sec. Sec. 1.382-1, 1.382-2, 
1.382-5, 1.382-6, and 1.383-0, and, if applicable, Sec. Sec. 1.263A-9, 
1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-
3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of 
Sec. Sec. 1.382-2, 1.382-5, 1.382-6, 1.382-7, and 1.383-1), and 1.1504-
4, to those ownership changes.

[T.D. 8264, 54 FR 38668, Sept. 20, 1989; T.D. 8264, 54 FR 46187, Nov. 1, 
1989; T.D. 8264, 54 FR 50043, Dec. 4, 1989. Redesignated and amended by 
T.D. 8352, 56 FR 29434, June 27, 1991; T.D. 9885, 84 FR 67038, Dec. 6, 
2019; T.D. 9905, 85 FR 56837, Sept. 14, 2020]



Sec. 1.383-2  Limitations on certain capital losses and excess credits
in computing alternative minimum tax. [Reserved]



Sec. 1.385-1  General provisions.

    (a) Overview of section 385 regulations. This section and Sec. Sec. 
1.385-3 through 1.385-4 (collectively, the section 385 regulations) 
provide rules under section 385 to determine the treatment of an 
interest in a corporation as stock or indebtedness (or as in part stock 
and in part indebtedness) in particular factual situations. Paragraph 
(b) of this section provides the general rule for determining the 
treatment of an interest based on provisions of the Internal

[[Page 751]]

Revenue Code and on common law, including the factors prescribed under 
common law. Paragraphs (c), (d), and (e) of this section provide 
definitions and rules of general application for purposes of the section 
385 regulations. Section 1.385-3 sets forth additional factors that, 
when present, control the determination of whether an interest in a 
corporation that is held by a member of the corporation's expanded group 
is treated (in whole or in part) as stock or indebtedness.
    (b) General rule. Except as otherwise provided in the Internal 
Revenue Code and the regulations thereunder, including the section 385 
regulations, whether an interest in a corporation is treated for 
purposes of the Internal Revenue Code as stock or indebtedness (or as in 
part stock and in part indebtedness) is determined based on common law, 
including the factors prescribed under such common law.
    (c) Definitions. The definitions in this paragraph (c) apply for 
purposes of the section 385 regulations. For additional definitions that 
apply for purposes of their respective sections, see Sec. Sec. 1.385-
3(g) and 1.385-4(e).
    (1) Controlled partnership. The term controlled partnership means, 
with respect to an expanded group, a partnership with respect to which 
at least 80 percent of the interests in partnership capital or profits 
are owned, directly or indirectly, by one or more members of the 
expanded group. For purposes of identifying a controlled partnership, 
indirect ownership of a partnership interest is determined by applying 
the principles of paragraph (c)(4)(iii) of this section. Such 
determination is separate from the determination of the status of a 
corporation as a member of an expanded group. An unincorporated 
organization described in Sec. 1.761-2 that elects to be excluded from 
all of subchapter K of chapter 1 of the Internal Revenue Code is not a 
controlled partnership.
    (2) Covered member. The term covered member means a member of an 
expanded group that is--
    (i) A domestic corporation; and
    (ii) [Reserved]
    (3) Disregarded entity. The term disregarded entity means a business 
entity (as defined in Sec. 301.7701-2(a) of this chapter) that is 
disregarded as an entity separate from its owner for federal income tax 
purposes under Sec. Sec. 301.7701-1 through 301.7701-3 of this chapter.
    (4) Expanded group--(i) In general. The term expanded group means 
one or more chains of corporations (other than S corporations) connected 
through stock ownership with a common parent corporation that is not an 
S corporation or a regulated investment company or a real estate 
investment trust subject to tax under subchapter M of chapter 1 of the 
Internal Revenue Code (a RIC or a REIT, respectively) (such common 
parent corporation, an expanded group parent), but only if--
    (A) The expanded group parent owns directly or indirectly stock 
meeting the requirements of section 1504(a)(2) (modified by substituting 
``or'' for ``and'' in section 1504(a)(2)(A)) in at least one of the 
other corporations; and
    (B) Stock meeting the requirements of section 1504(a)(2) (modified 
by substituting ``or'' for ``and'' in section 1504(a)(2)(A)) in each of 
the other corporations (except the expanded group parent) is owned 
directly or indirectly by one or more of the other corporations.
    (ii) Definition of stock. For purposes of paragraph (c)(4)(i) of 
this section, the term stock has the same meaning as ``stock'' in 
section 1504 (without regard to Sec. 1.1504-4) and all shares of stock 
within a single class are considered to have the same value. Thus, 
control premiums and minority and blockage discounts within a single 
class are not taken into account.
    (iii) Indirect stock ownership. For purposes of paragraph (c)(4)(i) 
of this section, indirect stock ownership is determined by applying the 
constructive ownership rules of section 318(a) with the following 
modifications:
    (A) Section 318(a)(1) and (a)(3) do not apply except as set forth in 
paragraph (c)(4)(v) of this section;
    (B) Section 318(a)(2)(C) applies by substituting ``5 percent'' for 
``50 percent;'' and
    (C) Section 318(a)(4) only applies to options (as defined in Sec. 
1.1504-4(d)) that are reasonably certain to be exercised as described in 
Sec. 1.1504-4(g).

[[Page 752]]

    (iv) Member of an expanded group or expanded group member. The 
expanded group parent and each of the other corporations described in 
paragraphs (c)(4)(i)(A) and (c)(4)(i)(B) of this section is a member of 
an expanded group (also referred to as an expanded group member). For 
purposes of the section 385 regulations, a corporation is a member of an 
expanded group if it is described in this paragraph (c)(4)(iv) 
immediately before the relevant time for determining membership (for 
example, immediately before the issuance of a debt instrument (as 
defined in Sec. 1.385-3(g)(4)) or immediately before a distribution or 
acquisition that may be subject to Sec. 1.385-3(b)(2) or (3)).
    (v) Brother-sister groups with non-corporate owners. [Reserved]
    (vi) Special rule for indirect ownership through options for certain 
members of consolidated groups. In the case of an option of which a 
member of a consolidated group, other than the common parent, is the 
issuing corporation (as defined in Sec. 1.1504-4(c)(1)), section 
318(a)(4) only applies (for purposes of applying paragraph 
(c)(4)(iii)(C) of this section) to the option if the option is treated 
as stock or as exercised under Sec. 1.1504-4(b) for purposes of 
determining whether a corporation is a member of an affiliated group.
    (vii) Examples. The following examples illustrate the rules of this 
paragraph (c)(4). Except as otherwise stated, for purposes of the 
examples in this paragraph (c)(4)(vii), all persons described are 
corporations that have a single class of stock outstanding and file 
separate federal tax returns and are not an S corporation, a RIC, or a 
REIT. In addition, the stock of each publicly traded corporation is 
widely held such that no person directly or indirectly owns stock in the 
publicly traded corporation meeting the requirements of section 
1504(a)(2) (as modified by this paragraph (c)(4)).
    (A) Example 1. Two different expanded group parents--(1) Facts. P 
has two classes of common stock outstanding: Class A and Class B. X, a 
publicly traded corporation, directly owns all shares of P's Class A 
common stock, which is high-vote common stock representing 85% of the 
vote and 15% of the value of the stock of P. Y, a publicly traded 
corporation, directly owns all shares of P's Class B common stock, which 
is low-vote common stock representing 15% of the vote and 85% of the 
value of the stock of P. P directly owns 100% of the stock of S1.
    (2) Analysis. X owns directly 85% of the vote of the stock of P, 
which is stock meeting the requirements of section 1504(a)(2) (as 
modified by paragraph (c)(4)(i)(A) of this section). Therefore, X is an 
expanded group parent described in paragraph (c)(4)(i) of this section 
with respect to P. Y owns 85% of the value of the stock of P, which is 
stock meeting the requirements of section 1504(a)(2) (as modified by 
paragraph (c)(4)(i)(A) of this section). Therefore, Y is also an 
expanded group parent described in paragraph (c)(4)(i) of this section 
with respect to P. P owns directly 100% of the voting power and value of 
the stock of S1, which is stock meeting the requirements of section 
1504(a)(2) (as modified by paragraph (c)(4)(i)(B) of this section). 
Therefore, X, P, and S1 constitute an expanded group as defined in 
paragraph (c)(4)(i) of this section. Additionally, Y, P, and S1 
constitute an expanded group as defined in paragraph (c)(4) of this 
section. X and Y are not members of the same expanded group under 
paragraph (c)(4) of this section because X does not directly or 
indirectly own any of the stock of Y and Y does not directly or 
indirectly own any of the stock of X, such that X and Y do not comprise 
a chain of corporations described in paragraph (c)(4)(i) of this 
section.
    (B) Example 2. Inclusion of a REIT within an expanded group--(1) 
Facts. All of the stock of P is publicly traded. In addition to other 
assets representing 85% of the value of its total assets, P directly 
owns all of the stock of S1. S1 owns 99% of the stock of S2. The 
remaining 1% of the stock of S2 is owned by 100 unrelated individuals. 
In addition to other assets representing 85% of the value of its total 
assets, S2 owns all of the stock of S3, which has elected to be treated 
as a taxable REIT subsidiary of S2 under section 856(l)(1). Both P and 
S2 are REITs.
    (2) Analysis. P directly owns 100% of the stock of S1. However, 
under paragraph (c)(4)(i) of this section, P cannot

[[Page 753]]

be the expanded group parent because P is a REIT. Because no other 
corporation owns stock in P meeting the requirements described in 
paragraph (c)(4)(i) of this section, P is not an expanded group member. 
S1 directly owns 99% of the stock of S2, which is stock meeting the 
requirements of section 1504(a)(2) (as modified by paragraph 
(c)(4)(i)(A) of this section). Although S2 is a corporation that is a 
REIT, a REIT may be a member of an expanded group described under 
paragraph (c)(4)(i) of this section provided the corporation is not the 
expanded group parent. In this case, S1 is the expanded group parent. S2 
directly owns 100% of the stock of S3, which is stock meeting the 
requirements of section 1504(a)(2) (as modified by paragraph 
(c)(4)(i)(B) of this section). Therefore, S1, S2, and S3 constitute an 
expanded group as defined in paragraph (c)(4) of this section.
    (C) Example 3. Attribution of hook stock--(1) Facts. P, a publicly 
traded corporation, directly owns 50% of the stock of S1. S1 directly 
owns 100% of the stock of S2. S2 directly owns the remaining 50% of the 
stock of S1.
    (2) Analysis. (i) P directly owns 50% of the stock of S1. Under 
paragraph (c)(4)(iii) of this section (which applies section 318(a)(2) 
with modifications), P constructively owns 50% of the stock of S2 
because P directly owns 50% of the stock of S1, which directly owns 100% 
of S2. Under section 318(a)(5)(A), stock constructively owned by P by 
reason of the application of section 318(a)(2) is, for purposes of 
section 318(a)(2), considered as actually owned by P.
    (ii) S2 directly owns 50% of the stock of S1. Thus, under paragraph 
(c)(4)(iii) of this section, P is treated as constructively owning an 
additional 25% of the stock of S1. For purposes of determining the 
expanded group, P's ownership must be recalculated treating the 
additional 25% of S1 stock as actually owned. Under the second 
application of section 318(a)(2)(C) as modified by paragraph (c)(4)(iii) 
of this section, P constructively owns an additional 12.5% of the stock 
of S1 as follows: 25% (P's new attributed ownership of S1) x 100% (S1's 
ownership of S2) x 50% (S2's ownership of S1) = 12.5%. After two 
iterations, P's ownership in S1 is 87.5% (50% direct ownership + 25% 
first order constructive ownership + 12.5% second order constructive 
ownership) and thus S1 is a member of the expanded group that includes P 
and S2. Subsequent iterative calculations of P's ownership, treating 
constructive ownership as actual ownership, would demonstrate that P 
owns, directly and indirectly, 100% of the stock of S1. P, S1, and S2 
therefore constitute an expanded group as defined in paragraph (c)(4) of 
this section and P is the expanded group parent.
    (D) Example 4. Attribution of hook stock when an intermediary has 
multiple owners--(1) Facts. The facts are the same as in paragraph 
(c)(4)(vii)(C)(1) of this section (Example 3), except that P directly 
owns only 25% of the stock of S1. X, a corporation unrelated to P, also 
directly owns 25% of the stock of S1.
    (2) Analysis. (i) P and X each directly owns 25% of the stock of S1. 
Under paragraph (c)(4)(iii) of this section, P and X each constructively 
owns 25% of the stock of S2 because P and X each directly owns 25% of 
the stock of S1, which directly owns 100% of the stock of S2. Under 
section 318(a)(5)(A), stock constructively owned by P or X by reason of 
the application of section 318(a)(2) is, for purposes of section 
318(a)(2), considered as actually owned by P or X, respectively.
    (ii) S2 directly owns 50% of the stock of S1. Thus, under paragraph 
(c)(4)(iii) of this section, P and X each is treated as constructively 
owning an additional 12.5% of the stock of S1. Under a second 
application of section 318(a)(2)(C) as modified by paragraph (c)(4)(iii) 
of this section, P and X each constructively owns an additional 6.25% of 
the stock of S1 as follows: 12.5% (each of P's and X's new attributed 
ownership of S1) x 100% (S1's ownership of S2) x 50% (S2's ownership of 
S1) = 6.25%. After two iterations, each of P's and X's ownership in S1 
is 43.75% (25% direct ownership + 12.5% first order constructive 
ownership + 6.25% second order constructive ownership). Subsequent 
iterative calculations of each of P's and X's ownership, treating 
constructive ownership as actual ownership, would demonstrate that P and 
X each owns, directly and indirectly, 50% of the stock of S1.

[[Page 754]]

    (iii) S1 and S2 constitute an expanded group as defined under 
paragraph (c)(4)(i) of this section because S1 directly owns 100% of the 
stock of S2. S1 is the expanded group parent of the expanded group and 
neither P nor X are a member of the expanded group that includes S1 and 
S2.
    (5) Regarded owner. The term regarded owner means a person (which 
cannot be a disregarded entity) that is the single owner (within the 
meaning of Sec. 301.7701-2(c)(2)(i) of this chapter) of a disregarded 
entity.
    (d) Treatment of deemed exchanges--(1) Debt instrument deemed to be 
exchanged for stock--(i) In general. If a debt instrument (as defined in 
Sec. 1.385-3(g)(4)) is deemed to be exchanged under the section 385 
regulations, in whole or in part, for stock, the holder is treated for 
all Federal tax purposes as having realized an amount equal to the 
holder's adjusted basis in that portion of the debt instrument as of the 
date of the deemed exchange (and as having basis in the stock deemed to 
be received equal to that amount), and, except as provided in paragraph 
(d)(1)(iv)(B) of this section, the issuer is treated for all Federal tax 
purposes as having retired that portion of the debt instrument for an 
amount equal to its adjusted issue price as of the date of the deemed 
exchange. In addition, neither party accounts for any accrued but unpaid 
qualified stated interest on the debt instrument or any foreign exchange 
gain or loss with respect to that accrued but unpaid qualified stated 
interest (if any) as of the deemed exchange. This paragraph (d)(1)(i) 
does not affect any rules in Title 26 of the United States Code that 
otherwise apply to the debt instrument prior to the date of the deemed 
exchange (for example, this paragraph (d)(1)(i) does not affect the 
issuer's deduction of accrued but unpaid qualified stated interest 
otherwise deductible prior to the date of the deemed exchange). 
Moreover, the stock issued in the deemed exchange is not treated as a 
payment of accrued but unpaid original issue discount or qualified 
stated interest on the debt instrument for Federal tax purposes.
    (ii) Section 988. Notwithstanding the first sentence of paragraph 
(d)(1)(i) of this section, the rules of Sec. 1.988-2(b)(13) apply to 
require the holder and the issuer of a debt instrument that is deemed to 
be exchanged under the section 385 regulations, in whole or in part, for 
stock to recognize any exchange gain or loss, other than any exchange 
gain or loss with respect to accrued but unpaid qualified stated 
interest that is not taken into account under paragraph (d)(1)(i) of 
this section at the time of the deemed exchange. For purposes of this 
paragraph (d)(1)(ii), in applying Sec. 1.988-2(b)(13) the exchange gain 
or loss under section 988 is treated as the total gain or loss on the 
exchange.
    (iii) Section 108(e)(8). For purposes of section 108(e)(8), if the 
issuer of a debt instrument is treated as having retired all or a 
portion of the debt instrument in exchange for stock under paragraph 
(d)(1)(i) of this section, the stock is treated as having a fair market 
value equal to the adjusted issue price of that portion of the debt 
instrument as of the date of the deemed exchange.
    (iv) Issuer of stock deemed exchanged for debt. For purposes of 
applying paragraph (d)(1)(i) of this section--
    (A) A debt instrument that is issued by a disregarded entity is 
deemed to be exchanged for stock of the regarded owner under Sec. 
1.385-3(d)(4);
    (B) A debt instrument that is issued by a partnership that becomes a 
deemed transferred receivable, in whole or in part, is deemed to be 
exchanged by the holder for deemed partner stock under Sec. 1.385-
3(f)(4) and the partnership is therefore not treated for any federal tax 
purpose as having retired any portion of the debt instrument; and
    (C) A debt instrument that is issued in any situation not described 
in paragraph (d)(1)(iv)(A) or (B) of this section is deemed to be 
exchanged for stock of the issuer of the debt instrument.
    (2) Stock deemed to be exchanged for newly-issued debt instrument.
    (i) [Reserved]
    (ii) Debt instruments recharacterized under Sec. 1.385-3. If a debt 
instrument treated as stock under Sec. 1.385-3(b) is deemed to be 
exchanged under Sec. 1.385-3(d)(2), in whole or in part, for a newly-
issued debt instrument, the issue price of the newly-issued debt 
instrument is

[[Page 755]]

determined under either section 1273(b)(4) or 1274, as applicable.
    (e) Indebtedness in part. [Reserved]
    (f) Applicability date. This section applies to taxable years ending 
on or after January 19, 2017.

[T.D. 9790, 81 FR 72950, Oct. 21, 2016, as amended by T.D. 9790, 82 FR 
8166, Jan. 24, 2017; T.D. 9880, 84 FR 59301, Nov. 4, 2019; T.D. 9897, 85 
FR 28870, May 14, 2020]



Sec. 1.385-3  Certain distributions of debt instruments and similar
transactions.

    (a) Scope. This section sets forth factors that control the 
determination of whether an interest is treated as stock or 
indebtedness. Specifically, this section addresses the issuance of a 
covered debt instrument to a related person as part of a transaction or 
series of transactions that does not result in new investment in the 
operations of the issuer. Paragraph (b) of this section sets forth rules 
for determining when these factors are present, such that a covered debt 
instrument is treated as stock under this section. Paragraph (c) of this 
section provides exceptions to the application of paragraph (b) of this 
section. Paragraph (d) of this section provides operating rules. 
Paragraph (e) of this section reserves on the affirmative use of this 
section. Paragraph (f) of this section provides rules for the aggregate 
treatment of controlled partnerships. Paragraph (g) of this section 
provides definitions. Paragraph (h) of this section provides examples 
illustrating the application of the rules of this section. Paragraph (j) 
of this section provides dates of applicability. For rules regarding the 
application of this section to members of a consolidated group, see 
generally Sec. 1.385-4.
    (b) Covered debt instrument treated as stock--(1) Effect of 
characterization as stock. Except as otherwise provided in paragraph 
(d)(7) of this section, to the extent a covered debt instrument is 
treated as stock under paragraphs (b)(2), (3), or (4) of this section, 
it is treated as stock for all federal tax purposes.
    (2) General rule. Except as otherwise provided in paragraphs (c) and 
(e) of this section, a covered debt instrument is treated as stock to 
the extent the covered debt instrument is issued by a covered member to 
a member of the covered member's expanded group in one or more of the 
following transactions:
    (i) In a distribution;
    (ii) In exchange for expanded group stock, other than in an exempt 
exchange; or
    (iii) In exchange for property in an asset reorganization, but only 
to the extent that, pursuant to the plan of reorganization, a 
shareholder in the transferor corporation that is a member of the 
issuer's expanded group immediately before the reorganization receives 
the covered debt instrument with respect to its stock in the transferor 
corporation.
    (3) Funding rule--(i) In general. Except as otherwise provided in 
paragraphs (c) and (e) of this section, a covered debt instrument that 
is not a qualified short-term debt instrument (as defined in paragraph 
(b)(3)(vii) of this section) is treated as stock to the extent that it 
is both issued by a covered member to a member of the covered member's 
expanded group in exchange for property and, pursuant to paragraph 
(b)(3)(iii) or (b)(3)(iv) of this section, treated as funding a 
distribution or acquisition described in one or more of paragraphs 
(b)(3)(i)(A) through (C) of this section. A covered member that makes a 
distribution or acquisition described in paragraphs (b)(3)(i)(A) through 
(C) is referred to as a ``funded member,'' regardless of when it issues 
a covered debt instrument in exchange for property.
    (A) A distribution of property by the funded member to a member of 
the funded member's expanded group, other than in an exempt 
distribution;
    (B) An acquisition of expanded group stock, other than an exempt 
exchange, by the funded member from a member of the funded member's 
expanded group in exchange for property other than expanded group stock; 
or
    (C) An acquisition of property by the funded member in an asset 
reorganization but only to the extent that, pursuant to the plan of 
reorganization, a shareholder in the transferor corporation that is a 
member of the funded member's expanded group immediately before the 
reorganization receives other property or money within the

[[Page 756]]

meaning of section 356 with respect to its stock in the transferor 
corporation.
    (ii) Transactions described in more than one paragraph. For purposes 
of this section, to the extent that a distribution or acquisition by a 
funded member is described in more than one of paragraphs (b)(3)(i)(A) 
through (C) of this section, the funded member is treated as making only 
a single distribution or acquisition described in paragraph (b)(3)(i) of 
this section. In the case of an asset reorganization, to the extent an 
acquisition by the transferee corporation is described in paragraph 
(b)(3)(i)(C) of this section, a distribution or acquisition by the 
transferor corporation is not also described in paragraph (b)(3)(i)(A) 
through (C) of this section. For purposes of this paragraph (b)(3)(ii), 
whether a distribution or acquisition is described in paragraphs 
(b)(3)(i)(A) through (C) of this section is determined without regard to 
paragraph (c) of this section.
    (iii) Per se funding rule--(A) In general. A covered debt instrument 
is treated as funding a distribution or acquisition described in 
paragraphs (b)(3)(i)(A) through (C) of this section if the covered debt 
instrument is issued by a funded member during the period beginning 36 
months before the date of the distribution or acquisition, and ending 36 
months after the date of the distribution or acquisition (per se 
period).
    (B) Multiple interests. If, pursuant to paragraph (b)(3)(iii)(A) of 
this section, two or more covered debt instruments may be treated as 
stock by reason of this paragraph (b)(3), the covered debt instruments 
are tested under paragraph (b)(3)(iii)(A) of this section based on the 
order in which they are issued, with the earliest issued covered debt 
instrument tested first. See paragraph (h)(3) of this section, Example 
6, for an illustration of this rule.
    (C) Multiple distributions or acquisitions. If, pursuant to 
paragraph (b)(3)(iii)(A) of this section, a covered debt instrument may 
be treated as funding more than one distribution or acquisition 
described in paragraphs (b)(3)(i)(A) through (C) of this section, the 
covered debt instrument is treated as funding one or more distributions 
or acquisitions based on the order in which the distributions or 
acquisitions occur, with the earliest distribution or acquisition 
treated as the first distribution or acquisition that is funded. See 
paragraph (h)(3) of this section, Example 9, for an illustration of this 
rule.
    (D) Transactions that straddle different expanded groups--(1) In 
general. For purposes of paragraph (b)(3)(iii)(A) of this section, a 
covered debt instrument is not treated as issued by a funded member 
during the per se period with respect to a distribution or acquisition 
described in paragraphs (b)(3)(i)(A) through (C) of this section if all 
of the conditions described in paragraphs (b)(3)(iii)(D)(1)(i) through 
(iii) of this section are satisfied.
    (i) The distribution or acquisition occurs prior to the issuance of 
the covered debt instrument by the funded member or, if the funded 
member is treated as making the distribution or acquisition of a 
predecessor or a successor, the predecessor or successor is not a member 
of the expanded group of which the funded member is a member on the date 
on which the distribution or the acquisition occurs.
    (ii) The distribution or acquisition is made by the funded member 
when the funded member is a member of an expanded group that does not 
have an expanded group parent that is the funded member's expanded group 
parent when the covered debt instrument is issued. For purposes of the 
preceding sentence, a reference to an expanded group parent includes a 
reference to a predecessor or successor of the expanded group parent.
    (iii) On the date of the issuance of the covered debt instrument, 
the recipient member (as defined in paragraph (b)(3)(iii)(D)(2) of this 
section) is neither a member nor a controlled partnership of an expanded 
group of which the funded member is a member.
    (2) Recipient member. For purposes of this paragraph (b)(3)(iii)(D), 
the term recipient member means, with respect to a distribution or 
acquisition by a funded member described in paragraphs (b)(3)(i)(A) 
through (C) of this section, the expanded group member that receives a 
distribution of property, property in exchange for expanded group stock, 
or other property or money within the meaning of section 356 with

[[Page 757]]

respect to its stock in the transferor corporation. For purposes of this 
paragraph (b)(3)(iii)(D), a reference to the recipient member includes a 
predecessor or successor of the recipient member or one or more other 
entities that, in the aggregate, acquire substantially all of the 
property of the recipient member.
    (E) Modifications of a covered debt instrument--(1) In general. For 
purposes of paragraph (b)(3)(iii)(A) of this section, if a covered debt 
instrument is treated as exchanged for a modified covered debt 
instrument pursuant to Sec. 1.1001-3(b), the modified covered debt 
instrument is treated as issued on the original issue date of the 
covered debt instrument.
    (2) Effect of certain modifications. Notwithstanding paragraph 
(b)(3)(iii)(E)(1) of this section, if a covered debt instrument is 
treated as exchanged for a modified covered debt instrument pursuant to 
Sec. 1.1001-3(b) and the modification, or one of the modifications, 
that results in the deemed exchange includes the substitution of an 
obligor on the covered debt instrument, the addition or deletion of a 
co-obligor on the covered debt instrument, or the material deferral of 
scheduled payments due under the covered debt instrument, then the 
modified covered debt instrument is treated as issued on the date of the 
deemed exchange for purposes of paragraph (b)(3)(iii)(A) of this 
section.
    (3) Additional principal amount. For purposes of paragraph 
(b)(3)(iii)(A) of this section, if the principal amount of a covered 
debt instrument is increased, the portion of the covered debt instrument 
attributable to such increase is treated as issued on the date of such 
increase.
    (iv) Principal purpose rule. For purposes of this paragraph (b)(3), 
a covered debt instrument that is not issued by a funded member during 
the per se period with respect to a distribution or acquisition 
described in paragraphs (b)(3)(i)(A) through (C) of this section is 
treated as funding the distribution or acquisition to the extent that it 
is issued by a funded member with a principal purpose of funding a 
distribution or acquisition described in paragraphs (b)(3)(i)(A) through 
(C) of this section. Whether a covered debt instrument is issued with a 
principal purpose of funding a distribution or acquisition described in 
paragraphs (b)(3)(i)(A) through (C) of this section is determined based 
on all the facts and circumstances. A covered debt instrument may be 
treated as issued with a principal purpose of funding a distribution or 
acquisition described in paragraphs (b)(3)(i)(A) through (C) of this 
section regardless of whether it is issued before or after the 
distribution or acquisition.
    (v) Predecessors and successors--(A) In general. Subject to the 
limitations in paragraph (b)(3)(v)(B) of this section, for purposes of 
this paragraph (b)(3), references to a funded member include references 
to any predecessor or successor of such member. See paragraph (h)(3) of 
this section, Examples 9 and 10, for illustrations of this rule.
    (B) Limitations to the application of the per se funding rule. For 
purposes of paragraph (b)(3)(iii)(A) of this section, a covered debt 
instrument issued by a funded member that satisfies the condition 
described in paragraph (b)(3)(iii)(A) with respect to a distribution or 
acquisition described in paragraphs (b)(3)(i)(A) through (C) of this 
section made by a predecessor or successor of the funded member is not 
treated as issued during the per se period with respect to the 
distribution or acquisition unless the conditions described in 
paragraphs (b)(3)(v)(B)(1) and (2) of this section are satisfied:
    (1) The covered debt instrument is issued by the funded member 
during the period beginning 36 months before the date of the transaction 
in which the predecessor or successor becomes a predecessor or successor 
and ending 36 months after the date of the transaction.
    (2) The distribution or acquisition is made by the predecessor or 
successor during the period beginning 36 months before the date of the 
transaction in which the predecessor or successor becomes a predecessor 
or successor of the funded member and ending 36 months after the date of 
the transaction.
    (vi) Treatment of funded transactions. When a covered debt 
instrument is treated as stock pursuant to paragraph (b)(3) of this 
section, the distribution or acquisition described in paragraphs 
(b)(3)(i)(A) through (C) of this section

[[Page 758]]

that is treated as funded by such covered debt instrument is not 
recharacterized as a result of the treatment of the covered debt 
instrument as stock.
    (vii) Qualified short-term debt instrument. The term qualified 
short-term debt instrument means a covered debt instrument that is 
described in paragraphs (b)(3)(vii)(A) though (D) of this section.
    (A) Short-term funding arrangement. A covered debt instrument is 
described in this paragraph (b)(3)(vii)(A) if the requirements of the 
specified current assets test described in paragraph (b)(3)(vii)(A)(1) 
of this section or the 270-day test described in paragraph 
(b)(3)(vii)(A)(2) of this section (the alternative tests) are satisfied, 
provided that an issuer may only claim the benefit of one of the 
alternative tests with respect to covered debt instruments issued by the 
issuer in the same taxable year.
    (1) Specified current assets test--(i) In general. The requirements 
of this paragraph (b)(3)(vii)(A)(1) are satisfied with respect to a 
covered debt instrument if the requirement of paragraph 
(b)(3)(vii)(A)(1)(ii) of this section is satisfied, but only to the 
extent the requirement of paragraph (b)(3)(vii)(A)(1)(iii) of this 
section is satisfied.
    (ii) Maximum interest rate. The rate of interest charged with 
respect to the covered debt instrument does not exceed an arm's length 
interest rate, as determined under section 482 and Sec. Sec. 1.482-1 
through 1.482-9, that would be charged with respect to a comparable debt 
instrument of the issuer with a term that does not exceed the longer of 
90 days and the issuer's normal operating cycle.
    (iii) Maximum outstanding balance. The amount owed by the issuer 
under covered debt instruments issued to members of the issuer's 
expanded group that satisfy the requirements of paragraph 
(b)(3)(vii)(A)(1)(ii), (b)(3)(vii)(A)(2) (if the covered debt instrument 
was issued in a prior taxable year), or (b)(3)(vii)(B) or (C) of this 
section immediately after the covered debt instrument is issued does not 
exceed the maximum of the amounts of specified current assets reasonably 
expected to be reflected, under applicable accounting principles, on the 
issuer's balance sheet as a result of transactions in the ordinary 
course of business during the subsequent 90-day period or the issuer's 
normal operating cycle, whichever is longer. For purposes of the 
preceding sentence, in the case of an issuer that is a qualified cash 
pool header, the amount owed by the issuer shall not take into account 
deposits described in paragraph (b)(3)(vii)(D) of this section. 
Additionally, the amount owed by any issuer shall be reduced by the 
amount of the issuer's deposits with a qualified cash pool header, but 
only to the extent of amounts borrowed from the same qualified cash pool 
header that satisfy the requirements of paragraph (b)(3)(vii)(A)(2) (if 
the covered debt instrument was issued in a prior taxable year) or 
(b)(3)(vii)(A)(1)(ii) of this section.
    (iv) Specified current assets. For purposes of paragraph 
(b)(3)(vii)(A)(1)(iii) of this section, the term specified current 
assets means assets that are reasonably expected to be realized in cash 
or sold (including by being incorporated into inventory that is sold) 
during the normal operating cycle of the issuer, other than cash, cash 
equivalents, and assets that are reflected on the books and records of a 
qualified cash pool header.
    (v) Normal operating cycle. For purposes of paragraph 
(b)(3)(vii)(A)(1) of this section, the term normal operating cycle means 
the issuer's normal operating cycle as determined under applicable 
accounting principles, except that if the issuer has no single clearly 
defined normal operating cycle, then the normal operating cycle is 
determined based on a reasonable analysis of the length of the operating 
cycles of the multiple businesses and their sizes relative to the 
overall size of the issuer.
    (vi) Applicable accounting principles. For purposes of paragraph 
(b)(3)(vii)(A)(1) of this section, the term applicable accounting 
principles means the financial accounting principles generally accepted 
in the United States, or an international financial accounting standard, 
that is applicable to the issuer in preparing its financial

[[Page 759]]

statements, computed on a consistent basis.
    (2) 270-day test--(i) In general. A covered debt instrument is 
described in this paragraph (b)(3)(vii)(A)(2) if the requirements of 
paragraphs (b)(3)(vii)(A)(2)(ii) through (iv) of this section are 
satisfied.
    (ii) Maximum term and interest rate. The covered debt instrument 
must have a term of 270 days or less or be an advance under a revolving 
credit agreement or similar arrangement and must bear a rate of interest 
that does not exceed an arm's length interest rate, as determined under 
section 482 and Sec. Sec. 1.482-1 through 1.482-9, that would be 
charged with respect to a comparable debt instrument of the issuer with 
a term that does not exceed 270 days.
    (iii) Lender-specific indebtedness limit. The issuer is a net 
borrower from the lender for no more than 270 days during the taxable 
year of the issuer, and in the case of a covered debt instrument 
outstanding during consecutive tax years, the issuer is a net borrower 
from the lender for no more than 270 consecutive days, in both cases 
taking into account only covered debt instruments that satisfy the 
requirement of paragraph (b)(3)(vii)(A)(2)(ii) of this section other 
than covered debt instruments described in paragraph (b)(3)(vii)(B) or 
(C) of this section.
    (iv) Overall indebtedness limit. The issuer is a net borrower under 
all covered debt instruments issued to members of the issuer's expanded 
group that satisfy the requirements of paragraphs (b)(3)(vii)(A)(2)(ii) 
and (iii) of this section, other than covered debt instruments described 
in paragraph (b)(3)(vii)(B) or (C) of this section, for no more than 270 
days during the taxable year of the issuer, determined without regard to 
the identity of the lender under such covered debt instruments.
    (v) Inadvertent error. An issuer's failure to satisfy the 270-day 
test will be disregarded if the failure is reasonable in light of all 
the facts and circumstances and the failure is promptly cured upon 
discovery. A failure to satisfy the 270-day test will be considered 
reasonable if the taxpayer maintains due diligence procedures to prevent 
such failures, as evidenced by having written policies and operational 
procedures in place to monitor compliance with the 270-day test and 
management-level employees of the expanded group having undertaken 
reasonable efforts to establish, follow, and enforce such policies and 
procedures.
    (B) Ordinary course loans. A covered debt instrument is described in 
this paragraph (b)(3)(vii)(B) if the covered debt instrument is issued 
as consideration for the acquisition of property other than money in the 
ordinary course of the issuer's trade or business, provided that the 
obligation is reasonably expected to be repaid within 120 days of 
issuance.
    (C) Interest-free loans. A covered debt instrument is described in 
this paragraph (b)(3)(vii)(C) if the instrument does not provide for 
stated interest or no interest is charged on the instrument, the 
instrument does not have original issue discount (as defined in section 
1273 and Sec. Sec. 1.1273-1 and 1.1273-2), interest is not imputed 
under section 483 or section 7872 and Sec. Sec. 1.483-1 through 1.483-4 
or Sec. Sec. 1.7872-1 through 1.7872-16, respectively, and interest is 
not required to be charged under section 482 and Sec. Sec. 1.482-1 
through 1.482-9.
    (D) Deposits with a qualified cash pool header--(1) In general. A 
covered debt instrument is described in this paragraph (b)(3)(vii)(D) if 
it is a demand deposit received by a qualified cash pool header 
described in paragraph (b)(3)(vii)(D)(2) of this section pursuant to a 
cash-management arrangement described in paragraph (b)(3)(vii)(D)(3) of 
this section. This paragraph (b)(3)(vii)(D) does not apply if a purpose 
for making the demand deposit is to facilitate the avoidance of the 
purposes of this section with respect to a qualified business unit (as 
defined in section 989(a) and Sec. 1.989(a)-1) (QBU) that is not a 
qualified cash pool header.
    (2) Qualified cash pool header. The term qualified cash pool header 
means an expanded group member, controlled partnership, or QBU described 
in Sec. 1.989(a)-1(b)(2)(ii), that has as its principal purpose 
managing a cash-management arrangement for participating expanded group 
members, provided that the excess (if any) of funds on deposit with such 
expanded group member, controlled partnership, or QBU

[[Page 760]]

(header) over the outstanding balance of loans made by the header is 
maintained on the books and records of the header in the form of cash or 
cash equivalents, or invested through deposits with, or the acquisition 
of obligations or portfolio securities of, persons that do not have a 
relationship to the header (or, in the case of a header that is a QBU 
described in Sec. 1.989(a)-1(b)(2)(ii), its owner) described in section 
267(b) or section 707(b).
    (3) Cash-management arrangement. The term cash-management 
arrangement means an arrangement the principal purpose of which is to 
manage cash for participating expanded group members. For purposes of 
the preceding sentence, managing cash means borrowing excess funds from 
participating expanded group members and lending funds to participating 
expanded group members, and may also include foreign exchange 
management, clearing payments, investing excess cash with an unrelated 
person, depositing excess cash with another qualified cash pool header, 
and settling intercompany accounts, for example through netting centers 
and pay-on-behalf-of programs.
    (viii) Distributions or acquisitions occurring before April 5, 2016. 
A distribution or acquisition that occurs before April 5, 2016, is not 
taken into account for purposes of applying this paragraph (b)(3).
    (4) Anti-abuse rule. If a member of an expanded group enters into a 
transaction with a principal purpose of avoiding the purposes of this 
section or Sec. 1.385-3, an interest issued or held by that member or 
another member of the member's expanded group may, depending on the 
relevant facts and circumstances, be treated as stock. Paragraphs 
(b)(4)(i) and (ii) of this section include a non-exhaustive list of 
transactions that could result in an interest being treated as stock 
under this paragraph (b)(4).
    (i) Interests. An interest is treated as stock if it is issued with 
a principal purpose of avoiding the purposes of this section or Sec. 
1.385-3. Interests subject to this paragraph (b)(4)(i) may include:
    (A) An interest that is not a covered debt instrument for purposes 
of this section (for example, a contract to which section 483 applies 
that is not otherwise a covered debt instrument or a non-periodic swap 
payment that is not otherwise a covered debt instrument).
    (B) A covered debt instrument issued to a person that is not a 
member of the issuer's expanded group, if the covered debt instrument is 
later acquired by a member of the issuer's expanded group or such person 
later becomes a member of the issuer's expanded group.
    (C) A covered debt instrument issued to an entity that is not 
taxable as a corporation for federal tax purposes.
    (D) A covered debt instrument issued in connection with a 
reorganization or similar transaction.
    (E) A covered debt instrument issued as part of a plan or a series 
of transactions to expand the applicability of the transition rules 
described in Sec. 1.385-3(j)(2) or Sec. 1.385-3(k)(2).
    (ii) Other transactions. A covered debt instrument is treated as 
stock if the funded member or any member of the expanded group engages 
in a transaction (including a distribution or acquisition) with a 
principal purpose of avoiding the purposes of this section or Sec. 
1.385-3. Transactions subject to this paragraph (b)(4)(ii) may include:
    (A) A member of the issuer's expanded group is substituted as a new 
obligor or added as a co-obligor on an existing covered debt instrument.
    (B) A covered debt instrument is transferred in connection with a 
reorganization or similar transaction.
    (C) A covered debt instrument funds a distribution or acquisition 
where the distribution or acquisition is made by a member other than the 
funded member and the funded member acquires the assets of the other 
member in a transaction that does not make the other member a 
predecessor to the funded member.
    (D) Members of a consolidated group engage in transactions as part 
of a plan or a series of transactions through the use of the 
consolidated group rules set forth in Sec. 1.385-4, including through 
the use of the departing member rules.
    (5) Coordination between general rule and funding rule. For purposes 
of this section, a distribution or acquisition described in paragraph 
(b)(2) of this section is not also described in paragraph (b)(3)(i) of 
this section. In the

[[Page 761]]

case of an asset reorganization, an acquisition described in paragraph 
(b)(2)(iii) of this section by the transferee corporation is not also a 
distribution or acquisition described in paragraph (b)(3)(i) of this 
section by the transferor corporation. For purposes of this paragraph 
(b)(5), whether a distribution or acquisition is described in paragraphs 
(b)(2)(i) through (iii) of this section is determined without regard to 
paragraph (c) of this section.
    (6) Non-duplication. Except as otherwise provided in paragraph 
(d)(2) of this section, to the extent a distribution or acquisition 
described in paragraphs (b)(3)(i)(A) through (C) of this section is 
treated as funded by a covered debt instrument under paragraph (b)(3) of 
this section, the distribution or acquisition is not treated as funded 
by another covered debt instrument and the covered debt instrument is 
not treated as funding another distribution or acquisition for purposes 
of paragraph (b)(3).
    (c) Exceptions--(1) In general. This paragraph (c) provides 
exceptions for purposes of applying paragraphs (b)(2) and (b)(3) of this 
section to a covered member. These exceptions are applied in the 
following order: First, paragraph (c)(2) of this section; second, 
paragraph (c)(3) of this section; and, third, paragraph (c)(4) of this 
section. The exceptions under Sec. 1.385-3(c)(2) and (c)(3) apply to 
distributions and acquisitions that are otherwise described in paragraph 
(b)(2) or (b)(3)(i) of this section after applying paragraphs (b)(3)(ii) 
and (b)(5) of this section. Except as otherwise provided, the exceptions 
are applied by taking into account the aggregate treatment of controlled 
partnerships described in Sec. 1.385-3(f).
    (2) Exclusions for transactions otherwise described in paragraph 
(b)(2) or (b)(3)(i) of this section--(i) Exclusion for certain 
acquisitions of subsidiary stock--(A) In general. An acquisition of 
expanded group stock (including by issuance) is not treated as described 
in paragraph (b)(2)(ii) or (b)(3)(i)(B) of this section if, immediately 
after the acquisition, the covered member that acquires the expanded 
group stock (acquirer) controls the member of the expanded group from 
which the expanded group stock is acquired (seller), and the acquirer 
does not relinquish control of the seller pursuant to a plan that 
existed on the date of the acquisition, other than in a transaction in 
which the seller ceases to be a member of the expanded group of which 
the acquirer is a member. For purposes of the preceding sentence, an 
acquirer and seller do not cease to be members of the same expanded 
group by reason of a complete liquidation described in section 331.
    (B) Control. For purposes of this paragraph (c)(2)(i) and paragraph 
(c)(3)(ii)(E) of this section, control of a corporation means the direct 
or indirect ownership of more than 50 percent of the total combined 
voting power of all classes of stock of the corporation entitled to vote 
and more than 50 percent of the total value of the stock of the 
corporation. For purposes of the preceding sentence, indirect ownership 
is determined by applying the principles of section 958(a) without 
regard to whether an intermediate entity is foreign or domestic.
    (C) Rebuttable presumption. For purposes of paragraph (c)(2)(i)(A) 
of this section, the acquirer is presumed to have a plan to relinquish 
control of the seller on the date of the acquisition if the acquirer 
relinquishes control of the seller within the 36-month period following 
the date of the acquisition. The presumption created by the previous 
sentence may be rebutted by facts and circumstances clearly establishing 
that the loss of control was not contemplated on the date of the 
acquisition and that the avoidance of the purposes of this section or 
Sec. 1.385-3 was not a principal purpose for the subsequent loss of 
control.
    (ii) Exclusion for compensatory stock acquisitions. An acquisition 
of expanded group stock is not treated as described in paragraph 
(b)(2)(ii) or (b)(3)(i)(B) of this section if the expanded group stock 
is delivered to individuals that are employees, directors, or 
independent contractors in consideration for services rendered by such 
individuals to a member of the expanded group or a controlled 
partnership in which a member of the expanded group is an expanded group 
partner.
    (iii) Exclusion for distributions or acquisitions resulting from 
transfer pricing

