Limitations on Duplication of Net Built-in Losses, 54156-54168 [2013-21330]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 78, Number 170 (Tuesday, September 3, 2013)]
[Rules and Regulations]
[Pages 54156-54168]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-21330]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9633]
RIN 1545-BE58


Limitations on Duplication of Net Built-in Losses

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under section 
362(e)(2) of the Internal Revenue Code of 1986 (Code). The regulations 
apply to certain nonrecognition transfers of loss property to 
corporations. The regulations affect all parties to the transaction.

DATES: Effective Date: These final regulations are effective on 
September 3, 2013.
    Applicability Date: For dates of applicability see Sec.  1.358-
2(d), Sec.  1.362-4(j).

FOR FURTHER INFORMATION CONTACT: Theresa A. Abell (202) 622-7700 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under OMB control number 1545-2247. The collection of 
information in these final regulations is in Sec.  1.362-4(d). This 
information is required by the IRS to verify basis of property 
transferred in certain tax-free transactions when taxpayers make the 
election provided for under section 362(e)(2)(C).
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by section 6103.

Background

    Section 362(e)(2) was enacted in the American Jobs Creation Act of 
2004 (Pub. L. 108-357, 188 Stat. 1418 (2004)) in order to prevent the 
duplication of loss in certain corporate nonrecognition transfers. 
Section 362(e)(2) applies to corporate acquisitions of property with a 
net built-in loss in transactions described in section 362(a) 
(transactions to which section 351 applies and acquisitions of property 
as paid-in surplus or contributions to capital), but only if the 
transaction is not described in section 362(e)(1) (transactions in 
which there is an importation of built-in loss). When a transaction is 
subject to section 362(e)(2), the acquiring corporation's basis in loss 
property is reduced by the property's allocable portion of the 
transferor's net built-in loss. See section 362(e)(2)(B). However, 
under section 362(e)(2)(C), the parties to the transaction can make an 
irrevocable election to apply the reduction to the transferor's basis 
in the stock received in the exchange instead of to the transferee's 
basis in the property received in the exchange.
    Notice 2005-70, 2005-2 CB 694, was published on October 11, 2005, 
to provide interim guidance for making an election to apply section 
362(e)(2)(C). See Sec.  601.601(d)(2) of this chapter. Under Notice 
2005-70, an election would be considered effective once a certification 
was included by the transferor or, if the transferor is a controlled 
foreign corporation (CFC), by all of its controlling U.S. shareholders 
as defined in Sec.  1.964-1(c)(5), on a timely filed original Federal 
income tax return (designated a ``U.S. return'' under the final 
regulations) for the year of the transaction. Notice 2005-70 expressly 
permitted taxpayers to make a protective election that would have no 
effect on a transaction that is ultimately not subject to section 
362(e)(2). The Notice also allowed other statements to be treated as 
effective elections if sufficient information was provided to the IRS 
with respect to the transfer and parties.
    Proposed regulations under section 362(e)(2) were published in the 
Federal Register (71 FR 62067) on October 23, 2006. Following the 
publication of the proposed regulations, the IRS received questions 
concerning the application of section 362(e)(2) to transactions 
involving S corporations and partnerships and concerning the filing of 
the section 362(e)(2)(C) election, particularly with respect to 
transactions between persons outside the United States. The IRS also 
has become aware of certain ambiguities (described later in this 
preamble) relating to the proper operation of the statute. Two written 
comments were submitted; no public hearing was requested or held.

Summary of Proposed Regulations

1. General Application of Section, Interaction With Other Law

    The proposed regulations included a number of specific provisions 
regarding the general operation of the statutory framework, such as 
provisions stating that section 362(e)(2) is to be applied on a 
transferor-by-transferor basis; that a transaction is treated as 
subject to section 362(e)(2) to the extent it is not a transfer of net 
built-in loss property under section 362(e)(1); that gain recognized by 
the transferor is taken into account in determining the transferee's 
basis immediately after the transfer; and that section 362(e)(2) 
applies to any transaction described in section 362(a) without regard 
to whether the transaction is also described in section 362(b) or any 
other section. These provisions responded to inquiries from 
practitioners concerning section 362(e)(2) and its interaction with 
generally applicable provisions of the Code.

2. Exceptions From the Application of Section 362(e)(2)

    The proposed regulations included two exceptions under which a 
transaction would be treated as not subject to section 362(e)(2) 
notwithstanding that the transaction is generally described in that 
section.
    Under the first exception, if a transfer is not relevant for 
Federal income tax purposes at the time it occurs and it does not 
become relevant for Federal income tax purposes at any time within two 
years of the transfer, then, solely for purposes of determining whether 
section 362(e)(2) applies to the transaction, the property exchanged 
would be deemed to have a basis equal to its fair market value 
(designated value under the final regulations) immediately after the 
transaction. As a result, the transfer would not be subject to section 
362(e)(2). This exception reflected a concern that transferors not 
anticipating that a transfer would be relevant for

[[Page 54157]]

Federal income tax purposes would not be likely to undertake the 
valuation and record-keeping necessary to comply with the statute. 
However, if a transfer that was not relevant for Federal income tax 
purposes when it occurred became relevant for Federal income tax 
purposes at any time within two years of the transfer, the 
administrative burden of compliance would not be unreasonable, and, if 
a transaction was undertaken with a view to reducing or avoiding 
Federal income tax, the transferor must expect the transfer to be 
relevant for Federal income tax purposes. Because relief would be 
either unnecessary or inappropriate in either case, relief was not 
extended to those cases.
    Under the second exception, a transaction would not be subject to 
section 362(e)(2) to the extent that the transferor distributes the 
stock received in the transaction and, in the distribution, no gain or 
loss was recognized and no person takes the stock or other property 
with a basis determined by reference to the transferor's basis in the 
distributed stock. This relief reflected a determination that, to the 
extent there is no duplicated loss that could be recognized by any 
taxpayer, section 362(e)(2) should not apply to the transaction.

3. Securities Received Without the Recognition of Gain or Loss

    Section 362(e)(2) is silent with respect to securities received 
without the recognition of gain or loss in a transaction otherwise 
subject to section 362(e)(2). However, the IRS and Treasury Department 
determined that the statutory purpose of preventing loss duplication 
would be circumvented if section 362(e)(2) did not apply to securities 
issued in such cases. For example, if loss property is transferred in 
exchange for stock and securities and any part of the securities are 
retained following the distribution of the stock under section 355, 
loss would be duplicated and preserved in the retained securities. To 
prevent this circumvention of the statutory purpose, the proposed 
regulations defined the term ``stock'' to include both stock and 
securities for purposes of section 362(e)(2).

4. Liabilities

    In general, as illustrated in Example 5 in paragraph (d) of Sec.  
1.362-4 of the proposed regulations, liabilities assumed in the 
transaction do not affect the application of section 362(e)(2). 
However, the proposed regulations provided that, if a section 
362(e)(2)(C) election is made, the reduction to stock basis is limited 
to the amount that the transferee would otherwise reduce its basis in 
the transferred assets. This was intended to prevent the reduction of 
stock basis attributable to contingent liabilities associated with a 
trade or business, for which basis is specifically preserved under 
section 358(h)(2)(A).

5. The Section 362(e)(2)(C) Election

    The proposed regulations adopted the general approach of Notice 
2005-70, treating an election as effective if the transferor files a 
certification (designated the ``election statement'' in the proposed 
regulations) on its U.S. return for the year of the transfer or, if the 
transferor is a CFC, if the controlling U.S. shareholders all file the 
election statement on or with their U.S. returns. The proposed 
regulations also adopted the rule allowing a protective election.
    In addition, the proposed regulations substantially expanded the 
guidance provided in Notice 2005-70. The proposed regulations added an 
express requirement that the transferor and the transferee execute a 
written, binding agreement. The proposed regulations also included 
guidance on the filing of an election statement in circumstances not 
addressed in the Notice (for example, if the transferor was not 
required to file a U.S. return and was not a CFC) and provided that the 
statement must be filed in accordance with the regulations in order for 
the section 362(e)(2)(C) election to be effective.
    In addition, the proposed regulations provided that the basis 
tracing provisions in Sec.  1.358-2 would not apply to transactions in 
which a section 362(e)(2)(C) election is made. Thus, if A transferred 
multiple shares of X stock to Y in a transaction subject to section 
362(e)(2), the Y shares received in the transaction would each be 
allocated an equal portion of A's aggregate basis in the X shares 
transferred, without regard to A's bases in the individual shares of X 
stock surrendered. As a result, there would be no disparity among A's 
bases in its Y shares following a section 362(e)(2)(C) election. This 
rule was intended to prevent a preservation of loss that would be 
contrary to the objective of section 362(e)(2).

6. Partnerships and S Corporations

    The proposed regulations confirmed that any reduction under section 
362(e)(2)(C) to the basis in stock received by a partnership or S 
corporation in a transaction subject to section 362(e)(2) is an 
expenditure or expense of the transferor partnership or S corporation. 
As a result, the section 362(e)(2)(C) stock basis reduction would cause 
a reduction to the basis of the partner in its interest in the 
partnership or the S corporation shareholder's basis in its stock of 
the S corporation.

Summary of Comments and Guidance

    In general, the commenters concurred with the positions taken in 
the proposed regulations, but requested that the overall operation of 
the statute be clarified. For example, since the issuance of the 
proposed regulations, the IRS has become aware of certain questions 
relating to the allocation of net built-in loss where gain is 
recognized and multiple properties are transferred in the transaction. 
In addition, practitioners requested further guidance on the 
application of section 362(e)(2) to transactions that are also subject 
to section 362(e)(1), to transactions involving partnerships and S 
corporations, and to transactions between persons not connected with 
the United States, particularly with regard to the making of the 
section 362(e)(2)(C) election.
    Accordingly, these final regulations generally adopt the 
substantive rules of the proposed regulations. In addition, the final 
regulations revise the structure of the proposed rules to clarify the 
application of section 362(e)(2) and to provide a framework that will 
better coordinate with the provisions of section 362(e)(1) and the 
regulations that are to be promulgated under that section. These are 
not substantive changes from the proposed regulations but are solely 
intended to simplify the application of section 362(e)(2). The material 
changes and additions to the proposed regulations are as follows:

1. Clarification of Overall Application of Section 362(e)(2)

    The final regulations adopt a general operative rule and related 
definitions to facilitate the identification of transactions that are 
subject to section 362(e)(2) and to then determine the tax treatment 
required by this section. This approach responds to comments requesting 
more clarity on the general operation of the provision.
    The general operative rule set forth in the final regulations is 
that whenever a person (Transferor) transfers property to a corporation 
(Acquiring) in a loss duplication transaction, Acquiring's basis in 
each loss duplication property (as determined without regard to section 
362(e)(2)) is reduced by the property's allocable portion of 
Transferor's net built-in loss.
    The final regulations define the term ``loss duplication 
transaction'' as any section 362(a) transfer in which

[[Page 54158]]

Acquiring's aggregate basis in the property transferred by Transferor 
would exceed the aggregate value of such property immediately after the 
transaction. The term ``loss duplication property'' refers to 
individual property transferred in the loss duplication transaction 
that Acquiring would take with a basis that would exceed value 
immediately after the transfer. Finally, the term ``Transferor's net 
built-in loss'' is defined as the excess of Acquiring's aggregate basis 
in property received from Transferor over the aggregate value of such 
property immediately after the transaction. For purposes of applying 
each of these definitions, Acquiring's basis in property is determined 
immediately after the transfer, disregarding section 362(e)(2) but 
taking into account all other applicable rules, including section 
362(e)(1).
    The final regulations thus incorporate in the operative rules and 
definitions the transferor-by-transferor approach and other general 
provisions that reflect the statutory construct as implemented by the 
proposed regulations, including that a transfer can be subject to both 
section 362(e)(1) and section 362(e)(2) and the priority given to 
section 362(e)(1) in such cases. These principles are further 
illustrated in the examples.

