[Federal Register Volume 83, Number 111 (Friday, June 8, 2018)]
[Rules and Regulations]
[Pages 26580-26593]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-12407]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9833]
RIN 1545-BO43


Partnership Transactions Involving Equity Interests of a Partner

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final rule.

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SUMMARY: This document contains final regulations that prevent a 
corporate partner from avoiding corporate-level gain through 
transactions with a partnership involving equity interests of the 
partner or certain related entities. This document also contains final 
regulations that allow consolidated group members that are partners in 
the same partnership to aggregate their bases in stock distributed by 
the partnership for the purpose of limiting the application of rules 
that might otherwise cause basis reduction or gain recognition. This 
document also contains final regulations that may also require certain 
corporations that engage in gain elimination transactions to reduce the 
basis of corporate assets or to recognize gain. These final regulations 
affect partnerships and their partners.

DATES: 
    Effective Date: These final regulations are effective on June 8, 
2018.
    Applicability Date: These final regulations are applicable on or 
after June 12, 2015.

FOR FURTHER INFORMATION CONTACT: Concerning the final regulations, 
Kevin I. Babitz, (202) 317-6852.

SUPPLEMENTARY INFORMATION: 

Background

1. Overview

    On June 12, 2015, the Department of the Treasury (and the IRS 
published final and temporary regulations (TD 9722) under section 
337(d) of the Internal Revenue Code (Code) in the Federal Register (80 
FR 33402). On July 8, 2015, corrections to TD 9722 were published in 
the Federal Register (80 FR 38940-38941) (together with TD 9722, the 
temporary regulations). The temporary regulations expire on June 11, 
2018.
    A notice of proposed rulemaking (REG-149518-03) withdrawing 
proposed regulations under section 337(d) published in 1992, and 
proposing new proposed regulations by cross-reference to the temporary 
regulations, was published in the Federal Register (80 FR 33451) on the 
same date as TD 9722. Additionally, on June 12, 2015, the Treasury 
Department and the IRS published proposed regulations (REG-138759-14) 
under section 732(f) in the Federal Register (80 FR 33452) (together 
with the 2015 proposed regulations under section 337(d), the 2015 
regulations).
    The Treasury Department and the IRS received one comment letter in 
response to the 2015 regulations. Except as described below, the 
commenter largely supported the 2015 regulations while recommending 
some minor modifications and clarifications to the 2015 regulations 
under both section 337(d) and section 732(f). The comment letter is 
discussed in detail in the Explanation of Provisions section of this 
preamble.
    After considering this comment letter, this Treasury decision 
adopts as final regulations the rules set forth in the 2015 regulations 
under section 337(d) (with only minor, nonsubstantive clarifications in 
response to the commenter's request for additional certainty regarding 
certain collateral effects) and section 732(f) (without any change). 
However, the Treasury Department and the IRS are considering publishing 
a new notice of proposed rulemaking to propose more substantive 
amendments to the final regulations under section 337(d) and to allow 
for additional public comment with respect to these more substantive 
proposals in response to the comment letter, further reflection by the 
Treasury Department and the IRS, and concerns raised by practitioners.

2. Regulations Under Section 337(d)

A. Background
    In General Utilities & Operating Co. v. Helvering, 296 U.S. 200 
(1935), the Supreme Court held that corporations generally could 
distribute appreciated property to their shareholders without the 
recognition of any corporate level gain (the General Utilities 
doctrine). Beginning with legislation in 1969 and culminating in the 
Tax Reform Act of 1986, Public Law 99-514 (100 Stat. 2085) (the Act), 
Congress repealed the General Utilities doctrine by enacting section 
336(a) to apply gain and loss recognition to liquidating distributions.
    Under current law, sections 311(b) and 336(a) require a corporation 
that distributes appreciated property to its shareholders to recognize 
gain determined as if the property were sold to the shareholders for 
its fair market value. Additionally, section 631 of the Act added 
section 337(d) to permit the Secretary to prescribe regulations that 
are necessary or appropriate to carry out the purposes of the General 
Utilities repeal, ``including regulations to ensure that [the repeal of 
the General Utilities doctrine] may not be circumvented through the use 
of any provision of law or regulations.''
    After the enactment of sections 311(b) and 337(d), the Treasury 
Department and the IRS became aware of transactions in which taxpayers 
used a partnership to postpone or avoid completely gain generally 
required to be recognized under section 311(b). In one example of this 
transaction, a corporation entered into a partnership and contributed 
appreciated property. The partnership then acquired stock of that 
corporate partner, and later made a liquidating distribution of this 
stock to the corporate partner. Under section 731(a), the corporate 
partner did not recognize gain on the partnership's distribution of its 
stock. By means of this transaction, the corporation had disposed of 
the appreciated property it formerly held and had acquired its own 
stock, permanently avoiding its gain in the appreciated property. If 
the corporation had directly exchanged the appreciated property for its 
own stock, section 311(b) would have required the corporation to 
recognize gain upon the exchange.
    In response to these types of abusive transactions, the Treasury 
Department and the IRS issued Notice 89-37, 1989-1 CB 679, on March 9, 
1989. Notice 89-37 announced that future regulations under section 
337(d) would address the use of partnerships to avoid the repeal of the 
General Utilities doctrine.
    On December 15, 1992, the Treasury Department and the IRS published 
a notice of proposed rulemaking under section 337(d) (PS-91-90, REG-
208989-90, 1993-1 CB 919) in the Federal Register (57 FR 59324) 
addressing abusive partnership transactions involving stock of a 
corporate partner (the 1992 proposed regulations). The 1992 proposed 
regulations set forth a deemed redemption rule and a separate 
distribution rule to prevent a corporate partner from avoiding 
corporate-level gain through transactions with a partnership involving 
stock of the corporate partner, stock of the partner's affiliate, and 
other equity interests in the corporate partner or affiliate. The 1992 
proposed regulations treated a corporation as an affiliate of a partner 
at

[[Page 26581]]

the time of a deemed redemption or distribution by the partnership if, 
immediately thereafter, the partner and corporation were members of an 
affiliated group as defined in section 1504(a) without regard to 
section 1504(b) (section 337(d) affiliation). On January 19, 1993, the 
Treasury Department and the IRS issued Notice 93-2, 1993-1 CB 292, 
which stated that the 1992 proposed regulations would be amended to 
limit the application of the regulations to transactions in which 
section 337(d) affiliation existed immediately before the deemed 
redemption or distribution. The Treasury Department and the IRS 
received comments on the 1992 proposed regulations, and adopted a 
number of these comments in the 2015 regulations.
B. The 2015 Regulations
    The 2015 regulations under section 337(d) set forth a rule (the 
deemed redemption rule) that was aimed at protecting the repeal of the 
General Utilities doctrine. The 2015 regulations provided that certain 
transactions create the economic effect of an exchange of appreciated 
property for Stock of the Corporate Partner and, to tax such exchange 
appropriately, the deemed redemption rule provided that a Corporate 
Partner recognizes gain at the time of, and to the extent that, any 
transaction (or series of transactions) has the economic effect of an 
exchange by the partner of its interest in appreciated property for an 
interest in Stock of the Corporate Partner owned, acquired, or 
distributed by the partnership. (The terms Corporate Partner and Stock 
of the Corporate Partner are defined in section 1.B.i. of the 
Explanation of Provisions.)
    The 2015 regulations did not adopt the separate distribution rule 
set forth in the 1992 proposed regulations. Instead, the 2015 
regulations applied the deemed redemption rule to partnership 
distributions of Stock of the Corporate Partner to the Corporate 
Partner as though the partnership amended its agreement, immediately 
before the distribution, to allocate 100 percent of the distributed 
stock to the Corporate Partner. The 2015 regulations also set forth de 
minimis and inadvertence exceptions to the deemed redemption rule.

3. Regulations Under Section 732(f)

A. Section 732(f)
    Section 538 of the Ticket to Work and Work Incentives Improvement 
Act of 1999, Public Law 106-170 (113 Stat. 1860) (December 17, 1999), 
added section 732(f) generally effective for distributions of made 
after July 14, 1999. Section 732(f) provides that if (1) a corporate 
partner receives a distribution from a partnership of stock in another 
corporation (distributed corporation); (2) the corporate partner has 
control of the distributed corporation, defined as ownership of stock 
meeting the requirements of section 1504(a)(2), immediately after the 
distribution or at any time thereafter (control requirement); and (3) 
the partnership's basis in the stock immediately before the 
distribution exceeded the corporate partner's basis in the stock 
immediately after the distribution, then the basis of the distributed 
corporation's property must be reduced by this excess. The amount of 
this reduction is limited to the amount by which the sum of the 
aggregate adjusted basis of property and the amount of money of the 
distributed corporation exceeds the corporate partner's adjusted basis 
in the stock of the distributed corporation. The corporate partner must 
recognize gain to the extent that the basis of the distributed 
corporation's property cannot be reduced.
    Congress enacted section 732(f) due to concerns that a corporate 
partner could otherwise negate the effects of a basis step-down to 
distributed property required under section 732(b) by applying the 
step-down against the basis of the stock of the distributed 
corporation.
    For example, assume a corporate partner has a partnership interest 
with zero basis and receives a partnership distribution of high-basis 
stock in a corporation. The corporate partner's basis in the 
distributed corporation's stock is reduced to zero under section 732(a) 
or section 732(b). If the partnership has elected under section 754, 
then the basis of other partnership property is increased by an equal 
amount under section 734(b). The section 732 basis decrease and the 
section 734(b) basis increase generally offset each other. However, if 
the corporate partner owned stock in the distributed corporation that 
satisfied the control requirement, the corporate partner could 
liquidate the distributed corporation under section 332, and section 
334(b) would generally provide for a carryover basis in the distributed 
corporation's property received by the corporate partner in the 
liquidation. Taken together, these rules could permit the partnership 
to increase the basis of its retained property without an equivalent 
basis reduction following the liquidation of the distributed 
corporation. Section 732(f) generally precludes this result by 
requiring that either the distributed corporation must reduce the basis 
of its property or the corporate partner must recognize gain (to the 
extent the distributed corporation is unable to reduce the basis of its 
property). Thus, section 732(f) generally ensures that any basis 
increase under section 734(b) is offset.
    Section 732(f)(8) grants the Secretary authority to prescribe 
regulations that may be necessary to carry out the purposes of this 
subsection, including regulations to avoid double counting and to 
prevent the abuse of such purposes.
B. The 2015 Regulations
    In the preamble to the 2015 regulations under section 732(f), the 
Treasury Department and the IRS stated that the application of section 
732(f) was too broad in some circumstances and too narrow in others. 
Specifically, the application was overbroad because section 732(f) 
could require basis reduction or gain recognition even though that 
basis reduction or gain recognition did not further the purposes of 
section 732(f). Alternatively, the application was too narrow because 
corporate partners could inappropriately avoid the purposes of section 
732(f) by engaging in transactions that allow corporate partners to 
receive property held by a distributed corporation without reducing the 
basis of that property to account for basis reductions under section 
732(b) made when the partnership distributed stock of the distributed 
corporation to the corporate partner.
    To address these concerns, the 2015 regulations set forth specific 
rules governing the application of section 732(f) in two specific sets 
of circumstances. The first rule would permit consolidated group 
members to aggregate the bases of their respective interests in the 
same partnership, in certain circumstances, for section 732(f) 
purposes. The second rule would restrict corporate partners from 
entering into certain transactions or a series of transactions (gain 
elimination transactions), such as a distribution followed by a 
reorganization under section 368(a), that might eliminate gain in the 
stock of a distributed corporation while avoiding the effects of a 
basis step-down under section 732(f) because the control requirement 
would not be immediately satisfied.
    In addition, the 2015 regulations under section 732(f) required 
taxpayers to apply those rules to tiered partnerships in a manner 
consistent with the purpose of section 732(f).