[[Page 762]]

adjustments. A distribution or acquisition deemed to occur under Sec. 
1.482-1(g) (including adjustments made pursuant to Revenue Procedure 99-
32, 1999-2 C.B. 296) is not treated as described in paragraph 
(b)(3)(i)(A) or (B) of this section.
    (iv) Exclusion for acquisitions of expanded group stock by a dealer 
in securities. An acquisition of expanded group stock by a dealer in 
securities (within the meaning of section 475(c)(1)), or by an expanded 
group partner treated as acquiring expanded group stock pursuant to 
Sec. 1.385-3(f)(2) if the relevant controlled partnership is a dealer 
in securities, is not treated as described in paragraph (b)(2)(ii) or 
(b)(3)(i)(B) of this section to the extent the expanded group stock is 
acquired in the ordinary course of the dealer's business of dealing in 
securities. The preceding sentence applies solely to the extent that--
    (A) The dealer accounts for the stock as securities held primarily 
for sale to customers in the ordinary course of business;
    (B) The dealer disposes of the stock within a period of time that is 
consistent with the holding of the stock for sale to customers in the 
ordinary course of business, taking into account the terms of the stock 
and the conditions and practices prevailing in the markets for similar 
stock during the period in which it is held; and
    (C) The dealer does not sell or otherwise transfer the stock to a 
person in the same expanded group, other than in a sale to a dealer that 
in turn satisfies the requirements of paragraph (c)(2)(iv) of this 
section.
    (v) Exclusion for certain acquisitions of expanded group stock 
resulting from application of this section. The following deemed 
acquisitions are not treated as acquisitions of expanded group stock 
described in paragraph (b)(3)(i)(B) of this section, provided that they 
are not part of a plan or arrangement to prevent the application of 
paragraph (b)(3)(i) to a covered debt instrument:
    (A) An acquisition of a covered debt instrument that is treated as 
stock by means of paragraph (b)(3) of this section.
    (B) An acquisition of stock of a regarded owner that is deemed to be 
issued under Sec. 1.385-3(d)(4).
    (C) An acquisition of deemed partner stock pursuant to a deemed 
transfer or a specified event described in Sec. 1.385-3(f)(4) or (5).
    (3) Reductions for transactions described in paragraph (b)(2) or 
(b)(3)(i) of this section--(i) Reduction for expanded group earnings--
(A) In general. The aggregate amount of any distributions or 
acquisitions by a covered member described in paragraph (b)(2) or 
(b)(3)(i) of this section in a taxable year during the covered member's 
expanded group period is reduced by the covered member's expanded group 
earnings account (as defined in paragraph (c)(3)(i)(B) of this section) 
for the expanded group period as of the close of the taxable year. The 
reduction described in this paragraph (c)(3)(i)(A) applies to one or 
more distributions or acquisitions based on the order in which the 
distributions or acquisitions occur, regardless of whether any 
distribution or acquisition would be treated as funded by a covered debt 
instrument without regard to this paragraph (c)(3).
    (B) Expanded group earnings account. The term expanded group 
earnings account means, with respect to a covered member and an expanded 
group period (as defined in paragraph (c)(3)(i)(E) of this section) of 
the covered member, the excess, if any, of the covered member's expanded 
group earnings (as defined in paragraph (c)(3)(i)(C) of this section) 
for the expanded group period over the covered member's expanded group 
reductions (as defined in paragraph (c)(3)(i)(D) of this section) for 
the expanded group period.
    (C) Expanded group earnings--(1) In general. The term expanded group 
earnings means, with respect to a covered member and an expanded group 
period of the covered member, the earnings and profits accumulated by 
the covered member during the expanded group period, computed as of the 
close of the taxable year of the covered member, without diminution by 
reason of any distributions or acquisitions by the covered member 
described in paragraphs (b)(2) and (b)(3)(i) of this section. 
Notwithstanding the preceding sentence, the expanded group earnings of a 
covered member do not include earnings and profits accumulated by

[[Page 763]]

the covered member in any taxable year ending before April 5, 2016.
    (2) Special rule for change in expanded group within a taxable year. 
For purposes of calculating a covered member's expanded group earnings 
for a taxable year that is not wholly included in an expanded group 
period, the covered member's expanded group earnings are ratably 
allocated among the portion of the taxable year included in the expanded 
group period and the portion of the taxable year not included in the 
expanded group period. For purposes of the preceding sentence, the 
expanded group period is determined by excluding the day on which the 
covered member becomes a member of an expanded group with the same 
expanded group parent and including the day on which the covered member 
ceases to be a member of an expanded group with the same expanded group 
parent.
    (3) Look-through rule for dividends--(i) In general. For purposes of 
paragraph (c)(3)(i)(C)(1) of this section, a dividend from a member of 
the same expanded group (distributing member) is not taken into account 
for purposes of calculating a covered member's expanded group earnings, 
except to the extent the dividend is attributable to earnings and 
profits accumulated by the distributing member in a taxable year ending 
after April 4, 2016, during its expanded group period (qualified 
earnings and profits). For purposes of the preceding sentence, a 
dividend received from a member (intermediate distributing member) is 
not taken into account for purposes of calculating the qualified 
earnings and profits of a distributing member (or another intermediate 
distributing member), except to the extent the dividend is attributable 
to qualified earnings and profits of the intermediate distributing 
member. A dividend from a distributing member or an intermediate 
distributing member is considered to be attributable to qualified 
earnings and profits to the extent thereof. If the distributing member 
or the intermediate distributing member is not a covered member, the 
expanded group period of the member is determined under the principles 
of paragraph (c)(3)(i)(E) of this section. If a controlled partnership 
receives a dividend from a distributing member and a portion of the 
dividend is allocated (including through one or more partnerships) to a 
covered member, then, for purposes of this paragraph (c)(3)(i)(C)(3), 
the covered member is treated as receiving the dividend from the 
distributing member.
    (ii) Dividend. For purposes of paragraph (c)(3)(i)(C)(3)(i) of this 
section, the term dividend has the meaning specified in section 316, 
including the portion of gain recognized under section 1248 that is 
treated as a dividend and deemed dividends under section 367(b) and the 
regulations thereunder. In addition, the term dividend includes 
inclusions with respect to stock (for example, inclusions under sections 
951(a) and 1293).
    (4) Effect of interest deductions. For purposes of calculating the 
expanded group earnings of a covered member for a taxable year, expanded 
group earnings are calculated without regard to the application of this 
section during the taxable year to a covered debt instrument issued by 
the covered member that was not treated as stock under paragraph (b) of 
this section as of the close of the preceding taxable year, or, if the 
covered member is an expanded group partner in a controlled partnership 
that is the issuer of a debt instrument, without regard to the 
application of Sec. 1.385-3(f)(4)(i) during the taxable year with 
respect to the covered member's share of the debt instrument. To the 
extent that the application of this paragraph (c)(3)(i)(C)(4) reduces 
the expanded group earnings of the covered member for the taxable year, 
the expanded group earnings of the covered member are increased as of 
the beginning of the succeeding taxable year during the expanded group 
period.
    (D) Expanded group reductions. The term expanded group reductions 
means, with respect to a covered member and an expanded group period of 
the covered member, the amounts by which acquisitions or distributions 
described in paragraph (b)(2) or (b)(3)(i) of this section were reduced 
by reason of paragraph (c)(3)(i)(A) of this section during the portion 
of the expanded group period preceding the taxable year.

[[Page 764]]

    (E) Expanded group period--(1) In general. For purposes of this 
paragraph (c)(3)(i) and paragraph (c)(3)(ii) of this section, the term 
expanded group period means, with respect to a covered member, the 
period during which a covered member is a member of an expanded group 
with the same expanded group parent.
    (2) Mere change. For purposes of paragraph (c)(3)(i)(E)(1) of this 
section, an expanded group parent that is a resulting corporation 
(within the meaning of Sec. 1.368-2(m)(1)) in a reorganization 
described in section 368(a)(1)(F) is treated as the same expanded group 
parent as an expanded group parent that is a transferor corporation 
(within the meaning of Sec. 1.368-2(m)(1)) in the same reorganization, 
provided that either--
    (i) The transferor corporation is not a covered member; or
    (ii) Both the transferor corporation and the resulting corporation 
are covered members.
    (F) Special rules for certain corporate transactions--(1) Reduction 
for expanded group earnings in an asset reorganization. For purposes of 
applying paragraph (c)(3)(i) of this section, a distribution or 
acquisition described in paragraph (b)(2) or (b)(3)(i) of this section 
that occurs pursuant to a reorganization described in section 381(a)(2) 
is reduced solely by the expanded group earnings account of the 
acquiring member after taking into account the adjustment to its 
expanded group earnings account provided in paragraph 
(c)(3)(i)(F)(2)(ii) of this section.
    (2) Effect of certain corporate transactions on the calculation of 
expanded group earnings account--(i) In general. Section 381 and Sec. 
1.312-10 are not taken into account for purposes of calculating a 
covered member's expanded group earnings account for an expanded group 
period. The expanded group earnings account that a covered member 
succeeds to under paragraphs (c)(3)(i)(F)(2)(ii) through (iv) of this 
section is attributed to the covered member's expanded group period as 
of the close of the date of the distribution or transfer.
    (ii) Section 381 transactions. If a covered member (acquiring 
member) acquires the assets of another covered member (acquired member) 
in a transaction described in section 381(a), and, immediately before 
the transaction, both corporations are members of the same expanded 
group, then the acquiring member succeeds to the expanded group earnings 
account of the acquired member, if any, determined after application of 
paragraph (c)(3)(i) of this section with respect to the final taxable 
year of the acquired member.
    (iii) Section 1.312-10(a) transactions. If a covered member 
(transferor member) transfers property to another covered member 
(transferee member) in a transaction described in Sec. 1.312-10(a), the 
expanded group earnings account of the transferor member is allocated 
between the transferor member and the transferee member in the same 
proportion as the earnings and profits of the transferor member are 
allocated between the transferor member and the transferee member under 
Sec. 1.312-10(a).
    (iv) Section 1.312-10(b) transactions. If a covered member 
(distributing member) distributes the stock of another covered member 
(controlled member) in a transaction described in Sec. 1.312-10(b), the 
expanded group earnings account of the distributing member is decreased 
by the amount that the expanded group earnings account of the 
distributing member would have been decreased under paragraph 
(c)(3)(i)(F)(2)(iii) of this section if the distributing member had 
transferred the stock of the controlled member to a newly formed 
corporation in a transaction described in Sec. 1.312-10(a). If the 
amount of the decrease described in the preceding sentence exceeds the 
expanded group earnings account of the controlled member immediately 
before the transaction described in Sec. 1.312-10(b), then the expanded 
group earnings account of the controlled member after the transaction is 
equal to the amount of the decrease.
    (G) Overlapping expanded groups. A covered member that is a member 
of two expanded groups at the same time has a single expanded group 
earnings account with respect to a single expanded group period. In this 
case, the expanded group period is determined by reference to the 
shorter of the two periods during which the covered member is a member 
of an expanded group with the same expanded group parent.

[[Page 765]]

    (ii) Reduction for qualified contributions--(A) In general. The 
amount of a distribution or acquisition by a covered member described in 
paragraph (b)(2) or (b)(3)(i) of this section is reduced by the 
aggregate fair market value of the stock issued by the covered member in 
one or more qualified contributions (as defined in paragraph 
(c)(3)(ii)(B) of this section) during the qualified period (as defined 
in paragraph (c)(3)(ii)(C) of this section), but only to the extent the 
qualified contribution or qualified contributions have not reduced 
another distribution or acquisition. The reduction described in this 
paragraph (c)(3)(ii)(A) applies to one or more distributions or 
acquisitions based on the order in which the distributions or 
acquisitions occur, regardless of whether any distribution or 
acquisition would be treated as funded by a covered debt instrument 
without regard to this paragraph (c)(3).
    (B) Qualified contribution. The term qualified contribution means, 
with respect to a covered member, except as provided in paragraph 
(c)(3)(ii)(E) of this section, a contribution of property, other than 
excluded property (defined in paragraph (c)(3)(ii)(D) of this section), 
to the covered member by a member of the covered member's expanded group 
(or by a controlled partnership of the expanded group) in exchange for 
stock.
    (C) Qualified period. The term qualified period means, with respect 
to a covered member, a qualified contribution, and a distribution or 
acquisition described in paragraph (b)(2) or (b)(3)(i) of this section, 
the period beginning on the later of the beginning of the periods 
described in paragraphs (c)(3)(ii)(C)(1) and (2) of this section, and 
ending on the earlier of the ending of the periods described in 
paragraphs (c)(3)(ii)(C)(1) and (2) of this section or the date 
described in paragraph (c)(3)(ii)(C)(3) of this section.
    (1) The period beginning 36 months before the date of the 
distribution or acquisition, and ending 36 months after the date of the 
distribution or acquisition.
    (2) The covered member's expanded group period (as defined in 
paragraph (c)(3)(i)(E) of this section) that includes the distribution 
or acquisition.
    (3) The last day of the first taxable year that a covered debt 
instrument issued by the covered member would, absent the application of 
this paragraph (c)(3)(ii) with respect to the distribution or 
acquisition, be treated, in whole or in part, as stock under paragraph 
(b) of this section or, in the case of a covered debt instrument issued 
by a controlled partnership in which the covered member is an expanded 
group partner, the covered debt instrument would be treated, in whole or 
in part, as a specified portion.
    (D) Excluded property. The term excluded property means--
    (1) Expanded group stock;
    (2) Property acquired by the covered member in an asset 
reorganization from a member of the expanded group of which the covered 
member is a member;
    (3) A covered debt instrument of any member of the same expanded 
group, including a covered debt instrument issued by the covered member;
    (4) Property acquired by the covered member in exchange for a 
covered debt instrument issued by the covered member that is 
recharacterized under paragraph (b)(3) of this section;
    (5) A debt instrument issued by a controlled partnership of the 
expanded group of which the covered member is a member, including the 
portion of such a debt instrument that is a deemed transferred 
receivable or a retained receivable; and
    (6) Any other property acquired by the covered member with a 
principal purpose to avoid the purposes of this section or Sec. 1.385-
3, including a transaction involving an indirect transfer of property 
described in paragraphs (c)(3)(ii)(D)(1) through (5) of this section.
    (E) Excluded contributions--(1) Upstream contributions from certain 
subsidiaries. For purposes of paragraph (c)(3)(ii)(B) of this section, a 
contribution of property from a corporation (controlled member) that the 
covered member controls, within the meaning of paragraph (c)(2)(i)(B) of 
this section, is not a qualified contribution.
    (2) Contributions to a predecessor or successor. For purposes of 
paragraph (c)(3)(ii)(B) of this section, a contribution of property to a 
covered member

[[Page 766]]

from a corporation of which the covered member is a predecessor or 
successor, or from a corporation controlled by that corporation within 
the meaning of paragraph (c)(2)(i)(B) of this section, is not a 
qualified contribution.
    (3) Contributions that do not increase fair market value. A 
contribution of property to a covered member that is not described in 
paragraph (c)(3)(ii)(E)(1) or (2) of this section is not a qualified 
contribution to the extent that the contribution does not increase the 
aggregate fair market value of the outstanding stock of the covered 
member immediately after the transaction and taking into account all 
related transactions, other than distributions and acquisitions 
described in paragraphs (b)(2) and (b)(3)(i) of this section.
    (4) Contributions that become excluded contributions after the date 
of the contribution. If a contribution of property described in 
paragraph (c)(3)(ii)(E)(1) or (2) of this section occurs before the 
covered member acquires control of the controlled member described in 
paragraph (c)(3)(ii)(E)(1) or before the transaction in which the 
corporation described in paragraph (c)(3)(ii)(E)(2) becomes a 
predecessor or successor to the covered member, the contribution of 
property ceases to be a qualified contribution on the date that the 
covered member acquires control of the controlled member or on the date 
of the transaction in which the corporation becomes a predecessor or 
successor to the covered member (transaction date). If the contribution 
of property occurs within 36 months before the transaction date, the 
covered member is treated as making a distribution described in 
paragraph (b)(3)(i)(A) of this section on the transaction date equal to 
the amount by which any distribution or acquisition described in 
paragraph (b)(2) or (b)(3)(i) of this section was reduced under 
paragraph (c)(3)(ii)(A) of this section because the contribution of 
property was treated as a qualified contribution.
    (F) Special rules for certain corporate transactions--(1) Reduction 
for qualified contributions in an asset reorganization. For purposes of 
applying paragraph (c)(3)(ii)(A) of this section, a distribution or 
acquisition described in paragraph (b)(2) or (b)(3)(i) of this section 
that occurs pursuant to a reorganization described in section 381(a)(2) 
is reduced solely by the qualified contributions of the acquiring member 
after taking into account the adjustment to its qualified contributions 
provided in paragraph (c)(3)(ii)(F)(2) of this section.
    (2) Effect of certain corporate transactions on the calculation of 
qualified contributions--(i) In general. This paragraph (c)(3)(ii)(F)(2) 
provides rules for allocating or reducing the qualified contributions of 
a covered member as a result of certain corporation transactions. For 
purposes of paragraph (c)(3)(ii)(C)(1) of this section, a qualified 
contribution that a covered member succeeds to under paragraphs 
(c)(3)(ii)(F)(2)(ii) and (iii) of this section is treated as made to the 
covered member on the date on which the qualified contribution was made 
to the covered member that received the qualified contribution. For 
purposes of paragraph (c)(3)(ii)(C)(2) of this section, a qualified 
contribution that a covered member succeeds to under paragraphs 
(c)(3)(ii)(F)(2)(ii) and (iii) of this section is attributed to the 
covered member's expanded group period as of the close of the date of 
the distribution or transfer. For purposes of paragraph (c)(3)(ii)(C)(3) 
of this section, a qualified contribution a covered member succeeds to 
under paragraphs (c)(3)(ii)(F)(2)(ii) and (iii) of this section is 
treated as made to the covered member as of the close of the date of the 
distribution or transfer.
    (ii) Section 381 transactions. If a covered member (acquiring 
member) acquires the assets of another covered member (acquired member) 
in a transaction described in section 381(a), and, immediately before 
the transaction, both corporations are members of the same expanded 
group, the acquiring member succeeds to the qualified contributions of 
the acquired member, if any, adjusted for the application of paragraph 
(c)(3)(ii)(E)(4) of this section.
    (iii) Section 1.312-10(a) transactions. If a covered member 
(transferor member) transfers property to another covered member 
(transferee member) in a transaction described in Sec. 1.312-10(a), 
each qualified contribution of the

[[Page 767]]

transferor member is allocated between the transferor member and the 
transferee member in the same proportion as the earnings and profits of 
the transferor member are allocated between the transferor member and 
the transferee member under Sec. 1.312-10(a).
    (iv) Section 1.312-10(b) transactions. If a covered member 
(distributing member) distributes the stock of another covered member 
(controlled member) in a transaction described in Sec. 1.312-10(b), 
each qualified contribution of the distributing member is decreased by 
the amount that each qualified contribution of the distributing member 
would have been decreased under paragraph (c)(3)(ii)(F)(2)(iii) of this 
section if the distributing member had transferred the stock of the 
controlled member to a newly formed corporation in a transaction 
described in Sec. 1.312-10(a). No amount of the qualified contributions 
of the distributing member is allocated to the controlled member.
    (iii) Predecessors and successors. For purposes of this paragraph 
(c)(3), references to a covered member do not include references to any 
corporation of which the covered member is a predecessor or successor. 
Accordingly, a distribution or acquisition by a covered member described 
in paragraphs (b)(3)(i)(A) through (C) is reduced solely by the expanded 
group earnings account of the covered member (taking into account the 
application of paragraph (c)(3)(i)(F)(2) of this section) and the 
qualified contributions of the covered member (taking into account the 
application of paragraph (c)(3)(ii)(F)(2) of this section), 
notwithstanding that the distribution or acquisition is treated as made 
by a funded member of which the covered member is a predecessor or 
successor.
    (iv) Ordering rule. The exceptions described in this paragraph 
(c)(3) are applied in the following order: First, paragraph (c)(3)(i) of 
this section; and, second, paragraph (c)(3)(ii) of this section.
    (4) Threshold exception. A covered debt instrument is not treated as 
stock under this section if, immediately after the covered debt 
instrument would be treated as stock under this section but for the 
application of this paragraph (c)(4), the aggregate adjusted issue price 
of covered debt instruments held by members of the issuer's expanded 
group that would be treated as stock under this section but for the 
application of this paragraph (c)(4) does not exceed $50 million. To the 
extent a debt instrument issued by a controlled partnership would be 
treated as a specified portion (as defined in paragraph (g)(23) of this 
section) but for the application of this paragraph (c)(4), the debt 
instrument is treated as a covered debt instrument described in the 
preceding sentence for purposes of this paragraph (c)(4). To the extent 
that, immediately after a covered debt instrument would be treated as 
stock under this section but for the application of this paragraph 
(c)(4), the aggregate adjusted issue price of covered debt instruments 
held by members of the issuer's expanded group that would be treated as 
stock under this section but for the application of this paragraph 
(c)(4) exceeds $50 million, only the amount of the covered debt 
instrument in excess of $50 million is treated as stock under this 
section. For purposes of this rule, any covered debt instrument that is 
not denominated in U.S. dollars is translated into U.S. dollars at the 
spot rate (as defined in Sec. 1.988-1(d)) on the date that the covered 
debt instrument is issued.
    (d) Operating rules--(1) Timing. This paragraph (d)(1) provides 
rules for determining when a covered debt instrument is treated as stock 
under paragraph (b) of this section. For special rules regarding the 
treatment of a deemed exchange of a covered debt instrument that occurs 
pursuant to paragraphs (d)(1)(ii), (d)(1)(iii), or (d)(1)(iv) of this 
section, see Sec. 1.385-1(d).
    (i) General timing rule. Except as otherwise provided in this 
paragraph (d)(1), when paragraph (b) of this section applies to treat a 
covered debt instrument as stock, the covered debt instrument is treated 
as stock when the covered debt instrument is issued. When paragraph 
(b)(3) of this section applies to treat a covered debt instrument as 
stock when the covered debt instrument is issued, see also paragraph 
(b)(3)(vi) of this section.
    (ii) Exception when a covered debt instrument is treated as funding 
a distribution or acquisition that occurs after the

[[Page 768]]

issuance of the covered debt instrument. When paragraph (b)(3)(iii) of 
this section applies to treat a covered debt instrument as funding a 
distribution or acquisition described in paragraph (b)(3)(i)(A) through 
(C) of this section that occurs after the covered debt instrument is 
issued, the covered debt instrument is deemed to be exchanged for stock 
on the date that the distribution or acquisition occurs. See paragraph 
(h)(3) of this section, Examples 4 and 9, for an illustration of this 
rule.
    (iii) Exception for certain predecessor and successor transactions. 
To the extent that a covered debt instrument would not be treated as 
stock but for the fact that a funded member is treated as the 
predecessor or successor of another expanded group member under 
paragraph (b)(3)(v) of this section, the covered debt instrument is 
deemed to be exchanged for stock on the later of the date that the 
funded member completes the transaction causing it to become a 
predecessor or successor of the other expanded group member or the date 
that the covered debt instrument would be treated as stock under 
paragraph (d)(1)(i) or (ii) of this section.
    (iv) Exception when a covered debt instrument is re-tested under 
paragraph (d)(2) of this section. When paragraph (b)(3)(iii) of this 
section applies to treat a covered debt instrument as funding a 
distribution or acquisition described in paragraphs (b)(3)(i)(A) through 
(C) of this section as a result of a re-testing described in paragraph 
(d)(2)(ii) of this section that occurs in a taxable year subsequent to 
the taxable year in which the covered debt instrument is issued, the 
covered debt instrument is deemed to be exchanged for stock on the later 
of the date of the re-testing or the date that the covered debt 
instrument would be treated as stock under paragraph (d)(1)(i) or (ii) 
of this section. See paragraph (h)(3) of this section, Example 7, for an 
illustration of this rule.
    (2) Covered debt instrument treated as stock that leaves the 
expanded group--(i) Events that cause a covered debt instrument to cease 
to be treated as stock. Subject to paragraph (b)(4) of this section, 
this paragraph (d)(2)(i) applies with respect to a covered debt 
instrument that is treated as stock under this section when the holder 
and issuer of a covered debt instrument cease to be members of the same 
expanded group, either because the covered debt instrument is 
transferred to a person that is not a member of the expanded group that 
includes the issuer or because the holder or the issuer ceases to be a 
member of the same expanded group, or in the case of a holder that is a 
controlled partnership, when the holder ceases to be a controlled 
partnership with respect to the expanded group of which the issuer is a 
member, either because the partnership ceases to be a controlled 
partnership or because the issuer ceases to be a member of the same 
expanded group with respect to which the holder is a controlled 
partnership. In such a case, the covered debt instrument ceases to be 
treated as stock under this section. For this purpose, immediately 
before the transaction that causes the holder and issuer of the covered 
debt instrument to cease to be members of the same expanded group, or, 
if the holder is a controlled partnership, that causes the holder to 
cease to be a controlled partnership with respect to the expanded group 
of which the issuer is a member, the issuer is deemed to issue a new 
covered debt instrument to the holder in exchange for the covered debt 
instrument that was treated as stock in a transaction that is 
disregarded for purposes of paragraphs (b)(2) and (b)(3) of this 
section.
    (ii) Re-testing of covered debt instruments and certain 
distributions and acquisitions--(A) General rule. For purposes of 
paragraph (b)(3)(iii) of this section, when paragraph (d)(2)(i) of this 
section or Sec. 1.385-4(c)(2) causes a covered debt instrument that 
previously was treated as stock pursuant to paragraph (b)(3) of this 
section to cease to be treated as stock, all other covered debt 
instruments of the issuer that are not treated as stock on the date that 
the transaction occurs that causes paragraph (d)(2)(i) of this section 
to apply are re-tested to determine whether those other covered debt 
instruments are treated as funding the distribution or acquisition that 
previously was treated as funded by the covered debt instrument that 
ceases to

[[Page 769]]

be treated as stock pursuant to paragraph (d)(2)(i) of this section. In 
addition, a covered debt instrument that is issued after an application 
of paragraph (d)(2)(i) of this section and within the per se period may 
also be treated as funding that distribution or acquisition. See 
paragraph (h)(3) of this section, Example 7, for an illustration of this 
rule.
    (B) Re-testing upon a specified event with respect to a debt 
instrument issued by a controlled partnership. If, with respect to a 
covered member that is an expanded group partner and a debt instrument 
issued by the controlled partnership, there is reduction in the covered 
member's specified portion under Sec. 1.385-3(f)(5)(i) by reason of a 
specified event, the covered member must re-test its debt instruments as 
described in paragraph (d)(2)(ii)(A) of this section.
    (3) Inapplicability of section 385(c)(1). Section 385(c)(1) does not 
apply with respect to a covered debt instrument to the extent that it is 
treated as stock under this section.
    (4) Treatment of disregarded entities. This paragraph (d)(4) applies 
to the extent that a covered debt instrument issued by a disregarded 
entity, the regarded owner of which is a covered member, would, absent 
the application of this paragraph (d)(4), be treated as stock under this 
section. In this case, rather than the covered debt instrument being 
treated as stock to such extent (applicable portion), the covered member 
that is the regarded owner of the disregarded entity is deemed to issue 
its stock in the manner described in this paragraph (d)(4). If the 
applicable portion otherwise would have been treated as stock under 
paragraph (b)(2) of this section, then the covered member is deemed to 
issue its stock to the expanded group member to which the covered debt 
instrument was, in form, issued (or transferred) in the transaction 
described in paragraph (b)(2) of this section. If the applicable portion 
otherwise would have been treated as stock under paragraph (b)(3)(i) of 
this section, then the covered member is deemed to issue its stock to 
the holder of the covered debt instrument in exchange for a portion of 
the covered debt instrument equal to the applicable portion. In each 
case, the covered member that is the regarded owner of the disregarded 
entity is treated as the holder of the applicable portion of the debt 
instrument issued by the disregarded entity, and the actual holder is 
treated as the holder of the remaining portion of the covered debt 
instrument and the stock deemed to be issued by the regarded owner. 
Under Federal tax principles, the applicable portion of the debt 
instrument issued by the disregarded entity generally is disregarded. 
This paragraph (d)(4) must be applied in a manner that is consistent 
with the principles of paragraph (f)(4) of this section. Thus, for 
example, stock deemed issued is deemed to have the same terms as the 
covered debt instrument issued by the disregarded entity, other than the 
identity of the issuer, and payments on the stock are determined by 
reference to payments made on the covered debt instrument issued by the 
disregarded entity. See Sec. 1.385-4(b)(3) for additional rules that 
apply if the regarded owner of the disregarded entity is a member of a 
consolidated group. If the regarded owner of a disregarded entity is a 
controlled partnership, then paragraph (f) of this section applies as 
though the controlled partnership were the issuer in form of the debt 
instrument.
    (5) Payments with respect to partially recharacterized covered debt 
instruments--(i) General rule. Except as otherwise provided in paragraph 
(d)(5)(ii) of this section, a payment with respect to an instrument that 
is partially recharacterized as stock is treated as made pro rata to the 
portion treated as stock and to the portion treated as indebtedness.
    (ii) Special rule for payments not required pursuant to the terms of 
the instrument. A payment with respect to an instrument that is 
partially recharacterized as stock and that is a payment that is not 
required to be made pursuant to the terms of the instrument (for 
example, a prepayment of principal) may be designated by the issuer and 
the holder as with respect to the portion treated as stock or to the 
portion treated as indebtedness, in whole or in part. In the absence of 
such designation, see paragraph (d)(5)(i) of this section.

[[Page 770]]

    (6) Treatment of a general rule transaction to which an exception 
applies. To the extent a covered member would, absent the application of 
paragraph (c)(2) or (c)(3) of this section, be treated as making a 
distribution or acquisition described in paragraph (b)(2) of this 
section, then, solely for purposes of applying paragraph (b)(3) of this 
section, the covered member is treated as issuing the covered debt 
instrument issued in the distribution or acquisition to a member of the 
covered member's expanded group in exchange for property.
    (7) Treatment for purposes of section 1504(a)--(i) Debt instruments 
treated as stock. A covered debt instrument that is treated as stock 
under paragraph (b)(2), (3), or (4) of this section and that is not 
described in section 1504(a)(4) is not treated as stock for purposes of 
determining whether the issuer is a member of an affiliated group 
(within the meaning of section 1504(a)).
    (ii) Deemed partner stock and stock deemed issued by a regarded 
owner. If deemed partner stock or stock that is deemed issued by a 
regarded owner under Sec. 1.385-3(d)(4) is not described in section 
1504(a)(4), then that stock is not treated as stock for purposes of 
determining whether the issuer of the stock is a member of an affiliated 
group (within the meaning of section 1504(a)).
    (e) No affirmative use. [Reserved]
    (f) Treatment of controlled partnerships--(1) In general. For 
purposes of this section and Sec. 1.385-4, a controlled partnership is 
treated as an aggregate of its partners in the manner described in this 
paragraph (f). Paragraph (f)(2) of this section sets forth rules 
concerning the aggregate treatment when a controlled partnership 
acquires property from a member of the expanded group. Paragraph (f)(3) 
of this section sets forth rules concerning the aggregate treatment when 
a controlled partnership issues a debt instrument. Paragraph (f)(4) of 
this section deems a debt instrument issued by a controlled partnership 
to be held by an expanded group partner rather than the holder-in-form 
in certain cases. Paragraph (f)(5) of this section sets forth the rules 
concerning events that cause the deemed results described in paragraph 
(f)(4) of this section to cease. Paragraph (f)(6) of this section 
exempts certain issuances of a controlled partnership's debt to a 
partner and a partner's debt to a controlled partnership from the 
application of this section. For definitions applicable for this 
section, see paragraph (g) of this section. For examples illustrating 
the application of this section, see paragraph (h) of this section.
    (2) Acquisitions of property by a controlled partnership--(i) 
Acquisitions of property when a member of the expanded group is a 
partner on the date of the acquisition--(A) Aggregate treatment. Except 
as otherwise provided in paragraphs (f)(2)(i)(C) and (f)(6) of this 
section, if a controlled partnership, with respect to an expanded group, 
acquires property from a member of the expanded group (transferor 
member), then, for purposes of this section, a member of the expanded 
group that is an expanded group partner on the date of the acquisition 
is treated as acquiring its share (as determined under paragraph 
(f)(2)(i)(B) of this section) of the property. The expanded group 
partner is treated as acquiring its share of the property from the 
transferor member in the manner (for example, in a distribution, in an 
exchange for property, or in an issuance), and on the date on which, the 
property is actually acquired by the controlled partnership from the 
transferor member. Accordingly, this section applies to a member's 
acquisition of property described in this paragraph (f)(2)(i)(A) in the 
same manner as if the member actually acquired the property from the 
transferor member, unless explicitly provided otherwise.
    (B) Expanded group partner's share of property. For purposes of 
paragraph (f)(2)(i)(A) of this section, a partner's share of property 
acquired by a controlled partnership is determined in accordance with 
the partner's liquidation value percentage (as defined in paragraph 
(g)(17) of this section) with respect to the controlled partnership. The 
liquidation value percentage is determined on the date on which the 
controlled partnership acquires the property.
    (C) Exception if transferor member is an expanded group partner. If 
a transferor

[[Page 771]]

member is an expanded group partner in the controlled partnership, 
paragraph (f)(2)(i)(A) of this section does not apply to such partner.
    (ii) Acquisitions of expanded group stock when a member of the 
expanded group becomes a partner after the acquisition--(A) Aggregate 
treatment. Except as otherwise provided in paragraph (f)(2)(ii)(C) of 
this section, if a controlled partnership, with respect to an expanded 
group, owns expanded group stock, and a member of the expanded group 
becomes an expanded group partner in the controlled partnership, then, 
for purposes of this section, the member is treated as acquiring its 
share (as determined under paragraph (f)(2)(ii)(B) of this section) of 
the expanded group stock owned by the controlled partnership. The member 
is treated as acquiring its share of the expanded group stock on the 
date on which the member becomes an expanded group partner. Furthermore, 
the member is treated as if it acquires its share of the expanded group 
stock from a member of the expanded group in exchange for property other 
than expanded group stock, regardless of the manner in which the 
partnership acquired the stock and in which the member acquires its 
partnership interest. Accordingly, this section applies to a member's 
acquisition of expanded group stock described in this paragraph 
(f)(2)(ii)(A) in the same manner as if the member actually acquired the 
stock from a member of the expanded group in exchange for property other 
than expanded group stock, unless explicitly provided otherwise.
    (B) Expanded group partner's share of expanded group stock. For 
purposes of paragraph (f)(2)(ii)(A) of this section, a partner's share 
of expanded group stock owned by a controlled partnership is determined 
in accordance with the partner's liquidation value percentage with 
respect to the controlled partnership. The liquidation value percentage 
is determined on the date on which a member of the expanded group 
becomes an expanded group partner in the controlled partnership.
    (C) Exception if an expanded group partner acquires its interest in 
a controlled partnership in exchange for expanded group stock. Paragraph 
(f)(2)(ii)(A) of this section does not apply to a member of an expanded 
group that acquires its interest in a controlled partnership either from 
another partner in exchange solely for expanded group stock or upon a 
partnership contribution to the controlled partnership comprised solely 
of expanded group stock.
    (3) Issuances of debt instruments by a controlled partnership to a 
member of an expanded group--(i) Aggregate treatment. If a controlled 
partnership, with respect to an expanded group, issues a debt instrument 
to a member of the expanded group, then, for purposes of this section, a 
covered member that is an expanded group partner is treated as the 
issuer with respect to its share (as determined under paragraph 
(f)(3)(ii) of this section) of the debt instrument issued by the 
controlled partnership. This section applies to the portion of the debt 
instrument treated as issued by the covered member as described in this 
paragraph (f)(3)(i) in the same manner as if the covered member actually 
issued the debt instrument to the holder-in-form, unless otherwise 
provided. See paragraph (f)(4) of this section, which deems a debt 
instrument issued by a controlled partnership to be held by an expanded 
group partner rather than the holder-in-form in certain cases.
    (ii) Expanded group partner's share of a debt instrument issued by a 
controlled partnership--(A) General rule. An expanded group partner's 
share of a debt instrument issued by a controlled partnership is 
determined on each date on which the partner makes a distribution or 
acquisition described in paragraph (b)(2) or (b)(3)(i) of this section 
(testing date). An expanded group partner's share of a debt instrument 
issued by a controlled partnership to a member of the expanded group is 
determined in accordance with the partner's issuance percentage (as 
defined in paragraph (g)(16) of this section) on the testing date. A 
partner's share determined under this paragraph (f)(3)(ii)(A) is 
adjusted as described in paragraph (f)(3)(ii)(B) of this section.
    (B) Additional rules if there is a specified portion with respect to 
a debt instrument--(1) An expanded group partner's share (as determined 
under paragraph

[[Page 772]]

(f)(3)(ii)(A) of this section) of a debt instrument issued by a 
controlled partnership is reduced, but not below zero, by the sum of all 
of the specified portions (as defined in paragraph (g)(23) of this 
section), if any, with respect to the debt instrument that correspond to 
one or more deemed transferred receivables (as defined in paragraph 
(g)(8) of this section) that are deemed to be held by the partner.
    (2) If the aggregate of all of the expanded group partners' shares 
(as determined under paragraph (f)(3)(ii)(A) of this section and reduced 
under paragraph (f)(3)(ii)(B)(1) of this section) of the debt instrument 
exceeds the adjusted issue price of the debt, reduced by the sum of all 
of the specified portions with respect to the debt instrument that 
correspond to one or more deemed transferred receivables that are deemed 
to be held by one or more expanded group partners (excess amount), then 
each expanded group partner's share (as determined under paragraph 
(f)(3)(ii)(A) of this section and reduced under paragraph 
(f)(3)(ii)(B)(1) of this section) of the debt instrument is reduced. The 
amount of an expanded group partner's reduction is the excess amount 
multiplied by a fraction, the numerator of which is the partner's share, 
and the denominator of which is the aggregate of all of the expanded 
group partners' shares.
    (iii) Qualified short-term debt instrument. The determination of 
whether a debt instrument is a qualified short-term debt instrument for 
purposes of paragraph (b)(3)(vii) of this section is made at the 
partnership-level without regard to paragraph (f)(3)(i) of this section.
    (4) Recharacterization when there is a specified portion with 
respect to a debt instrument issued by a controlled partnership--(i) 
General rule. A specified portion, with respect to a debt instrument 
issued by a controlled partnership and an expanded group partner, is not 
treated as stock under paragraph (b)(2) or (b)(3)(i) of this section. 
Except as otherwise provided in paragraphs (f)(4)(ii) and (iii) of this 
section, the holder-in-form (as defined in paragraph (g)(15) of this 
section) of the debt instrument is deemed to transfer a portion of the 
debt instrument (a deemed transferred receivable, as defined in 
paragraph (g)(8) of this section) with a principal amount equal to the 
adjusted issue price of the specified portion to the expanded group 
partner in exchange for stock in the expanded group partner (deemed 
partner stock, as defined in paragraph (g)(6) of this section) with a 
fair market value equal to the principal amount of the deemed 
transferred receivable. Except as otherwise provided in paragraph 
(f)(4)(vi) of this section (concerning the treatment of a deemed 
transferred receivable for purposes of section 752) and paragraph (f)(5) 
of this section (concerning specified events subsequent to the deemed 
transfer), the deemed transfer described in this paragraph (f)(4)(i) is 
deemed to occur for all Federal tax purposes.
    (ii) Expanded group partner is the holder-in-form of a debt 
instrument. If the specified portion described in paragraph (f)(4)(i) of 
this section is with respect to an expanded group partner that is the 
holder-in-form of the debt instrument, then paragraph (f)(4)(i) of this 
section will not apply with respect to that specified portion except 
that only the first sentence of paragraph (f)(4)(i) of this section is 
applicable.
    (iii) Expanded group partner is a consolidated group member. This 
paragraph (f)(4)(iii) applies when one or more expanded group partners 
is a member of a consolidated group that files (or is required to file) 
a consolidated U.S. Federal income tax return. In this case, 
notwithstanding Sec. 1.385-4(b)(1) (which generally treats members of a 
consolidated group as one corporation for purposes of this section), the 
holder-in-form of the debt instrument issued by the controlled 
partnership is deemed to transfer the deemed transferred receivable or 
receivables to the expanded group partner or partners that are members 
of a consolidated group that make, or are treated as making under 
paragraph (f)(2) of this section, the regarded distributions or 
acquisitions (within the meaning of Sec. 1.385-4(e)(5)) described in 
paragraph (b)(2) or (b)(3)(i) of this section in exchange for deemed 
partner stock in such partner or partners. To the extent those regarded 
distributions or acquisitions are made by

[[Page 773]]

a member of the consolidated group that is not an expanded group partner 
(excess amount), the holder-in-form is deemed to transfer a portion of 
the deemed transferred receivable or receivables to each member of the 
consolidated group that is an expanded group partner in exchange for 
deemed partner stock in the expanded group partner. The portion is the 
excess amount multiplied by a fraction, the numerator of which is the 
portion of the consolidated group's share (as determined under paragraph 
(f)(3)(ii) of this section) of the debt instrument issued by the 
controlled partnership that would have been the expanded group partner's 
share if the partner was not a member of a consolidated group, and the 
denominator of which is the consolidated group's share of the debt 
instrument issued by the controlled partnership.
    (iv) Rules regarding deemed transferred receivables and deemed 
partner stock--(A) Terms of deemed partner stock. Deemed partner stock 
has the same terms as the deemed transferred receivable with respect to 
the deemed transfer, other than the identity of the issuer.
    (B) Treatment of payments with respect to a debt instrument for 
which there is one or more deemed transferred receivables. When a 
payment is made with respect to a debt instrument issued by a controlled 
partnership for which there is one or more deemed transferred 
receivables, then, if the amount of the retained receivable (as defined 
in paragraph (g)(22) of this section) held by the holder-in-form is zero 
and a single deemed holder is deemed to hold all of the deemed 
transferred receivables, the entire payment is allocated to the deemed 
transferred receivables held by the single deemed holder. If the amount 
of the retained receivable held by the holder-in-form is greater than 
zero or there are multiple deemed holders of deemed transferred 
receivables, or both, the payment is apportioned among the retained 
receivable, if any, and each deemed transferred receivable in proportion 
to the principal amount of all the receivables. The portion of a payment 
allocated or apportioned to a retained receivable or a deemed 
transferred receivable reduces the principal amount of, or accrued 
interest with respect to, as applicable depending on the payment, the 
retained receivable or deemed transferred receivable. When a payment 
allocated or apportioned to a deemed transferred receivable reduces the 
principal amount of the receivable, the expanded group partner that is 
the deemed holder with respect to the deemed transferred receivable is 
deemed to redeem the same amount of deemed partner stock, and the 
specified portion with respect to the debt instrument is reduced by the 
same amount. When a payment allocated or apportioned to a deemed 
transferred receivable reduces accrued interest with respect to the 
receivable, the expanded group partner that is the deemed holder with 
respect to the deemed transferred receivable is deemed to make a 
matching distribution in the same amount with respect to the deemed 
partner stock. The controlled partnership is treated as the paying agent 
with respect to the deemed partner stock.
    (v) Holder-in-form transfers debt instrument in a transaction that 
is not a specified event. If the holder-in-form transfers the debt 
instrument (which is disregarded for Federal tax purposes) to a member 
of the expanded group or a controlled partnership (and therefore the 
transfer is not a specified event described in paragraph (f)(5)(iii)(F) 
of this section), then, for Federal tax purposes, the holder-in-form is 
deemed to transfer the retained receivable and the deemed partner stock 
to the transferee.
    (vi) Allocation of deemed transferred receivable under section 752. 
A partnership liability that is a debt instrument with respect to which 
there is one or more deemed transferred receivables is allocated for 
purposes of section 752 without regard to any deemed transfer.
    (5) Specified events affecting ownership following a deemed 
transfer--(i) General rule. If a specified event (within the meaning of 
paragraph (f)(5)(iii) of this section) occurs with respect to a deemed 
transfer, then, immediately before the specified event, the expanded 
group partner that is both the issuer of the deemed partner stock and 
the

