[Federal Register Volume 65, Number 245 (Wednesday, December 20, 2000)]
[Rules and Regulations]
[Pages 79719-79735]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-32041]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8913]
RIN 1545-AW71


Guidance Under Section 355(d); Recognition of Gain on Certain 
Distributions of Stock or Securities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to 
recognition of gain on certain distributions of stock or securities of 
a controlled corporation. These final regulations affect corporations 
and their shareholders. These regulations reflect the enactment of 
section 355(d) of the Internal Revenue Code by the Omnibus Budget 
Reconciliation Act of 1990.

DATES: Effective Date: These regulations are effective December 20, 
2000.
    Applicability Date: These regulations apply to distributions 
occurring after December 20, 2000, except they do not apply to 
distributions occurring pursuant to a written agreement which is 
(subject to customary conditions) binding on December 20, 2000, and at 
all times thereafter.

FOR FURTHER INFORMATION CONTACT: Michael N. Kaibni, (202) 622-7550 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On May 3, 1999, the IRS and Treasury issued a notice of proposed 
rulemaking (REG-106004-98) in the Federal Register (64 FR 23554) 
setting forth rules under section 355(d) of the Internal Revenue Code 
relating to the recognition of gain on certain distributions of stock 
or securities of a controlled corporation. Generally, section 355(d) 
requires recognition of gain on a distribution of stock or securities 
of a controlled corporation (Controlled) (as though the Controlled 
stock or securities were sold to the distributee at its fair market 
value) if, immediately after the distribution, any person holds 
disqualified stock of the distributing corporation (Distributing) or of 
any distributed Controlled that constitutes a 50 percent or greater 
interest. Disqualified stock is stock in Distributing acquired by 
purchase after October 9, 1990, and during the five-year period (taking 
into account section 355(d)(6)) ending on the date of distribution (the 
five-year period), or Controlled stock either (1) acquired by purchase 
during the five-year period or (2) distributed with respect to either 
disqualified Distributing stock or on Distributing securities acquired 
by purchase during the five-year period. No public hearing regarding 
these proposed regulations was held. Written comments to the notice 
were received. After consideration of all the comments, the proposed 
regulations are adopted as revised by this Treasury decision. The 
principal revisions are discussed below.

Explanation of Revisions and Summary of Comments

1. Purposes of Section 355(d) Not Violated

    Generally, Congress intended section 355(d) to prevent taxpayers 
from using section 355 to dispose of subsidiaries in sale-like 
transactions, or to obtain a fair market value stepped-up basis for 
future dispositions, without incurring a corporate level tax. See H.R. 
Rep 101-881, at 341 (1990). Under proposed Sec. 1.355-6(b)(3), section 
355(d) does not apply to a distribution that does not violate its 
purposes (the purpose exception). As proposed, the purpose exception 
applies if the effect of the distribution and any related transaction 
is that a disqualified person neither increases an interest in 
Distributing or Controlled nor obtains a purchased basis in Controlled 
stock. A disqualified person is any person that, immediately after a 
distribution, holds disqualified stock in Distributing or Controlled 
that constitutes a 50 percent or greater interest (under section 
355(d)(4) and proposed Sec. 1.355-6(c)). The proposed regulations 
define purchased basis as basis in Controlled stock that is 
disqualified stock, unless the Controlled stock and the Distributing 
stock on which the Controlled stock is distributed are treated as 
acquired by purchase solely under the attribution rules of section 
355(d)(8) and proposed Sec. 1.355-6(e)(1). Commentators have expressed 
concern that certain distributions of stock may technically constitute 
disqualified distributions under the proposed regulations, yet do not 
appear to violate the purposes of section 355(d). Section 1.355-6(b)(3) 
has

