[Federal Register Volume 63, Number 249 (Tuesday, December 29, 1998)]
[Rules and Regulations]
[Pages 71591-71596]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-34210]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8802]
RIN 1545-AN21


Certain Asset Transfers to a Tax-Exempt Entity

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that implement 
provisions of the Tax Reform Act of 1986 and the Technical and 
Miscellaneous Revenue Act of 1988. The final regulations generally 
affect a taxable corporation that transfers all or substantially all of 
its assets to a tax-exempt entity or converts from a taxable 
corporation to a tax-exempt entity in a transaction other than a 
liquidation, and generally require the taxable corporation to recognize 
gain or loss as if it had sold the assets transferred at fair market 
value.

DATES: Effective Date: These regulations are effective January 28, 
1999.
    Applicability Date: For dates of applicability of these 
regulations, see Sec. 1.337(d)-4(e).

FOR FURTHER INFORMATION CONTACT: Stephen R. Cleary, (202) 622-7530 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information in these final regulations has been 
reviewed and, pending receipt and evaluation of public comments, 
approved by the Office of Management and Budget (OMB) under 44 U.S.C. 
3507 and assigned control number 1545-1633.
    The collection of information in this regulation is described in 
Sec. 1.337(d)-4(b)(1)(i). The information is a written representation 
made by a tax-exempt entity estimating the percentage it will use 
assets formerly held by a taxable corporation in an activity the income 
from which is subject to tax under section 511(a), as opposed to other 
activities. The information may be used by the taxable corporation in 
computing the amount of gain or loss that is recognized under the 
regulations. The information may also be used by the IRS in determining 
whether the proper amount of tax is due on the transaction. The 
collection of information is not mandatory but will enable the taxable 
corporation to support its reporting of the tax consequences of the 
transaction. The likely respondents are tax-exempt entities subject to 
the unrelated business income tax under section 511(a) (including most 
organizations that are exempt from tax under section 501, state 
colleges and universities, and certain charitable trusts).
    Comments concerning the collection of information should be sent to 
the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attention: IRS Reports Clearance Officer, OP:FS:FP, 
Washington, DC 20224. Any such comments should be submitted not later 
than March 1, 1999.
    Comments are specifically requested concerning:
    (a) Whether the collection of information is necessary for the 
proper performance of the functions of the Internal Revenue Service, 
including whether the information will have practical utility;
    (b) The accuracy of the estimated burden associated with the 
collection of information (see below);
    (c) How the quality, utility, and clarity of the information 
requested may be enhanced;
    (d) How the burden of complying with the collection of information 
may be minimized, including through the application of automated 
collection techniques or other forms of information technology; and
    (e) Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of services to provide information.
    Estimated total annual reporting burden: 125 hours. The annual 
burden per respondent varies from 1 hour to 10 hours, depending on 
individual circumstances, with an estimated average of 5 hours.
    Estimated number of respondents: 25.
    Estimated frequency of responses: Once.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by OMB.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
return information are confidential, as required by 26 U.S.C. 6103.

Background

    On January 15, 1997, proposed regulations Sec. 1.337(d)-4 were 
published in the Federal Register (62 FR 2064, [REG-209121-89, 1997-1 
C.B. 719]). The regulations were proposed to amend 26 CFR part 1 and 
were intended to carry out the purposes of the repeal of the General 
Utilities doctrine (``General Utilities repeal'') as enacted in the Tax 
Reform Act of 1986 (the ``1986 Act'').
    The 1986 Act amended sections 336 and 337, generally requiring 
corporations to recognize gain or loss when appreciated or depreciated 
property is distributed in complete liquidation or is sold in 
connection with a complete liquidation. Section 337(d) directs the 
Secretary to prescribe regulations as may be necessary to carry out the 
purposes of General Utilities repeal, including rules to ``ensure that 
these purposes shall not be circumvented * * * through the use of a * * 
* tax-exempt entity.''
    The legislative history concerning a 1988 amendment to section 
337(d) explains:

    The bill also clarifies in connection with the built-in gain 
provisions of the Act that the Treasury Department shall prescribe 
such regulations as may be necessary or appropriate to carry out 
those provisions * * * . For example, this includes rules to

[[Page 71592]]

require the recognition of gain if appreciated property of a C 
corporation is transferred to a * * * tax-exempt entity [footnote 
32] in a carryover basis transaction that would otherwise eliminate 
corporate level tax on the built-in appreciation.
    [footnote 32] The Act generally requires recognition of gain if 
a C corporation transfers appreciated assets to a tax exempt entity 
in a section 332 liquidation. See Code section 337(b)(2).