[[Page 774]]

deemed holder of the deemed transferred receivable is deemed to 
distribute the deemed transferred receivable (or portion thereof, as 
determined under paragraph (f)(5)(iv) of this section) to the holder-in-
form in redemption of the deemed partner stock (or portion thereof, as 
determined under paragraph (f)(5)(iv) of this section) deemed to be held 
by the holder-in-form. The deemed distribution is deemed to occur for 
all Federal tax purposes, except that the distribution is disregarded 
for purposes of paragraph (b) of this section. Except when the deemed 
transferred receivable (or portion thereof, as determined under 
paragraph (f)(5)(iv) of this section) is deemed to be retransferred 
under paragraph (f)(5)(ii) of this section, the principal amount of the 
retained receivable held by the holder-in-form is increased by the 
principal amount of the deemed transferred receivable, the deemed 
transferred receivable ceases to exist for Federal tax purposes, and the 
specified portion (or portion thereof) that corresponds to the deemed 
transferred receivable (or portion thereof) ceases to be treated as a 
specified portion for purposes of this section.
    (ii) New deemed transfer when a specified event involves a 
transferee that is a covered member that is an expanded group partner. 
If the specified event is described in paragraph (f)(5)(iii)(E) of this 
section, the holder-in-form of the debt instrument is deemed to 
retransfer the deemed transferred receivable (or portion thereof, as 
determined under paragraph (f)(5)(iv) of this section) that the holder-
in-form is deemed to have received pursuant to paragraph (f)(5)(i) of 
this section, to the transferee expanded group partner in exchange for 
deemed partner stock issued by the transferee expanded group partner 
with a fair market value equal to the principal amount of the deemed 
transferred receivable (or portion thereof) that is retransferred. For 
purposes of this section, this deemed transfer is treated in the same 
manner as a deemed transfer described in paragraph (f)(4)(i) of this 
section.
    (iii) Specified events. A specified event, with respect to a deemed 
transfer, occurs when, immediately after the transaction and taking into 
account all related transactions:
    (A) The controlled partnership that is the issuer of the debt 
instrument either ceases to be a controlled partnership or ceases to 
have an expanded group partner that is a covered member.
    (B) The holder-in-form is a member of the expanded group immediately 
before the transaction, and the holder-in-form and the deemed holder 
cease to be members of the same expanded group for the reasons described 
in paragraph (d)(2) of this section.
    (C) The holder-in-form is a controlled partnership immediately 
before the transaction, and the holder-in-form ceases to be a controlled 
partnership.
    (D) The expanded group partner that is both the issuer of deemed 
partner stock and the deemed holder transfers (directly or indirectly 
through one or more partnerships) all or a portion of its interest in 
the controlled partnership to a person that neither is a covered member 
nor a controlled partnership with an expanded group partner that is a 
covered member. If there is a transfer of only a portion of the 
interest, see paragraph (f)(5)(iv) of this section.
    (E) The expanded group partner that is both the issuer of deemed 
partner stock and the deemed holder transfers (directly or indirectly 
through one or more partnerships) all or a portion of its interest in 
the controlled partnership to a covered member or a controlled 
partnership with an expanded group partner that is a covered member. If 
there is a transfer of only a portion of the interest, see paragraph 
(f)(5)(iv) of this section.
    (F) The holder-in-form transfers the debt instrument (which is 
disregarded for Federal tax purposes) to a person that is neither a 
member of the expanded group nor a controlled partnership. See paragraph 
(f)(4)(v) of this section if the holder-in-form transfers the debt 
instrument to a member of the expanded group or a controlled 
partnership.
    (iv) Specified event involving a transfer of only a portion of an 
interest in a controlled partnership. If, with respect to a specified 
event described in paragraph (f)(5)(iii)(D) or (E) of this section, an

[[Page 775]]

expanded group partner transfers only a portion of its interest in a 
controlled partnership, then, only a portion of the deemed transferred 
receivable that is deemed to be held by the expanded group partner is 
deemed to be distributed in redemption of an equal portion of the deemed 
partner stock. The portion of the deemed transferred receivable referred 
to in the preceding sentence is equal to the product of the entire 
principal amount of the deemed transferred receivable deemed to be held 
by the expanded group partner multiplied by a fraction, the numerator of 
which is the portion of the expanded group partner's capital account 
attributable to the interest that is transferred, and the denominator of 
which is the expanded group partner's capital account with respect to 
its entire interest, determined immediately before the specified event.
    (6) Issuance of a partnership's debt instrument to a partner and a 
partner's debt instrument to a partnership. If a controlled partnership, 
with respect to an expanded group, issues a debt instrument to an 
expanded group partner, or if a covered member that is an expanded group 
partner issues a covered debt instrument to a controlled partnership, 
and in each case, no partner deducts or receives an allocation of 
expense with respect to the debt instrument, then this section does not 
apply to the debt instrument.
    (g) Definitions. The definitions in this paragraph (g) apply for 
purposes of this section and Sec. Sec. 1.385-3 and 1.385-4.
    (1) Asset reorganization. The term asset reorganization means a 
reorganization described in section 368(a)(1)(A), (C), (D), (F), or (G).
    (2) Consolidated group. The term consolidated group has the meaning 
specified in Sec. 1.1502-1(h).
    (3) Covered debt instrument--(i) In general. The term covered debt 
instrument means a debt instrument issued after April 4, 2016, that is 
not a qualified dealer debt instrument (as defined in paragraph 
(g)(3)(ii) of this section) or an excluded statutory or regulatory debt 
instrument (as defined in paragraph (g)(3)(iii) of this section), and 
that is issued by a covered member that is not an excepted regulated 
financial company (as defined in paragraph (g)(3)(iv) of this section) 
or a regulated insurance company (as defined in paragraph (g)(3)(v) of 
this section).
    (ii) Qualified dealer debt instrument. For purposes of this 
paragraph (g)(3), the term qualified dealer debt instrument means a debt 
instrument that is issued to or acquired by an expanded group member 
that is a dealer in securities (within the meaning of section 475(c)(1)) 
in the ordinary course of the dealer's business of dealing in 
securities. The preceding sentence applies solely to the extent that--
    (A) The dealer accounts for the debt instruments as securities held 
primarily for sale to customers in the ordinary course of business;
    (B) The dealer disposes of the debt instruments (or the debt 
instruments mature) within a period of time that is consistent with the 
holding of the debt instruments for sale to customers in the ordinary 
course of business, taking into account the terms of the debt 
instruments and the conditions and practices prevailing in the markets 
for similar debt instruments during the period in which it is held; and
    (C) The dealer does not sell or otherwise transfer the debt 
instrument to a member of the dealer's expanded group unless that sale 
or transfer is to a dealer that satisfies the requirements of this 
paragraph (g)(3)(ii).
    (iii) Excluded statutory or regulatory debt instrument. For purposes 
of this paragraph (g)(3), the term excluded statutory or regulatory debt 
instrument means a debt instrument that is described in any of the 
following paragraphs:
    (A) Production payments treated as a loan under section 636(a) or 
(b).
    (B) A ``regular interest'' in a real estate mortgage investment 
conduit described in section 860G(a)(1).
    (C) A debt instrument that is deemed to arise under Sec. 1.482-
1(g)(3) (including adjustments made pursuant to Revenue Procedure 99-32, 
1999-2 C.B. 296).
    (D) A stripped bond or coupon described in section 1286, unless such 
instrument was issued with a principal purpose of avoiding the purposes 
of this section or Sec. 1.385-3.
    (E) A lease treated as a loan under section 467.

[[Page 776]]

    (iv) Excepted regulated financial company. For purposes of this 
paragraph (g)(3), the term excepted regulated financial company means a 
covered member that is a regulated financial company (as defined in 
paragraph (g)(3)(iv)(A) of this section) or a member of a regulated 
financial group (as defined in paragraph (g)(3)(iv)(B) of this section).
    (A) Regulated financial company. For purposes of paragraph 
(g)(3)(iv), the term regulated financial company means--
    (1) A bank holding company, as defined in 12 U.S.C. 1841;
    (2) A covered savings and loan holding company, as defined in 12 CFR 
217.2;
    (3) A national bank;
    (4) A bank that is a member of the Federal Reserve System and is 
incorporated by special law of any State, or organized under the general 
laws of any State, or of the United States, including a Morris Plan 
bank, or other incorporated banking institution engaged in a similar 
business;
    (5) An insured depository institution, as defined in 12 U.S.C. 
1813(c)(2);
    (6) A nonbank financial company subject to a determination under 12 
U.S.C. 5323(a)(1) or (b)(1);
    (7) A U.S. intermediate holding company formed by a foreign banking 
organization in compliance with 12 CFR 252.153;
    (8) An Edge Act corporation organized under section 25A of the 
Federal Reserve Act (12 U.S.C. 611-631);
    (9) Corporations having an agreement or undertaking with the Board 
of Governors of the Federal Reserve System under section 25 of the 
Federal Reserve Act (12 U.S.C. 601-604a);
    (10) A supervised securities holding company, as defined in 12 
U.S.C. 1850a(a)(5);
    (11) A broker or dealer that is registered with the Securities and 
Exchange Commission under 15 U.S.C. 78o(b);
    (12) A futures commission merchant, as defined in 7 U.S.C. 1a(28);
    (13) A swap dealer, as defined in 7 U.S.C. 1a(49);
    (14) A security-based swap dealer, as defined in 15 U.S.C. 
78c(a)(71);
    (15) A Federal Home Loan Bank, as defined in 12 U.S.C. 1422(1)(A);
    (16) A Farm Credit System Institution chartered and subject to the 
provisions of the Farm Credit Act of 1971 (12 U.S.C. 2001 et seq.); or
    (17) A small business investment company, as defined in 15 U.S.C. 
662(3).
    (B) Regulated financial group--(1) General rule. For purposes of 
paragraph (g)(3)(iv) of this section, except as otherwise provided in 
paragraph (g)(3)(iv)(B)(2) of this section, the term regulated financial 
group means any expanded group of which a covered member that is a 
regulated financial company within the meaning of paragraphs 
(g)(3)(iv)(A)(1) through (10) of this section would be the expanded 
group parent if no person owned, directly or indirectly (as defined in 
Sec. 1.385-1(c)(4)(iii)), the regulated financial company. A domestic 
eligible entity (within the meaning of Sec. 301.7701-5(a) of this 
chapter) treated as a partnership or disregarded as an entity separate 
from its owner is, for purposes of this paragraph (g)(3)(iv)(B), also 
treated as a covered member.
    (2) Exception for certain non-financial entities. A corporation is 
not a member of a regulated financial group if it is held by a regulated 
financial company pursuant to 12 U.S.C. 1843(k)(1)(B), 12 U.S.C. 
1843(k)(4)(H), or 12 U.S.C. 1843(o).
    (v) Regulated insurance company. For purposes of this paragraph 
(g)(3), the term regulated insurance company means a covered member that 
is--
    (A) Subject to tax under subchapter L of chapter 1 of the Internal 
Revenue Code;
    (B) Domiciled or organized under the laws of one of the 50 states or 
the District of Columbia (for purposes of paragraph (g)(3)(v) of this 
section, each being a ``state'');
    (C) Licensed, authorized, or regulated by one or more states to sell 
insurance, reinsurance, or annuity contracts to persons other than 
related persons (within the meaning of section 954(d)(3)) in such 
states, but in no case will a corporation satisfy the requirements of 
this paragraph (g)(3)(v)(C) if a principal purpose for obtaining such 
license, authorization, or regulation was to qualify the issuer as a 
regulated insurance company; and

[[Page 777]]

    (D) Engaged in regular issuances of (or subject to ongoing liability 
with respect to) insurance, reinsurance, or annuity contracts with 
persons that are not related persons (within the meaning of section 
954(d)(3)).
    (4) Debt instrument. The term debt instrument means an interest that 
would, but for the application of this section, be treated as a debt 
instrument as defined in section 1275(a) and Sec. 1.1275-1(d).
    (5) Deemed holder. The term deemed holder means, with respect to a 
deemed transfer, the expanded group partner that is deemed to hold a 
deemed transferred receivable by reason of the deemed transfer.
    (6) Deemed partner stock. The term deemed partner stock means, with 
respect to a deemed transfer, the stock deemed issued by an expanded 
group partner as described in paragraphs (f)(4)(i) and (iii) and 
(f)(5)(ii) of this section. The amount of deemed partner stock is 
reduced as described in paragraphs (f)(4)(iv)(B) and (f)(5)(i) of this 
section.
    (7) Deemed transfer. The term deemed transfer means, with respect to 
a specified portion, the transfer described in paragraph (f)(4)(i) or 
(iii) or (f)(5)(ii) of this section.
    (8) Deemed transferred receivable. The term deemed transferred 
receivable means, with respect to a deemed transfer, the portion of the 
debt instrument described in paragraph (f)(4)(i) or (iii) or (f)(5)(ii) 
of this section. The deemed transferred receivable is reduced as 
described in paragraphs (f)(4)(iv)(B) and (f)(5)(i) of this section.
    (9) Distribution. The term distribution means any distribution made 
by a corporation with respect to its stock.
    (10) Exempt distribution. The term exempt distribution means 
either--
    (i) A distribution of stock that is permitted to be received without 
the recognition of gain or income under section 354(a)(1) or 355(a)(1), 
or, if section 356 applies, that is not treated as other property or 
money described in section 356; or
    (ii) A distribution of property in a complete liquidation under 
section 336(a) or 337(a).
    (11) Exempt exchange. The term exempt exchange means an acquisition 
of expanded group stock in which either--
    (i) In a case in which the transferor and transferee of the expanded 
group stock are parties to an asset reorganization, either--
    (A) Section 361(a) or (b) applies to the transferor of the expanded 
group stock and the stock is not transferred by issuance; or
    (B) Section 1032 or Sec. 1.1032-2 applies to the transferor of the 
expanded group stock and the stock is distributed by the transferee 
pursuant to the plan of reorganization;
    (ii) The transferor of the expanded group stock is a shareholder 
that receives property in a complete liquidation to which section 331 or 
332 applies; or
    (iii) The transferor of the expanded group stock is an acquiring 
entity that is deemed to issue the stock in exchange for cash from an 
issuing corporation in a transaction described in Sec. 1.1032-3(b).
    (12) Expanded group partner. The term expanded group partner means, 
with respect to a controlled partnership of an expanded group, a member 
of the expanded group that is a partner (directly or indirectly through 
one or more partnerships).
    (13) Expanded group stock. The term expanded group stock means, with 
respect to a member of an expanded group, stock of a member of the same 
expanded group.
    (14) Funded member. The term funded member has the meaning provided 
in paragraph (b)(3)(i) of this section.
    (15) Holder-in-form. The term holder-in-form means, with respect to 
a debt instrument issued by a controlled partnership, the person that, 
absent the application of paragraph (f)(4) of this section, would be the 
holder of the debt instrument for Federal tax purposes. Therefore, the 
term holder-in-form does not include a deemed holder (as defined in 
paragraph (g)(5) of this section).
    (16) Issuance percentage. The term issuance percentage means, with 
respect

[[Page 778]]

to a controlled partnership and an expanded group partner, the ratio 
(expressed as a percentage) of the partner's reasonably anticipated 
distributive share of all the partnership's interest expense over a 
reasonable period, divided by all of the partnership's reasonably 
anticipated interest expense over that same period, taking into account 
any and all relevant facts and circumstances. The relevant facts and 
circumstances include, without limitation, the term of the debt 
instrument; whether the partnership anticipates issuing other debt 
instruments; and the partnership's anticipated section 704(b) income and 
expense, and the partners' respective anticipated allocation 
percentages, taking into account anticipated changes to those allocation 
percentages over time resulting, for example, from anticipated 
contributions, distributions, recapitalizations, or provisions in the 
controlled partnership agreement.
    (17) Liquidation value percentage. The term liquidation value 
percentage means, with respect to a controlled partnership and an 
expanded group partner, the ratio (expressed as a percentage) of the 
liquidation value of the expanded group partner's interest in the 
partnership divided by the aggregate liquidation value of all the 
partners' interests in the partnership. The liquidation value of an 
expanded group partner's interest in a controlled partnership is the 
amount of cash the partner would receive with respect to the interest if 
the partnership (and any partnership through which the partner 
indirectly owns an interest in the controlled partnership) sold all of 
its property for an amount of cash equal to the fair market value of the 
property (taking into account section 7701(g)), satisfied all of its 
liabilities (other than those described in Sec. 1.752-7), paid an 
unrelated third party to assume all of its Sec. 1.752-7 liabilities in 
a fully taxable transaction, and then the partnership (and any 
partnership through which the partner indirectly owns an interest in the 
controlled partnership) liquidated.
    (18) Member of a consolidated group. The term member of a 
consolidated group means a corporation described in Sec. 1.1502-1(b).
    (19) Per se period. The term per se period has the meaning provided 
in paragraph (b)(3)(iii)(A) of this section.
    (20) Predecessor--(i) In general. Except as otherwise provided in 
paragraph (g)(20)(ii) of this section, the term predecessor means, with 
respect to a corporation--
    (A) The distributor or transferor corporation in a transaction 
described in section 381(a) in which the corporation is the acquiring 
corporation; or
    (B) The distributing corporation in a distribution or exchange to 
which section 355 (or so much of section 356 that relates to section 
355) applies in which the corporation is a controlled corporation.
    (ii) Predecessor ceasing to be a member of the same expanded group 
as corporation. The term predecessor does not include the distributing 
corporation described in paragraph (g)(20)(i)(B) of this section from 
the date that the distributing corporation ceases to be a member of the 
expanded group of which the controlled corporation is a member.
    (iii) Multiple predecessors. A corporation may have more than one 
predecessor, including by reason of a predecessor of the corporation 
having a predecessor or successor. Accordingly, references to a 
corporation also include references to a predecessor or successor of a 
predecessor of the corporation.
    (21) Property. The term property has the meaning specified in 
section 317(a).
    (22) Retained receivable. The term retained receivable means, with 
respect to a debt instrument issued by a controlled partnership, the 
portion of the debt instrument that is not transferred by the holder-in-
form pursuant to one or more deemed transfers. The retained receivable 
is adjusted for decreases described in paragraph (f)(4)(iv)(B) of this 
section and increases described in paragraph (f)(5)(i) of this section.
    (23) Specified portion. The term specified portion means, with 
respect to a debt instrument issued by a controlled partnership and a 
covered member that is an expanded group partner, the portion of the 
debt instrument that is treated under paragraph (f)(3)(i) of this 
section as issued on a testing date (within the meaning of paragraph 
(f)(3)(ii) of this section) by the covered

[[Page 779]]

member and that, absent the application of paragraph (f)(4)(i) of this 
section, would be treated as stock under paragraph (b)(2) or (b)(3)(i) 
of this section on the testing date. A specified portion is reduced as 
described in paragraphs (f)(4)(iv)(B) and (f)(5)(i) of this section.
    (24) Successor--(i) In general. Except as otherwise provided in 
paragraph (g)(24)(iii) of this section, the term successor means, with 
respect to a corporation--
    (A) The acquiring corporation in a transaction described in section 
381(a) in which the corporation is the distributor or transferor 
corporation;
    (B) A controlled corporation in a distribution or exchange to which 
section 355 (or so much of section 356 that relates to section 355) 
applies in which the corporation is the distributing corporation; or
    (C) Subject to the rules in paragraph (g)(24)(ii) of this section, a 
seller in an acquisition described in paragraph (c)(2)(i)(A) of this 
section in which the corporation is the acquirer.
    (ii) Special rules for certain acquisitions of subsidiary stock. The 
following rules apply with respect to a successor described in paragraph 
(g)(24)(i)(C) of this section:
    (A) The seller is a successor to the acquirer only to the extent of 
the value (adjusted as described in paragraph (g)(24)(ii)(C) of this 
section) of the expanded group stock acquired from the seller in 
exchange for property (other than expanded group stock) in the 
acquisition described in paragraph (c)(2)(i)(A) of this section.
    (B) A distribution or acquisition by either the seller or a 
successor seller to or from either the acquirer, the seller, or a 
successor seller is not treated as described in paragraph (b)(3) of this 
section for purposes of applying paragraph (b)(3) of this section to a 
covered debt instrument of the acquirer. For purposes of the preceding 
sentence, the term successor seller means a member of the expanded group 
that receives property (other than expanded group stock) in a 
distribution or acquisition from the seller or another successor seller 
and is controlled by the acquirer as determined under the principles of 
paragraph (c)(2)(i) of this section. A successor seller is treated as a 
successor to the acquirer to the extent of the value of the property 
received in a distribution or acquisition described in the preceding 
sentence and, for purposes of applying this paragraph (g)(24)(ii)(B).
    (C) To the extent that a covered debt instrument of the acquirer is 
treated as funding a distribution or acquisition by the seller or 
successor seller described in paragraphs (b)(3)(i)(A) through (C) of 
this section, or would be treated but for the exceptions described in 
paragraphs (c)(3)(i) and (ii) of this section, the value of the expanded 
group stock described in paragraph (g)(24)(ii)(A) of this section is 
reduced by an amount equal to the distribution or acquisition for 
purposes of any further application of paragraph (g)(24)(ii)(A) of this 
section with respect to the acquirer and seller.
    (iii) Successor ceasing to be a member of the same expanded group as 
corporation. The term successor does not include a controlled 
corporation described in paragraph (g)(24)(i)(B) of this section with 
respect to a distributing corporation or a seller described in paragraph 
(g)(24)(i)(C) of this section with respect to an acquirer from the date 
that the controlled corporation or the seller ceases to be a member of 
the expanded group of which the controlled corporation or acquirer, 
respectively, is a member.
    (iv) Multiple successors. A corporation may have more than one 
successor, including by reason of a successor of the corporation having 
a predecessor or successor. Accordingly, references to a corporation 
also include references to a predecessor or successor of a successor of 
the corporation.
    (25) Taxable year. The term taxable year refers to the taxable year 
of the issuer of the covered debt instrument.
    (h) Examples--(1) Assumed facts. Except as otherwise stated, the 
following facts are assumed for purposes of the examples in paragraph 
(h)(3) of this section:
    (i) FP is a foreign corporation that owns 100% of the stock of USS1, 
a covered member, 100% of the stock of USS2, a covered member, and 100% 
of the stock of FS, a foreign corporation;

[[Page 780]]

    (ii) USS1 owns 100% of the stock of DS, a covered member, and CFC, 
which is a controlled foreign corporation within the meaning of section 
957;
    (iii) At the beginning of Year 1, FP is the common parent of an 
expanded group comprised solely of FP, USS1, USS2, FS, DS, and CFC (the 
FP expanded group);
    (iv) The FP expanded group has more than $50 million of covered debt 
instruments described in paragraph (c)(4) of this section at all times;
    (v) No issuer of a covered debt instrument has a positive expanded 
group earnings account within the meaning of paragraph (c)(3)(i)(B) of 
this section or has received qualified contributions within the meaning 
of paragraph (c)(3)(ii) of this section;
    (vi) All notes are covered debt instruments (as defined in paragraph 
(g)(3) of this section) and are not qualified short-term debt 
instruments (as defined in paragraph (b)(3)(vii) of this section);
    (vii) Each entity has as its taxable year the calendar year;
    (viii) PRS is a partnership for federal income tax purposes;
    (ix) No corporation is a member of a consolidated group;
    (x) No domestic corporation is a United States real property holding 
corporation within the meaning of section 897(c)(2);
    (xi) Each note is issued with adequate stated interest (as defined 
in section 1274(c)(2)); and
    (xii) Each transaction occurs after January 19, 2017.
    (2) No inference. Except as otherwise provided in this section, it 
is assumed for purposes of the examples in paragraph (h)(3) of this 
section that the form of each transaction is respected for federal tax 
purposes. No inference is intended, however, as to whether any 
particular note would be respected as indebtedness or as to whether the 
form of any particular transaction described in an example in paragraph 
(h)(3) of this section would be respected for federal tax purposes.
    (3) Examples. The following examples illustrate the rules of this 
section.
    (i) Example 1. Distribution of a covered debt instrument--(A) Facts. 
On Date A in Year 1, FS lends $100x to USS1 in exchange for USS1 Note A. 
On Date B in Year 2, USS1 issues USS1 Note B, which is has a value of 
$100x, to FP in a distribution.
    (B) Analysis. USS1 Note B is a covered debt instrument that is 
issued by USS1 to FP, a member of the expanded group of which USS1 is a 
member, in a distribution. Accordingly, USS1 Note B is treated as stock 
under paragraph (b)(2)(i) of this section. Under paragraph (d)(1)(i) of 
this section, USS1 Note B is treated as stock when it is issued by USS1 
to FP on Date B in Year 2. Accordingly, USS1 is treated as distributing 
USS1 stock to its shareholder FP in a distribution that is subject to 
section 305. Under paragraph (b)(5) of this section, because the 
distribution of USS1 Note B is described in paragraph (b)(2)(i) of this 
section, the distribution of USS1 Note B is not treated as a 
distribution of property described in paragraph (b)(3)(i)(A) of this 
section. Accordingly, USS1 Note A is not treated as funding the 
distribution of USS1 Note B for purposes of paragraph (b)(3)(i)(A) of 
this section.
    (ii) Example 2. Covered debt instrument issued for expanded group 
stock that is exchanged for stock in a corporation that is not a member 
of the same expanded group--(A) Facts. UST is a publicly traded domestic 
corporation. On Date A in Year 1, USS1 issues USS1 Note to FP in 
exchange for FP stock. Subsequently, on Date B of Year 1, USS1 transfers 
the FP stock to UST's shareholders, which are not members of the FP 
expanded group, in exchange for all of the stock of UST.
    (B) Analysis. (1) Because USS1 and FP are both members of the FP 
expanded group, USS1 Note is treated as stock when it is issued by USS1 
to FP in exchange for FP stock on Date A in Year 1 under paragraphs 
(b)(2)(ii) and (d)(1)(i) of this section. This result applies even 
though, pursuant to the same plan, USS1 transfers the FP stock to 
persons that are not members of the FP expanded group. The exchange of 
USS1 Note for FP stock is not an exempt exchange within the meaning of 
paragraph (g)(11) of this section.
    (2) Because USS1 Note is treated as stock for federal tax purposes 
when it is issued by USS1, pursuant to section

[[Page 781]]

Sec. 1.367(b)-10(a)(3)(ii) (defining property for purposes of Sec. 
1.367(b)-10) there is no potential application of Sec. 1.367(b)-10(a) 
to USS1's acquisition of the FP stock.
    (iii) Example 3. Issuance of a note in exchange for expanded group 
stock--(A) Facts. On Date A in Year 1, USS1 issues USS1 Note to FP in 
exchange for 40% of the FS stock owned by FP.
    (B) Analysis. (1) Because USS1 and FP are both members of the FP 
expanded group, USS1 Note is treated as stock when it is issued by USS1 
to FP in exchange for FS stock on Date A in Year 1 under paragraphs 
(b)(2)(ii) and (d)(1)(i) of this section. The exchange of USS1 Note for 
FS stock is not an exempt exchange within the meaning of paragraph 
(g)(11) of this section.
    (2) Because USS1 Note is treated as stock for federal tax purposes 
when it is issued by USS1, USS1 Note is not treated as property for 
purposes of section 304(a) because it is not property within the meaning 
specified in section 317(a). Therefore, USS1's acquisition of FS stock 
from FP in exchange for USS1 Note is not an acquisition described in 
section 304(a)(1).
    (iv) Example 4. Funding occurs in same taxable year as 
distribution--(A) Facts. On Date A in Year 1, FP lends $200x to DS in 
exchange for DS Note A. On Date B in Year 1, DS distributes $400x of 
cash to USS1 in a distribution.
    (B) Analysis. Under paragraph (b)(3)(iii)(A) of this section, DS 
Note A is treated as funding the distribution by DS to USS1 because DS 
Note A is issued to a member of the FP expanded group during the per se 
period with respect to DS's distribution to USS1. Accordingly, under 
paragraphs (b)(3)(i)(A) and (d)(1)(ii) of this section, DS Note A is 
treated as stock on Date B in Year 1.
    (v) Example 5. Additional funding--(A) Facts. The facts are the same 
as in paragraph (h)(3)(iv)(A) of this section (Example 4), except that, 
in addition, on Date C in Year 2, FP lends an additional $300x to DS in 
exchange for DS Note B.
    (B) Analysis. The analysis is the same as in paragraph (h)(3)(iv)(B) 
of this section (Example 4) with respect to DS Note A. DS Note B is also 
issued to a member of the FP expanded group during the per se period 
with respect to DS's distribution to USS1. Under paragraphs 
(b)(3)(iii)(A) and (b)(6) of this section, DS Note B is treated as 
funding only the remaining portion of DS's distribution to USS1, which 
is $200x. Accordingly, $200x of DS Note B is treated as stock under 
paragraph (b)(3)(i)(A) of this section. Under paragraph (d)(1)(i) of 
this section, $200x of DS Note B is treated as stock when it is issued 
by DS to FP on Date C in Year 2. The remaining $100x of DS Note B 
continues to be treated as indebtedness.
    (vi) Example 6. Funding involving multiple interests--(A) Facts. On 
Date A in Year 1, FP lends $300x to USS1 in exchange for USS1 Note A. On 
Date B in Year 2, USS1 distributes $300x of cash to FP. On Date C in 
Year 3, FP lends another $300x to USS1 in exchange for USS1 Note B.
    (B) Analysis. (1) Under paragraph (b)(3)(iii)(B) of this section, 
USS1 Note A is tested under paragraph (b)(3) of this section before USS1 
Note B is tested. USS1 Note A is issued during the per se period with 
respect to USS1's $300x distribution to FP and, therefore, is treated as 
funding the distribution under paragraph (b)(3)(iii)(A) of this section. 
Beginning on Date B in Year 2, USS1 Note A is treated as stock under 
paragraphs (b)(3)(i)(A) and (d)(1)(ii) of this section.
    (2) Under paragraph (b)(3)(iii)(B) of this section, USS1 Note B is 
tested under paragraph (b)(3) of this section after USS1 Note A is 
tested. Because USS1 Note A is treated as funding the entire $300x 
distribution by USS1 to FP, USS1 Note B will continue to be treated as 
indebtedness. See paragraph (b)(6) of this section.
    (vii) Example 7. Re-testing--(A) Facts. The facts are the same as in 
paragraph (h)(3)(vi)(A) of this section (Example 6), except that on Date 
D in Year 4, FP sells USS1 Note A to Bank.
    (B) Analysis. (1) Under paragraph (d)(2)(i) of this section, USS1 
Note A ceases to be treated as stock when FP sells USS1 Note A to Bank 
on Date D in Year 4. Immediately before FP sells USS1 Note A to Bank, 
USS1 is deemed to issue a debt instrument to FP in exchange for USS1 
Note A in a transaction that is disregarded for purposes of paragraphs 
(b)(2) and (b)(3) of this section.

[[Page 782]]

    (2) Under paragraph (d)(2)(ii) of this section, after USS1 Note A is 
deemed exchanged for a new debt instrument, USS1's other covered debt 
instruments that are not treated as stock as of Date D in Year 4 (USS1 
Note B) are re-tested for purposes of paragraph (b)(3)(iii) of this 
section to determine whether the instruments are treated as funding the 
$300x distribution by USS1 to FP on Date B in Year 2. USS1 Note B was 
issued by USS1 to FP during the per se period. Accordingly, USS1 Note B 
is re-tested under paragraph (b)(3)(iii) of this section. Under 
paragraph (b)(3)(iii) of this section, USS1 Note B is treated as funding 
the distribution on Date C in Year 3 and, accordingly, is treated as 
stock under paragraph (b)(3)(i)(A) of this section. USS1 Note B is 
deemed to be exchanged for stock on Date D in Year 4, the re-testing 
date, under paragraph (d)(1)(iv) of this section. See Sec. 1.385-1(d) 
for rules regarding the treatment of this deemed exchange.
    (viii) Example 8. Distribution of expanded group stock and covered 
debt instrument in a reorganization that qualifies under section 355--
(A) Facts. On Date A in Year 1, FP lends $200x to USS2 in exchange for 
USS2 Note. In a transaction that is treated as independent from the 
transaction on Date A in Year 1, on Date B in Year 2, USS2 transfers a 
portion of its assets to DS2, a newly formed domestic corporation, in 
exchange for all of the stock of DS2 and DS2 Note. Immediately 
afterwards, USS2 distributes all of the DS2 stock and the DS2 Note to FP 
with respect to FP's USS2 stock in a transaction that qualifies under 
section 355. USS2's transfer of a portion of its assets to DS2 qualifies 
as a reorganization described in section 368(a)(1)(D). The DS2 stock has 
a value of $150x and DS2 Note has a value of $50x. The DS2 stock is not 
non-qualified preferred stock as defined in section 351(g)(2). Absent 
the application of this section, DS2 Note would be treated by FP as 
other property within the meaning of section 356.
    (B) Analysis. (1) The contribution and distribution transaction is a 
reorganization described in section 368(a)(1)(D) involving a transfer of 
property by USS2 to DS2 in exchange for DS2 stock and DS2 Note. The 
transfer of property by USS2 to DS2 is a contribution of excluded 
property described in paragraph (c)(3)(ii)(D)(2) of this section and an 
excluded contribution described in paragraph (c)(3)(ii)(E)(2) of this 
section. Accordingly, USS2's contribution of property to DS2 is not a 
qualified contribution described in paragraph (c)(3)(ii)(B) of this 
section.
    (2) DS2 Note is a covered debt instrument that is issued by DS2 to 
USS2, both members of the FP expanded group, in exchange for property of 
USS2 in an asset reorganization (as defined in paragraph (g)(1) of this 
section), and received by FP, another FP expanded group member 
immediately before the reorganization, as other property with respect to 
FP's USS2 stock. Accordingly, the transaction is described in paragraph 
(b)(2)(iii) of this section, and DS2 Note is treated as stock when it is 
issued by DS2 to USS2 on Date B in Year 2 pursuant to paragraphs 
(b)(2)(iii) and (d)(1)(i) of this section.
    (3) Because the issuance of DS2 Note by DS2 in exchange for the 
property of USS2 in an asset reorganization is described in paragraph 
(b)(2)(iii) of this section, the distribution and acquisition of DS2 
Note by USS2 is not treated as a distribution or acquisition described 
in paragraph (b)(3)(i) of this section. Accordingly, USS2 Note is not 
treated as funding the distribution of DS2 Note for purposes of 
paragraph (b)(3)(i) of this section.
    (4) USS2's acquisition of DS2 stock is not an acquisition described 
in paragraph (b)(3)(i)(B) of this section because it is an exempt 
exchange (as defined in paragraph (g)(11) of this section). USS2's 
acquisition of DS2 stock is an exempt exchange because USS2 and DS2 are 
both parties to a reorganization that is an asset reorganization, 
section 1032 applies to DS2, the transferor of the expanded group stock, 
and the DS2 stock is distributed by USS2, the transferee of the expanded 
group stock, pursuant to the plan of reorganization.
    (5) USS2's distribution of $150x of the DS2 stock is a distribution 
of stock that is permitted to be received by FP without recognition of 
gain under section 355(a)(1). Accordingly, USS2's distribution of the 
DS2 stock (other than

[[Page 783]]

the DS2 Note) to FP is an exempt distribution, and is not described in 
paragraph (b)(3)(i)(A) of this section.
    (6) Because USS2 has not made a distribution or acquisition that is 
described in paragraph (b)(3)(i)(A), (B), or (C) of this section, USS2 
Note is not treated as stock.
    (ix) Example 9. Funding a distribution by a successor to funded 
member--(A) Facts. The facts are the same as in Example 8 of this 
paragraph (h)(3), except that on Date C in Year 3, DS2 distributes $200x 
of cash to FP and, subsequently, on Date D in Year 3, USS2 distributes 
$100x of cash to FP.
    (B) Analysis. (1) USS2 is a predecessor of DS2 under paragraph 
(g)(20)(i)(B) of this section and DS2 is a successor to USS2 under 
paragraph (g)(24)(i)(B) of this section because USS2 is the distributing 
corporation and DS2 is the controlled corporation in a distribution to 
which section 355 applies. Accordingly, under paragraph (b)(3)(v) of 
this section, a distribution by DS2 is treated as a distribution by 
USS2. Under paragraphs (b)(3)(iii)(A) and (b)(3)(v)(B) of this section, 
USS2 Note is treated as funding the distribution by DS2 to FP because 
USS2 Note was issued during the per se period with respect to DS2's 
$200x cash distribution, and because both the issuance of USS2 Note and 
the distribution by DS2 occur during the per se period with respect to 
the section 355 distribution. Accordingly, under paragraphs (b)(3)(i)(A) 
and (d)(1)(ii) of this section, USS2 Note is treated as stock beginning 
on Date C in Year 3. See Sec. 1.385-1(d) for rules regarding the 
treatment of this deemed exchange.
    (2) Because the entire amount of USS2 Note is treated as funding 
DS2's $200x distribution to FP, under paragraph (b)(3)(iii)(C) of this 
section, USS2 Note is not treated as funding the subsequent distribution 
by USS2 on Date D in Year 3.
    (x) Example 10. Asset reorganization; section 354 qualified 
property--(A) Facts. On Date A in Year 1, FS lends $100x to USS2 in 
exchange for USS2 Note. On Date B in Year 2, in a transaction that 
qualifies as a reorganization described in section 368(a)(1)(D), USS2 
transfers all of its assets to USS1 in exchange for stock of USS1 and 
the assumption by USS1 of all of the liabilities of USS2, and USS2 
distributes to FP, with respect to FP's USS2 stock, all of the USS1 
stock that USS2 receives. FP does not recognize gain under section 
354(a)(1).
    (B) Analysis. (1) USS1 is a successor to USS2 under paragraph 
(g)(24)(i)(A) of this section. For purposes of paragraph (b)(3) of this 
section, USS2 and, under paragraph (b)(3)(v)(A) of this section, its 
successor, USS1, are funded members with respect to USS2 Note. Although 
USS2, a funded member, distributes property (USS1 stock) to its 
shareholder, FP, pursuant to the reorganization, the distribution of 
USS1 stock is not described in paragraph (b)(3)(i)(A) of this section 
because the stock is distributed in an exempt distribution (as defined 
in paragraph (g)(10) of this section). In addition, neither USS1's 
acquisition of the assets of USS2 nor USS2's acquisition of USS1 stock 
is described in paragraph (b)(3)(i)(C) of this section because FP does 
not receive other property within the meaning of section 356 with 
respect to its stock in USS2.
    (2) USS2's acquisition of USS1 stock is not an acquisition described 
in paragraph (b)(3)(i)(B) of this section because it is an exempt 
exchange (as defined in paragraph (g)(11) of this section). USS2's 
acquisition of USS1 stock is an exempt exchange because USS1 and USS2 
are both parties to an asset reorganization, section 1032 applies to 
USS1, the transferor of the USS1 stock, and the USS1 stock is 
distributed by USS2, the transferee, pursuant to the plan of 
reorganization. Furthermore, USS2's acquisition of its own stock from FS 
is not an acquisition described in paragraph (b)(3)(i)(B) of this 
section because USS2 acquires its stock in exchange for USS1 stock.
    (3) Because neither USS1 nor USS2 has made a distribution or 
acquisition described in paragraph (b)(3)(i)(A), (B), or (C) of this 
section, USS2 Note is not treated as stock under paragraph 
(b)(3)(iii)(A) of this section.
    (xi) Example 11. Distribution of a covered debt instrument and 
issuance of a covered debt instrument with a principal purpose of 
avoiding the purposes of this section--(A) Facts. On Date A in Year 1, 
USS1 issues USS1 Note A, which has a

[[Page 784]]

value of $100x, to FP in a distribution. On Date B in Year 1, with a 
principal purpose of avoiding the purposes of this section, FP sells 
USS1 Note A to Bank for $100x of cash and lends $100x to USS1 in 
exchange for USS1 Note B.
    (B) Analysis. USS1 Note A is a covered debt instrument that is 
issued by USS1 to FP, a member of USS1's expanded group, in a 
distribution. Accordingly, under paragraphs (b)(2)(i) and (d)(1)(i) of 
this section, USS1 Note A is treated as stock when it is issued by USS1 
to FP on Date A in Year 1. Accordingly, USS1 is treated as distributing 
USS1 stock to FP. Because the distribution of USS1 Note A is described 
in paragraph (b)(2)(i) of this section, the distribution of USS1 Note A 
is not described in paragraph (b)(3)(i)(A) of this section under 
paragraph (b)(5) of this section. Under paragraph (d)(2)(i) of this 
section, USS1 Note A ceases to be treated as stock when FP sells USS1 
Note A to Bank on Date B in Year 1. Immediately before FP sells USS1 
Note A to Bank, USS1 is deemed to issue a debt instrument to FP in 
exchange for USS1 Note A in a transaction that is disregarded for 
purposes of paragraphs (b)(2) and (b)(3)(i) of this section. USS1 Note B 
is not treated as stock under paragraph (b)(3)(i)(A) of this section 
because the funded member, USS1, has not made a distribution of 
property. However, because the transactions occurring on Date B of Year 
1 were undertaken with a principal purpose of avoiding the purposes of 
this section, USS1 Note B is treated as stock on Date B of Year 1 under 
paragraph (b)(4) of this section.
    (xii) Example 12: Distribution of a covered debt instrument to a 
controlled partnership--(A) Facts. CFC and FS are equal partners in PRS. 
PRS owns 100% of the stock in X Corp, a domestic corporation. On Date A 
in Year 1, X Corp issues X Note to PRS in a distribution.
    (B) Analysis. (1) Under Sec. 1.385-1(c)(4), in determining whether 
X Corp is a member of the FP expanded group that includes CFC and FS, 
CFC and FS are each treated as owning 50% of the X Corp stock held by 
PRS. Accordingly, 100% of X Corp's stock is treated as owned by CFC and 
FS, and X Corp is a member of the FP expanded group.
    (2) Together CFC and FS own 100% of the interests in PRS capital and 
profits, such that PRS is a controlled partnership under Sec. 1.385-
1(c)(1). CFC and FS are both expanded group partners on the date on 
which PRS acquired X Note. Therefore, pursuant to paragraph (f)(2)(i)(A) 
of this section, each of CFC and FS is treated as acquiring its share of 
X Note in the same manner (in this case, by a distribution of X Note), 
and on the date on which, PRS acquired X Note. Likewise, X Corp is 
treated as issuing to each of CFC and FS its share of X Note. Under 
paragraph (f)(2)(i)(B) of this section, each of CFC's and FS's share of 
X Note, respectively, is determined in accordance with its liquidation 
value percentage determined on Date A in Year 1, the date X Corp 
distributed X Note to PRS. On Date A in Year 1, pursuant to paragraph 
(g)(17) of this section, each of CFC's and FS's liquidation value 
percentages is 50%. Accordingly, on Date A in Year 1, under paragraph 
(f)(2)(i)(A) of this section, for purposes of this section, CFC and FS 
are each treated as acquiring 50% of X Note in a distribution.
    (3) Under paragraphs (b)(2)(i) and (d)(1)(i) of this section, X Note 
is treated as stock on the date of issuance, which is Date A in Year 1. 
Under paragraph (f)(2)(i)(A) of this section, each of CFC and FS are 
treated as acquiring 50% of X Note in a distribution for purposes of 
this section. Therefore, X Corp is treated as distributing its stock to 
PRS in a distribution described in section 305.
    (xiii) Example 13: Loan to a controlled partnership; proportionate 
distributions by expanded group partners--(A) Facts. DS, USS2, and USP 
are partners in PRS. USP is a domestic corporation that is not a member 
of the FP expanded group. Each of DS and USS2 own 45% of the interests 
in PRS profits and capital, and USP owns 10% of the interests in PRS 
profits and capital. The PRS partnership agreement provides that all 
items of PRS income, gain, loss, deduction, and credit are allocated in 
accordance with the percentages in the preceding sentence. On Date A in 
Year 1, FP lends $200x to PRS in exchange for PRS Note with stated 
principal amount of $200x, which is payable at maturity. PRS Note also

