[Federal Register: March 18, 2003 (Volume 68, Number 52)]
[Rules and Regulations]
[Page 12817-12825]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr18mr03-10]
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 9047]
RIN 1545-BA36 and 1545-AW92
Certain Transfers of Property to Regulated Investment Companies
[RICs] and Real Estate Investment Trusts [REITs]
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations and removal of temporary regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations that apply to certain
transactions or events that result in a Regulated Investment Company
[RIC] or a Real Estate Investment Trust [REIT] owning property that has
a basis determined by reference to a C corporation's basis in the
property. These regulations affect RICs, REITs, and C corporations and
clarify the tax treatment of transfers of C corporation property to a
RIC or REIT.
DATES: Effective Date: These regulations are effective March 18, 2003.
Applicability Dates: For dates of applicability, see Sec. Sec.
1.337(d)-5(d), 1.337(d)-6(e) and 1.337(d)-7(f).
FOR FURTHER INFORMATION CONTACT: Jennifer D. Sledge, (202) 622-7750
(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 control number 1545-1672. This information is required
to obtain a benefit, i.e., to elect to recognize gain as if the C
corporation had sold the property at fair market value or to elect
section 1374 treatment.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number assigned by the Office of
Management and Budget.
The estimated annual burden per respondent is 30 minutes.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP,
Washington, DC 20224, and to the Office of Management and Budget, ATTN:
Desk Officer for the Department of the Treasury, Office of Information
and Regulatory Affairs, Washington, DC 20503.
Books or records relating to a collection of information must be
retained as long as their contents might become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
This document contains amendments to 26 CFR part 1. On February 7,
2000, temporary regulations [TD 8872] (the 2000 temporary regulations)
relating to certain transactions or events that result in a RIC or REIT
owning property that has a basis determined by reference to a C
corporation's basis in the property were published in the Federal
Register (65 FR 5775). A notice of proposed rulemaking (REG-209135-88)
cross-referencing the temporary regulations was published in the
Federal Register for the same day (65 FR 5805). The 2000 temporary
regulations were intended to carry out the purposes of the repeal of
the General Utilities doctrine as enacted in the Tax Reform Act of 1986
(the 1986 Act)(Public Law 99-514, 100 Stat. 2085), as amended by the
Technical and Miscellaneous Revenue Act of 1988 (Public Law 100-647,
102 Stat. 3342).
The 1986 Act amended sections 336 and 337 to require corporations
to recognize gain or loss on the distribution of property in connection
with complete liquidations other than certain subsidiary liquidations.
Section 337(d) directs the Secretary to prescribe regulations as may be
necessary to carry out the purposes of the General Utilities repeal,
including rules to ``ensure that such purposes may not be circumvented
* * * through the use of a regulated investment company, a real estate
investment trust, or tax-exempt entity * * *.''
The 2000 temporary regulations also reflected the principles set
forth in Notice 88-19 (1988-1 C.B. 486), in which the IRS announced its
intention to promulgate regulations under the authority of section
337(d) with respect to transactions or events that result in a RIC or
REIT owning property that has a basis determined by reference to a C
corporation's basis (a carryover basis). Notice 88-19 provided that the
regulations would apply with respect to the net built-in gain of C
corporation assets that become assets of a RIC or REIT by the
qualification of a C corporation as a RIC or REIT or by the transfer of
assets of a C corporation to a RIC or REIT (a conversion transaction).
The Notice further provided that, where the regulations apply, the C
corporation would be treated, for all purposes, as if it had sold all
of its assets at their respective fair market values and immediately
liquidated. The Notice provided, however, that the regulations would
not allow the recognition of a net loss and that immediate gain
recognition could be avoided if the C corporation that qualified as a
RIC or REIT or the transferee RIC or REIT, as the case may have been,
elected to be subject to tax under section 1374 with respect to the C
corporation property. Notice 88-19 also indicated that the regulations
would apply retroactively to June 10, 1987.
A public hearing on the cross-referenced notice of proposed
rulemaking was held on May 10, 2000. Written or electronic comments
responding to the notice of proposed rulemaking were received. After
consideration of these comments, Treasury and the IRS decided to issue
two new sets of temporary regulations. On January 2, 2002, temporary
regulations [TD 8975] (the 2002 temporary regulations) were published
in the Federal Register (67 FR 8). The regulations under Sec.
1.337(d)-6T apply to conversion transactions occurring on or after June
10, 1987 and before January 2, 2002, and the regulations under Sec.
1.337(d)-7T apply to conversion transactions occurring on or after
January 2, 2002. A notice of proposed
[[Page 12818]]
rulemaking (REG-142299-01 and REG-209135-88) cross-referencing the
temporary regulations was published in the Federal Register for the
same day (67 FR 48).
The regulations under Sec. 1.337(d)-6T provide that, if property
of a C corporation that is not a RIC or REIT becomes the property of a
RIC or REIT in a conversion transaction, then the C corporation is
subject to deemed sale treatment, unless the RIC or REIT elects to be
subject to section 1374 treatment. Thus, the C corporation generally
recognizes gain and loss as if it sold the property converted to RIC or
REIT property or transferred to the RIC or REIT (the converted
property) to an unrelated party at fair market value immediately before
the conversion transaction. If the C corporation recognizes net gain on
the deemed sale, then the basis of the converted property in the hands
of the RIC or REIT is adjusted to its fair market value immediately
before the conversion transaction. The regulations under Sec.
1.337(d)-6T do not permit a C corporation to recognize a net loss on
the deemed sale. Where there is a net loss, the C corporation
recognizes no gain or loss on the deemed sale, and the C corporation's
basis in the converted property carries over to the RIC or REIT.
The regulations under Sec. 1.337(d)-7T provide that, if property
of a C corporation that is not a RIC or REIT becomes the property of a
RIC or REIT in a conversion transaction, then the RIC or REIT will be
subject to tax on the net built-in gain in the converted property under
the rules of section 1374 and the regulations thereunder, unless the C
corporation that qualifies as a RIC or REIT or transfers property to a
RIC or REIT elects deemed sale treatment. In most other respects, the
regulations under Sec. 1.337(d)-7T follow the regulations under Sec.
1.337(d)-6T.
No public hearing was requested or held on the 2002 temporary
regulations. Written or electronic comments responding to the notice of
proposed rulemaking were received. After consideration of all the
comments, the proposed regulations are adopted as amended (the final
regulations) by this Treasury decision, and the corresponding temporary
regulations are removed. The revisions are discussed below.
Explanation and Summary of Comments
This preamble first discusses a change in the time for making the
section 1374 election under Sec. 1.337(d)-6. This preamble then
discusses the clarification of the rules concerning the use of loss
carryforwards, credits and credit carryforwards found in the
regulations under both Sec. 1.337(d)-6 and Sec. 1.337(d)-7. Finally,
this preamble discusses the clarification of certain issues related to
the special rule for partnerships found in Sec. 1.337(d)-7.