2. Additional Definitions

    Several questions were raised concerning whether certain persons 
were required to file a U.S. return within the meaning of the 
regulations. To address these concerns, the final regulations define 
the term ``U.S. return'' as a return of income that must be filed under 
section 6012 or an information return that must be filed under Subtitle 
F, Chapter 61, Subchapter A, Part III of the Code (sections 6031 and 
following). The final regulations further provide that the requirement 
to file the return must be unconditional. Thus, the term does not 
include forms that are merely elective to receive a particular tax 
treatment, such as statements filed to make an election or to reduce or 
avoid withholding by a person not otherwise required to file a U.S. 
return. These changes are intended to eliminate uncertainty as to 
whether a person has a filing requirement for purposes of determining 
whether a transaction qualifies for relief as a transaction outside the 
United States. The final regulations also clarify the time for filing 
and the person that must file a statement that the Transferor and 
Acquiring are making an election under section 362(e)(2)(C) (designated 
as a ``Section 362(e)(2)(C) Statement'' under the final regulations). 
The Section 362(e)(2)(C) Statement is described more fully later in 
this preamble.
    The final regulations modify the definition of the term 
``controlling U.S. shareholder.'' Under the final regulations, only 
persons owning a direct interest in the CFC or an interest treated as 
owned by reason of an interest in a partnership, estate, trust, or 
corporation are treated as controlling U.S. shareholders. This change 
reflects a concern that, for this purpose, a rule treating persons as 
controlling U.S. shareholders solely by reason of the family 
attribution rules presents undue administrability concerns and can 
cause inappropriate results in certain cases.

3. Exception for Transactions Outside the U.S. Tax System

    The IRS and Treasury Department continue to believe that 
administrative relief is appropriate when the parties to the transfer 
do not expect the transfer to be relevant for Federal tax purposes, and 
in fact the transfer does not become relevant for Federal tax purposes 
within two years of the transfer. Accordingly, the final regulations 
retain the rule in the proposed regulations excepting transactions 
wholly outside the U.S. tax system. However, the final regulations 
conform the formulation of the rule to the formulation of the exception 
for transactions in which duplicated loss is eliminated. That is, the 
rule in the final regulations does not presume that basis and value are 
equal (with the result that no loss is transferred and so section 
362(e)(2) does not apply), as in the proposed regulations, but instead 
provides simply that section 362(e)(2) will not apply to a qualifying 
transaction. Like the proposed regulations, the final regulations 
provide that a transaction will qualify for this exception only if the 
transaction is between persons not connected to the United States, the 
transaction does not become relevant for Federal tax purposes within 
two years of the transfer, and the transaction is not undertaken 
pursuant to a plan to reduce or avoid Federal taxes.

4. Controlled Foreign Partnerships (CFPs)

    The IRS and Treasury Department have determined that, for purposes 
of the administrative relief granted for transactions outside the 
United States, as well as for purposes of determining the person that 
must file a Section 362(e)(2)(C) Statement, CFPs should be treated in 
the same manner as CFCs. First, the reason that CFCs are ineligible for 
relief is that a CFC could not reasonably expect a transfer to have no 
relevance for Federal income tax purposes, and so the administrative 
relief is not warranted. The same is true with respect to CFPs. Second, 
with respect to the filing of a Section 362(e)(2)(C) Statement, 
although a CFP may not be required to file a U.S. return, the reporting 
U.S. partners of a CFP have a relationship to the CFP, and a filing 
obligation with respect to the CFP's activities, that is materially the 
same as that of the controlling U.S. shareholders of a CFC. Thus, the 
reporting U.S. partners of a CFP have the same reporting requirements 
under these final regulations as the controlling U.S. shareholders of a 
CFC. For purposes of these final regulations, a partnership is a CFP if 
it is treated as such for purposes of section 6038; a CFP's reporting 
U.S. partners are generally those persons that would be required to 
file an information return with respect to the CFP under section 6038.

5. Liabilities

    The final regulations retain the approach in the proposed 
regulations that generally disregards liability assumptions. Example 5 
in paragraph (d) of the proposed regulations Sec.  1.362-4 is expanded, 
however, to illustrate more fully the application of section 362(e)(2) 
to transactions in which fixed and contingent liabilities are assumed. 
See Example 5 in paragraph (h) of the final regulations Sec.  1.362-4.
    However, in both written comments and informal inquiries, 
practitioners have raised concerns about the effect of this rule when 
the property transferred is an interest in a partnership with 
liabilities. In particular, practitioners are concerned because 
partnership liabilities increase each partner's basis in its 
partnership interest but do not give rise to a corresponding increase 
in the value of those interests. The result can be the appearance of a 
built-in loss.
    To address this problem, the final regulations generally adopt the 
approach proposed by commentators, specifically, by modifying the 
definition of the term ``value'' (generally, fair market value) to take 
liabilities into account when determining whether a partnership 
interest is a loss asset. However, because there can be differences 
between Transferor's share of partnership liabilities and Acquiring's 
share of partnership liabilities, the final regulations provide that 
the value of a partnership interest is the sum of cash that Acquiring 
would receive for such interest, increased by any Sec.  1.752-1 
liabilities (as defined in Sec.  1.752-1(a)(4)) of the partnership that 
are allocated to Acquiring with regard to such transferred interest 
under section

[[Page 54159]]

752. The final regulations include an example that illustrates the 
application and effect of this rule. See Example 8(ii) in paragraph (h) 
of the final regulations Sec.  1.362-4. The final regulations also 
clarify that any section 743(b) adjustment to be made as a result of 
the transaction is made after any section 362(e) basis adjustment.

6. Elections Under Section 362(e)(2)(C)

    Since the enactment of section 362(e)(2), the questions most 
frequently asked of the IRS concern the making of the section 
362(e)(2)(C) election, notwithstanding the publication of Notice 2005-
70 and the proposed regulations. Accordingly, the final regulations not 
only generally adopt the rules set forth in Notice 2005-70 and in the 
proposed regulations, but they also expand those rules significantly to 
address the questions raised.
a. Section 362(e)(2)(C) Statement
    To begin, the final regulations retain the fundamental structure of 
the proposed regulations. Thus, under the final regulations, a written, 
binding agreement to make a section 362(e)(2)(C) election must be 
executed by Transferor and Acquiring, and a Section 362(e)(2)(C) 
Statement must be filed in accordance with the regulations. A section 
362(e)(2)(C) election is effective only if both conditions are met. The 
final regulations do not prescribe a particular form for the agreement 
to make the section 362(e)(2)(C) election; however, the final 
regulations do require the written, binding agreement to be in effect 
prior to the time a Section 362(e)(2)(C) Statement is filed.
    The final regulations generally adopt the structure of the proposed 
regulations regarding the time and manner of filing of the Section 
362(e)(2)(C) Statement. Thus, under the final regulations, the 
statement is filed by Transferor (if Transferor is otherwise required 
to file a U.S. return for the year of the transaction) or by all of 
Transferor's controlling U.S. shareholders or reporting U.S. partners 
(if Transferor is a CFC or CFP at the time of the transaction and is 
not otherwise required to file a U.S. return). Further, if Transferor 
is not otherwise required to file a U.S. return and is not a CFC or 
CFP, then the statement is filed by Acquiring (if Acquiring is 
otherwise required to file a U.S. return in the year of the 
transaction) or by all of Acquiring's controlling U.S. shareholders (if 
Acquiring is a CFC at the time of the transaction and is not otherwise 
required to file a U.S. return).
    Unlike the proposed regulations, the final regulations do not 
require or permit the filing of the Section 362(e)(2)(C) Statement by a 
U.S. person (as defined in section 7701(a)(30)) that is not otherwise 
required to file a U.S. return. This change was made because these 
regulations do not create an independent filing requirement, and not 
all U.S. persons would otherwise be required to file a U.S. return.
b. Neither Party Able To File a Section 362(e)(2)(C) Statement
    Like the proposed regulations, the final regulations provide rules 
regarding the filing of a Section 362(e)(2)(C) Statement if neither 
Transferor, Acquiring, nor any of their shareholders would be required 
to file the statement at the time of the transaction but at some later 
time either Transferor or Acquiring becomes a person required to file a 
U.S. return or a CFC, or the stock or loss duplication property is 
acquired by such a person or a CFC in a transferred basis transaction. 
For this purpose, the final regulations expand the proposed rule to 
treat CFPs in the same manner as CFCs.
    The final regulations expand the proposed rules in two respects. 
First, the final regulations provide that, if a person holds property 
received in a transaction with a basis determined directly or 
indirectly by reference to the basis of loss duplication property or 
stock received in a loss duplication transaction, the filing 
requirements will treat such person as Transferor or Acquiring (as 
applicable) for purposes of determining who must file a Section 
362(e)(2)(C) Statement and when.
    Second, the final regulations provide that a Section 362(e)(2)(C) 
Statement must be filed with a U.S. return (or U.S. returns) for the 
first taxable year in which property with a basis determined by 
reference to the basis of loss duplication property or stock received 
in a loss duplication transaction is acquired by a person required to 
file a U.S. return, a CFC, or a CFP. If, in the same taxable year, more 
than one person has an event that causes such basis to become relevant 
for U.S. tax purposes, the Section 362(e)(2)(C) Statement must be filed 
by all such persons with their U.S. return for that first year.
    These two changes were determined necessary to prevent transactions 
from qualifying for the two-year exception for transactions outside the 
U.S. tax system if the basis of property exchanged in a transaction 
becomes relevant for U.S. tax purposes within two years of the 
transaction, as it would not be unduly burdensome to require the 
valuation necessary to comply with section 362(e)(2) in such a case.
    These rules are expected to have limited application, inasmuch as 
they will generally only apply if, within two years of the transaction, 
a party to the transaction becomes a person required to file a U.S. 
return, a CFC, or a CFP, or such a person acquires the loss duplication 
property or stock received in a loss duplication transaction in a 
transferred basis transaction. These rules will also apply in the 
limited situations in which Transferor is a U.S. person not otherwise 
required to file a U.S. return and Acquiring is neither required to 
file a U.S. return, a CFC, nor a CFP (such a case would not qualify for 
the two-year exception for transactions outside the U.S. tax system 
because a U.S. person is a party to the transaction).

