[Federal Register Volume 77, Number 73 (Monday, April 16, 2012)]
[Proposed Rules]
[Pages 22516-22519]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-8995]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-139991-08]
RIN 1545-BI84


Certain Transfers of Property to Regulated Investment Companies 
[RICs] and Real Estate Investment Trusts [REITs]

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed amendments to regulations 
under section 337(d) of the Internal Revenue Code. The proposed 
regulations provide guidance concerning certain transfers of property 
from a C corporation to a Regulated Investment Company (RIC) or a Real 
Estate Investment Trust (REIT) and will affect the parties to such 
transactions. This document also invites comments from the public 
regarding these proposed regulations.

DATES: Written or electronic comments and requests for a public hearing 
must be received by July 16, 2012.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-139991-08), room 
5205, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
139991-08), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal at http://www.regulations.gov (IRS REG-139991-08).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Grid Glyer (202) 622-7930 or Maury Passman (202) 622-7750 with respect 
to the corporate issues, and David H. Kirk (202) 622-3060 with respect 
to the partnership issues; concerning submissions of comments, 
Oluwafunmilayo Taylor (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Congress repealed the General Utilities doctrine in the Tax Reform 
Act of 1986 (Pub. L. 99-514, 100 Stat. 2085), as amended by the 
Technical and Miscellaneous Revenue Act of 1988 (Pub. L. 100-647, 102 
Stat. 3342), when sections 336 and 337 of the Internal Revenue Code 
were amended to require corporations to recognize gain or loss on the 
distribution of property in connection with complete liquidations other 
than certain subsidiary liquidations. Section 337(d)(1) directs the 
Secretary to prescribe regulations as may be necessary to carry out the 
purposes of General Utilities repeal, including rules to ``ensure that 
such purposes may not be circumvented * * * through the use of a 
regulated investment company, a real estate investment trust, or tax-
exempt entity * * *.''
    On March 18, 2003, regulations under Sec.  1.337(d)-7 (the 
regulations) were published in the Federal Register (TD 9047, 68 FR 
12817). The regulations generally provide (in paragraphs (a) and 
(b)(1)) that if property of a C corporation (the C corporation 
transferor) becomes the property of a RIC or REIT by the qualification 
of that C corporation as a RIC or REIT or by the transfer of assets of 
that C corporation to a RIC or REIT (a conversion transaction), then 
the RIC or REIT will be subject to tax on the net built-in gain in the 
converted property under the rules of section 1374 and the underlying 
regulations. This treatment, however, does not apply if the C 
corporation transferor elects to recognize gain and loss as if it sold 
the converted property to an unrelated party at fair market value 
(deemed sale treatment).

Explanation and Summary of Comments

    This preamble first discusses the proposal as it relates to net 
built-in gain property acquired by a RIC or REIT either in a like-kind 
exchange (where the C corporation transferor's gain is not recognized 
by reason of section 1031) or in an involuntary conversion (where such 
gain is not recognized by reason of section 1033). This preamble then 
discusses a proposed revision to the definition of a C corporation in 
the regulations, which provides that a transfer of property by a tax-
exempt entity to a RIC or REIT is not treated as a conversion 
transaction unless the tax-exempt entity would have been subject to tax 
if a deemed sale election had been made.
    In addition, the proposed regulations also add definitions for the 
terms RIC, REIT, and S corporation. While these terms are not 
explicitly defined in the regulations, their meanings are both self-
evident and unambiguous in that context. Nonetheless, for clarification 
and ease of use, the proposed regulations add explicit definitions.

A. Like-Kind Exchanges and Involuntary Conversions

    The current regulations generally provide that if property of a C 
corporation becomes the property of a RIC or REIT in a conversion 
transaction, then, absent a deemed sale election, the RIC or REIT will 
be subject to tax on the net built-in gain in the converted property 
under the rules of section 1374 and the underlying regulations (as 
modified in paragraph (b) of the regulations), as if the RIC or REIT 
were an S corporation.
    Commentators have expressed concern that the general rule may 
inappropriately expose property transferred in certain exchanged basis 
transactions--specifically, like-kind exchanges and involuntary 
conversions--to this treatment. In these transactions, the C 
corporation transferor replaces property it transferred to a RIC or 
REIT with property that has an equivalent basis and built-in gain, and 
as a result, the built-in gain remains subject to corporate tax in the 
hands of the transferor. Therefore, there would not be any 
circumvention of the purposes of General Utilities repeal. Section 
1.337(d)-4(b)(3) provides an exception in an analogous context (where a 
C corporation transfers all or substantially all of its assets to a 
tax-exempt entity) to the extent the transaction qualifies for 
nonrecognition treatment under section 1031 or section 1033.

