[Federal Register: January 21, 2009 (Volume 74, Number 12)]
[Proposed Rules]
[Page 3509-3526]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr21ja09-35]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-143686-07]
RIN 1545-BH35
The Allocation of Consideration and Allocation and Recovery of
Basis in Transactions Involving Corporate Stock or Securities
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations under sections
301, 302, 304, 351, 354, 356, 358, 368, 861, 1001, and 1016 of the
Internal Revenue Code (Code). The proposed regulations provide guidance
regarding the recovery of stock basis in distributions under section
301 and transactions that are treated as dividends to which section 301
applies, as well as guidance regarding the determination of gain and
the basis of stock or securities received in exchange for, or with
respect to, stock or securities in certain transactions. The proposed
regulations affect shareholders and security holders of corporations.
These proposed regulations are necessary to provide such shareholders
and security holders with guidance regarding the allocation and
recovery of basis on distributions of property.
DATES: Written or electronic comments, and a request for a public
hearing, must be received by April 21, 2009.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-143686-07), room
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand-delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
143686-07), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC, or sent electronically, via the Federal
eRulemaking Portal at www.regulations.gov (IRSREG-143686-07).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations
under sections 301, 302, and 304, Theresa M. Kolish, (202) 622-7530;
concerning the proposed regulations under sections 351, 354, 356, 358,
368, 1001, and 1016, Rebecca O. Burch, (202) 622-7550; concerning the
proposed regulations under section 861, Jeffrey L. Parry, (202) 622-
4476; concerning submission of comments or to request a hearing,
Richard Hurst (202) 622-7180 (not toll free numbers).
Background
The primary objective of these proposed regulations is to provide a
single model for stock basis recovery by a shareholder that receives a
constructive or actual distribution to which section 301 applies and a
single model for sale and exchange transactions to which section 302(a)
applies, including certain elements of a reorganization exchange.
Further to this objective, these proposed regulations define the scope
of the exchange that must be analyzed under particular Code provisions,
and provide a methodology for determining gain realized under section
356 and stock basis under section 358.
In addition, these proposed regulations respond to comments
received by the IRS and Treasury Department regarding the current
section 358 regulations, such as suggestions to expand the tracing
rules to stock transfers that are subject to section 351 but do not
qualify as reorganizations, questions regarding whether (and, if so, to
what extent) shareholder elections constitute terms of an exchange, and
whether the terms of an exchange control for purposes of qualifying a
transaction as a reorganization under section 368. Finally, these
proposed regulations include amendments to the section 304 regulations
that import the statutory amendments to that section. See section 226
of the Tax Equity and Fiscal Responsibility Act of 1982, Public Law 97-
248 (96 Stat. 325, 490) (September 3, 1982), section 712(l) of the
Deficit Reduction Act of 1984, Public Law 98-369 (98 Stat. 494, 953-55)
(July 18, 1984), section 1875(b) of the Tax Reform Act of 1986, Public
Law 99-514 (100
[[Page 3510]]
Stat. 2085, 2894) (October 22, 1986), and section 1013 of the Taxpayer
Relief Act of 1997, Public Law 105-34 (111 Stat. 788, 918) (August 5,
1997).
Explanation of Provisions
I. Introduction--Exchanges and Distributions to Which Sections 301 and
302 Apply
Section 301 provides rules for the treatment of a distribution with
respect to stock but does not specify how to identify the shares upon
which a distribution is made. Furthermore, the tax law does not provide
rules concerning whether a shareholder recovers its stock basis in the
aggregate, or alternatively, whether a shareholder is required to
recover stock basis share-by-share. Finally, the tax law does not
provide specifically that transactions treated as section 301
distributions (i.e., redemptions under section 302(d), certain section
304 transactions, and certain reorganizations) should be subject to the
same rules as actual section 301 distributions. In the reorganization
context, the Code provides consequences resulting from different types
of exchanges, but does not specify whether the exchange is based on a
shareholder's aggregate stock holdings, or alternatively, based on
particular elements of the overall exchange.
Rules related to stock basis recovery and stock basis
determinations have evolved independently over many years on a
transactional basis. Ad hoc development of these authorities has lead
to the possibility of variant treatment of economically similar
transactions to which section 301 or 302(a) applies either directly or
through the operation of other Code provisions. Moreover, because there
has not been a comprehensive review of these issues, many questions
lack definitive answers. Prior guidance attempted to address particular
areas of uncertainty within the subject matter of basis recovery and
basis identification. Without the benefit of addressing all related
issues, however, certain of this prior guidance was needed
reconsidered. See REG-150313-01. Other guidance built the framework for
basis identification that has encouraged the development of these
proposed regulations.
Building on themes developed in Sec. 1.358-2 and comments received
from the tax community, this proposal is intended to be a comprehensive
approach to stock basis recovery and stock basis identification to
produce consistent results among economically similar transactions,
regardless of the transaction type or the specific Code provision that
results in the application of section 301 or 302(a).
The cornerstone of this proposal is that a share of stock is the
basic unit of property that can be disposed of and, accordingly, the
results of a transaction should generally derive from the consideration
received in respect of that share. This guiding principle has section
1012 as its underpinning and has become fundamental to the tax
treatment of shareholders, regardless of the specific nature of a
shareholder's exchange. See Sec. 1.358-2 and Sec. 1.367(b)-13. A
corollary to this basic premise is that a reorganization exchange is
not an event that justifies alteration of a shareholder's tax position
beyond what is necessary to reflect the results of the reorganization.
To harmonize the tax treatment of economically similar
transactions, these proposed regulations adopt a single model for
section 301 distributions (dividend equivalent transactions) and a
single model for sale or exchange transactions to which section 302(a)
applies (non-dividend equivalent transactions), regardless of whether
section 301 or section 302(a) applies directly or by reason of section
302(d), 304 or 356.
II. Distributions With Respect to Stock and Dividend Equivalent
Transactions
A. Section 301 Distributions
Consistent with the fundamental notion that a share of stock is the
basic unit of property, the results of a section 301 distribution
should derive from the consideration received in respect of each share
of stock, notwithstanding designations otherwise. Johnson v. United
States, 435 F.2d 1257 (4th Cir. 1971). Accordingly, these proposed
regulations treat a section 301 distribution as received on a pro rata,
share-by-share basis with respect to the class of stock upon which the
distribution is made. Thus, a distribution that is not a dividend
within the meaning of section 301(c)(1) can result in gain with respect
to some shares of a class while other shares have unrecovered basis.
B. Dividend Equivalent Redemptions
To promote consistency among transactions treated as section 301
distributions under the Code, these proposed regulations apply the same
basis recovery rules described above to both dividend equivalent
redemptions and certain section 304 transactions. Accordingly, under
these proposed regulations, a dividend equivalent redemption results in
a pro rata, share-by-share distribution to all shares of the ``redeemed
class'' held by the redeemed shareholder immediately before the
redemption. The proposed regulations define the term ``redeemed class''
to mean all of the shares of that class held by the redeemed
shareholder. Similar to an actual section 301 distribution, the
proportional approach to basis recovery in dividend equivalent
redemptions can produce gain with respect to some shares while other
shares have unrecovered basis.
The constructive section 301 distribution is limited to the shares
of the redeemed class (instead of constructing a pro rata distribution
among all shares of various classes held by the redeemed shareholder)
because different classes of stock have distinct legal entitlements
that are respected for federal income tax purposes. H.K. Porter Co., 87
T.C. 689 (1986); Comm'r v. Spaulding Bakeries, 252 F.2d 693 (2d Cir.