7. Transactions Involving Partnerships and S Corporations

    Like the proposed regulations, the final regulations expressly 
confirm that any reduction to a transferor's basis in Acquiring stock 
by reason of a section 362(e)(2)(C) election is an expenditure or 
expense under section 705(a)(2)(B) (if Transferor is a partnership) and 
under section 1367(a)(2)(D) (if Transferor is an S corporation). 
However, in response to questions raised with regard to the proposed 
regulations, the final regulations provide further guidance on the 
interaction between section 362(e)(2) and both subchapter K and 
subchapter S. Specifically, the final regulations clarify that no stock 
basis reduction is required under section 1367(a)(2)(D) by reason of a 
reduction to the S corporation's basis in acquired assets if a section 
362(e)(2)(C) election is not made. In addition, the final regulations 
include examples illustrating the consequences of transfers to and by S 
corporations, as well as transfers by partnerships. For example, 
practitioners raised concerns that S corporation shareholders electing 
to reduce the basis of their S corporation stock under section 
362(e)(2)(C) may inadvertently eliminate their loss completely when the 
transferred asset is sold. The IRS and Treasury Department recognize 
that the elimination of any tax benefit from the economic loss can 
result in such cases and, to alert taxpayers to the potential 
elimination of loss, the final regulations include an example to 
illustrate the application of section 362(e)(2) to transfers made both 
with and without the election under section 362(e)(2)(C). See Example 9 
in paragraph (h) of the final regulations Sec.  1.362-4.

[[Page 54160]]

8. Examples

    The final regulations include revised and expanded examples based 
on those in the proposed regulations. For example, in response to 
questions about the scope of the application of section 362(e)(2) to 
reorganizations, the final regulations include not only examples from 
the proposed regulations illustrating the application of section 
362(e)(2) to transactions qualifying as both section 351 transactions 
and reorganizations, they also include an example illustrating the 
nonapplicability of section 362(e)(2) to triangular reorganizations 
that do not include a transfer to which section 362(a) applies.

9. Other Requests for Comments in the Proposed Regulations

    Although the preamble to the proposed regulations invited comments 
concerning whether special rules were needed to address the interaction 
of section 362(e)(2) and section 336(d) when a section 362(e)(2)(C) 
election is made, and whether the regulations should deem a section 
362(e)(2)(C) election in the case of a section 304 transaction, no 
comments were received regarding these issues. Accordingly, no special 
rules addressing these issues are included in the final regulations.

10. Effective/Applicability Date

    These final regulations generally adopt the proposed effective date 
and thus are applicable to transactions occurring after September 3, 
2013. However, the final regulations modify the proposed effective date 
to provide that the final regulations do not apply to transactions 
after September 3, 2013, that were effected pursuant to a binding 
agreement that was in effect prior to September 3, 2013, and at all 
times thereafter. In addition, the final regulations provide that 
taxpayers may apply these rules to any transaction occurring after 
October 22, 2004.

11. Revision of Sec.  602.101, Table of OMB Control Numbers

    This Treasury Decision revises Sec.  602.101 of this chapter (OMB 
Control Numbers under Paperwork Reduction Act) to include the OMB 
control number 1545-2247 issued with respect to the collection of 
information in this Treasury Decision, as well as OMB control number 
1545-2125 issued with respect to the collections of information in 
Sec. Sec.  1.336-2 and 1.336-4 (TD 9619, 78 FR 28467) May 15, 2013.

Effect on Other Documents

    The following publication is obsolete as of September 3, 2013: 
Notice 2005-70 (2005-2 CB 694).

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866, as 
supplemented by Executive Order 13563. Therefore, a regulatory 
assessment is not required. Further, it is hereby certified that these 
final regulations will not have a significant economic impact on a 
substantial number of small entities. This certification is based on 
the fact that the collection of information in these regulations merely 
provides a mechanism whereby, once a transferor and transferee have 
agreed that it would be advantageous to elect the special basis 
treatment afforded under section 362(e)(2)(C), the transferor (or in 
limited cases the transferee) can report the existence of the 
agreement, and minimal identifying information regarding the 
transaction and the parties, on its return in order to make the 
election effective. The minimal identifying information should be 
readily available to the parties and the professional skills that would 
be necessary to make the election would be the same as those required 
to prepare a return for the small business. Accordingly, a Regulatory 
Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) is not required. Pursuant to section 7805(f) of the Code, 
these final regulations, as well as the proposed regulations preceding 
these final regulations, were 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.

Drafting Information

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

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

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

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry for Sec.  1.362-4 to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.362-4 also issued under 26 U.S.C. 362(e)(2)(C)(ii). * 
* *


0
Par. 2. Section 1.358-2 is amended by revising paragraph (a)(2)(viii) 
and adding a new sentence at the end of paragraph (d) to read as 
follows:


Sec.  1.358-2  Allocation of basis among nonrecognition property.

    (a) * * *
    (2) * * *
    (viii) This paragraph (a)(2) shall not apply to determine the basis 
of a share of stock or security received by a shareholder or security 
holder in an exchange described in both section 351 and either section 
354 or 356, if, in connection with the exchange--
    (A) The shareholder or security holder exchanges property for stock 
or securities in an exchange to which neither section 354 nor section 
356 applies;
    (B) The shareholder or security holder exchanges property for stock 
or securities in a transaction for which an election to apply section 
362(e)(2)(C) is in effect; or
    (C) Liabilities of the shareholder or security holder are assumed.
* * * * *
    (d) Effective/applicability date. * * * However, paragraph 
(a)(2)(viii) of this section applies only to exchanges and 
distributions of stock occurring on or after September 3, 2013; 
taxpayers may also apply paragraph (a)(2)(viii) of this section to 
transactions occurring after October 22, 2004.

0
Par. 3. Section 1.362-4 is amended by revising the section heading and 
paragraph (a)(1), and adding paragraphs (b) through (j) to read as 
follows:


Sec.  1.362-4  Basis of loss duplication property.

    (a) Purpose and scope--(1) In general. The purpose of section 
362(e)(2) and this section is to prevent the duplication of net loss in 
transfers to which section 351 applies, capital contributions, and 
paid-in surplus (each, a section 362(a) transaction). See paragraph (g) 
of this section for definitions of terms used in this section.
    (2) * * *
    (b) Basis determinations under section 362(e)(2) and this section.

[[Page 54161]]

Notwithstanding section 362(a), if a corporation (Acquiring) receives 
loss duplication property (as defined in paragraph (g)(1) of this 
section) from a person (Transferor) in a loss duplication transaction 
(as defined in paragraph (g)(2) of this section), Acquiring's basis in 
such property is equal to the basis of the property determined without 
regard to section 362(e)(2) and this section (as described in paragraph 
(g)(1)(ii) of this section), reduced by the property's allocable 
portion of Transferor's net built-in loss (as defined in paragraph 
(g)(3) of this section). If more than one Transferor transfers property 
to a corporation in a section 362(a) transaction, whether and the 
extent to which section 362(e)(2) and this section apply is determined 
separately for each Transferor.
    (c) Exceptions--(1) Transactions in which net built-in loss is 
eliminated without recognition. Section 362(e)(2) does not apply to a 
transaction to the extent that--
    (i) Without recognizing gain or loss, Transferor distributes the 
Acquiring stock received in the transaction; and
    (ii) Upon completion of the transaction, no person holds Acquiring 
stock or any other asset with a basis determined, in whole or in part, 
by reference to Transferor's basis in the distributed Acquiring stock.
    (2) Certain transactions outside of the United States. Section 
362(e)(2) does not apply to a transaction if--
    (i) Neither Transferor nor Acquiring is a U.S. person (as defined 
in section 7701(a)(30)), a person otherwise required to file a U.S. 
return for the year of the transaction, a controlled foreign 
corporation (CFC, as defined in paragraph (g)(7) of this section), or a 
controlled foreign partnership (CFP, as defined in paragraph (g)(9) of 
this section) on the date of the transaction;
    (ii) The transfer occurs more than two years prior to the date of 
any event described in paragraph (d)(3)(ii)(E), (F), or (G) of this 
section; and
    (iii) The original transaction and the event or events described in 
paragraph (d)(3)(ii)(E), (F), or (G) of this section were not entered 
into with a view to reducing or avoiding the Federal income tax 
liability of any person by avoiding the application of section 
362(e)(2) and this section to the original transaction.
    (d) Election to reduce Transferor's stock basis instead of 
Acquiring's asset basis--(1) In general. In lieu of making the basis 
reductions otherwise required under paragraph (b) of this section, 
Transferor and Acquiring may elect to reduce Transferor's basis in 
Acquiring stock that is received in the transaction without the 
recognition of gain or loss (the section 362(e)(2)(C) election). The 
section 362(e)(2)(C) election may be made protectively and will have no 
effect to the extent that property transferred in the transaction is 
determined not to be subject to section 362(e)(2) and this section. 
However, the election is irrevocable once it is made. A section 
362(e)(2)(C) election is made and effective if--
    (i) Prior to the filing of a Section 362(e)(2)(C) Statement 
(described in paragraph (d)(3)(i) of this section), Transferor and 
Acquiring enter into a written, binding agreement to elect to apply 
section 362(e)(2)(C); and
    (ii) The Section 362(e)(2)(C) Statement is filed in accordance with 
the provisions of paragraph (d)(3) of this section.
    (2) Effect of section 362(e)(2)(C) election. If a section 
362(e)(2)(C) election is made and in effect--
    (i) An amount equal to the portion of Transferor's net built-in 
loss (as defined in paragraph (g)(3) of this section) that would 
otherwise be applied to reduce asset basis under paragraph (b) of this 
section is allocated among the Acquiring shares received or deemed 
received in the exchange (in proportion to the value of such shares) 
and applied to reduce Transferor's basis (determined without regard to 
section 362(e)(2) and this section) in each such share; and
    (ii) Acquiring's basis in loss duplication property received from 
Transferor in the transaction is not determined under section 362(e)(2) 
and this section.
    (3) Section 362(e)(2)(C) Statement--(i) Form and contents of 
statement. The Section 362(e)(2)(C) Statement is to be titled ``Section 
362(e)(2)(C) Statement.'' The Section 362(e)(2)(C) Statement must--
    (A) Identify (by name and tax identification number, if any) 
Transferor and Acquiring;
    (B) State that Transferor and Acquiring have entered into a 
written, binding agreement to elect to apply section 362(e)(2)(C) as 
required in paragraph (d)(1)(i) of this section; and
    (C) State the date of the transaction (or, if the transaction 
includes transfers on more than one date, then the dates of all 
transfers) to which the election applies.
    (ii) Filing the Section 362(e)(2)(C) Statement. In general, the 
Section 362(e)(2)(C) Statement is filed by the person or entity 
described in the applicable paragraph of this paragraph (d)(3)(ii). 
Thus, if Transferor is a partnership, S corporation, trust (including a 
subpart E trust), or other pass-through entity, or Acquiring is an S 
corporation, the entity (and not the partners, shareholders, or other 
persons having an interest in the entity or its property) is the person 
that must file the Section 362(e)(2)(C) Statement, without regard to 
whether such entity is foreign or domestic. However, in the case of a 
CFC or CFP, the controlling U.S. shareholders of the CFC or the 
reporting U.S. partners of the CFP, respectively, file the Section 
362(e)(2)(C) Statement.
    (A) Transferor is a person required to file a U.S. return. If 
Transferor is a person required to file a U.S. return for the year of 
the transfer, Transferor must include the Section 362(e)(2)(C) 
Statement on or with its timely filed (including extensions) original 
U.S. return for the taxable year in which the transfer occurred.
    (B) Transferor is a CFC or CFP and not required to file a U.S. 
return. If paragraph (d)(3)(ii)(A) of this section does not apply and 
Transferor is either a CFC or a CFP on the date of the transfer, all of 
Transferor's controlling U.S. shareholders (in the case of a CFC) or 
all of Transferor's reporting U.S. partners (in the case of a CFP) must 
include the Section 362(e)(2)(C) Statement on or with their timely 
filed (including extensions) original U.S. returns for their taxable 
years in which the transfer occurred.
    (C) Transferor is not a person required to file a U.S. return, a 
CFC, or a CFP, but Acquiring is required to file U.S. return. If 
paragraphs (d)(3)(ii)(A) and (B) of this section do not apply and 
Acquiring is a person required to file a U.S. return for the year of 
the transfer, Acquiring must include the Section 362(e)(2)(C) Statement 
on or with its timely filed (including extensions) original U.S. return 
for the taxable year in which the transfer occurred.
    (D) Transferor is not a person required to file a U.S. return, a 
CFC, or a CFP, Acquiring is not required to file a U.S. return, but 
Acquiring is a CFC. If paragraphs (d)(3)(ii)(A) through (C) of this 
section do not apply and Acquiring is a CFC on the date of the 
transfer, all of Acquiring's controlling U.S. shareholders must include 
the Section 362(e)(2)(C) Statement on or with their timely filed 
(including extensions) original U.S. returns for their taxable years in 
which the transfer occurred.
    (E) Neither Transferor nor Acquiring is a person required to file a 
U.S. return, a CFC, or a CFP, but Transferor later becomes a person 
required to file a U.S. return, a CFC, or a CFP. If paragraphs 
(d)(3)(ii)(A) through (D) of this section do not apply and Transferor 
becomes a person required to file a U.S. return, a CFC, or a CFP, 
Transferor (if required to file a U.S. return), all of Transferor's 
controlling U.S. shareholders (if