[[Page 785]]

provides for annual payments of interest that are qualified stated 
interest. PRS uses all $200x in its business and does not distribute any 
money or other property to a partner. Subsequently, on Date B in Year 1, 
DS distributes $90x to USS1, USS2 distributes $90x to FP, and USP 
distributes $20x to its shareholder. Each of DS's and USS2's issuance 
percentage is 45% on Date B in Year 1, the date of the distributions and 
therefore a testing date under paragraph (f)(3)(ii)(A) of this section.
    (B) Analysis. (1) DS and USS2 together own 90% of the interests in 
PRS profits and capital and therefore PRS is a controlled partnership 
under Sec. 1.385-1(c)(1). Under Sec. 1.385-1(c)(2), each of DS and 
USS2 is a covered member.
    (2) Under paragraph (f)(3)(i) of this section, each of DS and USS2 
is treated as issuing its share of PRS Note, and under paragraph 
(f)(3)(ii)(A) of this section, DS's and USS2's share is each $90x (45% 
of $200x). USP is not an expanded group partner and therefore has no 
issuance percentage and is not treated as issuing any portion of PRS 
Note.
    (3) The $90x distributions made by DS to USS1 and by USS2 to FP are 
described in paragraph (b)(3)(i)(A) of this section. Under paragraph 
(b)(3)(iii)(A) of this section, the portions of PRS Note treated as 
issued by each of DS and USS2 are treated as funding the distribution 
made by DS and USS2 because the distributions occurred within the per se 
period with respect to PRS Note. Under paragraph (b)(3)(i) of this 
section, the portions of PRS Note treated as issued by each of DS and 
USS2 would, absent the application of paragraph (f)(4)(i) of this 
section, be treated as stock of DS and USS2 on Date B in Year 1, the 
date of the distributions. See paragraph (d)(1)(ii) of this section. 
Under paragraph (g)(23) of this section, each of the $90x portions is a 
specified portion.
    (4) Under paragraph (f)(4)(i) of this section, the specified 
portions are not treated as stock under paragraph (b)(3)(i) of this 
section. Instead, FP is deemed to transfer a portion of PRS Note with a 
principal amount equal to $90x (the adjusted issue price of the 
specified portion with respect to DS) to DS in exchange for deemed 
partner stock in DS with a fair market value of $90x. Similarly, FP is 
deemed to transfer a portion of PRS Note with a principal amount equal 
to $90x (the adjusted issue price of the specified portion with respect 
to USS2) to USS2 in exchange for deemed partner stock in USS2 with a 
fair market value of $90x. The principal amount of the retained 
receivable held by FP is $20x ($200x-$90x-$90x).
    (xiv) Example 14: Loan to a controlled partnership; disproportionate 
distributions by expanded group partners--(A) Facts. The facts are the 
same as in paragraph (h)(3)(xiii)(A) of this section (Example 13), 
except that on Date B in Year 1, DS distributes $45x to USS1 and USS2 
distributes $135x to FP.
    (B) Analysis. (1) The analysis is the same as in paragraph 
(h)(3)(xiii)(B)(1) of this section (Example 13).
    (2) The analysis is the same as in paragraph (h)(3)(xiii)(B)(2) of 
this section (Example 13).
    (3) The $45x and $135x distributions made by DS to USS1 and by USS2 
to FP, respectively, are described in paragraph (b)(3)(i)(A) of this 
section. Under paragraph (b)(3)(iii)(A) of this section, the portion of 
PRS Note treated as issued by DS is treated as funding the distribution 
made by DS because the distribution occurred within the per se period 
with respect to PRS Note, but under paragraph (b)(3)(i) of this section, 
only to the extent of DS's $45x distribution. USS2 is treated as issuing 
$90x of PRS Note, all of which is treated as funding $90x of USS2's 
$135x distribution under paragraph (b)(3)(iii)(A) of this section. Under 
paragraph (b)(3)(i) of this section, absent the application of paragraph 
(f)(4)(i) of this section, $45x of PRS Note would be treated as stock of 
DS and $90x of PRS Note would be treated as stock of USS2 on Date B in 
Year 1, the date of the distributions. See paragraph (d)(1)(ii) of this 
section. Under paragraph (g)(23) of this section, $45x of PRS Note is a 
specified portion with respect to DS and $90x of PRS Note is a specified 
portion with respect to USS2.
    (4) Under paragraph (f)(4)(i) of this section, the specified 
portions are not treated as stock under paragraph (b)(3)(i) of this 
section. Instead, FP is deemed to transfer a portion of PRS Note with a 
principal amount equal to

[[Page 786]]

$45x (the adjusted issue price of the specified portion with respect to 
DS) to DS in exchange for stock of DS with a fair market value of $90x. 
Similarly, FP is deemed to transfer a portion of PRS Note with a 
principal amount equal to $90x (the adjusted issue price of the 
specified portion with respect to USS2) to USS2 in exchange for stock of 
USS2 with a fair market value of $90x. The principal amount of the 
retained receivable held by FP is $65x ($200x-$45x-$90x).
    (xv) Example 15: Loan to partnership; distribution in later year--
(A) Facts. The facts are the same as in paragraph (h)(3)(xiii)(A) of 
this section (Example 13), except that USS2 does not distribute $90x to 
FP until Date C in Year 2, which is less than 36 months after Date A in 
Year 1. On Date C in Year 2, DS's, USS2's, and USP's issuance 
percentages under paragraph (g)(16) of this section are unchanged at 
45%, 45%, and 10%, respectively.
    (B) Analysis. (1) The analysis is the same as in paragraph 
(h)(3)(xiii)(B)(1) of this section (Example 13).
    (2) The analysis is the same as in paragraph (h)(3)(xiii)(B)(2) of 
this section (Example 13).
    (3) With respect to the distribution made by DS, the analysis is the 
same as in paragraph (h)(3)(xiii)(B)(3) of this section (Example 13).
    (4) With respect to the deemed transfer to DS, the analysis is the 
same as in paragraph (h)(3)(xiii)(B)(4) of this section (Example 13). 
Accordingly, the amount of the retained receivable held by FP as of Date 
B in Year 1 is $110x ($200x-$90x).
    (5) Under paragraph (f)(3)(ii)(A) of this section, USS2's share of 
PRS Note is determined on Date C in Year 2. On Date C in Year 2, DS's, 
USS2's, and USP's respective shares of PRS Note under paragraph 
(f)(3)(ii)(A) of this section are $90x, $90x, and $20x. However, because 
DS is treated as the issuer with respect to a $90x specified portion of 
PRS Note, DS's share of PRS Note is reduced by $90x to $0 under 
paragraph (f)(3)(ii)(B)(1) of this section. No reduction to either of 
USS2's or USP's share of PRS Note is required under paragraph 
(f)(3)(ii)(B)(2) of this section because the aggregate of DS's, USS2's, 
and USP's shares of PRS Note as reduced is $110x (DS has a $0 share, 
USS2 has a $90x share, and USP has a $20x share), which does not exceed 
$110x (the $200x adjusted issue price of PRS Note reduced by the $90x 
specified portion with respect to DS). Under paragraph (f)(3)(i) of this 
section, USS2 is treated as issuing its share of PRS Note.
    (6) The $90x distribution made by USS2 to FP is described in 
paragraph (b)(3)(i)(A) of this section. Under paragraph (b)(3)(iii)(A) 
of this section, the portion of PRS Note treated as issued by USS2 is 
treated as funding the distribution made by USS2, because the 
distribution occurred within the per se period with respect to PRS Note. 
Accordingly, the portion of PRS Note treated as issued by USS2 would, 
absent the application of paragraph (f)(4)(i) of this section, be 
treated as stock of USS2 under paragraph (b)(3)(i) of this section on 
Date C in Year 2. See paragraph (d)(1)(ii) of this section. Under 
paragraph (g)(23) of this section, the $90x portion is a specified 
portion.
    (7) Under paragraph (f)(4)(i) of this section, the specified portion 
of PRS Note treated as issued by USS2 is not treated as stock under 
paragraph (b)(3)(i) of this section. Instead, on Date C in Year 2, FP is 
deemed to transfer a portion of PRS Note with a principal amount equal 
to $90x (the adjusted issue price of the specified portion with respect 
to USS2) to USS2 in exchange for stock in USS2 with a fair market value 
of $90x. The principal amount of the retained receivable held by FP is 
reduced from $110x to $20x.
    (xvi) Example 16: Loan to a controlled partnership; partnership 
ceases to be a controlled partnership--(A) Facts. The facts are the same 
as in paragraph (h)(3)(xiii)(A) of this section (Example 13), except 
that on Date C in Year 4, USS2 sells its entire interest in PRS to an 
unrelated person.
    (B) Analysis. (1) On date C in Year 4, PRS ceases to be a controlled 
partnership with respect to the FP expanded group under Sec. 1.385-
1(c)(1). This is the case because DS, the only remaining partner that is 
a member of the FP expanded group, only owns 45% of the total interest 
in PRS profits and capital. Because PRS ceases to be a controlled 
partnership, a specified event (within the meaning of paragraph

[[Page 787]]

(f)(5)(iii)(A) of this section) occurs with respect to the deemed 
transfers with respect to each of DS and USS2.
    (2) Under paragraph (f)(5)(i) of this section, on Date C in Year 4, 
immediately before PRS ceases to be a controlled partnership, each of DS 
and USS2 is deemed to distribute its deemed transferred receivable to FP 
in redemption of FP's deemed partner stock in DS and USS2. The specified 
portion that corresponds to each of the deemed transferred receivables 
ceases to be treated as a specified portion. Furthermore, the deemed 
transferred receivables cease to exist, and the retained receivable held 
by FP increases from $20x to $200x.
    (xvii) Example 17: Transfer of an interest in a partnership to a 
covered member--(A) Facts. The facts are the same as in paragraph 
(h)(3)(xiii)(A) of this section (Example 13), except that on Date C in 
Year 4, USS2 sells its entire interest in PRS to USS1.
    (B) Analysis. (1) After USS2 sells its interest in PRS to USS1, DS 
and USS1 together own 90% of the interests in PRS profits and capital 
and therefore PRS continues to be a controlled partnership under Sec. 
1.385-1(c)(1). A specified event (within the meaning of paragraph 
(f)(5)(iii)(E) of this section) occurs as result of the sale only with 
respect to the deemed transfer with respect to USS2.
    (2) Under paragraph (f)(5)(i) of this section, on Date C in Year 4, 
immediately before USS2 sells its entire interest in PRS to USS1, USS2 
is deemed to distribute its deemed transferred receivable to FP in 
redemption of FP's deemed partner stock in USS2. Because the specified 
event is described in paragraph (f)(5)(iii)(E) of this section, under 
paragraph (f)(5)(ii) of this section, FP is deemed to retransfer the 
deemed transferred receivable deemed received from USS2 to USS1 in 
exchange for deemed partner stock in USS1 with a fair market value equal 
to the principal amount of the deemed transferred receivable that is 
retransferred to USS1.
    (xviii) Example 18: Loan to partnership and all partners are members 
of a consolidated group--(A) Facts. USS1 and DS are equal partners in 
PRS. USS1 and DS are members of a consolidated group, as defined in 
Sec. 1.1502-1(h). The PRS partnership agreement provides that all items 
of PRS income, gain, loss, deduction, and credit are allocated equally 
between USS1 and DS. On Date A in Year 1, FP lends $200x to PRS in 
exchange for PRS Note. PRS uses all $200x in its business and does not 
distribute any money or other property to any partner. On Date B in Year 
1, DS distributes $200x to USS1, and USS1 distributes $200x to FP. If 
neither of USS1 or DS were a member of the consolidated group, each 
would have an issuance percentage under paragraph (g)(16) of this 
section, determined as of Date A in Year 1, of 50%.
    (B) Analysis. (1) Pursuant to Sec. 1.385-4(b)(6), PRS is treated as 
a partnership for purposes of this section. Under Sec. 1.385-4(b)(1), 
DS and USS1 are treated as one corporation for purposes of this section, 
and thus a single covered member under Sec. 1.385-1(c)(2). For purposes 
of this section, the single covered member owns 100% of the PRS profits 
and capital and therefore PRS is a controlled partnership under Sec. 
1.385-1(c)(1). Under paragraph (f)(3)(i) of this section, the single 
covered member is treated as issuing all $200x of PRS Note to FP, a 
member of the same expanded group as the single covered member. DS's 
distribution to USS1 is a disregarded distribution because it is a 
distribution between members of a consolidated group that is disregarded 
under the one-corporation rule described in Sec. 1.385-4(b)(1). 
However, under paragraph (b)(3)(iii)(A) of this section, PRS Note, 
treated as issued by the single covered member, is treated as funding 
the distribution by USS1 to FP, which is described in paragraph 
(b)(3)(i)(A) of this section and which is a regarded distribution. 
Accordingly, PRS Note, absent the application of paragraph (f)(4)(i) of 
this section, would be treated as stock under paragraph (b) of this 
section on Date B in Year 1. Thus, pursuant to paragraph (g)(23) of this 
section, the entire PRS Note is a specified portion.
    (2) Under paragraphs (f)(4)(i) and (iii) of this section, the 
specified portion is not treated as stock and, instead, FP is deemed to 
transfer PRS Note with a principal amount equal to $200x to USS1 in 
exchange for stock of USS1

[[Page 788]]

with a fair market value of $200x. Under paragraph (f)(4)(iii) of this 
section, FP is deemed to transfer PRS Note to USS1 because only USS1 
made a regarded distribution described in paragraph (b)(3)(i) of this 
section.
    (xix) Example 19: Loan to a disregarded entity--(A) Facts. DS owns 
DRE, a disregarded entity within the meaning of Sec. 1.385-1(c)(3). On 
Date A in Year 1, FP lends $200x to DRE in exchange for DRE Note. 
Subsequently, on Date B in Year 1, DS distributes $100x of cash to USS1.
    (B) Analysis. Under paragraph (b)(3)(iii)(A) of this section, $100x 
of DRE Note would be treated as funding the distribution by DS to USS1 
because DRE Note is issued to a member of the FP expanded group during 
the per se period with respect to DS's distribution to USS1. 
Accordingly, under paragraphs (b)(3)(i)(A) and (d)(1)(ii) of this 
section, $100x of DRE Note would be treated as stock on Date B in Year 
1. However, under paragraph (d)(4) of this section, DS, as the regarded 
owner, within the meaning of Sec. 1.385-1(c)(5), of DRE is deemed to 
issue its stock to FP in exchange for a portion of DRE Note equal to the 
$100x applicable portion (as defined in paragraph (d)(4) of this 
section). Thus, DS is treated as the holder of $100x of DRE Note, which 
is disregarded, and FP is treated as the holder of the remaining $100x 
of DRE Note. The $100x of stock deemed issued by DS to FP has the same 
terms as DRE Note, other than the issuer, and payments on the stock are 
determined by reference to payments on DRE Note.
    (i) [Reserved]
    (j) Applicability date and transition rules--(1) In general. Except 
as provided in paragraph (j)(2) or (3) or (k) of this section, this 
section applies to taxable years ending on or after January 19, 2017.
    (2) Transition rules--(i) Transition rule for covered debt 
instruments that would be treated as stock in taxable years ending 
before January 19, 2017. If paragraphs (b) and (d)(1) of this section, 
taking into account Sec. Sec. 1.385-1, 1.385-3, and 1.385-4, would have 
treated a covered debt instrument as stock in a taxable year ending 
before January 19, 2017 but for the application of paragraph (j)(1) of 
this section, to the extent that the covered debt instrument is held by 
a member of the expanded group of which the issuer is a member 
immediately after January 19, 2017, then the covered debt instrument is 
deemed to be exchanged for stock immediately after January 19, 2017.
    (ii) Transition rule for certain covered debt instruments treated as 
stock in taxable years ending on or after January 19, 2017. If 
paragraphs (b) and (d)(1) of this section, taking into account 
Sec. Sec. 1.385-1, 1.385-3, and 1.385-4, would treat a covered debt 
instrument as stock on or before January 19, 2017 but in a taxable year 
ending on or after January 19, 2017, that covered debt instrument is not 
treated as stock during the 90-day period after October 21, 2016. 
Instead, to the extent that the covered debt instrument is held by a 
member of the expanded group of which the issuer is a member immediately 
after January 19, 2017, the covered debt instrument is deemed to be 
exchanged for stock immediately after January 19, 2017.
    (iii) Transition funding rule. When a covered debt instrument would 
be recharacterized as stock after April 4, 2016, and on or before 
January 19, 2017 (the transition period), but that covered debt 
instrument is not recharacterized as stock on such date due to the 
application of paragraph (j)(1), (j)(2)(i), or (j)(2)(ii) of this 
section, any payments made with respect to such covered debt instrument 
(other than stated interest), including pursuant to a refinancing, after 
the date that the covered debt instrument would have been 
recharacterized as stock and through the remaining portion of the 
transition period are treated as distributions for purposes of applying 
paragraph (b)(3) of this section for taxable years ending on or after 
January 19, 2017. In addition, to the extent that the holder and the 
issuer of the covered debt instrument cease to be members of the same 
expanded group during the transition period, the distribution or 
acquisition that would have caused the covered debt instrument to be 
treated as stock is available to be treated as funded by other covered 
debt instruments of the issuer for purposes of paragraph (b)(3) of this 
section (to the extent provided in paragraph (b)(3)(iii) of this 
section).

[[Page 789]]

The prior sentence is applied in a manner that is consistent with the 
rules set forth in paragraph (d)(2) of this section.
    (iv) Coordination between the general rule and funding rule. When a 
covered debt instrument would be recharacterized as stock pursuant to 
paragraph (b)(2) of this section after April 4, 2016, and on or before 
January 19, 2017, but that covered debt instrument is not 
recharacterized as stock on such date due to the application of 
paragraph (j)(1), (j)(2)(i), or (j)(2)(ii) of this section, the issuance 
of such covered debt instrument is not treated as a distribution or 
acquisition described in Sec. 1.385-3(b)(3)(i), but only to the extent 
that the covered debt instrument is held by a member of the expanded 
group of which the issuer is a member immediately after January 19, 
2017.
    (v) Option to apply proposed regulations. In lieu of applying 
Sec. Sec. 1.385-1, 1.385-3, and 1.385-4, taxpayers may apply the 
provisions matching Sec. Sec. 1.385-1, 1.385-3, and 1.385-4 from the 
Internal Revenue Bulletin (IRB) 2016-17 (https://www.irs.gov/pub/irs-
irbs/irb16-17.pdf) to all debt instruments issued by a particular issuer 
(and members of its expanded group that are covered members) after April 
4, 2016, and before October 13, 2016, solely for purposes of determining 
whether a debt instrument is treated as stock, provided that those 
sections are consistently applied.
    (3) Paragraph (f)(4)(iii) of this section. Paragraph (f)(4)(iii) of 
this section applies to taxable years for which the U.S. Federal income 
tax return is due, without extensions, after May 14, 2020. For taxable 
years ending on or after January 19, 2017, and for which the U.S. 
Federal income tax return is due, without extensions, on or before May 
14, 2020, see Sec. 1.385-3T(f)(4)(iii), as contained in 26 CFR in part 
1 in effect on April 1, 2019. In the case of a taxable year that ends 
after October 13, 2019, and on or before May 14, 2020, a taxpayer may 
choose to apply paragraph (f)(4)(iii) of this section to the portion of 
the taxable year that occurs after the expiration of Sec. 1.385-3T on 
October 13, 2019, provided that all members of the taxpayer's expanded 
group apply such paragraph.
    (k) Additional transition rules. See transition rules in Sec. 
1.385-3T(k)(2) as contained in 26 CFR in part 1 in effect on April 1, 
2019.

[T.D. 9790, 81 FR 72960, Oct. 21, 2016, as amended by T.D. 9790, 82 FR 
8167, Jan. 24, 2017; T.D. 9880, 84 FR 59302, Nov. 4, 2019; T.D 9897, 85 
FR 28870, May 14, 2020]



Sec. 1.385-4  Treatment of consolidated groups.

    (a) Scope. This section provides rules for applying Sec. 1.385-3 to 
members of consolidated groups. Paragraph (b) of this section sets forth 
rules concerning the extent to which, solely for purposes of applying 
Sec. 1.385-3, members of a consolidated group that file (or that are 
required to file) a consolidated U.S. Federal income tax return are 
treated as one corporation. Paragraph (c) of this section sets forth 
rules concerning the treatment of a debt instrument that ceases to be, 
or becomes, a consolidated group debt instrument. Paragraph (d) of this 
section provides rules for applying the funding rule of Sec. 1.385-
3(b)(3) to members that depart a consolidated group. For definitions 
applicable to this section, see paragraph (e) of this section and 
Sec. Sec. 1.385-1(c) and 1.385-3(g). For examples illustrating the 
application of this section, see paragraph (f) of this section.
    (b) Treatment of consolidated groups--(1) Members treated as one 
corporation. For purposes of this section and Sec. 1.385-3, and except 
as otherwise provided in this section and Sec. 1.385-3, all members of 
a consolidated group (as defined in Sec. 1.1502-1(h)) that file (or 
that are required to file) a consolidated U.S. Federal income tax return 
are treated as one corporation. Thus, for example, when a member of a 
consolidated group issues a covered debt instrument that is not a 
consolidated group debt instrument, the consolidated group generally is 
treated as the issuer of the covered debt instrument for purposes of 
this section and Sec. 1.385-3. Also, for example, when one member of a 
consolidated group issues a covered debt instrument that is not a 
consolidated group debt instrument and therefore is treated as issued by 
the consolidated group, and another member of the consolidated group 
makes a distribution or acquisition described in Sec. 1.385-
3(b)(3)(i)(A) through (C) with an expanded group member that is not a 
member of the

[[Page 790]]

consolidated group, Sec. 1.385-3(b)(3)(i) may treat the covered debt 
instrument as funding the distribution or acquisition made by the 
consolidated group. In addition, except as otherwise provided in this 
section, acquisitions and distributions described in Sec. 1.385-3(b)(2) 
and (b)(3)(i) in which all parties to the transaction are members of the 
same consolidated group both before and after the transaction are 
disregarded for purposes of this section and Sec. 1.385-3.
    (2) One-corporation rule inapplicable to expanded group member 
determination. The one-corporation rule described in paragraph (b)(1) of 
this section does not apply in determining the members of an expanded 
group. Notwithstanding the previous sentence, an expanded group does not 
exist for purposes of this section and Sec. 1.385-3 if it consists only 
of members of a single consolidated group.
    (3) Application of Sec. 1.385-3 to debt instruments issued by 
members of a consolidated group--(i) Debt instrument treated as stock of 
the issuing member of a consolidated group. If a covered debt instrument 
treated as issued by a consolidated group under the one-corporation rule 
described in paragraph (b)(1) of this section is treated as stock under 
Sec. 1.385-3, the covered debt instrument is treated as stock in the 
member of the consolidated group that would be the issuer of such debt 
instrument without regard to this section. But see Sec. 1.385-3(d)(7) 
(providing that a covered debt instrument that is treated as stock under 
Sec. 1.385-3(b)(2), (3), or (4) and that is not described in section 
1504(a)(4) is not treated as stock for purposes of determining whether 
the issuer is a member of an affiliated group (within the meaning of 
section 1504(a)).
    (ii) Application of the covered debt instrument exclusions. For 
purposes of determining whether a debt instrument issued by a member of 
a consolidated group is a covered debt instrument, each test described 
in Sec. 1.385-3(g)(3) is applied on a separate member basis without 
regard to the one-corporation rule described in paragraph (b)(1) of this 
section.
    (iii) Qualified short-term debt instrument. The determination of 
whether a member of a consolidated group has issued a qualified short-
term debt instrument for purposes of Sec. 1.385-3(b)(3)(vii) is made on 
a separate member basis without regard to the one-corporation rule 
described in paragraph (b)(1) of this section.
    (4) Application of the reductions of Sec. 1.385-3(c)(3) to members 
of a consolidated group--(i) Application of the reduction for expanded 
group earnings--(A) In general. A consolidated group maintains one 
expanded group earnings account with respect to an expanded group 
period, and only the earnings and profits, determined in accordance with 
Sec. 1.1502-33 (without regard to the application of Sec. 1.1502-
33(b)(2), (e), and (f)), of the common parent (within the meaning of 
section 1504) of the consolidated group are considered in calculating 
the expanded group earnings for the expanded group period of the 
consolidated group. Accordingly, a regarded distribution or acquisition 
made by a member of a consolidated group is reduced to the extent of the 
expanded group earnings account of the consolidated group.
    (B) Effect of certain corporate transactions on the calculation of 
expanded group earnings--(1) Consolidation. A consolidated group 
succeeds to the expanded group earnings account of a joining member 
under the principles of Sec. 1.385-3(c)(3)(i)(F)(2)(ii).
    (2) Deconsolidation--(i) In general. Except as otherwise provided in 
paragraph (b)(4)(i)(B)(2)(ii) of this section, no amount of the expanded 
group earnings account of a consolidated group for an expanded group 
period, if any, is allocated to a departing member. Accordingly, 
immediately after leaving the consolidated group, the departing member 
has no expanded group earnings account with respect to its expanded 
group period.
    (ii) Allocation of expanded group earnings to a departing member in 
a distribution described in section 355. If a departing member leaves 
the consolidated group by reason of an exchange or distribution to which 
section 355 (or so much of section 356 that relates to section 355) 
applies, the expanded group earnings account of the consolidated group 
is allocated between the consolidated group and the departing member

[[Page 791]]

in proportion to the earnings and profits of the consolidated group and 
the earnings and profits of the departing member immediately after the 
transaction.
    (ii) Application of the reduction for qualified contributions--(A) 
In general. For purposes of applying Sec. 1.385-3(c)(3)(ii)(A) to a 
consolidated group--
    (1) A qualified contribution to any member of a consolidated group 
that remains a member of the consolidated group immediately after the 
qualified contribution from a person other than a member of the same 
consolidated group is treated as made to the one corporation described 
in paragraph (b)(1) of this section;
    (2) A qualified contribution that causes a member of a consolidated 
group to become a departing member of that consolidated group is treated 
as made to the departing member and not to the consolidated group of 
which the departing member was a member immediately prior to the 
qualified contribution; and
    (3) No contribution of property by a member of a consolidated group 
to any other member of the consolidated group is a qualified 
contribution.
    (B) Effect of certain corporate transactions on the calculation of 
qualified contributions--(1) Consolidation. A consolidated group 
succeeds to the qualified contributions of a joining member under the 
principles of Sec. 1.385-3(c)(3)(ii)(F)(2)(ii).
    (2) Deconsolidation--(i) In general. Except as otherwise provided in 
paragraph (b)(4)(ii)(B)(2)(ii) of this section, no amount of the 
qualified contributions of a consolidated group for an expanded group 
period, if any, is allocated to a departing member. Accordingly, 
immediately after leaving the consolidated group, the departing member 
has no qualified contributions with respect to its expanded group 
period.
    (ii) Allocation of qualified contributions to a departing member in 
a distribution described in section 355. If a departing member leaves 
the consolidated group by reason of an exchange or distribution to which 
section 355 (or so much of section 356 that relates to section 355) 
applies, each qualified contribution of the consolidated group is 
allocated between the consolidated group and the departing member in 
proportion to the earnings and profits of the consolidated group and the 
earnings and profits of the departing member immediately after the 
transaction.
    (5) Order of operations. For purposes of this section and Sec. 
1.385-3, the consequences of a transaction involving one or more members 
of a consolidated group are determined as provided in paragraphs 
(b)(5)(i) and (ii) of this section.
    (i) First, determine the characterization of the transaction under 
Federal tax law without regard to the one-corporation rule described in 
paragraph (b)(1) of this section.
    (ii) Second, apply this section and Sec. 1.385-3 to the transaction 
as characterized to determine whether to treat a debt instrument as 
stock, treating the consolidated group as one corporation under 
paragraph (b)(1) of this section, unless otherwise provided.
    (6) Partnership owned by a consolidated group. For purposes of this 
section and Sec. 1.385-3, and notwithstanding the one-corporation rule 
described in paragraph (b)(1) of this section, a partnership that is 
wholly owned by members of a consolidated group is treated as a 
partnership. Thus, for example, if members of a consolidated group own 
all of the interests in a controlled partnership that issues a debt 
instrument to a member of the consolidated group, such debt instrument 
would be treated as a consolidated group debt instrument because, under 
Sec. 1.385-3(f)(3)(i), for purposes of this section and Sec. 1.385-3, 
a consolidated group member that is an expanded group partner is treated 
as the issuer with respect to its share of the debt instrument issued by 
the partnership.
    (7) Predecessor and successor--(i) In general. Pursuant to paragraph 
(b)(5) of this section, the determination as to whether a member of an 
expanded group is a predecessor or successor of another member of the 
consolidated group is made without regard to paragraph (b)(1) of this 
section. For purposes of Sec. 1.385-3(b)(3), if a consolidated group 
member is a predecessor or successor of a member of the same expanded 
group that is not a member of

[[Page 792]]

the same consolidated group, the consolidated group is treated as a 
predecessor or successor of the expanded group member (or the 
consolidated group of which that expanded group member is a member). 
Thus, for example, a departing member that departs a consolidated group 
in a distribution or exchange to which section 355 applies is a 
successor to the consolidated group and the consolidated group is a 
predecessor of the departing member.
    (ii) Joining members. For purposes of Sec. 1.385-3(b)(3), the term 
predecessor also means, with respect to a consolidated group, a joining 
member and the term successor also means, with respect to a joining 
member, a consolidated group.
    (c) Consolidated group debt instruments--(1) Debt instrument ceases 
to be a consolidated group debt instrument but continues to be issued 
and held by expanded group members--(i) Consolidated group member leaves 
the consolidated group. For purposes of this section and Sec. 1.385-3, 
when a debt instrument ceases to be a consolidated group debt instrument 
as a result of a transaction in which the member of the consolidated 
group that issued the instrument (the issuer) or the member of the 
consolidated group holding the instrument (the holder) ceases to be a 
member of the same consolidated group but both the issuer and the holder 
continue to be members of the same expanded group, the issuer is treated 
as issuing a new debt instrument to the holder in exchange for property 
immediately after the debt instrument ceases to be a consolidated group 
debt instrument. To the extent the newly-issued debt instrument is a 
covered debt instrument that is treated as stock under Sec. 1.385-
3(b)(3), the covered debt instrument is then immediately deemed to be 
exchanged for stock of the issuer. For rules regarding the treatment of 
the deemed exchange, see Sec. 1.385-1(d). For examples illustrating the 
rule in this paragraph (c)(1)(i), see paragraphs (f)(3)(iv) and (v) of 
this section (Examples 4 and 5).
    (ii) Consolidated group debt instrument that is transferred outside 
of the consolidated group. For purposes of this section and Sec. 1.385-
3, when a member of a consolidated group that holds a consolidated group 
debt instrument transfers the debt instrument to an expanded group 
member that is not a member of the same consolidated group (transferee 
expanded group member), the debt instrument is treated as issued by the 
consolidated group to the transferee expanded group member immediately 
after the debt instrument ceases to be a consolidated group debt 
instrument. Thus, for example, for purposes of this section and Sec. 
1.385-3, the sale of a consolidated group debt instrument to a 
transferee expanded group member is treated as an issuance of the debt 
instrument by the consolidated group to the transferee expanded group 
member in exchange for property. To the extent the newly-issued debt 
instrument is a covered debt instrument that is treated as stock upon 
being transferred, the covered debt instrument is deemed to be exchanged 
for stock of the member of the consolidated group treated as the issuer 
of the debt instrument (determined under paragraph (b)(3)(i) of this 
section) immediately after the covered debt instrument is transferred 
outside of the consolidated group. For rules regarding the treatment of 
the deemed exchange, see Sec. 1.385-1(d). For examples illustrating the 
rule in this paragraph (c)(1)(ii), see paragraphs (f)(3)(ii) and (iii) 
of this section (Examples 2 and 3).
    (iii) Overlap transactions. If a debt instrument ceases to be a 
consolidated group debt instrument in a transaction to which both 
paragraphs (c)(1)(i) and (ii) of this section apply, then only the rules 
of paragraph (c)(1)(ii) of this section apply with respect to such debt 
instrument.
    (iv) Subgroup exception. A debt instrument is not treated as ceasing 
to be a consolidated group debt instrument for purposes of paragraphs 
(c)(1)(i) and (ii) of this section if both the issuer and the holder of 
the debt instrument are members of the same consolidated group 
immediately after the transaction described in paragraph (c)(1)(i) or 
(ii) of this section.
    (2) Covered debt instrument treated as stock becomes a consolidated 
group debt instrument. When a covered debt instrument that is treated as 
stock under Sec. 1.385-3 becomes a consolidated group debt instrument, 
then immediately

[[Page 793]]

after the covered debt instrument becomes a consolidated group debt 
instrument, the issuer is deemed to issue a new covered debt instrument 
to the holder in exchange for the covered debt instrument that was 
treated as stock. In addition, in a manner consistent with Sec. 1.385-
3(d)(2)(ii)(A), when the covered debt instrument that previously was 
treated as stock becomes a consolidated group debt instrument, other 
covered debt instruments issued by the issuer of that instrument 
(including a consolidated group that includes the issuer) that are not 
treated as stock when the instrument becomes a consolidated group debt 
instrument are re-tested to determine whether those other covered debt 
instruments are treated as funding the regarded distribution or 
acquisition that previously was treated as funded by the instrument 
(unless such distribution or acquisition is disregarded under paragraph 
(b)(1) of this section). Further, also in a manner consistent with Sec. 
1.385-3(d)(2)(ii)(A), a covered debt instrument that is issued by the 
issuer (including a consolidated group that includes the issuer) after 
the application of this paragraph (c)(2) and within the per se period 
may also be treated as funding that regarded distribution or 
acquisition.
    (3) No interaction with the intercompany obligation rules of Sec. 
1.1502-13(g). The rules of this section do not affect the application of 
the rules of Sec. 1.1502-13(g). Thus, any deemed satisfaction and 
reissuance of a debt instrument under Sec. 1.1502-13(g) and any deemed 
issuance and deemed exchange of a debt instrument under this paragraph 
(c) that arise as part of the same transaction or series of transactions 
are not integrated. Rather, each deemed satisfaction and reissuance 
under the rules of Sec. 1.1502-13(g), and each deemed issuance and 
exchange under the rules of this section, are respected as separate 
steps and treated as separate transactions.
    (d) Application of the funding rule of Sec. 1.385-3(b)(3) to 
members departing a consolidated group. This paragraph (d) provides 
rules for applying the funding rule of Sec. 1.385-3(b)(3) when a 
departing member ceases to be a member of a consolidated group, but only 
if the departing member and the consolidated group are members of the 
same expanded group immediately after the deconsolidation.
    (1) Continued application of the one-corporation rule. A disregarded 
distribution or acquisition by any member of the consolidated group 
continues to be disregarded when the departing member ceases to be a 
member of the consolidated group.
    (2) Continued recharacterization of a departing member's covered 
debt instrument as stock. A covered debt instrument of a departing 
member that is treated as stock of the departing member under Sec. 
1.385-3(b) continues to be treated as stock when the departing member 
ceases to be a member of the consolidated group.
    (3) Effect of issuances of covered debt instruments that are not 
consolidated group debt instruments on the departing member and the 
consolidated group. If a departing member has issued a covered debt 
instrument (determined without regard to the one-corporation rule 
described in paragraph (b)(1) of this section) that is not a 
consolidated group debt instrument and that is not treated as stock 
immediately before the departing member ceases to be a consolidated 
group member, then the departing member (and not the consolidated group) 
is treated as issuing the covered debt instrument on the date and in the 
manner the covered debt instrument was issued. If the departing member 
is not treated as the issuer of a covered debt instrument pursuant to 
the preceding sentence, then the consolidated group continues to be 
treated as issuing the covered debt instrument on the date and in the 
manner the covered debt instrument was issued.
    (4) Treatment of prior regarded distributions or acquisitions. This 
paragraph (d)(4) applies when a departing member ceases to be a 
consolidated group member in a transaction other than a distribution to 
which section 355 (or so much of section 356 as relates to section 355) 
applies, and the consolidated group has made a regarded distribution or 
acquisition. In this case, to the extent the distribution or acquisition 
has not caused a covered debt instrument of the consolidated group to be 
treated as stock under Sec. 1.385-3(b) on or before

[[Page 794]]

the date the departing member leaves the consolidated group, then--
    (i) If the departing member made the regarded distribution or 
acquisition (determined without regard to the one-corporation rule 
described in paragraph (b)(1) of this section), the departing member 
(and not the consolidated group) is treated as having made the regarded 
distribution or acquisition.
    (ii) If the departing member did not make the regarded distribution 
or acquisition (determined without regard to the one-corporation rule 
described in paragraph (b)(1) of this section), then the consolidated 
group (and not the departing member) continues to be treated as having 
made the regarded distribution or acquisition.
    (e) Definitions. The definitions in this paragraph (e) apply for 
purposes of this section.
    (1) Consolidated group debt instrument. The term consolidated group 
debt instrument means a covered debt instrument issued by a member of a 
consolidated group and held by a member of the same consolidated group.
    (2) Departing member. The term departing member means a member of an 
expanded group that ceases to be a member of a consolidated group but 
continues to be a member of the same expanded group. In the case of 
multiple members leaving a consolidated group as a result of a single 
transaction that continue to be members of the same expanded group, if 
such members are treated as one corporation under paragraph (b)(1) of 
this section immediately after the transaction, that one corporation is 
a departing member with respect to the consolidated group.
    (3) Disregarded distribution or acquisition. The term disregarded 
distribution or acquisition means a distribution or acquisition 
described in Sec. 1.385-3(b)(2) or (b)(3)(i) between members of a 
consolidated group that is disregarded under the one-corporation rule 
described in paragraph (b)(1) of this section.
    (4) Joining member. The term joining member means a member of an 
expanded group that becomes a member of a consolidated group and 
continues to be a member of the same expanded group. In the case of 
multiple members joining a consolidated group as a result of a single 
transaction that continue to be members of the same expanded group, if 
such members were treated as one corporation under paragraph (b)(1) of 
this section immediately before the transaction, that one corporation is 
a joining member with respect to the consolidated group.
    (5) Regarded distribution or acquisition. The term regarded 
distribution or acquisition means a distribution or acquisition 
described in Sec. 1.385-3(b)(2) or (b)(3)(i) that is not disregarded 
under the one-corporation rule described in paragraph (b)(1) of this 
section.
    (f) Examples--(1) Assumed facts. Except as otherwise stated, the 
following facts are assumed for purposes of the examples in paragraph 
(f)(3) of this section:
    (i) FP is a foreign corporation that owns 100% of the stock of USS1, 
a covered member, and 100% of the stock of FS, a foreign corporation;
    (ii) USS1 owns 100% of the stock of DS1 and DS3, both covered 
members;
    (iii) DS1 owns 100% of the stock of DS2, a covered member;
    (iv) FS owns 100% of the stock of UST, a covered member;
    (v) At the beginning of Year 1, FP is the common parent of an 
expanded group comprised solely of FP, USS1, FS, DS1, DS2, DS3, and UST 
(the FP expanded group);
    (vi) USS1, DS1, DS2, and DS3 are members of a consolidated group of 
which USS1 is the common parent (the USS1 consolidated group);
    (vii) The FP expanded group has outstanding more than $50 million of 
debt instruments described in Sec. 1.385-3(c)(4) at all times;
    (viii) No issuer of a covered debt instrument has a positive 
expanded group earnings account, within the meaning of Sec. 1.385-
3(c)(3)(i)(B), or has received a qualified contribution, within the 
meaning of Sec. 1.385-3(c)(3)(ii)(B);
    (ix) All notes are covered debt instruments, within the meaning of 
Sec. 1.385-3(g)(3), and are not qualified short-term debt instruments, 
within the meaning of Sec. 1.385-3(b)(3)(vii);
    (x) All notes between members of a consolidated group are 
intercompany obligations within the meaning of Sec. 1.1502-
13(g)(2)(ii);
    (xi) Each entity has as its taxable year the calendar year;

[[Page 795]]

    (xii) No domestic corporation is a United States real property 
holding corporation within the meaning of section 897(c)(2);
    (xiii) Each note is issued with adequate stated interest (as defined 
in section 1274(c)(2)); and
    (xiv) Each transaction occurs after January 19, 2017.
    (2) No inference. Except as otherwise provided in this section, it 
is assumed for purposes of the examples in paragraph (f)(3) of this 
section that the form of each transaction is respected for Federal tax 
purposes. No inference is intended, however, as to whether any 
particular note would be respected as indebtedness or as to whether the 
form of any particular transaction described in an example in paragraph 
(f)(3) of this section would be respected for Federal tax purposes.
    (3) Examples. The following examples illustrate the rules of this 
section.
    (i) Example 1: Order of operations--(A) Facts. On Date A in Year 1, 
UST issues UST Note to USS1 in exchange for DS3 stock representing less 
than 20% of the value and voting power of DS3.
    (B) Analysis. UST is acquiring the stock of DS3, the non-common 
parent member of a consolidated group. Pursuant to paragraph (b)(5)(i) 
of this section, the transaction is first analyzed without regard to the 
one-corporation rule described in paragraph (b)(1) of this section, and 
therefore UST is treated as issuing a covered debt instrument in 
exchange for expanded group stock. The exchange of UST Note for DS3 
stock is not an exempt exchange within the meaning of Sec. 1.385-
3(g)(11) because UST and USS1 are not parties to an asset 
reorganization. Pursuant to paragraph (b)(5)(ii) of this section, Sec. 
1.385-3 (including Sec. 1.385-3(b)(2)(ii)) is then applied to the 
transaction, thereby treating UST Note as stock for Federal tax purposes 
when it is issued by UST to USS1. The UST Note is not treated as 
property for purposes of section 304(a) because it is not property 
within the meaning specified in section 317(a). Therefore, UST's 
acquisition of DS3 stock from USS1 in exchange for UST Note is not an 
acquisition described in section 304(a)(1).
    (ii) Example 2: Distribution of consolidated group debt instrument--
(A) Facts. On Date A in Year 1, DS1 issues DS1 Note to USS1 in a 
distribution. On Date B in Year 2, USS1 distributes DS1 Note to FP.
    (B) Analysis. Under paragraph (b)(1) of this section, the USS1 
consolidated group is treated as one corporation for purposes of Sec. 
1.385-3. Accordingly, when DS1 issues DS1 Note to USS1 in a distribution 
on Date A in Year 1, DS1 is not treated as issuing a debt instrument to 
another member of DS1's expanded group in a distribution for purposes of 
Sec. 1.385-3(b)(2), and DS1 Note is not treated as stock under Sec. 
1.385-3. When USS1 distributes DS1 Note to FP, DS1 Note is deemed 
satisfied and reissued under Sec. 1.1502-13(g)(3)(ii), immediately 
before DS1 Note ceases to be an intercompany obligation. Under paragraph 
(c)(1)(ii) of this section, when USS1 distributes DS1 Note to FP, the 
USS1 consolidated group is treated as issuing DS1 Note to FP in a 
distribution on Date B in Year 2. Accordingly, DS1 Note is treated as 
stock under Sec. 1.385-3(b)(2)(i). Under paragraph (c)(1)(ii) of this 
section, DS1 Note is deemed to be exchanged for stock of the issuing 
member, DS1, immediately after DS1 Note is transferred outside of the 
USS1 consolidated group. Under paragraph (c)(3) of this section, the 
deemed satisfaction and reissuance under Sec. 1.1502-13(g)(3)(ii) and 
the deemed issuance and exchange under paragraph (c)(1)(ii) of this 
section, are respected as separate steps and treated as separate 
transactions.
    (iii) Example 3: Sale of consolidated group debt instrument--(A) 
Facts. On Date A in Year 1, DS1 lends $200x of cash to USS1 in exchange 
for USS1 Note. On Date B in Year 2, USS1 distributes $200x of cash to 
FP. Subsequently, on Date C in Year 2, DS1 sells USS1 Note to FS for 
$200x.
    (B) Analysis. Under paragraph (b)(1) of this section, the USS1 
consolidated group is treated as one corporation for purposes of Sec. 
1.385-3. Accordingly, when USS1 issues USS1 Note to DS1 for property on 
Date A in Year 1, the USS1 consolidated group is not treated as a funded 
member, and when USS1 distributes $200x to FP on Date B in Year 2, that 
distribution is a transaction described in Sec. 1.385-3(b)(3)(i)(A), 
but does