1958). Accordingly, a constructive section 301 distribution is
conformed to an actual section 301 distribution by identifying those
shares with respect to which an actual section 301 distribution would
have been received, and by reducing the basis of only those shares.
i. Basis Adjustments in Dividend Equivalent Redemptions if Less Than
All of the Shares of a Single Class Held by the Taxpayer Are Redeemed
If less than all of the shares of a class of stock held by the
taxpayer are redeemed, the proposed regulations provide that in a
hypothetical recapitalization described in section 368(a)(1)(E), the
redeemed shareholder is deemed to exchange all its shares in the class,
including the redeemed shares, for the actual number of shares held
after the redemption transaction. The tracing rules of the section 358
regulations apply to preserve the basis of the shares exchanged in the
recapitalization in the remaining shares of the redeemed class held by
the shareholder. Thus, under these proposed regulations, a dividend
equivalent redemption is generally treated in the same manner, and its
results are the same as, a section 301 distribution in which no shares
were cancelled.
ii. Basis Recovery in Dividend Equivalent Redemptions in Which the
Taxpayer Surrenders All of Its Shares in a Single Class
Under current law, if all of the shares of a single class held by a
shareholder are redeemed in a dividend equivalent redemption, any
unrecovered basis in the redeemed shares is permitted to shift to other
shares in certain circumstances. See Sec. 1.302-2(c). The
[[Page 3511]]
IRS and Treasury Department believe that the shifting of stock basis is
inconsistent with the fundamental principle that each share is a
separate unit of property, and can lead to inappropriate results.
Accordingly, these proposed regulations do not permit the shifting of
basis to other shares held (directly or by attribution) by the redeemed
shareholder. Instead, the proposed regulations preserve the tax
consequences of the unrecovered basis for the redeemed shareholder by
treating the amount of the unrecovered basis as a deferred loss of the
redeemed shareholder that can be accessed when the conditions of
sections 302(b)(1), (2), or (3) are satisfied, or alternatively, when
all the shares of the issuing corporation (or its successor) become
worthless within the meaning of section 165(g).
C. Dividend Equivalent Reorganization Exchanges
If, pursuant to a reorganization, a shareholder receives qualifying
property and boot in exchange for its target corporation stock, the tax
consequences of the receipt of the boot under these proposed
regulations will depend upon whether the reorganization exchange is
dividend equivalent or not. See section III. of this Preamble for a
description of the proposed rules that would apply if the
reorganization is not dividend equivalent.
In general, the determination of whether an exchange has the effect
of the distribution of a dividend for purposes of section 356(a)(2) is
determined by examining the effect of the shareholder's ``overall
exchange.'' Commissioner v. Clark, 489 U.S. 726, 738 (1989). Thus, the
key to this determination is the scope of the exchange. For example, if
the shareholder exchanges shares of preferred stock solely for boot and
shares of common stock solely for qualifying property pursuant to a
plan of reorganization, is the determination of whether the exchange of
the preferred stock for boot is dividend equivalent based solely on
that particular exchange or on the overall exchange of the preferred
and common stock for the qualifying property and the boot? The same
question would arise with respect to each particular exchange if the
shareholder exchanged the preferred and common stock for a combination
of qualifying property and boot. The Clark decision examined a
reorganization exchange involving a single class of stock, and does not
provide guidance in the context of multiple classes of stock.
In the case of a section 302 redemption, the exchanging shareholder
determines dividend equivalency based on all the facts and
circumstances. See Zenz v. Quinlivan, 213 F.2d 914 (C.A.6 1954). To
promote consistency between sale or exchange transactions, these
proposed regulations provide that the overall reorganization exchange
shall be taken into account in determining whether a particular
exchange is dividend equivalent. Thus, a shareholder that exchanges a
class of stock solely for boot and another class of stock solely for
nonqualifying property shall consider the overall exchange (the
exchange of the two classes of stock for boot and qualifying property)
in determining whether each particular exchange is dividend equivalent.
If it is determined that a reorganization exchange is dividend
equivalent, because different classes of stock have distinct legal
entitlements that are respected for federal income tax purposes, the
proposed regulations provide that an exchange of a class of stock
solely of boot is an exchange to which section 302(d) (and not section
356(a)(2)) applies.
To ensure similar tax treatment of dividend equivalent
reorganization exchanges and dividend equivalent redemptions, if the
reorganization exchange is dividend equivalent the proposed regulations
limit the ability of the exchanging shareholder to specify the terms of
the exchange. Specifically, if the shareholder receives more than one
class of stock or surrenders one class of stock and securities, the
shareholder may specify the terms of the exchange between the classes
of stock surrendered (or between one or more classes of stock and
securities surrendered), provided the designation is economically
reasonable, but not between particular shares of the same class of
stock.
As with the redemption of shares of a redeemed class in a dividend
equivalent redemption, a shareholder's receipt solely of boot with
respect to a class of stock in a reorganization exchange is treated as
received pro rata, on a share-by-share basis, with respect to each
share in the class--under the principles of Johnson, the shareholder
cannot specify that the boot is received with respect to particular
shares within the class. Consequently, such an exchange could result in
gain recognition with respect to some shares while other shares in the
class could have recovered basis.
In formulating the proposed regulations, the IRS and Treasury
Department considered different alternatives. For example, in a
dividend equivalent reorganization exchange pursuant to section
356(a)(2), the IRS and Treasury Department considered whether gain
realized with respect to a class should be determined in the aggregate
(for example, with respect to all shares within a class). Under this
approach, no gain would be realized with respect to a class that has a
block of built-in gain stock and block of built-in loss stock where the
built-in loss is at least equal to the built-in gain. The IRS and
Treasury Department rejected such an approach because it would
contradict the fundamental principle that a share is a discrete unit of
property, and also would compromise the principle that a reorganization
exchange is not an event that justifies stock basis averaging. The IRS
and Treasury Department also considered eliminating a shareholder's
ability to specify the terms of a dividend equivalent reorganization
exchange based on the premise that under Johnson, all consideration
received in such an exchange should be considered received pro rata
among all shares, regardless of whether more than one class is
surrendered. The IRS and Treasury Department rejected this approach in
favor of the approach of the proposed regulations that is analogous to
the proposed treatment of dividend equivalent redemptions, under which
each share of the redeemed class is treated as receiving a pro rata
share of the proceeds, and shares outside of the redeemed class are not
treated as receiving any part of the distribution.
D. Special Rules Related to Apportionment of Interest and Other
Expenses
Under section 864(e), taxpayers apportion interest expense between
statutory and residual groupings on the basis of the relative values of
their assets in each grouping. For this purpose, taxpayers may choose
to value their assets using either fair market value or tax book value
(adjusted basis). The proposed regulations provide that for purposes of
apportioning expenses on the basis of the tax book value of assets, the
adjusted basis in any remaining shares of the redeemed class owned by
the redeemed shareholder, any shares that are not in the redeemed
class, or any shares owned by certain affiliated corporations shall be
increased by the amount of the unrecovered basis of redeemed shares.
Thus, under the proposed regulations, the interest expense allocation
and apportionment consequences of a dividend equivalent redemption are
the same as an actual section 301 distribution.
[[Page 3512]]
E. Section 1059
Section 1059(a) provides that if a corporation receives an
extraordinary dividend with respect to any share of stock and such
corporation has not held such stock for more than two years before the
dividend announcement date, then the corporation's basis in such stock
shall be reduced (but not below zero) by the non-taxed portion of such
dividends.