[[Page 26582]]

Explanation of Provisions

1. Final Regulations Under Section 337(d)

A. Generally
    The final regulations under section 337(d) provide that the purpose 
of the regulations is to prevent corporate taxpayers from using a 
partnership to circumvent gain required to be recognized under section 
311(b) or section 336(a). These final regulations, including the rules 
governing the amount, timing, and character of recognized gain, must be 
applied in a manner consistent with, and which reasonably carries out, 
this purpose.
    These final regulations apply when a partnership, either directly 
or indirectly, owns, acquires, or distributes Stock of the Corporate 
Partner (as defined in Sec.  1.337(d)-3(c)(2) of these final 
regulations). Under these final regulations, a Corporate Partner (as 
defined at Sec.  1.337(d)-3(c)(1) of these final regulations) may 
recognize gain when it is treated as acquiring or increasing its 
interest in Stock of the Corporate Partner held by a partnership in 
exchange for appreciated property in a manner that avoids gain 
recognition under section 311(b) or section 336(a). These final 
regulations also provide exceptions under which a Corporate Partner is 
not required to recognize gain.
B. Scope and Definitions
i. Corporate Partner and Stock of the Corporate Partner
    The 2015 regulations defined a Corporate Partner as a person that 
holds or acquires an interest in a partnership and that is classified 
as a corporation for federal income tax purposes. The 2015 regulations 
defined Stock of the Corporate Partner expansively to include the 
Corporate Partner's stock, or other equity interests, including 
options, warrants, and similar interests, in the Corporate Partner, or 
in a corporation that controls the Corporate Partner within the meaning 
of section 304(c), except that section 318(a)(1) and (3) shall not 
apply (referred to in this Explanation of Provisions as a Controlling 
Corporation). Stock of the Corporate Partner also included interests in 
any entity to the extent that the value of the interest is attributable 
to Stock of the Corporate Partner.
    The commenter asked whether an equity interest issued by a third 
party on a Corporate Partner's stock, such as an option issued by a 
bank on the Corporate Partner's stock, was considered Stock of the 
Corporate Partner. The Treasury Department and the IRS confirm that all 
options, warrants, and other similar interests issued by third parties 
on a Corporate Partner's stock, a Controlling Corporation's stock, or 
any interests in any entity to the extent that the value of the 
interest is attributable to Stock of the Corporate Partner, are Stock 
of the Corporate Partner under both the temporary regulations and these 
final regulations. No inference is intended regarding whether options, 
warrants, and other similar interests are subject to section 1032 where 
they create an equity interest in the Stock of the Corporate Partner.
ii. Stock of the Corporate Partner: Controlling Corporations
    The 2015 regulations provided that Stock of the Corporate Partner 
includes the stock (or other equity interests) in a Controlling 
Corporation. The commenter asked whether stock in a Controlling 
Corporation wholly constitutes Stock of the Corporate Partner or only 
constitutes Stock of the Corporate Partner to the extent the value of 
the Controlling Corporation's stock is attributable to that 
corporation's interest in the Corporate Partner. These final 
regulations clarify that it is intended that stock (or any other equity 
interest) in a Controlling Corporation will wholly constitute Stock of 
the Corporate Partner irrespective of the ratio of the Controlling 
Corporation's interest in the Corporate Partner to the Controlling 
Corporation's total assets. In response to this comment, the final 
regulations also include a new example to clearly illustrate this 
point. See Example 2 of Sec.  1.337(d)-3(h) in these final regulations.
    With respect to the rule that Stock of the Corporate Partner 
includes an interest in an entity to the extent that the value of the 
interest is attributable to the Stock of the Corporate Partner (Value 
Rule), the commenter asked that, in cases in which the entity is not 
controlled by the Corporate Partner and which is not a Controlling 
Corporation, that a limitation be added that the interest in the entity 
would not be treated as Stock of the Corporate Partner if less than 20 
percent of the assets of the entity consisted of Stock of the Corporate 
Partner. The Treasury Department and the IRS agree with the commenter 
that the Value Rule in the 2015 regulations could be overbroad in 
certain situations but decline to adopt the commenter's specific 
suggestion in these final regulations because such a rule would be too 
generous and could permit taxpayers to structure transactions that 
would contravene the purpose of section 337(d) and these regulations. 
However, the Treasury Department and the IRS are considering publishing 
new proposed regulations to limit the application of the Value Rule to 
entities that are not Controlling Corporations but which own, directly 
or indirectly, 5 percent or more of the stock, by vote or value, of the 
Corporate Partner and clarifying how taxpayers would determine what 
portion of the value of the interest in the entity is attributable to 
Stock of the Corporate Partner.
iii. Stock of the Corporate Partner: Attribution
    The 2015 regulations defined Stock of the Corporate Partner to 
include stock in a Controlling Corporation. The 2015 regulations 
employed the section 304(c) definition of control, which generally 
requires the ownership of stock with either 50 percent of the voting 
power in the corporation or 50 percent of the value of the corporation. 
While section 304(c) incorporates the constructive ownership rules of 
section 318(a) with some modifications, the 2015 regulations excluded 
the application of sections 318(a)(1) and (3) from its definition of 
control.
    The commenter agreed with excluding section 318(a)(3) attribution 
from the application of section 304(c) under the 2015 regulations, but 
noted that it may be inappropriate to exclude section 318(a)(1) family 
attribution. The commenter suggested that families could invoke this 
exclusion to structure partnerships in such a way to avoid these 
regulations but which would be transactions that should otherwise be 
subject to these final regulations. The Treasury Department and the IRS 
agree that excluding family attribution under section 318(a)(1) could 
produce inappropriate results. Additionally, the Treasury Department 
and the IRS have also determined that taxpayers could structure 
transactions designed to take advantage of the lack of section 
318(a)(3) attribution. Therefore, the Treasury Department and the IRS 
are considering publishing new proposed regulations to further modify 
the definition of Stock of the Corporate Partner so that it would no 
longer exclude attribution under sections 318(a)(1) and (3) when 
determining whether an interest in an entity is Stock of the Corporate 
Partners under section 304(c), but which would limit the proposed 
expanded scope of section 304(c) control to entities that own, directly 
or indirectly, an interest in the Corporate Partner.

[[Page 26583]]

iv. Stock of the Corporate Partner: Related-Party Partnerships
    The 2015 regulations provided an exception from the definition of 
Stock of the Corporate Partner in the case of certain related-party 
partnerships. Under this exception, Stock of the Corporate Partner did 
not include any stock or other equity interests held or acquired by a 
partnership if all interests in the partnership's capital and profits 
are held by members of an affiliated group defined in section 1504(a) 
that includes the Corporate Partner (Affiliated Group Exception).
    The commenter suggested that the final regulations extend the 
Affiliated Group Exception to partnerships in which a high percentage, 
but not all, of its interests are owned by affiliated group members. 
The commenter asserted that, under these facts, there would be no 
reason to require gain recognition. The commenter also recommended that 
the final regulations extend the affiliated group exception to lower-
tier partnerships owned by one or more upper-tier partnerships, if the 
upper-tier partnerships are entirely owned by members of an affiliated 
group that includes the Corporate Partner.
    After further study of this issue, and in light of the other 
exceptions to the deemed redemption rule, the Treasury Department and 
the IRS decline to adopt these comments because even without such 
extensions the Affiliated Group Exception could permit inappropriate 
elimination of corporate level built-in gain. For example--

    Assume that P, a corporation, owns all of the stock of S1, and 
S1 owns all of the stock of CP. P, S1, and CP are members of an 
affiliated group. P and CP form a 50-50 partnership, where CP 
contributes an appreciated asset to the partnership, and P 
contributes S1 stock with a basis equal to fair market value. After 
seven years, the partnership liquidates and distributes the S1 stock 
to CP and the appreciated asset to P. At that time, the asset may be 
sold outside of the group with an artificially increased basis. 
While the built-in gain that was in the asset now is preserved in 
the S1 stock held by CP, the group may permanently eliminate the 
gain without tax by causing CP to liquidate. CP would receive 
nonrecognition treatment on distribution of the S1 stock to S1 under 
section 332, and S1 would receive nonrecognition treatment on the 
receipt of its own stock under section 1032. Thus, the liquidation 
of CP permanently eliminates the built-in gain on the appreciated 
asset that attached to the hook stock CP held in S1 after the 
liquidation of the partnership.

    Although these final regulations retain the Affiliated Group 
Exception, the Treasury Department and the IRS are considering 
publishing new proposed regulations to remove the Affiliated Group 
Exception because this exception can permit corporations to engage in 
transactions with partnerships to eliminate permanently the built-in 
gain on appreciated assets or otherwise to avoid the purposes of 
General Utilities repeal and these regulations.
v. Section 337(d) Transactions
    The 2015 regulations provided that, for partnerships that hold 
Stock of the Corporate Partner, the 2015 regulations apply to a 
transaction (or a series of transactions) that is a ``Section 337(d) 
Transaction.'' The 2015 regulations defined a Section 337(d) 
Transaction as a transaction (or series of transactions) that has the 
effect of an exchange by a Corporate Partner of its interest in 
appreciated property for an interest in Stock of the Corporate Partner 
owned, acquired, or distributed by a partnership. For example, a 
Section 337(d) Transaction may occur if: (i) A Corporate Partner 
contributes appreciated property to a partnership that owns Stock of 
the Corporate Partner; (ii) a partnership acquires Stock of the 
Corporate Partner; (iii) a partnership that owns Stock of the Corporate 
Partner distributes appreciated property to a partner other than the 
Corporate Partner; (iv) a partnership distributes Stock of the 
Corporate Partner to the Corporate Partner; or (v) a partnership 
agreement is amended in a manner that increases a Corporate Partner's 
interest in the Stock of the Corporate Partner (including in connection 
with a contribution to, or distribution from, a partnership).
    In certain circumstances, a partnership's acquisition of Stock of 
the Corporate Partner does not have the effect of an exchange of 
appreciated property for that stock. For example, if a partnership with 
an operating business uses the cash generated in that business to 
purchase Stock of the Corporate Partner, the deemed redemption rule 
does not apply to the stock purchase because the Corporate Partner's 
share in appreciated property has not been reduced, and thus no 
exchange has occurred. The Treasury Department and the IRS acknowledge 
that such stock acquisitions would not trigger the deemed redemption 
rule. The Treasury Department and the IRS note, however, that because 
of the administrative difficulties in tracing the source of cash used 
to acquire Corporate Partner stock, taxpayers wishing to invoke this 
exception must maintain appropriate records or other documentation to 
affirmatively demonstrate that the consideration used in the exchange 
to acquire the Stock of the Corporate Partner at issue came from 
operating cashflow.
    The commenter asked whether the 2015 regulations encompassed other 
types of acquisitions of Stock of the Corporate Partner for cash, and 
requested that the final regulations include examples of transactions 
that do not have the effect of an exchange of appreciated property for 
Stock of the Corporate Partner. The Treasury Department and the IRS 
considered this comment, but decline to add additional examples because 
those examples would go beyond the scope of these final regulations 
which is to prevent the exchange of appreciated property for Stock of 
the Corporate Partner.
C. Deemed Redemption Rule
i. Generally
    The 2015 regulations provided that if a transaction is a Section 
337(d) Transaction, a Corporate Partner must recognize gain under the 
deemed redemption rule. To determine the amount of gain, the Corporate 
Partner must first determine the amount of appreciated property (other 
than Stock of the Corporate Partner) effectively exchanged for Stock of 
the Corporate Partner (by value) and then calculate the amount of 
taxable gain recognized.
    The deemed redemption rule applies only to the extent that the 
transaction has the effect of an exchange by the Corporate Partner of 
its interest in appreciated property for Stock of the Corporate 
Partner. Thus, this rule does not apply to the extent a transaction has 
the effect of an exchange by a Corporate Partner of non-appreciated 
property for Stock of the Corporate Partner or has the effect of an 
exchange by a Corporate Partner of appreciated property for property 
other than Stock of the Corporate Partner.
    The 2015 regulations set forth general principles that apply in 
determining the amount of appreciated property effectively exchanged 
for Stock of the Corporate Partner. These general principles require 
that the Corporate Partner's economic interest with respect to both 
Stock of the Corporate Partner and all other appreciated property of 
the partnership be determined based on all facts and circumstances, 
including the allocation and distribution rights set forth in the 
partnership agreement.
    A Corporate Partner must recognize gain under the 2015 regulations 
even if the Section 337(d) Transaction would not otherwise change the 
Corporate Partner's allocable share of gain under section 704(c). For 
example, if a Corporate Partner contributes