S. Rep. No. 445, 100th Cong., 2d Sess. 66 (1988).

Explanation of Provision

A. The Proposed Rule

    (1) A taxable corporation that transfers all or substantially all 
of its assets to one or more tax-exempt entities is required to 
recognize gain or loss as if the assets transferred were sold at their 
fair market values (Sec. 1.337(d)-4(a)(1), Asset Sale Rule);
    (2) A taxable corporation that changes its status to a tax-exempt 
entity generally is treated as having transferred all of its assets to 
a tax-exempt entity immediately before the change in status becomes 
effective in a transaction governed by the Asset Sale Rule 
(Sec. 1.337(d)-4(a)(2), Change in Status Rule);
    (3) The Change in Status Rule does not apply (subject to 
application of the anti-abuse rule) if the corporation formerly was 
tax-exempt and the change in status is within three years of the later 
of (a) the corporation first filing a return as a taxable corporation, 
or (b) a final determination that the corporation had become a taxable 
corporation (Sec. 1.337(d)-4(a)(3), 3-Year Rule);
    (4) The Asset Sale Rule does not apply if the transferred assets 
are used by the tax-exempt entity in an activity the income from which 
is subject to the unrelated business tax under section 511(a); 
notwithstanding any other provision of law, gain on such assets will 
later be included in unrelated business taxable income when the tax-
exempt entity disposes of the assets or ceases to use the assets in an 
activity the income from which is subject to tax under section 511(a) 
(Sec. 1.337(d)-4(b)(1), UBTI Rule);
    (5) The regulations apply to transfers of assets occurring after 
January 28, 1999, unless the transfer is pursuant to a written 
agreement which is (subject to customary conditions) binding on or 
before that date (Sec. 1.337(d)-4(e), Effective Date Rule).
    The IRS and Treasury Department received approximately 32 written 
comments on the proposed regulations. In addition, the IRS held a 
public hearing on the proposed regulations on May 6, 1997. After 
consideration of all the written and oral comments, the IRS and 
Treasury Department are adopting the proposed regulations as revised by 
this Treasury Decision. The comments and changes to the regulations 
made in response to the comments are summarized below.

B. Comments and Changes in Response to Comments

1. Asset Sale Rule
    Some commentators questioned whether section 337(d) authorizes 
taxation of asset transfers other than liquidations. Section 337(d) 
authorizes regulations to prevent circumvention of General Utilities 
repeal through the ``use of'' any provision of law or regulations 
(specifically including the corporate reorganization rules in Part III 
of Subchapter C). The statutory rules in sections 336 and 337(b)(2), 
enacted as part of General Utilities repeal, provide for corporate-
level gain or loss recognition when a taxable corporation liquidates 
into a controlling tax-exempt entity. The regulations published in this 
Treasury Decision are intended to reach transactions that are 
economically similar to those liquidations but take different forms, 
such as a taxable corporation's transfer of substantially all of its 
assets to a tax-exempt entity or a taxable corporation's change in 
status resulting in its becoming a tax-exempt entity. The IRS and 
Treasury Department believe that section 337(d) provides clear 
authority for these regulations.
    Some commentators questioned whether section 337(d) authorizes 
regulations that would tax transfers of assets without consideration, 
noting that making a gift generally does not cause the recognition of 
gain to the donor. Other commentators claimed that the proposed 
regulations, to the extent they apply to transfers of assets to 
charitable organizations, conflict with the policy of the charitable 
contribution deduction under section 170. The regulations do not affect 
the tax treatment of a corporation's gift of a portion of its assets to 
charity, nor do they affect the shareholders' tax treatment when 
transferring all or any part of the corporation's assets to charity by 
transferring all or any part of the corporation's stock to charity. The 
regulations apply only to transfers of all or substantially all of the 
assets of a taxable corporation to a tax-exempt entity or a taxable 
corporation's conversion to a tax-exempt entity. If shareholders donate 
all of a corporation's stock to a charity and the charity then 
liquidates the corporation, section 337(b)(2) taxes the liquidating 
corporation's gain. The final regulations, which remain unchanged from 
the proposed regulations in this respect, tax a taxable corporation's 
gain in other transactions that have the same economic effect.
    One commentator proposed that the final regulations allow deferral 
of gain recognition on any asset transferred to a tax-exempt entity 
until the entity disposes of the asset. The commentator suggests a rule 
similar to that of section 1374, which provides generally that a C 
corporation that converts to being an S corporation is subject to tax 
if it disposes of assets held at the time of conversion during the ten-
year period after the conversion. Under this rule, the tax-exempt 
entity would not be taxed on the built-in gain in assets that it 
retains. For the reasons stated above, the IRS and Treasury Department 
have concluded that the regulations generally should follow the rule in 
section 337(b)(2) rather than the rule contained in section 1374 to 
best accomplish the goal set forth in the statute and legislative 
history.
    One commentator suggested that the Asset Sale Rule should not apply 
to a taxable corporation transferring assets to a tax-exempt entity in 
a like-kind exchange described in section 1031 or an involuntary 
conversion described in section 1033. In transactions described in 
these sections, the taxable corporation acquires replacement property 
that has a basis determined by reference to the basis of the property 
replaced. Because the built-in appreciation in the transferred asset is 
preserved in the replacement asset and remains in the hands of a 
taxable corporation, General Utilities repeal is not circumvented in 
these transactions. Accordingly, the final regulations exclude 
transactions from the Asset Sale Rule to the extent the transactions 
qualify for nonrecognition of gain or loss under section 1031 or 1033.
    Some commentators proposed removing section 528 homeowners 
associations from the list of tax-exempt entities subject to the 
regulations because dispositions of assets by a homeowners association 
are subject to tax. Under section 528, homeowners associations are 
subject to tax on all of their income except for exempt function 
income, which is defined as fees, dues, or assessments from homeowners. 
Gains from the sale of a homeowners association's property are taxable; 
therefore, General Utilities repeal is not circumvented by transfers to 
homeowners associations. In addition, the properties that become the 
subject of section 528 homeowners associations generally are developed 
as business