Except as provided in regulations, in the case of any redemption of
stock which would not have been treated (in whole or in part) as a
dividend if any options had not been taken into account under section
318(a)(4), or section 304(a) had not applied, any amount treated as a
dividend is treated as an extraordinary dividend, without regard to the
taxpayer's holding period in the stock. Section 1059(e)(1)(A)(iii). In
the case of these types of redemptions, section 1059(e)(1)(A) (flush
language) provides that only the basis of the stock redeemed shall be
taken into account under section 1059(a). These proposed regulations do
not affect the basis reduction provided for in section 1059(e)(1)(A) if
section 1059(e)(1)(A)(iii) otherwise applies. Accordingly, to the
extent of an extraordinary dividend described in section
1059(e)(1)(A)(iii), a redeeming shareholder would first reduce basis as
prescribed by section 1059(e)(1)(A). These proposed regulations would
then apply to the extent the distribution is not a dividend within the
meaning of section 301(c)(1).
F. Redemptions of Stock Held by Partnerships, Trusts, and S
Corporations
The treatment of unrecovered basis as a deferred loss raises
special issues where the redeemed shareholder is an S corporation, a
partnership, or a trust (each a flow-through entity). These proposed
regulations reserve with respect to the issues relating to redeemed
shareholders that are flow-through entities pending further study and
comment. The primary issue under study is whether an ``outside'' basis
adjustment that reflects the deferred loss should occur at the time of
the dividend equivalent redemption, or alternatively, when there is an
inclusion date with respect to the deduction.
In general, a deferred loss is reflected in the outside basis of an
interest in a flow-through entity when the deduction can be accessed by
the entity. Accordingly, as a general matter, disconformity can exist
between inside attributes and outside basis where an inside attribute
is a deferred loss. Conversely, a net operating loss of a flow-through
entity reduces the outside basis of an interest in the entity in the
year that the net operating loss arises.
Although disconformity generally can exist where a flow-through
entity has a deferred loss, the IRS and Treasury Department are
concerned that deferred losses arising from unrecovered basis presents
an opportunity to separate the deferred loss from the dividend income
resulting from the redemption. The IRS and Treasury Department question
whether such a separation would be appropriate, and believe that
treating the deferred loss as a net operating loss in the year of the
redemption for basis adjustment purposes may be the better approach.
However, the IRS and Treasury Department acknowledge that it may be
inappropriate to require the owners of a flow-through entity to reduce
outside basis before the deferred loss can be accessed, simply because
the owners of the flow-through entity cannot access the deferred loss.
The IRS and Treasury Department request comments on this issue.
Flow-through entities also present the question of when it is
appropriate to treat an owner of the flow-through entity as the
redeemed shareholder, and when it is appropriate to treat the flow-
through entity itself as the redeemed shareholder. For example, where
the owner completely divests of its interest in the flow-through
entity, it may be appropriate to treat the owner as the redeemed
shareholder for determining whether the sale of the flow-through entity
interest is an inclusion date with respect to that owner. This
treatment may be more appropriate if the deferred loss is treated as a
net operating loss that already has reduced the outside basis of the
entity's owner. Conversely, if the deferred loss is not treated as a
net operating loss, it may be more appropriate to treat the flow-
through entity as the redeemed shareholder in all cases. The IRS and
Treasury Department request comments on this issue.
G. Consolidated Groups and Basis Recovery in Dividend Equivalent
Redemptions
The IRS and Treasury Department continue to study the issues raised
when a redeemed shareholder with a deferred loss files a consolidated
return. The IRS and Treasury Department believe that certain of the
concerns raised by REG-150313-01 are addressed in these proposed
regulations by the deemed recapitalization mechanic described in
section II.B.i. of this Preamble.
III. Redemptions Treated as a Sale or Exchange Pursuant to Section
302(a)
A. In General
Under current law for redemptions characterized under section
302(a), a shareholder that owns shares of stock with different bases
can decide whether to surrender for redemption high basis shares, low
basis shares or any combination thereof. See Sec. 1.1012-1(c).
Consistent with treating a share as a discrete unit of property, the
proposed regulations do not limit this electivity. Additionally, as
further discussed below, these proposed regulations affirm the ability
of a shareholder to specify the terms of a reorganization exchange
where the receipt of boot results in sale or exchange treatment.
B. Reorganization Exchanges That Result in Sale or Exchange Treatment
If it is determined that the reorganization exchange is not
dividend equivalent (as described in section II.C. of this Preamble),
section 302(a) will apply to the extent shares are exchanged solely for
boot. Just as a shareholder can elect to surrender high basis shares,
low basis shares or any combination thereof in a non-dividend
equivalent redemption, a shareholder engaging in a reorganization
exchange that is not dividend equivalent can specify the receipt solely
of boot for a share, provided that the terms of the exchange are
economically reasonable. In such case, the shareholder will recognize
gain or loss with respect to that share pursuant to section 302(a), and
section 356(a)(1) will not apply.
IV. Extension of Tracing Principles To Determine Basis in Certain Stock
Transfers That Are Not Reorganizations, and Other Proposals in Response
to Specific Comments
A. Application of Tracing Principles to Certain Section 351 Exchanges
and Capital
The current section 358 regulations apply tracing principles to
determine the basis of stock received in a section 351 exchange only
where the section 351 exchange also qualifies as a reorganization and
no liabilities was assumed in the exchange. The principal reason for
this limitation is the interaction of the basis tracing rules with the
aggregate approach to gain determination under section 357(c). The IRS
and Treasury Department continue to study this issue, but have
concluded that the resolution of this issue is not necessary to broaden
the application of the tracing rules to transfers of stock in section
351 exchanges in which no
[[Page 3513]]
liabilities are assumed. Thus, for example, in an exchange to which
section 351 applies where the transferor transfers two blocks of stock
with disparate basis and other property, the separate bases will be
preserved under section 358, provided that liabilities are not assumed
in the exchange.
In addition, these proposed regulations incorporate the deemed
issuance and recapitalization approach of the current section 358
regulations to section 351 exchanges to preserve basis if insufficient
shares, or no shares at all, are actually issued in the exchange. These
proposed regulations also extend the deemed issuance and
recapitalization approach to shareholder capital contributions to which
section 118 applies.
B. Miscellaneous
The IRS and Treasury Department have received a number of comments
on the current section 358 regulations. These proposed regulations make
a number of clarifying, but nonsubstantive, modifications to the
current section 358 regulations. Specifically, the proposed regulations
add headings throughout the existing final Sec. Sec. 1.358-1 and
1.358-2 regulations without substantive change. In addition, the
proposed regulations address the following comments received with
respect to the current section 358 regulations.
Commentators questioned how shareholder elections factor into the
terms of the exchange. These proposed regulations include two new
examples illustrating the effect of such elections.
Commentators questioned the effect of the terms of an exchange on
the determination of whether a transaction qualifies as a
reorganization, and therefore is not subject to the general rule of
section 1001. These proposed regulations include cross-references in
the regulations under sections 368 and 1001 to clarify that, to the
extent the terms of the exchange specify that a particular property is
received in exchange for a particular property, such terms shall
control for purposes of determining whether a transaction qualifies as
a reorganization provided such terms are economically reasonable.
Finally, in addition to provisions relating to the determination of
basis, these proposed regulations add a rule that addresses certain
issues considered in Rev. Rul. 68-55 (1968-1 CB 140). Specifically,
consistent with Rev. Rul. 68-55, these regulations provide that, for
purposes of determining gain under section 351(b), the fair market
value of each category of consideration received in a section 351
exchange is allocated between the transferred assets in based on
relative fair market values.
V. Specifically Requested Comments
In addition to the comments requested throughout this Preamble, the
IRS and Treasury request comments on the following areas.