[[Page 26584]]

appreciated property to a newly-formed partnership and an individual 
contributes cash that the partnership subsequently uses to purchase 
Stock of the Corporate Partner, then the purchase of the stock is a 
Section 337(d) Transaction even though the Corporate Partner's 
allocable share of gain in the appreciated property under section 
704(c) is the same before and after the purchase. See Example 4 of 
Sec.  1.337(d)-3(h) in these final regulations.
    The Treasury Department and the IRS did not receive comments on 
this general deemed redemption rule. Therefore, these final regulations 
adopt the rule set forth in the 2015 regulations.
ii. Subsequent Transactions
    Under the 2015 regulations, the deemed redemption rule did not 
apply to transactions involving stock that does not meet the definition 
of Stock of the Corporate Partner. The commenter asked whether, in 
cases in which the deemed redemption rule does not apply to an initial 
transaction because the definition of Stock of the Corporate Partner is 
not satisfied, if certain subsequent transactions would trigger gain 
recognition by treating those transactions as Section 337(d) 
Transactions. The Treasury Department and the IRS intend for certain 
subsequent transactions to trigger gain recognition as Section 337(d) 
Transactions. Therefore, in response to this comment, the Treasury 
Department and the IRS clarify that these final regulations apply to 
certain transactions involving related parties in which a first 
transaction does not constitute a Section 337(d) Transaction because 
the partnership does not own stock in either a Corporate Partner or in 
a Controlling Corporation, but the Corporate Partner in a later, 
separate transaction transfers its partnership interest to a related 
corporation whose stock the partnership owns. In these transactions, 
the deemed redemption rule will trigger gain as if the first 
transaction was a Section 337(d) Transaction with the result that the 
transferee corporation who is now itself a Corporate Partner will 
``step into the shoes'' of the first Corporate Partner and will be 
subject to the deemed redemption rule to the extent of the first 
Corporate Partner's remaining built-in gain in the appreciated asset 
immediately prior to the transfer.
iii. Prior Transactions
    The 2015 regulations provided that, if the Corporate Partner has an 
existing interest in the partnership's Stock of the Corporate Partner 
prior to the Section 337(d) Transaction, the deemed redemption rule 
applies only with respect to the Corporate Partner's incremental 
increase in the Stock of the Corporate Partner. For example, changing 
allocations to increase a Corporate Partner's interest in the Stock of 
the Corporate Partner from 50 percent to 80 percent and to decrease the 
Corporate Partner's interest in other appreciated property from 80 
percent to 50 percent would have the effect of an exchange by the 
Corporate Partner of the 30-percent incremental decrease in its 
interest in the appreciated property for the 30-percent incremental 
increase in the Stock of the Corporate Partner. The Treasury Department 
and the IRS did not receive comments on this rule, and therefore, these 
final regulations adopt the rule set forth in the 2015 regulations.
iv. Special Rule for Determination of Corporate Partner's Interest
    For purposes of recognizing gain under the deemed redemption rule, 
the 2015 regulations provided that a Corporate Partner's interest in an 
identified share of Stock of the Corporate Partner will never be less 
than the Corporate Partner's largest interest (by value) in that share 
of Stock of the Corporate Partner that was taken into account when the 
partnership previously determined whether there had been a Section 
337(d) Transaction (regardless of whether the Corporate Partner 
recognized gain in the earlier transaction). See Example 7 of Sec.  
1.337(d)-3(h) in these final regulations. This rule ensures that 
alternating increases and decreases in a Corporate Partner's interest 
in Stock of the Corporate Partner do not cause duplicate gain 
recognition.
    This limitation does not apply if any reduction in the Corporate 
Partner's interest in the identified share of Stock of the Corporate 
Partner occurred as part of a plan or arrangement to circumvent the 
purpose of these final regulations. See Example 8 of Sec.  1.337(d)-
3(h) in these final regulations.
    The commenter raised a question regarding the numbers used in this 
Example 8 (which was numbered as Example 7 in the 2015 regulations 
under section 337(d)). The commenter pointed out that under the 
example's facts, the two partners make initial contributions to the 
partnership in a 99 to 1 ratio, and make subsequent contributions in a 
50 to 50 ratio. The commenter questioned why the example stated that 
the two partners are ``equal partners'' in all respects after the 
subsequent contributions. In response to this comment, the Treasury 
Department and the IRS clarify the example to provide that the 
subsequent contributions resulted in the partners' total contributions 
as being in a 50 to 50 ratio, so that, after the partners make these 
subsequent contributions, the partners have equal interests in the 
partnership in all respects. The aim of the example is to illustrate 
the rule that partners cannot utilize this special rule for determining 
a Corporate Partner's interest to circumvent the purpose of these final 
regulations. The Treasury Department and the IRS did not receive any 
other comments on this rule, and therefore, these final regulations 
adopt the rule set forth in the 2015 regulations.
v. Amount and Character of Gain
    The 2015 regulations provided that, if a transaction is a Section 
337(d) Transaction, the deemed redemption rule requires the Corporate 
Partner to recognize a percentage of the total gain in partnership 
appreciated property that is subject to the exchange equal to a 
fraction, the numerator of which is the Corporate Partner's interest 
(by value) in appreciated property effectively exchanged for Stock of 
the Corporate Partner under the deemed redemption rule, and the 
denominator of which is the Corporate Partner's interest (by value) in 
appreciated property immediately before the Section 337(d) Transaction. 
The 2015 regulations define this fraction as the Gain Percentage. The 
Corporate Partner's gain under the deemed redemption rule equals the 
product of (i) the Corporate Partner's Gain Percentage and (ii) the 
gain from the appreciated property that is the subject of the exchange 
that the Corporate Partner would recognize if, immediately before the 
Section 337(d) Transaction, all assets of the partnership and any 
assets contributed to the partnership in the Section 337(d) Transaction 
were sold in a fully taxable transaction for cash in an amount equal to 
the fair market value of such property (taking into account section 
7701(g)), reduced, but not below zero, by any gain the Corporate 
Partner is required to recognize with respect to the appreciated 
property in the Section 337(d) Transaction under any other section of 
the Code.
    The gain from the hypothetical sale used to compute gain under the 
deemed redemption rule is determined by applying the principles of 
section 704(c), which generally requires the partnership to take into 
account variations between the adjusted tax basis and fair market value 
of partnership property at the time it is contributed to the 
partnership and upon certain other events that allow or

[[Page 26585]]