[[Page 54162]]

Transferor becomes a CFC not otherwise required to file a U.S. return), 
or all of Transferor's reporting U.S. partners (if Transferor becomes a 
CFP not otherwise required to file a U.S. return) must include the 
Section 362(e)(2)(C) Statement on or with their timely filed (including 
extensions) original U.S. returns for their taxable years in which an 
event described in this paragraph (d)(3)(ii)(E) first occurs. For 
purposes of this paragraph (d)(3)(ii)(E), the term Transferor includes 
any person holding property with a basis determined directly or 
indirectly by reference to Transferor's basis in the Acquiring stock 
received in the transaction.
    (F) Transferor is not and does not become a person required to file 
a U.S. return, a CFC, or a CFP, Acquiring is not, but later becomes 
either a person required to file a U.S. return, a CFC, or a CFP. If 
paragraphs (d)(3)(ii)(A) through (E) of this section do not apply and 
Acquiring becomes a person required to file a U.S. return, a CFC, or a 
CFP, Acquiring (if required to file a U.S. return), all of Acquiring's 
controlling U.S. shareholders (if Acquiring becomes a CFC not otherwise 
required to file a U.S. return), or all of Acquiring's reporting U.S. 
partners (if Acquiring becomes a CFP not otherwise required to file a 
U.S. return) must include the Section 362(e)(2)(C) Statement on or with 
their timely filed (including extensions) original U.S. returns for 
their taxable years in which an event described in this paragraph 
(d)(3)(ii)(F) first occurs. For purposes of this paragraph 
(d)(3)(ii)(F), the term Acquiring includes any person holding property 
with a basis determined directly or indirectly by reference to 
Acquiring's basis in loss duplication property received in the 
transaction.
    (G) Transferor and Acquiring are not and do not become a person 
required to file a U.S. return, a CFC, or a CFP, but the basis of the 
loss duplication property or Acquiring stock later becomes relevant for 
Federal tax purposes. If paragraphs (d)(3)(ii)(A) through (F) of this 
section do not apply and, in a transferred basis transaction, a person 
required to file a U.S. return, a CFC, or a CFP acquires either loss 
duplication property or Acquiring stock that was received in the loss 
duplication transaction, or any property the basis of which is 
determined in whole or in part by reference to any such property or 
stock, all such persons (or, in the case of a CFC or CFP not required 
to file a U.S. return, all the controlling U.S. shareholders or all the 
reporting U.S. partners, as applicable) must include the Section 
362(e)(2)(C) Statement on or with their timely filed (including 
extensions) original U.S. returns for their first taxable year(s) in 
which there occurs an event or events described in this paragraph 
(d)(3)(ii)(G).
    (e) Transfers by partnerships and S corporations--(1) Transfers by 
partnerships. If a partnership transfers property in a loss duplication 
transaction with respect to which a section 362(e)(2)(C) election is 
made, the resulting reduction to the partnership's basis in the 
Acquiring stock received in exchange for the loss duplication property 
is treated as an expenditure of the partnership described in section 
705(a)(2)(B).
    (2) Transfers by S corporations. If an S corporation transfers 
property in a loss duplication transaction with respect to which a 
section 362(e)(2)(C) election is made, the resulting reduction to the S 
corporation's basis in the Acquiring stock received in exchange for the 
loss duplication property is treated as an expense of the S corporation 
described in section 1367(a)(2)(D).
    (f) Transfers to S corporations. If a person transfers property to 
an S corporation in a loss duplication transaction, any resulting 
reduction under section 362(e)(2) and this section to the S 
corporation's basis in the property received is not treated as an 
expense of the S corporation described in section 1367(a)(2)(D).
    (g) Definitions. For purposes of section 362(e)(2) and this 
section--
    (1) Loss duplication property is any property--
    (i) That is transferred by Transferor to Acquiring in a loss 
duplication transaction (as defined in paragraph (g)(2) of this 
section); and
    (ii) That Acquiring would take with a basis in excess of value 
immediately after the transaction; for this purpose, the basis 
Acquiring would take in the property is determined immediately after 
the transaction and without regard to section 362(e)(2) and this 
section, but otherwise taking into account all applicable provisions of 
law, including, without limitation, section 362(e)(1).
    (2) A loss duplication transaction is a section 362(a) transaction 
in which Acquiring's aggregate basis in the property received from 
Transferor would, but for section 362(e)(2) and this section, exceed 
the aggregate value of such property immediately after the transaction. 
For this purpose--
    (i) A transaction is a section 362(a) transaction if it is 
described in section 362(a) without regard to whether it is also 
described in any other provision of the Internal Revenue Code (Code), 
including, without limitation, section 362(b); and
    (ii) Acquiring's aggregate basis in the property received from 
Transferor is determined immediately after the transaction and without 
regard to section 362(e)(2) and this section, but otherwise taking into 
account all applicable provisions of law, including, without 
limitation, section 362(e)(1).
    (3) Transferor's net built-in loss is the excess of--
    (i) Acquiring's aggregate basis (determined under paragraph 
(g)(2)(ii) of this section) in all property received from Transferor in 
a loss duplication transaction, over
    (ii) The aggregate value of such property immediately after the 
transaction.
    (4) A property's built-in loss is the excess of Acquiring's basis 
in the property (determined as described in paragraph (g)(1)(ii) of 
this section) over the property's value (determined immediately after 
the transaction).
    (5) A property's allocable portion of Transferor's net built-in 
loss is the portion of Transferor's net built-in loss that bears the 
same ratio to Transferor's net built-in loss that the property's built-
in loss bears to the aggregate built-in losses reflected in the bases 
of loss duplication property transferred by Transferor in the 
transaction.
    (6) A U.S. return is a return of income under section 6012 or an 
information return under Subtitle F, Chapter 61, Subchapter A, Part III 
of the Code (sections 6031 and following) or the regulations 
thereunder, that the taxpayer is unconditionally required to file. 
Thus, the term does not include elective forms or statements that are 
required to be filed only to obtain a particular tax treatment, 
including forms filed to make an election or to reduce or avoid 
withholding by a person not otherwise required to file a U.S. return 
(as described in this paragraph (g)(6)) (for example, a notice of 
nonrecognition under Sec.  1.1445-2(d)).
    (7) A controlled foreign corporation (CFC) is any corporation 
described in section 957 or section 953(c).
    (8) A controlling U.S. shareholder is any person that is treated as 
a controlling U.S. shareholder under Sec.  1.964-1(c)(5) because such 
person either owns a direct interest in the CFC or is treated as owning 
an interest in the CFC by reason of section 318(a)(2) (attribution from 
partnerships, estates, trusts, and corporations).
    (9) A controlled foreign partnership (CFP) is any partnership 
treated as a controlled foreign partnership for purposes of section 
6038.
    (10) A reporting U.S. partner is any partner of a CFP that is 
required to file an information return with respect to

[[Page 54163]]

the CFP pursuant to section 6038 or the regulations thereunder, without 
regard to Sec.  1.6038-3(c) or (j). In addition, in applying the 
constructive ownership rules of Sec.  1.6038-3(b)(4), the term 
``nonresident alien'' is replaced by the term ``individual.''
    (11) The term stock means both Acquiring stock and Acquiring 
securities received by Transferor in the transaction if gain or loss on 
the receipt of the stock or securities is not recognized in whole or in 
part.
    (12) Value--(i) General rule. The term value means fair market 
value.
    (ii) Special rule for transfers of partnership interests. 
Notwithstanding the general rule in paragraph (g)(12)(i) of this 
section, when referring to a partnership interest, for purposes of 
section 362(e)(2) and this section, the term value means the sum of the 
cash that Acquiring would receive for the interest, assuming an 
exchange between a willing buyer and a willing seller (neither being 
under any compulsion to buy or sell and both having reasonable 
knowledge of relevant facts), increased by any Sec.  1.752-1 
liabilities (as defined in Sec.  1.752-1(a)(4)) of the partnership 
allocated to Acquiring with regard to such transferred interest under 
section 752 immediately after the transfer to Acquiring. See Sec.  
1.743-1 regarding the application of section 743(b) following a section 
362(e) basis reduction.
    (h) Examples. The examples in this paragraph (h) illustrate the 
application of section 362(e)(2) and this section. For purposes of 
these examples, X, Y, P, S, S1, S2, and DC are domestic corporations; A 
and B are U.S. individuals; FC1 and FC2 are foreign corporations and, 
unless otherwise indicated, are not required to file a U.S. return and 
are not CFCs; and PRS is a domestic partnership. Unless the facts 
indicate otherwise, all persons and transactions are unrelated; 
Acquiring's basis in the transferred property is not determined under 
section 362(e)(1); the property transferred is not described in section 
362(e)(1)(B); no election is made under section 362(e)(2)(C), and the 
transactions are not subject to recharacterization.