The proposed regulations under section 302 do not apply to a
redemption of stock described in section 306(c). Pursuant to section
306(a)(2), a redemption of stock described in section 306(c) is treated
as a distribution of property to which section 301 applies. Example 2
of Sec. 1.306-1 suggests that the unrecovered basis of redeemed
section 306 stock is added to the basis of the stock with respect to
which the section 306 stock was distributed. The IRS and Treasury
Department request comments on whether such treatment is appropriate or
whether an alternative regime should apply when such a section 306(c)
redemption is treated as a section 301 distribution.
Comments are also requested regarding whether, after a section 355
pro rata split-up, the controlled corporations are the same as or
different from the distributing corporation for purposes of determining
whether the date of distribution would be an inclusion date for a
deferred loss attributable to unrecovered basis.
Finally, the IRS and Treasury Department recognize that the
proposed regulations may not address all related issues arising in all
cash ``D'' reorganizations. Specifically, these proposed regulations
may heighten the importance of whether the nominal share deemed issued
in such a reorganization is received in respect of particular shares
surrendered by the exchanging shareholder. The IRS and Treasury
Department request comments with respect to this issue.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. Further, it
is hereby certified that these proposed regulations will not have a
significant economic impact on a substantial number of small entities.
This certification is based on the fact that these regulations provide
clarifying guidance of existing law and do not create additional
obligations for, or impose an economic impact on small entities.
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, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written (a signed original and eight
(8) copies) or electronic comments that are submitted timely to the
IRS. All comments will be available for public inspection and copying.
If a public hearing is scheduled, notice of the date, time, and place
for the public hearing will be published in the Federal Register.
Drafting Information
The principal authors of these regulations are Theresa M. Kolish
and Rebecca O. Burch of the Office of Associate Chief Counsel
(Corporate). Other personnel from offices of the IRS and Treasury
Department participated in their development.
Availability of IRS Documents
IRS revenue rulings, procedures, and notices cited in this preamble
are made available by the Superintendent of Documents, U.S. Government
Printing Office, Washington, DC 20402.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR Part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read,
in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.301-2 is added to read as follows:
Sec. 1.301-2 Application to basis.
(a) Application to basis. That portion of a distribution which is
not a dividend shall be applied pro rata, on a share-by-share basis, to
reduce the adjusted basis of each share of stock held by the
shareholder within the class of stock upon which the distribution is
made. The following example illustrates this paragraph (a):
Example. (i) Facts. Corporation X, a calendar year taxpayer, has
only common stock outstanding. A, an individual, owns all 100
shares; 25 were acquired on Date 1 for $25 (Block 1) and 75 were
acquired on Date
[[Page 3514]]
2 for $175 (Block 2). On December 31, when Corporation X had
earnings and profits of $100, it made a $3 distribution on each
share of common stock.
(ii) Analysis. A is treated as receiving $75 of the distribution
on block 1 and $225 on block 2. On Block 1, A will have a $25
dividend under section 301(c)(1), a $25 return of capital under
section 301(c)(2) and a $25 gain under section 301(c)(3). On Block
2, A will have a $75 dividend under section 301(c)(1), a $150 return
of capital under section 301(c)(2) and will have a remaining basis
of $25 in the shares of block 2.
(b) Effective/applicability date. This section applies to
transactions that occur after the date these regulations are published
as final regulations in the Federal Register.
Sec. 1.302-2 [Amended]
Par. 3. In Sec. 1.302-2, paragraph (c) is removed and reserved.
Par. 4. Section 1.302-5 is added to read as follows:
Sec. 1.302-5 Redemptions under section 302(d).
(a) In general--(1) Share-by-share basis reduction. In any case in
which an amount received in redemption of stock (as defined in section
317(b)) is treated as a distribution to which section 301 applies, that
portion of a distribution that is not a dividend shall be applied to
reduce the adjusted basis of each share held by the redeemed
shareholder (as defined in paragraph (b) of this section) in the
redeemed class (as defined in paragraph (b) of this section). Such
reduction shall be applied pro rata, on a share-by-share basis, to all
shares of the redeemed class held by the redeemed shareholder. Gain, if
any, on a share shall be determined under section 301(c)(3).
(2) Deemed recapitalization. Except as provided in paragraph (a)(3)
of this section, immediately following the reduction of basis as
provided in section 301(c)(2) and paragraph (a)(1) of this section, all
shares of the redeemed class, including the redeemed shares, held by
the redeemed shareholder will be treated as surrendered in a
reorganization described in section 368(a)(1)(E) in exchange for the
number of shares of the redeemed class directly held by the redeemed
shareholder after the redemption. The basis of the shares deemed
received in the reorganization described in section 368(a)(1)(E) will
be determined under the rules of section 358 and Sec. 1.358-2.
(3) Redemption of all shares of redeemed class--(i) Remaining basis
treated as loss. If all the shares of the redeemed class held by the
redeemed shareholder are redeemed, an amount equal to the basis of the
redeemed stock, after adjusting such basis to reflect the application
of section 301(c)(2) as provided in paragraph (a)(1) of this section,
will be treated as a loss on a disposition of the redeemed stock on the
date of the redemption. Such loss is taken into account on the
inclusion date as defined in paragraph (b) of this section.
(ii) Attributes of loss. Notwithstanding that a loss described in
paragraph (a)(3)(i) of this section may be deferred and taken into
account on a date later than the date of the redemption, the attributes
(for example, character and source) of such loss are determined on the
date of the redemption that gave rise to such loss.
(b) Definitions--(1) Redeemed shareholder. Except as provided in
paragraph (c) of this section, the term redeemed shareholder means the
person whose stock is redeemed in a transaction. If the redeemed
shareholder is a corporation, and the assets of the redeemed
shareholder are acquired in a transaction described in section 381(a)
(other than transactions described in paragraph (b)(4)(ii) of this
section), the acquiring corporation (within the meaning of section 381)
thereafter is treated as the redeemed shareholder.
(2) Redeemed class. With respect to a shareholder whose stock has
been redeemed, the term redeemed class means all of the shares of that
class held by the redeemed shareholder. For this purpose, a class is
defined with respect to economic rights to distributions rather than
the labels attached to shares or rights with respect to corporate
governance.
(3) Redeeming corporation. The term redeeming corporation means the
corporation that issued the stock that is redeemed.
(4) Inclusion date--(i) Definition. The term inclusion date means
the earlier of--
(A) The first date on which the redeemed shareholder would satisfy
the criteria of section 302(b)(1), (2), or (3), if the facts and
circumstances that exist at the end of such day had existed immediately
after the redemption; or
(B) The first date on which all classes of stock of the redeeming
corporation become worthless within the meaning of section 165(g).
Solely for purposes of this paragraph, if the assets of the redeeming
corporation (or its successor) are acquired by another corporation in a
transaction described in section 381(a), the inclusion date for the
redeemed shareholder is determined by treating all of the facts and
circumstances that exist at the end of the day that includes the
section 381 transaction (including the acquisition of the assets of the
redeeming corporation or its successor) as existing immediately after
the redemption. A successor for this purpose means a corporation that
acquires the assets of the redeeming corporation in a transaction to
which section 381(a) applies.
(ii) Special rules for corporate shareholders. If the redeemed
shareholder is a corporation, the inclusion date includes the date such
corporation has disposed of all of its assets in a transaction in which
all gain and loss with respect to its assets is recognized in whole,
and the corporation ceases to exist for tax purposes. If the redeemed
shareholder is a foreign corporation, the inclusion date includes the
date such corporation transfers its assets to a domestic corporation in
either a liquidation described in section 332 or a reorganization
described in section 368(a)(1) to which section 381 applies. If the
redeemed shareholder is a foreign corporation that is not a controlled
foreign corporation within the meaning of section 957(a) on the date of
the redemption, the inclusion date includes the date such corporation
transfers its assets to a controlled foreign corporation in a
liquidation described in section 332 or a reorganization described in
section 368(a)(1) to which section 381 applies.