require the value of partnership property to be redetermined under 
Sec.  1.704-1(b)(2)(iv)(f). See Examples 4 and 6 of Sec.  1.337(d)-3(h) 
in these final regulations. A partner's share of gain under section 
704(c) for this purpose includes any remedial allocations under Sec.  
1.704-3(d) for a partnership that has elected under section 704(c) to 
report notional items of offsetting tax gain and loss to its partners 
to eliminate distortions that may arise when the partnership's total 
tax gain or loss on the sale of partnership property is less than all 
partners' aggregate share of gain or loss from the property. The 
Treasury Department and the IRS did not receive comments on this 
general rule governing the amount of gain from a Section 337(d) 
Transaction. These final regulations therefore adopt the rule set forth 
in the 2015 regulations. However, the commenter asked whether section 
743(b) basis adjustments are taken into account when determining a 
Corporate Partner's gain in a Section 337(d) Transaction. The Treasury 
Department and the IRS confirm that basis adjustments, including 
adjustments made pursuant to section 743(b), are taken into account 
when calculating this gain, so that the Corporate Partner would not be 
subject to a duplication of tax liability.
    The commenter also noted that the 2015 regulations do not specify 
the character of the gain that a Corporate Partner recognizes in a 
Section 337(d) Transaction. In response to this comment, the final 
regulations clarify that the character of the gain that the Corporate 
Partner recognizes in a Section 337(d) Transaction is the same 
character of the gain that the Corporate Partner would have recognized 
if, immediately before the Section 337(d) Transaction, the Corporate 
Partner had disposed of the appreciated property in a fully taxable 
transaction for cash in an amount equal to the fair market value of 
such property (taking into account section 7701(g)).
vi. Basis Rules
    The 2015 regulations contained two rules related to the effect of 
the deemed redemption rule on partner and partnership basis. First, the 
2015 regulations require the Corporate Partner to increase its basis in 
its partnership interest by an amount equal to the gain that the 
Corporate Partner recognizes in a Section 337(d) Transaction. This 
basis increase is necessary to prevent the Corporate Partner from 
recognizing gain a second time when the partnership liquidates (or, if 
property is distributed to the Corporate Partner, when that property is 
sold). Under the 2015 regulations, this basis increase applies 
regardless of whether the partnership has a Section 754 election in 
effect. The commenter suggested that the final regulations clarify how 
a basis increase is treated for basis-recovery purposes. The final 
regulations provide this clarification by specifying that this increase 
is treated as property that is placed in service by the partnership in 
the taxable year of the Section 337(d) Transaction.
    Second, the 2015 regulations require the partnership to increase 
its adjusted tax basis in the appreciated property that is treated as 
the subject of a Section 337(d) Transaction by the amount of gain that 
the Corporate Partner recognized with respect to that property as a 
result of the Section 337(d) Transaction. The Treasury Department and 
the IRS did not receive comments on this basis increase rule and, 
accordingly, these final regulations adopt the rule set forth in the 
2015 regulations.
D. Partnership Distributions of Stock of the Corporate Partner
i. General Rule Governing Distributions
    The 2015 regulations extended the deemed redemption rule to certain 
distributions to the Corporate Partner of Stock of the Corporate 
Partner. These rules governing distributions applied only if the 
distributed stock had previously been the subject of a Section 337(d) 
Transaction or became the subject of a Section 337(d) Transaction as a 
result of the distribution (a section 337(d) distribution). The 2015 
regulations did not apply to a distribution to the Corporate Partner of 
the Stock of the Corporate Partner to which section 732(f) applied at 
the time of the distribution.
    If the deemed redemption rule applied to a distribution, the 2015 
regulations deem the partnership to amend its agreement immediately 
before the distribution to allocate a 100 percent interest in that 
portion of the stock to the Corporate Partner that is distributed and 
to allocate an appropriately reduced interest in other partnership 
property away from the Corporate Partner. The 2015 regulations employ 
this deemed allocation solely for purposes of recognizing gain, and no 
inference is intended with regard to the treatment of such allocations 
generally.
    The Treasury Department and the IRS did not receive comments on 
this general rule governing partnership distributions and, accordingly, 
these final regulations adopt the rule set forth in the 2015 
regulations.
ii. Gain Recognition Rule
    The 2015 regulations provided that if a distribution is a section 
337(d) distribution, then in addition to any gain recognized under the 
deemed redemption rule upon the distribution of Stock of the Corporate 
Partner to the Corporate Partner, the 2015 regulations also would 
require the Corporate Partner to recognize gain to the extent that the 
partnership's basis in the distributed Stock of the Corporate Partner 
exceeds the Corporate Partner's basis in its partnership interest (as 
reduced by any cash distributed in the transaction) immediately before 
the distribution.
    The commenter noted that the language used in this provision 
differs from the gain recognition provision of section 732(f)(1)(C), 
which evaluates whether the partnership's adjusted basis in the 
distributed stock immediately before the distribution exceeded the 
Corporate Partner's adjusted basis in that stock immediately after the 
distribution. The commenter asked whether these differences were 
intentional and, if so, for the explanation of the differences. The 
differences were not intentional and the Treasury Department and the 
IRS have determined that the provisions should be the same. 
Accordingly, the language of the gain recognition rule in these final 
regulations is modified to conform to the language used in the section 
732(f) gain recognition provision.
iii. Basis Rules
    The 2015 regulations set forth two rules under sections 337(d) and 
732 to coordinate the effects of the rule requiring gain recognition 
when the basis of the Stock of the Corporate Partner is stepped down on 
a section 337(d) distribution with existing rules for determining the 
basis of property upon partnership distributions.
    The first rule applied for purposes of: (1) Determining the basis 
of property distributed to the Corporate Partner (other than the basis 
of the Corporate Partner in its own stock); (2) determining the basis 
of the Corporate Partner's remaining partnership interest; (3) 
determining the partnership's basis in undistributed Stock of the 
Corporate Partner; and (4) computing gain on the distribution. For 
these purposes, the basis of Stock of the Corporate Partner distributed 
to the Corporate Partner equals the greater of (i) the partnership's 
basis of that distributed Stock of the Corporate Partner immediately 
before the distribution, or (ii) the fair market value of that 
distributed Stock of the Corporate Partner immediately before

[[Page 26586]]

the distribution, less the Corporate Partner's allocable share of gain 
from all of the Stock of the Corporate Partner, if the partnership sold 
all of its assets in a fully taxable transaction for cash in an amount 
equal to the fair market value of such property (taking into account 
section 7701(g)) immediately before the distribution. See Examples 3 
and 4 of Sec.  1.337(d)-3(h) in these final regulations. This special 
rule is necessary to prevent basis from shifting away from distributed 
Stock of the Corporate Partner to other property. This basis shift 
could occur, for example, upon a distribution of less than all of the 
partnership's Stock of the Corporate Partner to the Corporate Partner.
    The commenter asked whether this basis rule applies solely to the 
Corporate Partner or whether it applies for all purposes and 
recommended expanding Example 4 of Sec.  1.337(d)-3(h) in these final 
regulations (which was numbered as Example 3 in the 2015 regulations 
under section 337(d)) to address the basis consequences to the 
partnership and to the non-corporate partner. The Treasury Department 
and the IRS confirm that this basis rule applies for all purposes, and 
these final regulations expand Example 4 of Sec.  1.337(d)-3(h) to 
discuss the basis that AX partnership and partner A have in the X stock 
that is distributed to A.
    The second rule applied when a Corporate Partner receives both 
Stock of the Corporate Partner and other property in a section 337(d) 
distribution. Under this rule, the basis to be allocated to the 
properties distributed under section 732(a) or (b) is allocated first 
to the Stock of the Corporate Partner before taking into account the 
distribution of any other property (other than cash). Therefore, before 
taking into account the distribution of other property, the Corporate 
Partner will reduce its basis in its partnership interest by the 
Corporate Partner's basis in the distributed Stock of the Corporate 
Partner (but not below zero). The Corporate Partner will determine its 
basis in other distributed partnership property and in its remaining 
partnership interest after giving effect to this reduction. The 2015 
regulations set forth this rule to ensure that the purposes of the 
repeal of the General Utilities doctrine are not circumvented through 
the use of any provision of law or regulations.
    When a Corporate Partner receives a partnership distribution of its 
own stock, it is unclear under existing law whether the Corporate 
Partner has basis in that stock. (See, for example, Rev. Rul. 2006-2, 
2006-1 CB 261.) The resolution of this question is beyond the scope of 
these final regulations. However, because the distribution to a 
Corporate Partner of its own stock affects the Corporate Partner's 
basis in other distributed property and any retained partnership 
interest, these final regulations make clear that the partnership and 
the Corporate Partner must determine the basis of other distributed 
property and any retained partnership interest by reference to the 
partnership's basis in the distributed Stock of the Corporate Partner. 
That is, the Corporate Partner determines its basis in other 
distributed property and in any retained partnership interest as though 
the distributed stock was stock other than Stock of the Corporate 
Partner. Similarly, the 2015 regulations computed any gain recognition 
on the distribution by comparing the Corporate Partner's basis in its 
partnership interest to the basis of that Stock of the Corporate 
Partner in the hands of the partnership (without regard to whether the 
Corporate Partner can have basis in the distributed stock). No 
inference is intended with respect to the question of whether a 
corporation does or does not have basis in its own stock.
    The commenter noted that duplication of gain under sections 337(d) 
and 732(f) may occur under the 2015 regulations. The commenter provided 
an example in which a Corporate Partner could potentially recognize 
gain first under section 337(d) from a partnership distribution to 
which section 732(f) does not apply, because its control requirement is 
not satisfied at the time of the distribution, but then later be 
subject to the 732(f) basis reduction if the control requirement is 
subsequently satisfied. The Treasury Department and the IRS agree with 
the commenter and therefore, these final regulations set forth a basis 
rule providing that, for purposes of determining the amount of the 
decrease to the basis of property held by a distributed corporation 
pursuant to section 732(f), the amount of this decrease is reduced by 
the amount of gain that a Corporate Partner has recognized under this 
section in a Section 337(d) Transaction, both in cases where section 
732(f) applies at the time of the Section 337(d) Transaction and in 
cases where section 732(f) is subsequently triggered. This rule 
prevents the Corporate Partner from recognizing the same gain twice.
E. Exceptions
i. De Minimis Exception
    The 2015 regulations set forth a de minimis rule providing that the 
2015 regulations do not apply to a Corporate Partner if three 
conditions are satisfied. These conditions are tested upon the 
occurrence of a Section 337(d) Transaction and upon any subsequent 
revaluation event described in Sec.  1.704-1(b)(2)(iv)(f).
    The first condition requires that both the Corporate Partner and 
any persons related to the Corporate Partner under section 267(b) or 
section 707(b) own, in the aggregate, less than 5 percent of the 
partnership. The second condition requires that the partnership hold 
Stock of the Corporate Partner worth less than 2 percent of the value 
of the partnership's gross assets, including Stock of the Corporate 
Partner. The third condition requires that the partnership has never, 
at any point in time, held more than $1,000,000 in Stock of the 
Corporate Partner or more than 2 percent of any particular class of 
Stock of the Corporate Partner.`
    The 2015 regulations provided a special rule that applies if the 
conditions of the de minimis rule are satisfied at the time of a 
Section 337(d) Transaction, but are not satisfied at the time of a 
subsequent Section 337(d) Transaction or revaluation event described in 
Sec.  1.704-1(b)(2)(iv)(f). This rule provided that, solely for 
purposes of the deemed redemption rule, a Corporate Partner may 
determine its gain on the subsequent acquisition or revaluation event 
as if it had already recognized gain at the previous event. 
Accordingly, the Corporate Partner would only recognize gain with 
respect to appreciation arising between the earlier acquisition or 
revaluation event and the subsequent event. Neither the Corporate 
Partner nor the partnership increases its basis by the gain the 
Corporate Partner would have recognized if the de minimis rule did not 
apply to the prior acquisition or revaluation event.
    The Treasury Department and the IRS are concerned that taxpayers 
could intentionally plan to combine entities, each meeting the de 
minimis limits, to avoid the purposes of these final regulations. To 
address this concern, in these final regulations, the Treasury 
Department and the IRS add a clarifying provision to the de minimis 
exception stating that the exception does not apply to Stock of the 
Corporate Partner that is acquired as part of a plan to circumvent the 
purpose of these final regulations.

[[Page 26587]]

ii. Exception for Certain Dispositions of Stock
    The 2015 regulations set forth another exception titled the 
``inadvertence rule.'' This exception provided that the 2015 
regulations do not apply to Section 337(d) Transactions in which the 
partnership satisfies two requirements. First, the partnership must 
dispose of, by sale or distribution, the Stock of the Corporate Partner 
before the due date (including extensions) of its federal income tax 
return for the taxable year in which the partnership acquired the stock 
(or in which the Corporate Partner joined the partnership, if 
applicable). Second, the partnership must not have distributed the 
Stock of the Corporate Partner to the Corporate Partner or a person 
possessing section 304(c) control of the Corporate Partner.
    The commenter asked, whether, notwithstanding the exception's 
title, the dispositions needed to be inadvertent to qualify for the 
exception. In order to avoid any ambiguity or any assumption that these 
dispositions must be inadvertent, these final regulations rename the 
exception to state that the exception simply applies to ``certain 
dispositions of stock'' that qualify for the exception and that 
inadvertence is not a requirement.
    The Treasury Department and the IRS also note that this exception 
requires that the stock at issue is not distributed to the Corporate 
Partner or a Controlling Corporation. As discussed in (1)(B) of this 
Explanation of Provisions with respect to the general definition of 
Stock of the Corporate Partner, the Treasury Department and the IRS are 
considering publishing new proposed regulations to modify the 
definition of Stock of the Corporate Partner to remove the exception 
for attribution under section 318(a)(1) and (3) from the scope of 
section 304(c) control.
F. Other Comments
    The commenter requested that these final regulations provide 
examples on how to measure a Corporate Partner's partnership interest 
in more complex partnership agreements, such as situations in which the 
agreement contains a distribution waterfall. Similarly, the commenter 
requested that these final regulations provide more detailed examples 
relating to tiered partnership structures. The Treasury Department and 
the IRS believe that the purpose of these final regulations is to set 
forth rules of general applicability to prevent a corporate partner 
from avoiding corporate level gain through transactions with a 
partnership. The Treasury Department and the IRS therefore believe that 
providing such detailed examples is beyond the scope of these final 
regulations.