[[Page 796]]

not cause USS1 Note to be recharacterized under Sec. 1.385-3(b)(3). 
When DS1 sells USS1 Note to FS, USS1 Note is deemed satisfied and 
reissued under Sec. 1.1502-13(g)(3)(ii), immediately before USS1 Note 
ceases to be an intercompany obligation. Under paragraph (c)(1)(ii) of 
this section, when the USS1 Note is transferred to FS for $200x on Date 
C in Year 2, the USS1 consolidated group is treated as issuing USS1 Note 
to FS in exchange for $200x on that date. Because USS1 Note is issued by 
the USS1 consolidated group to FS within the per se period as defined in 
Sec. 1.385-3(g)(19) with respect to the distribution by the USS1 
consolidated group to FP, USS1 Note is treated as funding the 
distribution under Sec. 1.385-3(b)(3)(iii)(A) and, accordingly, is 
treated as stock under Sec. 1.385-3(b)(3). Under Sec. 1.385-3(d)(1)(i) 
and paragraph (c)(1)(ii) of this section, USS1 Note is deemed to be 
exchanged for stock of the issuing member, USS1, immediately after USS1 
Note is transferred outside of the USS1 consolidated group. Under 
paragraph (c)(3) of this section, the deemed satisfaction and reissuance 
under Sec. 1.1502-13(g)(3)(ii) and the deemed issuance and exchange 
under paragraph (c)(1)(ii) of this section are respected as separate 
steps and treated as separate transactions.
    (iv) Example 4: Treatment of consolidated group debt instrument and 
departing member's regarded distribution or acquisition when the issuer 
of the instrument leaves the consolidated group--(A) Facts. The facts 
are the same as provided in paragraph (f)(1) of this section, except 
that USS1 and FS own 90% and 10% of the stock of DS1, respectively. On 
Date A in Year 1, DS1 distributes $80x of cash and newly-issued DS1 
Note, which has a value of $10x, to USS1. Also on Date A in Year 1, DS1 
distributes $10x of cash to FS. On Date B in Year 2, FS purchases all of 
USS1's stock in DS1 (90% of the stock of DS1), resulting in DS1 ceasing 
to be a member of the USS1 consolidated group.
    (B) Analysis. Under paragraph (b)(1) of this section, the USS1 
consolidated group is treated as one corporation for purposes of Sec. 
1.385-3. Accordingly, DS1's distribution of $80x of cash to USS1 on Date 
A in Year 1 is a disregarded distribution or acquisition, and under 
paragraph (d)(1) of this section, continues to be a disregarded 
distribution or acquisition when DS1 ceases to be a member of the USS1 
consolidated group. In addition, when DS1 issues DS1 Note to USS1 in a 
distribution on Date A in Year 1, DS1 is not treated as issuing a debt 
instrument to a member of DS1's expanded group in a distribution for 
purposes of Sec. 1.385-3(b)(2)(i), and DS1 Note is not treated as stock 
under Sec. 1.385-3(b)(2)(i). DS1's issuance of DS1 Note to USS1 is also 
a disregarded distribution or acquisition, and under paragraph (d)(1) of 
this section, continues to be a disregarded distribution or acquisition 
when DS1 ceases to be a member of the USS1 consolidated group. The 
distribution of $10x cash by DS1 to FS on Date A in Year 1 is a regarded 
distribution or acquisition. When FS purchases 90% of the stock of DS1's 
from USS1 on Date B in Year 2 and DS1 ceases to be a member of the USS1 
consolidated group, DS1 Note is deemed satisfied and reissued under 
Sec. 1.1502-13(g)(3)(ii), immediately before DS1 Note ceases to be an 
intercompany obligation. Under paragraph (c)(1)(i) of this section, for 
purposes of Sec. 1.385-3, DS1 is treated as issuing a new debt 
instrument to USS1 in exchange for property immediately after DS1 Note 
ceases to be a consolidated group debt instrument. Under paragraph 
(d)(4)(i) of this section, the departing member, DS1 (and not the USS1 
consolidated group) is treated as having distributed $10x to FS on Date 
A in Year 1 (a regarded distribution or acquisition) for purposes of 
applying Sec. 1.385-3(b)(3) after DS1 ceases to be a member of the USS1 
consolidated group. Because DS1 Note is reissued by DS1 to USS1 within 
the per se period (as defined in Sec. 1.385-3(g)(19)) with respect to 
DS1's regarded distribution to FS, DS1 Note is treated as funding the 
distribution under Sec. 1.385-3(b)(3)(iii)(A) and, accordingly, is 
treated as stock under Sec. 1.385-3(b)(3). Under Sec. 1.385-3(d)(1)(i) 
and paragraph (c)(1)(i) of this section, DS1 Note is immediately deemed 
to be exchanged for stock of DS1 on Date B in Year 2. Under paragraph 
(c)(3) of this section, the deemed satisfaction and reissuance under 
Sec. 1.1502-13(g)(3)(ii) and the deemed issuance and exchange under 
paragraph (c)(1)(i) of this section are

[[Page 797]]

respected as separate steps and treated as separate transactions. Under 
Sec. 1.385-3(d)(7)(i), after DS1 Note is treated as stock held by USS1, 
DS1 Note is not treated as stock for purposes of determining whether DS1 
is a member of the USS1 consolidated group.
    (v) Example 5: Treatment of consolidated group debt instrument and 
consolidated group's regarded distribution or acquisition--(A) Facts. On 
Date A in Year 1, DS1 issues DS1 Note to USS1. On Date B in Year 2, USS1 
distributes $100x of cash to FP. On Date C in Year 3, USS1 sells all of 
its interest in DS1 to FS, resulting in DS1 ceasing to be a member of 
the USS1 consolidated group.
    (B) Analysis. Under paragraph (b)(1) of this section, the USS1 
consolidated group is treated as one corporation for purposes of Sec. 
1.385-3. Accordingly, when DS1 issues DS1 Note to USS1 in a distribution 
on Date A in Year 1, DS1 is not treated as issuing a debt instrument to 
a member of DS1's expanded group in a distribution for purposes of Sec. 
1.385-3(b)(2)(i), and DS1 Note is not treated as stock under Sec. 
1.385-3(b)(2)(i). DS1's issuance of DS1 Note to USS1 is also a 
disregarded distribution or acquisition, and under paragraph (d)(1) of 
this section, continues to be a disregarded distribution or acquisition 
when DS1 ceases to be a member of the USS1 consolidated group. The 
distribution of $100x cash by DS1 to USS1 on Date B in Year 2 is a 
regarded distribution or acquisition. When FS purchases all of the stock 
of DS1 from USS1 on Date C in Year 3 and DS1 ceases to be a member of 
the USS1 consolidated group, DS1 Note is deemed satisfied and reissued 
under Sec. 1.1502-13(g)(3)(ii), immediately before DS1 Note ceases to 
be an intercompany obligation. Under paragraph (c)(1)(i) of this 
section, for purposes of Sec. 1.385-3, DS1 is treated as issuing a new 
debt instrument to USS1 in exchange for property immediately after DS1 
Note ceases to be a consolidated group debt instrument. Under paragraph 
(d)(4)(ii) of this section, the USS1 consolidated group (and not DS1) is 
treated as having distributed $100x to FP on Date B in Year 2 (a 
regarded distribution or acquisition) for purposes of applying Sec. 
1.385-3(b)(3) after DS1 ceases to be a member of the USS1 consolidated 
group. Because DS1 has not engaged in a regarded distribution or 
acquisition that would have been treated as funded by the reissued DS1 
Note, the reissued DS1 Note is not treated as stock.
    (vi) Example 6: Treatment of departing member's issuance of a 
covered debt instrument--(A) Facts. On Date A in Year 1, FS lends $100x 
of cash to DS1 in exchange for DS1 Note. On Date B in Year 2, USS1 
distributes $30x of cash to FP. On Date C in Year 2, USS1 sells all of 
its DS1 stock to FP, resulting in DS1 ceasing to be a member of the USS1 
consolidated group.
    (B) Analysis. Under paragraph (b)(1) of this section, the USS1 
consolidated group is treated as one corporation for purposes of Sec. 
1.385-3. Accordingly, on Date A in Year 1, the USS1 consolidated group 
is treated as issuing DS1 Note to FS, and on Date B in Year 2, the USS1 
consolidated group is treated as distributing $30x of cash to FP. 
Because DS1 Note is issued by the USS1 consolidated group to FS within 
the per se period as defined in Sec. 1.385-3(g)(19) with respect to the 
distribution by the USS1consoldiated group of $30x cash to FP, $30x of 
DS1 Note is treated as funding the distribution under Sec. 1.385-
3(b)(3)(iii)(A), and, accordingly, is treated as stock on Date B in Year 
2 under Sec. 1.385-3(b)(3) and Sec. 1.385-3(d)(1)(ii). Under paragraph 
(d)(3) of this section, DS1 (and not the USS1 consolidated group) is 
treated as the issuer of the remaining portion of DS1 Note for purposes 
of applying Sec. 1.385-3(b)(3) after DS1 ceases to be a member of the 
USS1 consolidated group.
    (g) Applicability date. This section applies to taxable years for 
which the U.S. Federal income tax return is due, without extensions, 
after May 14, 2020. For taxable years ending on or after January 19, 
2017, and for which the U.S. Federal income tax return is due, without 
extensions, on or before May 14, 2020, see Sec. 1.385-4T, as contained 
in 26 CFR in part 1 in effect on April 1, 2019. In the case of a taxable 
year that ends after October 13, 2019, and on or before May 14, 2020, a 
taxpayer may choose to apply this section to the portion of the taxable 
year that occurs after the expiration of Sec. 1.385-4T on October 13, 
2019,

[[Page 798]]

provided that all members of the taxpayer's expanded group apply this 
section in its entirety.

[T.D 9897, 85 FR 28878, May 14, 2020]



Sec. Sec. 1.386-1.400  [Reserved]

[[Page 799]]



                              FINDING AIDS




  --------------------------------------------------------------------

  A list of CFR titles, subtitles, chapters, subchapters and parts and 
an alphabetical list of agencies publishing in the CFR are included in 
the CFR Index and Finding Aids volume to the Code of Federal Regulations 
which is published separately and revised annually.


  Table of CFR Titles and Chapters
  Alphabetical List of Agencies Appearing in the CFR
  Table of OMB Control Numbers
  List of CFR Sections Affected

[[Page 801]]



                    Table of CFR Titles and Chapters




                      (Revised as of April 1, 2021)

                      Title 1--General Provisions

         I  Administrative Committee of the Federal Register 
                (Parts 1--49)
        II  Office of the Federal Register (Parts 50--299)
       III  Administrative Conference of the United States (Parts 
                300--399)
        IV  Miscellaneous Agencies (Parts 400--599)
        VI  National Capital Planning Commission (Parts 600--699)

                    Title 2--Grants and Agreements

            Subtitle A--Office of Management and Budget Guidance 
                for Grants and Agreements
         I  Office of Management and Budget Governmentwide 
                Guidance for Grants and Agreements (Parts 2--199)
        II  Office of Management and Budget Guidance (Parts 200--
                299)
            Subtitle B--Federal Agency Regulations for Grants and 
                Agreements
       III  Department of Health and Human Services (Parts 300--
                399)
        IV  Department of Agriculture (Parts 400--499)
        VI  Department of State (Parts 600--699)
       VII  Agency for International Development (Parts 700--799)
      VIII  Department of Veterans Affairs (Parts 800--899)
        IX  Department of Energy (Parts 900--999)
         X  Department of the Treasury (Parts 1000--1099)
        XI  Department of Defense (Parts 1100--1199)
       XII  Department of Transportation (Parts 1200--1299)
      XIII  Department of Commerce (Parts 1300--1399)
       XIV  Department of the Interior (Parts 1400--1499)
        XV  Environmental Protection Agency (Parts 1500--1599)
     XVIII  National Aeronautics and Space Administration (Parts 
                1800--1899)
        XX  United States Nuclear Regulatory Commission (Parts 
                2000--2099)
      XXII  Corporation for National and Community Service (Parts 
                2200--2299)
     XXIII  Social Security Administration (Parts 2300--2399)
      XXIV  Department of Housing and Urban Development (Parts 
                2400--2499)
       XXV  National Science Foundation (Parts 2500--2599)
      XXVI  National Archives and Records Administration (Parts 
                2600--2699)

[[Page 802]]

     XXVII  Small Business Administration (Parts 2700--2799)
    XXVIII  Department of Justice (Parts 2800--2899)
      XXIX  Department of Labor (Parts 2900--2999)
       XXX  Department of Homeland Security (Parts 3000--3099)
      XXXI  Institute of Museum and Library Services (Parts 3100--
                3199)
     XXXII  National Endowment for the Arts (Parts 3200--3299)
    XXXIII  National Endowment for the Humanities (Parts 3300--
                3399)
     XXXIV  Department of Education (Parts 3400--3499)
      XXXV  Export-Import Bank of the United States (Parts 3500--
                3599)
     XXXVI  Office of National Drug Control Policy, Executive 
                Office of the President (Parts 3600--3699)
    XXXVII  Peace Corps (Parts 3700--3799)
     LVIII  Election Assistance Commission (Parts 5800--5899)
       LIX  Gulf Coast Ecosystem Restoration Council (Parts 5900--
                5999)

                        Title 3--The President

         I  Executive Office of the President (Parts 100--199)

                           Title 4--Accounts

         I  Government Accountability Office (Parts 1--199)

                   Title 5--Administrative Personnel

         I  Office of Personnel Management (Parts 1--1199)
        II  Merit Systems Protection Board (Parts 1200--1299)
       III  Office of Management and Budget (Parts 1300--1399)
        IV  Office of Personnel Management and Office of the 
                Director of National Intelligence (Parts 1400--
                1499)
         V  The International Organizations Employees Loyalty 
                Board (Parts 1500--1599)
        VI  Federal Retirement Thrift Investment Board (Parts 
                1600--1699)
      VIII  Office of Special Counsel (Parts 1800--1899)
        IX  Appalachian Regional Commission (Parts 1900--1999)
        XI  Armed Forces Retirement Home (Parts 2100--2199)
       XIV  Federal Labor Relations Authority, General Counsel of 
                the Federal Labor Relations Authority and Federal 
                Service Impasses Panel (Parts 2400--2499)
       XVI  Office of Government Ethics (Parts 2600--2699)
       XXI  Department of the Treasury (Parts 3100--3199)
      XXII  Federal Deposit Insurance Corporation (Parts 3200--
                3299)
     XXIII  Department of Energy (Parts 3300--3399)
      XXIV  Federal Energy Regulatory Commission (Parts 3400--
                3499)
       XXV  Department of the Interior (Parts 3500--3599)
      XXVI  Department of Defense (Parts 3600--3699)

[[Page 803]]

    XXVIII  Department of Justice (Parts 3800--3899)
      XXIX  Federal Communications Commission (Parts 3900--3999)
       XXX  Farm Credit System Insurance Corporation (Parts 4000--
                4099)
      XXXI  Farm Credit Administration (Parts 4100--4199)
    XXXIII  U.S. International Development Finance Corporation 
                (Parts 4300--4399)
     XXXIV  Securities and Exchange Commission (Parts 4400--4499)
      XXXV  Office of Personnel Management (Parts 4500--4599)
     XXXVI  Department of Homeland Security (Parts 4600--4699)
    XXXVII  Federal Election Commission (Parts 4700--4799)
        XL  Interstate Commerce Commission (Parts 5000--5099)
       XLI  Commodity Futures Trading Commission (Parts 5100--
                5199)
      XLII  Department of Labor (Parts 5200--5299)
     XLIII  National Science Foundation (Parts 5300--5399)
       XLV  Department of Health and Human Services (Parts 5500--
                5599)
      XLVI  Postal Rate Commission (Parts 5600--5699)
     XLVII  Federal Trade Commission (Parts 5700--5799)
    XLVIII  Nuclear Regulatory Commission (Parts 5800--5899)
      XLIX  Federal Labor Relations Authority (Parts 5900--5999)
         L  Department of Transportation (Parts 6000--6099)
       LII  Export-Import Bank of the United States (Parts 6200--
                6299)
      LIII  Department of Education (Parts 6300--6399)
       LIV  Environmental Protection Agency (Parts 6400--6499)
        LV  National Endowment for the Arts (Parts 6500--6599)
       LVI  National Endowment for the Humanities (Parts 6600--
                6699)
      LVII  General Services Administration (Parts 6700--6799)
     LVIII  Board of Governors of the Federal Reserve System 
                (Parts 6800--6899)
       LIX  National Aeronautics and Space Administration (Parts 
                6900--6999)
        LX  United States Postal Service (Parts 7000--7099)
       LXI  National Labor Relations Board (Parts 7100--7199)
      LXII  Equal Employment Opportunity Commission (Parts 7200--
                7299)
     LXIII  Inter-American Foundation (Parts 7300--7399)
      LXIV  Merit Systems Protection Board (Parts 7400--7499)
       LXV  Department of Housing and Urban Development (Parts 
                7500--7599)
      LXVI  National Archives and Records Administration (Parts 
                7600--7699)
     LXVII  Institute of Museum and Library Services (Parts 7700--
                7799)
    LXVIII  Commission on Civil Rights (Parts 7800--7899)
      LXIX  Tennessee Valley Authority (Parts 7900--7999)
       LXX  Court Services and Offender Supervision Agency for the 
                District of Columbia (Parts 8000--8099)
      LXXI  Consumer Product Safety Commission (Parts 8100--8199)
    LXXIII  Department of Agriculture (Parts 8300--8399)

[[Page 804]]

     LXXIV  Federal Mine Safety and Health Review Commission 
                (Parts 8400--8499)
     LXXVI  Federal Retirement Thrift Investment Board (Parts 
                8600--8699)
    LXXVII  Office of Management and Budget (Parts 8700--8799)
      LXXX  Federal Housing Finance Agency (Parts 9000--9099)
   LXXXIII  Special Inspector General for Afghanistan 
                Reconstruction (Parts 9300--9399)
    LXXXIV  Bureau of Consumer Financial Protection (Parts 9400--
                9499)
    LXXXVI  National Credit Union Administration (Parts 9600--
                9699)
     XCVII  Department of Homeland Security Human Resources 
                Management System (Department of Homeland 
                Security--Office of Personnel Management) (Parts 
                9700--9799)
    XCVIII  Council of the Inspectors General on Integrity and 
                Efficiency (Parts 9800--9899)
      XCIX  Military Compensation and Retirement Modernization 
                Commission (Parts 9900--9999)
         C  National Council on Disability (Parts 10000--10049)
        CI  National Mediation Board (Part 10101)

                      Title 6--Domestic Security

         I  Department of Homeland Security, Office of the 
                Secretary (Parts 1--199)
         X  Privacy and Civil Liberties Oversight Board (Parts 
                1000--1099)

                         Title 7--Agriculture

            Subtitle A--Office of the Secretary of Agriculture 
                (Parts 0--26)
            Subtitle B--Regulations of the Department of 
                Agriculture
         I  Agricultural Marketing Service (Standards, 
                Inspections, Marketing Practices), Department of 
                Agriculture (Parts 27--209)
        II  Food and Nutrition Service, Department of Agriculture 
                (Parts 210--299)
       III  Animal and Plant Health Inspection Service, Department 
                of Agriculture (Parts 300--399)
        IV  Federal Crop Insurance Corporation, Department of 
                Agriculture (Parts 400--499)
         V  Agricultural Research Service, Department of 
                Agriculture (Parts 500--599)
        VI  Natural Resources Conservation Service, Department of 
                Agriculture (Parts 600--699)
       VII  Farm Service Agency, Department of Agriculture (Parts 
                700--799)
      VIII  Agricultural Marketing Service (Federal Grain 
                Inspection Service, Fair Trade Practices Program), 
                Department of Agriculture (Parts 800--899)

[[Page 805]]

        IX  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Fruits, Vegetables, Nuts), Department 
                of Agriculture (Parts 900--999)
         X  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Milk), Department of Agriculture 
                (Parts 1000--1199)
        XI  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Miscellaneous Commodities), Department 
                of Agriculture (Parts 1200--1299)
       XIV  Commodity Credit Corporation, Department of 
                Agriculture (Parts 1400--1499)
        XV  Foreign Agricultural Service, Department of 
                Agriculture (Parts 1500--1599)
       XVI  (Parts 1600--1699) [Reserved]
      XVII  Rural Utilities Service, Department of Agriculture 
                (Parts 1700--1799)
     XVIII  Rural Housing Service, Rural Business-Cooperative 
                Service, Rural Utilities Service, and Farm Service 
                Agency, Department of Agriculture (Parts 1800--
                2099)
        XX  (Parts 2200--2299) [Reserved]
       XXV  Office of Advocacy and Outreach, Department of 
                Agriculture (Parts 2500--2599)
      XXVI  Office of Inspector General, Department of Agriculture 
                (Parts 2600--2699)
     XXVII  Office of Information Resources Management, Department 
                of Agriculture (Parts 2700--2799)
    XXVIII  Office of Operations, Department of Agriculture (Parts 
                2800--2899)
      XXIX  Office of Energy Policy and New Uses, Department of 
                Agriculture (Parts 2900--2999)
       XXX  Office of the Chief Financial Officer, Department of 
                Agriculture (Parts 3000--3099)
      XXXI  Office of Environmental Quality, Department of 
                Agriculture (Parts 3100--3199)
     XXXII  Office of Procurement and Property Management, 
                Department of Agriculture (Parts 3200--3299)
    XXXIII  Office of Transportation, Department of Agriculture 
                (Parts 3300--3399)
     XXXIV  National Institute of Food and Agriculture (Parts 
                3400--3499)
      XXXV  Rural Housing Service, Department of Agriculture 
                (Parts 3500--3599)
     XXXVI  National Agricultural Statistics Service, Department 
                of Agriculture (Parts 3600--3699)
    XXXVII  Economic Research Service, Department of Agriculture 
                (Parts 3700--3799)
   XXXVIII  World Agricultural Outlook Board, Department of 
                Agriculture (Parts 3800--3899)
       XLI  [Reserved]
      XLII  Rural Business-Cooperative Service and Rural Utilities 
                Service, Department of Agriculture (Parts 4200--
                4299)

[[Page 806]]

         L  Rural Business-Cooperative Service, Rural Housing 
                Service, and Rural Utilities Service, Department 
                of Agriculture (Part 5001)

                    Title 8--Aliens and Nationality

         I  Department of Homeland Security (Parts 1--499)
         V  Executive Office for Immigration Review, Department of 
                Justice (Parts 1000--1399)

                 Title 9--Animals and Animal Products

         I  Animal and Plant Health Inspection Service, Department 
                of Agriculture (Parts 1--199)
        II  Agricultural Marketing Service (Fair Trade Practices 
                Program), Department of Agriculture (Parts 200--
                299)
       III  Food Safety and Inspection Service, Department of 
                Agriculture (Parts 300--599)

                           Title 10--Energy

         I  Nuclear Regulatory Commission (Parts 0--199)
        II  Department of Energy (Parts 200--699)
       III  Department of Energy (Parts 700--999)
         X  Department of Energy (General Provisions) (Parts 
                1000--1099)
      XIII  Nuclear Waste Technical Review Board (Parts 1300--
                1399)
      XVII  Defense Nuclear Facilities Safety Board (Parts 1700--
                1799)
     XVIII  Northeast Interstate Low-Level Radioactive Waste 
                Commission (Parts 1800--1899)

                      Title 11--Federal Elections

         I  Federal Election Commission (Parts 1--9099)
        II  Election Assistance Commission (Parts 9400--9499)

                      Title 12--Banks and Banking

         I  Comptroller of the Currency, Department of the 
                Treasury (Parts 1--199)
        II  Federal Reserve System (Parts 200--299)
       III  Federal Deposit Insurance Corporation (Parts 300--399)
        IV  Export-Import Bank of the United States (Parts 400--
                499)
         V  (Parts 500--599) [Reserved]
        VI  Farm Credit Administration (Parts 600--699)
       VII  National Credit Union Administration (Parts 700--799)
      VIII  Federal Financing Bank (Parts 800--899)
        IX  (Parts 900--999) [Reserved]
         X  Bureau of Consumer Financial Protection (Parts 1000--
                1099)

[[Page 807]]

        XI  Federal Financial Institutions Examination Council 
                (Parts 1100--1199)
       XII  Federal Housing Finance Agency (Parts 1200--1299)
      XIII  Financial Stability Oversight Council (Parts 1300--
                1399)
       XIV  Farm Credit System Insurance Corporation (Parts 1400--
                1499)
        XV  Department of the Treasury (Parts 1500--1599)
       XVI  Office of Financial Research, Department of the 
                Treasury (Parts 1600--1699)
      XVII  Office of Federal Housing Enterprise Oversight, 
                Department of Housing and Urban Development (Parts 
                1700--1799)
     XVIII  Community Development Financial Institutions Fund, 
                Department of the Treasury (Parts 1800--1899)

               Title 13--Business Credit and Assistance

         I  Small Business Administration (Parts 1--199)
       III  Economic Development Administration, Department of 
                Commerce (Parts 300--399)
        IV  Emergency Steel Guarantee Loan Board (Parts 400--499)
         V  Emergency Oil and Gas Guaranteed Loan Board (Parts 
                500--599)

                    Title 14--Aeronautics and Space

         I  Federal Aviation Administration, Department of 
                Transportation (Parts 1--199)
        II  Office of the Secretary, Department of Transportation 
                (Aviation Proceedings) (Parts 200--399)
       III  Commercial Space Transportation, Federal Aviation 
                Administration, Department of Transportation 
                (Parts 400--1199)
         V  National Aeronautics and Space Administration (Parts 
                1200--1299)
        VI  Air Transportation System Stabilization (Parts 1300--
                1399)

                 Title 15--Commerce and Foreign Trade

            Subtitle A--Office of the Secretary of Commerce (Parts 
                0--29)
            Subtitle B--Regulations Relating to Commerce and 
                Foreign Trade
         I  Bureau of the Census, Department of Commerce (Parts 
                30--199)
        II  National Institute of Standards and Technology, 
                Department of Commerce (Parts 200--299)
       III  International Trade Administration, Department of 
                Commerce (Parts 300--399)
        IV  Foreign-Trade Zones Board, Department of Commerce 
                (Parts 400--499)
       VII  Bureau of Industry and Security, Department of 
                Commerce (Parts 700--799)

[[Page 808]]

      VIII  Bureau of Economic Analysis, Department of Commerce 
                (Parts 800--899)
        IX  National Oceanic and Atmospheric Administration, 
                Department of Commerce (Parts 900--999)
        XI  National Technical Information Service, Department of 
                Commerce (Parts 1100--1199)
      XIII  East-West Foreign Trade Board (Parts 1300--1399)
       XIV  Minority Business Development Agency (Parts 1400--
                1499)
            Subtitle C--Regulations Relating to Foreign Trade 
                Agreements
        XX  Office of the United States Trade Representative 
                (Parts 2000--2099)
            Subtitle D--Regulations Relating to Telecommunications 
                and Information
     XXIII  National Telecommunications and Information 
                Administration, Department of Commerce (Parts 
                2300--2399) [Reserved]

                    Title 16--Commercial Practices

         I  Federal Trade Commission (Parts 0--999)
        II  Consumer Product Safety Commission (Parts 1000--1799)

             Title 17--Commodity and Securities Exchanges

         I  Commodity Futures Trading Commission (Parts 1--199)
        II  Securities and Exchange Commission (Parts 200--399)
        IV  Department of the Treasury (Parts 400--499)

          Title 18--Conservation of Power and Water Resources

         I  Federal Energy Regulatory Commission, Department of 
                Energy (Parts 1--399)
       III  Delaware River Basin Commission (Parts 400--499)
        VI  Water Resources Council (Parts 700--799)
      VIII  Susquehanna River Basin Commission (Parts 800--899)
      XIII  Tennessee Valley Authority (Parts 1300--1399)

                       Title 19--Customs Duties

         I  U.S. Customs and Border Protection, Department of 
                Homeland Security; Department of the Treasury 
                (Parts 0--199)
        II  United States International Trade Commission (Parts 
                200--299)
       III  International Trade Administration, Department of 
                Commerce (Parts 300--399)
        IV  U.S. Immigration and Customs Enforcement, Department 
                of Homeland Security (Parts 400--599) [Reserved]

[[Page 809]]

                     Title 20--Employees' Benefits

         I  Office of Workers' Compensation Programs, Department 
                of Labor (Parts 1--199)
        II  Railroad Retirement Board (Parts 200--399)
       III  Social Security Administration (Parts 400--499)
        IV  Employees' Compensation Appeals Board, Department of 
                Labor (Parts 500--599)
         V  Employment and Training Administration, Department of 
                Labor (Parts 600--699)
        VI  Office of Workers' Compensation Programs, Department 
                of Labor (Parts 700--799)
       VII  Benefits Review Board, Department of Labor (Parts 
                800--899)
      VIII  Joint Board for the Enrollment of Actuaries (Parts 
                900--999)
        IX  Office of the Assistant Secretary for Veterans' 
                Employment and Training Service, Department of 
                Labor (Parts 1000--1099)

                       Title 21--Food and Drugs

         I  Food and Drug Administration, Department of Health and 
                Human Services (Parts 1--1299)
        II  Drug Enforcement Administration, Department of Justice 
                (Parts 1300--1399)
       III  Office of National Drug Control Policy (Parts 1400--
                1499)

                      Title 22--Foreign Relations

         I  Department of State (Parts 1--199)
        II  Agency for International Development (Parts 200--299)
       III  Peace Corps (Parts 300--399)
        IV  International Joint Commission, United States and 
                Canada (Parts 400--499)
         V  United States Agency for Global Media (Parts 500--599)
       VII  U.S. International Development Finance Corporation 
                (Parts 700--799)
        IX  Foreign Service Grievance Board (Parts 900--999)
         X  Inter-American Foundation (Parts 1000--1099)
        XI  International Boundary and Water Commission, United 
                States and Mexico, United States Section (Parts 
                1100--1199)
       XII  United States International Development Cooperation 
                Agency (Parts 1200--1299)
      XIII  Millennium Challenge Corporation (Parts 1300--1399)
       XIV  Foreign Service Labor Relations Board; Federal Labor 
                Relations Authority; General Counsel of the 
                Federal Labor Relations Authority; and the Foreign 
                Service Impasse Disputes Panel (Parts 1400--1499)
        XV  African Development Foundation (Parts 1500--1599)
       XVI  Japan-United States Friendship Commission (Parts 
                1600--1699)
      XVII  United States Institute of Peace (Parts 1700--1799)

[[Page 810]]

                          Title 23--Highways

         I  Federal Highway Administration, Department of 
                Transportation (Parts 1--999)
        II  National Highway Traffic Safety Administration and 
                Federal Highway Administration, Department of 
                Transportation (Parts 1200--1299)
       III  National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 1300--1399)

                Title 24--Housing and Urban Development

            Subtitle A--Office of the Secretary, Department of 
                Housing and Urban Development (Parts 0--99)
            Subtitle B--Regulations Relating to Housing and Urban 
                Development
         I  Office of Assistant Secretary for Equal Opportunity, 
                Department of Housing and Urban Development (Parts 
                100--199)
        II  Office of Assistant Secretary for Housing-Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Parts 200--299)
       III  Government National Mortgage Association, Department 
                of Housing and Urban Development (Parts 300--399)
        IV  Office of Housing and Office of Multifamily Housing 
                Assistance Restructuring, Department of Housing 
                and Urban Development (Parts 400--499)
         V  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 500--599)
        VI  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 600--699) [Reserved]
       VII  Office of the Secretary, Department of Housing and 
                Urban Development (Housing Assistance Programs and 
                Public and Indian Housing Programs) (Parts 700--
                799)
      VIII  Office of the Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Section 8 Housing Assistance 
                Programs, Section 202 Direct Loan Program, Section 
                202 Supportive Housing for the Elderly Program and 
                Section 811 Supportive Housing for Persons With 
                Disabilities Program) (Parts 800--899)
        IX  Office of Assistant Secretary for Public and Indian 
                Housing, Department of Housing and Urban 
                Development (Parts 900--1699)
         X  Office of Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Interstate Land Sales 
                Registration Program) [Reserved]
       XII  Office of Inspector General, Department of Housing and 
                Urban Development (Parts 2000--2099)
        XV  Emergency Mortgage Insurance and Loan Programs, 
                Department of Housing and Urban Development (Parts 
                2700--2799) [Reserved]
        XX  Office of Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Parts 3200--3899)

[[Page 811]]

      XXIV  Board of Directors of the HOPE for Homeowners Program 
                (Parts 4000--4099) [Reserved]
       XXV  Neighborhood Reinvestment Corporation (Parts 4100--
                4199)

                           Title 25--Indians

         I  Bureau of Indian Affairs, Department of the Interior 
                (Parts 1--299)
        II  Indian Arts and Crafts Board, Department of the 
                Interior (Parts 300--399)
       III  National Indian Gaming Commission, Department of the 
                Interior (Parts 500--599)
        IV  Office of Navajo and Hopi Indian Relocation (Parts 
                700--899)
         V  Bureau of Indian Affairs, Department of the Interior, 
                and Indian Health Service, Department of Health 
                and Human Services (Part 900--999)
        VI  Office of the Assistant Secretary, Indian Affairs, 
                Department of the Interior (Parts 1000--1199)
       VII  Office of the Special Trustee for American Indians, 
                Department of the Interior (Parts 1200--1299)

                      Title 26--Internal Revenue

         I  Internal Revenue Service, Department of the Treasury 
                (Parts 1--End)

           Title 27--Alcohol, Tobacco Products and Firearms

         I  Alcohol and Tobacco Tax and Trade Bureau, Department 
                of the Treasury (Parts 1--399)
        II  Bureau of Alcohol, Tobacco, Firearms, and Explosives, 
                Department of Justice (Parts 400--799)

                   Title 28--Judicial Administration

         I  Department of Justice (Parts 0--299)
       III  Federal Prison Industries, Inc., Department of Justice 
                (Parts 300--399)
         V  Bureau of Prisons, Department of Justice (Parts 500--
                599)
        VI  Offices of Independent Counsel, Department of Justice 
                (Parts 600--699)
       VII  Office of Independent Counsel (Parts 700--799)
      VIII  Court Services and Offender Supervision Agency for the 
                District of Columbia (Parts 800--899)
        IX  National Crime Prevention and Privacy Compact Council 
                (Parts 900--999)
        XI  Department of Justice and Department of State (Parts 
                1100--1199)

[[Page 812]]

                            Title 29--Labor

            Subtitle A--Office of the Secretary of Labor (Parts 
                0--99)
            Subtitle B--Regulations Relating to Labor
         I  National Labor Relations Board (Parts 100--199)
        II  Office of Labor-Management Standards, Department of 
                Labor (Parts 200--299)
       III  National Railroad Adjustment Board (Parts 300--399)
        IV  Office of Labor-Management Standards, Department of 
                Labor (Parts 400--499)
         V  Wage and Hour Division, Department of Labor (Parts 
                500--899)
        IX  Construction Industry Collective Bargaining Commission 
                (Parts 900--999)
         X  National Mediation Board (Parts 1200--1299)
       XII  Federal Mediation and Conciliation Service (Parts 
                1400--1499)
       XIV  Equal Employment Opportunity Commission (Parts 1600--
                1699)
      XVII  Occupational Safety and Health Administration, 
                Department of Labor (Parts 1900--1999)
        XX  Occupational Safety and Health Review Commission 
                (Parts 2200--2499)
       XXV  Employee Benefits Security Administration, Department 
                of Labor (Parts 2500--2599)
     XXVII  Federal Mine Safety and Health Review Commission 
                (Parts 2700--2799)
        XL  Pension Benefit Guaranty Corporation (Parts 4000--
                4999)

                      Title 30--Mineral Resources

         I  Mine Safety and Health Administration, Department of 
                Labor (Parts 1--199)
        II  Bureau of Safety and Environmental Enforcement, 
                Department of the Interior (Parts 200--299)
        IV  Geological Survey, Department of the Interior (Parts 
                400--499)
         V  Bureau of Ocean Energy Management, Department of the 
                Interior (Parts 500--599)
       VII  Office of Surface Mining Reclamation and Enforcement, 
                Department of the Interior (Parts 700--999)
       XII  Office of Natural Resources Revenue, Department of the 
                Interior (Parts 1200--1299)

                 Title 31--Money and Finance: Treasury

            Subtitle A--Office of the Secretary of the Treasury 
                (Parts 0--50)
            Subtitle B--Regulations Relating to Money and Finance
         I  Monetary Offices, Department of the Treasury (Parts 
                51--199)
        II  Fiscal Service, Department of the Treasury (Parts 
                200--399)
        IV  Secret Service, Department of the Treasury (Parts 
                400--499)
         V  Office of Foreign Assets Control, Department of the 
                Treasury (Parts 500--599)

[[Page 813]]

        VI  Bureau of Engraving and Printing, Department of the 
                Treasury (Parts 600--699)
       VII  Federal Law Enforcement Training Center, Department of 
                the Treasury (Parts 700--799)
      VIII  Office of Investment Security, Department of the 
                Treasury (Parts 800--899)
        IX  Federal Claims Collection Standards (Department of the 
                Treasury--Department of Justice) (Parts 900--999)
         X  Financial Crimes Enforcement Network, Department of 
                the Treasury (Parts 1000--1099)

                      Title 32--National Defense

            Subtitle A--Department of Defense
         I  Office of the Secretary of Defense (Parts 1--399)
         V  Department of the Army (Parts 400--699)
        VI  Department of the Navy (Parts 700--799)
       VII  Department of the Air Force (Parts 800--1099)
            Subtitle B--Other Regulations Relating to National 
                Defense
       XII  Department of Defense, Defense Logistics Agency (Parts 
                1200--1299)
       XVI  Selective Service System (Parts 1600--1699)
      XVII  Office of the Director of National Intelligence (Parts 
                1700--1799)
     XVIII  National Counterintelligence Center (Parts 1800--1899)
       XIX  Central Intelligence Agency (Parts 1900--1999)
        XX  Information Security Oversight Office, National 
                Archives and Records Administration (Parts 2000--
                2099)
       XXI  National Security Council (Parts 2100--2199)
      XXIV  Office of Science and Technology Policy (Parts 2400--
                2499)
     XXVII  Office for Micronesian Status Negotiations (Parts 
                2700--2799)
    XXVIII  Office of the Vice President of the United States 
                (Parts 2800--2899)

               Title 33--Navigation and Navigable Waters

         I  Coast Guard, Department of Homeland Security (Parts 
                1--199)
        II  Corps of Engineers, Department of the Army, Department 
                of Defense (Parts 200--399)
        IV  Great Lakes St. Lawrence Seaway Development 
                Corporation, Department of Transportation (Parts 
                400--499)

                          Title 34--Education

            Subtitle A--Office of the Secretary, Department of 
                Education (Parts 1--99)
            Subtitle B--Regulations of the Offices of the 
                Department of Education

[[Page 814]]

         I  Office for Civil Rights, Department of Education 
                (Parts 100--199)
        II  Office of Elementary and Secondary Education, 
                Department of Education (Parts 200--299)
       III  Office of Special Education and Rehabilitative 
                Services, Department of Education (Parts 300--399)
        IV  Office of Career, Technical, and Adult Education, 
                Department of Education (Parts 400--499)
         V  Office of Bilingual Education and Minority Languages 
                Affairs, Department of Education (Parts 500--599) 
                [Reserved]
        VI  Office of Postsecondary Education, Department of 
                Education (Parts 600--699)
       VII  Office of Educational Research and Improvement, 
                Department of Education (Parts 700--799) 
                [Reserved]
            Subtitle C--Regulations Relating to Education
        XI  (Parts 1100--1199) [Reserved]
       XII  National Council on Disability (Parts 1200--1299)

                          Title 35 [Reserved]

             Title 36--Parks, Forests, and Public Property

         I  National Park Service, Department of the Interior 
                (Parts 1--199)
        II  Forest Service, Department of Agriculture (Parts 200--
                299)
       III  Corps of Engineers, Department of the Army (Parts 
                300--399)
        IV  American Battle Monuments Commission (Parts 400--499)
         V  Smithsonian Institution (Parts 500--599)
        VI  [Reserved]
       VII  Library of Congress (Parts 700--799)
      VIII  Advisory Council on Historic Preservation (Parts 800--
                899)
        IX  Pennsylvania Avenue Development Corporation (Parts 
                900--999)
         X  Presidio Trust (Parts 1000--1099)
        XI  Architectural and Transportation Barriers Compliance 
                Board (Parts 1100--1199)
       XII  National Archives and Records Administration (Parts 
                1200--1299)
        XV  Oklahoma City National Memorial Trust (Parts 1500--
                1599)
       XVI  Morris K. Udall Scholarship and Excellence in National 
                Environmental Policy Foundation (Parts 1600--1699)

             Title 37--Patents, Trademarks, and Copyrights

         I  United States Patent and Trademark Office, Department 
                of Commerce (Parts 1--199)
        II  U.S. Copyright Office, Library of Congress (Parts 
                200--299)
       III  Copyright Royalty Board, Library of Congress (Parts 
                300--399)
        IV  National Institute of Standards and Technology, 
                Department of Commerce (Parts 400--599)

[[Page 815]]

           Title 38--Pensions, Bonuses, and Veterans' Relief

         I  Department of Veterans Affairs (Parts 0--199)
        II  Armed Forces Retirement Home (Parts 200--299)

                       Title 39--Postal Service

         I  United States Postal Service (Parts 1--999)
       III  Postal Regulatory Commission (Parts 3000--3099)

                  Title 40--Protection of Environment

         I  Environmental Protection Agency (Parts 1--1099)
        IV  Environmental Protection Agency and Department of 
                Justice (Parts 1400--1499)
         V  Council on Environmental Quality (Parts 1500--1599)
        VI  Chemical Safety and Hazard Investigation Board (Parts 
                1600--1699)
       VII  Environmental Protection Agency and Department of 
                Defense; Uniform National Discharge Standards for 
                Vessels of the Armed Forces (Parts 1700--1799)
      VIII  Gulf Coast Ecosystem Restoration Council (Parts 1800--
                1899)
        IX  Federal Permitting Improvement Steering Council (Part 
                1900)

          Title 41--Public Contracts and Property Management

            Subtitle A--Federal Procurement Regulations System 
                [Note]
            Subtitle B--Other Provisions Relating to Public 
                Contracts
        50  Public Contracts, Department of Labor (Parts 50-1--50-
                999)
        51  Committee for Purchase From People Who Are Blind or 
                Severely Disabled (Parts 51-1--51-99)
        60  Office of Federal Contract Compliance Programs, Equal 
                Employment Opportunity, Department of Labor (Parts 
                60-1--60-999)
        61  Office of the Assistant Secretary for Veterans' 
                Employment and Training Service, Department of 
                Labor (Parts 61-1--61-999)
   62--100  [Reserved]
            Subtitle C--Federal Property Management Regulations 
                System
       101  Federal Property Management Regulations (Parts 101-1--
                101-99)
       102  Federal Management Regulation (Parts 102-1--102-299)
  103--104  (Parts 103-001--104-099) [Reserved]
       105  General Services Administration (Parts 105-1--105-999)
       109  Department of Energy Property Management Regulations 
                (Parts 109-1--109-99)
       114  Department of the Interior (Parts 114-1--114-99)
       115  Environmental Protection Agency (Parts 115-1--115-99)
       128  Department of Justice (Parts 128-1--128-99)
  129--200  [Reserved]

[[Page 816]]

            Subtitle D--Other Provisions Relating to Property 
                Management [Reserved]
            Subtitle E--Federal Information Resources Management 
                Regulations System [Reserved]
            Subtitle F--Federal Travel Regulation System
       300  General (Parts 300-1--300-99)
       301  Temporary Duty (TDY) Travel Allowances (Parts 301-1--
                301-99)
       302  Relocation Allowances (Parts 302-1--302-99)
       303  Payment of Expenses Connected with the Death of 
                Certain Employees (Part 303-1--303-99)
       304  Payment of Travel Expenses from a Non-Federal Source 
                (Parts 304-1--304-99)

                        Title 42--Public Health

         I  Public Health Service, Department of Health and Human 
                Services (Parts 1--199)
   II--III  [Reserved]
        IV  Centers for Medicare & Medicaid Services, Department 
                of Health and Human Services (Parts 400--699)
         V  Office of Inspector General-Health Care, Department of 
                Health and Human Services (Parts 1000--1099)

                   Title 43--Public Lands: Interior

            Subtitle A--Office of the Secretary of the Interior 
                (Parts 1--199)
            Subtitle B--Regulations Relating to Public Lands
         I  Bureau of Reclamation, Department of the Interior 
                (Parts 400--999)
        II  Bureau of Land Management, Department of the Interior 
                (Parts 1000--9999)
       III  Utah Reclamation Mitigation and Conservation 
                Commission (Parts 10000--10099)

             Title 44--Emergency Management and Assistance

         I  Federal Emergency Management Agency, Department of 
                Homeland Security (Parts 0--399)
        IV  Department of Commerce and Department of 
                Transportation (Parts 400--499)