(c) Rules for special shareholders--(1) Redeemed shareholder is a
partnership. [Reserved]
(2) Redeemed shareholder is an S corporation. [Reserved]
(3) Redeemed shareholder is an estate or trust. [Reserved]
(d) Operating rules for treatment of loss attributable to basis of
redeemed stock--
(1) Treatment as a deferred loss. Any loss attributable to the
basis of redeemed stock under paragraph (a) of this section that has
not been permitted to be taken into account under such section shall be
treated as a deferred loss. The character of the deferred loss as
ordinary or capital is determined at the time of the redemption.
(2) Effect of loss attributable to basis of redeemed stock on
earnings and profits. If the redeemed shareholder is a corporation, any
deferred loss attributable to the basis of redeemed stock is not
reflected in such corporation's earnings and profits before it is taken
into account pursuant to the rules of paragraph (a)(3) of this section.
See, for example, Sec. Sec. 1.312-6(a) and 1.312-7.
(e) Examples. For the purposes of the examples in this section,
Corporations X, Y and Z are domestic corporations
[[Page 3515]]
that file U.S. tax returns on a calendar-year basis. The examples are
as follows:
Example 1. (i) Facts. A and B, husband and wife, each own 100
shares (50 percent) of the common stock of Corporation X which they
hold as a capital asset. On Date 1, A acquired 50 shares for $100
(block 1) and 50 shares on Date 2 for $200 (block 2). On December
31, Corporation X, which has no current or accumulated earnings and
profits, redeems all of A's block 2 shares for $300. Under section
302(d), the redemption proceeds are treated under section 301 as a
recovery of basis.
(ii) Analysis. Under this section, immediately before the
redemption, the distribution of property is applied on a pro rata,
share-by-share basis with respect to each of the shares in the
redeemed class held directly by A, the redeemed shareholder.
Accordingly, A will have a $50 capital gain on block 1 ($150-100)
under section 301(c)(3) and $50 of basis remaining on block 2 ($150-
200). To reflect the actual number of shares held by A after the
redemption, A's shares in the redeemed class, including the shares
actually surrendered, will be treated as exchanged in a
recapitalization under section 368(a)(1)(E). The basis in A's
recapitalized shares will be determined under Sec. 1.358-2.
Accordingly, A will have 25 shares with a zero basis (attributable
to block 1) and 25 shares with a basis of $50 (attributable to block
2).
Example 2. (i) Facts. The facts are the same as in Example 1,
except that, Corporation X, on the following December 31, when it
has no current or accumulated earnings and profits, redeems all of
A's remaining 50 shares for $40. A does not file an agreement
described in section 302(c)(2)(A)(iii) waiving family attribution
under section 318.
(ii) Analysis. Since A is treated under section 318(a)(1) as
owning B's shares, the redemption is described in section 302(d) and
is treated as a distribution to which section 301 applies. As in
Example 1, immediately before the redemption, the distribution is
applied on a pro rata, share-by-share basis with respect to each of
the shares in the redeemed class held by A. Accordingly, A
recognizes a $20 gain and a $30 loss. The $30 deferred loss under
Sec. 1.302-5(a)(3) may be taken into account by A on the inclusion
date (see Sec. 1.302-5(a)(3)(ii)).
Example 3. (i) Facts. Corporation X has both common and
preferred stock outstanding. A, an individual, has 100 shares of
common stock with a basis of $100 and 100 shares of preferred stock
with a basis of $200. The 100 shares of common stock represent
voting control of Corporation X. Corporation X, when it has no
current or accumulated earnings and profits, redeems all of A's
preferred stock for $150. Section 302(d) applies to the redemption,
and therefore the distribution is treated as a distribution of
property to which section 301 applies.
(ii) Analysis. If Corporation X had declared a distribution
under section 301 with respect to the redeemed preferred stock, the
distribution would have been limited to the shares of common stock.
Therefore, the only basis recovered under section 301(c)(2) is the
basis of A's preferred stock. A has $50 in excess basis after the
redemption of all its preferred stock which will not shift to the
common stock held by A. Under Sec. 1.302-5(a)(3), the excess basis
will be treated as a deferred loss until the inclusion date.
Example 4. (i) Facts. Corporation Z has 100 shares of stock
outstanding, 50 shares of which are owned by each of A and his son,
B. A's basis in each of his shares of Corporation Z stock is $1. In
Year 1, Corporation Z redeems all of A's shares of Corporation Z
stock for $200. A does not file an agreement described in section
302(c)(2)(A)(iii) waiving family attribution under section 318. At
the end of Year 1, Corporation Z has current and accumulated
earnings and profits in excess of $200. Section 302(d) applies to
the redemption, and therefore the distribution is treated as a
distribution to which section 301 applies. A recognizes dividend
income of $200. In Year 6, Corporation Y, a publicly traded
corporation acquires all of Corporation Z's assets in exchange
solely for voting stock in a reorganization described in section
368(a)(1)(C). In the reorganization, B surrenders his shares of
Corporation Z stock which, at the time of the reorganization have an
aggregate fair market value of $200, and receives in exchange 5,000
shares of common stock of Corporation Y representing less than one
percent of the fair market value of all the stock of Y.
(ii) Analysis. Under this section, an amount equal to A's basis
in the redeemed stock after the Year 1 redemption, $50, is treated
as a deferred loss on a disposition of the redeemed stock on the
date of the redemption. Under paragraph (b)(3) of this section,
solely for purposes of determining whether a particular date on or
after the date of the reorganization is the inclusion date,
Corporation Y, the acquiring corporation, is treated as the
redeeming corporation. If the facts and circumstances that exist at
the end of the day of the reorganization had existed on the date of
the redemption, the redemption would have been treated as a
distribution in part or full payment in exchange for the redeemed
stock pursuant to section 302(a). Therefore, the date of the
reorganization is the inclusion date and A is permitted to take into
account the deferred loss of $50 attributable to his basis in the
redeemed stock in Year 6.
(f) Effective/applicability date. This section applies to
transactions that occur after the date these regulations are published
as final regulations in the Federal Register.
Par. 5. Section 1.304-1 is revised to read as follows:
Sec. 1.304-1 In general.
(a) In general. Section 304 is applicable where a shareholder sells
stock of one corporation to a related corporation as defined in section
304. Sales to which section 304 is applicable shall be treated as
redemptions subject to sections 302 and 303.
(b) Effective/applicability date. This section applies to
transactions that occur after the date these regulations are published
as final regulations in the Federal Register.
Par. 6. Section 1.304-2 is amended by revising paragraphs (a) and
(c), and adding paragraph (d) to read as follows:
Sec. 1.304-2 Acquisition by related corporation (other than a
subsidiary).
(a) In general (1) If a corporation (the acquiring corporation), in
return for property, acquires the stock of another corporation (the
issuing corporation) from one or more persons, and such person or
persons from whom the stock was acquired were in control of both such
corporations, then such property shall be treated as received in
redemption of the common stock of the acquiring corporation. As to each
person transferring stock, the amount received shall be treated as a
distribution to which section 301 applies, if section 302(a) or 303
does not apply. For the amount constituting a dividend in such cases,
see Sec. 1.304-6.
(2) Section 302(b). In applying section 302(b), reference shall be
made to the ownership of stock in the issuing corporation and not to
the ownership of the acquiring corporation (except for the purposes of
applying section 318(a)). Section 318(a) shall be applied without
regard to the 50 percent limitation contained in section 318(a)(2)(C)
and (3)(C).