[[Page 79720]]

been expanded and clarified in the final regulations to prevent the 
application of section 355(d) in the case of certain transactions that 
do not violate its purposes. (Under the final regulations, certain 
references to stock include securities.) The revisions are explained 
below.
a. Technical Clarification of Disqualified Person
    The definition of ``disqualified person'' in the proposed 
regulations could be read to include persons who hold disqualified 
stock in Distributing or Controlled but who did not directly or 
indirectly purchase that stock. This could result in certain 
distributions that should not violate the purposes of section 355(d) 
nevertheless being disqualified distributions. The final regulations 
clarify that the term ``disqualified person'' includes only a person 
that meets that definition because of its own purchase of 
``disqualified stock'' (or who receives stock in Controlled with 
respect to stock that the person purchased).
b. Related Transactions
    Commentators suggested that some ``related acquisitions'' of stock 
in Distributing or Controlled prior to or following a distribution 
should not be taken into account in determining if the purpose rule 
applies. The IRS and Treasury agree that in many cases a related 
acquisition that increases a disqualified person's interest in 
Distributing or Controlled should not be taken into account. In 
addition, the IRS and Treasury are concerned that the proposed 
regulations could be interpreted to allow taxpayers, by relying on 
certain other related transactions, to avoid section 355(d) 
inappropriately, where a distribution of stock, if viewed 
independently, would constitute a disqualified distribution. For 
example, where a distribution of Controlled stock to a Distributing 
shareholder constitutes a disqualified distribution, a subsequent but 
related distribution of that stock should not have the effect of 
``cleansing'' the prior disqualified distribution. Based on these 
concerns, and a belief that other provisions of the final regulations 
will adequately address the effect of related transactions (e.g., the 
anti-avoidance provision, Sec. 1.355-6(b)(4)), the final regulations 
remove the reference to related transactions in the purpose rule.
c. Fractional Shares
    Some commentators requested that de minimis increases in interest 
in the stock of Distributing or Controlled should be disregarded in 
determining whether the purpose rule applies. The final regulations 
provide that an issuance of cash in lieu of fractional shares is 
disregarded in applying the purpose exception.

2. Disqualified Stock

    Generally, under the proposed regulations, disqualified stock is 
any stock in Distributing or Controlled acquired by purchase during the 
five-year period and any Controlled stock received in a distribution to 
the extent attributable to distributions on any stock in Distributing 
acquired by purchase during the five-year period. The definition of 
disqualified stock has been modified in the final regulations. The 
final regulations provide that stock of Distributing or Controlled that 
is acquired by a purchase within the five-year period (including such 
stock treated as indirectly acquired by purchase under section 
355(d)(8) or Sec. 1.355-6(e)(1), (2), (3) or (4) of the final 
regulations) ceases to be acquired by that purchase if the basis 
resulting from the purchase is eliminated. 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).
    For example, under the proposed regulations, a direct purchase by 
Distributing of all of the stock in Controlled, followed by a 