[[Page 71593]]

ventures, and the developer has substantial incentive to realize the 
increase in value of its assets in connection with their transfer to 
the association, thus providing additional protection with respect to 
General Utilities repeal. Also, a homeowners association may alternate 
between taxable and tax-exempt status because its exemption is based on 
a year-by-year election under section 528(c)(1)(E). In a given year, a 
homeowners association may prefer taxable status to tax-exempt status 
under section 528 because a section 528 organization is taxed at a 30 
percent flat rate on income other than membership fees, dues, or 
assessments, while a taxable homeowners association is subject to tax 
on all income but at the progressive rates of section 11 (15 to 35 
percent). The tax on non-exempt income under section 528 may exceed the 
tax the association would pay as a taxable corporation. Congress 
anticipated that these entities may alternate between taxable and tax-
exempt status and that the assets of these entities will remain subject 
to tax on transfer. Imposing a tax on appreciated property each time 
such an entity converts its status could inhibit this flexibility. For 
this reason, and because General Utilities repeal will not be 
compromised, the IRS and Treasury Department believe that an 
organization's election to be treated under section 528 for a tax year 
should not trigger gain recognition. Accordingly, the final regulations 
do not treat section 528 homeowners associations as tax-exempt entities 
for purposes of section 337(d). For similar reasons, the final 
regulations do not define political organizations described in section 
527 as tax-exempt entities for purposes of section 337(d).
    Some commentators suggested that social clubs that are tax-exempt 
as organizations described in section 501(c)(7) should be removed from 
the list of tax-exempt entities for purposes of section 337(d). 
Commentators also suggested that tax-exempt social clubs be allowed to 
defer gain on transactions subject to the regulations, because social 
clubs may be subject to tax on gains from asset sales. Section 
512(a)(3)(A) generally taxes the income of a section 501(c)(7) social 
club except for the social club's ``exempt function income,'' as 
defined in section 512(a)(3)(B). Section 512(a)(3)(A) also applies to 
tax-exempt organizations described in section 501(c)(9), (17), or (20). 
The final regulations, however, do not provide relief from the general 
rules of the regulations for section 501(c)(7) organizations. Unlike 
section 528 homeowners associations, section 501(c)(7) social clubs are 
permitted to avoid gain recognition on certain asset sales. For 
example, if the club replaces the property sold with other property 
used directly in the performance of its tax-exempt function, no tax is 
owed on any gain recognized. Because of these exceptions, the IRS and 
Treasury Department believe that deferring tax on transfers of assets 
to section 501(c)(7) organizations would not be consistent with General 
Utilities repeal. Accordingly, the final regulations follow the 
proposed regulations and apply to transfers of assets to section 
501(c)(7) organizations.
2. Change in Status Rule
    A significant number of commentators contended that the Change in 
Status Rule could have a major adverse effect on mutual or cooperative 
electric companies that are tax-exempt as organizations described in 
section 501(c)(12). That section provides tax exemption for benevolent 
life insurance associations of a purely local character, mutual ditch 
or irrigation companies, mutual or cooperative telephone companies, or 
like organizations (including mutual or cooperative electric 
companies), but only if more than 85 percent of their income is 
collected from members for the sole purpose of meeting losses and 