(3) Section 302(d). If, pursuant to section 302(d), section 301
applies to the property received in redemption of the common stock of
the acquiring corporation pursuant to paragraph (a)(1) of this section,
the transferor and the acquiring corporation shall be treated, for all
Federal income tax purposes, in the same manner as if the transferor
had transferred the stock of the issuing corporation to the acquiring
corporation in exchange for the common stock of the acquiring
corporation in a transaction to which section 351 applies, and then the
acquiring corporation had redeemed the common stock it was treated as
issuing in an exchange for property. Accordingly, the acquiring
corporation's basis in the stock of the issuing corporation is
determined under section 362, and, under section 358, the transferor's
basis in the common stock of the acquiring corporation deemed issued to
the transferor in the deemed section 351 transaction is equal to the
transferors basis in the stock of the issuing corporation it
surrendered.
(4) Basis of redeemed shares. To the extent that section 301(c)(2)
applies to the redemption of the common stock of the acquiring
corporation issued in the deemed section 351 exchange, the amount
distributed in such redemption
[[Page 3516]]
shall be applied to reduce the adjusted basis of each share of common
stock directly held or deemed held by the transferor on a pro rata,
share-by-share basis. See Sec. 1.302-5(a).
(5) Sale or exchange treatment. If section 301 does not apply to
the property treated as received in redemption of the common stock of
the acquiring corporation pursuant to paragraph (a)(1) of this section,
the property received by the transferor shall be treated as received in
a distribution in full payment in exchange for such common stock of the
acquiring corporation under section 302(a). The basis and the holding
period of the common stock of the acquiring corporation that is treated
as redeemed will be the same as the basis and holding period of the
stock of the issuing corporation actually surrendered. The acquiring
corporation shall take a cost basis in the stock of the issuing
corporation that it acquires under section 1012.
* * * * *
(c) Examples. For purposes of the examples in this section, each of
corporation is a domestic corporation that files a U.S. tax return on a
calendar-year basis and in each instance the fair market value of the
issuing corporation stock is in excess of its adjusted basis. The
principles of this section are illustrated by the following examples:
Example 1. (i) Facts. Corporation X and Corporation Y each has
100 shares of common stock outstanding. A, an individual, owns one-
half of the stock of each corporation, B owns one-half of the stock
of Corporation X, and C owns one-half of the stock of Corporation Y.
A, B, and C are unrelated. A sells 30 shares of the stock of
Corporation X, which have an adjusted basis of $10, to Corporation Y
for $50.
(ii) Analysis. Section 304(a)(1) applies to A's sale of 30
shares of Corporation X stock to Corporation Y because A controls
both Corporation X and Corporation Y within the meaning of section
304(c), and Corporation Y acquires the 30 shares of Corporation X
stock from A in exchange for property ($50 of cash). Pursuant to
section 304(a)(1), the cash received by A is treated as a redemption
of the stock of Corporation Y. Because before the sale A owns 50
percent of the stock of Corporation X and after the sale A owns only
35 percent of such stock (20 shares directly and 15 constructively
because one-half of the 30 shares owned by Corporation Y are
attributed to A), the redemption is substantially disproportionate
as to A pursuant to the provisions of section 302(b)(2). A,
therefore, recognizes a gain of $40 ($50 minus $10). If the stock
surrendered is a capital asset, such gain is long-term or short-term
capital gain depending on the period of time that A held such stock.
A's basis in the stock of Corporation Y is not changed as a result
of the sale. Under section 1012, the basis that Corporation Y takes
in the acquired stock of Corporation X is its cost of $50.
Example 2. (i) Facts. Corporation X and Corporation Y each has
200 shares of common stock outstanding, all of which are owned by H,
an individual. H has a basis $100 in his Corporation X stock and $30
in his Corporation Y stock. Corporation X has $40 and Corporation Y
has $20 of current and accumulated earnings and profits. H sells his
200 shares of Corporation X stock to Corporation Y for $150 at a
time when Corporation Y stock also has a fair market value of $150.
(ii) Analysis. Section 304(a)(1) applies to H's sale of his 200
shares of Corporation X stock to Corporation Y because H controls
both Corporation X and Corporation Y within the meaning of section
304(c), and Corporation Y acquires the 200 shares of Corporation X
stock from H in exchange for property. Pursuant to section
304(a)(1), the cash received by H is treated as a redemption of the
stock of Corporation Y. Because before the sale H directly owns 100
percent of Corporation X and after the sale H is treated as owning
100 percent of Corporation X, section 302(a) does not apply to the
deemed redemption distribution. Under section 302(d), the proceeds
of the deemed redemption are treated as a distribution to which
section 301 applies. Therefore, H is treated as transferring the
Corporation X stock to Corporation Y in exchange for Corporation Y
common stock in a transaction to which section 351(a) applies.
Corporation Y's basis in the Corporation X stock acquired is $100
under section 362(a), the same basis that H had in the Corporation X
stock surrendered. H takes a basis of $100 in the Corporation Y
common stock H is treated as receiving in the deemed section 351
exchange. Corporation Y is then treated as redeeming such
Corporation Y common stock from H for $150 in a transaction to which
section 301 applies. H is treated as receiving a dividend of $60
($20 from the current and accumulated earnings and profits of
Corporation Y and then $40 from the current and accumulated earnings
and profits of Corporation X) (see section 304(b)). Under Sec.
1.302-5, the remaining $90 of the distribution will be applied to
and reduce the basis of each share of Corporation Y stock held by H.
Accordingly, H will have no gain on the shares deemed received in
the section 351 exchange which have a $100 basis, but will have a
$15 gain on the Corporation Y shares with a $30 basis. After the
redemption transaction, all of H's shares in Corporation Y,
including the deemed shares that are redeemed, are treated as
exchanged in a recapitalization described in section 368(a)(1)(E).
The basis of the redeemed shares and the shares actually outstanding
in Corporation Y are allocated pursuant to Sec. 1.358-2(a).
Accordingly, of H's 200 shares in Corporation Y common stock, 100
will have a basis of $55, and 100 will have a zero basis.
Example 3. (i) Facts. Corporation W acquired all of the
outstanding stock of Corporation X stock for $75 (100 shares of
common) and then acquired all of the outstanding stock of
Corporation Y (50 shares of common stock for $75 and 50 shares of
common stock for $100). Only corporation Y has current or
accumulated earnings and profits ($100). Corporation W sells all the
shares in Corporation X to Corporation Y for $300. At the time of
the transaction, the Corporation X and Corporation Y stock have the
same fair market value.
(ii) Analysis. Section 304(a)(1) applies to Corporation W's sale
of Corporation X to Corporation Y because Corporation W is in
control of both Corporation X and Corporation Y within the meaning
of section 304(c), and Corporation Y acquires the Corporation X
stock in exchange for property. Because before the sale Corporation
W owns 100 percent of Corporation X, and after the sale is treated
as owning 100 percent of Corporation X, section 302(a) does not
apply to the deemed redemption distribution. Under section 302(d),
the proceeds of the deemed redemption are treated as a distribution
to which section 301 applies. Section 1059(e)(1)(A)(iii) also
applies. Corporation W is treated as transferring the Corporation X
stock to Corporation Y in exchange for Corporation Y common stock in
a transaction to which section 351(a) applies. Corporation Y's basis
in the Corporation X stock is $75 under section 362(a), the same
basis that Corporation W had in the stock it surrendered.
Corporation W takes a $75 basis in the Corporation Y common stock it
is deemed to receive in the deemed section 351 transaction.