                       Title 45--Public Welfare

            Subtitle A--Department of Health and Human Services 
                (Parts 1--199)
            Subtitle B--Regulations Relating to Public Welfare

[[Page 817]]

        II  Office of Family Assistance (Assistance Programs), 
                Administration for Children and Families, 
                Department of Health and Human Services (Parts 
                200--299)
       III  Office of Child Support Enforcement (Child Support 
                Enforcement Program), Administration for Children 
                and Families, Department of Health and Human 
                Services (Parts 300--399)
        IV  Office of Refugee Resettlement, Administration for 
                Children and Families, Department of Health and 
                Human Services (Parts 400--499)
         V  Foreign Claims Settlement Commission of the United 
                States, Department of Justice (Parts 500--599)
        VI  National Science Foundation (Parts 600--699)
       VII  Commission on Civil Rights (Parts 700--799)
      VIII  Office of Personnel Management (Parts 800--899)
        IX  Denali Commission (Parts 900--999)
         X  Office of Community Services, Administration for 
                Children and Families, Department of Health and 
                Human Services (Parts 1000--1099)
        XI  National Foundation on the Arts and the Humanities 
                (Parts 1100--1199)
       XII  Corporation for National and Community Service (Parts 
                1200--1299)
      XIII  Administration for Children and Families, Department 
                of Health and Human Services (Parts 1300--1399)
       XVI  Legal Services Corporation (Parts 1600--1699)
      XVII  National Commission on Libraries and Information 
                Science (Parts 1700--1799)
     XVIII  Harry S. Truman Scholarship Foundation (Parts 1800--
                1899)
       XXI  Commission of Fine Arts (Parts 2100--2199)
     XXIII  Arctic Research Commission (Parts 2300--2399)
      XXIV  James Madison Memorial Fellowship Foundation (Parts 
                2400--2499)
       XXV  Corporation for National and Community Service (Parts 
                2500--2599)

                          Title 46--Shipping

         I  Coast Guard, Department of Homeland Security (Parts 
                1--199)
        II  Maritime Administration, Department of Transportation 
                (Parts 200--399)
       III  Coast Guard (Great Lakes Pilotage), Department of 
                Homeland Security (Parts 400--499)
        IV  Federal Maritime Commission (Parts 500--599)

                      Title 47--Telecommunication

         I  Federal Communications Commission (Parts 0--199)
        II  Office of Science and Technology Policy and National 
                Security Council (Parts 200--299)

[[Page 818]]

       III  National Telecommunications and Information 
                Administration, Department of Commerce (Parts 
                300--399)
        IV  National Telecommunications and Information 
                Administration, Department of Commerce, and 
                National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 400--499)
         V  The First Responder Network Authority (Parts 500--599)

           Title 48--Federal Acquisition Regulations System

         1  Federal Acquisition Regulation (Parts 1--99)
         2  Defense Acquisition Regulations System, Department of 
                Defense (Parts 200--299)
         3  Department of Health and Human Services (Parts 300--
                399)
         4  Department of Agriculture (Parts 400--499)
         5  General Services Administration (Parts 500--599)
         6  Department of State (Parts 600--699)
         7  Agency for International Development (Parts 700--799)
         8  Department of Veterans Affairs (Parts 800--899)
         9  Department of Energy (Parts 900--999)
        10  Department of the Treasury (Parts 1000--1099)
        12  Department of Transportation (Parts 1200--1299)
        13  Department of Commerce (Parts 1300--1399)
        14  Department of the Interior (Parts 1400--1499)
        15  Environmental Protection Agency (Parts 1500--1599)
        16  Office of Personnel Management Federal Employees 
                Health Benefits Acquisition Regulation (Parts 
                1600--1699)
        17  Office of Personnel Management (Parts 1700--1799)
        18  National Aeronautics and Space Administration (Parts 
                1800--1899)
        19  Broadcasting Board of Governors (Parts 1900--1999)
        20  Nuclear Regulatory Commission (Parts 2000--2099)
        21  Office of Personnel Management, Federal Employees 
                Group Life Insurance Federal Acquisition 
                Regulation (Parts 2100--2199)
        23  Social Security Administration (Parts 2300--2399)
        24  Department of Housing and Urban Development (Parts 
                2400--2499)
        25  National Science Foundation (Parts 2500--2599)
        28  Department of Justice (Parts 2800--2899)
        29  Department of Labor (Parts 2900--2999)
        30  Department of Homeland Security, Homeland Security 
                Acquisition Regulation (HSAR) (Parts 3000--3099)
        34  Department of Education Acquisition Regulation (Parts 
                3400--3499)
        51  Department of the Army Acquisition Regulations (Parts 
                5100--5199) [Reserved]
        52  Department of the Navy Acquisition Regulations (Parts 
                5200--5299)

[[Page 819]]

        53  Department of the Air Force Federal Acquisition 
                Regulation Supplement (Parts 5300--5399) 
                [Reserved]
        54  Defense Logistics Agency, Department of Defense (Parts 
                5400--5499)
        57  African Development Foundation (Parts 5700--5799)
        61  Civilian Board of Contract Appeals, General Services 
                Administration (Parts 6100--6199)
        99  Cost Accounting Standards Board, Office of Federal 
                Procurement Policy, Office of Management and 
                Budget (Parts 9900--9999)

                       Title 49--Transportation

            Subtitle A--Office of the Secretary of Transportation 
                (Parts 1--99)
            Subtitle B--Other Regulations Relating to 
                Transportation
         I  Pipeline and Hazardous Materials Safety 
                Administration, Department of Transportation 
                (Parts 100--199)
        II  Federal Railroad Administration, Department of 
                Transportation (Parts 200--299)
       III  Federal Motor Carrier Safety Administration, 
                Department of Transportation (Parts 300--399)
        IV  Coast Guard, Department of Homeland Security (Parts 
                400--499)
         V  National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 500--599)
        VI  Federal Transit Administration, Department of 
                Transportation (Parts 600--699)
       VII  National Railroad Passenger Corporation (AMTRAK) 
                (Parts 700--799)
      VIII  National Transportation Safety Board (Parts 800--999)
         X  Surface Transportation Board (Parts 1000--1399)
        XI  Research and Innovative Technology Administration, 
                Department of Transportation (Parts 1400--1499) 
                [Reserved]
       XII  Transportation Security Administration, Department of 
                Homeland Security (Parts 1500--1699)

                   Title 50--Wildlife and Fisheries

         I  United States Fish and Wildlife Service, Department of 
                the Interior (Parts 1--199)
        II  National Marine Fisheries Service, National Oceanic 
                and Atmospheric Administration, Department of 
                Commerce (Parts 200--299)
       III  International Fishing and Related Activities (Parts 
                300--399)
        IV  Joint Regulations (United States Fish and Wildlife 
                Service, Department of the Interior and National 
                Marine Fisheries Service, National Oceanic and 
                Atmospheric Administration, Department of 
                Commerce); Endangered Species Committee 
                Regulations (Parts 400--499)
         V  Marine Mammal Commission (Parts 500--599)

[[Page 820]]

        VI  Fishery Conservation and Management, National Oceanic 
                and Atmospheric Administration, Department of 
                Commerce (Parts 600--699)

[[Page 821]]





           Alphabetical List of Agencies Appearing in the CFR




                      (Revised as of April 1, 2021)

                                                  CFR Title, Subtitle or 
                     Agency                               Chapter

Administrative Conference of the United States    1, III
Advisory Council on Historic Preservation         36, VIII
Advocacy and Outreach, Office of                  7, XXV
Afghanistan Reconstruction, Special Inspector     5, LXXXIII
     General for
African Development Foundation                    22, XV
  Federal Acquisition Regulation                  48, 57
Agency for International Development              2, VII; 22, II
  Federal Acquisition Regulation                  48, 7
Agricultural Marketing Service                    7, I, VIII, IX, X, XI; 9, 
                                                  II
Agricultural Research Service                     7, V
Agriculture, Department of                        2, IV; 5, LXXIII
  Advocacy and Outreach, Office of                7, XXV
  Agricultural Marketing Service                  7, I, VIII, IX, X, XI; 9, 
                                                  II
  Agricultural Research Service                   7, V
  Animal and Plant Health Inspection Service      7, III; 9, I
  Chief Financial Officer, Office of              7, XXX
  Commodity Credit Corporation                    7, XIV
  Economic Research Service                       7, XXXVII
  Energy Policy and New Uses, Office of           2, IX; 7, XXIX
  Environmental Quality, Office of                7, XXXI
  Farm Service Agency                             7, VII, XVIII
  Federal Acquisition Regulation                  48, 4
  Federal Crop Insurance Corporation              7, IV
  Food and Nutrition Service                      7, II
  Food Safety and Inspection Service              9, III
  Foreign Agricultural Service                    7, XV
  Forest Service                                  36, II
  Information Resources Management, Office of     7, XXVII
  Inspector General, Office of                    7, XXVI
  National Agricultural Library                   7, XLI
  National Agricultural Statistics Service        7, XXXVI
  National Institute of Food and Agriculture      7, XXXIV
  Natural Resources Conservation Service          7, VI
  Operations, Office of                           7, XXVIII
  Procurement and Property Management, Office of  7, XXXII
  Rural Business-Cooperative Service              7, XVIII, XLII
  Rural Development Administration                7, XLII
  Rural Housing Service                           7, XVIII, XXXV
  Rural Utilities Service                         7, XVII, XVIII, XLII
  Secretary of Agriculture, Office of             7, Subtitle A
  Transportation, Office of                       7, XXXIII
  World Agricultural Outlook Board                7, XXXVIII
Air Force, Department of                          32, VII
  Federal Acquisition Regulation Supplement       48, 53
Air Transportation Stabilization Board            14, VI
Alcohol and Tobacco Tax and Trade Bureau          27, I
Alcohol, Tobacco, Firearms, and Explosives,       27, II
     Bureau of
AMTRAK                                            49, VII
American Battle Monuments Commission              36, IV
American Indians, Office of the Special Trustee   25, VII
Animal and Plant Health Inspection Service        7, III; 9, I
Appalachian Regional Commission                   5, IX
Architectural and Transportation Barriers         36, XI
   Compliance Board
[[Page 822]]

Arctic Research Commission                        45, XXIII
Armed Forces Retirement Home                      5, XI; 38, II
Army, Department of                               32, V
  Engineers, Corps of                             33, II; 36, III
  Federal Acquisition Regulation                  48, 51
Benefits Review Board                             20, VII
Bilingual Education and Minority Languages        34, V
     Affairs, Office of
Blind or Severely Disabled, Committee for         41, 51
     Purchase from People Who Are
  Federal Acquisition Regulation                  48, 19
Career, Technical, and Adult Education, Office    34, IV
     of
Census Bureau                                     15, I
Centers for Medicare & Medicaid Services          42, IV
Central Intelligence Agency                       32, XIX
Chemical Safety and Hazard Investigation Board    40, VI
Chief Financial Officer, Office of                7, XXX
Child Support Enforcement, Office of              45, III
Children and Families, Administration for         45, II, III, IV, X, XIII
Civil Rights, Commission on                       5, LXVIII; 45, VII
Civil Rights, Office for                          34, I
Coast Guard                                       33, I; 46, I; 49, IV
Coast Guard (Great Lakes Pilotage)                46, III
Commerce, Department of                           2, XIII; 44, IV; 50, VI
  Census Bureau                                   15, I
  Economic Analysis, Bureau of                    15, VIII
  Economic Development Administration             13, III
  Emergency Management and Assistance             44, IV
  Federal Acquisition Regulation                  48, 13
  Foreign-Trade Zones Board                       15, IV
  Industry and Security, Bureau of                15, VII
  International Trade Administration              15, III; 19, III
  National Institute of Standards and Technology  15, II; 37, IV
  National Marine Fisheries Service               50, II, IV
  National Oceanic and Atmospheric                15, IX; 50, II, III, IV, 
       Administration                             VI
  National Technical Information Service          15, XI
  National Telecommunications and Information     15, XXIII; 47, III, IV
       Administration
  National Weather Service                        15, IX
  Patent and Trademark Office, United States      37, I
  Secretary of Commerce, Office of                15, Subtitle A
Commercial Space Transportation                   14, III
Commodity Credit Corporation                      7, XIV
Commodity Futures Trading Commission              5, XLI; 17, I
Community Planning and Development, Office of     24, V, VI
     Assistant Secretary for
Community Services, Office of                     45, X
Comptroller of the Currency                       12, I
Construction Industry Collective Bargaining       29, IX
     Commission
Consumer Financial Protection Bureau              5, LXXXIV; 12, X
Consumer Product Safety Commission                5, LXXI; 16, II
Copyright Royalty Board                           37, III
Corporation for National and Community Service    2, XXII; 45, XII, XXV
Cost Accounting Standards Board                   48, 99
Council on Environmental Quality                  40, V
Council of the Inspectors General on Integrity    5, XCVIII
     and Efficiency
Court Services and Offender Supervision Agency    5, LXX; 28, VIII
     for the District of Columbia
Customs and Border Protection                     19, I
Defense, Department of                            2, XI; 5, XXVI; 32, 
                                                  Subtitle A; 40, VII
  Advanced Research Projects Agency               32, I
  Air Force Department                            32, VII
  Army Department                                 32, V; 33, II; 36, III; 
                                                  48, 51
  Defense Acquisition Regulations System          48, 2
  Defense Intelligence Agency                     32, I
  Defense Logistics Agency                        32, I, XII; 48, 54

[[Page 823]]

  Engineers, Corps of                             33, II; 36, III
  National Imagery and Mapping Agency             32, I
  Navy, Department of                             32, VI; 48, 52
  Secretary of Defense, Office of                 2, XI; 32, I
Defense Contract Audit Agency                     32, I
Defense Intelligence Agency                       32, I
Defense Logistics Agency                          32, XII; 48, 54
Defense Nuclear Facilities Safety Board           10, XVII
Delaware River Basin Commission                   18, III
Denali Commission                                 45, IX
Disability, National Council on                   5, C; 34, XII
District of Columbia, Court Services and          5, LXX; 28, VIII
     Offender Supervision Agency for the
Drug Enforcement Administration                   21, II
East-West Foreign Trade Board                     15, XIII
Economic Analysis, Bureau of                      15, VIII
Economic Development Administration               13, III
Economic Research Service                         7, XXXVII
Education, Department of                          2, XXXIV; 5, LIII
  Bilingual Education and Minority Languages      34, V
       Affairs, Office of
  Career, Technical, and Adult Education, Office  34, IV
       of
  Civil Rights, Office for                        34, I
  Educational Research and Improvement, Office    34, VII
       of
  Elementary and Secondary Education, Office of   34, II
  Federal Acquisition Regulation                  48, 34
  Postsecondary Education, Office of              34, VI
  Secretary of Education, Office of               34, Subtitle A
  Special Education and Rehabilitative Services,  34, III
       Office of
Educational Research and Improvement, Office of   34, VII
Election Assistance Commission                    2, LVIII; 11, II
Elementary and Secondary Education, Office of     34, II
Emergency Oil and Gas Guaranteed Loan Board       13, V
Emergency Steel Guarantee Loan Board              13, IV
Employee Benefits Security Administration         29, XXV
Employees' Compensation Appeals Board             20, IV
Employees Loyalty Board                           5, V
Employment and Training Administration            20, V
Employment Policy, National Commission for        1, IV
Employment Standards Administration               20, VI
Endangered Species Committee                      50, IV
Energy, Department of                             2, IX; 5, XXIII; 10, II, 
                                                  III, X
  Federal Acquisition Regulation                  48, 9
  Federal Energy Regulatory Commission            5, XXIV; 18, I
  Property Management Regulations                 41, 109
Energy, Office of                                 7, XXIX
Engineers, Corps of                               33, II; 36, III
Engraving and Printing, Bureau of                 31, VI
Environmental Protection Agency                   2, XV; 5, LIV; 40, I, IV, 
                                                  VII
  Federal Acquisition Regulation                  48, 15
  Property Management Regulations                 41, 115
Environmental Quality, Office of                  7, XXXI
Equal Employment Opportunity Commission           5, LXII; 29, XIV
Equal Opportunity, Office of Assistant Secretary  24, I
     for
Executive Office of the President                 3, I
  Environmental Quality, Council on               40, V
  Management and Budget, Office of                2, Subtitle A; 5, III, 
                                                  LXXVII; 14, VI; 48, 99
  National Drug Control Policy, Office of         2, XXXVI; 21, III
  National Security Council                       32, XXI; 47, II
  Presidential Documents                          3
  Science and Technology Policy, Office of        32, XXIV; 47, II
  Trade Representative, Office of the United      15, XX
       States
Export-Import Bank of the United States           2, XXXV; 5, LII; 12, IV
Family Assistance, Office of                      45, II

[[Page 824]]

Farm Credit Administration                        5, XXXI; 12, VI
Farm Credit System Insurance Corporation          5, XXX; 12, XIV
Farm Service Agency                               7, VII, XVIII
Federal Acquisition Regulation                    48, 1
Federal Aviation Administration                   14, I
  Commercial Space Transportation                 14, III
Federal Claims Collection Standards               31, IX
Federal Communications Commission                 5, XXIX; 47, I
Federal Contract Compliance Programs, Office of   41, 60
Federal Crop Insurance Corporation                7, IV
Federal Deposit Insurance Corporation             5, XXII; 12, III
Federal Election Commission                       5, XXXVII; 11, I
Federal Emergency Management Agency               44, I
Federal Employees Group Life Insurance Federal    48, 21
     Acquisition Regulation
Federal Employees Health Benefits Acquisition     48, 16
     Regulation
Federal Energy Regulatory Commission              5, XXIV; 18, I
Federal Financial Institutions Examination        12, XI
     Council
Federal Financing Bank                            12, VIII
Federal Highway Administration                    23, I, II
Federal Home Loan Mortgage Corporation            1, IV
Federal Housing Enterprise Oversight Office       12, XVII
Federal Housing Finance Agency                    5, LXXX; 12, XII
Federal Labor Relations Authority                 5, XIV, XLIX; 22, XIV
Federal Law Enforcement Training Center           31, VII
Federal Management Regulation                     41, 102
Federal Maritime Commission                       46, IV
Federal Mediation and Conciliation Service        29, XII
Federal Mine Safety and Health Review Commission  5, LXXIV; 29, XXVII
Federal Motor Carrier Safety Administration       49, III
Federal Permitting Improvement Steering Council   40, IX
Federal Prison Industries, Inc.                   28, III
Federal Procurement Policy Office                 48, 99
Federal Property Management Regulations           41, 101
Federal Railroad Administration                   49, II
Federal Register, Administrative Committee of     1, I
Federal Register, Office of                       1, II
Federal Reserve System                            12, II
  Board of Governors                              5, LVIII
Federal Retirement Thrift Investment Board        5, VI, LXXVI
Federal Service Impasses Panel                    5, XIV
Federal Trade Commission                          5, XLVII; 16, I
Federal Transit Administration                    49, VI
Federal Travel Regulation System                  41, Subtitle F
Financial Crimes Enforcement Network              31, X
Financial Research Office                         12, XVI
Financial Stability Oversight Council             12, XIII
Fine Arts, Commission of                          45, XXI
Fiscal Service                                    31, II
Fish and Wildlife Service, United States          50, I, IV
Food and Drug Administration                      21, I
Food and Nutrition Service                        7, II
Food Safety and Inspection Service                9, III
Foreign Agricultural Service                      7, XV
Foreign Assets Control, Office of                 31, V
Foreign Claims Settlement Commission of the       45, V
     United States
Foreign Service Grievance Board                   22, IX
Foreign Service Impasse Disputes Panel            22, XIV
Foreign Service Labor Relations Board             22, XIV
Foreign-Trade Zones Board                         15, IV
Forest Service                                    36, II
General Services Administration                   5, LVII; 41, 105
  Contract Appeals, Board of                      48, 61
  Federal Acquisition Regulation                  48, 5
  Federal Management Regulation                   41, 102
  Federal Property Management Regulations         41, 101
  Federal Travel Regulation System                41, Subtitle F

[[Page 825]]

  General                                         41, 300
  Payment From a Non-Federal Source for Travel    41, 304
       Expenses
  Payment of Expenses Connected With the Death    41, 303
       of Certain Employees
  Relocation Allowances                           41, 302
  Temporary Duty (TDY) Travel Allowances          41, 301
Geological Survey                                 30, IV
Government Accountability Office                  4, I
Government Ethics, Office of                      5, XVI
Government National Mortgage Association          24, III
Grain Inspection, Packers and Stockyards          7, VIII; 9, II
     Administration
Gulf Coast Ecosystem Restoration Council          2, LIX; 40, VIII
Harry S. Truman Scholarship Foundation            45, XVIII
Health and Human Services, Department of          2, III; 5, XLV; 45, 
                                                  Subtitle A
  Centers for Medicare & Medicaid Services        42, IV
  Child Support Enforcement, Office of            45, III
  Children and Families, Administration for       45, II, III, IV, X, XIII
  Community Services, Office of                   45, X
  Family Assistance, Office of                    45, II
  Federal Acquisition Regulation                  48, 3
  Food and Drug Administration                    21, I
  Indian Health Service                           25, V
  Inspector General (Health Care), Office of      42, V
  Public Health Service                           42, I
  Refugee Resettlement, Office of                 45, IV
Homeland Security, Department of                  2, XXX; 5, XXXVI; 6, I; 8, 
                                                  I
  Coast Guard                                     33, I; 46, I; 49, IV
  Coast Guard (Great Lakes Pilotage)              46, III
  Customs and Border Protection                   19, I
  Federal Emergency Management Agency             44, I
  Human Resources Management and Labor Relations  5, XCVII
       Systems
  Immigration and Customs Enforcement Bureau      19, IV
  Transportation Security Administration          49, XII
HOPE for Homeowners Program, Board of Directors   24, XXIV
     of
Housing, Office of, and Multifamily Housing       24, IV
     Assistance Restructuring, Office of
Housing and Urban Development, Department of      2, XXIV; 5, LXV; 24, 
                                                  Subtitle B
  Community Planning and Development, Office of   24, V, VI
       Assistant Secretary for
  Equal Opportunity, Office of Assistant          24, I
       Secretary for
  Federal Acquisition Regulation                  48, 24
  Federal Housing Enterprise Oversight, Office    12, XVII
       of
  Government National Mortgage Association        24, III
  Housing--Federal Housing Commissioner, Office   24, II, VIII, X, XX
       of Assistant Secretary for
  Housing, Office of, and Multifamily Housing     24, IV
       Assistance Restructuring, Office of
  Inspector General, Office of                    24, XII
  Public and Indian Housing, Office of Assistant  24, IX
       Secretary for
  Secretary, Office of                            24, Subtitle A, VII
Housing--Federal Housing Commissioner, Office of  24, II, VIII, X, XX
     Assistant Secretary for
Housing, Office of, and Multifamily Housing       24, IV
     Assistance Restructuring, Office of
Immigration and Customs Enforcement Bureau        19, IV
Immigration Review, Executive Office for          8, V
Independent Counsel, Office of                    28, VII
Independent Counsel, Offices of                   28, VI
Indian Affairs, Bureau of                         25, I, V
Indian Affairs, Office of the Assistant           25, VI
     Secretary
Indian Arts and Crafts Board                      25, II
Indian Health Service                             25, V
Industry and Security, Bureau of                  15, VII

[[Page 826]]

Information Resources Management, Office of       7, XXVII
Information Security Oversight Office, National   32, XX
     Archives and Records Administration
Inspector General
  Agriculture Department                          7, XXVI
  Health and Human Services Department            42, V
  Housing and Urban Development Department        24, XII, XV
Institute of Peace, United States                 22, XVII
Inter-American Foundation                         5, LXIII; 22, X
Interior, Department of                           2, XIV
  American Indians, Office of the Special         25, VII
       Trustee
  Endangered Species Committee                    50, IV
  Federal Acquisition Regulation                  48, 14
  Federal Property Management Regulations System  41, 114
  Fish and Wildlife Service, United States        50, I, IV
  Geological Survey                               30, IV
  Indian Affairs, Bureau of                       25, I, V
  Indian Affairs, Office of the Assistant         25, VI
       Secretary
  Indian Arts and Crafts Board                    25, II
  Land Management, Bureau of                      43, II
  National Indian Gaming Commission               25, III
  National Park Service                           36, I
  Natural Resource Revenue, Office of             30, XII
  Ocean Energy Management, Bureau of              30, V
  Reclamation, Bureau of                          43, I
  Safety and Enforcement Bureau, Bureau of        30, II
  Secretary of the Interior, Office of            2, XIV; 43, Subtitle A
  Surface Mining Reclamation and Enforcement,     30, VII
       Office of
Internal Revenue Service                          26, I
International Boundary and Water Commission,      22, XI
     United States and Mexico, United States 
     Section
International Development, United States Agency   22, II
     for
  Federal Acquisition Regulation                  48, 7
International Development Cooperation Agency,     22, XII
     United States
International Development Finance Corporation,    5, XXXIII; 22, VII
     U.S.
International Joint Commission, United States     22, IV
     and Canada
International Organizations Employees Loyalty     5, V
     Board
International Trade Administration                15, III; 19, III
International Trade Commission, United States     19, II
Interstate Commerce Commission                    5, XL
Investment Security, Office of                    31, VIII
James Madison Memorial Fellowship Foundation      45, XXIV
Japan-United States Friendship Commission         22, XVI
Joint Board for the Enrollment of Actuaries       20, VIII
Justice, Department of                            2, XXVIII; 5, XXVIII; 28, 
                                                  I, XI; 40, IV
  Alcohol, Tobacco, Firearms, and Explosives,     27, II
       Bureau of
  Drug Enforcement Administration                 21, II
  Federal Acquisition Regulation                  48, 28
  Federal Claims Collection Standards             31, IX
  Federal Prison Industries, Inc.                 28, III
  Foreign Claims Settlement Commission of the     45, V
       United States
  Immigration Review, Executive Office for        8, V
  Independent Counsel, Offices of                 28, VI
  Prisons, Bureau of                              28, V
  Property Management Regulations                 41, 128
Labor, Department of                              2, XXIX; 5, XLII
  Benefits Review Board                           20, VII
  Employee Benefits Security Administration       29, XXV
  Employees' Compensation Appeals Board           20, IV
  Employment and Training Administration          20, V
  Federal Acquisition Regulation                  48, 29
  Federal Contract Compliance Programs, Office    41, 60
       of
  Federal Procurement Regulations System          41, 50
  Labor-Management Standards, Office of           29, II, IV

[[Page 827]]

  Mine Safety and Health Administration           30, I
  Occupational Safety and Health Administration   29, XVII
  Public Contracts                                41, 50
  Secretary of Labor, Office of                   29, Subtitle A
  Veterans' Employment and Training Service,      41, 61; 20, IX
       Office of the Assistant Secretary for
  Wage and Hour Division                          29, V
  Workers' Compensation Programs, Office of       20, I, VI
Labor-Management Standards, Office of             29, II, IV
Land Management, Bureau of                        43, II
Legal Services Corporation                        45, XVI
Libraries and Information Science, National       45, XVII
     Commission on
Library of Congress                               36, VII
  Copyright Royalty Board                         37, III
  U.S. Copyright Office                           37, II
Management and Budget, Office of                  5, III, LXXVII; 14, VI; 
                                                  48, 99
Marine Mammal Commission                          50, V
Maritime Administration                           46, II
Merit Systems Protection Board                    5, II, LXIV
Micronesian Status Negotiations, Office for       32, XXVII
Military Compensation and Retirement              5, XCIX
     Modernization Commission
Millennium Challenge Corporation                  22, XIII
Mine Safety and Health Administration             30, I
Minority Business Development Agency              15, XIV
Miscellaneous Agencies                            1, IV
Monetary Offices                                  31, I
Morris K. Udall Scholarship and Excellence in     36, XVI
     National Environmental Policy Foundation
Museum and Library Services, Institute of         2, XXXI
National Aeronautics and Space Administration     2, XVIII; 5, LIX; 14, V
  Federal Acquisition Regulation                  48, 18
National Agricultural Library                     7, XLI
National Agricultural Statistics Service          7, XXXVI
National and Community Service, Corporation for   2, XXII; 45, XII, XXV
National Archives and Records Administration      2, XXVI; 5, LXVI; 36, XII
  Information Security Oversight Office           32, XX
National Capital Planning Commission              1, IV, VI
National Counterintelligence Center               32, XVIII
National Credit Union Administration              5, LXXXVI; 12, VII
National Crime Prevention and Privacy Compact     28, IX
     Council
National Drug Control Policy, Office of           2, XXXVI; 21, III
National Endowment for the Arts                   2, XXXII
National Endowment for the Humanities             2, XXXIII
National Foundation on the Arts and the           45, XI
     Humanities
National Geospatial-Intelligence Agency           32, I
National Highway Traffic Safety Administration    23, II, III; 47, VI; 49, V
National Imagery and Mapping Agency               32, I
National Indian Gaming Commission                 25, III
National Institute of Food and Agriculture        7, XXXIV
National Institute of Standards and Technology    15, II; 37, IV
National Intelligence, Office of Director of      5, IV; 32, XVII
National Labor Relations Board                    5, LXI; 29, I
National Marine Fisheries Service                 50, II, IV
National Mediation Board                          5, CI; 29, X
National Oceanic and Atmospheric Administration   15, IX; 50, II, III, IV, 
                                                  VI
National Park Service                             36, I
National Railroad Adjustment Board                29, III
National Railroad Passenger Corporation (AMTRAK)  49, VII
National Science Foundation                       2, XXV; 5, XLIII; 45, VI
  Federal Acquisition Regulation                  48, 25
National Security Council                         32, XXI; 47, II
National Technical Information Service            15, XI
National Telecommunications and Information       15, XXIII; 47, III, IV, V
   Administration
[[Page 828]]

National Transportation Safety Board              49, VIII
Natural Resource Revenue, Office of               30, XII
Natural Resources Conservation Service            7, VI
Navajo and Hopi Indian Relocation, Office of      25, IV
Navy, Department of                               32, VI
  Federal Acquisition Regulation                  48, 52
Neighborhood Reinvestment Corporation             24, XXV
Northeast Interstate Low-Level Radioactive Waste  10, XVIII
     Commission
Nuclear Regulatory Commission                     2, XX; 5, XLVIII; 10, I
  Federal Acquisition Regulation                  48, 20
Occupational Safety and Health Administration     29, XVII
Occupational Safety and Health Review Commission  29, XX
Ocean Energy Management, Bureau of                30, V
Oklahoma City National Memorial Trust             36, XV
Operations Office                                 7, XXVIII
Patent and Trademark Office, United States        37, I
Payment From a Non-Federal Source for Travel      41, 304
     Expenses
Payment of Expenses Connected With the Death of   41, 303
     Certain Employees
Peace Corps                                       2, XXXVII; 22, III
Pennsylvania Avenue Development Corporation       36, IX
Pension Benefit Guaranty Corporation              29, XL
Personnel Management, Office of                   5, I, IV, XXXV; 45, VIII
  Federal Acquisition Regulation                  48, 17
  Federal Employees Group Life Insurance Federal  48, 21
       Acquisition Regulation
  Federal Employees Health Benefits Acquisition   48, 16
       Regulation
  Human Resources Management and Labor Relations  5, XCVII
       Systems, Department of Homeland Security
Pipeline and Hazardous Materials Safety           49, I
     Administration
Postal Regulatory Commission                      5, XLVI; 39, III
Postal Service, United States                     5, LX; 39, I
Postsecondary Education, Office of                34, VI
President's Commission on White House             1, IV
     Fellowships
Presidential Documents                            3
Presidio Trust                                    36, X
Prisons, Bureau of                                28, V
Privacy and Civil Liberties Oversight Board       6, X
Procurement and Property Management, Office of    7, XXXII
Public and Indian Housing, Office of Assistant    24, IX
     Secretary for
Public Contracts, Department of Labor             41, 50
Public Health Service                             42, I
Railroad Retirement Board                         20, II
Reclamation, Bureau of                            43, I
Refugee Resettlement, Office of                   45, IV
Relocation Allowances                             41, 302
Research and Innovative Technology                49, XI
     Administration
Rural Business-Cooperative Service                7, XVIII, XLII
Rural Development Administration                  7, XLII
Rural Housing Service                             7, XVIII, XXXV
Rural Utilities Service                           7, XVII, XVIII, XLII
Safety and Environmental Enforcement, Bureau of   30, II
Saint Lawrence Seaway Development Corporation     33, IV
Science and Technology Policy, Office of, and     32, XXIV; 47, II
     National Security Council
Secret Service                                    31, IV
Securities and Exchange Commission                5, XXXIV; 17, II
Selective Service System                          32, XVI
Small Business Administration                     2, XXVII; 13, I
Smithsonian Institution                           36, V
Social Security Administration                    2, XXIII; 20, III; 48, 23
Soldiers' and Airmen's Home, United States        5, XI
Special Counsel, Office of                        5, VIII
Special Education and Rehabilitative Services,    34, III
     Office of
State, Department of                              2, VI; 22, I; 28, XI
  Federal Acquisition Regulation                  48, 6

[[Page 829]]

Surface Mining Reclamation and Enforcement,       30, VII
     Office of
Surface Transportation Board                      49, X
Susquehanna River Basin Commission                18, VIII
Tennessee Valley Authority                        5, LXIX; 18, XIII
Trade Representative, United States, Office of    15, XX
Transportation, Department of                     2, XII; 5, L
  Commercial Space Transportation                 14, III
  Emergency Management and Assistance             44, IV
  Federal Acquisition Regulation                  48, 12
  Federal Aviation Administration                 14, I
  Federal Highway Administration                  23, I, II
  Federal Motor Carrier Safety Administration     49, III
  Federal Railroad Administration                 49, II
  Federal Transit Administration                  49, VI
  Maritime Administration                         46, II
  National Highway Traffic Safety Administration  23, II, III; 47, IV; 49, V
  Pipeline and Hazardous Materials Safety         49, I
       Administration
  Saint Lawrence Seaway Development Corporation   33, IV
  Secretary of Transportation, Office of          14, II; 49, Subtitle A
  Transportation Statistics Bureau                49, XI
Transportation, Office of                         7, XXXIII
Transportation Security Administration            49, XII
Transportation Statistics Bureau                  49, XI
Travel Allowances, Temporary Duty (TDY)           41, 301
Treasury, Department of the                       2, X; 5, XXI; 12, XV; 17, 
                                                  IV; 31, IX
  Alcohol and Tobacco Tax and Trade Bureau        27, I
  Community Development Financial Institutions    12, XVIII
       Fund
  Comptroller of the Currency                     12, I
  Customs and Border Protection                   19, I
  Engraving and Printing, Bureau of               31, VI
  Federal Acquisition Regulation                  48, 10
  Federal Claims Collection Standards             31, IX
  Federal Law Enforcement Training Center         31, VII
  Financial Crimes Enforcement Network            31, X
  Fiscal Service                                  31, II
  Foreign Assets Control, Office of               31, V
  Internal Revenue Service                        26, I
  Investment Security, Office of                  31, VIII
  Monetary Offices                                31, I
  Secret Service                                  31, IV
  Secretary of the Treasury, Office of            31, Subtitle A
Truman, Harry S. Scholarship Foundation           45, XVIII
United States Agency for Global Media             22, V
United States and Canada, International Joint     22, IV
     Commission
United States and Mexico, International Boundary  22, XI
     and Water Commission, United States Section
U.S. Copyright Office                             37, II
Utah Reclamation Mitigation and Conservation      43, III
     Commission
Veterans Affairs, Department of                   2, VIII; 38, I
  Federal Acquisition Regulation                  48, 8
Veterans' Employment and Training Service,        41, 61; 20, IX
     Office of the Assistant Secretary for
Vice President of the United States, Office of    32, XXVIII
Wage and Hour Division                            29, V
Water Resources Council                           18, VI
Workers' Compensation Programs, Office of         20, I, VII
World Agricultural Outlook Board                  7, XXXVIII

[[Page 831]]







                      Table of OMB Control Numbers



The OMB control numbers for chapter I of title 26 were consolidated into 
Sec. Sec.  601.9000 and 602.101 at 50 FR 10221, Mar. 14, 1985. At 61 FR 
58008, Nov. 12, 1996, Sec.  601.9000 was removed. Section 602.101 is 
reprinted below for the convenience of the user.



PART 602_OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT--Table of Contents





Sec.  602.101  OMB Control numbers.

    (a) Purpose. This part collects and displays the control numbers 
assigned to collections of information in Internal Revenue Service 
regulations by the Office of Management and Budget (OMB) under the 
Paperwork Reduction Act of 1980. The Internal Revenue Service intends 
that this part comply with the requirements of Sec. Sec.  1320.7(f), 
1320.12, 1320.13, and 1320.14 of 5 CFR part 1320 (OMB regulations 
implementing the Paperwork Reduction Act), for the display of control 
numbers assigned by OMB to collections of information in Internal 
Revenue Service regulations. This part does not display control numbers 
assigned by the Office of Management and Budget to collections of 
information of the Bureau of Alcohol, Tobacco, and Firearms.
    (b) Display.

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
1.1(h)-1(e)................................................    1545-1654
1.25-1T....................................................    1545-0922
                                                               1545-0930
1.25-2T....................................................    1545-0922
                                                               1545-0930
1.25-3T....................................................    1545-0922
                                                               1545-0930
1.25-4T....................................................    1545-0922
1.25-5T....................................................    1545-0922
1.25-6T....................................................    1545-0922
1.25-7T....................................................    1545-0922
1.25-8T....................................................    1545-0922
1.25A-1....................................................    1545-1630
1.28-1.....................................................    1545-0619
1.31-2.....................................................    1545-0074
1.32-2.....................................................    1545-0074
1.32-3.....................................................    1545-1575
1.36B-5....................................................    1545-2232
1.37-1.....................................................    1545-0074
1.37-3.....................................................    1545-0074
1.41-2.....................................................    1545-0619
1.41-3.....................................................    1545-0619
1.41-4A....................................................    1545-0074
1.41-4 (b) and (c).........................................    1545-0074
1.41-8(b)..................................................    1545-1625
1.41-8(d)..................................................    1545-0732
1.41-9.....................................................    1545-0619
1.42-1T....................................................    1545-0984
                                                               1545-0988
1.42-5.....................................................    1545-1357
1.42-6.....................................................    1545-1102
1.42-8.....................................................    1545-1102
1.42-10....................................................    1545-1102
1.42-13....................................................    1545-1357
1.42-14....................................................    1545-1423
1.42-17....................................................    1545-1357
1.42-18....................................................    1545-2088
1.43-3(a)(3)...............................................    1545-1292
1.43-3(b)(3)...............................................    1545-1292
1.44B-1....................................................    1545-0219
1.45D-1....................................................    1545-1765
1.45G-1....................................................    1545-2031
1.46-1.....................................................    1545-0123
                                                               1545-0155
1.46-3.....................................................    1545-0155
1.46-4.....................................................    1545-0155
1.46-5.....................................................    1545-0155
1.46-6.....................................................    1545-0155
1.46-8.....................................................    1545-0155
1.46-9.....................................................    1545-0155
1.46-10....................................................    1545-0118
1.47-1.....................................................    1545-0155
                                                               1545-0166
1.47-3.....................................................    1545-0155
                                                               1545-0166
1.47-4.....................................................    1545-0123
1.47-5.....................................................    1545-0092
1.47-6.....................................................    1545-0099
1.48-3.....................................................    1545-0155
1.48-4.....................................................    1545-0155
                                                               1545-0808
1.48-5.....................................................    1545-0155
1.48-6.....................................................    1545-0155
1.48-12....................................................    1545-0155
                                                               1545-1783
1.50A-1....................................................    1545-0895
1.50A-2....................................................    1545-0895
1.50A-3....................................................    1545-0895
1.50A-4....................................................    1545-0895
1.50A-5....................................................    1545-0895
1.50A-6....................................................    1545-0895
1.50A-7....................................................    1545-0895
1.50B-1....................................................    1545-0895
1.50B-2....................................................    1545-0895
1.50B-3....................................................    1545-0895
1.50B-4....................................................    1545-0895
1.50B-5....................................................    1545-0895
1.51-1.....................................................    1545-0219

[[Page 832]]

 
                                                               1545-0241
                                                               1545-0244
                                                               1545-0797
1.52-2.....................................................    1545-0219
1.52-3.....................................................    1545-0219
1.56(g)-1..................................................    1545-1233
1.57-5.....................................................    1545-0227
1.58-1.....................................................    1545-0175
1.59-1.....................................................    1545-1903
1.61-2.....................................................    1545-0771
1.61-4.....................................................    1545-0187
1.61-15....................................................    1545-0074
1.62-2.....................................................    1545-1148
1.63-1.....................................................    1545-0074
1.66-4.....................................................    1545-1770
1.67-2T....................................................    1545-0110
1.67-3.....................................................    1545-1018
1.67-3T....................................................    1545-0118
1.71-1T....................................................    1545-0074
1.72-4.....................................................    1545-0074
1.72-6.....................................................    1545-0074
1.72-9.....................................................    1545-0074
1.72-17....................................................    1545-0074
1.72-17A...................................................    1545-0074
1.72-18....................................................    1545-0074
1.74-1.....................................................    1545-1100
1.79-2.....................................................    1545-0074
1.79-3.....................................................    1545-0074
1.83-2.....................................................    1545-0074
1.83-5.....................................................    1545-0074
1.83-6.....................................................    1545-1448
1.103-10...................................................    1545-0123
                                                               1545-0940
1.103A-2...................................................    1545-0720
1.105-4....................................................    1545-0074
1.105-5....................................................    1545-0074
1.105-6....................................................    1545-0074
1.108-4....................................................    1545-1539
1.108-5....................................................    1545-1421
1.108-7....................................................    1545-2155
1.108(i)-1.................................................    1545-2147
1.108(i)-2.................................................    1545-2147
1.110-1....................................................    1545-1661
1.117-5....................................................    1545-0869
1.118-2....................................................    1545-1639
1.119-1....................................................    1545-0067
1.120-3....................................................    1545-0057
1.121-1....................................................    1545-0072
1.121-2....................................................    1545-0072
1.121-3....................................................    1545-0072
1.121-4....................................................    1545-0072
                                                               1545-0091
1.121-5....................................................    1545-0072
1.127-2....................................................    1545-0768
1.132-2....................................................    1545-0771
1.132-5....................................................    1545-0771
1.132-9(b).................................................    1545-1676
1.141-1....................................................    1545-1451
1.141-12...................................................    1545-1451
1.142-2....................................................    1545-1451
1.142(f)(4)-1..............................................    1545-1730
1.148-0....................................................    1545-1098
1.148-1....................................................    1545-1098
1.148-2....................................................    1545-1098
                                                               1545-1347
1.148-3....................................................    1545-1098
                                                               1545-1347
1.148-4....................................................    1545-1098
                                                               1545-1347
1.148-5....................................................    1545-1098
                                                               1545-1490
1.148-6....................................................    1545-1098
                                                               1545-1451
1.148-7....................................................    1545-1098
                                                               1545-1347
1.148-8....................................................    1545-1098
1.148-11...................................................    1545-1098
                                                               1545-1347
1.149(e)-1.................................................    1545-0720
1.150-1....................................................    1545-1347
1.151-1....................................................    1545-0074
1.152-3....................................................    1545-0071
                                                               1545-1783
1.152-4....................................................    1545-0074
1.152-4T...................................................    1545-0074
1.162-1....................................................    1545-0139
1.162-2....................................................    1545-0139
1.162-3....................................................    1545-0139
1.162-4....................................................    1545-0139
1.162-5....................................................    1545-0139
1.162-6....................................................    1545-0139
1.162-7....................................................    1545-0139
1.162-8....................................................    1545-0139
1.162-9....................................................    1545-0139
1.162-10...................................................    1545-0139
1.162-11...................................................    1545-0139
1.162-12...................................................    1545-0139
1.162-13...................................................    1545-0139
1.162-14...................................................    1545-0139
1.162-15...................................................    1545-0139
1.162-16...................................................    1545-0139
1.162-17...................................................    1545-0139
1.162-18...................................................    1545-0139
1.162-19...................................................    1545-0139
1.162-20...................................................    1545-0139
1.162-24...................................................    1545-2115
1.162-27...................................................    1545-1466
1.163-5....................................................    1545-0786
                                                               1545-1132
1.163-8T...................................................    1545-0995
1.163-10T..................................................    1545-0074
1.163-13...................................................    1545-1491
1.163(d)-1.................................................    1545-1421
1.165-1....................................................    1545-0177
1.165-2....................................................    1545-0177
1.165-3....................................................    1545-0177
1.165-4....................................................    1545-0177
1.165-5....................................................    1545-0177
1.165-6....................................................    1545-0177
1.165-7....................................................    1545-0177
1.165-8....................................................    1545-0177
1.165-9....................................................    1545-0177
1.165-10...................................................    1545-0177
1.165-11...................................................    1545-0074
                                                               1545-0177
                                                               1545-0786
1.165-12...................................................    1545-0786
1.166-1....................................................    1545-0123
1.166-2....................................................    1545-1254
1.166-4....................................................    1545-0123
1.166-10...................................................    1545-0123
1.167(a)-5T................................................    1545-1021
1.167(a)-7.................................................    1545-0172
1.167(a)-11................................................    1545-0152
                                                               1545-0172
1.167(a)-12................................................    1545-0172
1.167(d)-1.................................................    1545-0172
1.167(e)-1.................................................    1545-0172
1.167(f)-11................................................    1545-0172
1.167(l)-1.................................................    1545-0172
1.168(d)-1.................................................    1545-1146
1.168(i)-1.................................................    1545-1331
1.168-5....................................................    1545-0172
1.169-4....................................................    1545-0172