    Example 1. Transfer described in section 351--(i) Basic 
application of section. (A) Facts. A owns Asset 1 (basis $90, value 
$60) and Asset 2 (basis $110, value $120). In a transaction to which 
section 351 applies, A transfers Asset 1 and Asset 2 to X in 
exchange for a single outstanding share of X stock representing all 
the outstanding X stock immediately after the transaction.
    (B) Analysis--(1) Loss duplication transaction. A's transfer of 
Asset 1 and Asset 2 is a section 362(a) transaction. But for section 
362(e)(2) and this section, X's aggregate basis in those assets 
would be $200 ($90 + $110), which would exceed the aggregate value 
of the assets $180 ($60 + $120) immediately after the transaction. 
Accordingly, the transfer is a loss duplication transaction and A 
has a net built-in loss of $20 ($200-$180).
    (2) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in Asset 1 would be $90, which 
would exceed Asset 1's $60 value immediately after the transaction. 
Accordingly, Asset 1 is loss duplication property. But for section 
362(e)(2) and this section, X's basis in Asset 2 would be $110, 
which would not exceed Asset 2's $120 value immediately after the 
transaction. Accordingly, Asset 2 is not loss duplication property.
    (C) Basis in loss duplication property. X's basis in Asset 1 is 
$70, computed as its $90 basis under section 362(a) reduced by A's 
$20 net built-in loss.
    (D) Basis in other property. Under section 362(a), X has a 
transferred basis of $110 in Asset 2. Under section 358(a), A has an 
exchanged basis of $200 in the X stock it receives in the 
transaction.
    (ii) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A) of this Example 1, except that A and X make an 
election under section 362(e)(2)(C). Under paragraph (d)(2)(i) of 
this section, A reduces its basis in the X stock, as determined 
without regard to section 362(e)(2) and this section, by the amount 
of A's net built-in loss that would have been applied to reduce X's 
basis in Asset 1 had the section 362(e)(2)(C) election not been 
made. In addition, no reduction is made to X's basis in Asset 1, as 
determined without regard to section 362(e)(2) and this section. As 
a result, A's basis in the X stock is $180 ($200-$20), X's basis in 
Asset 1 is $90, and X's basis in Asset 2 is $110.
    Example 2. Transfer described in both section 351 and section 
368(a)(1)(B)--(i) Basic application of section--(A) Facts. P owns 
the sole outstanding share of S1 stock and the ten outstanding 
shares of S2 stock. In a transaction to which section 351 applies 
and that is described in section 368(a)(1)(B), P transfers its ten 
S2 shares to S1 in exchange for an additional ten shares of S1 
voting stock. At the time of the transfer, P has a basis of $10 each 
in five of its S2 shares (Shares 1-5) and a basis of $5 each in its 
other five S2 shares (Shares 6-10), and the value of each share is 
$7.
    (B) Analysis--(1) Loss duplication transaction. P's transfer of 
the S2 shares is a section 362(a) transaction notwithstanding that 
it is also a transaction described in section 368(a)(1)(B) and 
therefore section 362(b). But for section 362(e)(2) and this 
section, S1's aggregate basis in the S2 shares would be $75 ($10 x 
5, or $50, for Shares 1-5 + $5 x 5, or $25, for Shares 6-10). Thus, 
S1's $75 aggregate basis in the shares would exceed the aggregate 
value of the shares, $70 ($7 x 10 shares), immediately after the 
transaction. Accordingly, the transfer is a loss duplication 
transaction and P has a net built-in loss of $5 ($75-$70).
    (2) Identifying loss duplication property. But for section 
362(e)(2) and this section, S1's basis in each of Shares 1-5 would 
be $10, which would exceed each share's $7 value immediately after 
the transaction. Accordingly, Shares 1-5 are each loss duplication 
property. But for section 362(e)(2) and this section, S1's basis in 
each of Shares 6-10 would be $5, which would not exceed each share's 
$7 value immediately after the transaction. Accordingly, Shares 6-10 
are not loss duplication property.
    (C) Basis in loss duplication property. S1's basis in each of 
Shares 1-5 is $9, computed as its $10 basis (determined without 
regard to section 362(e)(2) and this section) reduced by $1, the 
share's allocable portion (1/5) of P's net built-in loss ($5).
    (D) Basis in other property. Under section 362(a), S1 has a 
transferred basis of $5 in each of Shares 6-10. Under section 
358(a), P has an exchanged basis in the ten S1 shares it receives in 
the exchange ($10 in each of the five S1 shares received in exchange 
for Shares 1-5 and $5 in each of the five S1 shares received in 
exchange for Shares 5-10).
    (ii) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A) of this Example 2, except that an election under 
section 362(e)(2)(C) is made to reduce P's basis in the shares of S1 
stock received in the exchange. Under paragraph (d)(2)(i) of this 
section, P reduces its basis in the S1 stock by $5, the amount of 
P's net built-in loss that S1's basis in the S2 shares would have 
been reduced under section 362(e)(2) and this section had the 
section 362(e)(2)(C) election not been made, and no reduction is 
made to S1's basis in the S2 stock (as determined without regard to 
section 362(e)(2) and this section). Because an election is being 
made under section 362(e)(2)(C), P's basis in the new S1 shares is 
not determined under the general rule of Sec.  1.358-2(a)(2)(i) 
(under which P's basis in each new S1 share would be equal to the 
basis of the S2 share transferred in exchange for the S1 share). 
Section 1.358-2(a)(2)(viii)(B). Accordingly, P's basis in each new 
S1 share will be $7, the share's allocable portion of P's $75 
aggregate basis in the S2 shares transferred in the transaction (or, 
$7.50 per share), reduced under paragraph (d)(2)(i) of this section 
by the $5 that would have been applied to reduce S1's basis in the 
S2 shares had the section 362(e)(2)(C) election not been made (or 
$.50 per share). Under paragraph (d)(2)(ii) of this section and 
section 362(a), S1 receives five shares of the S2 stock with a basis 
of $10 each and five shares of the S2 stock with a basis of $5 each.

    Example 3. Transfer described in both section 351 and section 
368(a)(1)(A), multiple transferors, elimination of duplicated loss--
(i) Facts. A owns Asset 1 (basis $120, value $130) and all the 
outstanding shares of X stock. B owns all the outstanding shares of 
Y stock (basis $150). Y owns Asset 2 (basis $250, value $210). 
Pursuant to a single plan, A transfers Asset 1 to X in exchange for 
additional X shares and, in a transaction qualifying as a 
reorganization described in section 368(a)(1)(A), Y merges with and 
into X. In the merger, B receives X stock with a basis equal to B's 
basis in its Y stock immediately before the merger. A's transfer of 
Asset 1 to X in exchange for X stock and Y's transfer of Asset 2 to 
X in the merger are both transactions to which section 351 applies. 
Notwithstanding

[[Page 54164]]

that the transfers by A and Y are pursuant to a single plan forming 
one transaction, section 362(e)(2) and this section apply to each 
transferor separately.
    (ii) Application of section to A's transfer of Asset 1. A's 
transfer of Asset 1 is a section 362(a) transaction. But for section 
362(e)(2) and this section, X's basis in Asset 1 would be $120, 
which would not exceed Asset 1's $130 value immediately after the 
transaction. Accordingly, A's transfer of Asset 1 is not a loss 
duplication transaction notwithstanding that, taking both A's 
transfer and Y's transfer into account, X has an aggregate net loss 
in Asset 1 and Asset 2. Because Asset 1 is not received in a loss 
duplication transaction, it is not loss duplication property and 
section 362(e)(2) and this section do not apply to A's transfer of 
Asset 1.
    (iii) Application of section to Y's transfer of Asset 2--(A) 
Analysis--(1) Loss duplication transaction. Y's transfer of Asset 2 
to X is a section 362(a) transaction, notwithstanding that it is 
also a transaction described in section 368(a)(1)(A) and therefore 
section 362(b). But for section 362(e)(2) and this section, X's 
basis in Asset 2 would be $250, which would exceed Asset 2's $210 
value immediately after the transaction. Accordingly, Y's transfer 
is a loss duplication transaction and Y has a net built-in loss of 
$40.
    (2) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in Asset 2 would be $250, 
which would exceed Asset 2's $210 value immediately after the 
transaction. Accordingly, Asset 2 is loss duplication property.
    (B) Basis in loss duplication property. Although Asset 2 is loss 
duplication property, section 362(e)(2) does not apply to Y's 
transfer of Asset 2 to X because Y distributes all of the X stock 
received in the exchange without recognizing gain or loss, and, upon 
completion of the transaction, no person will hold the X stock or 
any other asset with a basis determined in whole or in part by 
reference to Y's basis in such stock. Accordingly, under paragraph 
(c)(1) of this section, X's basis in Asset 2 is not determined under 
section 362(e)(2) and this section. Thus, under section 362(a), X's 
basis in Asset 2 is $250.
    (iv) Basis in other property. Under section 358, A's basis in 
the X stock received in exchange for Asset 1 is $120 and B's basis 
in the X stock received in the merger is $150. Under section 362(a), 
X's basis in Asset 1 is $120.