Corporation Y is then treated as redeeming such Corporation Y common
stock from Corporation W for $300. In a redemption to which section
301 applies, Corporation W is treated as receiving a dividend of
$100 (from the current and accumulated earnings and profits of
Corporation Y) (see section 304(b)). Under section 1059, the $100
dividend is treated as an extraordinary dividend which, under the
flush language of section 1059(e)(1)(A)(iii), reduces only the basis
of the stock deemed redeemed, which has a basis of $75. Accordingly,
Corporation W recognizes a $25 gain. Under Sec. 1.302-5, the
remaining $200 of the distribution is applied to reduce the basis of
the Corporation Y stock held by Corporation W on a pro rata, share-
by-share basis, including the basis in the shares deemed redeemed.
Accordingly, $100 is allocated to the Corporation Y stock that
Corporation W deemed received in the section 351 transaction that
now has a zero basis after the application of section 1059 and the
remaining $100 is allocated to Corporation W's other two blocks of
Corporation Y stock. Corporation W has a total gain of $125 on the
Corporation Y stock deemed received and redeemed; and $25 and $50,
respectively, of remaining basis in the other 2 blocks of
corporation Y shares. After the redemption transaction, all of
Corporation W's shares in corporation Y, including the deemed shares
that are redeemed, are treated as exchanged in a recapitalization
described in section 368(a)(1)(E). As a result, corporation W will
have 100 shares in corporation Y, 50 shares will have a zero basis,
25 shares will have a $25 basis, and 25 shares will have a $50
basis.
(d) Effective/applicability date. This section applies to
transactions that
[[Page 3517]]
occur after the date these regulations are published as final
regulations in the Federal Register.
Par. 7. Section 1.304-3 is amended by revising paragraph (a) and
adding paragraph (c) to read as follows:
Sec. 1.304-3 Acquisition by a subsidiary.
(a) In general. If a subsidiary, in return for property, acquires
stock of its parent corporation from a shareholder of the parent
corporation, the acquisition of such stock will be treated as if the
parent corporation had redeemed its own stock in exchange for the
property. For the purposes of this section, a corporation is a parent
corporation if it meets the 50 percent ownership requirements of
section 304(c). The determination of whether the amount received shall
be treated as received in payment in exchange for the stock will be
made by applying section 302(b) with reference to the stock of the
issuing parent corporation, or by applying section 303.
* * * * *
(c) Effective/applicability date. This section applies to
transactions that occur after the date these regulations are published
as final regulations in the Federal Register.
Par. 8. Section 1.304-5 is amended by adding a sentence at the end
of paragraph (a) and revising paragraph (c) to read as follows:
Sec. 1.304-5 Control.
(a) * * * Specifically, section 318(a) will be applied by
substituting ``5 percent'' for ``50 percent'' in section 318(a)(2)(C)
and by substituting ``5 percent'' for ``50 percent'' in section
318(a)(3)(C), except that if section 318(a)(3)(C) would not have
applied but for this substitution, by considering a corporation as
owning the stock (other than stock in such corporation) owned by or for
any shareholder of such corporation in that proportion which the value
of the stock which such shareholder owned in such corporation bears to
the value of all stock in such corporation.
* * * * *
(c) Effective/applicability date. This section applies to
transactions that occur after the date these regulations are published
as final regulations in the Federal Register.
Par. 9. Section 1.351-2 is amended by redesignating paragraphs (b),
(c), (d) and (e) as paragraphs (c), (d), (e) and (f), respectively and
adding new paragraphs (b) and (g) to read as follows:
Sec. 1.351-2 Receipt of property.
* * * * *
(b) To determine the amount of gain recognized under section
351(b), the fair market value of each category of consideration
received by each transferor is allocated to the properties transferred
in proportion to each property's relative fair market value. The
application of this paragraph (b) is illustrated by the following
example:
Example. C transfers $2,000 in exchange for 200 shares of stock.
D transfers Asset I, Asset II, and Asset III in exchange for $100
cash and 100 shares of stock. The exchange is subject to section
351. At the time of the exchange, Asset I has a fair market value of
$220 and a basis of $400, Asset II has a fair market value of $330
and a basis of $200, and Asset III has a fair market value of $550
and a basis of $250. No gain or loss is recognized to C. Gain, but
not loss, is recognized by D. To determine the gain recognized by D
under section 351(b), the fair market value of each category of
consideration received is allocated to the properties transferred in
proportion to the relative fair market values of the properties
transferred. Asset I represents 20 percent of the total fair market
value of assets transferred (220/1100), Asset II represents 30
percent (330/1100), and Asset III represents 50 percent (550/1100).
Under paragraph (b) of this section, the amount of gain recognized
by D is determined by allocating a pro rata portion of each class of
consideration received to each property transferred as follows: (A)
$20 cash and 20 shares of stock to Asset I (20 percent of 100 shares
of stock and 20 percent of $100 (B) $30 cash and 30 shares of stock
to Asset II (30 percent of 100 shares of stock and 30 percent of
$100); and (C) $50 cash and 50 shares of stock to Asset III (50
percent of 100 shares of stock and 50 percent of $100). D realizes a
loss of $180 on Asset I, none of which is recognized, a gain of $130
on Asset II, $30 of which is recognized, and a gain of $300 on Asset
III, $50 of which is recognized.
* * * * *
(g) This section applies to exchanges that occur after the date
these regulations are published as final regulations in the Federal
Register, except for exchanges which occur pursuant to a written
agreement that is binding on or before the date these regulations are
published as final in the Federal Register. For exchanges that occur on
or before the date that these regulations are published as final
regulations in the Federal Register, see this section as contained in
26 CFR part 1 revised April 1, for the year before these regulations
are published as final regulations in the Federal Register.
Par. 10. Section 1.354-1 is amended by:
1. Revising the section heading.
2. Redesignating paragraphs (d), (e) and (f) as paragraphs (e), (f)
and (g), respectively.
3. Adding new paragraphs (d) and (h).
4. Adding Example 5 to the end of newly designated paragraph (e).
The additions and revisions read as follows:
Sec. 1.354-1 Exchanges of stock, securities and other property in
certain reorganizations.
* * * * *
(d) Exchanges solely or partly for money or other property--(1)
Determination of consideration for a share of stock or a security. In
determining the consideration received for a share of stock or a
security, except as otherwise provided in this paragraph (d)(1), a pro
rata portion of any other property and money received shall be treated
as received in exchange for each share of stock and security
surrendered, based on the fair market value of such surrendered share
of stock or security. However, to the extent the terms of the exchange
specify the other property or money that is received in exchange for a
particular share of stock or security surrendered or a particular class
of stock or securities surrendered, such terms shall control provided
that the terms are economically reasonable, unless the shareholder's
exchange has the effect of a distribution of a dividend. If the
exchange has the effect of a distribution of a dividend and the terms
of an exchange specify the other property or money that is received
with respect to a particular share of stock and such specification
would otherwise be economically reasonable, such other property or
money shall be treated as received pro rata in exchange for each share
of stock within that class (as defined in section 1.302-5(b)(2)) held
by the exchanging shareholder. Notwithstanding the preceding sentence,
economically reasonable designations between classes of stock or
securities (as opposed to within a class) shall generally control. All
exchanges made by an exchanging shareholder, whether governed by
section 354, 356, or 302, are taken into account to determine whether
the shareholder's exchange has the effect of a distribution of a
dividend.
(2) Treatment of exchanges of stock solely for money or other
property. Neither section 354 nor so much of section 356 as relates to
section 354 applies to a shareholder's surrender of a share of stock in
exchange solely for money or other property that is not permitted to be
received without the recognition of gain, even though such exchange is
pursuant to a plan of reorganization described in section 368(a), and
even though section 354, section 356 or both sections 354 and 356 apply
to the exchange of other shares by that shareholder or other
shareholders. See section 302 and the regulations
[[Page 3518]]
under that section for the treatment of such an exchange.