2. Final Regulations Under Section 732(f)

    These final regulations adopt the rules set forth in the 2015 
regulations under section 732(f) without any change to conform the 
application of section 732(f) with Congress' identified purposes for 
enacting sections 337(d), 732(f), and 1502 in certain situations.
A. Aggregation of Section 732(b) Basis Adjustments
    As discussed in the Background, section 732(f) generally applies on 
a partner-by-partner basis. However, the Treasury Department and the 
IRS determined that, in certain circumstances, it is appropriate to 
aggregate the bases of consolidated group members in a partnership for 
purposes of applying section 732(f).
    The 2015 regulations provided that corporate partners that are 
members of the same consolidated group (as defined in Sec.  1.1502-
1(h)) could aggregate their bases in interests in the same partnership 
for purposes of section 732(f) when two conditions are met. First, two 
or more of the corporate partners receive a distribution of stock in a 
distributed corporation from the partnership. Second, the distributed 
corporation is or becomes a member of the distributee partners' 
consolidated group following the distribution.
    Under this rule, section 732(f) only applies to the extent that the 
partnership's adjusted basis in the distributed stock immediately 
before the distribution exceeds the aggregate basis of the distributed 
stock in the hands of all members of the distributee corporate 
partners' consolidated group immediately after the distribution. The 
2015 regulations included the requirement that the distributed 
corporation be a member of the consolidated group in order to avoid 
unintended consequences that could result if that corporation were a 
controlled foreign corporation.
    The commenter recommended that the final regulations extend this 
basis-aggregation rule to include a distributed corporation (including 
a controlled foreign corporation) that is owned by members of the 
distributee partners' consolidated group following the distribution. 
The commenter stated that the distributed corporation need not be a 
member of the distributee partners' consolidated group, and that the 
rule should apply to corporations like a controlled foreign corporation 
that cannot be a member of a consolidated group. The Treasury 
Department and the IRS decline to adopt the comment because there could 
be unanticipated consequences if the distributed corporation were a 
controlled foreign corporation.
B. Gain Elimination Transactions
    The 2015 regulations also provided rules that restrict corporate 
partners from entering into transactions or a series of transactions 
(gain elimination transactions), such as a distribution followed by a 
reorganization under section 368(a), that might eliminate gain in the 
stock of a distributed corporation while avoiding the effects of a 
basis step-down in transactions, because the section 732(f) control 
requirement is not immediately satisfied.
    Accordingly, the 2015 regulations provided that, in the event of a 
gain elimination transaction, section 732(f) shall apply as though the 
corporate partner acquired control (as defined in section 732(f)(5)) of 
the distributed corporation immediately before the gain elimination 
transaction.
    The Treasury Department and the IRS did not receive comments on the 
proposed rule governing gain elimination transactions. These final 
regulations adopt the rules set forth in the 2015 regulations.
C. Tiered Partnerships
    The 2015 regulations required taxpayers to apply its rules to 
tiered partnerships in a manner consistent with the purpose of section 
732(f). These final regulations maintain this requirement. The 
commenter requested that these final regulations provide examples 
illustrating their application to tiered partnerships. The Treasury 
Department and the IRS decline to adopt this comment, because such 
examples are beyond the scope of these final regulations, which is to 
set forth rules of general applicability governing the application of 
section 732(f) to two specific sets of circumstances.

Applicability Date

    These final regulations apply to transactions occurring on or after 
June 12, 2015.

Special Analyses

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Department of the Treasury and the Office of 
Management and Budget regarding review of tax regulations.
    Further, pursuant to the Regulatory Flexibility Act (5 U.S.C. 
chapter 6), it is

[[Page 26588]]

hereby certified that these final regulations would not have a 
significant economic impact on a substantial number of small entities. 
This certification is based on the fact that these final regulations 
would primarily affect sophisticated ownership structures involving 
corporations that own partnerships owning stock or other equity 
interests in corporate partners. Additionally, these final regulations 
contain a number of de minimis and other exceptions that render the 
final regulations inapplicable to most small businesses, and do not 
impose a collection of information on small entities.
    Pursuant to section 7805(f), these final regulations have been 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business, and no 
comments were received.

Statement of Availability of IRS Documents

    Notice 89-37 cited in this document is published in the Internal 
Revenue Bulletin (or Cumulative Bulletin) and is available from the 
Superintendent of Documents, U.S. Government Publishing Office, 
Washington, DC 20402, or by visiting the IRS website at http://www.irs.gov.

Drafting Information

    The principal author of these final regulations is Kevin I. Babitz, 
Office of the Associate Chief Counsel (Passthroughs and Special 
Industries). However, other personnel from the Treasury Department and 
the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART I--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the sectional authority for Sec.  1.337(d)-3T, adding a sectional 
authority for Sec.  1.337(d)(3) in numerical order, and revising the 
sectional authority for Sec.  1.732-3 to read as follows:

    Authority:  26 U.S.C. 7805 * * *
* * * * *
    Section 1.337(d)-3 also issued under 26 U.S.C. 337(d).
* * * * *
    Section 1.732-3 also issued under 26 U.S.C. 337(d), 732(f)(8), 
and 1502.
* * * * *

0
Par. 2. Section 1.337(d)-3 is added to read as follows:


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

    (a) Purpose. The purpose of this section is to prevent corporate 
taxpayers from using a partnership to circumvent gain required to be 
recognized under section 311(b) or section 336(a). The rules of this 
section, including the determination of the amount of gain, must be 
applied in a manner that is consistent with and reasonably carries out 
this purpose.
    (b) In general. This section applies when a partnership, either 
directly or indirectly, owns, acquires, or distributes Stock of the 
Corporate Partner (within the meaning of paragraph (c)(2) of this 
section). Under paragraphs (d) or (e) of this section, a Corporate 
Partner (within the meaning of paragraph (c)(1) of this section) is 
required to recognize gain when a transaction has the effect of the 
Corporate Partner acquiring or increasing an interest in its own stock 
in exchange for appreciated property in a manner that contravenes the 
purpose of this section as set forth in paragraph (a) of this section. 
Paragraph (f) of this section sets forth exceptions under which a 
Corporate Partner does not recognize gain.
    (c) Definitions. The following definitions apply for purposes of 
this section:
    (1) Corporate Partner. A Corporate Partner is a person that is 
classified as a corporation for federal income tax purposes and holds 
or acquires an interest in a partnership.
    (2) Stock of the Corporate Partner--(i) In general. With respect to 
a Corporate Partner, Stock of the Corporate Partner includes the 
Corporate Partner's stock, or other equity interests, including 
options, warrants, and similar interests, in the Corporate Partner or a 
corporation that controls the Corporate Partner within the meaning of 
section 304(c) (except that section 318(a)(1) and (3) shall not apply). 
Stock of the Corporate Partner also includes interests in any entity to 
the extent that the value of the interest is attributable to Stock of 
the Corporate Partner.
    (ii) Affiliated partner exception. Stock of the Corporate Partner 
does not include any stock or other equity interests held or acquired 
by a partnership if all interests in the partnership's capital and 
profits are held by members of an affiliated group as defined in 
section 1504(a) that includes the Corporate Partner.
    (3) Section 337(d) Transaction. A Section 337(d) Transaction is a 
transaction (or series of transactions) that has the effect of an 
exchange by a Corporate Partner of its interest in appreciated property 
for an interest in Stock of the Corporate Partner owned, acquired, or 
distributed by a partnership. For example, a Section 337(d) Transaction 
may occur when --
    (i) A Corporate Partner contributes appreciated property to a 
partnership that owns Stock of the Corporate Partner;
    (ii) A partnership acquires Stock of the Corporate Partner;
    (iii) A partnership that owns Stock of the Corporate Partner 
distributes appreciated property to a partner other than a Corporate 
Partner;
    (iv) A partnership distributes Stock of the Corporate Partner to 
the Corporate Partner; or
    (v) A partnership agreement is amended in a manner that increases a 
Corporate Partner's interest in Stock of the Corporate Partner 
(including in connection with a contribution to, or distribution from, 
a partnership).
    (4) Gain Percentage. A Corporate Partner's Gain Percentage equals a 
fraction, the numerator of which is the Corporate Partner's interest 
(by value) in appreciated property effectively exchanged for Stock of 
the Corporate Partner under the test described in paragraphs (d)(1) and 
(2) of this section, and the denominator of which is the Corporate 
Partner's interest (by value) in that appreciated property immediately 
before the Section 337(d) Transaction. Paragraph (d) of this section 
requires a partnership to multiply the Gain Percentage by the Corporate 
Partner's aggregate gain in appreciated property to determine gain 
recognized under this section.
    (d) Deemed redemption rule--(1) In general. A Corporate Partner in 
a partnership that engages in a Section 337(d) Transaction recognizes 
gain at the time, and to the extent, that the Corporate Partner's 
interest in appreciated property (other than Stock of the Corporate 
Partner) is reduced in exchange for an increased interest in Stock of 
the Corporate Partner, as determined under paragraph (d)(2) of this 
section. This section does not apply to the extent a transaction has 
the effect of an exchange by a Corporate Partner of non-appreciated 
property for Stock of the Corporate Partner, or has the effect of an 
exchange by a Corporate Partner for property other than Stock of the 
Corporate Partner.
    (2) Corporate Partner's interest in partnership property. The 
Corporate Partner's interest with respect to both Stock of the 
Corporate Partner and the appreciated property that is the subject