    Example 4. Transfer described in both section 351 and section 
368(a)(1)(D), followed by a distribution qualifying under section 
355--(i) Basic transaction--(A) Facts. A and B each own one of the 
two outstanding shares of X common stock. X's assets include Asset 1 
(basis $120, value $70), Asset 2 (basis $160, value $110), and Asset 
3 (basis $220, value $240). In a transaction to which section 351 
applies and that is described in section 368(a)(1)(D), X transfers 
Asset 1, Asset 2, and Asset 3 to Y in exchange for all the Y stock; 
then, in a distribution that qualifies under section 355, X 
distributes all the Y stock received in the exchange to A in 
exchange for all of A's X stock. Under section 361(c)(1), X does not 
recognize gain or loss as a result of the distribution of all the Y 
stock.
    (B) Analysis--(1) Loss duplication transaction. X's transfer of 
Asset 1, Asset 2, and Asset 3 is a section 362(a) transaction. But 
for section 362(e)(2) and this section, Y's aggregate basis in those 
assets would be $500 ($120 + $160 + $220). The aggregate value of 
the assets immediately after the transaction is $420 ($70 + $110 + 
$240). Thus, Y's aggregate basis in the assets would exceed the 
aggregate value of the assets immediately after the transaction. 
Accordingly, the transfer is a loss duplication transaction and X 
has a net built-in loss of $80 ($500 - $420).
    (2) Identifying loss duplication property. But for section 
362(e)(2) and this section, Y's basis in Asset 1 would be $120, 
which would exceed Asset 1's $70 value immediately after the 
transaction. Accordingly, Asset 1 is loss duplication property. But 
for section 362(e)(2) and this section, Y's basis in Asset 2 would 
be $160, which would exceed Asset 2's $110 value immediately after 
the transaction. Accordingly, Asset 2 is also loss duplication 
property. But for section 362(e)(2) and this section, Y's basis in 
Asset 3 would be $220 and would therefore not exceed Asset 3's $240 
value immediately after the transaction. Accordingly, Asset 3 is not 
loss duplication property.
    (C) Basis in loss duplication property. Although Asset 1 and 
Asset 2 are each loss duplication property, X will distribute the Y 
stock received in exchange for Asset 1 and Asset 2 without 
recognition of gain or loss, and, upon completion of the 
transaction, no person will hold the Y stock received by X or any 
other asset with a basis determined in whole or in part by reference 
to X's basis in the Y stock received in the exchange. (A's basis in 
the Y stock will be determined by reference to his basis in his X 
stock.) Accordingly, under paragraph (c)(1) of this section, Y's 
bases in Asset 1 and Asset 2 are determined under section 362(a) and 
not under section 362(e)(2) and this section. Thus, Y's basis in 
Asset 1 is $120 and Y's basis in Asset 2 is $160.
    (D) Basis in other property. Under section 358, A's basis in the 
Y stock received in exchange for his X stock is determined by 
reference to his basis in his X stock surrendered. Under section 
362(a), Y's basis in Asset 3 is $220.
    (ii) Section 355(e)--(A) Facts. The facts are the same as in 
paragraph (i)(A) of this Example 4, except that, after the section 
355 distribution, Y is acquired pursuant to a plan (within the 
meaning of Sec.  1.355-7), resulting in the application of section 
355(e) to the transactions.
    (B) Analysis. Because section 361(c)(2), and not section 
361(c)(1), will apply to X's distribution of Y stock, X will not 
qualify for nonrecognition treatment on the distribution of the Y 
stock. As a result, paragraph (c)(1) of this section does not apply 
to the transaction, and Y's bases in Asset 1 and Asset 2, the loss 
duplication property, are determined under section 362(e)(2) and 
this section. Asset 1 has a built-in loss of $50 ($120 - $70), and 
Asset 2 has a built-in loss of $50 ($160 - $110). Thus, Asset 1's 
allocable portion of X's net built-in loss is $40 ($50/$100 x $80), 
and Asset 2's allocable portion of X's net built-in loss is $40 
($50/$100 x $80). Accordingly, Y receives Asset 1 with a basis of 
$80 ($120 - $40) and Asset 2 with a basis of $120 ($160 - $40).
    (iii) Retained stock and securities--(A) Facts. The facts are 
the same as in paragraph (i)(A) of this Example 4, except that X 
transfers Asset 1, Asset 2, and Asset 3 to Y in exchange for Y stock 
and Y securities, each constituting half of the consideration. In 
addition, for a valid business purpose, X retains Y stock and Y 
securities each worth 1 percent of the total consideration.
    (B) Analysis. Paragraph (c)(1) of this section applies only to 
the extent that stock received in a transaction is distributed 
without recognition of gain or loss. Thus, section 362(e)(2) and 
this section apply to the extent that property was exchanged for the 
retained Y stock and Y securities (2 percent of the total). 
Accordingly, Y reduces its basis in Asset 1 and in Asset 2, the loss 
duplication property, by $1.60 (two percent of X's $80 net built-in 
loss). Asset 1 has a built-in loss of $50 ($120 - $70), and Asset 2 
has a built-in loss of $50 ($160 - $110). Thus, Asset 1's allocable 
portion of X's net built-in loss is $.80 ($50/$100 x $1.60), and 
Asset 2's allocable portion of X's net built-in loss is $.80 ($50/
$100 x $1.60). As a result, Y receives Asset 1 with a basis of 
$119.20 ($120 - $.80) and Asset 2 with a basis of $159.20 ($160 - 
$.80).
    (iv) Retained stock and securities with a section 362(e)(2)(C) 
election--(A) Facts. The facts are the same as in paragraph (iii)(A) 
of this Example 4, except that an election under section 
362(e)(2)(C) is made to reduce X's bases in its retained Y stock and 
retained Y securities.
    (B) Analysis. Under paragraph (d)(2)(i) of this section, X 
reduces its basis in the retained Y stock and the retained Y 
securities (determined without regard to section 362(e)(2) and this 
section) by $1.60, the portion of X's $80 net built-in loss that 
would have been applied to reduce Y's basis in the transferred 
assets had the election to apply section 362(e)(2)(C) not been made. 
(Because the value of the Y stock and the value of the Y securities 
are equal, X's $500 basis in the transferred property would be 
allocated equally between the Y stock and the Y securities, $250 to 
each, under Sec.  1.358-2(b)(2), and the retained Y stock and Y 
securities have a basis of $2.50 each (one percent of $250).) For 
the reasons set forth in paragraph (ii)(B) of this Example 4, Y 
would have been required to reduce its basis in the transferred 
assets by $1.60. Accordingly, X must reduce its aggregate basis in 
the retained Y stock and Y securities by $1.60. Under paragraph 
(d)(2)(i) of this section, the $1.60 basis reduction is allocated 
and applied to reduce X's bases in the retained Y stock and Y 
securities in proportion to the value of each. Because X retained Y 
stock and Y securities with equal values, X holds each of the 
retained Y stock and securities with an adjusted basis of $1.70 
($2.50 - $.80). Under paragraph (d)(2)(ii) of this section, Y 
receives Asset 1 with a basis of $120, Asset 2 with a basis of $160, 
and Asset 3 with a basis of $220.

    Example 5. Transfer of liabilities--(i) Liabilities described in 
section 358(d)(1)--(A) Basic application of section, no section

[[Page 54165]]

362(e)(2)(C) election--(1) Facts. A owns Asset 1 (basis $800, value 
$700). A also has a $200 liability that has been taken into account 
for tax purposes and is thus described in section 358(d)(1), and not 
in sections 357(c)(3), 358(d)(2), and 358(h)(1). A transfers Asset 1 
to X in exchange for a single outstanding share of X stock 
representing all the outstanding X stock immediately after the 
transaction and X's assumption of the liability. The transfer is a 
transaction to which section 351 applies.
    (2) Analysis--(i) Loss duplication transaction. A's transfer of 
Asset 1 is a section 362(a) transaction. But for section 362(e)(2) 
and this section, X's basis in Asset 1 would be $800, which would 
exceed Asset 1's $700 value immediately after the transaction. 
Accordingly, the transfer is a loss duplication transaction and A 
has a net built-in loss of $100 ($800 - $700).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in Asset 1 would be $800, 
which would exceed the $700 value of Asset 1 immediately after the 
transaction. Accordingly, Asset 1 is loss duplication property.
    (3) Basis in loss duplication property. X's basis in Asset 1 is 
$700, computed as its $800 basis determined under section 362(a) 
reduced by A's $100 net built-in loss.
    (4) Basis in other property. Under sections 358(a) and (d)(1), 
A's basis in the X stock is $600 ($800 basis in property 
transferred--$200 liability assumed).
    (B) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A)(1) of this Example 5, except that A and X make an 
election under section 362(e)(2)(C). In this case, A's $100 net 
built-in loss that would have been applied to reduce X's basis in 
Asset 1 is applied to reduce A's basis in the X stock received. As a 
result, A's basis in the X stock is $500 ($600, as determined in 
paragraph (i)(A)(4) of this Example 5, reduced by $100) and X's 
basis in Asset 1 is $800.
    (ii) Contingent liabilities described in section 358(h)(1), 
section 358(h)(2)(A) exception applies--(A) Facts. The facts are the 
same as in paragraph (i)(A)(1) of this Example 5, except that A's 
liability (valued at $200) has not been taken into account for tax 
purposes and is described in sections 358(d)(2) and 358(h)(1). 
However, Asset 1 is a trade or business and the liability is 
associated with the trade or business; as a result, the liability is 
described in section 358(h)(2)(A) and is excepted from the general 
rule of section 358(h)(1).
    (B) Analysis. For the reasons set forth in paragraph (i)(A)(2) 
of this Example 5, A's transfer of Asset 1 is a loss duplication 
transaction, A has a net built-in loss of $100, and Asset 1 is loss 
duplication property.
    (C) Basis in loss duplication property. For the reasons set 
forth in paragraph (i)(A)(3) of this Example 5, X's basis in Asset 1 
is $700.
    (D) Basis in other property. A's basis in the X stock is $800 
under sections 358(a), 358(d)(2), and 358(h)(2)(A).
    (E) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (ii)(A) of this Example 5, except that A and X make an 
election under section 362(e)(2)(C). In this case, A's $100 net 
built-in loss that would have applied to reduce X's basis in Asset 1 
is applied to reduce A's basis in the X stock received. As a result, 
A's basis in the X stock is $700 ($800, as determined in paragraph 
(ii)(D) of this Example 5, reduced by $100). X's basis in Asset 1 is 
$800.

    Example 6. Section 351 transfer with boot--(i) Basic 
transaction-(A) Facts. A owns Asset 1 (basis $80, value $100) and 
Asset 2 (basis $30, value $25). In a transaction to which section 
351 applies, A transfers Asset 1 and Asset 2 to X in exchange for 10 
shares of X stock and $25.
    (B) Analysis--(1) Loss duplication transaction. A's transfer of 
Asset 1 and Asset 2 is a section 362(a) transaction. But for section 
362(e)(2) and this section, X's aggregate basis in those assets 
would be $130, computed as follows. Under section 362(a), a 
corporation's basis in property acquired in a transaction to which 
section 351 applies is the same as the property's basis in the hands 
of the transferor, increased by any gain recognized to the 
transferor on such transfer. Under section 351(b), gain (but not 
loss) is recognized to the extent a transferor in a section 351 
exchange receives other property or money in addition to the stock 
permitted to be received without the recognition of gain. To 
determine the amount of gain recognized under section 351(b), the 
consideration is allocated proportionately (by value) among the 
transferred properties. A's gain on the transfer is therefore 
computed as follows: Asset 1 reflects 80 percent of the value 
transferred ($100/$125) and Asset 2 reflects 20 percent of the value 
transferred ($25/$125). Thus, 80 percent of the stock (eight shares) 
and the cash ($20) are treated as being received in exchange for 
Asset 1 and 20 percent of the stock (two shares) and the cash ($5) 
are treated as being received in exchange for Asset 2. Thus, under 
section 351(b), A recognizes $20 of gain for the cash received in 
exchange for Asset 1, but A recognizes no loss for the amount 
received for Asset 2. As a result, under section 362(a), X would 
have a basis of $100 in Asset 1 and $30 in Asset 2. Thus, X's 
aggregate basis in the assets would be $130, which exceeds the $125 
aggregate value of the assets ($100 + $25)). The transfer is a loss 
duplication transaction and A has a net built-in loss of $5 ($130-
$125).
    (2) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in Asset 1 would be $100 (A's 
$80 basis increased by A's $20 gain recognized), which would not 
exceed Asset 1's $100 value immediately after the transaction. 
Accordingly, Asset 1 is not loss duplication property. But for 
section 362(e)(2) and this section, X's basis in Asset 2 would be 
$30, which would exceed Asset 2's $25 value immediately after the 
transaction. Accordingly, Asset 2 is loss duplication property.
    (C) Basis in loss duplication property. X's basis in Asset 2 is 
$25, computed as its $30 basis under section 362(a) reduced by A's 
$5 net built-in loss.
    (D) Basis in other property. Under section 362(a), X's basis in 
Asset 1 is $100 (A's $80 basis increased by the $20 gain 
recognized). Under section 358, A's basis in the X stock is $105 
(the sum of its $80 basis in Asset 1, its $30 basis in Asset 2, and 
its $20 gain recognized, reduced by the $25 cash received in the 
exchange).
    (ii) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A) of this Example 6, except that A and X elect to 
reduce A's stock basis under section 362(e)(2)(C). Under paragraph 
(d)(2)(i) of this section, A reduces its $105 basis in the X stock 
by $5, the amount of A's net built-in loss of that would have been 
applied to reduce X's basis in Asset 2 had the section 362(e)(2)(C) 
election not been made. As a result, A's basis in the X stock is 
$100, and X's basis in Asset 2 is $30.