Time for Making Section 1374 Election Under Sec. 1.337(d)-6
As explained above, the regulations under Sec. 1.337(d)-6T provide
that, if property of a C corporation that is not a RIC or REIT becomes
the property of a RIC or REIT in a conversion transaction, then the C
corporation is subject to deemed sale treatment, unless the RIC or REIT
elects to be subject to section 1374 treatment. Under Sec. 1.337(d)-
6T(c)(4)(ii), the section 1374 election may be filed by the RIC or REIT
with any Federal income tax return filed by the RIC or REIT on or
before March 15, 2003, provided that the RIC or REIT has reported
consistently with such election for all periods. Commentators expressed
concern that, in the case of a conversion transaction occurring on
January 1, 2002 (the last date of applicability of Sec. 1.337(d)-6T),
the time limit for making a section 1374 election could preclude a RIC
or REIT from extending the due date of its Federal income tax return
beyond March 15, 2003. In response to this comment, the final
regulations under Sec. 1.337(d)-6 extend the time for making the
section 1374 election to September 15, 2003.
Use of Loss Carryforwards, Credits and Credit Carryforwards
Under the 2002 temporary regulations, recognized built-in gains and
recognized built-in losses that have been taxed in accordance with
these regulations are treated like other gains and losses of RICs and
REITs that are not subject to tax under these regulations. Thus, they
are included in computing investment company taxable income for
purposes of section 852(b)(2), real estate investment trust taxable
income for purposes of section 857(b)(2), net capital gain for purposes
of sections 852(b)(3) and 857(b)(3), gross income derived from sources
within any foreign country or possession of the United States for
purposes of section 853, and the dividends paid deduction for purposes
of sections 852(b)(2)(D), 852(b)(3)(A), 857(b)(2)(B), and 857(b)(3)(A).
In addition, consistent with section 1374, the 2002 temporary
regulations generally allow RICs and REITs to use loss carryforwards
and credits and credit carryforwards arising in taxable years for which
the corporation that generated the attribute was a C corporation (and
not a RIC or REIT) to reduce net recognized built-in gain and the tax
thereon, subject to the limitations imposed by sections 1374(b)(2) and
(b)(3) and Sec. Sec. 1.1374-5 and 1.1374-6. The 2002 temporary
regulations also provide an ordering rule for applying loss
carryforwards, credits, and credit carryforwards to reduce net
recognized built-in gain (and the tax thereon) and RIC or REIT taxable
income (and the tax thereon). Under this ordering rule, loss
carryforwards of a RIC or REIT must be used to reduce net recognized
built-in gain for a taxable year to the greatest extent possible before
such losses can be used to reduce investment company taxable income for
purposes of section 852(b) or real estate investment trust taxable
income for purposes of section 857(b). A similar rule applies to the
use of credits and credit carryforwards.
A commentator asked whether the use of loss carryforwards, credits
and credit carryforwards for purposes of section 1374 affected the use
of loss carryforwards, credits and credit carryforwards for purposes of
subchapter M. In response to this comment, the final regulations under
Sec. Sec. 1.337(d)-6 and 1.337(d)-7 clarify that the use of loss
carryforwards, credits and credit carryforwards for purposes of the
section 1374 tax does not change the extent to which such loss
carryforwards, credits and credit carryforwards can be used for
purposes of subchapter M.
Special Rule for Partnerships Under Sec. 1.337(d)-7
Section Sec. 1.337(d)-7T applies to property transferred by a
partnership to a RIC or REIT to the extent of any C corporation
partner's proportionate share of the transferred property (the
partnership rule). The regulations state that, if the partnership
elects deemed sale treatment with respect to such transfer, then any
gain recognized by the partnership on the deemed sale must be specially
allocated to the C corporation partner.
In response to comments, the regulations have been revised to
clarify that the principles of section 704(b) and (c) apply in
determining the C corporation partner's share of the transferred
property. As revised, the regulations provide that the principles of
these regulations apply to property transferred by a partnership to a
RIC or REIT to the extent of any C corporation partner's distributive
share of the gain or loss in the transferred property. The following
sections highlight other specific comments received with respect to
this rule.
[[Page 12819]]
Partnerships With Multiple Corporate Partners
A commentator expressed concern that the partnership rule does not
specify whether the C corporation partner or the partnership is
considered the transferor for purposes of making the deemed sale
election. Further, the commentator asserted that in the case of a
partnership with multiple corporate partners, each corporate partner
should be allowed to make (or not make) a deemed sale election.
Treasury and the IRS believe that requiring each corporate partner
to make a deemed sale election would be inconsistent with section
703(b) (which generally requires that elections be made at the
partnership level) and would create unnecessary administrative
complexity. Therefore, the final regulations under Sec. 1.337(d)-7
retain the rule under section 703(b) that the deemed sale election is
made at the partnership level.
Contribution of Loss Assets by Partnership
Under the partnership rule, if a partnership were to elect deemed
sale treatment under Sec. 1.337(d)-7T, any gain recognized by the
partnership on the deemed sale is allocated to the C corporation
partner. A commentator expressed concern that if the contribution by
the partnership to a RIC or REIT includes multiple assets, the deemed
sale may generate losses on certain assets and gain on others even
though there is an overall net built-in gain. The commentator suggested
that losses recognized by the partnership must also be allocated to the
C corporation partner.
Under Sec. 1.337(d)-7T, when a partnership elects deemed sale
treatment, only net gains are recognized. If a net gain is recognized,
the C corporation partner will receive the benefit of offsetting losses
(as a result of the reduction in net gain). The final regulations under
Sec. 1.337(d)-7 have been modified to clarify that the gain allocated
to the C corporation partner on a deemed sale transaction is the C
corporation partner's distributive share of the net gain in the assets
transferred to the RIC or REIT by the partnership.
Allocation of Gain or Loss on Subsequent Sale of RIC or REIT Stock
Under section 358, a partnership that elects deemed sale treatment
under Sec. 1.337(d)-7T(c) with respect to a conversion transaction
increases its basis in the RIC or REIT stock by the net gain recognized
on such transaction. A commentator suggested that the C corporation
partner should be allowed to use this basis increase to offset any gain
or loss recognized by the partnership on the eventual sale of the RIC
or REIT stock.
Treasury and the IRS agree with this comment. Accordingly, the
final regulations under Sec. 1.337(d)-7 provide that any adjustment to
the basis of the RIC or REIT stock held by the partnership as a result
of electing deemed sale treatment will constitute an adjustment to the
basis of that stock with respect to the C corporation partner only.