[[Page 26589]]

of the exchange is determined based on all facts and circumstances, 
including the allocation and distribution rights set forth in the 
partnership agreement. The Corporate Partner's interest in an 
identified share of Stock of the Corporate Partner will never be less 
than the Corporate Partner's largest interest (by value) in that share 
of Stock of the Corporate Partner that was taken into account when the 
partnership previously determined whether there had been a Section 
337(d) Transaction with respect to such share (regardless of whether 
the Corporate Partner recognized gain in the earlier transaction). See 
Example 7 of paragraph (h) of this section. However, this limitation 
will not apply if any reduction in the Corporate Partner's interest in 
the identified share of Stock of the Corporate Partner occurred as part 
of a plan or arrangement to circumvent the purpose of this section. See 
Example 8 of paragraph (h) of this section.
    (3) Amount and character of gain recognized on the exchange--(i) 
Amount of gain. The amount of gain the Corporate Partner recognizes 
under paragraph (d)(1) of this section equals the product of the 
Corporate Partner's Gain Percentage and the gain from the appreciated 
property that is the subject of the exchange that the Corporate Partner 
would recognize if, immediately before the Section 337(d) Transaction, 
all assets of the partnership and any assets contributed to the 
partnership in the Section 337(d) Transaction were sold in a fully 
taxable transaction for cash in an amount equal to the fair market 
value of such property (taking into account section 7701(g)), reduced, 
but not below zero, by any gain the Corporate Partner is required to 
recognize with respect to the appreciated property in the Section 
337(d) Transaction under any other provision of this chapter. This gain 
is computed taking into account allocations of tax items applying the 
principles of section 704(c), including any remedial allocations under 
Sec.  1.704-3(d), and also taking into account any basis adjustments 
including adjustments made pursuant to section 743(b).
    (ii) Character of gain. The character of the gain that the 
Corporate Partner recognizes under paragraph (d)(1) of this section 
from the appreciated property that is the subject of the exchange shall 
be the character of the gain that the Corporate Partner would recognize 
if, immediately before the Section 337(d) Transaction, the Corporate 
Partner had disposed of the appreciated property that is the subject of 
the exchange in a fully taxable transaction for cash in an amount equal 
to the fair market value of such property (taking into account section 
7701(g)).
    (4) Basis adjustments--(i) Corporate Partner's basis in the 
partnership interest. The basis of the Corporate Partner's interest in 
the partnership is increased by the amount of gain that the Corporate 
Partner recognizes under this paragraph (d).
    (ii) Partnership's basis in partnership property. The partnership's 
adjusted tax basis in the appreciated property that is treated as the 
subject of the exchange under this paragraph (d) is increased by the 
amount of gain recognized with respect to that property by the 
Corporate Partner as a result of that exchange, regardless of whether 
the partnership has an election in effect under section 754. For basis 
recovery purposes, this basis increase is treated as property that is 
placed in service by the partnership in the taxable year of the Section 
337(d) Transaction.
    (e) Distribution of Stock of the Corporate Partner--(1) In general. 
This paragraph (e) applies to distributions to the Corporate Partner of 
Stock of the Corporate Partner to which section 732(f) does not apply 
and that have previously been the subject of a Section 337(d) 
Transaction or become the subject of a Section 337(d) Transaction as a 
result of the distribution. Upon the distribution of Stock of the 
Corporate Partner to the Corporate Partner, paragraph (d) of this 
section will apply as though immediately before the distribution the 
partners amended the partnership agreement to allocate to the Corporate 
Partner a 100 percent interest in that portion of the Stock of the 
Corporate Partner that is distributed, and to allocate an appropriately 
reduced interest in other partnership property away from the Corporate 
Partner.
    (2) Basis rules--(i) Basis allocation on distributions of stock and 
other property. If, as part of the same transaction, a partnership 
distributes Stock of the Corporate Partner and other property (other 
than cash) to the Corporate Partner, see Sec.  1.732-1(c)(1)(iii) for a 
rule allocating basis first to the Stock of the Corporate Partner 
before the distribution of the other property.
    (ii) Computation of basis. For purposes of determining the basis of 
property distributed to a partner in a transaction that includes the 
distribution of Stock of the Corporate Partner (other than the basis of 
the Corporate Partner in its own stock), the basis of the partner's 
remaining partnership interest, and the partnership's basis in 
undistributed Stock of the Corporate Partner, and for purposes of 
computing gain under paragraph (e)(3) of this section, the 
partnership's basis of Stock of the Corporate Partner distributed to 
the partner equals the greater of--
    (A) The partnership's basis of that distributed Stock of the 
Corporate Partner immediately before the distribution; or
    (B) The fair market value of that distributed Stock of the 
Corporate Partner immediately before the distribution less the 
partner's allocable share of gain from all of the Stock of the 
Corporate Partner if the partnership sold all of its assets in a fully 
taxable transaction for cash in an amount equal to the fair market 
value of such property (taking into account section 7701(g)) 
immediately before the distribution.
    (iii) Section 732(f) basis reduction. For purposes of determining 
the amount of the decrease to the basis of property held by a 
distributed corporation pursuant to section 732(f), the amount of this 
decrease shall be reduced by the amount of gain that a Corporate 
Partner has recognized under this section in the same Section 337(d) 
Transaction or in a prior Section 337(d) Transaction involving the 
property.
    (3) Gain recognition. The Corporate Partner will recognize gain on 
a distribution of Stock of the Corporate Partner to the Corporate 
Partner to the extent that the partnership's adjusted basis in the 
distributed Stock of the Corporate Partner (as determined under 
paragraph (e)(2)(ii) of this section) immediately before the 
distribution exceeds the Corporate Partner's adjusted basis in its 
partnership interest immediately after the distribution.
    (f) Exceptions--(1) De minimis rule--(i) In general. Unless Stock 
of the Corporate Partner is acquired as part of a plan to circumvent 
the purpose of this section, this section does not apply to a Corporate 
Partner if at the time that the partnership acquires Stock of the 
Corporate Partner or at the time of a revaluation event as described in 
Sec.  1.704-1(b)(2)(iv)(f) (without regard to whether or not the 
partnership revalues its assets)--
    (A) The Corporate Partner and any persons related to the Corporate 
Partner under section 267(b) or section 707(b) own in the aggregate 
less than 5 percent of the partnership;
    (B) The partnership holds Stock of the Corporate Partner with a 
value of less than 2 percent of the partnership's gross assets 
(including the Stock of the Corporate Partner); and
    (C) The partnership has never, at any point in time, held in the 
aggregate--
    (1) Stock of the Corporate Partner with a fair market value greater 
than $1,000,000; or

[[Page 26590]]

    (2) More than 2 percent of any particular class of Stock of the 
Corporate Partner.
    (ii) De minimis rule ceases to apply. If a partnership satisfies 
the conditions of the de minimis rule of paragraph (f)(1) of this 
section upon an acquisition of Stock of the Corporate Partner or 
revaluation event as described in Sec.  1.704-1(b)(2)(iv)(f), but later 
fails to satisfy the conditions of the de minimis rule upon a 
subsequent acquisition or revaluation event, then solely for purposes 
of paragraph (d) of this section, the Corporate Partner may compute its 
gain on the subsequent acquisition or revaluation event as if it had 
already recognized gain at the previous event. Neither the Corporate 
Partner nor the partnership increases its basis by the gain the 
Corporate Partner would have recognized if the de minimis rule of 
paragraph (f)(1) of this section did not apply to the prior acquisition 
or revaluation event.
    (2) Certain dispositions of stock. Unless acquired as part of a 
plan to circumvent the purpose of this section, this section does not 
apply to Stock of the Corporate Partner that--
    (i) Is disposed of (by sale or distribution) by the partnership 
before the due date (including extensions) of its federal income tax 
return for the taxable year during which the Stock of the Corporate 
Partner is acquired (or for the taxable year in which the Corporate 
Partner becomes a partner, whichever is applicable); and
    (ii) Is not distributed to the Corporate Partner or a corporation 
that controls the Corporate Partner within the meaning of section 
304(c), except that section 318(a)(1) and (3) shall not apply.
    (g) Tiered partnerships. The rules of this section shall apply to 
tiered partnerships in a manner that is consistent with the purpose set 
forth in paragraph (a) of this section.
    (h) Examples. The following examples illustrate the principles of 
this section. All amounts in the following examples are reported in 
millions of dollars:
    Example 1. Deemed redemption rule--contribution of Stock of the 
Corporate Partner. (i) In Year 1, X, a corporation, and A, an 
individual, form partnership AX as equal partners in all respects. X 
contributes Asset 1 with a fair market value of $100 and a basis of 
$20. A contributes X stock, which is Stock of the Corporate Partner, 
with a basis and fair market value of $100.
    (ii) Because A and X are equal partners in AX in all respects, 
the partnership formation causes X's interest in X stock to increase 
from $0 to $50 and its interest in Asset 1 to decrease from $100 to 
$50. Thus, the partnership formation is a Section 337(d) Transaction 
because the formation has the effect of an exchange by X of $50 of 
Asset 1 for $50 of X stock.
    (iii) X must recognize gain under paragraph (d) of this section 
with respect to Asset 1 to prevent the circumvention of section 
311(b) principles. X's gain equals the product of X's Gain 
Percentage and the gain from Asset 1 that X would recognize 
(decreased, but not below zero, by any gain that X recognized with 
respect to Asset 1 in the Section 337(d) Transaction under any other 
provision of this chapter) if, immediately before the Section 337(d) 
Transaction, all assets were sold in a fully taxable transaction for 
cash in an amount equal to the fair market value of such property. 
If Asset 1 had been sold in a fully taxable transaction immediately 
before the formation of partnership AX, X's allocable share of gain 
would have been $80. X's Gain Percentage is 50 percent (equal to a 
fraction, the numerator of which is X's $50 interest in Asset 1 
effectively exchanged for X stock, and the denominator of which is 
X's $100 interest in Asset 1 immediately before the Section 337(d) 
Transaction). Thus, X recognizes $40 of gain ($80 multiplied by 50 
percent) under the deemed redemption rule in paragraph (d) of this 
section. Under paragraph (d)(4)(i) of this section, X's basis in its 
AX partnership interest increases from $20 to $60. Under paragraph 
(d)(4)(ii) of this section, AX's basis in Asset 1 increases from $20 
to $60 because Asset 1 is the appreciated property treated as the 
subject of the exchange.
    Example 2.  Deemed redemption rule--contribution of stock in a 
corporation that controls the Corporate Partner. (i) In Year 1, X, a 
corporation, and A, an individual, form partnership AX as equal 
partners in all respects. X contributes Asset 1 with a fair market 
value of $100 and a basis of $20. A contributes stock in P, with a 
basis and fair market value of $100. P is the sole owner of X. P's 
interest in X constitutes 10 percent of P's total assets.
    (ii) Because P controls X within the meaning of section 304(c), 
stock in P is Stock of the Corporate Partner under paragraph 
(c)(2)(i) of this section.
    (iii) Because A and X are equal partners in AX in all respects, 
the partnership formation causes X's interest in Stock of the 
Corporate Partner stock to increase from $0 to $50 and its interest 
in Asset 1 to decrease from $100 to $50. Thus, the partnership 
formation is a Section 337(d) Transaction because the formation has 
the effect of an exchange by X of $50 of Asset 1 for $50 of Stock of 
the Corporate Partner.
    (iv) X must recognize gain under paragraph (d) of this section 
with respect to Asset 1 to prevent the circumvention of section 
311(b) principles. X's gain equals the product of X's Gain 
Percentage and the gain from Asset 1 that X would recognize 
(decreased, but not below zero, by any gain that X recognized with 
respect to Asset 1 in the Section 337(d) Transaction under any other 
provision of this chapter) if, immediately before the Section 337(d) 
Transaction, all assets were sold in a fully taxable transaction for 
cash in an amount equal to the fair market value of such property. 
If Asset 1 had been sold in a fully taxable transaction immediately 
before the formation of partnership AX, X's allocable share of gain 
would have been $80. X's Gain Percentage is 50 percent (equal to a 
fraction, the numerator of which is X's $50 interest in Asset 1 
effectively exchanged for Stock of the Corporate Partner, and the 
denominator of which is X's $100 interest in Asset 1 immediately 
before the Section 337(d) Transaction). Thus, X recognizes $40 of 
gain ($80 multiplied by 50 percent) under the deemed redemption rule 
in paragraph (d) of this section. Under paragraph (d)(4)(i) of this 
section, X's basis in its AX partnership interest increases from $20 
to $60. Under paragraph (d)(4)(ii) of this section, AX's basis in 
Asset 1 increases from $20 to $60 because Asset 1 is the appreciated 
property treated as the subject of the exchange.
    Example 3.  Distribution of Stock of the Corporate Partner--pro 
rata distribution. (i) The facts are the same as in Example 1(i) of 
this paragraph (h). AX liquidates in Year 9, when Asset 1 and the X 
stock each have a fair market value of $200. X and A each receive 50 
percent of Asset 1 and 50 percent of the X stock in the liquidation. 
At the time AX liquidates, X's basis in its AX partnership interest 
is $60 and A's basis in its AX partnership interest is $100.
    (ii) When AX liquidates, X's interests in its stock and in Asset 
1 do not change. Thus, the liquidation is not a Section 337(d) 
Transaction because it does not have the effect of an exchange by X 
of appreciated property for Stock of the Corporate Partner.
    (iii) Paragraph (e) of this section applies because the 
distributed X stock was the subject of a previous Section 337(d) 
Transaction and because section 732(f) does not apply. Under Sec.  
1.732-1(c)(1)(iii), the distribution to X of X stock is deemed to 
immediately precede the distribution of 50 percent of Asset 1 to X 
for purposes of determining X's basis in the distributed property. 
For purposes of determining X's basis in Asset 1 and X's gain on 
distribution, the basis of the distributed X stock is treated as 
$50, the greater of $50 (50 percent of the stock's $100 basis in the 
hands of the partnership), or $50, the fair market value of that 
distributed X stock ($100) less X's allocable share of gain from the 
distributed X stock if AX had sold all of its assets in a fully 
taxable transaction for cash in an amount equal to the fair market 
value of such property immediately before the distribution ($50). 
Thus, X reduces its basis in its partnership interest by $50 prior 
to the distribution of Asset 1. Accordingly, X's basis in the 
distributed portion of Asset 1 is $10. Because AX's basis in the 
distributed X stock immediately before the distribution ($50) does 
not exceed X's basis in its AX partnership interest immediately 
before the distribution ($60), X recognizes no gain under paragraph 
(e)(3) of this section.
    Example 4.  Distribution of Stock of the Corporate Partner--non 
pro rata distribution. (i) The facts are the same as Example 3(i) of 
this paragraph (h), except that when AX liquidates, X receives 75 
percent of the X stock and 25 percent of Asset 1 and A receives 25 
percent of the X stock and 75 percent of Asset 1.
    (ii) The liquidation of AX causes X's interest in X stock to 
increase from $100 to $150 and its interest in Asset 1 to decrease 
from $100 to $50. Thus, AX's liquidating distributions of X stock 
and Asset 1 to X are