[[Page 22517]]

    Accordingly, the proposed regulations provide an exception from the 
general rule of the current regulations for a transfer of property by a 
C corporation to a RIC or REIT to the extent that the transfer 
qualifies for non-recognition treatment under either section 1031 or 
1033. In such a transaction, the C corporation transferor's basis in 
the property it receives is derived from its basis in the transferred 
property, and thus reflects the built-in gain. At the same time, the 
basis of the transferee RIC or REIT in the converted property has no 
relation to the C corporation transferor's basis therein.
    Treasury and the IRS are not proposing to extend this treatment to 
all exchanged basis transactions, such as exchanges that would 
otherwise qualify for nonrecognition treatment under section 351 of the 
Code, out of a concern that such an exemption could create 
opportunities to avoid corporate-level tax on built-in gains and would 
give rise to administrative difficulties that could be addressed only 
through extensive rulemaking.

B. Transfers by Tax-Exempt Entities

    The regulations apply to property transferred by a C corporation 
directly to a RIC or REIT, and indirectly through a partnership to the 
extent of any C corporation partner's proportionate share of the 
transferred property (the partnership rule). The regulations state that 
if the partnership elects deemed sale treatment with respect to such 
transfer, then any net gain recognized by the partnership on the deemed 
sale must be allocated to the C corporation partner.
    Commentators have expressed concern that the partnership rule 
presents unintended effects when the partnership has multiple C 
corporation partners including both taxable and tax-exempt entities. If 
such a partnership transfers built-in gain property to a RIC or REIT in 
a conversion transaction without making a deemed sale election (that 
is, section 1374 treatment applies), and if the transferee RIC or REIT 
sells the converted property during the recognition period, then the 
RIC or REIT is subject to a corporate-level tax on the net built-in 
gain, including the portion of the net built-in gain that otherwise 
would have been allocated to tax-exempt C corporation partners had a 
deemed sale election been made. This is because the net recognized 
built-in gain is determined with reference to the amount of gain that 
would have been allocated to all C corporation partners, regardless of 
their taxable or tax-exempt status. In contrast, if the transferring 
partnership were to make a deemed sale election, the taxable C 
corporation partners would recognize gain that otherwise could have 
been deferred if section 1374 treatment had applied.
    Treasury and the IRS believe that the inclusion of direct or 
indirect transfers by tax-exempt entities in the scope of the final 
regulations furthers the purposes of General Utilities repeal only to 
the extent that those entities would have been subject to tax had a 
deemed sale election been made (for example, if a deemed sale election 
would have generated unrelated business taxable income or would have 
adversely affected the entity's tax-exempt status). Accordingly, the 
proposed regulations would amend the final regulations to provide that 
the definition of a C corporation excludes tax-exempt entities within 
the meaning of Sec.  1.337(d)-4(c)(2). As a result, transfers of 
property by a tax-exempt entity to a RIC or REIT (or by a partnership 
to a RIC or REIT to the extent of a tax-exempt partner's distributive 
share of the gain in the transferred property) generally will not be 
subject to section 1374 treatment. For this purpose, however, an entity 
will not be considered to be tax-exempt to the extent it would be 
subject to tax (such as under section 511) under Title 26 of the United 
States Code with respect to gain (if any) resulting from a deemed sale 
election if such an election were made under Sec.  1.337(d)-7(c)(5) 
with respect to the transfer. Thus, for example, if a partnership in 
which a tax-exempt C corporation described in Sec.  1.337(d)-4(c)(2) is 
a partner transfers property to a RIC or REIT in a conversion 
transaction, and the tax-exempt entity would not have been subject to 
unrelated business income tax under section 511 or to tax under any 
other provision of the Code had the partnership made a deemed sale 
election in connection with the transfer, the transfer would be 
excluded from the scope of the final regulations (and the transferee 
RIC or REIT will not be subject to section 1374 treatment) to the 
extent of the tax-exempt entity's distributive share of the built-in 
gain or loss in the converted property. However, to the extent the tax-
exempt partner would have been subject to unrelated business income tax 
under section 511 or to tax under any other provision of the Code with 
respect to its distributive share of the built-in gain on the property, 
the transferee RIC or REIT would be subject to tax on the built-in gain 
on the property under the rules of section 1374 as if the RIC or REIT 
were an S corporation unless the transferring partnership elects deemed 
sale treatment.
    Section 1.337(d)-7(e) provides that the principles of Sec.  
1.337(d)-7 apply to property transferred by a partnership to a RIC or 
REIT to the extent of any C corporation partner's distributive share of 
the gain or loss in the transferred property. The proposed regulations 
provide that Sec.  1.337(d)-7(e) also applies to determine the 
distributive share of the gain or loss in the transferred property of a 
C corporation partner of a higher-tier partnership in a tiered 
partnership structure in which the transferor partnership is a lower-
tier partnership.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866, as supplemented by Executive Order 13565. Therefore, a 
regulatory assessment is not required. Pursuant to the Regulatory 
Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that these 
proposed regulations would not have a significant economic impact on a 
substantial number of small entities because the proposed regulations 
limit the situations in which these regulations apply to all 
businesses, including small businesses. This certification is based on 
the fact that these proposed regulations do not create additional 
obligations for, or impose an economic impact on, small entities. 
Therefore, a regulatory flexibility analysis is not required. Pursuant 
to section 7805(f) of the Code, these proposed regulations will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. Treasury and the IRS request comments on all aspects of the 
proposed rules. All comments will be available for public inspection 
and copying. A public hearing may be scheduled if requested in writing 
by any person that timely submits written or electronic comments. If a 
public hearing is scheduled, notice of the date, time, and place for 
the public hearing will be published in the Federal Register.