distribution of the Controlled corporation stock is a disqualified 
distribution. Under the final regulations, because the distribution of 
Controlled will result in an elimination of the basis that resulted 
from Distributing's purchase of Controlled stock, the Controlled stock 
would no longer be treated as purchased. The Controlled stock is 
therefore not disqualified stock and the distribution of Controlled 
would not be a disqualified distribution. Further, any purchases of 
stock of lower tier subsidiaries of Controlled that arise under section 
355(d)(8) as a result of Distributing's purchase of Controlled also 
would cease to be treated as purchased when Distributing's basis in 
Controlled is eliminated. Thus, in the example above, if Controlled has 
a subsidiary that would have been deemed purchased by Distributing when 
Distributing purchased the Controlled stock, the stock of that 
subsidiary would cease to be treated as purchased when Distributing's 
basis in Controlled is eliminated.
    In general, basis of stock resulting from a purchase also is 
treated as eliminated if such stock is transferred to another person in 
an exchange or other transfer to which Sec. 1.355-6(e)(2) or (3) 
(relating to carryover basis and exchange basis transactions) applies. 
The elimination of basis as a result of the transfer, however, does not 
affect the deemed purchase under Sec. 1.355-6(e)(2) or (3) that arises 
as a result of the transfer. Thus, for example, if A purchases 
Controlled stock and subsequently transfers that stock to Distributing 
in a reorganization qualifying under section 368(a)(1)(B) in exchange 
for Distributing stock, A's basis in Controlled is eliminated. Under 
Sec. 1.355-6(e)(3), A is deemed to purchase the Distributing stock on 
the date A purchased the Controlled stock. The elimination of A's basis 
in Controlled does not affect A's deemed purchase of its stock in 
Distributing (i.e., A's exchanged basis in its Distributing stock 
resulting from its deemed purchase of that stock is not eliminated). 
Also, Distributing is deemed under Sec. 1.355-6(e)(2) to have purchased 
the Controlled stock on the date A purchased the Controlled stock. The 
elimination of A's basis in Controlled does not affect the deemed 
purchase by Distributing of the Controlled stock (i.e., Distributing's 
carryover basis in its Controlled stock resulting from its deemed 
purchase of that stock is not eliminated).
    Under section 355(d)(3)(b)(ii) and Sec. 1.355-6(b)(2)(i)(B)(2), 
disqualified stock includes Controlled stock received in exchange for 
Distributing stock acquired by purchase. In a split-off or split-up, 
the distributee shareholder will exchange its stock in Distributing for 
Controlled stock in an exchange described in Sec. 1.355-6(e)(3). 
Technically, under the basis elimination rule, this would cause the 
Distributing stock held by such shareholder to no longer be treated as 
``acquired by purchase'' at the time of the distribution. As a result, 
the distributed Controlled stock would not be received in exchange for 
Distributing stock ``acquired by purchase,'' and thus, would not be 
disqualified stock. In order to prevent this result, Sec. 1.355-
(6)(b)(2)(iii)(B)(3) provides that basis resulting from a purchase of 
Distributing stock that is exchanged for Controlled stock is not 
eliminated notwithstanding that Sec. 1.355-6(e)(3) applies to the 
exchange.
    The modified definition of disqualified stock eliminates the need 
for the ``purchased interest no longer held'' rule of Sec. 1.355-
6(b)(3)(iv) of the proposed regulations, since transactions that result 
in the purchased interest no