[[Page 26591]]

a Section 337(d) Transaction because the distributions have the 
effect of an exchange by X of $50 of Asset 1 for $50 of X stock.
    (iii)(A) X must recognize gain with respect to Asset 1 to 
prevent the circumvention of section 311(b) principles. Under 
paragraph (e)(1) of this section, paragraph (d) of this section is 
applied as if X and A amended the AX partnership agreement to 
allocate to X a 100 percent interest in the distributed portion of 
the X stock. X must recognize gain equal to the product of X's Gain 
Percentage and the gain from Asset 1 that X would have recognized 
(decreased, but not below zero, by any gain X recognized with 
respect to Asset 1 in the Section 337(d) Transaction under any other 
provision of this chapter) if, immediately before the Section 337(d) 
Transaction, AX had sold all of its assets in a fully taxable 
transaction for cash in an amount equal to the fair market value of 
such property.
    (B) If Asset 1 had been sold in a fully taxable transaction 
immediately before the amendment of the AX partnership agreement, 
X's allocable share of gain would have been $90, or the sum of X's 
$40 remaining gain under section 704(c) and $50 of the $100 post-
contribution appreciation. X's Gain Percentage is 50 percent (equal 
to a fraction, the numerator of which is X's $50 interest in Asset 1 
effectively exchanged for X stock, and the denominator of which is 
X's $100 interest in Asset 1 immediately before the Section 337(d) 
Transaction). Thus, X recognizes $45 of gain ($90 multiplied by 50 
percent) under the deemed redemption rule in paragraph (d) of this 
section. Under paragraph (d)(4)(i) of this section, X's basis in its 
AX partnership interest increases from $60 to $105. Under paragraph 
(d)(4)(ii) of this section, AX's basis in Asset 1 increases from $60 
to $105 because Asset 1 is the appreciated property treated as the 
subject of the exchange.
    (iv)(A) Paragraph (e) of this section applies because the 
distributed X stock was the subject of a previous Section 337(d) 
Transaction and because section 732(f) does not apply. Under Sec.  
1.732-1(c)(1)(iii), AX is treated as first distributing the X stock 
to X before the distribution of 25 percent of Asset 1. For purposes 
of determining X's basis in Asset 1 and X's gain on distribution, 
the basis of the distributed X stock is treated as $100, the greater 
of $75 (75 percent of the stock's $100 basis in the hands of the 
partnership) or $100, the fair market value of the distributed X 
stock ($150) less X's allocable share of gain if the partnership had 
sold all of the X stock immediately before the distribution for cash 
in an amount equal to its fair market value ($50). Thus, X will 
reduce its basis in its partnership interest by $100 prior to the 
distribution of Asset 1. Accordingly, X's basis in the distributed 
portion of Asset 1 is $5. Because AX's basis in the distributed X 
stock immediately before the distribution as computed for purposes 
of this section ($100) does not exceed X's basis in its AX 
partnership interest immediately before the distribution ($105), X 
recognizes no additional gain under paragraph (e)(3) of this 
section.
    (B) For purposes of determining A's basis in Asset 1 and A's 
gain on distribution, the basis of the distributed X stock is 
treated as $25, the greater of $25 (25 percent of the stock's $100 
basis in the hands of the partnership) or $0, the fair market value 
of the distributed X stock ($50) less A's allocable share of gain if 
the partnership had sold all of the X stock immediately before the 
distribution for cash in an amount equal to its fair market value 
($50). Thus, A will reduce its basis in its partnership interest by 
$25 prior to the distribution of Asset 1. Accordingly, A's basis in 
the distributed portion of Asset 1 is $75. Because AX's basis in the 
distributed X stock immediately before the distribution as computed 
for purposes of this section ($100) does not exceed A's basis in its 
AX partnership interest immediately before the distribution ($100), 
A recognizes no additional gain under paragraph (e)(3) of this 
section.
    Example 5.  Deemed redemption rule--subsequent purchase of Stock 
of the Corporate Partner. The facts are the same as Example 1(i) of 
this paragraph (h), except that A contributes cash of $100 instead 
of X stock. In a later year, when the value of Asset 1 has not 
changed, AX uses the contributed cash to purchase X stock for $100. 
AX's purchase of X stock has the effect of an exchange by X of 
appreciated property for X stock, and thus, is a Section 337(d) 
Transaction. X must recognize gain at the time, and to the extent, 
that X's share of appreciated property (other than X stock) is 
reduced in exchange for X stock. Thus, the consequences of the 
partnership's purchase of X stock are the same as those described in 
Example 1(ii) and (iii) of this paragraph (h), resulting in X 
recognizing $40 of gain.
    Example 6.  Change in allocation ratios--amendment of 
partnership agreement. (i) The facts are the same as Example 3(i) of 
this paragraph (h), except that in Year 9, AX does not liquidate, 
and the AX partnership agreement is amended to allocate to X 80 
percent of the income, gain, loss, and deduction from the X stock 
and to allocate to A 80 percent of the income, gain, loss, and 
deduction from Asset 1. If AX had sold the partnership assets 
immediately before the change to the partnership agreement, X would 
have been allocated $90 of gain from Asset 1 and $50 of gain from 
the X stock.
    (ii) The amendment to the AX partnership agreement causes X's 
interest in its stock to increase from $100 (50 percent of the stock 
value immediately before the amendment of the agreement) to $160 (80 
percent of stock value immediately following amendment of agreement) 
and its interest in Asset 1 to decrease from $100 to $40. Thus, the 
amendment of the partnership agreement is a Section 337(d) 
Transaction because the amendment has the effect of an exchange by X 
of $60 of Asset 1 for $60 of its stock.
    (iii) X must recognize gain equal to the product of X's Gain 
Percentage and the gain from Asset 1 that X would have recognized 
(decreased, but not below zero, by any gain X recognized with 
respect to Asset 1 in the Section 337(d) Transaction under any other 
provision of this chapter) if, immediately before the Section 337(d) 
Transaction, AX had sold all of its assets in a fully taxable 
transaction for cash in an amount equal to the fair market value of 
such property. If Asset 1 had been sold in a fully taxable 
transaction immediately before the amendment of the AX partnership 
agreement, X's allocable share of gain would have been $90, or the 
sum of X's $40 remaining gain under section 704(c) and 50 percent of 
the $100 post-contribution appreciation. X's Gain Percentage is 60 
percent (equal to a fraction, the numerator of which is X's $60 
interest in Asset 1 effectively exchanged for X stock, and the 
denominator of which is X's $100 interest in Asset 1 immediately 
before the Section 337(d) Transaction). Thus, X recognizes $54 of 
gain ($90 multiplied by 60 percent) under the deemed redemption rule 
in paragraph (d) of this section. Under paragraph (d)(4)(i) of this 
section, X's basis in its AX partnership interest increases from $60 
to $114. Under paragraph (d)(4)(ii) of this section, AX's basis in 
Asset 1 increases from $60 to $114 because Asset 1 is the 
appreciated property treated as the subject of the exchange.
    Example 7.  Change in allocation ratios--admission and exit of a 
partner. (i) The facts are the same as Example 1(i) of this 
paragraph (h). In addition, in Year 2, when the values of Asset 1 
and the X stock have not changed, B contributes $100 of cash to AX 
in exchange for a one-third interest in the partnership. Upon the 
admission of B as a partner, X's interest in Asset 1 decreases from 
$50 to $33.33, and its interest in B's contributed cash increases. 
B's admission is not a Section 337(d) Transaction because it does 
not have the effect of an exchange by X of its interest in Asset 1 
for X stock. Accordingly, X does not recognize gain under paragraph 
(d) of this section.
    (ii) In Year 9, when the values of Asset 1 and the X stock have 
not changed, the partnership distributes $50 of cash and 50 percent 
of Asset 1 (valued at $50) to B in liquidation of B's interest. X 
and A are equal partners in all respects after the distribution. 
Upon the liquidation of B's interest, X's interest in Asset 1 
decreases from $33.33 to $25, and its interest in X stock increases 
from $33.33 to $50. AX's liquidation of B's interest has the effect 
of an exchange by X of appreciated property for X stock, and thus, 
is a Section 337(d) Transaction.
    (iii) Pursuant to paragraph (d)(2) of this section, X's interest 
in X stock and other appreciated property held by the partnership is 
determined based on all facts and circumstances, including 
allocation and distribution rights in the partnership agreement. 
However, paragraph (d)(2) of this section also requires that X's 
interest in its stock for purposes of paragraph (d) will never be 
less than the Corporate Partner's largest interest (by value) in 
those shares of Stock of the Corporate Partner taken into account 
when the partnership previously determined whether there had been a 
Section 337(d) Transaction (regardless of whether the Corporate 
Partner recognized gain in the earlier transaction). Although X's 
interest in X stock increases to $50 upon AX's liquidation of B's 
interest, X's largest interest previously taken into account under 
paragraph (d)(1) of this section was $50. Thus, X's interest in its 
stock is not considered to be increased, and X therefore recognizes 
no gain under paragraph (d) of