Drafting Information

    The principal authors of these regulations are Grid Glyer and Maury 
Passman of the Office of Associate Chief

[[Page 22518]]

Counsel (Corporate). Other personnel from Treasury Department and the 
IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.337(d)-7 is also issued under 26 U.S.C. 337(d) * * *

    Par. 2. Section 1.337(d)-7 is amended by:
    1. Revising paragraphs (a)(2), (d)(1), (e) and (f)
    2. Adding paragraph (d)(3),
    The revisions and addition read as follows:


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

    (a) * * *
    (2) Definitions. For purposes of this section:
    (i) C corporation. The term C corporation has the meaning provided 
in section 1361(a)(2) except that the term does not include a RIC, a 
REIT, or a tax-exempt entity within the meaning of paragraph (a)(2)(vi) 
of this section.
    (ii) Conversion transaction. The term conversion transaction means 
the qualification of a C corporation as a RIC or REIT or the transfer 
of property owned by a C corporation to a RIC or REIT.
    (iii) RIC. The term RIC means a regulated investment company within 
the meaning of section 851(a).
    (iv) REIT. The term REIT means a real estate investment trust 
within the meaning of section 856(a).
    (v) S corporation. The term S corporation has the meaning provided 
in section 1361(a)(1).
    (vi) Tax-exempt entity. The term tax-exempt entity, with respect to 
a conversion transaction, means an entity--
    (A) Described in Sec.  1.337(d)-4(c)(2), and
    (B) That would not be subject to tax under Title 26 of the United 
States Code with respect to gain (if any) resulting from a deemed sale 
election if such an election were made under paragraph (c)(5) of this 
section with respect to the conversion transaction.
* * * * *
    (d) Exceptions--(1) Gain otherwise recognized. Paragraph (a) of 
this section does not apply to any conversion transaction to the extent 
that gain or loss otherwise is recognized on such conversion 
transaction by the C corporation that either qualifies as a RIC or a 
REIT or that transfers property to a RIC or REIT. See, for example, 
sections 311(b), 336(a), 351(b), 351(e), 356, 357(c), 367, 
368(a)(2)(F), 1001, 1031(b), and 1033(b).
* * * * *
    (3) Special rules for like-kind exchanges and involuntary 
conversions--(i) In general. Paragraph (a) of this section does not 
apply to a conversion transaction to the extent that a C corporation 
transfers property with a built-in gain to a RIC or REIT and the C 
corporation's gain is not recognized by reason of either section 1031 
or 1033.
    (ii) Clarification regarding exchanged property previously subject 
to section 1374 treatment. Notwithstanding paragraph (d)(3)(i) of this 
section, if, in a transaction described in paragraph (d)(3)(i) of this 
section, a RIC or REIT surrenders property that was subject to section 
1374 treatment immediately prior to the transaction, the rules of 
section 1374(d)(6) will apply to continue section 1374 treatment to the 
replacement property acquired by the RIC or REIT in the transaction.
    (iii) Examples. The rules of this paragraph (d)(3) are illustrated 
by the following examples. In each of the examples, X is a REIT, Y is a 
C corporation, and X and Y are not related.

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

[[Page 22519]]

Facts. X owned property (Property 1). On January 1, Year 2, Property 
1 had a fair market value of $100 and a basis of $70, and X was not 
subject to section 1374 treatment with respect to Property 1. On 
that date, when Property 1 was under a threat of condemnation, X 
sold Property 1 to an unrelated party for $100 (First Transaction). 
X elected to defer gain recognition under section 1033(a)(2), and 
purchased qualifying replacement property (Property 2) for $100 from 
Y (Second Transaction) prior to the expiration of the period 
described in section 1033(a)(2)(B).
    (ii) Analysis. The transfer of Property 2 by Y to X in the 
Second Transaction is a conversion transaction within the meaning of 
paragraph (a)(2)(ii) of this section. The Second Transaction 
(combined with the First Transaction) qualified for nonrecognition 
treatment under section 1033(a) as to X, but not as to Y. Assume no 
nonrecognition provision applied to Y; thus, Y recognized gain or 
loss on its sale of Property 2 in the Second Transaction, and the 
Second Transaction is not subject to paragraph (a) of this section 
by reason of paragraph (d)(3)(i) of this section.