Partnerships With Tax-Exempt Partners
A commentator expressed concern that the partnership rule in Sec.
1.337(d)-7T may have an unintended punitive effect when the C
corporation partner is a tax-exempt entity. Tax-exempt entities that
are partners in a partnership that holds debt financed property are
subject to tax under the unrelated business income tax (UBIT) rules
unless certain criteria are satisfied. One of these criteria (the
fractions rule) requires that: (1) the tax-exempt partner's share of
overall partnership income for any tax year is no greater than its
smallest share of partnership loss in any tax year; and (2) each
allocation with respect to the partnership has substantial economic
effect within the meaning of section 704(b)(2). The commentator
expressed concern that the special allocation of gain to the tax-exempt
partner that is required by ``1.337(d)-7T when the partnership makes a
deemed sale election may violate the fractions rule, tainting all
income from the partnership for UBIT purposes.
In response to this comment, Treasury and the IRS have amended the
regulations under section 514 to provide that allocations that are
mandated by statute or regulation (other than subchapter K of chapter 1
of the Internal Revenue Code and the regulations thereunder) are not
considered for purposes of determining qualification under the
fractions rule. This rule applies to partnership allocations made in
taxable years beginning on or after January 1, 2002.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations and, because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Therefore, a Regulatory Flexibility Analysis is not required.
Pursuant to section 7805(f) of the Code, these final regulations will
be submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.
Drafting Information
The principal author of these regulations is Jennifer D. Sledge of
the Office of Associate Chief Counsel (Corporate). Other personnel from
Treasury Department and the IRS 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
Paragraph 1. The authority citation for part 1 is amended by
removing the entries for ``Section 1.337(d)-5T'', ``Section 1.337(d)-
6T'', and ``Section 1.337(d)-7T'' and adding entries in numerical order
to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.337(d)-5 also issued under 26 U.S.C. 337.
Section 1.337(d)-6 also issued under 26 U.S.C. 337.
Section 1.337(d)-7 also issued under 26 U.S.C. 337. * * *
Sec. 1.337(d)-5T [Redesignated as Sec. 1.337(d)-5]
Par. 2. Section 1.337(d)-5T is redesignated as Sec. 1.337(d)-5 and
the language ``(temporary)'' is removed from the end of the section
heading.
Par. 3. Newly designated Sec. 1.337(d)-5 is amended as follows:
1. In paragraph (b)(3), first sentence, the reference to ``Sec.
1.337(d)-5T(b)'' is removed and ``paragraph (b) of this section'' is
added in its place.
2. In paragraph (d), third sentence, the references to ``Sec.
1.337(d)-5T(b)(1)'' and ``Sec. 1.337(d)-6T'' are removed and
``paragraph (b)(1) of this section'' and ``Sec. 1.337(d)-6'' are added
in their places, respectively.
3. In paragraph (d), fourth sentence, the reference to ``Sec.
1.337(d)-6T'' is
[[Page 12820]]
removed and ``Sec. 1.337(d)-6'' is added in its place.
4. In paragraph (d), last sentence, the reference to ``Sec.
1.337(d)-7T'' is removed and ``Sec. 1.337(d)-7'' is added in its
place.
Par. 4. Section 1.337(d)-6 is added to read as follows:
Sec. 1.337(d)-6 New transitional rules imposing tax on property owned
by a C corporation that becomes property of a RIC or REIT.
(a) General rule--(1) Property owned by a C corporation that
becomes property of a RIC or REIT. If property owned by a C corporation
(as defined in paragraph (a)(2)(i) of this section) becomes the
property of a RIC or REIT (the converted property) in a conversion
transaction (as defined in paragraph (a)(2)(ii) of this section), then
deemed sale treatment will apply as described in paragraph (b) of this
section, unless the RIC or REIT elects section 1374 treatment with
respect to the conversion transaction as provided in paragraph (c) of
this section. See paragraph (d) of this section for exceptions to this
paragraph (a).
(2) Definitions--(i) C corporation. For purposes of this section,
the term C corporation has the meaning provided in section 1361(a)(2)
except that the term does not include a RIC or REIT.
(ii) Conversion transaction. For purposes of this section, the term
conversion transaction means the qualification of a C corporation as a
RIC or REIT or the transfer of property owned by a C corporation to a
RIC or REIT.
(b) Deemed sale treatment--(1) In general. If property owned by a C
corporation becomes the property of a RIC or REIT in a conversion
transaction, then the C corporation recognizes gain and loss as if it
sold the converted property to an unrelated party at fair market value
on the deemed sale date (as defined in paragraph (b)(3) of this
section). This paragraph (b) does not apply if its application would
result in the recognition of a net loss. For this purpose, net loss is
the excess of aggregate losses over aggregate gains (including items of
income), without regard to character.
(2) Basis adjustment. If a corporation recognizes a net gain under
paragraph (b)(1) of this section, then the converted property has a
basis in the hands of the RIC or REIT equal to the fair market value of
such property on the deemed sale date.
(3) Deemed sale date--(i) RIC or REIT qualifications. If the
conversion transaction is a qualification of a C corporation as a RIC
or REIT, then the deemed sale date is the end of the last day of the C
corporation's last taxable year before the first taxable year in which
it qualifies to be taxed as a RIC or REIT.
(ii) Other conversion transactions. If the conversion transaction
is a transfer of property owned by a C corporation to a RIC or REIT,
then the deemed sale date is the end of the day before the day of the
transfer.
(4) Example. The rules of this paragraph (b) are illustrated by the
following example:
Example. Deemed sale treatment on merger into RIC. (i) X, a
calendar-year taxpayer, has qualified as a RIC since January 1,
1991. On May 31, 1994, Y, a C corporation and calendar-year
taxpayer, transfers all of its property to X in a transaction that
qualifies as a reorganization under section 368(a)(1)(C). X does not
elect section 1374 treatment under paragraph (c) of this section and
chooses not to rely on Sec. 1.337(d)-5. As a result of the
transfer, Y is subject to deemed sale treatment under this paragraph
(b) on its tax return for the short taxable year ending May 31,
1994. On May 31, 1994, Y's only assets are Capital Asset, which has
a fair market value of $100,000 and a basis of $40,000 as of the end
of May 30, 1994, and $50,000 cash. Y also has an unrestricted net
operating loss carryforward of $12,000 and accumulated earnings and
profits of $50,000. Y has no taxable income for the short taxable
year ending May 31, 1994, other than gain recognized under this
paragraph (b). In 1997, X sells Capital Asset for $110,000. Assume
the applicable corporate tax rate is 35%.