    Example 7. Section 304 sale of built-in loss stock--(i) Basic 
transaction--(A) Facts. A owns all the stock of X (basis $90, value 
$60) and all the stock of Y. A sells all his X stock to Y for $60. 
Under section 304, A is treated as though he transferred the X stock 
to Y in exchange for Y stock in a transaction to which section 351 
applies. Then, Y is treated as redeeming the Y stock it was treated 
as having issued to A in the deemed section 351 transaction.
    (B) Analysis--(1) Loss duplication transaction. A's deemed 
transfer of X stock to Y is a section 362(a) transaction. But for 
section 362(e)(2) and this section, Y's aggregate basis in the X 
stock would be $90, which would exceed the X stock's value of $60 
immediately after the transaction. Accordingly, the transfer is a 
loss duplication transaction and A has a net built-in loss of $30.
    (2) Identifying loss duplication property. But for section 
362(e)(2) and this section, Y's basis in the X stock would be $90, 
which would exceed the X stock's $60 value immediately after the 
transaction. Accordingly, the X stock is loss duplication property.
    (C) Basis in loss duplication property. Y's basis in the X stock 
is $60, its $90 basis determined without regard to section 362(e)(2) 
and this section, reduced by A's $30 net built-in loss.
    (D) Basis in other property. Under section 358(a), A has an 
exchanged basis of $90 in the Y stock he is deemed to receive in the 
exchange; the effect of the deemed redemption of that stock is then 
determined under section 302.
    (ii) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A) of this Example 7, except that the parties elect to 
reduce A's stock basis under section 362(e)(2)(C). For the reasons 
set forth in paragraphs (i)(B) and (C) of this Example 7, Y's basis 
in the X stock would be reduced by $30. Accordingly, A's basis in 
the deemed-issued Y stock is $60, his $90 basis otherwise determined 
under section 358(a) reduced by the $30 that would have been applied 
to reduce Y's basis in the X stock under section 362(e)(2) and this 
section; the effect of the deemed redemption of that stock is then 
determined under section 302. Y's basis in the X stock is $90.

    Example 8. Transactions involving partnerships--(i) Transfer by 
a partnership--(A) Basic application of section--(1) Facts. PRS owns 
Asset 1 (basis $100, value $70). PRS contributes Asset 1 to X in a 
transaction to which section 351 applies.

[[Page 54166]]

    (2) Analysis--(i) Loss duplication transaction. PRS's transfer 
of Asset 1 is a section 362(a) transaction. But for section 
362(e)(2) and this section, X's basis in Asset 1 would be $100, 
which would exceed Asset 1's $70 value immediately after the 
transaction. Accordingly, the transfer is a loss duplication 
transaction and PRS has a net built-in loss of $30 ($100-$70).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in Asset 1 would be $100, 
which would exceed Asset 1's $70 value immediately after the 
transaction. Accordingly, Asset 1 is loss duplication property.
    (3) Basis in loss duplication property. X's basis in Asset 1 is 
$70, computed as its $100 basis under section 362(a) reduced by 
PRS's $30 net built-in loss.
    (4) Basis in other property. Under section 358(a), PRS has an 
exchanged basis of $100 in the X stock it receives in the exchange.
    (B) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A)(1) of this Example 8, except that PRS and X elect 
to reduce PRS's stock basis under section 362(e)(2)(C). In this 
case, PRS's $30 net built-in loss (as determined in paragraph 
(i)(A)(2)(i) of this Example 8) that would have been applied to 
reduce X's basis in Asset 1 is applied to reduce PRS's basis in the 
X stock received. As a result, PRS's basis in the X stock is $70 
($100-$30) and X's basis in Asset 1 is $100. The $30 reduction to 
PRS's basis in the X stock is treated as an expenditure of PRS under 
section 705(a)(2)(B) and paragraph (e)(1) of this section. As a 
result, the partners of PRS must reduce their bases in their PRS 
interests.
    (ii) Transfer of interest in partnership with liability--(A) 
Basic application of section--(1) Facts. A and two other individuals 
are equal partners in PRS. A's basis in its partnership interest is 
$247. A's share of PRS's Sec.  1.752-1 liabilities (as defined in 
Sec.  1.752-1(a)(4)) is $145. A transfers his partnership interest 
to X in a transaction to which section 351 applies. PRS has no 
election in effect under section 754. If X were to sell the PRS 
interest immediately after the transfer, X would receive $100 in 
cash or other property. In addition, assume that, taking into 
account the rules under Sec.  1.752-4, X's share of PRS's Sec.  
1.752-1 liabilities (as defined in Sec.  1.752-1(a)(4)) is $150 
immediately after the transfer.
    (2) Analysis--(i) Loss duplication transaction. A's transfer of 
its PRS interest is a section 362(a) transaction. But for section 
362(e)(2) and this section, X's basis in the PRS interest, would be 
$252 (A's basis of $247, reduced by A's $145 share of PRS 
liabilities, increased by X's $150 share of PRS liabilities) and, 
under paragraph (g)(12)(ii) of this section, the value of the PRS 
interest would be $250 (the sum of $100, the cash X would receive if 
X immediately sold the interest, and $150, X's share of the Sec.  
1.752-1 liabilities (as defined in Sec.  1.752-1(a)(4)) under 
section 752 immediately after the transfer to X). Therefore, the 
transfer is a loss duplication transaction and A has a net built-in 
loss of $2 ($252-$250).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in the PRS interest would be 
$252, which would exceed the PRS interest's $250 value immediately 
after the transaction. Accordingly, the PRS interest is loss 
duplication property.
    (3) Basis in loss duplication property. X's basis in the PRS 
interest is $250, computed as its $252 basis under section 362(a), 
taking into account the rules under section 752, reduced by A's $2 
net built-in loss.
    (4) Basis in other property. Under section 358, taking into 
account the rules under section 752, A has a basis of $102 ($247 
reduced by A's $145 share of PRS liabilities) in the X stock he 
receives in the transaction.
    (B) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A) of this Example 8, except that A and X make an 
election under section 362(e)(2)(C). Under paragraph (d)(2)(i) of 
this section, A reduces his basis in the X stock, as determined 
without regard to section 362(e)(2) and this section, by the amount 
of A's net built-in loss that would have been applied to reduce X's 
basis in the PRS interest had the section 362(e)(2)(C) election not 
been made. In addition, no reduction is made to X's basis in the PRS 
interest, as determined without regard to section 362(e)(2) and this 
section. As a result, A's basis in the X stock is $100 ($102-$2) and 
X's basis in the PRS interest is $252.
    (C) Transfer of partnership interest with liability, not loss 
duplication transaction. The facts are the same as in paragraph 
(ii)(A)(1) of this Example 8, except that A's share of PRS's Sec.  
1.752-1 liabilities (as defined in Sec.  1.752-1(a)(4)) is $155. But 
for section 362(e)(2) and this section, X's basis in the PRS 
interest would be $242 (A's basis of $247, reduced by A's $155 share 
of PRS liabilities, increased by X's $150 share of PRS liabilities), 
which would not exceed the PRS interest's $250 value immediately 
after the transaction. Accordingly, A's transfer of the PRS interest 
is not a loss duplication transaction and section 362(e)(2) and this 
section have no application to the transaction. Under section 
362(a), X's basis in the PRS interest is $242 and, under section 
358, taking into account the rules under section 752, A has a basis 
of $92 ($247 reduced by A's $155 share of PRS liabilities) in the X 
stock he receives in the transaction.

    Example 9. Transactions involving S Corporations--(i) Transfer 
by S Corporation--(A) No section 362(e)(2)(C) election--(1) Facts. 
S, an S corporation as defined in section 1361(a)(1), owns Asset 1 
(basis $100, value $70). S transfers Asset 1 to X in exchange for a 
single outstanding share of X stock representing all the outstanding 
X stock immediately after the transaction. S does not elect to treat 
X as a qualified subchapter S subsidiary. The transaction is one to 
which section 351 applies.
    (2) Analysis--(i) Loss duplication transaction. S's transfer of 
Asset 1 is a section 362(a) transaction. But for section 362(e)(2) 
and this section, X's basis in Asset 1 would be $100, which would 
exceed Asset 1's $70 value immediately after the transaction. 
Accordingly, the transfer is a loss duplication transaction and S 
has a net built-in loss of $30 ($100-$70).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, X's basis in Asset 1 would be $100, 
which would exceed Asset 1's $70 value immediately after the 
transaction. Accordingly, Asset 1 is loss duplication property.
    (iii) Basis in loss duplication property. X's basis in Asset 1 
is $70, computed as its $100 basis under section 362(a) reduced by 
S's $30 net built-in loss.
    (iv) Basis in other property. Under section 358(a), S has an 
exchanged basis of $100 in the X stock it receives in the exchange.
    (B) Section 362(e)(2)(C) election. The facts are the same as in 
paragraph (i)(A)(1) of this Example 9, except that S and X elect to 
reduce S's stock basis under section 362(e)(2). In this case, S's 
$30 built-in loss (as determined in paragraph (i)(A)(2)(i) of this 
Example 9) that would have been applied to reduce X's basis in Asset 
1 is applied to reduce S's basis in the X stock received. As a 
result, S's basis in the X stock is $70 ($100 - $30) and X's basis 
in Asset 1 is $100. The $30 reduction to S's basis in the X stock is 
treated as an expense of S under section 1367(a)(2)(D) and paragraph 
(e)(2) of this section. As a result, the shareholders of S must 
reduce their bases in their S stock.
    (ii) Transfer to S Corporation--(A) Basic application of 
section. (1) Facts. A owns Asset 1 (basis $90, value $60) and Asset 
2 (basis $110, value $120). In a transaction to which section 351 
applies, A transfers Asset 1 and Asset 2 to S, an S corporation as 
defined in section 1361(a)(1), in exchange for a single share of S 
stock representing all the outstanding S stock immediately after the 
transaction.
    (2) Analysis--(i) Loss duplication transaction. A's transfer of 
Asset 1 and Asset 2 is a section 362(a) transaction. But for section 
362(e)(2) and this section, S's aggregate basis in those assets 
would be $200 ($90 + $110), which would exceed the aggregate value 
of the assets $180 ($60 + $120) immediately after the transaction. 
Accordingly, the transfer is a loss duplication transaction and A 
has a net built-in loss of $20 ($200 - $180).
    (ii) Identifying loss duplication property. But for section 
362(e)(2) and this section, S's basis in Asset 1 would be $90, which 
would exceed Asset 1's $60 value immediately after the transaction. 
As a result, Asset 1 is loss duplication property. But for section 
362(e)(2) and this section, S's basis in Asset 2 would be $110, 
which would not exceed Asset 2's $120 value immediately after the 
transaction. As a result, Asset 2 is not loss duplication property.
    (3) Basis in loss duplication property. S's basis in Asset 1 is 
$70, computed as its $90 basis under section 362(a) reduced by S's 
$20 net built-in loss. The $20 reduction to S's basis in Asset 1 
does not require a reduction to A's basis in its S stock under 
section 1367(a)(2)(D). See paragraph (f) of this section.
    (4) Basis in other property. Under section 362(a), S has a 
transferred basis of $110 in Asset 2. Under section 358(a), A has a 
basis of $200 in the S stock it receives in the exchange.
    (B) Section 362(e)(2)(C) election--(1) Application of section to 
transaction. The facts are the same as in paragraph (ii)(A)(1) of 
this Example 9, except that A and S elect

[[Page 54167]]

to reduce A's stock basis under section 362(e)(2)(C). In this case, 
A's $20 built-in loss (as determined in paragraph (ii)(A)(2) of this 
Example 9) that would have been applied to reduce S's basis in Asset 
1 is applied to reduce A's basis in the S stock received. As a 
result, A's basis in the S stock is $180 ($200 - $20), S's basis in 
Asset 1 is $90, and S's basis in Asset 2 is $110.
    (2) Tax consequences of subsequent disposition of transferred 
assets. The facts are the same as in paragraph (ii)(B)(1) of this 
Example 9 except that, in addition, the year after the transaction, 
S sells Asset 1 (basis $90, value $60) and Asset 2 (basis $110, 
value $120) for $180, recognizing the $20 net built-in loss. The 
loss is allocated to A and reduces A's basis in the S stock from 
$180 to $160 under section 1367(a)(2)(B). If A then sells its S 
stock for its $180 value, A will recognize a gain of $20.