[[Page 833]]

 
1.170-1....................................................    1545-0074
1.170-2....................................................    1545-0074
1.170-3....................................................    1545-0123
1.170A-1...................................................    1545-0074
1.170A-2...................................................    1545-0074
1.170A-4(A)(b).............................................    1545-0123
1.170A-8...................................................    1545-0074
1.170A-9...................................................    1545-0052
                                                               1545-0074
1.170A-11..................................................    1545-0074
                                                               1545-0123
                                                               1545-1868
1.170A-12..................................................    1545-0020
                                                               1545-0074
1.170A-13..................................................    1545-0074
                                                               1545-0754
                                                               1545-0908
                                                               1545-1431
1.170A-13(f)...............................................    1545-1464
1.170A-14..................................................    1545-0763
1.170A-15..................................................    1545-1953
1.170A-16..................................................    1545-1953
1.170A-17..................................................    1545-1953
1.170A-18..................................................    1545-1953
1.171-4....................................................    1545-1491
1.171-5....................................................    1545-1491
1.172-1....................................................    1545-0172
1.172-13...................................................    1545-0863
1.173-1....................................................    1545-0172
1.174-3....................................................    1545-0152
1.174-4....................................................    1545-0152
1.175-3....................................................    1545-0187
1.175-6....................................................    1545-0152
1.179-2....................................................    1545-1201
1.179-3....................................................    1545-1201
1.179-5....................................................    1545-0172
                                                               1545-1201
1.179B-1T..................................................    1545-2076
1.179C-1...................................................    1545-2103
1.179C-1T..................................................    1545-2103
1.180-2....................................................    1545-0074
1.181-1....................................................    1545-2059
1.181-2....................................................    1545-2059
1.181-3....................................................    1545-2059
1.182-6....................................................    1545-0074
1.183-1....................................................    1545-0195
1.183-2....................................................    1545-0195
1.183-3....................................................    1545-0195
1.183-4....................................................    1545-0195
1.190-3....................................................    1545-0074
1.194-2....................................................    1545-0735
1.194-4....................................................    1545-0735
1.195-1....................................................    1545-1582
1.197-1T...................................................    1545-1425
1.197-2....................................................    1545-1671
1.199-6....................................................    1545-1966
1.213-1....................................................    1545-0074
1.215-1T...................................................    1545-0074
1.217-2....................................................    1545-0182
1.243-3....................................................    1545-0123
1.243-4....................................................    1545-0123
1.243-5....................................................    1545-0123
1.248-1....................................................    1545-0172
1.261-1....................................................    1545-1041
1.263(a)-1.................................................    1545-2248
1.263(a)-3.................................................    1545-2248
1.263(a)-5.................................................    1545-1870
1.263(e)-1.................................................    1545-0123
1.263A-1...................................................    1545-0987
1.263A-1T..................................................    1545-0187
1.263A-2...................................................    1545-0987
1.263A-3...................................................    1545-0987
1.263A-8(b)(2)(iii)........................................    1545-1265
1.263A-9(d)(1).............................................    1545-1265
1.263A-9(f)(1)(ii).........................................    1545-1265
1.263A-9(f)(2)(iv).........................................    1545-1265
1.263A-9(g)(2)(iv)(C)......................................    1545-1265
1.263A-9(g)(3)(iv).........................................    1545-1265
1.265-1....................................................    1545-0074
1.265-2....................................................    1545-0123
1.266-1....................................................    1545-0123
1.267(f)-1.................................................    1545-0885
1.268-1....................................................    1545-0184
1.274-1....................................................    1545-0139
1.274-2....................................................    1545-0139
1.274-3....................................................    1545-0139
1.274-4....................................................    1545-0139
1.274-5....................................................    1545-0771
1.274-5A...................................................    1545-0139
                                                               1545-0771
1.274-5T...................................................    1545-0074
                                                               1545-0172
                                                               1545-0771
1.274-6....................................................    1545-0139
                                                               1545-0771
1.274-6T...................................................    1545-0074
                                                               1545-0771
1.274-7....................................................    1545-0139
1.274-8....................................................    1545-0139
1.279-6....................................................    1545-0123
1.280C-4...................................................    1545-1155
1.280F-3T..................................................    1545-0074
1.280G-1...................................................    1545-1851
1.281-4....................................................    1545-0123
1.302-4....................................................    1545-0074
1.305-3....................................................    1545-0123
1.305-5....................................................    1545-1438
1.307-2....................................................    1545-0074
1.312-15...................................................    1545-0172
1.316-1....................................................    1545-0123
1.331-1....................................................    1545-0074
1.332-4....................................................    1545-0123
1.332-6....................................................    1545-2019
1.336-2....................................................    1545-2125
1.336-4....................................................    1545-2125
1.337(d)-1.................................................    1545-1160
1.337(d)-2.................................................    1545-1160
                                                               1545-1774
1.337(d)-4.................................................    1545-1633
1.337(d)-5.................................................    1545-1672
1.337(d)-6.................................................    1545-1672
1.337(d)-7.................................................    1545-1672
1.338-2....................................................    1545-1658
1.338-5....................................................    1545-1658
1.338-10...................................................    1545-1658
1.338-11...................................................    1545-1990
1.338(h)(10)-1.............................................    1545-1658
1.338(i)-1.................................................    1545-1990
1.351-3....................................................    1545-2019
1.355-5....................................................    1545-2019
1.362-2....................................................    1545-0123
1.362-4....................................................    1545-2247
1.367(a)-1T................................................    1545-0026
1.367(a)-2T................................................    1545-0026
1.367(a)-3.................................................    1545-0026
                                                               1545-1478
1.367(a)-3T................................................    1545-2183
1.367(a)-6T................................................    1545-0026
1.367(a)-7.................................................    1545-2183
1.367(a)-7T................................................    1545-2183
1.367(a)-8.................................................    1545-1271
                                                               1545-2056
                                                               1545-2183
1.367(b)-1.................................................    1545-1271

[[Page 834]]

 
1.367(b)-3T................................................    1545-1666
1.367(d)-1T................................................    1545-0026
1.367(e)-1.................................................    1545-1487
1.367(e)-2.................................................    1545-1487
1.368-1....................................................    1545-1691
1.368-3....................................................    1545-2019
1.371-1....................................................    1545-0123
1.371-2....................................................    1545-0123
1.374-3....................................................    1545-0123
1.381(b)-1.................................................    1545-0123
1.381(c)(4)-1..............................................    1545-0123
                                                               1545-0152
                                                               1545-0879
1.381(c)(5)-1..............................................    1545-0123
                                                               1545-0152
1.381(c)(6)-1..............................................    1545-0123
                                                               1545-0152
1.381(c)(8)-1..............................................    1545-0123
1.381(c)(10)-1.............................................    1545-0123
1.381(c)(11)-1(k)..........................................    1545-0123
1.381(c)(13)-1.............................................    1545-0123
1.381(c)(17)-1.............................................    1545-0045
1.381(c)(22)-1.............................................    1545-1990
1.381(c)(25)-1.............................................    1545-0045
1.382-1T...................................................    1545-0123
1.382-2....................................................    1545-0123
1.382-2T...................................................    1545-0123
1.382-3....................................................    1545-1281
                                                               1545-1345
1.382-4....................................................    1545-1120
1.382-6....................................................    1545-1381
1.382-8....................................................    1545-1434
1.382-9....................................................    1545-1120
                                                               1545-1260
                                                               1545-1275
                                                               1545-1324
1.382-11...................................................    1545-2019
1.382-91...................................................    1545-1260
                                                               1545-1324
1.383-1....................................................    1545-0074
                                                               1545-1120
1.401-1....................................................    1545-0020
                                                               1545-0197
                                                               1545-0200
                                                               1545-0534
                                                               1545-0710
1.401(a)-11................................................    1545-0710
1.401(a)-20................................................    1545-0928
1.401(a)-31................................................    1545-1341
1.401(a)-50................................................    1545-0710
1.401(a)(9)-1..............................................    1545-1573
1.401(a)(9)-3..............................................    1545-1466
1.401(a)(9)-4..............................................    1545-1573
1.401(a)(9)-6..............................................    1545-2234
1.401(a)(31)-1.............................................    1545-1341
1.401(b)-1.................................................    1545-0197
1.401(f)-1.................................................    1545-0710
1.401(k)-1.................................................    1545-1039
                                                               1545-1069
                                                               1545-1669
                                                               1545-1930
1.401(k)-2.................................................    1545-1669
1.401(k)-3.................................................    1545-1669
1.401(k)-4.................................................    1545-1669
1.401(m)-3.................................................    1545-1699
1.401-14...................................................    1545-0710
1.402(c)-2.................................................    1545-1341
1.402(f)-1.................................................    1545-1341
                                                               1545-1632
1.402A-1...................................................    1545-1992
1.403(b)-1.................................................    1545-0710
1.403(b)-3.................................................    1545-0996
1.403(b)-7.................................................    1545-1341
1.403(b)-10................................................    1545-2068
1.404(a)-12................................................    1545-0710
1.404A-2...................................................    1545-0123
1.404A-6...................................................    1545-0123
1.408-2....................................................    1545-0390
1.408-5....................................................    1545-0747
1.408-6....................................................    1545-0203
                                                               1545-0390
1.408-7....................................................    1545-0119
1.408(q)-1.................................................    1545-1841
1.408A-2...................................................    1545-1616
1.408A-4...................................................    1545-1616
1.408A-5...................................................    1545-1616
1.408A-7...................................................    1545-1616
1.410(a)-2.................................................    1545-0710
1.410(d)-1.................................................    1545-0710
1.411(a)-11................................................    1545-1471
                                                               1545-1632
1.411(d)-4.................................................    1545-1545
1.411(d)-6.................................................    1545-1477
1.412(c)(1)-2..............................................    1545-0710
1.412(c)(2)-1..............................................    1545-0710
1.412(c)(3)-2..............................................    1545-0710
1.414(c)-5.................................................    1545-0797
1.414(r)-1.................................................    1545-1221
1.415-2....................................................    1545-0710
1.415-6....................................................    1545-0710
1.417(a)(3)-1..............................................    1545-0928
1.417(e)-1.................................................    1545-1471
                                                               1545-1724
1.417(e)-1T................................................    1545-1471
1.419A(f)(6)-1.............................................    1545-1795
1.422-1....................................................    1545-0820
1.430(f)-1.................................................    1545-2095
1.430(g)-1.................................................    1545-2095
1.430(h)(2)-1..............................................    1545-2095
1.432(e)(9)-1T.............................................    1545-2260
1.436-1....................................................    1545-2095
1.441-2....................................................    1545-1748
1.442-1....................................................    1545-0074
                                                               1545-0123
                                                               1545-0134
                                                               1545-0152
                                                               1545-0820
                                                               1545-1748
1.443-1....................................................    1545-0123
1.444-3T...................................................    1545-1036
1.444-4....................................................    1545-1591
1.446-1....................................................    1545-0074
                                                               1545-0152
1.446-4(d).................................................    1545-1412
1.448-1(g).................................................    1545-0152
1.448-1(h).................................................    1545-0152
1.448-1(i).................................................    1545-0152
1.448-2....................................................    1545-1855
1.448-2T...................................................    1545-0152
                                                               1545-1855
1.451-1....................................................    1545-0091
1.451-4....................................................    1545-0123
1.451-6....................................................    1545-0074
1.451-7....................................................    1545-0074
1.453-1....................................................    1545-0152
1.453-2....................................................    1545-0152
1.453-8....................................................    1545-0152
                                                               1545-0228
1.453A-1...................................................    1545-0152
                                                               1545-1134
1.453A-3...................................................    1545-0963
1.454-1....................................................    1545-0074
1.455-2....................................................    1545-0152
1.455-6....................................................    1545-0123

[[Page 835]]

 
1.456-2....................................................    1545-0123
1.456-6....................................................    1545-0123
1.456-7....................................................    1545-0123
1.457-8....................................................    1545-1580
1.458-1....................................................    1545-0879
1.458-2....................................................    1545-0152
1.460-1....................................................    1545-1650
1.460-6....................................................    1545-1031
                                                               1545-1572
                                                               1545-1732
1.461-1....................................................    1545-0074
1.461-2....................................................    1545-0096
1.461-4....................................................    1545-0917
1.461-5....................................................    1545-0917
1.463-1T...................................................    1545-0916
1.465-1T...................................................    1545-0712
1.466-1T...................................................    1545-0152
1.466-4....................................................    1545-0152
1.468A-3...................................................    1545-1269
                                                               1545-1378
                                                               1545-1511
1.468A-3(h), 1.468A-7, and 1.468A-8(d).....................    1545-2091
1.468A-4...................................................    1545-0954
1.468A-7...................................................    1545-0954
                                                               1545-1511
1.468A-8...................................................    1545-1269
1.468B-1...................................................    1545-1631
1.468B-1(j)................................................    1545-1299
1.468B-2(k)................................................    1545-1299
1.468B-2(l)................................................    1545-1299
1.468B-3(b)................................................    1545-1299
1.468B-3(e)................................................    1545-1299
1.468B-5(b)................................................    1545-1299
1.468B-9...................................................    1545-1631
1.469-1....................................................    1545-1008
1.469-2T...................................................    1545-0712
                                                               1545-1091
1.469-4T...................................................    1545-0985
                                                               1545-1037
1.469-7....................................................    1545-1244
1.471-2....................................................    1545-0123
1.471-5....................................................    1545-0123
1.471-6....................................................    1545-0123
1.471-8....................................................    1545-0123
1.471-11...................................................    1545-0123
                                                               1545-0152
1.472-1....................................................    1545-0042
                                                               1545-0152
1.472-2....................................................    1545-0152
1.472-3....................................................    1545-0042
1.472-5....................................................    1545-0152
1.472-8....................................................    1545-0028
                                                               1545-0042
                                                               1545-1767
1.475(a)-4.................................................    1545-1945
1.481-4....................................................    1545-0152
1.481-5....................................................    1545-0152
1.482-1....................................................    1545-1364
1.482-4....................................................    1545-1364
1.482-7....................................................    1545-1364
                                                               1545-1794
1.482-9(b).................................................    1545-2149
1.501(a)-1.................................................    1545-0056
                                                               1545-0057
1.501(c)(3)-1..............................................    1545-0056
1.501(c)(9)-5..............................................    1545-0047
1.501(c)(17)-3.............................................    1545-0047
1.501(e)-1.................................................    1545-0814
1.501(r)-3.................................................    1545-0047
1.501(r)-4.................................................    1545-0047
1.501(r)-6.................................................    1545-0047
1.503(c)-1.................................................    1545-0047
                                                               1545-0052
1.505(c)-1T................................................    1545-0916
1.506-1....................................................    1545-2268
1.507-1....................................................    1545-0052
1.507-2....................................................    1545-0052
1.508-1....................................................    1545-0052
                                                               1545-0056
1.509(a)-3.................................................    1545-0047
1.509(a)-4.................................................    1545-2157
1.509(a)-5.................................................    1545-0047
1.509(c)-1.................................................    1545-0052
1.512(a)-1.................................................    1545-0687
1.512(a)-4.................................................    1545-0047
                                                               1545-0687
1.521-1....................................................    1545-0051
                                                               1545-0058
1.527-2....................................................    1545-0129
1.527-5....................................................    1545-0129
1.527-6....................................................    1545-0129
1.527-9....................................................    1545-0129
1.528-8....................................................    1545-0127
1.529A-2...................................................    1545-2293
1.529A-5...................................................    1545-2262
1.529A-6...................................................    1545-2262
1.529A-7...................................................    1545-2262
1.533-2....................................................    1545-0123
1.534-2....................................................    1545-0123
1.542-3....................................................    1545-0123
1.545-2....................................................    1545-0123
1.545-3....................................................    1545-0123
1.547-2....................................................    1545-0045
                                                               1545-0123
1.547-3....................................................    1545-0123
1.561-1....................................................    1545-0044
1.561-2....................................................    1545-0123
1.562-3....................................................    1545-0123
1.563-2....................................................    1545-0123
1.564-1....................................................    1545-0123
1.565-1....................................................    1545-0043
                                                               1545-0123
1.565-2....................................................    1545-0043
1.565-3....................................................    1545-0043
1.565-5....................................................    1545-0043
1.565-6....................................................    1545-0043
1.585-1....................................................    1545-0123
1.585-3....................................................    1545-0123
1.585-8....................................................    1545-1290
1.597-2....................................................    1545-1300
1.597-4....................................................    1545-1300
1.597-6....................................................    1545-1300
1.597-7....................................................    1545-1300
1.611-2....................................................    1545-0099
1.611-3....................................................    1545-0007
                                                               1545-0099
                                                               1545-1784
1.612-4....................................................    1545-0074
1.612-5....................................................    1545-0099
1.613-3....................................................    1545-0099
1.613-4....................................................    1545-0099
1.613-6....................................................    1545-0099
1.613-7....................................................    1545-0099
1.613A-3...................................................    1545-0919
1.613A-3(e)................................................    1545-1251
1.613A-3(l)................................................    1545-0919
1.613A-5...................................................    1545-0099
1.613A-6...................................................    1545-0099
1.614-2....................................................    1545-0099
1.614-3....................................................    1545-0099
1.614-5....................................................    1545-0099
1.614-6....................................................    1545-0099
1.614-8....................................................    1545-0099
1.617-1....................................................    1545-0099

[[Page 836]]

 
1.617-3....................................................    1545-0099
1.617-4....................................................    1545-0099
1.631-1....................................................    1545-0007
1.631-2....................................................    1545-0007
1.641(b)-2.................................................    1545-0092
1.642(c)-1.................................................    1545-0092
1.642(c)-2.................................................    1545-0092
1.642(c)-5.................................................    1545-0074
1.642(c)-6.................................................    1545-0020
                                                               1545-0074
                                                               1545-0092
1.642(g)-1.................................................    1545-0092
1.642(i)-1.................................................    1545-0092
1.645-1....................................................    1545-1578
1.663(b)-2.................................................    1545-0092
1.664-1....................................................    1545-0196
1.664-1(a)(7)..............................................    1545-1536
1.664-1(c).................................................    1545-2101
1.664-2....................................................    1545-0196
1.664-3....................................................    1545-0196
1.664-4....................................................    1545-0020
                                                               1545-0196
1.665(a)-0A through
1.665(g)-2A................................................    1545-0192
1.666(d)-1A................................................    1545-0092
1.671-4....................................................    1545-1442
1.671-5....................................................    1545-1540
1.701-1....................................................    1545-0099
1.702-1....................................................    1545-0074
1.703-1....................................................    1545-0099
1.704-2....................................................    1545-1090
1.706-1....................................................    1545-0074
                                                               1545-0099
                                                               1545-0134
1.706-1T...................................................    1545-0099
1.706-4(f).................................................    1545-0123
1.707-3(c)(2)..............................................    1545-1243
1.707-5(a)(7)(ii)..........................................    1545-1243
1.707-6(c).................................................    1545-1243
1.707-8....................................................    1545-1243
1.708-1....................................................    1545-0099
1.732-1....................................................    1545-0099
                                                               1545-1588
1.736-1....................................................    1545-0074
1.743-1....................................................    1545-0074
                                                               1545-1588
1.751-1....................................................    1545-0074
                                                               1545-0099
                                                               1545-0941
1.752-2....................................................    1545-1905
1.752-5....................................................    1545-1090
1.752-7....................................................    1545-1843
1.754-1....................................................    1545-0099
1.755-1....................................................    1545-0099
1.761-2....................................................    1545-1338
1.801-1....................................................    1545-0123
                                                               1545-0128
1.801-3....................................................    1545-0123
1.801-5....................................................    1545-0128
1.801-8....................................................    1545-0128
1.804-4....................................................    1545-0128
1.811-2....................................................    1545-0128
1.812-2....................................................    1545-0128
1.815-6....................................................    1545-0128
1.818-4....................................................    1545-0128
1.818-5....................................................    1545-0128
1.818-8....................................................    1545-0128
1.819-2....................................................    1545-0128
1.822-5....................................................    1545-1027
1.822-6....................................................    1545-1027
1.822-8....................................................    1545-1027
1.822-9....................................................    1545-1027
1.826-1....................................................    1545-1027
1.826-2....................................................    1545-1027
1.826-3....................................................    1545-1027
1.826-4....................................................    1545-1027
1.826-6....................................................    1545-1027
1.831-3....................................................    1545-0123
1.832-4....................................................    1545-1227
1.832-5....................................................    1545-0123
1.848-2(g)(8)..............................................    1545-1287
1.848-2(h)(3)..............................................    1545-1287
1.848-2(i)(4)..............................................    1545-1287
1.851-2....................................................    1545-1010
1.851-4....................................................    1545-0123
1.852-1....................................................    1545-0123
1.852-4....................................................    1545-0123
                                                               1545-0145
1.852-6....................................................    1545-0123
                                                               1545-0144
1.852-7....................................................    1545-0074
1.852-9....................................................    1545-0074
                                                               1545-0123
                                                               1545-0144
                                                               1545-0145
                                                               1545-1783
1.852-11...................................................    1545-1094
1.853-3....................................................    1545-2035
1.853-4....................................................    1545-2035
1.854-2....................................................    1545-0123
1.855-1....................................................    1545-0123
1.856-2....................................................    1545-0123
                                                               1545-1004
1.856-6....................................................    1545-0123
1.856-7....................................................    1545-0123
1.856-8....................................................    1545-0123
1.857-8....................................................    1545-0123
1.857-9....................................................    1545-0074
1.858-1....................................................    1545-0123
1.860-2....................................................    1545-0045
1.860-4....................................................    1545-0045
                                                               1545-1054
                                                               1545-1057
1.860E-1...................................................    1545-1675
1.860E-2(a)(5).............................................    1545-1276
1.860E-2(a)(7).............................................    1545-1276
1.860E-2(b)(2).............................................    1545-1276
1.860G-2...................................................    1545-2110
1.861-2....................................................    1545-0089
1.861-3....................................................    1545-0089
1.861-4....................................................    1545-1900
1.861-8....................................................    1545-0126
1.861-8(e)(6) and (g)......................................    1545-1224
1.861-9T...................................................    1545-0121
                                                               1545-1072
1.861-18...................................................    1545-1594
1.863-1....................................................    1545-1476
1.863-3....................................................    1545-1476
                                                               1545-1556
1.863-3A...................................................    1545-0126
1.863-4....................................................    1545-0126
1.863-7....................................................    1545-0132
1.863-8....................................................    1545-1718
1.863-9....................................................    1545-1718
1.864-4....................................................    1545-0126
1.871-1....................................................    1545-0096
1.871-6....................................................    1545-0795
1.871-7....................................................    1545-0089
1.871-10...................................................    1545-0089
                                                               1545-0165
1.874-1....................................................    1545-0089
1.881-4....................................................    1545-1440
1.882-4....................................................    1545-0126
1.883-0....................................................    1545-1677

[[Page 837]]

 
1.883-1....................................................    1545-1677
1.883-2....................................................    1545-1677
1.883-3....................................................    1545-1677
1.883-4....................................................    1545-1677
1.883-5....................................................    1545-1677
1.884-0....................................................    1545-1070
1.884-1....................................................    1545-1070
1.884-2....................................................    1545-1070
1.884-2T...................................................    1545-0126
                                                               1545-1070
1.884-4....................................................    1545-1070
1.884-5....................................................    1545-1070
1.892-1T...................................................    1545-1053
1.892-2T...................................................    1545-1053
1.892-3T...................................................    1545-1053
1.892-4T...................................................    1545-1053
1.892-5T...................................................    1545-1053
1.892-6T...................................................    1545-1053
1.892-7T...................................................    1545-1053
1.897-2....................................................    1545-0123
                                                               1545-0902
1.897-3....................................................    1545-0123
1.897-5T...................................................    1545-0902
1.897-6T...................................................    1545-0902
1.901-2....................................................    1545-0746
1.901-2A...................................................    1545-0746
1.901-3....................................................    1545-0122
1.902-1....................................................    1545-0122
                                                               1545-1458
1.904-1....................................................    1545-0121
                                                               1545-0122
1.904-2....................................................    1545-0121
                                                               1545-0122
1.904-3....................................................    1545-0121
1.904-4....................................................    1545-0121
1.904-5....................................................    1545-0121
1.904-7....................................................    1545-2104
1.904-7T...................................................    1545-2104
1.904(f)-1.................................................    1545-0121
                                                               1545-0122
1.904(f)-2.................................................    1545-0121
1.904(f)-3.................................................    1545-0121
1.904(f)-4.................................................    1545-0121
1.904(f)-5.................................................    1545-0121
1.904(f)-6.................................................    1545-0121
1.904(f)-7.................................................    1545-1127
1.905-2....................................................    1545-0122
1.905-3T...................................................    1545-1056
1.905-4T...................................................    1545-1056
1.905-5T...................................................    1545-1056
1.911-1....................................................    1545-0067
                                                               1545-0070
1.911-2....................................................    1545-0067
                                                               1545-0070
1.911-3....................................................    1545-0067
                                                               1545-0070
1.911-4....................................................    1545-0067
                                                               1545-0070
1.911-5....................................................    1545-0067
                                                               1545-0070
1.911-6....................................................    1545-0067
                                                               1545-0070
1.911-7....................................................    1545-0067
                                                               1545-0070
1.913-13...................................................    1545-0067
1.921-1T...................................................    1545-0190
                                                               1545-0884
                                                               1545-0935
                                                               1545-0939
1.921-2....................................................    1545-0884
1.927(a)-1T................................................    1545-0935
1.927(d)-2T................................................    1545-0935
1.931-1....................................................    1545-0074
                                                               1545-0123
1.934-1....................................................    1545-0782
1.935-1....................................................    1545-0074
                                                               1545-0087
                                                               1545-0803
1.936-1....................................................    1545-0215
                                                               1545-0217
1.936-4....................................................    1545-0215
1.936-5....................................................    1545-0704
1.936-6....................................................    1545-0215
1.936-7....................................................    1545-0215
1.936-10(c)................................................    1545-1138
1.937-1....................................................    1545-1930
1.952-2....................................................    1545-0126
1.953-2....................................................    1545-0126
1.954-1....................................................    1545-1068
1.954-2....................................................    1545-1068
1.955-2....................................................    1545-0123
1.955-3....................................................    1545-0123
1.955A-2...................................................    1545-0755
1.955A-3...................................................    1545-0755
1.956-1....................................................    1545-0704
1.956-2....................................................    1545-0704
1.959-1....................................................    1545-0704
1.959-2....................................................    1545-0704
1.960-1....................................................    1545-0122
1.962-2....................................................    1545-0704
1.962-3....................................................    1545-0704
1.964-1....................................................    1545-0126
                                                               1545-0704
                                                               1545-1072
                                                               1545-2104
1.964-3....................................................    1545-0126
1.970-2....................................................    1545-0126
1.985-2....................................................    1545-1051
                                                               1545-1131
1.985-3....................................................    1545-1051
1.987-1....................................................    1545-2265
1.987-3....................................................    1545-2265
1.987-9....................................................    1545-2265
1.987-10...................................................    1545-2265
1.988-0....................................................    1545-1131
1.988-1....................................................    1545-1131
1.988-2....................................................    1545-1131
1.988-3....................................................    1545-1131
1.988-4....................................................    1545-1131
1.988-5....................................................    1545-1131
1.988-6....................................................    1545-1831
1.992-1....................................................    1545-0190
                                                               1545-0938
1.992-2....................................................    1545-0190
                                                               1545-0884
                                                               1545-0938
1.992-3....................................................    1545-0190
                                                               1545-0938
1.992-4....................................................    1545-0190
                                                               1545-0938
1.993-3....................................................    1545-0938
1.993-4....................................................    1545-0938
1.994-1....................................................    1545-0938
1.995-5....................................................    1545-0938
1.1001-1...................................................    1545-1902
1.1012-1...................................................    1545-0074
                                                               1545-1139
1.1014-4...................................................    1545-0184
1.1015-1...................................................    1545-0020
1.1017-1...................................................    1545-1539
1.1031(d)-1T...............................................    1545-1021
1.1033(a)-2................................................    1545-0184
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1.1042-1T..................................................    1545-0916
1.1044(a)-1................................................    1545-1421
1.1045-1...................................................    1545-1893
1.1060-1...................................................    1545-1658
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1.1092(b)-1T...............................................    1545-0644
1.1092(b)-2T...............................................    1545-0644
1.1092(b)-3T...............................................    1545-0644
1.1092(b)-4T...............................................    1545-0644
1.1092(b)-5T...............................................    1545-0644
1.1211-1...................................................    1545-0074
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1.1221-2...................................................    1545-1480
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1.1242-1...................................................    1545-0184
1.1243-1...................................................    1545-0123
1.1244(e)-1................................................    1545-0123
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1.1245-2...................................................    1545-0184
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1.1245-6...................................................    1545-0184
1.1248-7...................................................    1545-0074
1.1248(f)-2................................................    1545-2183
1.1248(f)-3T...............................................    1545-2183
1.1250-1...................................................    1545-0184
1.1250-2...................................................    1545-0184
1.1250-3...................................................    1545-0184
1.1250-4...................................................    1545-0184
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1.1252-1...................................................    1545-0184
1.1252-2...................................................    1545-0184
1.1254-1(c)(3).............................................    1545-1352
1.1254-4...................................................    1545-1493
1.1254-5(d)(2).............................................    1545-1352
1.1258-1...................................................    1545-1452
1.1272-3...................................................    1545-1353
1.1273-2(f)(9).............................................    1545-1353
1.1273-2(h)(2).............................................    1545-1353
1.1274-3(d)................................................    1545-1353
1.1274-5(b)................................................    1545-1353
1.1274A-1(c)...............................................    1545-1353
1.1275-2...................................................    1545-1450
1.1275-3...................................................    1545-0887
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1.1275-4...................................................    1545-1450
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1.1287-1...................................................    1545-0786
1.1291-9...................................................    1545-1507
1.1291-10..................................................    1545-1304
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1.1294-1T..................................................    1545-1002
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1.1295-1...................................................    1545-1555
1.1295-3...................................................    1545-1555
1.1298-3...................................................    1545-1507
1.1301-1...................................................    1545-1662
1.1311(a)-1................................................    1545-0074
1.1361-1...................................................    1545-0731
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1.1362-8...................................................    1545-1590
1.1363-2...................................................    1545-1906
1.1366-1...................................................    1545-1613
1.1367-1(f)................................................    1545-1139
1.1368-1(f)(2).............................................    1545-1139
1.1368-1(f)(3).............................................    1545-1139
1.1368-1(f)(4).............................................    1545-1139
1.1368-1(g)(2).............................................    1545-1139
1.1374-1A..................................................    1545-0130
1.1377-1...................................................    1545-1462
1.1378-1...................................................    1545-1748
1.1383-1...................................................    1545-0074
1.1385-1...................................................    1545-0074
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1.1397E-1..................................................    1545-1908
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1.1398-2...................................................    1545-1375
1.1402(a)-2................................................    1545-0074
1.1402(a)-5................................................    1545-0074
1.1402(a)-11...............................................    1545-0074
1.1402(a)-15...............................................    1545-0074
1.1402(a)-16...............................................    1545-0074
1.1402(b)-1................................................    1545-0171
1.1402(c)-2................................................    1545-0074
1.1402(e)(1)-1.............................................    1545-0074
1.1402(e)(2)-1.............................................    1545-0074
1.1402(e)-1A...............................................    1545-0168
1.1402(e)-2A...............................................    1545-0168
1.1402(e)-3A...............................................    1545-0168
1.1402(e)-4A...............................................    1545-0168
1.1402(e)-5A...............................................    1545-0168
1.1402(f)-1................................................    1545-0074
1.1402(h)-1................................................    1545-0064
1.1411-10(g)...............................................    1545-2227
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1.1441-3...................................................    1545-0165
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1.1445-9T..................................................    1545-0902
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1.1502-9A..................................................    1545-0121
1.1502-13..................................................    1545-0123
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1.1502-21..................................................    1545-1237
1.1502.21T.................................................    1545-0123
1.1502-31..................................................    1545-1344
1.1502-32..................................................    1545-1344
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1.1502-33..................................................    1545-1344
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1.1502-75..................................................    1545-0025
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1.1502-76..................................................    1545-1344
1.1502-76T.................................................    1545-2019
1.1502-77..................................................    1545-1699
1.1502-77A.................................................    1545-0123
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1.1502-77B.................................................    1545-1699
1.1502-78..................................................    1545-0582
1.1502-95..................................................    1545-1218
1.1502-95A.................................................    1545-1218
1.1502-96..................................................    1545-1218
1.1503-2...................................................    1545-1583
1.1503-2A..................................................    1545-1083
1.1503(d)-1................................................    1545-1946
1.1503(d)-3................................................    1545-1946
1.1503(d)-4................................................    1545-1946
1.1503(d)-5................................................    1545-1946
1.1503(d)-6................................................    1545-1946
1.1552-1...................................................    1545-0123
1.1561-3...................................................    1545-0123
1.1563-1...................................................    1545-0123
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1.1563-3...................................................    1545-0123
1.5000A-3..................................................    1545-0074
1.5000A-4..................................................    1545-0074
1.5000C-2..................................................    1545-0096
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1.5000C-3..................................................    1545-0096
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1.5000C-4..................................................    1545-1223
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1.6001-1...................................................    1545-0058
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1.6011-2...................................................    1545-0055
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1.6011-3...................................................    1545-0238
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1.6011-4...................................................    1545-1685
1.6012-1...................................................    1545-0067
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1.6012-2...................................................    1545-0047
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1.6012-3...................................................    1545-0047
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1.6013-6...................................................    1545-0074
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1.6015-5...................................................    1545-1719
1.6015(a)-1................................................    1545-0087
1.6015(b)-1................................................    1545-0087
1.6015(d)-1................................................    1545-0087
1.6015(e)-1................................................    1545-0087
1.6015(f)-1................................................    1545-0087
1.6015(g)-1................................................    1545-0087
1.6015(h)-1................................................    1545-0087
1.6015(i)-1................................................    1545-0087
1.6017-1...................................................    1545-0074
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1.6031(a)-1................................................    1545-1583
1.6031(b)-1T...............................................    1545-0099
1.6031(c)-1T...............................................    1545-0099
1.6032-1...................................................    1545-0099
1.6033-2...................................................    1545-0047
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1.6033-3...................................................    1545-0052
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1.6035-2...................................................    1545-0704
1.6037-1...................................................    1545-0130
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1.6038-2...................................................    1545-1617
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1.6038-3...................................................    1545-1617
1.6038A-2..................................................    1545-1191
1.6038A-3..................................................    1545-1191
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1.6038B-1..................................................    1545-1617
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1.6038B-1T.................................................    1545-0026
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1.6038B-2..................................................    1545-1617
1.6039-2...................................................    1545-0820
1.6041-1...................................................    1545-0008
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1.6041-2...................................................    1545-0008
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1.6041-3...................................................    1545-1148
1.6041-4...................................................    1545-0115
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1.6041-6...................................................    1545-0008
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1.6045-1...................................................    1545-0715
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1.6045-1(c)(3)(xi)(C)......................................    1545-2186
1.6045-1(n)(5).............................................    1545-2186
1.6045A-1..................................................    1545-2186
1.6045-2...................................................    1545-0115
1.6045-4...................................................    1545-1085
1.6046-1...................................................    1545-0704
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1.6046-2...................................................    1545-0704
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1.6046A....................................................    1545-1646
1.6047-1...................................................    1545-0119
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1.6047-2...................................................    1545-2234
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1.6050A-1..................................................    1545-0115
1.6050B-1..................................................    1545-0120
1.6050D-1..................................................    1545-0120
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1.6050E-1..................................................    1545-0120
1.6050H-1..................................................    1545-0901
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1.6050H-2..................................................    1545-0901
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1.6050I-2..................................................    1545-1449
1.6050J-1T.................................................    1545-0877
1.6050K-1..................................................    1545-0941
1.6050S-1..................................................    1545-1678
1.6050S-2..................................................    1545-1729
1.6050S-3..................................................    1545-1678
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1.6655(e)-1................................................    1545-1421
1.6662-3(c)................................................    1545-0889
1.6662-4(e) and (f)........................................    1545-0889
1.6662-6...................................................    1545-1426
1.6694-1...................................................    1545-0074
1.6694-2...................................................    1545-0074
1.6694-2(c)................................................    1545-1231
1.6694-2(c)(3).............................................    1545-1231
1.6694-3(e)................................................    1545-1231
1.6695-1...................................................    1545-0074
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1.6851-2...................................................    1545-0086
                                                               1545-0138
1.7476-1...................................................    1545-0197
1.7476-2...................................................    1545-0197
1.7519-2T..................................................    1545-1036
1.7520-1...................................................    1545-1343
1.7520-2...................................................    1545-1343
1.7520-3...................................................    1545-1343
1.7520-4...................................................    1545-1343
1.7701(l)-3................................................    1545-1642
1.7872-15..................................................    1545-1792
1.9100-1...................................................    1545-0074
1.9101-1...................................................    1545-0008
2.1-4......................................................    1545-0123
2.1-5......................................................    1545-0123
2.1-6......................................................    1545-0123
2.1-10.....................................................    1545-0123
2.1-11.....................................................    1545-0123
2.1-12.....................................................    1545-0123
2.1-13.....................................................    1545-0123
2.1-20.....................................................    1545-0123
2.1-22.....................................................    1545-0123
2.1-26.....................................................    1545-0123
3.2........................................................    1545-0123
4.954-1....................................................    1545-1068
4.954-2....................................................    1545-1068
5.6411-1...................................................    1545-0042
                                                               1545-0074
                                                               1545-0098
                                                               1545-0129
                                                               1545-0172
                                                               1545-0582
                                                               1545-0619
5c.44F-1...................................................    1545-0619
5c.128-1...................................................    1545-0123

[[Page 842]]

 
5c.305-1...................................................    1545-0110
5c.442-1...................................................    1545-0152
5f.103-1...................................................    1545-0720
5f.6045-1..................................................    1545-0715
6a.103A-2..................................................    1545-0123
                                                               1545-0720
6a.103A-3..................................................    1545-0720
7.465-1....................................................    1545-0712
7.465-2....................................................    1545-0712
7.465-3....................................................    1545-0712
7.465-4....................................................    1545-0712
7.465-5....................................................    1545-0712
7.936-1....................................................    1545-0217
7.999-1....................................................    1545-0216
7.6039A-1..................................................    1545-0015
7.6041-1...................................................    1545-0115
11.410-1...................................................    1545-0710
11.412(c)-7................................................    1545-0710
11.412(c)-11...............................................    1545-0710
12.7.......................................................    1545-0190
12.8.......................................................    1545-0191
12.9.......................................................    1545-0195
14a.422A-1.................................................    1545-0123
15A.453-1..................................................    1545-0228
16A.126-2..................................................    1545-0074
16A.1255-1.................................................    1545-0184
16A.1255-2.................................................    1545-0184
18.1371-1..................................................    1545-0130
18.1378-1..................................................    1545-0130
18.1379-1..................................................    1545-0130
18.1379-2..................................................    1545-0130
20.2010-2..................................................    1545-0015
20.2011-1..................................................    1545-0015
20.2014-5..................................................    1545-0015
                                                               1545-0260
20.2014-6..................................................    1545-0015
20.2016-1..................................................    1545-0015
20.2031-2..................................................    1545-0015
20.2031-3..................................................    1545-0015
20.2031-4..................................................    1545-0015
20.2031-6..................................................    1545-0015
20.2031-7..................................................    1545-0020
20.2031-10.................................................    1545-0015
20.2032-1..................................................    1545-0015
20.2032A-3.................................................    1545-0015
20.2032A-4.................................................    1545-0015
20.2032A-8.................................................    1545-0015
20.2039-4..................................................    1545-0015
20.2051-1..................................................    1545-0015
20.2053-3..................................................    1545-0015
20.2053-9..................................................    1545-0015
20.2053-10.................................................    1545-0015
20.2055-1..................................................    1545-0015
20.2055-2..................................................    1545-0015
                                                               1545-0092
20.2055-3..................................................    1545-0015
20.2056(b)-4...............................................    1545-0015
20.2056(b)-7...............................................    1545-0015
                                                               1545-1612
20.2056A-2.................................................    1545-1443
20.2056A-3.................................................    1545-1360
20.2056A-4.................................................    1545-1360
20.2056A-10................................................    1545-1360
20.2106-1..................................................    1545-0015
20.2106-2..................................................    1545-0015
20.2204-1..................................................    1545-0015
20.2204-2..................................................    1545-0015
20.6001-1..................................................    1545-0015
20.6011-1..................................................    1545-0015
20.6018-1..................................................    1545-0015
                                                               1545-0531
20.6018-2..................................................    1545-0015
20.6018-3..................................................    1545-0015
20.6018-4..................................................    1545-0015
                                                               1545-0022
20.6036-2..................................................    1545-0015
20.6060-1(a)(1)............................................    1545-1231
20.6061-1..................................................    1545-0015
20.6065-1..................................................    1545-0015
20.6075-1..................................................    1545-0015
20.6081-1..................................................    1545-0015
                                                               1545-0181
                                                               1545-1707
20.6091-1..................................................    1545-0015
20.6107-1..................................................    1545-1231
20.6161-1..................................................    1545-0015
                                                               1545-0181
20.6161-2..................................................    1545-0015
                                                               1545-0181
20.6163-1..................................................    1545-0015
20.6166-1..................................................    1545-0181
20.6166A-1.................................................    1545-0015
20.6166A-3.................................................    1545-0015
20.6324A-1.................................................    1545-0754
20.7520-1..................................................    1545-1343
20.7520-2..................................................    1545-1343
20.7520-3..................................................    1545-1343
20.7520-4..................................................    1545-1343
22.0.......................................................    1545-0015
25.2511-2..................................................    1545-0020
25.2512-2..................................................    1545-0020
25.2512-3..................................................    1545-0020
25.2512-5..................................................    1545-0020
25.2512-9..................................................    1545-0020
25.2513-1..................................................    1545-0020
25.2513-2..................................................    1545-0020
                                                               1545-0021
25.2513-3..................................................    1545-0020
25.2518-2..................................................    1545-0959
25.2522(a)-1...............................................    1545-0196
25.2522(c)-3...............................................    1545-0020
                                                               1545-0196
25.2523(a)-1...............................................    1545-0020
                                                               1545-0196
25.2523(f)-1...............................................    1545-0015
25.2701-2..................................................    1545-1241
25.2701-4..................................................    1545-1241
25.2701-5..................................................    1545-1273
25.2702-5..................................................    1545-1485
25.2702-6..................................................    1545-1273
25.6001-1..................................................    1545-0020
                                                               1545-0022
25.6011-1..................................................    1545-0020
25.6019-1..................................................    1545-0020
25.6019-2..................................................    1545-0020
25.6019-3..................................................    1545-0020
25.6019-4..................................................    1545-0020
25.6060-1(a)(1)............................................    1545-1231
25.6061-1..................................................    1545-0020
25.6065-1..................................................    1545-0020
25.6075-1..................................................    1545-0020
25.6081-1..................................................    1545-0020
25.6091-1..................................................    1545-0020
25.6091-2..................................................    1545-0020
25.6107-1..................................................    1545-1231
25.6151-1..................................................    1545-0020
25.6161-1..................................................    1545-0020
25.7520-1..................................................    1545-1343
25.7520-2..................................................    1545-1343
25.7520-3..................................................    1545-1343
25.7520-4..................................................    1545-1343
26.2601-1..................................................    1545-0985
26.2632-1..................................................    1545-0985
                                                               1545-1892