[[Page 79721]]

longer being held also will result in an elimination of basis. 
Accordingly, that paragraph has been deleted. Examples have been added 
illustrating the effect of the changes discussed.

3. Purchase

    Section 355(d)(5) provides that, with certain exceptions, a 
purchase means any acquisition, but only if (1) the basis of the 
property acquired in the hands of the acquirer is not determined in 
whole or in part by reference to the adjusted basis of such property in 
the hands of the person from whom acquired, or under section 1014(a), 
and (2) the property is not acquired in an exchange to which section 
351, 354, 355 or 356 applies. The proposed regulations follow the 
statutory definition of a purchase and provide examples of both 
purchase and non-purchase acquisitions. See Sec. 1.355-6(d).
a. Section 338
    An example in the proposed regulations illustrates that if a 
section 338 election is made pursuant to an acquisition of stock, the 
stock acquired is treated as purchased for purposes of section 
355(d)(5)(A) (See Sec. 1.355-6(d)(1)(iii) Example 2). The example 
further illustrates that any stock held by the acquired target (and 
deemed sold to new target) also is purchased stock. The final 
regulations provide that 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 purchased for purposes of section 
355(d)(5)(A). However, the final regulations retain the rule that any 
stock 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 338(h)(10) election also is made with 
respect to that purchase).
b. Partnerships
    Section 1.355-6(d)(2)(v)(A) of the final regulations clarifies that 
an acquisition of stock (or an interest in another entity) by a partner 
pursuant to the liquidation of a partnership interest is a purchase of 
the stock (or other interest) acquired at the time of the liquidation 
of the partnership. Under Sec. 1.355-6(d)(2)(v)(B) of the final 
regulations, 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. The amount purchased 
is determined by reference to the amount of the basis adjustment over 
the fair market value of the stock (or other interest) at the time of 
the adjustment.
c. Transfers of Cash, Cash Items, Marketable Stock and Debt of the 
Transferor
    i. Transferred With Respect to an Active Trade or Business. 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 security, or any debt of the transferor. The proposed regulations 
provide certain exceptions to purchase treatment under section 
355(d)(5)(B). An acquisition of stock in exchange for any cash or cash 
item, marketable stock or debt of the transferor in a section 351 
transaction generally is not a purchase if the transferor transfers the 
items as part of an active trade or business and the transferred items 
do not exceed the reasonable needs of the trade or business (the active 
business exception). See Sec. 1.355-6(d)(3)(iv). The proposed 
regulations require, in part, that the transferee continue the active 
conduct of the trade or business. Commentators have expressed concern 
that this requirement would prevent a retransfer of the assets to a 
lower tier corporation within the same affiliated group. In Sec. 1.355-
6(d)(3)(iv)(4)(E), the final regulations clarify that a transfer of 
assets does not fail to meet the active business exception solely 
because the transferee transfers the assets to another member of the 
transferee's affiliated group if the requirements for the active 
business exception in Sec. 1.355-6(d)(3)(iv)(A)(1), (2), (3) and (4) 
would be met it the transferor had transferred the assets directly to 
the final transferee.
    ii. Transfers Between Members of the Same Affiliated Group. Under 
the proposed regulations, an acquisition of stock in exchange for any 
cash or cash item, marketable stock or security, or debt of the 
transferor in a section 351 transaction is generally not a purchase if 
the transferor corporation or corporations, the transferee corporation 
(whether formed in the transaction or already existing), and any 
distributed controlled corporation of the transferee corporation 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). See Sec. 1.355-6(d)(3)(v) for 
additional requirements. The final regulations clarify that the cash or 
cash item, marketable stock or security, or debt of the transferor that 
is transferred must not have been acquired from a nonmember in a 
related transaction in which section 362(a) or (b) applies to determine 
the basis in the acquired assets. Examples in the final regulations 
have been modified to reflect this clarification. See Sec. 1.355-
6(d)(4)(iii) and (d)(5)(iii) illustrating the effects of a forward and 
reverse triangular merger, respectively. The final regulations also 
eliminate the requirement that distributed controlled corporations be a 
member of the group before the section 351 transaction.
    iii. Certain Section 355 and Section 305 Distributions. Under 
Sec. 1.355-6(d)(1)(i)(B) of the proposed regulations, stock acquired in 
a distribution to which section 355 applies, whether in exchange for 
stock or pro rata, is not a purchase within the meaning of section 
355(d). The final regulations in Sec. 1.355-6(e)(4) modify this rule to 
provide that 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, the stock is 
deemed to be acquired by purchase by the distributee on the date the 
distributee acquired the recently purchased distributing stock. For 
this purpose, recently purchased distributing stock is stock in the 
distributing corporation acquired by purchase (determined without 
regard to the attribution rules of section 355(d)(8) and Sec. 1.355-
6(e)(1)) by the distributee during the five-year period with respect to 
that distribution. A similar rule is added with respect to 
distributions of stock under section 305(a) to the extent section 
307(a) applies to determine the recipient's basis.

4. Whether a Person Holds a 50 Percent or Greater Interest

a. Exchanged Basis Rule and Plan or Arrangement
    Section 1.355-6(c) of the proposed regulations provides rules for 
determining if a person holds a 50 percent or greater interest in 
Distributing or Controlled. Under section 355(d)(7)(B) and Sec. 1.355-
6(c)(4), if two or more persons act pursuant to a plan or arrangement 
with respect to acquisitions of stock or securities in Distributing or 
Controlled, those persons are treated as one person for purposes of 
section 355(d). A rule has been added to the final regulations 
clarifying the application of this rule in the context of an exchanged 
basis transaction with respect to purchased stock. If two or more 
persons do not act pursuant to a plan or arrangement with respect to an 
acquisition of stock in a corporation (the first corporation), a