    Example 10. Triangular reorganizations--(i) Facts. P owns all 
the stock of S1 and X owns all the stock of S2. In a merger 
described in section 368(a)(2)(D), S2 merges with and into S1, and X 
receives stock of P in exchange for its S2 stock. S2 has a net 
built-in loss in its assets acquired by S1 in the transaction.
    (ii) Analysis. The reorganization is not a section 362(a) 
transaction, notwithstanding that, under Sec.  1.358-6(c), P is 
treated as acquiring and then transferring S2's assets to S1 for 
purposes of determining P's adjustment to its basis in its S1 stock. 
Accordingly, S1's basis in the property acquired in the transaction 
is not determined under section 362(e)(2) and this section; it is 
determined under section 362(b).

    Example 11. Transfer that includes property described in section 
362(e)(1)(B) and property not described in section 362(e)(1)(B)--(i) 
Facts. FC1 transfers Asset 1 (basis $80, value $50) and Asset 2 
(basis $120, value $110) to DC in a transaction to which section 351 
applies. Asset 1 is not property described in section 362(e)(1)(B); 
Asset 2 is property described in section 362(e)(1)(B).
    (ii) Basis in property described in section 362(e)(1)(B). 
Immediately after the transfer and without regard to section 
362(e)(1) or section 362(e)(2) and this section, DC's aggregate 
basis in property described in section 362(e)(1)(B) (Asset 2) would 
be $120 under section 362(a). However, the aggregate value of such 
property immediately after the transfer is $110. Accordingly, the 
transfer of Asset 2 is an importation of net built-in loss within 
the meaning of section 362(e)(1)(C) and, under section 362(e)(1), 
X's basis in Asset 2 would be Asset 2's value, $110.
    (iii). Application of section--(A) Analysis--(1) Loss 
duplication transaction. FC1's transfer of Asset 1 and Asset 2 is a 
section 362(a) transaction. But for section 362(e)(2) and this 
section, DC's aggregate basis in those assets would be $190 (Asset 
1's $80 basis under section 362(a) + Asset 2's $110 basis under 
section 362(e)(1)), which would exceed the aggregate value of the 
assets $160 ($50 + $110) immediately after the transaction. 
Accordingly, the transfer is a loss duplication transaction and FC1 
has a net built-in loss of $30 ($190-$160).
    (2) Identifying loss duplication property. But for section 
362(e)(2) and this section, DC's basis in Asset 1 would be $80, 
which would exceed Asset 1's $50 value immediately after the 
transaction. Accordingly, Asset 1 is loss duplication property. But 
for section 362(e)(2) and this section, DC's basis in Asset 2 would 
be $110, which would not exceed Asset 2's $110 value immediately 
after the transaction. Accordingly, Asset 2 is not loss duplication 
property.
    (B) Basis in loss duplication property. DC's basis in Asset 1 is 
$50, computed as its $80 basis under section 362(a) reduced by FC1's 
$30 net built-in loss.
    (C) Basis in other property. Under section 362(e)(1), DC's basis 
in Asset 2 is $110. Under section 358(a), FC1 has an exchanged basis 
of $200 in the DC stock it receives in the transaction.

    Example 12. Section 362(e)(2)(C) elections with respect to 
transfers between persons that are not required to file a U.S. 
return and that are not CFCs or CFPs--(i) Basic application of 
section. On June 30, Year 1, FC1 transfers Asset 1 to FC2 in a 
transaction to which section 351 applies (the original transfer) and 
that is therefore a section 362(a) transaction. But for section 
362(e)(2) and this section, FC2's basis in Asset 1 (determined 
immediately after the transfer, taking into account all applicable 
law, including section 362(e)(1)) exceeds the value of Asset 1 
immediately after the transaction. Accordingly, the transaction is a 
loss duplication transaction and Asset 1 is loss duplication 
property. FC1 and FC2 executed a written, binding agreement to apply 
section 362(e)(2)(C) at some point before any Section 362(e)(2)(C) 
Statement is filed. However, the transfer was not entered into with 
a view to reducing or avoiding the Federal income tax liability of 
any person by avoiding the application of section 362(e)(2) and this 
section; further, no event described in paragraph (d)(3)(ii)(E), 
(F), or (G) of this section occurs prior to June 30, Year 3. As a 
result, under paragraph (c)(2) of this section, section 362(e)(2) 
and this section do not apply to the transfer. Accordingly, FC2's 
basis in Asset 1 is determined under section 362(a), no section 
362(e)(2)(C) election can be made, and any protective filing of a 
Section 362(e)(2)(C) Statement will have no effect.
    (ii) Loss duplication property later acquired by a person 
required to file U.S. return. The facts are the same as in paragraph 
(i) of this Example 12, except that, in addition, on January 1, Year 
2, FC2 transfers Asset 1 to DC in an exchange to which section 351 
applies. FC2's transfer is an event described in paragraph 
(d)(3)(ii)(G) of this section. As a result, paragraph (c)(2) does 
not except the original transfer from the application of section 
362(e)(2) and this section. Under paragraph (d)(3)(ii)(G) of this 
section, DC must include the Section 362(e)(2)(C) Statement for the 
original transfer on or with its Year 2 U.S. return in order for 
that election to be effective. The result would be the same if, 
instead of FC2 transferring Asset 1 to DC, FC1 transferred its FC2 
stock to DC in an exchange to which section 351 applies. (Further, 
if an asset transferred by FC1 or FC2 to DC is a loss asset 
immediately after its transfer to DC, DC's basis in that asset may 
be subject to section 362(e)(1).)
    (iii) Party to exchange later becomes a person required to file 
U.S. return. The facts are the same as in paragraph (i) of this 
Example 12, except that, in addition, on January 1, Year 2, FC2 
becomes engaged in a U.S. business. FC2's becoming engaged in a U.S. 
business is an event described in paragraph (d)(3)(ii)(F) of this 
section because it will cause FC2 to become a person required to 
file a U.S. return. As a result, paragraph (c)(2) of this section 
does not except the transfer from the application of section 
362(e)(2) and this section. Under paragraph (d)(3)(ii)(F) of this 
section, FC2 must include the Section 362(e)(2)(C) Statement for the 
original transfer on or with its Year 2 U.S. return in order for the 
section 362(e)(2)(C) election for the original transfer to be 
effective.
    (iv) Statement not filed with respect to designated event. The 
facts are the same as in paragraph (iii) of this Example 12, except 
that, in addition, FC1 became engaged in a U.S. trade or business on 
October 31, Year 1 and as a result became a person required to file 
a U.S. return, an event described in paragraph (d)(3)(ii)(E) of this 
section. As a result, paragraph (c)(2) of this section does not 
except the transfer from the application of section 362(e)(2) and 
this section. Further, in order for the election to be effective, 
FC1 must file the Section 362(e)(2)(C) Statement on or with its Year 
1 U.S. return. See paragraph (d)(3)(ii)(E) of this section. A 
statement filed by FC2 on or with its Year 2 U.S. return has no 
effect. Thus, if FC1 does not file the statement, the election does 
not become effective and basis is determined under the general rule 
of section 362(e)(2).
    (v) Nonrecognition transfer of loss duplication property outside 
United States, transferee later becomes engaged in U.S. trade or 
business. The facts are the same as in paragraph (i) of this Example 
12, except that, in addition, on December 31, Year 1, FC2 transfers 
Asset 1 to FC3 in a transferred basis transaction. In Year 2, FC3 
becomes engaged in a U.S. trade or business and as a result becomes 
a person required to file a U.S. return; Asset 1 is not used in or 
connected with the U.S. trade or business or otherwise subject to 
Federal income tax. FC3's becoming engaged in a U.S. trade or 
business is an event described in paragraph (d)(3)(ii)(F) of this 
section because FC3, a person who holds loss duplication property 
with a basis determined by FC2's basis in the property, will be 
required to file a U.S. return as a result of its becoming engaged 
in a U.S. business. As a result, paragraph (c)(2) of this section 
does not except the transfer from the application of section 
362(e)(2) and this section. Under paragraph (d)(3)(ii)(F) of this 
section, FC3 must include the Section 362(e)(2)(C) Statement for the 
original transfer on or with its Year 2 U.S. return in order for the 
section 362(e)(2)(C) election for the original transfer to be 
effective.

    (i) [Reserved].
    (j) Effective/applicability date. This section applies to 
transactions occurring after September 3, 2013, unless effected

[[Page 54168]]

pursuant to a binding agreement that was in effect prior to September 
3, 2013, and at all times thereafter. In addition, taxpayers may apply 
these regulations to transactions occurring after October 22, 2004.

0
Par. 4. In Sec.  1.705-1, paragraph (a)(9) is added to read as follows:


Sec.  1.705-1  Determination of basis of partner's interest.

    (a) * * *
    (9) For basis adjustments necessary to coordinate sections 705 and 
362(e)(2), see Sec.  1.362-4(f)(i).
* * * * *

0
Par. 5. In Sec.  1.1367-1, a new sentence is added at the end of 
paragraph (c)(2) to read as follows:


Sec.  1.1367-1  Adjustments to basis of shareholder's stock in an S 
corporation.

* * * * *
    (c) * * *
    (2) * * * For basis adjustments necessary to coordinate sections 
1367 and 362(e)(2), see Sec.  1.362-4(f)(ii).
* * * * *

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

0
Par. 6. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


0
Par. 7. In Sec.  602.101, paragraph (b) is amended by adding the 
following entries to the table in numerical order to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
   CFR part or section where identified and described       control No.
------------------------------------------------------------------------
 
                                * * * * *
1.336-2.................................................       1545-2125
1.336-4.................................................       1545-2125
 
                                * * * * *
1.362-4.................................................       1545-2247
 
                                * * * * *
------------------------------------------------------------------------


Beth Tucker,
Deputy Commissioner for Operations Support.
    Approved: August 23, 2013.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2013-21330 Filed 8-30-13; 8:45 am]
BILLING CODE 4830-01-P