[[Page 843]]

 
26.2642-1..................................................    1545-0985
26.2642-2..................................................    1545-0985
26.2642-3..................................................    1545-0985
26.2642-4..................................................    1545-0985
26.2642-6..................................................    1545-1902
26.2652-2..................................................    1545-0985
26.2654-1..................................................    1545-1902
26.2662-1..................................................    1545-0015
                                                               1545-0985
26.2662-2..................................................    1545-0985
26.6060-1(a)(1)............................................    1545-1231
26.6107-1..................................................    1545-1231
31.3102-3..................................................    1545-0029
                                                               1545-0059
                                                               1545-0065
31.3121(b)(19)-1...........................................    1545-0029
31.3121(d)-1...............................................    1545-0004
31.3121(i)-1...............................................    1545-0034
31.3121(r)-1...............................................    1545-0029
31.3121(s)-1...............................................    1545-0029
31.3121(v)(2)-1............................................    1545-1643
31.3302(a)-2...............................................    1545-0028
31.3302(a)-3...............................................    1545-0028
31.3302(b)-2...............................................    1545-0028
31.3302(e)-1...............................................    1545-0028
31.3306(c)(18)-1...........................................    1545-0029
31.3401(a)-1...............................................    1545-0029
31.3401(a)(6)..............................................    1545-1484
31.3401(a)(6)-1............................................    1545-0029
                                                               1545-0096
                                                               1545-0795
31.3401(a)(7)-1............................................    1545-0029
31.3401(a)(8)(A)-1 ........................................    1545-0029
                                                               1545-0666
31.3401(a)(8)(C)-1 ........................................    1545-0029
31.3401(a)(15)-1...........................................    1545-0182
31.3401(c)-1...............................................    1545-0004
31.3402(b)-1...............................................    1545-0010
31.3402(c)-1...............................................    1545-0010
31.3402(f)(1)-1............................................    1545-0010
31.3402(f)(2)-1............................................    1545-0010
                                                               1545-0410
31.3402(f)(3)-1............................................    1545-0010
31.3402(f)(4)-1............................................    1545-0010
31.3402(f)(4)-2............................................    1545-0010
31.3402(f)(5)-1............................................    1545-0010
                                                               1545-1435
31.3402(h)(1)-1............................................    1545-0029
31.3402(h)(3)-1............................................    1545-0010
                                                               1545-0029
31.3402(h)(4)-1............................................    1545-0010
31.3402(i)-(1).............................................    1545-0010
31.3402(i)-(2).............................................    1545-0010
31.3402(k)-1...............................................    1545-0065
31.3402(l)-(1).............................................    1545-0010
31.3402(m)-(1).............................................    1545-0010
31.3402(n)-(1).............................................    1545-0010
31.3402(o)-2...............................................    1545-0415
31.3402(o)-3...............................................    1545-0008
                                                               1545-0010
                                                               1545-0415
                                                               1545-0717
31.3402(p)-1...............................................    1545-0415
                                                               1545-0717
31.3402(q)-1...............................................    1545-0238
                                                               1545-0239
31.3404-1..................................................    1545-0029
31.3405(c)-1...............................................    1545-1341
31.3406(a)-1...............................................    1545-0112
31.3406(a)-2...............................................    1545-0112
31.3406(a)-3...............................................    1545-0112
31.3406(a)-4...............................................    1545-0112
31.3406(b)(2)-1............................................    1545-0112
31.3406(b)(2)-2............................................    1545-0112
31.3406(b)(2)-3............................................    1545-0112
31.3406(b)(2)-4............................................    1545-0112
31.3406(b)(2)-5............................................    1545-0112
31.3406(b)(3)-1............................................    1545-0112
31.3406(b)(3)-2............................................    1545-0112
31.3406(b)(3)-3............................................    1545-0112
31.3406(b)(3)-4............................................    1545-0112
31.3406(b)(4)-1............................................    1545-0112
31.3406(c)-1...............................................    1545-0112
31.3406(d)-1...............................................    1545-0112
31.3406(d)-2...............................................    1545-0112
31.3406(d)-3...............................................    1545-0112
31.3406(d)-4...............................................    1545-0112
31.3406(d)-5...............................................    1545-0112
31.3406(e)-1...............................................    1545-0112
31.3406(f)-1...............................................    1545-0112
31.3406(g)-1...............................................    1545-0096
                                                               1545-0112
                                                               1545-1819
31.3406(g)-2...............................................    1545-0112
31.3406(g)-3...............................................    1545-0112
31.3406(h)-1...............................................    1545-0112
31.3406(h)-2...............................................    1545-0112
31.3406(h)-3...............................................    1545-0112
31.3406(i)-1...............................................    1545-0112
31.3501(a)-1T..............................................    1545-0771
31.3503-1..................................................    1545-0024
31.3504-1..................................................    1545-0029
31.3511-1..................................................    1545-2266
31.6001-1..................................................    1545-0798
31.6001-2..................................................    1545-0034
                                                               1545-0798
31.6001-3..................................................    1545-0798
31.6001-4..................................................    1545-0028
31.6001-5..................................................    1545-0798
31.6001-6..................................................    1545-0029
                                                               1459-0798
31.6011(a)-1...............................................    1545-0029
                                                               1545-0034
                                                               1545-0035
                                                               1545-0059
                                                               1545-0074
                                                               1545-0256
                                                               1545-0718
                                                               1545-2097
31.6011(a)-2...............................................    1545-0001
                                                               1545-0002
31.6011(a)-3...............................................    1545-0028
31.6011(a)-3A..............................................    1545-0955
31.6011(a)-4...............................................    1545-0034
                                                               1545-0035
                                                               1545-0718
                                                               1545-1413
                                                               1545-2097
31.6011(a)-5...............................................    1545-0028
                                                               1545-0718
                                                               1545-2097
31.6011(a)-6...............................................    1545-0028
31.6011(a)-7...............................................    1545-0074
31.6011(a)-8...............................................    1545-0028
31.6011(a)-9...............................................    1545-0028
31.6011(a)-10..............................................    1545-0112
31.6011(b)-1...............................................    1545-0003
31.6011(b)-2...............................................    1545-0029
31.6051-1..................................................    1545-0008
                                                               1545-0182
                                                               1545-0458
                                                               1545-1729
31.6051-2..................................................    1545-0008
31.6051-3..................................................    1545-0008

[[Page 844]]

 
31.6053-1..................................................    1545-0029
                                                               1545-0062
                                                               1545-0064
                                                               1545-0065
                                                               1545-1603
31.6053-2..................................................    1545-0008
31.6053-3..................................................    1545-0065
                                                               1545-0714
31.6053-4..................................................    1545-0065
                                                               1545-1603
31.6060-1(a)(1)............................................    1545-1231
31.6065(a)-1...............................................    1545-0029
31.6071(a)-1...............................................    1545-0001
                                                               1545-0028
                                                               1545-0029
31.6071(a)-1A..............................................    1545-0955
31.6081(a)-1...............................................    1545-0008
                                                               1545-0028
31.6091-1..................................................    1545-0028
                                                               1545-0029
31.6107-1..................................................    1545-1231
31.6157-1..................................................    1545-0955
31.6205-1..................................................    1545-0029
                                                               1545-2097
31.6301(c)-1AT.............................................    1545-0035
                                                               1545-0112
                                                               1545-0257
31.6302-1..................................................    1545-1413
31.6302-2..................................................    1545-1413
31.6302-3..................................................    1545-1413
31.6302-4..................................................    1545-1413
31.6302(c)-2...............................................    1545-0001
                                                               1545-0257
31.6302(c)-2A..............................................    1545-0955
31.6302(c)-3...............................................    1545-0257
31.6402(a)-2...............................................    1545-0256
                                                               1545-2097
31.6413(a)-1...............................................    1545-0029
                                                               1545-2097
31.6413(a)-2...............................................    1545-0029
                                                               1545-0256
                                                               1545-2097
31.6413(c)-1...............................................    1545-0029
                                                               1545-0171
31.6414-1..................................................    1545-0029
                                                               1545-2097
32.1.......................................................    1545-0029
                                                               1545-0415
32.2.......................................................    1545-0029
35a.3406-2.................................................    1545-0112
35a.9999-5.................................................    1545-0029
36.3121(l)(1)-1............................................    1545-0137
36.3121(l)(1)-2............................................    1545-0137
36.3121(l)(3)-1............................................    1545-0123
36.3121(1)(7)-1............................................    1545-0123
36.3121(1)(10)-1...........................................    1545-0029
36.3121(1)(10)-3...........................................    1545-0029
36.3121(1)(10)-4...........................................    1545-0257
40.6060-1(a)(1)............................................    1545-1231
40.6107-1..................................................    1545-1231
40.6302(c)-3(b)(2)(ii).....................................    1545-1296
40.6302(c)-3(b)(2)(iii)....................................    1545-1296
40.6302(c)-3(e)............................................    1545-1296
40.6302(c)-3(f)(2)(ii).....................................    1545-1296
41.4481-1..................................................    1545-0143
41.4481-2..................................................    1545-0143
41.4483-3..................................................    1545-0143
41.6001-1..................................................    1545-0143
41.6001-2..................................................    1545-0143
41.6001-3..................................................    1545-0143
41.6060-1(a)(1)............................................    1545-1231
41.6071(a)-1...............................................    1545-0143
41.6081(a)-1...............................................    1545-0143
41.6091-1..................................................    1545-0143
41.6107-1..................................................    1545-1231
41.6109-1..................................................    1545-0143
41.6151(a)-1...............................................    1545-0143
41.6156-1..................................................    1545-0143
41.6161(a)(1)-1............................................    1545-0143
44.4401-1..................................................    1545-0235
44.4403-1..................................................    1545-0235
44.4412-1..................................................    1545-0236
44.4901-1..................................................    1545-0236
44.4905-1..................................................    1545-0236
44.4905-2..................................................    1545-0236
44.6001-1..................................................    1545-0235
44.6011(a)-1...............................................    1545-0235
                                                               1545-0236
44.6060-1(a)(1)............................................    1545-1231
44.6071-1..................................................    1545-0235
44.6091-1..................................................    1545-0235
44.6107-1..................................................    1545-1231
44.6151-1..................................................    1545-0235
44.6419-1..................................................    1545-0235
44.6419-2..................................................    1545-0235
46.4371-4..................................................    1545-0023
46.4374-1..................................................    1545-0023
46.4375-1..................................................    1545-2238
46.4376-1..................................................    1545-2238
46.4701-1..................................................    1545-0023
                                                               1545-0257
48.4041-4..................................................    1545-0023
48.4041-5..................................................    1545-0023
48.4041-6..................................................    1545-0023
48.4041-7..................................................    1545-0023
48.4041-9..................................................    1545-0023
48.4041-10.................................................    1545-0023
48.4041-11.................................................    1545-0023
48.4041-12.................................................    1545-0023
48.4041-13.................................................    1545-0023
48.4041-19.................................................    1545-0023
48.4041-20.................................................    1545-0023
48.4041-21.................................................    1545-1270
48.4042-2..................................................    1545-0023
48.4052-1..................................................    1545-1418
48.4061(a)-1...............................................    1545-0023
48.4061(a)-2...............................................    1545-0023
48.4061(b)-3...............................................    1545-0023
48.4064-1..................................................    1545-0014
                                                               1545-0242
48.4071-1..................................................    1545-0023
48.4073-1..................................................    1545-0023
48.4073-3..................................................    1545-0023
                                                               1545-1074
                                                               1545-1087
48.4081-2..................................................    1545-1270
                                                               1545-1418
48.4081-3..................................................    1545-1270
                                                               1545-1418
                                                               1545-1897
48.4081-4(b)(2)(ii)........................................    1545-1270
48.4081-4(b)(3)(i).........................................    1545-1270
48.4081-4(c)...............................................    1545-1270
48.4081-6(c)(1)(ii)........................................    1545-1270
48.4081-7..................................................    1545-1270
                                                               1545-1418
48.4082-1T.................................................    1545-1418
48.4082-2..................................................    1545-1418
48.4082-6..................................................    1545-1418
48.4082-7..................................................    1545-1418
48.4101-1..................................................    1545-1418
48.4101-1T.................................................    1545-1418
48.4101-2..................................................    1545-1418
48.4161(a)-1...............................................    1545-0723

[[Page 845]]

 
48.4161(a)-2...............................................    1545-0723
48.4161(a)-3...............................................    1545-0723
48.4161(b)-1...............................................    1545-0723
48.4216(a)-2...............................................    1545-0023
48.4216(a)-3...............................................    1545-0023
48.4216(c)-1...............................................    1545-0023
48.4221-1..................................................    1545-0023
48.4221-2..................................................    1545-0023
48.4221-3..................................................    1545-0023
48.4221-4..................................................    1545-0023
48.4221-5..................................................    1545-0023
48.4221-6..................................................    1545-0023
48.4221-7..................................................    1545-0023
48.4222(a)-1...............................................    1545-0014
                                                               1545-0023
48.4223-1..................................................    1545-0023
                                                               1545-0257
                                                               1545-0723
48.6302(c)-1...............................................    1545-0023
                                                               1545-0257
48.6412-1..................................................    1545-0723
48.6416(a)-1...............................................    1545-0023
                                                               1545-0723
48.6416(a)-2...............................................    1545-0723
48.6416(a)-3...............................................    1545-0723
48.6416(b)(1)-1............................................    1545-0723
48.6416(b)(1)-2............................................    1545-0723
48.6416(b)(1)-3............................................    1545-0723
48.6416(b)(1)-4............................................    1545-0723
48.6416(b)(2)-1............................................    1545-0723
48.6416(b)(2)-2............................................    1545-0723
48.6416(b)(2)-3............................................    1545-0723
                                                               1545-1087
48.6416(b)(2)-4............................................    1545-0723
48.6416(b)(3)-1............................................    1545-0723
48.6416(b)(3)-2............................................    1545-0723
48.6416(b)(3)-3............................................    1545-0723
48.6416(b)(4)-1............................................    1545-0723
48.6416(b)(5)-1............................................    1545-0723
48.6416(c)-1...............................................    1545-0723
48.6416(e)-1...............................................    1545-0023
                                                               1545-0723
48.6416(f)-1...............................................    1545-0023
                                                               1545-0723
48.6416(g)-1...............................................    1545-0723
48.6416(h)-1...............................................    1545-0723
48.6420(c)-2...............................................    1545-0023
48.6420(f)-1...............................................    1545-0023
48.6420-1..................................................    1545-0162
                                                               1545-0723
48.6420-2..................................................    1545-0162
                                                               1545-0723
48.6420-3..................................................    1545-0162
                                                               1545-0723
48.6420-4..................................................    1545-0162
                                                               1545-0723
48.6420-5..................................................    1545-0162
                                                               1545-0723
48.6420-6..................................................    1545-0162
                                                               1545-0723
48.6421-0..................................................    1545-0162
                                                               1545-0723
48.6421-1..................................................    1545-0162
                                                               1545-0723
48.6421-2..................................................    1545-0162
                                                               1545-0723
48.6421-3..................................................    1545-0162
                                                               1545-0723
48.6421-4..................................................    1545-0162
                                                               1545-0723
48.6421-5..................................................    1545-0162
                                                               1545-0723
48.6421-6..................................................    1545-0162
                                                               1545-0723
48.6421-7..................................................    1545-0162
                                                               1545-0723
48.6424-0..................................................    1545-0723
48.6424-1..................................................    1545-0723
48.6424-2..................................................    1545-0723
48.6424-3..................................................    1545-0723
48.6424-4..................................................    1545-0723
48.6424-5..................................................    1545-0723
48.6424-6..................................................    1545-0723
48.6427-0..................................................    1545-0723
48.6427-1..................................................    1545-0023
                                                               1545-0162
                                                               1545-0723
48.6427-2..................................................    1545-0162
                                                               1545-0723
48.6427-3..................................................    1545-0723
48.6427-4..................................................    1545-0723
48.6427-5..................................................    1545-0723
48.6427-8..................................................    1545-1418
48.6427-9..................................................    1545-1418
48.6427-10.................................................    1545-1418
48.6427-11.................................................    1545-1418
49.4251-1..................................................    1545-1075
49.4251-2..................................................    1545-1075
49.4251-4(d)(2)............................................    1545-1628
49.4253-3..................................................    1545-0023
49.4253-4..................................................    1545-0023
49.4264(b)-1...............................................    1545-0023
                                                               1545-0224
                                                               1545-0225
                                                               1545-0226
                                                               1545-0230
                                                               1545-0257
                                                               1545-0912
49.4271-1(d)...............................................    1545-0685
49.5000B-1.................................................    1545-2177
51.2(f)(2)(ii).............................................    1545-2209
51.7.......................................................    1545-2209
52.4682-1(b)(2)(iii).......................................    1545-1153
52.4682-2(b)...............................................    1545-1153
                                                               1545-1361
52.4682-2(d)...............................................    1545-1153
                                                               1545-1361
52.4682-3(c)(2)............................................    1545-1153
52.4682-3(g)...............................................    1545-1153
52.4682-4(f)...............................................    1545-0257
                                                               1545-1153
52.4682-5(d)...............................................    1545-1361
52.4682-5(f)...............................................    1545-1361
53.4940-1..................................................    1545-0052
                                                               1545-0196
53.4942(a)-1...............................................    1545-0052
53.4942(a)-2...............................................    1545-0052
53.4942(a)-3...............................................    1545-0052
53.4942(b)-3...............................................    1545-0052
53.4945-1..................................................    1545-0052
53.4945-4..................................................    1545-0052
53.4945-5..................................................    1545-0052
53.4945-6..................................................    1545-0052
53.4947-1..................................................    1545-0196
53.4947-2..................................................    1545-0196
53.4948-1..................................................    1545-0052
53.4958-6..................................................    1545-1623
53.4961-2..................................................    1545-0024
53.4963-1..................................................    1545-0024
53.6001-1..................................................    1545-0052
53.6011-1..................................................    1545-0049
                                                               1545-0052
                                                               1545-0092
                                                               1545-0196

[[Page 846]]

 
53.6060-1(a)(1)............................................    1545-1231
53.6065-1..................................................    1545-0052
53.6071-1..................................................    1545-0049
53.6081-1..................................................    1545-0066
                                                               1545-0148
53.6107-1..................................................    1545-1231
53.6161-1..................................................    1545-0575
54.4975-7..................................................    1545-0575
54.4977-1T.................................................    1545-0771
54.4980B-6.................................................    1545-1581
54.4980B-7.................................................    1545-1581
54.4980B-8.................................................    1545-1581
54.4980F-1.................................................    1545-1780
54.6011-1..................................................    1545-0575
54.6011-1T.................................................    1545-0575
54.6060-1(a)(1)............................................    1545-1231
54.6107-1..................................................    1545-1231
54.9801-3..................................................    1545-1537
54.9801-4..................................................    1545-1537
54.9801-5..................................................    1545-1537
54.9801-6..................................................    1545-1537
54.9812-1T.................................................    1545-2165
54.9815-1251T..............................................    1545-2178
54.9815-2711T..............................................    1545-2179
54.9815-2712T..............................................    1545-2180
54.9815-2714T..............................................    1545-2172
54.9815-2715...............................................    1545-2229
54.9815-2719AT.............................................    1545-2181
54.9815-2719T..............................................    1545-2182
55.6001-1..................................................    1545-0123
55.6011-1..................................................    1545-0123
                                                               1545-0999
                                                               1545-1016
55.6060-1(a)(1)............................................    1545-1231
55.6061-1..................................................    1545-0999
55.6071-1..................................................    1545-0999
55.6107-1..................................................    1545-1231
56.4911-6..................................................    1545-0052
56.4911-7..................................................    1545-0052
56.4911-9..................................................    1545-0052
56.4911-10.................................................    1545-0052
56.6001-1..................................................    1545-1049
56.6011-1..................................................    1545-1049
56.6060-1(a)(1)............................................    1545-1231
56.6081-1..................................................    1545-1049
56.6107-1..................................................    1545-1231
56.6161-1..................................................    1545-0257
                                                               1545-1049
57.2(e)(2)(i)..............................................    1545-2249
145.4051-1.................................................    1545-0745
145.4052-1.................................................    1545-0120
                                                               1545-0745
                                                               1545-1076
145.4061-1.................................................    1545-0224
                                                               1545-0230
                                                               1545-0257
                                                               1545-0745
156.6001-1.................................................    1545-1049
156.6011-1.................................................    1545-1049
156.6060-1(a)(1)...........................................    1545-1231
156.6081-1.................................................    1545-1049
156.6107-1.................................................    1545-1231
156.6161-1.................................................    1545-1049
157.6001-1.................................................    1545-1824
157.6011-1.................................................    1545-1824
157.6060-1(a)(1)...........................................    1545-1231
157.6081-1.................................................    1545-1824
157.6107-1.................................................    1545-1231
157.6161-1.................................................    1545-1824
301.6011-2.................................................    1545-0225
                                                               1545-0350
                                                               1545-0387
                                                               1545-0441
                                                               1545-0957
301.6011(g)-1..............................................    1545-2079
301.6017-1.................................................    1545-0090
301.6034-1.................................................    1545-0092
301.6036-1.................................................    1545-0013
                                                               1545-0773
301.6047-1.................................................    1545-0367
                                                               1545-0957
301.6056-1.................................................    1545-2251
301.6056-2.................................................    1545-2251
301.6057-1.................................................    1545-0710
301.6057-2.................................................    1545-0710
301.6058-1.................................................    1545-0710
301.6059-1.................................................    1545-0710
301.6103(c)-1..............................................    1545-1816
301.6103(n)-1..............................................    1545-1841
301.6103(p)(2)(B)-1........................................    1545-1757
301.6104(a)-1..............................................    1545-0495
301.6104(a)-5..............................................    1545-0056
301.6104(a)-6..............................................    1545-0056
301.6104(b)-1..............................................    1545-0094
                                                               1545-0742
301.6104(d)-1..............................................    1545-1655
301.6104(d)-2..............................................    1545-1655
301.6104(d)-3..............................................    1545-1655
301.6109-1.................................................    1545-0003
                                                               1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
                                                               1545-1461
                                                               1545-2242
301.6109-3.................................................    1545-1564
301.6110-3.................................................    1545-0074
301.6110-5.................................................    1545-0074
301.6111-1T................................................    1545-0865
                                                               1545-0881
301.6111-2.................................................    1545-0865
                                                               1545-1687
301.6112-1.................................................    1545-0865
                                                               1545-1686
301.6112-1T................................................    1545-0865
                                                               1545-1686
301.6114-1.................................................    1545-1126
                                                               1545-1484
301.6222(a)-2..............................................    1545-0790
301.6222(b)-1..............................................    1545-0790
301.6222(b)-2..............................................    1545-0790
301.6222(b)-3..............................................    1545-0790
301.6223(b)-1..............................................    1545-0790
301.6223(c)-1..............................................    1545-0790
301.6223(e)-2..............................................    1545-0790
301.6223(g)-1..............................................    1545-0790
301.6223(h)-1..............................................    1545-0790
301.6224(b)-1..............................................    1545-0790
301.6224(c)-1..............................................    1545-0790
301.6224(c)-3..............................................    1545-0790
301.6227(c)-1..............................................    1545-0790
301.6227(d)-1..............................................    1545-0790
301.6229(b)-2..............................................    1545-0790
301.6230(b)-1..............................................    1545-0790
301.6230(e)-1..............................................    1545-0790
301.6231(a)(1)-1...........................................    1545-0790
301.6231(a)(7)-1...........................................    1545-0790
301.6231(c)-1..............................................    1545-0790
301.6231(c)-2..............................................    1545-0790
301.6316-4.................................................    1545-0074
301.6316-5.................................................    1545-0074
301.6316-6.................................................    1545-0074
301.6316-7.................................................    1545-0029
301.6324A-1................................................    1545-0015

[[Page 847]]

 
301.6361-1.................................................    1545-0024
                                                               1545-0074
301.6361-2.................................................    1545-0024
301.6361-3.................................................    1545-0074
301.6402-2.................................................    1545-0024
                                                               1545-0073
                                                               1545-0091
301.6402-3.................................................    1545-0055
                                                               1545-0073
                                                               1545-0091
                                                               1545-0132
                                                               1545-1484
301.6402-5.................................................    1545-0928
301.6404-1.................................................    1545-0024
301.6404-2T................................................    1545-0024
301.6404-3.................................................    1545-0024
301.6405-1.................................................    1545-0024
301.6501(c)-1..............................................    1545-1241
                                                               1545-1637
301.6501(d)-1..............................................    1545-0074
                                                               1545-0430
301.6511(d)-1..............................................    1545-0024
                                                               1545-0582
301.6511(d)-2..............................................    1545-0024
                                                               1545-0582
301.6511(d)-3..............................................    1545-0024
                                                               1545-0582
301.6652-2.................................................    1545-0092
301.6685-1.................................................    1545-0092
301.6689-1T................................................    1545-1056
301.6707-1T................................................    1545-0865
                                                               1545-0881
301.6708-1T................................................    1545-0865
301.6712-1.................................................    1545-1126
301.6903-1.................................................    1545-0013
                                                               1545-1783
301.6905-1.................................................    1545-0074
301.7001-1.................................................    1545-0123
301.7101-1.................................................    1545-1029
301.7207-1.................................................    1545-0092
301.7216-2.................................................    1545-0074
301.7216-2(o)..............................................    1545-1209
301.7425-3.................................................    1545-0854
301.7430-2(c)..............................................    1545-1356
301.7502-1.................................................    1545-1899
301.7507-8.................................................    1545-0123
301.7507-9.................................................    1545-0123
301.7513-1.................................................    1545-0429
301.7517-1.................................................    1545-0015
301.7605-1.................................................    1545-0795
301.7623-1.................................................    1545-0409
                                                               1545-1534
301.7654-1.................................................    1545-0803
301.7701-3.................................................    1545-1486
301.7701-4.................................................    1545-1465
301.7701-7.................................................    1545-1600
301.7701-16................................................    1545-0795
301.7701(b)-1..............................................    1545-0089
301.7701(b)-2..............................................    1545-0089
301.7701(b)-3..............................................    1545-0089
301.7701(b)-4..............................................    1545-0089
301.7701(b)-5..............................................    1545-0089
301.7701(b)-6..............................................    1545-0089
301.7701(b)-7..............................................    1545-0089
                                                               1545-1126
301.7701(b)-9..............................................    1545-0089
301.7705-1.................................................    1545-2266
301.7705-2.................................................    1545-2266
301.7805-1.................................................    1545-0805
301.9000-5.................................................    1545-1850
301.9001-1.................................................    1545-0220
301.9100-2.................................................    1545-1488
301.9100-3.................................................    1545-1488
301.9100-4T................................................    1545-0016
                                                               1545-0042
                                                               1545-0074
                                                               1545-0129
                                                               1545-0172
                                                               1545-0619
301.9100-6T................................................    1545-0872
301.9100-7T................................................    1545-0982
301.9100-8.................................................    1545-1112
301.9100-11T...............................................    1545-0123
301.9100-12T...............................................    1545-0026
                                                               1545-0074
                                                               1545-0172
                                                               1545-1027
301.9100-14T...............................................    1545-0046
301.9100-15T...............................................    1545-0046
301.9100-16T...............................................    1545-0152
302.1-7....................................................    1545-0024
305.7701-1.................................................    1545-0823
305.7871-1.................................................    1545-0823
420.0-1....................................................    1545-0710
Part 509...................................................    1545-0846
Part 513...................................................    1545-0834
Part 514...................................................    1545-0845
Part 521...................................................    1545-0848
601.104....................................................    1545-0233
601.105....................................................    1545-0091
601.201....................................................    1545-0019
                                                               1545-0819
601.204....................................................    1545-0152
601.401....................................................    1545-0257
601.504....................................................    1545-0150
601.601....................................................    1545-0800
601.602....................................................    1545-0295
                                                               1545-0387
                                                               1545-0957
601.702....................................................    1545-0429
------------------------------------------------------------------------


[T.D. 8011, 50 FR 10222, Mar. 14, 1985]

    Editorial Note: For Federal Register citations affecting Sec.  
602.101, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.govinfo.gov.

[[Page 849]]



List of CFR Sections Affected



All changes in this volume of the Code of Federal Regulations (CFR) that 
were made by documents published in the Federal Register since January 
1, 2016 are enumerated in the following list. Entries indicate the 
nature of the changes effected. Page numbers refer to Federal Register 
pages. The user should consult the entries for chapters, parts and 
subparts as well as sections for revisions.
For changes to this volume of the CFR prior to this listing, consult the 
annual edition of the monthly List of CFR Sections Affected (LSA). The 
LSA is available at www.govinfo.gov. For changes to this volume of the 
CFR prior to 2001, see the ``List of CFR Sections Affected, 1949-1963, 
1964-1972, 1973-1985, and 1986-2000'' published in 11 separate volumes. 
The ``List of CFR Sections Affected 1986-2000'' is available at 
www.govinfo.gov.

                                  2016

26 CFR
                                                                   81 FR
                                                                    Page
Chapter I
1 Authority citation amended.......................................91021
1.304-6 Added......................................................20882
1.304-7T Added.....................................................20882
    (f) correctly revised..........................................40810
1.332-2 (a) amended; (f) added.....................................17071
1.332-6 (a)(3) revised; (e) amended................................17071
1.332-7 Amended....................................................17071
1.334-1 Revised....................................................17071
1.337-1 Added......................................................17074
1.337(d)-7 (b)(4), (c)(6) and (f) redesignated as (b)(5), (c)(7) 
        and (g); (a)(1), (b)(2)(iii), (c)(1) and new (g)(2) 
        revised; (a)(2)(vi), (vii), new (b)(4), new (c)(6) and new 
        (f) added; (b)(1)(ii), (d)(2)(iii) and new (g)(1) amended 
                                                                   36797
1.337(d)-7T Added..................................................36797
    (f)(3)(iii) correctly revised..................................41800
1.351-1 (a) heading, (1) heading, (2) heading, (b) heading, (2) 
        heading and (d) added; (a)(1) introductory text amended; 
        (a)(1)(i), (ii) and (b)(1) revised; undesignated text 
        following (a)(1)(ii) removed...............................17074
1.351-3 (a)(3) and (b)(3) revised; (f) added.......................17074
1.355-0 Introductory text revised; amended.........................91747
1.355-8T Added.....................................................91747
1.358-6 (a) and (f)(3) amended; (c)(4) introductory text and (e) 
        revised; (f)(4) added......................................17074
1.362-3 Added......................................................17075
1.362-4 (c) heading, (h) introductory text and Example 11 revised; 
        (c)(3) added; (h) Example 4 and (j) amended................17082
1.367(a)-0 Added...................................................91021
1.367(a)-1 Revised.................................................91022
1.367(a)-1T (a), (b)(1), (2), (3), (4)(i)(A), (ii), (c)(3)(ii)(A), 
        (d) introductory text, (1), (2), (4) and (5) removed.......91024
1.367(a)-2 Revised.................................................91024
1.367(a)-2T (a)(2) amended.........................................15169
    Removed........................................................91027
1.367(a)-3 (d)(2)(vi)(B), (3) Examples 6B, 6C, 9, (e) and 
        (g)(1)(vii)(A) revised; (g)(1)(ix) added...................15161
    (d)(3) Example 12 amended......................................15169
    (c)(11) redesignated as (c)(11)(i); (c)(3)(iii)(B) heading and 
new (11)(i) heading revised; (c)(3)(iii)(C), (11) heading and (ii) 
added; (c)(11)(i) amended..........................................20883

[[Page 850]]

    (a)(3), (c)(3)(i)(A), (ii)(B), (4)(i), (5)(iv), (d)(3) 
Examples 7A and 13 amended.........................................91027
1.367(a)-3T Removed................................................15169
    Added..........................................................20883
    (k) correctly revised..........................................40810
1.367(a)-4 Revised.................................................91027
1.367(a)-4T (d) amended............................................15169
    Removed........................................................91028
1.367(a)-5 Removed.................................................91028
1.367(a)-5T Removed................................................91028
1.367(a)-6 Added...................................................15169
    Revised........................................................91028
1.367(a)-6T (e)(4) and (j) removed.................................15169
    (b)(2), (c)(2) and (4) removed.................................91028
1.367(a)-7 (c) introductory text, (2)(i)(A), (ii)(A)(1), (v), 
        (4)(ii), (e)(1), (4)(i), (ii), (5)(i), (ii), (f)(4) 
        introductory text, (i), (ii), (iii), (g) introductory text 
        and (h) amended............................................15169
    (f)(11) revised; (j) redesignated as (j)(1) and amended; 
(j)(2) added; (a), (c), (2)(i)(B), (ii)(A)(2), (e)(1), (2)(i), 
(4)(ii), (5), (i), (ii), (f)(4)(ii), (g), Examples 1 and 2 and (h) 
amended............................................................91028
1.367(a)-8 (c)(6) and (j)(9) amended...............................15169
    (b)(1)(xvii), (c)(3)(viii), (4)(iv), (j)(3) and (8) amended....91029
1.367(b)-4 (b)(1)(iii) Examples 4 and 5 amended....................15169
    (a), (b) introductory text and (d)(1) revised; (b)(1)(i)(A)(2) 
and (B)(2) amended; (b)(1)(i)(C) and (h) added.....................20883
    (b)(1)(i)(B)(2), (ii)(A), (2)(i)(A), (B), (C), (3)(i) and 
(d)(2) Example corrected...........................................40811
1.367(b)-4T Revised................................................20883
    (d)(1) corrected...............................................40811
1.367(d)-1 Added...................................................91029
1.367(d)-1T (b), (c)(3), (g)(2)(i), (iii)(E) and (3) removed.......91030
1.367(e)-1 (e) amended.............................................15169
1.367(e)-2 (b)(3)(iii) and (e)(4)(ii)(B) revised...................91030
1.368-3 (a)(3) and (b)(3) revised; (e) added.......................17083
1.382-1 Introductory text revised; amended.........................24483
1.382-12 Added.....................................................24483
1.385-1 Added......................................................72950
1.385-2 Added......................................................72952
1.385-3 Added......................................................72960
1.385-3T Added.....................................................72972
1.385-4T Added.....................................................72979

                                  2017

26 CFR
                                                                   82 FR
                                                                    Page
Chapter I
1.306-3 (e) amended.................................................6237
1.306-4 Added.......................................................6237
1.336-1 (b)(5)(i)(A) revised........................................6237
1.336-5 Heading revised; amended....................................6237
1.337(d)-7 (b)(2)(iii) and (g)(2)(iii) revised......................5388
1.337(d)-7T (b)(1), (2), (3) and (g)(2)(iii) revised................5388
1.355-6 (d)(1)(i)(A)(2) and (g) revised.............................6237
1.367(a)-1 Corrected...............................................52848
1.381(c)(2)-1 (d) removed..........................................42938
1.382-1 Amended.....................................................6237
1.382-9 (d)(5)(ii)(D) and (6)(i) revised............................6237
1.385-1 (c)(4)(vii) Example 2 correctly amended.....................8166
1.385-2 (a)(3)(ii)(C)(3), (c)(3)(i)(A) heading, (4)(ii)(E) 
        heading, (3) and (d)(2)(i)(A) correctly revised; 
        (a)(5)(i), (ii), (b)(1), (c)(2)(ii), (iii)(A), (E), 
        (3)(i)(A)(3)(i), (4)(ii)(A), (B)(1), (e)(3)(ii), (h)(4) 
        Example, (ii)(A) and (C) corrected; (c)(4)(ii)(B)(2)(i) 
        heading correctly added.....................................8166
1.385-3 (b)(3)(iii)(E)(2), (5) heading, (c)(3)(i)(C)(3) heading, 
        (i), (g)(3)(iv)(B)(1), (24)(ii)(B) and (C) correctly 
        revised; (c)(3)(i)(C)(1) correctly amended; (g)(3)(ii) 
        introductory text heading, (iii) introductory text 
        heading, (iv) introductory text heading and (g)(3)(v) 
        heading correctly added.....................................8167
1.385-3T (b)(3)(vii)(A)(1)(iii), (h) Examples 13, 14, 15 and 18 
        correctly amended; (l) correctly revised....................8168

[[Page 851]]

1.385-4T (b)(2), (3)(i), (6), (c)(1)(i), (d)(3) and (4) 
        introductory text, (f)(3) Examples 1, 4, and 5 corrected; 
        (b)(3)(ii), (iii), (4)(ii)(A)(1), (5)(i), (d)(4)(i), (ii), 
        (e)(3), (5) and (h) correctly revised.......................8168

                                  2018

26 CFR
                                                                   83 FR
                                                                    Page
Chapter I
1 Authority citation amended................................26588, 32532
1.304-7 Added......................................................32532
1.304-7T Removed...................................................32533
1.337(d)-3 Added...................................................26588
1.337(d)-3T Removed................................................26592
1.367(a)-3 (c)(3)(iii)(C) and (11)(ii) revised.....................32533
1.367(a)-3T Removed................................................32533
1.367(b)-4 (a), (b) introductory text, (1)(i)(C), (d)(1), and (e) 
        through (h) revised........................................32533
1.367(b)-4T Removed................................................32536
1.367(b)-6 (a)(1)(iii) removed; (a)(1)(iv) and (v) redesignated as 
        new (a)(1)(iii) and (iv); new (a)(1)(iv) amended...........32536

                                  2019

26 CFR
                                                                   84 FR
                                                                    Page
Chapter I
1 Authority citation amended................................59301, 69316
1.312-15 (a)(1) amended; (e) added.................................50149
1.337(d)-7 (a)(1), (2)(vi), (vii), (b)(4), (c)(1), (6), (f), and 
        (g)(2)(ii) revised; (a)(2)(viii) added.....................26563
1.337(d)-7T Removed................................................26565
1.341-1--1.341-7 Undesignated center heading and sections removed 
                                                                    9233
1.355-0 Introductory text amended; section added...................69316
1.355-8 Added......................................................69317
1.355-8T Removed...................................................69317
1.381(c)(4)-1 (b)(2) amended.......................................33692
1.381(c)(11)-1 (b)(1), (2), (d)(2), (4), and (i) amended............9233
1.382-1 CFR correction: introductory text revised..................13520
1.382-7 (a) amended................................................33692
1.383-1 (d)(3)(i) amended..........................................67038
1.385-1 (a), (d)(1)(i), (iii), and (iv)(A) revised; (c), (4)(iv), 
        and (d)(1)(ii) amended; (d)(2)(i) removed..................59301
1.385-2 Removed....................................................59302
1.385-3 (g)(4) revised.............................................59302

                                  2020

26 CFR
                                                                   85 FR
                                                                    Page
Chapter I
1 Authority citation amended; correction...........................15949
1 Authority citation amended.........................28870, 56756, 59430
1.316-2 (b) amended................................................66476
1.332-8 Added......................................................59431
1.338-1 (b)(2)(i) revised..........................................86511
1.338-11 (d)(3)(i) amended; (d)(3)(iii) redesignated as 
        (d)(3)(iv); new (d)(3)(iii) and (7)(iii) added; (d)(2) and 
        new (3)(iv) revised........................................64392
1.355-8 Correction: (h)(8)(ii)(A) amended..........................15060
1.355-8 Technical correction.......................................15061
1.367 Correction: (g)(1)(v)(A) and (B) added.......................51347
1.367 Correction: (f)(10) amended..................................51347
1.367(a)-8 (c), (j), (k), and (m) through (r) amended; (r) heading 
        revised....................................................59431
1.381(c)(20)-1 Added...............................................56832
1.381(c)(22)-1 (b)(6) removed......................................64392
1.382-1 Table amended..............................................56834
1.382-2 (a)(1)(i)(A), (ii) introductory text, (A), and (b)(3) 
        revised; (a)(1)(i)(B), (ii)(B), (iv), (v), (2)(i), (ii) 
        through (v), (3)(i), (4)(i), (5), and (6) amended; 
        (a)(2)(vi), (7), and (8) added.............................56834
1.382-5 (d)(1) and (f) amended.....................................56835
1.382-6 (a) redesignated as (a)(1); (a)(1) heading, (2), and 
        (b)(4) added; (b)(3)(ii), and (d) amended; (h) revised.....56835
1.382-7 (d) and (g) added..........................................56837
1.383-0 (a) revised................................................56837

[[Page 852]]

1.383-1 (a), (c)(6)(i)(B), (d)(2)(i), (ii), (vi), (e)(1), (2), 
        (f), (g), and (j) amended; (d)(2)(iv) through (vii) 
        redesignated as (d)(2)(v) through (viii); (c)(6)(ii), 
        (d)(1), (2)(iii), new (v), (3)(ii), new (f)(2), and new 
        (3) revised; new (d)(2)(iv) and (j)(2) added; (k) removed 
                                                                   56837
1.385-1 (c)(4)(vii) Examples 1 through 4 redesignated as 
        (c)(4)(vii)(A) through (D); (c)(4)(vii)(A)(i), (ii), 
        (B)(i), (ii), (C)(i), (ii), (D)(i), (ii) redesignated as 
        (c)(4)(vii)(A)(1), (2), (B)(1), (2), (C)(1), (2), (D)(1), 
        and (2); (a), (c) introductory text, (4)(i) introductory 
        text, (vii) introductory text, (B)(2), new (1), (D)(1), 
        (d)(1)(iv)(A), and (B) amended; new (c)(4)(vii)(C)(2)(A), 
        (B), and (D)(2)(A) through (C) redesignated as 
        (c)(4)(vii)(C)(2)(i), (ii), and (D)(2)(i) through (iii)....28870
1.385-3 Heading revised; (a), (b)(4) introductory text, (i) 
        introductory text, (E), (ii) introductory text, (D), 
        (c)(1), (2)(i)(C), (iv), (v)(B), (C), (3)(i)(C)(4), 
        (ii)(D)(6), (d)(2)(ii)(A), (B), (7)(ii), (g) introductory 
        text, (3)(iii)(D), (j)(2)(i), (ii), and (v) amended; 
        (b)(3)(vii), (d)(4), (f), (g)(5) through (8), (15), (16), 
        (17), (22), and (23) revised; (h)(3) Examples 1 through 19 
        redesignated as (h)(3)(i) through (xi); new (h)(3)(i)(i), 
        (ii), (i), (ii), (iii)(i), (ii), (iv)(i), (ii), (v)(i), 
        (ii), (vi)(i), (ii), (vii)(i), (ii), (viii)(i), (ii), 
        (ix)(i), (ii), (x)(i), (ii), (xi)(i), (ii) redesignated as 
        (h)(3)(i)(A), (B), (ii)(A), (B), (iii)(A), (B), (iv)(A), 
        (B), (v)(A), (B), (vi)(A), (B), (vii)(A), (B), (viii)(A), 
        (B), (ix)(A), (B), (x)(A), (B), (xi)(A), and (B); 
        (h)(3)(ii)(B)(A), (B), (iii)(B)(A), (B), (vi)(B)(A), (B), 
        (vii)(B)(A), (B), (viii)(B)(A) through (F), (ix)(B)(A), 
        (B), (x), (B)(A), (B), and (C) redesignated as 
        (h)(3)(ii)(B)(1), (2), (iii)(B)(1), (2), (vi)(B)(1), (2), 
        (vii)(B)(1) through (6), (ix)(B)(1), (2), (x)(B)(1), (2), 
        and (3); (h)(3)(v)(A), (B), and (vii)(A) amended; 
        (h)(3)(xii) through (xix) and (j)(1) revised; (j)(3) and 
        (k) added..................................................28870
1.385-3T Removed...................................................28878
1.385-4 Added......................................................28878
1.385-4T Removed...................................................28878

[[Page 853]]

                                  2021

   (Regulations published from January 1, 2021, through April 1, 2021)

26 CFR
                                                                   86 FR
                                                                    Page
Chapter I
1.338-1 (b)(2)(i) revised...........................................6219
1.381(c)(5)-1 (a)(6) Examples 1 and 2 redesignated as (a)(6)(i) 
        and (ii); new (a)(6)(i)(i), new (i)(ii), new (ii)(i), and 
        new (ii)(ii) further redesignated as (a)(6)(i)(A), (B), 
        (ii)(A), and (B); new (a)(6)(ii)(A), new (B), and (f) 
        amended......................................................268


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