(ii) Under this paragraph (b), Y is treated as if it sold the
converted property (Capital Asset and $50,000 cash) at fair market
value on May 30, 1994, recognizing $60,000 of gain ($150,000 amount
realized--$90,000 basis). Y must report the gain on its tax return
for the short taxable year ending May 31, 1994. Y may offset this
gain with its $12,000 net operating loss carryforward and will pay
tax of $16,800 (35% of $48,000).
(iii) Under section 381, X succeeds to Y's accumulated earnings
and profits. Y's accumulated earnings and profits of $50,000
increase by $60,000 and decrease by $16,800 as a result of the
deemed sale. Thus, the aggregate amount of subchapter C earnings and
profits that must be distributed to satisfy section 852(a)(2)(B) is
$93,200 ($50,000 + $60,000 - $16,800). X's basis in Capital Asset is
$100,000. On X's sale of Capital Asset in 1997, X recognizes $10,000
of gain, which is taken into account in computing X's net capital
gain for purposes of section 852(b)(3).
(c) Election of section 1374 treatment--(1) In general--(i)
Property owned by a C corporation that becomes property of a RIC or
REIT. Paragraph (b) of this section does not apply if the RIC or REIT
that was formerly a C corporation or that acquired property from a C
corporation makes the election described in paragraph (c)(4) of this
section. A RIC or REIT that makes such an election will be subject to
tax on the net built-in gain in the converted property under the rules
of section 1374 and the regulations thereunder, as modified by this
paragraph (c), as if the RIC or REIT were an S corporation.
(ii) Property subject to the rules of section 1374 owned by a RIC,
REIT, or S corporation that becomes property of a RIC or REIT. If
property subject to the rules of section 1374 owned by a RIC, a REIT,
or an S corporation (the predecessor) becomes the property of a RIC or
REIT (the successor) in a continuation transaction, the rules of
section 1374 apply to the successor to the same extent that the
predecessor was subject to the rules of section 1374 with respect to
such property, and the 10-year recognition period of the successor with
respect to such property is reduced by the portion of the 10-year
recognition period of the predecessor that expired before the date of
the continuation transaction. For this purpose, a continuation
transaction means the qualification of the predecessor as a RIC or REIT
or the transfer of property from the predecessor to the successor in a
transaction in which the successor's basis in the transferred property
is determined, in whole or in part, by reference to the predecessor's
basis in that property.
(2) Modification of section 1374 treatment--(i) Net recognized
built-in gain for REITs--(A) Prelimitation amount. The prelimitation
amount determined as provided in Sec. 1.1374-2(a)(1) is reduced by the
portion of such amount, if any, that is subject to tax under section
857(b)(4), (5), (6), or (7). For this purpose, the amount of a REIT's
recognized built-in gain that is subject to tax under section 857(b)(5)
is computed as follows:
(1) Where the tax under section 857(b)(5) is computed by reference
to section 857(b)(5)(A), the amount of a REIT's recognized built-in
gain that is subject to tax under section 857(b)(5) is the tax imposed
by section 857(b)(5) multiplied by a fraction the numerator of which is
the amount of recognized built-in gain (without regard to recognized
built-in loss and recognized built-in gain from prohibited
transactions) that is not derived from sources referred to in section
856(c)(2) and the denominator of which is the gross income (without
regard to gross income from prohibited transactions) of the REIT that
is not derived from sources referred to in section 856(c)(2).
(2) Where the tax under section 857(b)(5) is computed by reference
to section 857(b)(5)(B), the amount of a REIT's recognized built-in
gain that is subject to tax under section 857(b)(5) is
[[Page 12821]]
the tax imposed by section 857(b)(5) multiplied by a fraction the
numerator of which is the amount of recognized built-in gain (without
regard to recognized built-in loss and recognized built-in gain from
prohibited transactions) that is not derived from sources referred to
in section 856(c)(3) and the denominator of which is the gross income
(without regard to gross income from prohibited transactions) of the
REIT that is not derived from sources referred to in section 856(c)(3).
(B) Taxable income limitation. The taxable income limitation
determined as provided in Sec. 1.1374-2(a)(2) is reduced by an amount
equal to the tax imposed under sections 857(b)(5), (6), and (7).
(ii) Loss carryforwards, credits and credit carryforwards--(A) Loss
carryforwards. Consistent with paragraph (c)(1)(i) of this section, net
operating loss carryforwards and capital loss carryforwards arising in
taxable years for which the corporation that generated the loss was not
subject to subchapter M of chapter 1 of the Internal Revenue Code are
allowed as a deduction against net recognized built-in gain to the
extent allowed under section 1374 and the regulations thereunder. Such
loss carryforwards must be used as a deduction against net recognized
built-in gain for a taxable year to the greatest extent possible before
such losses can be used to reduce other investment company taxable
income for purposes of section 852(b) or other real estate investment
trust taxable income for purposes of section 857(b) for that taxable
year.
(B) Credits and credit carryforwards. Consistent with paragraph
(c)(1)(i) of this section, minimum tax credits and business credit
carryforwards arising in taxable years for which the corporation that
generated the credit was not subject to subchapter M of chapter 1 of
the Internal Revenue Code are allowed to reduce the tax imposed on net
recognized built-in gain under this paragraph (c) to the extent allowed
under section 1374 and the regulations thereunder. Such credits and
credit carryforwards must be used to reduce the tax imposed under this
paragraph (c) on net recognized built-in gain for a taxable year to the
greatest extent possible before such credits and credit carryforwards
can be used to reduce the tax, if any, on other investment company
taxable income for purposes of section 852(b) or on other real estate
investment trust taxable income for purposes of section 857(b) for that
taxable year.
(iii) 10-year recognition period. In the case of a conversion
transaction that is a qualification of a C corporation as a RIC or
REIT, the 10-year recognition period described in section 1374(d)(7)
begins on the first day of the RIC's or REIT's first taxable year. In
the case of other conversion transactions, the 10-year recognition
period begins on the day the property is acquired by the RIC or REIT.
(3) Coordination with subchapter M rules--(i) Recognized built-in
gains and losses subject to subchapter M. Recognized built-in gains and
losses of a RIC or REIT are included in computing investment company
taxable income for purposes of section 852(b)(2), real estate
investment trust taxable income for purposes of section 857(b)(2),
capital gains for purposes of sections 852(b)(3) and 857(b)(3), gross
income derived from sources within any foreign country or possession of
the United States for purposes of section 853, and the dividends paid
deduction for purposes of sections 852(b)(2)(D), 852(b)(3)(A),
857(b)(2)(B), and 857(b)(3)(A). In computing such income and deduction
items, capital loss carryforwards and net operating loss carryforwards
that are used by the RIC or REIT to reduce recognized built-in gains
are allowed as a deduction, but only to the extent that they are
otherwise allowable as a deduction against such income under the
Internal Revenue Code (including section 852(b)(2)(B)).