expenses. The 85 percent test is applied annually, so that an electric 
cooperative could be taxable one year and tax-exempt the next year. The 
commentators requested that electric cooperatives be given relief from 
the Change in Status Rule because business exigencies may cause these 
cooperatives to fail the 85 percent test. They also noted that the 
relief provided in the proposed regulations for organizations 
temporarily losing their exempt status was insufficient because more 
than 3 years may elapse before the organization once again meets the 85 
percent test.
    In addition to meeting the 85 percent test, section 501(c)(12) 
organizations must operate according to cooperative principles to be 
eligible for exemption. See Rev. Rul. 72-36, 1972-1 C.B. 151; Buckeye 
Countrymark, Inc. v. Commissioner, 103 T.C. 547, 554-555 (1994), acq. 
on other issues, 1997-1 C.B. 1; Puget Sound Plywood, Inc. v. 
Commissioner, 44 T.C. 305, 308 (1965), acq. on other issues, 1966-2 
C.B. 6. An organization may operate according to cooperative principles 
yet fail the 85 percent test. Congress anticipated that section 
501(c)(12) mutual or cooperative organizations could alternate between 
taxable and tax-exempt status due to the operation of the 85 percent 
income requirement. The IRS and Treasury Department do not believe it 
is appropriate to treat these entities as having disposed of all their 
assets when they regain tax-exempt status where the sole reason for 
their becoming taxable was the failure to meet the 85 percent test. 
Therefore, the final regulations provide that the Change in Status Rule 
does not apply when an organization previously tax-exempt as an 
organization described in section 501(c)(12) loses exemption solely 
because it fails the 85 percent test and later regains tax-exempt 
status, provided that in each intervening taxable year it meets all the 
requirements for exemption under section 501(c)(12) except for the 85 
percent test.
    One commentator suggested that because social clubs alternate 
between taxable and tax-exempt status they should be given relief 
similar to that requested by section 501(c)(12) organizations. Social 
clubs can lose their tax exemption if they generate excessive nonmember 
income in a particular year. See S. Rep. No. 1318, 94th Cong., 2d Sess. 
4 (1976), 1976-2 C.B. 599. After considering this comment and the 
Service's experience with these organizations, we have concluded that 
the 3-Year Rule will provide adequate relief for social clubs from 
inappropriate application of the Change in Status Rule.
    A number of commentators urged exempting newly formed social clubs 
from the application of the regulations if they become tax-exempt 
within seven years of their formation, rather than within the three-
year period provided for other tax-exempt entities. Those commentators 
explained that some social clubs are organized when a real estate 
developer acquires land to be used for a housing development and a 
social club for the homeowners. The assets of the future social club 
are held by a corporation, but it cannot qualify as a tax-exempt 
section 501(c)(7) organization until several years later, after the 
stock or membership interests in the corporation have been transferred 
to the homeowners. Commentators familiar with development practices 
advised that it often takes up to seven years to transfer the club to 
the members' control. Furthermore, because the developer is forming the 
club as a business venture, the developer will work to realize the 
increase in the value of the club's assets as part of the transfer. For 
these reasons, providing additional time for newly-formed clubs to 
become tax-exempt does not conflict with General Utilities repeal. 
Therefore, the final regulations incorporate the recommendation made in 
the comments and provide that a social club will not