    (e) Special rule for partnerships--(1) In general. The principles 
of this section apply to property transferred by a partnership to a RIC 
or REIT to the extent of any gain or loss in the converted property 
that would be allocated directly or indirectly, through one or more 
partnerships, to a C corporation if the partnership sold the converted 
property to an unrelated party at fair market value on the deemed sale 
date (as defined in paragraph (c)(3) of this section). If the 
partnership were to elect deemed sale treatment under paragraph (c) of 
this section in lieu of section 1374 treatment under paragraph (b) of 
this section with respect to such transfer, then any net gain 
recognized by the partnership on the deemed sale must be allocated to 
the C corporation partner, but does not increase the capital account of 
any partner. Any adjustment to the partnership's basis in the RIC or 
REIT stock as a result of deemed sale treatment under paragraph (c) of 
this section shall constitute an adjustment to the basis of that stock 
with respect to the C corporation partner only. The principles of 
section 743 apply to such basis adjustment.

    (2) Example. Transfer by partnership of property to REIT. (i) 
Facts. PRS, a partnership for Federal income tax purposes, has three 
partners: TE, a tax-exempt entity (within the meaning of Sec.  
1.337(d)-7(a)(2)(vi)), owns 50 percent of the capital and profits of 
PRS; A, an individual, owns 30 percent of the capital and profits of 
PRS; and Y, a C corporation (within the meaning of Sec.  1.337(d)-
7(a)(2)(i)), owns the remaining 20 percent. PRS owns a building that 
it leases for commercial use (Property 1). On January 1, Year 2, 
when PRS has an adjusted basis in Property 1 of $100 and Property 1 
has a fair market value of $500, PRS transfers Property 1 to X, a 
REIT, in exchange for stock of X in an exchange described in section 
351. PRS does not elect deemed sale treatment under paragraph (c) of 
this section.
    (ii) Analysis. The transfer of Property 1 by PRS to X is a 
conversion transaction within the meaning of paragraph (a)(2)(ii) of 
this section to the extent of any gain or loss that would be 
allocated to any C corporation partner if PRS sold Property 1 at 
fair market value to an unrelated party on the deemed sale date. Y 
is a C corporation, but neither TE nor A is a C corporation within 
the meaning of paragraph (a)(2)(i) of this section. Therefore, the 
transfer of Property 1 by PRS to X is a conversion transaction 
within the meaning of paragraph (a)(2)(ii) of this section to the 
extent of Y's share of any such gain of PRS in Property 1. If PRS 
were to sell Property 1 to an unrelated party at fair market value 
on the deemed sale date, PRS would allocate $80 of built-in gain to 
Y. Thus, X is subject to section 1374 treatment on Property 1 with 
respect to $80 of built-in gain.
    (f) Effective/Applicability date--(1) In general. Except as 
provided in paragraph (f)(2) of this section, this section applies 
to conversion transactions that occur on or after January 2, 2002. 
For conversion transactions that occurred on or after June 10, 1987, 
and before January 2, 2002, see Sec. Sec.  1.337(d)-5 and 1.337(d)-
6.
    (2) Special rule. Paragraphs (a)(2), (d)(1), (d)(3) and (e) of 
this section apply to conversion transactions that occur on or after 
[INSERT DATE OF PUBLICATION OF THE TREASURY DECISION ADOPTING THESE 
RULES AS FINAL REGULATIONS IN THE FEDERAL REGISTER]. However, 
taxpayers may apply paragraphs (a)(2), (d)(1), (d)(3) and (e) of 
this section to conversion transactions that occurred before [INSERT 
DATE OF PUBLICATION OF THE TREASURY DECISION ADOPTING THESE RULES AS 
FINAL REGULATIONS IN THE FEDERAL REGISTER]. For conversion 
transactions that occurred on or after January 2, 2002 and before 
[INSERT DATE OF PUBLICATION OF THE TREASURY DECISION ADOPTING THESE 
RULES AS FINAL REGULATIONS IN THE FEDERAL REGISTER], see Sec.  
1.337(d)-7 as contained in 26 CFR part 1 in effect on April 1, 2011.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2012-8995 Filed 4-13-12; 8:45 am]
BILLING CODE 4830-01-P