(ii) Treatment of tax imposed. The amount of tax imposed under this
paragraph (c) on net recognized built-in gain for a taxable year is
treated as a loss sustained by the RIC or the REIT during such taxable
year. The character of the loss is determined by allocating the tax
proportionately (based on recognized built-in gain) among the items of
recognized built-in gain included in net recognized built-in gain. With
respect to RICs, the tax imposed under this paragraph (c) on net
recognized built-in gain is treated as attributable to the portion of
the RIC's taxable year occurring after October 31.
(4) Making the section 1374 election--(i) In general. A RIC or REIT
makes a section 1374 election with the following statement: ``[Insert
name and employer identification number of electing RIC or REIT] elects
under Sec. 1.337-6(c) to be subject to the rules of section 1374 and
the regulations thereunder with respect to its property that formerly
was held by a C corporation, [insert name and employer identification
number of the C corporation, if different from name and employer
identification number of the RIC or REIT].'' However, a RIC or REIT
need not file an election under this paragraph (c), but will be deemed
to have made such an election if it can demonstrate that it informed
the Internal Revenue Service prior to January 2, 2002 of its intent to
make a section 1374 election. An election under this paragraph (c) is
irrevocable.
(ii) Time for making the election. An election under this paragraph
(c) may be filed by the RIC or REIT with any Federal income tax return
filed by the RIC or REIT on or before September 15, 2003, provided that
the RIC or REIT has reported consistently with such election for all
periods.
(5) Example. The rules of this paragraph (c) are illustrated by the
following example:
Example. Section 1374 treatment on REIT election. (i) X, a C
corporation that is a calendar-year taxpayer, elects to be taxed as
a REIT on its 1994 tax return, which it files on March 15, 1995. As
a result, X is a REIT for its 1994 taxable year and would be subject
to deemed sale treatment under paragraph (b) of this section but for
X's timely election of section 1374 treatment under this paragraph
(c). X chooses not to rely on Sec. 1.337(d)-5. As of the beginning
of the 1994 taxable year, X's property consisted of Real Property,
which is not section 1221(a)(1) property and which had a fair market
value of $100,000 and an adjusted basis of $80,000, and $25,000
cash. X also had accumulated earnings and profits of $25,000,
unrestricted capital loss carryforwards of $3,000, and unrestricted
business credit carryforwards of $2,000. On July 1, 1997, X sells
Real Property for $110,000. For its 1997 taxable year, X has no
other income or deduction items. Assume the highest corporate tax
rate is 35%.
(ii) Upon its election to be taxed as a REIT, X retains its
$80,000 basis in Real Property and its $25,000 accumulated earnings
and profits. X retains its $3,000 of capital loss carryforwards and
its $2,000 of business credit carryforwards. To satisfy section
857(a)(2)(B), X must distribute $25,000, an amount equal to its
earnings and profits accumulated in non-REIT years, to its
shareholders by the end of its 1994 taxable year.
(iii) Upon X's sale of Real Property in 1997, X recognizes gain
of $30,000 ($110,000--$80,000). X's recognized built-in gain for
purposes of applying section 1374 is $20,000 ($100,000 fair market
value as of the beginning of X's first taxable year as a REIT--
$80,000 basis). Because X's $30,000 of net income for the 1997
taxable year exceeds the net recognized built-in gain of $20,000,
the taxable income limitation does not apply. X, therefore, has
$20,000 net recognized built-in gain for the year. Assuming that X
has not used its $3,000 of capital loss carryforwards in a prior
taxable year and that their use is allowed under section 1374(b)(2)
and Sec. 1.1374-5, X is allowed a $3,000 deduction against the
$20,000 net recognized built-in gain. X would owe tax of $5,950 (35%
of $17,000) on its net recognized built-in gain, except that X may
use its $2,000 of business credit carryforwards to reduce this tax,
assuming that X has not used the credit carryforwards in a prior
taxable year and that their use is allowed under section 1374(b)(3)
[[Page 12822]]
and Sec. 1.1374-6. Thus, X owes tax of $3,950 under this paragraph
(c).
(iv) For purposes of subchapter M of chapter 1 of the Internal
Revenue Code, X's earnings and profits for the year increase by
$26,050 ($30,000 capital gain on the sale of Real Property--$3,950
tax under this paragraph (c)). For purposes of section 857(b)(2) and
(b)(3), X's net capital gain for the year is $23,050 ($30,000
capital gain reduced by $3,000 capital loss carryforward and further
reduced by $3,950 tax).
(d) Exceptions--(1) Gain otherwise recognized. Paragraph (a) of
this section does not apply to any conversion transaction to the extent
that gain or loss otherwise is recognized on such conversion
transaction. See, for example, sections 336, 351(b), 351(e), 356,
357(c), 367, 368(a)(2)(F), and 1001.
(2) Re-election of RIC or REIT status--(i) Generally. Except as
provided in paragraphs (d)(2)(ii) and (iii) of this section, paragraph
(a)(1) of this section does not apply to any corporation that--
(A) Immediately prior to qualifying to be taxed as a RIC or REIT
was subject to tax as a C corporation for a period not exceeding two
taxable years; and
(B) Immediately prior to being subject to tax as a C corporation
was subject to tax as a RIC or REIT for a period of at least one
taxable year.
(ii) Property acquired from another corporation while a C
corporation. The exception described in paragraph (d)(2)(i) of this
section does not apply to property acquired by the corporation while it
was subject to tax as a C corporation from any person in a transaction
that results in the acquirer's basis in the property being determined
by reference to a C corporation's basis in the property.
(iii) RICs and REITs previously subject to section 1374 treatment.
If the RIC or REIT had property subject to paragraph (c) of this
section before the RIC or REIT became subject to tax as a C corporation
as described in paragraph (d)(2)(i) of this section, then paragraph (c)
of this section applies to the RIC or REIT upon its requalification as
a RIC or REIT, except that the 10-year recognition period with respect
to such property is reduced by the portion of the 10-year recognition
period that expired before the RIC or REIT became subject to tax as a C
corporation and by the period of time that the corporation was subject
to tax as a C corporation.
(e) Effective date. This section applies to conversion transactions
that occur on or after June 10, 1987, and before January 2, 2002. In
lieu of applying this section, taxpayers generally may apply Sec.
1.337(d)-5 to determine the tax consequences (for all taxable years) of
any conversion transaction that occurs on or after June 10, 1987 and
before January 2, 2002, except that RICs and REITs that are subject to
section 1374 treatment with respect to a conversion transaction may not
rely on Sec. 1.337(d)-5(b)(1), but must apply paragraphs (c)(1)(i),
(c)(2)(i), (c)(2)(ii), and (c)(3) of this section, with respect to
built-in gains and losses recognized in taxable years beginning on or
after January 2, 2002. Taxpayers are not prevented from relying on
Sec. 1.337(d)-5 merely because they elect section 1374 treatment in
the manner described in paragraph (c)(4) of this section instead of in
the manner described in Sec. 1.337(d)-5(b)(3) and (c). For conversion
transactions that occur on or after January 2, 2002, see Sec.