[[Page 71594]]

be subject to the Change in Status Rule if it converts to tax-exempt 
status within seven taxable years after the year in which it was 
formed.
    Two commentators suggested that the Change in Status Rule could 
adversely affect a taxable property and casualty insurance company that 
becomes tax-exempt as an organization described in section 501(c)(15) 
when it encounters financial difficulties leading to conservation or 
liquidation proceedings pursuant to authority granted by a state 
regulatory agency. A taxable property or casualty insurance company 
whose net written premiums or direct written premiums are $350,000 or 
less for the taxable year is eligible to be exempt from tax under 
section 501(c)(15). The final regulations provide an exception from the 
Change in Status Rule if in a taxable year an insurance company becomes 
an organization described in section 501(c)(15), and during that year 
and all subsequent years in which it is exempt under that section, the 
insurance company is the subject of a court supervised rehabilitation, 
conservatorship, liquidation, or similar state proceeding. In such 
cases, the reduction in premium income to $350,000 or less is likely to 
be involuntary and a direct result of the state proceeding. However, 
the final regulations continue to apply the Change in Status Rule to 
all other insurance companies qualifying for tax exemption under 
section 501(c)(15).
3. UBTI Rule
    Some commentators asked how the UBTI Rule would apply when assets 
that are transferred to a tax-exempt entity are used partly in an 
activity of the organization the income from which is subject to tax 
under section 511(a) (``section 511(a) activity'') and partly in other 
activities. The UBTI Rule in the proposed regulations defers gain 
recognition with respect to those assets that will be used in a section 
511(a) activity of the tax-exempt entity after the asset is transferred 
to the tax-exempt entity or after the taxable corporation converts to 
tax-exempt status. The final regulations provide that, if an asset will 
be used partly or wholly in a section 511(a) activity of a tax-exempt 
entity, 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 in the section 511(a) 
activity bears to 100 percent. The taxable corporation generally may 
rely on a written representation from the tax-exempt entity as to the 
anticipated percentage of use of the asset in a section 511(a) activity 
during the first taxable year after the transfer or change in status. 
If the percentage of an asset's use in the section 511(a) activity 
later decreases from the estimate used in computing gain or loss when 
the asset was transferred, the tax-exempt entity will recognize part of 
the deferred gain or loss in an amount that is proportionate to the 
decrease in use in the section 511(a) activity, and the gain or loss 
recognized will be subject to tax under section 511(a). The tax-exempt 
entity must use the same reasonable method of allocation for 
determining the percentage it uses assets in the section 511(a) 
activity for purposes of the UBTI Rule as it uses for other tax 
purposes (e.g., depreciation deductions). The tax-exempt entity also 
must use this same reasonable method of allocation for each taxable 
year that it holds the assets.
    One commentator asked that gain not be recognized when a tax-exempt 
entity disposes of an asset used in a section 511(a) activity in a 
transaction eligible for nonrecognition treatment under the Code. The 
proposed regulations provide that gain is recognized on such 
dispositions ``notwithstanding any other provision of law,'' 
corresponding with the rule in section 337(b)(2)(B)(ii), and overruling 
the application of nonrecognition provisions such as section 512(b)(5). 
In response to these comments, the final regulations allow continuing 
deferral to the extent that the tax-exempt entity disposes of assets in 
a transaction that qualifies for nonrecognition of gain or loss under 
section 1031 or section 1033, but only to the extent that the 
replacement asset is used in a section 511(a) activity. No exception is 
made with respect to other nonrecognition provisions.

Special Analyses

    It has been determined that this Treasury Decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations. It is hereby certified that the 
collection of information in these regulations will not have a 
significant economic impact on a substantial number of small entities. 
This certification is based upon the Internal Revenue Service's 
estimate that only 25 entities per year will be responding to the 
collection of information, and that the total annual reporting burden 
of this information collection for all responding entities will be only 
125 hours. Therefore, a Regulatory Flexibility Analysis under the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. 
Pursuant to section 7805(f), the notice of proposed rulemaking 
preceding these regulations was submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Drafting Information

    The principal author of these regulations is Stephen R. Cleary of 
the Office of Assistant Chief Counsel (Corporate), IRS. However, other 
personnel from the IRS and Treasury Department participated in their 
development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for 26 CFR Part 1 is amended by 
adding an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.337(d)-4 also issued under 26 U.S.C. 337. * * *

    Par. 2. Section 1.337(d)-4 is added to read as follows:


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

[[Page 71595]]

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 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. 1.501(a)-1, Sec. 1.505(c)-1T, and 
Sec. 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;
    (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

[[Page 71596]]

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.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

    Par. 4. In Sec. 602.101, paragraph (c) is amended by adding an 
entry in numerical order to the table to read as follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (c) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
 
                  *        *        *        *        *
1.337(d)-4.................................................    1545-1633
 
                  *        *        *        *        *
------------------------------------------------------------------------

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: December 17, 1998.

    Dated: December 17, 1998.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 98-34210 Filed 12-28-98; 8:45 am]
BILLING CODE 4830-01-P