[[Page 26592]]

this section, provided that the transactions did not occur as part 
of a plan or arrangement to circumvent the purpose of this section.
    Example 8.  Change in allocation ratios--plan to circumvent 
purpose of this section. (i) In Year 1, X, a corporation, and A, an 
individual, contribute $99 and $1, respectively, to newly-formed 
partnership AX, with X receiving a 99 percent interest in AX and A 
receiving a 1 percent interest in AX. AX borrows $100,000 from a 
third-party lender and uses the proceeds to purchase X stock, which 
is Stock of the Corporate Partner. Later, as part of a plan or 
arrangement to circumvent the purposes of this section, A 
contributes $99,999 of cash, which AX uses to repay the loan, and X 
contributes Asset 1 with a fair market value of $99,901 and basis of 
$20,000. After these contributions, A and X are equal partners in AX 
in all respects.
    (ii) Pursuant to paragraph (d)(2) of this section, X's interest 
in X stock and other appreciated property held by the partnership is 
determined based on all facts and circumstances, including 
allocation and distribution rights in the partnership agreement. 
Generally, pursuant to paragraph (d)(2) of this section, X's 
interest in X stock for purposes of paragraph (d) of this section 
will never be less than the Corporate Partner's largest interest (by 
value) in those shares of Stock of the Corporate Partner taken into 
account when the partnership previously determined whether there had 
been a Section 337(d) Transaction (regardless of whether the 
Corporate Partner recognized gain in the earlier transaction). This 
limitation does not apply, however, if the reduction in X's interest 
in X's stock occurred as part of a plan or arrangement to circumvent 
the purpose of this section. Because the transactions described in 
this example are part of a plan or arrangement to circumvent the 
purpose of this section, the limitation in paragraph (d)(2) of this 
section does not apply. Accordingly, the deemed redemption rule 
under paragraph (d) of this section applies to the transactions with 
the consequences described in Example 1(iii) of this paragraph (h), 
resulting in X recognizing $39,950.50 of gain.
    Example 9.  Tiered partnership. (i) In Year 1, X, a corporation, 
and A, an individual, form partnership UTP. X contributes Asset 1 
with a fair market value of $80 and a basis of $0 in exchange for an 
80 percent interest in UTP. A contributes $20 of cash in exchange 
for a 20 percent interest in UTP. UTP and B, an individual, form 
partnership LTP as equal partners. UTP contributes Asset 1 and $20 
of cash. B contributes X stock, which is Stock of the Corporate 
Partner, with a basis and fair market value of $100.
    (ii) Pursuant to paragraph (g) of this section, the rules of 
this section shall apply to tiered partnerships in a manner that is 
consistent with the purpose set forth in paragraph (a) of this 
section. Pursuant to paragraph (d)(1) of this section, if X is in a 
partnership that engages in a Section 337(d) Transaction, X must 
recognize gain at the time, and to the extent, that X's share of 
appreciated property is reduced in exchange for X stock. The 
formation of LTP causes X's interest in X stock to increase from $0 
to $40 and its interest in Asset 1 to decrease from $64 to $32. 
Thus, LTP's formation is a Section 337(d) Transaction because the 
formation has the effect of an exchange by X of $32 of Asset 1 for 
$32 of X stock.
    (iii) X must recognize gain with respect to Asset 1 to prevent 
the circumvention of section 311(b) principles. X must recognize 
gain equal to the product of X's Gain Percentage and the gain from 
Asset 1 (decreased, but not below zero, by any gain X recognized 
with respect to Asset 1 in the Section 337(d) Transaction under any 
other provision of this chapter) that X would recognize if, 
immediately before the Section 337(d) Transaction, all assets were 
sold in a fully taxable transaction for cash in an amount equal to 
the fair market value of such property. If Asset 1 had been sold in 
a fully taxable transaction immediately before LTP's formation, X's 
allocable share of gain would have been $80 pursuant to section 
704(c). X's Gain Percentage is 50 percent (equal to a fraction, the 
numerator of which is X's $32 interest in Asset 1 effectively 
exchanged for X stock, and the denominator of which is X's $64 
interest in Asset 1 immediately before the Section 337(d) 
Transaction). Thus, X recognizes $40 of gain ($80 multiplied by 50 
percent) under the deemed redemption rule in paragraph (d) of this 
section. Under paragraphs (d)(4)(i) and (ii) of this section, X's 
basis in its UTP partnership interest increases from $0 to $40, 
UTP's basis in its LTP partnership interest increases from $20 to 
$60, and LTP's basis in Asset 1 increases from $0 to $40 pursuant to 
paragraph (g) of this section.

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


Sec.  1.337(d)-3T   [Removed]

0
Par. 3. Remove Sec.  1.337(d)-3T.

0
Par. 4. Section 1.732-1 is amended by revising paragraphs (c)(1) and 
(c)(5)(ii) to read as follows:


Sec.  1.732-1   Basis of distributed property other than money.

* * * * *
    (c) * * *
    (1) General rule--(i) Unrealized receivables and inventory items. 
Except as provided in paragraph (c)(1)(iii) of this section, the basis 
to be allocated to properties distributed to a partner under section 
732(a)(2) or (b) is allocated first to any unrealized receivables (as 
defined in section 751(c)) and inventory items (as defined in section 
751(d)(2)) in an amount equal to the adjusted basis of each such 
property to the partnership immediately before the distribution. If the 
basis to be allocated is less than the sum of the adjusted bases to the 
partnership of the distributed unrealized receivables and inventory 
items, the adjusted basis of the distributed property must be decreased 
in the manner provided in Sec.  1.732-1(c)(2)(i). See Sec.  1.460-
4(k)(2)(iv)(D) for a rule determining the partnership's basis in long-
term contract accounted for under a long-term contract method of 
accounting.
    (ii) Other distributed property. Any basis not allocated to 
unrealized receivables or inventory items under paragraph (c)(1)(i) of 
this section or to stock of persons that control the corporate partner 
or to the corporate partner's stock under paragraph (c)(1)(iii) of this 
section is allocated to any other property distributed to the partner 
in the same transaction by assigning to each distributed property an 
amount equal to the adjusted basis of the property to the partnership 
immediately before the distribution. However, if the sum of the 
adjusted bases to the partnership of such other distributed property 
does not equal the basis to be allocated among the distributed 
property, any increase or decrease required to make the amounts equal 
is allocated among the distributed property as provided in Sec.  1.732-
1(c)(2).
    (iii) Stock distributed to the corporate partner. If a partnership 
makes a distribution described in Sec.  1.337(d)-3(e)(1), then for 
purposes of this section, the basis to be allocated to properties 
distributed under section 732(a)(2) or (b) is allocated first to the 
Stock of the Corporate Partner, as defined in Sec.  1.337(d)-3(c)(2), 
before the distribution of any other property (other than cash). The 
amount allocated to the Stock of the Corporate Partner is as provided 
in Sec.  1.337(d)-3(e)(2).
* * * * *
    (5) * * *
    (ii) Exception. Notwithstanding paragraph (c)(5)(i) of this 
section, the first sentence of each of paragraphs (c)(1)(i) and (ii) of 
this section, and paragraph (c)(1)(iii) of this section in its 
entirety, apply to distributions of Stock of the Corporate Partner, as 
defined in Sec.  1.337(d)-3(c)(2), that occur on or after June 12, 
2015.
* * * * *


Sec.  1.732-1T   [Removed]

0
Par. 5. Remove Sec.  1.732-1T.

0
Par. 6. Section 1.732-3 is revised to read as follows:


Sec.  1.732-3   Corresponding adjustment to basis of assets of a 
distributed corporation controlled by a corporate partner.

    (a) Determination of control. The determination of whether a 
corporate partner that is a member of a consolidated group has control 
of a distributed corporation for purposes of section 732(f) shall be 
made by applying the special aggregate stock ownership rules of Sec.  
1.1502-34.

[[Page 26593]]

    (b) Aggregation of basis within consolidated group. With respect to 
distributed stock of a corporation, if the following two conditions are 
met, then section 732(f) shall apply only to the extent that the 
partnership's adjusted basis in the distributed stock immediately 
before the distribution exceeds the aggregate basis of the distributed 
stock of the corporation in the hands of corporate partners that are 
members of the same consolidated group (as defined in Sec.  1.1502-
1(h)) immediately after the distribution:
    (1) Two or more of the corporate partners receive a distribution of 
stock in another corporation; and
    (2) The corporation, the stock of which was distributed by the 
partnership, is or becomes a member of the distributee partners' 
consolidated group following the distribution.
    (c) Application of section 732(f) to Gain Elimination 
Transactions--(1) General rule. In the event of a Gain Elimination 
Transaction, section 732(f) shall apply as though the Corporate Partner 
acquired control (as defined in section 732(f)(5)) of the Distributed 
Corporation immediately before the Gain Elimination Transaction.
    (2) Definitions. The following definitions apply for purposes of 
this paragraph (c):
    (i) Corporate Partner. The term Corporate Partner means a person 
that is classified as a corporation for federal income tax purposes and 
that holds or acquires an interest in a partnership.
    (ii) Stock. The term Stock includes other equity interests, 
including options, warrants, and similar interests.
    (iii) Distributed Stock. The term Distributed Stock means Stock 
distributed by a partnership to a Corporate Partner, or Stock the basis 
of which is determined by reference to the basis of such Stock. 
Distributed Stock also includes Stock owned directly or indirectly by a 
Distributed Corporation if the basis of such Stock has been reduced 
pursuant to section 732(f).
    (iv) Distributed Corporation. The term Distributed Corporation 
means the issuer of Distributed Stock (or, in the case of an option, 
the issuer of the Stock into which the option is exercisable).
    (v) Gain Elimination Transaction. The term Gain Elimination 
Transaction means a transaction in which Distributed Stock is disposed 
of and less than all of the gain is recognized unless--
    (A) The transferor of the Distributed Stock receives in exchange 
Stock or a partnership interest that is exchanged basis property (as 
defined in section 7701(a)(44)) with respect to the Distributed Stock; 
or
    (B) A transferee corporation holds the Distributed Stock as 
transferred basis property (as defined in section 7701(a)(43)) with 
respect to the transferor corporation's gain. A Gain Elimination 
Transaction includes (without limitation) a reorganization under 
section 368(a) in which the Corporate Partner and the Distributed 
Corporation combine, and a distribution of the Distributed Stock by the 
Corporate Partner to which section 355(c)(1) or 361(c)(1) applies.
    (d) Tiered partnerships. The rules of this section shall apply to 
tiered partnerships in a manner that is consistent with the purposes of 
section 732(f).
    (e) Applicability date. This section applies to transactions 
occurring on or after June 8, 2018.

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
    Approved: May 25, 2018.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2018-12407 Filed 6-7-18; 8:45 am]
 BILLING CODE 4830-01-P