1.337(d)-7.
Sec. 1.337(d)-6T [Removed]
Par. 5. Section 1.337(d)-6T is removed.
Par. 6. Section 1.337(d)-7 is added to read as follows:
Sec. 1.337(d)-7 Tax on property owned by a C corporation that becomes
property of a RIC or REIT.
(a) General rule--(1) Property owned by a C corporation that
becomes property of a RIC or REIT. If property owned by a C corporation
(as defined in paragraph (a)(2)(i) of this section) becomes the
property of a RIC or REIT (the converted property) in a conversion
transaction (as defined in paragraph (a)(2)(ii) of this section), then
section 1374 treatment will apply as described in paragraph (b) of this
section, unless the C corporation elects deemed sale treatment with
respect to the conversion transaction as provided in paragraph (c) of
this section. See paragraph (d) of this section for exceptions to this
paragraph (a).
(2) Definitions--(i) C corporation. For purposes of this section,
the term C corporation has the meaning provided in section 1361(a)(2)
except that the term does not include a RIC or REIT.
(ii) Conversion transaction. For purposes of this section, the term
conversion transaction means the qualification of a C corporation as a
RIC or REIT or the transfer of property owned by a C corporation to a
RIC or REIT.
(b) Section 1374 treatment--(1) In general--(i) Property owned by a
C corporation that becomes property of a RIC or REIT. If property owned
by a C corporation becomes the property of a RIC or REIT in a
conversion transaction, then the RIC or REIT will be subject to tax on
the net built-in gain in the converted property under the rules of
section 1374 and the regulations thereunder, as modified by this
paragraph (b), as if the RIC or REIT were an S corporation.
(ii) Property subject to the rules of section 1374 owned by a RIC,
REIT, or S corporation that becomes property of a RIC or REIT. If
property subject to the rules of section 1374 owned by a RIC, a REIT,
or an S corporation (the predecessor) becomes the property of a RIC or
REIT (the successor) in a continuation transaction, the rules of
section 1374 apply to the successor to the same extent that the
predecessor was subject to the rules of section 1374 with respect to
such property, and the 10-year recognition period of the successor with
respect to such property is reduced by the portion of the 10-year
recognition period of the predecessor that expired before the date of
the continuation transaction. For this purpose, a continuation
transaction means the qualification of the predecessor as a RIC or REIT
or the transfer of property from the predecessor to the successor in a
transaction in which the successor's basis in the transferred property
is determined, in whole or in part, by reference to the predecessor's
basis in that property.
(2) Modification of section 1374 treatment--(i) Net recognized
built-in gain for REITs--(A) Prelimitation amount. The prelimitation
amount determined as provided in Sec. 1.1374-2(a)(1) is reduced by the
portion of such amount, if any, that is subject to tax under section
857(b)(4), (5), (6), or (7). For this purpose, the amount of a REIT's
recognized built-in gain that is subject to tax under section 857(b)(5)
is computed as follows:
(1) Where the tax under section 857(b)(5) is computed by reference
to section 857(b)(5)(A), the amount of a REIT's recognized built-in
gain that is subject to tax under section 857(b)(5) is the tax imposed
by section 857(b)(5) multiplied by a fraction the numerator of which is
the amount of recognized built-in gain (without regard to recognized
built-in loss and recognized built-in gain from prohibited
transactions) that is not derived from sources referred to in section
856(c)(2) and the denominator of which is the gross income (without
regard to gross income from prohibited transactions) of the REIT that
is not derived from sources referred to in section 856(c)(2).
(2) Where the tax under section 857(b)(5) is computed by reference
to section 857(b)(5)(B), the amount of a REIT's recognized built-in
gain that is subject to tax under section 857(b)(5) is the tax imposed
by section 857(b)(5) multiplied by a fraction the numerator of which is
the amount of recognized
[[Page 12823]]
built-in gain (without regard to recognized built-in loss and
recognized built-in gain from prohibited transactions) that is not
derived from sources referred to in section 856(c)(3) and the
denominator of which is the gross income (without regard to gross
income from prohibited transactions) of the REIT that is not derived
from sources referred to in section 856(c)(3).
(B) Taxable income limitation. The taxable income limitation
determined as provided in Sec. 1.1374-2(a)(2) is reduced by an amount
equal to the tax imposed under section 857(b)(5), (6), and (7).
(ii) Loss carryforwards, credits and credit carryforwards --(A)
Loss carryforwards. Consistent with paragraph (b)(1)(i) of this
section, net operating loss carryforwards and capital loss
carryforwards arising in taxable years for which the corporation that
generated the loss was not subject to subchapter M of chapter 1 of the
Internal Revenue Code are allowed as a deduction against net recognized
built-in gain to the extent allowed under section 1374 and the
regulations thereunder. Such loss carryforwards must be used as a
deduction against net recognized built-in gain for a taxable year to
the greatest extent possible before such losses can be used to reduce
other investment company taxable income for purposes of section 852(b)
or other real estate investment trust taxable income for purposes of
section 857(b) for that taxable year.
(B) Credits and credit carryforwards. Consistent with paragraph
(b)(1)(i) of this section, minimum tax credits and business credit
carryforwards arising in taxable years for which the corporation that
generated the credit was not subject to subchapter M of chapter 1 of
the Internal Revenue Code are allowed to reduce the tax imposed on net
recognized built-in gain under this paragraph (b) to the extent allowed
under section 1374 and the regulations thereunder. Such credits and
credit carryforwards must be used to reduce the tax imposed under this
paragraph (b) on net recognized built-in gain for a taxable year to the
greatest extent possible before such credits and credit carryforwards
can be used to reduce the tax, if any, on other investment company
taxable income for purposes of section 852(b) or on other real estate
investment trust taxable income for purposes of section 857(b) for that
taxable year.
(iii) 10-year recognition period. In the case of a conversion
transaction that is a qualification of a C corporation as a RIC or
REIT, the 10-year recognition period described in section 1374(d)(7)
begins on the first day of the RIC's or REIT's first taxable year. In
the case of other conversion transactions, the 10-year recognition
period begins on the day the property is acquired by the RIC or REIT.