[[Page 79722]]

subsequent exchange basis acquisition 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. An example 
has been added illustrating the effect of this rule.
b. Options
    Section 1.355-6(c)(3) of the proposed and final regulations 
generally provides that options outstanding when the distribution 
occurs are treated as exercised when issued or last transferred if two 
criteria are met. First, the deemed exercise would cause a person to be 
a disqualified person. Second, immediately after the distribution, 
taking into account all the facts and circumstances, it is reasonably 
certain the option will be exercised. Commentators suggested that the 
``reasonably certain to be exercised'' test be replaced with a 
``principal purpose to avoid section 355(d)'' standard patterned on the 
regulations under section 382. The IRS and Treasury continue to 
believe, however, that the more objective standard of the proposed 
regulations is appropriate.
    In response to a comment, the final regulations exclude from the 
definition of options cash settlement options, phantom stock, stock 
appreciation rights, and national principal contracts. However, to the 
extent that such instruments are exercisable into stock, they still 
would be subject to the deemed exercise rule of the final regulations 
under Sec. 1.355-6(c)(3)(v) as an ``other instrument that provides for 
the right to purchase, issue, redeem, or transfer stock.'' The final 
regulations have also added a rule for substituted options treating the 
substituted option as issued on the date the original option was 
issued.
5. Statistical Sampling
    Under Sec. 1.355-6(f)(1) of the proposed regulations, a 
distributing corporation must determine whether a disqualified person 
holds its stock or the stock of any distributed controlled corporation. 
Under Sec. 1.355-6(f)(4), a distributing corporation may, absent actual 
knowledge with regard to a particular shareholder, presume that no 
less-than-five-percent shareholder of a corporation acquired stock or 
securities by purchase during the five-year period. In Sec. 1.355-
6(f)(5) Example 3, the final regulations clarify that application of 
statistical sampling procedures to estimate the basis of shares 
acquired in certain reorganizations does not have the effect of giving 
actual knowledge of a purchase of stock beyond the sample group.

6. Administrative Remedies

    A comment urged the adoption of various forms of administrative 
relief from the recognition of gain in a disqualified distribution. The 
suggested forms of relief included the issuance of private letter 
rulings granting tax free treatment in appropriate cases, gain 
recognition agreements, stock basis waivers, or some combination of the 
above. Section 355(d) applies at a specific time (at the time of the 
disqualified distribution) and requires Distributing to recognize gain 
as if it had sold Controlled at its fair market value at that time. 
Accordingly, the IRS and Treasury Department do not believe that it 
would be appropriate to adopt any of these administrative relief 
provisions. Basis reduction or gain recognition agreements could result 
in either a complete avoidance or a deferral of gain recognition. 
Moreover, the IRS and Treasury do not believe that granting exceptions 
to section 355(d) by private letter ruling is appropriate. However, the 
final regulations include a new provision stating that 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).

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 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 and, because 
these regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Therefore, a Regulatory Flexibility Analysis is not required. 
Pursuant to section 7805(f) of the Internal Revenue Code, these 
regulations were 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 Michael N. Kaibni of 
the Office of the Associate Chief Counsel (Corporate). 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.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

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

    Authority: 26 U.S.C. 7805 * * *

    Section 1.355-6 also issued under 26 U.S.C. 355(d)(9). * * *


    Par. 2. Section 1.355-0 is amended by revising the section heading, 
adding introductory text, removing the existing entry for Sec. 1.355-6, 
and adding new entries for Sec. 1.355-6 to read as follows:


Sec. 1.355-0  Table of contents.

    To facilitate the use of Secs. 1.355-1 through 1.355-6, this 
section lists the following major paragraphs in those sections:
* * * * *

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.
    (i) Application.
    (ii) General rule.

[[Page 79723]]

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


    Par. 3. Section 1.355-6 is revised to read as follows:


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 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

[[Page 79724]]

    (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 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

[[Page 79725]]

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.
    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 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

[[Page 79726]]

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 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 
(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

[[Page 79727]]

    (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 
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

[[Page 79728]]

has a fair market 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 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

[[Page 79729]]

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); 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, 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 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

[[Page 79730]]

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 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.
    (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.

[[Page 79731]]

    (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
    (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 Secs. 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

[[Page 79732]]

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 Secs. 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 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 
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

[[Page 79733]]

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 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 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 treated 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.


[[Page 79734]]


    (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 
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 none of its 
less-than-five-

[[Page 79735]]

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.

    (g) Effective date. 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 which is 
(subject to customary conditions) binding on December 20, 2000, and at 
all times thereafter.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: December 11, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury.
[FR Doc. 00-32041 Filed 12-19-00; 8:45 am]
BILLING CODE 4830-01-P