(3) Coordination with subchapter M rules--(i) Recognized built-in
gains and losses subject to subchapter M. Recognized built-in gains and
losses of a RIC or REIT are included in computing investment company
taxable income for purposes of section 852(b)(2), real estate
investment trust taxable income for purposes of section 857(b)(2),
capital gains for purposes of sections 852(b)(3) and 857(b)(3), gross
income derived from sources within any foreign country or possession of
the United States for purposes of section 853, and the dividends paid
deduction for purposes of sections 852(b)(2)(D), 852(b)(3)(A),
857(b)(2)(B), and 857(b)(3)(A). In computing such income and deduction
items, capital loss carryforwards and net operating loss carryforwards
that are used by the RIC or REIT to reduce recognized built-in gains
are allowed as a deduction, but only to the extent that they are
otherwise allowable as a deduction against such income under the
Internal Revenue Code (including section 852(b)(2)(B)).
(ii) Treatment of tax imposed. The amount of tax imposed under this
paragraph (b) on net recognized built-in gain for a taxable year is
treated as a loss sustained by the RIC or the REIT during such taxable
year. The character of the loss is determined by allocating the tax
proportionately (based on recognized built-in gain) among the items of
recognized built-in gain included in net recognized built-in gain. With
respect to RICs, the tax imposed under this paragraph (b) on net
recognized built-in gain is treated as attributable to the portion of
the RIC's taxable year occurring after October 31.
(4) Example. The rules of this paragraph (b) are illustrated by the
following example:
Example. Section 1374 treatment on REIT election. (i) X, a C
corporation that is a calendar-year taxpayer, elects to be taxed as
a REIT on its 2004 tax return, which it files on March 15, 2005. As
a result, X is a REIT for its 2004 taxable year and is subject to
section 1374 treatment under this paragraph (b). X does not elect
deemed sale treatment under paragraph (c) of this section. As of the
beginning of the 2004 taxable year, X's property consisted of Real
Property, which is not section 1221(a)(1) property and which had a
fair market value of $100,000 and an adjusted basis of $80,000, and
$25,000 cash. X also had accumulated earnings and profits of
$25,000, unrestricted capital loss carryforwards of $3,000, and
unrestricted business credit carryforwards of $2,000. On July 1,
2007, X sells Real Property for $110,000. For its 2007 taxable year,
X has no other income or deduction items. Assume the highest
corporate tax rate is 35%.
(ii) Upon its election to be taxed as a REIT, X retains its
$80,000 basis in Real Property and its $25,000 accumulated earnings
and profits. X retains its $3,000 of capital loss carryforwards and
its $2,000 of business credit carryforwards. To satisfy section
857(a)(2)(B), X must distribute $25,000, an amount equal to its
earnings and profits accumulated in non-REIT years, to its
shareholders by the end of its 2004 taxable year.
(iii) Upon X's sale of Real Property in 2007, X recognizes gain
of $30,000 ($110,000--$80,000). X's recognized built-in gain for
purposes of applying section 1374 is $20,000 ($100,000 fair market
value as of the beginning of X's first taxable year as a REIT--
$80,000 basis). Because X's $30,000 of net income for the 2007
taxable year exceeds the net recognized built-in gain of $20,000,
the taxable income limitation does not apply. X, therefore, has
$20,000 net recognized built-in gain for the year. Assuming that X
has not used its $3,000 of capital loss carryforwards in a prior
taxable year and that their use is allowed under section 1374(b)(2)
and Sec. 1.1374-5, X is allowed a $3,000 deduction against the
$20,000 net recognized built-in gain. X would owe tax of $5,950 (35%
of $17,000) on its net recognized built-in gain, except that X may
use its $2,000 of business credit carryforwards to reduce the tax,
assuming that X has not used the credit carryforwards in a prior
taxable year and that their use is allowed under section 1374(b)(3)
and Sec. 1.1374-6. Thus, X owes tax of $3,950 under this paragraph
(b).
(iv) For purposes of subchapter M of chapter 1 of the Internal
Revenue Code, X's earnings and profits for the year increase by
$26,050 ($30,000 capital gain on the sale of Real Property--$3,950
tax under this paragraph (b)). For purposes of section 857(b)(2) and
(b)(3), X's net capital gain for the year is $23,050 ($30,000
capital gain reduced by $3,000 capital loss carryforward and further
reduced by $3,950 tax).
(c) Election of deemed sale treatment--(1) In general. Paragraph
(b) of this section does not apply if the C corporation that qualifies
as a RIC or REIT or transfers property to a RIC or REIT makes the
election described in paragraph (c)(5) of this section. A C corporation
that makes such an election recognizes gain and loss as if it sold the
converted property to an unrelated party at fair market value on the
deemed sale date (as defined in paragraph (c)(3) of this section). See
paragraph (c)(4) of this section concerning limitations on the use of
loss in computing gain. This paragraph (c) does not apply if its
application would result in the recognition of a net loss. For this
purpose, net loss is the excess of aggregate losses over aggregate
gains (including items of income), without regard to character.
[[Page 12824]]
(2) Basis adjustment. If a corporation recognizes a net gain under
paragraph (c)(1) of this section, then the converted property has a
basis in the hands of the RIC or REIT equal to the fair market value of
such property on the deemed sale date.
(3) Deemed sale date--(i) RIC or REIT qualifications. If the
conversion transaction is a qualification of a C corporation as a RIC
or REIT, then the deemed sale date is the end of the last day of the C
corporation's last taxable year before the first taxable year in which
it qualifies to be taxed as a RIC or REIT.
(ii) Other conversion transactions. If the conversion transaction
is a transfer of property owned by a C corporation to a RIC or REIT,
then the deemed sale date is the end of the day before the day of the
transfer.
(4) Anti-stuffing rule. A C corporation must disregard converted
property in computing gain or loss recognized on the conversion
transaction under this paragraph (c), if--
(i) The converted property was acquired by the C corporation in a
transaction to which section 351 applied or as a contribution to
capital;
(ii) Such converted property had an adjusted basis immediately
after its acquisition by the C corporation in excess of its fair market
value on the date of acquisition; and
(iii) The acquisition of such converted property by the C
corporation was part of a plan a principal purpose of which was to
reduce gain recognized by the C corporation in connection with the
conversion transaction. For purposes of this paragraph (c)(4), the
principles of section 336(d)(2) apply.
(5) Making the deemed sale election. A C corporation (or a
partnership to which the principles of this section apply under
paragraph (e) of this section) makes the deemed sale election with the
following statement: ``[Insert name and employer identification number
of electing corporation or partnership] elects deemed sale treatment
under Sec. 1.337(d)-7(c) with respect to its property that was
converted to property of, or transferred to, a RIC or REIT, [insert
name and employer identification number of the RIC or REIT, if
different from the name and employer identification number of the C
corporation or partnership].'' This statement must be attached to the
Federal income tax return of the C corporation or partnership for the
taxable year in which the deemed sale occurs. An election under this
paragraph (c) is irrevocable.
(6) Examples. The rules of this paragraph (c) are illustrated by
the following examples:
Example 1. Deemed sale treatment on merger into RIC. (i) X, a
calendar-year taxpayer, has qualified as a RIC since January 1,
2001. On May 31, 2004, Y, a C corporation and calendar-year
taxpayer, transfers all of its property to X in a transaction that
qualifies as a reorganization under section 368(a)(1)(C). As a
result of the transfer, Y would be subject to section 1374 treatment
under paragraph (b) of this section but for its timely election of
deemed sale treatment under this paragraph (c). As a result of such
election, Y is subject to deemed sale treatment on its tax return
for the short taxable year ending May 31, 2004. On May 31, 2004, Y's
only assets are Capital Asset, which has a fair market value of
$100,000 and a basis of $40,000 as of the end of May 30, 2004, and
$50,000 cash. Y also has an unrestricted net operating loss
carryforward of $12,000 and accumulated earnings and profits of
$50,000. Y has no taxable income for the short taxable year ending
May 31, 2004, other than gain recognized under this paragraph (c).
In 2007, X sells Capital Asset for $110,000. Assume the applicable
corporate tax rate is 35%.
(ii) Under this paragraph (c), Y is treated as if it sold the
converted property (Capital Asset and $50,000 cash) at fair market
value on May 30, 2004, recognizing $60,000 of gain ($150,000 amount
realized--$90,000 basis). Y must report the gain on its tax return
for the short taxable year ending May 31, 2004. Y may offset this
gain with its $12,000 net operating loss carryforward and will pay
tax of $16,800 (35% of $48,000).
(iii) Under section 381, X succeeds to Y's accumulated earnings
and profits. Y's accumulated earnings and profits of $50,000
increase by $60,000 and decrease by $16,800 as a result of the
deemed sale. Thus, the aggregate amount of subchapter C earnings and
profits that must be distributed to satisfy section 852(a)(2)(B) is
$93,200 ($50,000 + $60,000-$16,800). X's basis in Capital Asset is
$100,000. On X's sale of Capital Asset in 2007, X recognizes $10,000
of gain which is taken into account in computing X's net capital
gain for purposes of section 852(b)(3).
Example 2. Loss limitation. (i) Assume the facts are the same as
those described in Example 1, but that, prior to the reorganization,
a shareholder of Y contributed to Y a capital asset, Capital Asset
2, which has a fair market value of $10,000 and a basis of $20,000,
in a section 351 transaction.
(ii) Assuming that Y's acquisition of Capital Asset 2 was made
pursuant to a plan a principal purpose of which was to reduce the
amount of gain that Y would recognize in connection with the
conversion transaction, Capital Asset 2 would be disregarded in
computing the amount of Y's net gain on the conversion transaction.
(d) Exceptions--(1) Gain otherwise recognized. Paragraph (a) of
this section does not apply to any conversion transaction to the extent
that gain or loss otherwise is recognized on such conversion
transaction. See, for example, sections 336, 351(b), 351(e), 356,
357(c), 367, 368(a)(2)(F), and 1001.
(2) Re-election of RIC or REIT status--(i) Generally. Except as
provided in paragraphs (d)(2)(ii) and (iii) of this section, paragraph
(a)(1) of this section does not apply to any corporation that--
(A) Immediately prior to qualifying to be taxed as a RIC or REIT
was subject to tax as a C corporation for a period not exceeding two
taxable years; and
(B) Immediately prior to being subject to tax as a C corporation
was subject to tax as a RIC or REIT for a period of at least one
taxable year.
(ii) Property acquired from another corporation while a C
corporation. The exception described in paragraph (d)(2)(i) of this
section does not apply to property acquired by the corporation while it
was subject to tax as a C corporation from any person in a transaction
that results in the acquirer's basis in the property being determined
by reference to a C corporation's basis in the property.
(iii) RICs and REITs previously subject to section 1374 treatment.
If the RIC or REIT had property subject to paragraph (b) of this
section before the RIC or REIT became subject to tax as a C corporation
as described in paragraph (d)(2)(i) of this section, then paragraph (b)
of this section applies to the RIC or REIT upon its requalification as
a RIC or REIT, except that the 10-year recognition period with respect
to such property is reduced by the portion of the 10-year recognition
period that expired before the RIC or REIT became subject to tax as a C
corporation and by the period of time that the corporation was subject
to tax as a C corporation.
(e) Special rule for partnerships. The principles of this section
apply to property transferred by a partnership to a RIC or REIT to the
extent of any C corporation partner's distributive share of the gain or
loss in the transferred property. If the partnership were to elect
deemed sale treatment under paragraph (c) of this section in lieu of
section 1374 treatment under paragraph (b) of this section with respect
to such transfer, then any net gain recognized by the partnership on
the deemed sale must be allocated to the C corporation partner, but
does not increase the capital account of any partner. Any adjustment to
the partnership's basis in the RIC or REIT stock as a result of deemed
sale treatment under paragraph (c) of this section shall constitute an
adjustment to the basis of that stock with respect to the C corporation
partner only. The principles of section 743 apply to such basis
adjustment.
[[Page 12825]]
(f) Effective date. This section applies to conversion transactions
that occur on or after January 2, 2002. For conversion transactions
that occurred on or after June 10, 1987, and before January 2, 2002,
see Sec. Sec. 1.337(d)-5 and 1.337(d)-6.
Sec. 1.337(d)-7T [Removed]
Par. 7. Section 1.337(d)-7T is removed.
Par. 8. In Sec. 1.514(c)-2, paragraph (e)(1)(v) is added to read
as follows:
Sec. 1.514(c)-2 Permitted allocations under section 514(c)(9)(E).
* * * * *
(e) * * *
(1) * * *
(v) Allocations made in taxable years beginning on or after January
1, 2002, that are mandated by statute or regulation other than
subchapter K of chapter 1 of the Internal Revenue Code and the
regulations thereunder.
PART 602--[AMENDED]
Par. 9. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 10. In Sec. 602.101, paragraph (b) is amended by removing the
entries for ``1.337(d)-5T'', ``1.337(d)-6T'', and ``1.337-7T'' and
adding entries in numerical order to the table to read as follows:
Sec. 602.101 OMB Control numbers.
* * * * *
(b) * * *
------------------------------------------------------------------------
Current OMB
CFR part or section where identified or described control No.
------------------------------------------------------------------------
* * * * *
1.337(d)-5.............................................. 1545-1672
1.337(d)-6.............................................. 1545-1672
1.337(d)-7.............................................. 1545-1672
* * * * *
------------------------------------------------------------------------
David A. Mader,
Assistant Deputy Commissioner of Internal Revenue.
Approved: March 7, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-6221 Filed 3-13-03; 1:16 pm]
BILLING CODE 4830-01-P