(e) * * *
Example 5. D owns shares of Class A common stock, Series 1
preferred stock, and Series 2 preferred stock in Corporation T. The
Series 1 preferred stock and the Series 2 preferred stock are
different classes of stock. Pursuant to a reorganization described
in section 368(a) to which corporations T and V are parties, D
surrenders all of D's Class A common stock in Corporation T in
exchange for common stock in Corporation V, all of D's Series 1
preferred stock in Corporation T in exchange for both cash and
common stock in Corporation V, and all of D's Series 2 preferred
stock in Corporation T in exchange solely for cash. Section 354
applies to the exchange of the Class A common stock in Corporation T
for Corporation V common stock. Section 356 applies to the exchange
of Series 1 preferred stock for Corporation V common stock and cash.
Neither section 354 (nor so much of section 356 as relates to
section 354) applies to the exchange of Series 2 preferred stock in
Corporation T solely for cash (see section 302 and regulations
thereunder).
* * * * *
(h) This section applies to exchanges that occur after the date
these regulations are published as final regulations in the Federal
Register, except for exchanges which occur pursuant to a written
agreement that is binding on or before the date these regulations are
published as final in the Federal Register. For exchanges that occur on
or before the date these regulations are published as final regulations
in the Federal Register, see this section as contained in 26 CFR part 1
revised April 1, for the year before these regulations are published as
final regulations in the Federal Register.
Par. 11. Section 1.355-1 is amended by adding new paragraph (e) to
read as follows:
Sec. 1.355-1 Distribution of stock and securities of a controlled
corporation.
* * * * *
(e) Exchanges solely or partly for money and other property--(1)
Determination of consideration for a share of stock or a security. In
determining the consideration received for a share of stock or a
security, except as otherwise provided in this paragraph (e)(1), a pro
rata portion of any other property and money received shall be treated
as received in exchange for each share of stock and security
surrendered, based on the fair market value of such surrendered share
of stock or security. However, to the extent the terms of the exchange
specify the other property or money that is received in exchange for a
particular share of stock or security surrendered or a particular class
of stock or securities surrendered, such terms shall control provided
that the terms are economically reasonable, unless the shareholder's
exchange has the effect of a distribution of a dividend. If the
exchange has the effect of a distribution of a dividend and the terms
of an exchange specify the other property or money that is received
with respect to a particular share of stock and such specification
would otherwise be economically reasonable, such other property or
money shall be treated as received pro rata in exchange for each share
of stock within that class (as defined in Sec. 1.302-5(b)(2)) held by
the exchanging shareholder. Notwithstanding the preceding sentence,
economically reasonable designations among classes of stock (as opposed
to within a class) shall generally control. All exchanges made by an
exchanging shareholder, whether governed by section 355, 356, or 302,
are taken into account to determine whether the shareholder's exchange
has the effect of a distribution of a dividend.
(2) Treatment of exchanges of stock solely for money or other
property. Neither section 355 nor so much of section 356 as relates to
section 355 applies to a shareholder's surrender of a share of stock in
exchange solely for money or other property that is not permitted to be
received without the recognition of gain, even though such exchange is
pursuant to a plan of reorganization described in section 368(a), or
even though section 355, section 356 or both sections 355 and 356 apply
to the exchange of other shares by that shareholder or other
shareholders. See section 302 and the regulations under that section
for the treatment of such an exchange. Any such exchange is treated as
occurring immediately before any distribution of or exchange for the
stock of the controlled corporation to which section 355 (or so much of
section 356 as relates to section 355) applies.
(3) Effective/applicability date. This paragraph (e) applies to
transactions that occur after the date these regulations are published
as final regulations in the Federal Register, except for exchanges
which occur pursuant to a written agreement that is binding on or
before the date these regulations are published as final in the Federal
Register.
Par. 12. Section 1.356-1 is amended by revising paragraph (b),
Examples 3 and 4 to paragraph (d), and paragraph (g) to read as
follows:
Sec. 1.356-1 Receipt of additional consideration in connection with
an exchange.
* * * * *
(b) The rules of Sec. 1.354-1(d)(1) or Sec. 1.355-1(e)(1), as the
case may be, apply for purposes of computing the gain, if any,
recognized pursuant to section 356(a) and paragraph (a)(1) of this
section.
* * * * *
(d) * * *
Example 3. (i) Facts. J, an individual, acquired 10 shares of
stock of Corporation X on Date 1 for $3 each (Block 1) and 10 shares
of stock of Corporation X on Date 2 for $9 each (Block 2). On Date
3, Corporation Y acquires the assets of Corporation X in a
reorganization under section 368(a)(1)(A). Pursuant to the terms of
the plan of reorganization, J surrenders all of J's shares of
Corporation X stock for 10 shares of Corporation Y stock and $100 of
cash. On the date of the exchange, the fair market value of each
share of stock of Corporation X is $10 and the fair market value of
each share of Corporation Y stock is $10. The terms of the exchange
do not specify that shares of Corporation Y stock or cash are
received in exchange for particular shares of stock of Corporation
X. In addition, the distribution of the $100 of cash does not have
the effect of a distribution of a dividend.
(ii) Analysis. Under paragraph (b) of this section, because the
terms of the exchange do not specify that the cash is received in
exchange for particular shares of stock of Corporation X, a pro rata
portion of the cash received is treated as received in exchange for
each share of stock of Corporation X based on the fair market value
of the surrendered shares. Therefore, J is treated as receiving
shares of Corporation Y stock with a fair market value of $100 and
$100 of cash in exchange for each block of J's stock of Corporation
X. J realizes a gain of $70 on the exchange of the Block 1 shares of
Corporation X stock, $50 of which is recognized under section 356
and paragraph (a) of this section, and J realizes a gain of $10 on
the exchange of the Block 2 shares of Corporation X stock, all of
which is recognized under section 356 and paragraph (a) of this
section. Because J's gain recognized is not treated as a dividend
under section 356(a)(2), such gain shall be treated as gain from the
exchange of property.
Example 4. (i) Facts. The facts are the same as in Example 3,
except that the terms of the plan of reorganization specify that J
receives 10 shares of stock of Corporation Y in exchange for J's
Block 1 shares of stock of Corporation X and $100 of cash in
exchange for J's Block 2 shares of stock of corporation X.
(ii) Analysis. Under paragraph (b) of this section, because the
terms of the exchange specify that J receives 10 shares of stock of
Corporation Y in exchange for J's Block 1 shares of stock of
Corporation X and $100 of cash in exchange for J's Block 2 shares of
stock of Corporation X and such terms are economically reasonable,
such terms control. J realizes a gain of $70 on the exchange of the
Block 1 shares of stock, none of which is recognized under section
354. J realizes a gain of $10 on the exchange of the Block 2 shares
of stock of Corporation X, all of which is recognized under section
302(a).
* * * * *
[[Page 3519]]
(g) This section applies to exchanges and distributions that occur
after the date these regulations are published as final regulations in
the Federal Register, except for exchanges which occur pursuant to a
written agreement that is binding on or before the date these
regulations are published as final in the Federal Register. For
exchanges and distributions that occur on or before the date these
regulations are published as final regulations in the Federal Register,
see this section as contained in 26 CFR part 1 revised April 1, for the
year before these regulations are published as final regulations in the
Federal Register.
Par. 13. Section 1.358-1 is revised to read as follows:
Sec. 1.358-1 Basis to distributees.
(a) Certain exchanges or distributions in which only nonrecognition
property is received--(1) Exchanges to which section 354 or 355
applies. In the case of an exchange to which section 354 or 355 applies
in which only nonrecognition property is received, the sum of the basis
of all of the stock and securities received in the transaction shall be
the same as the basis of all of the stock and securities in such
corporation surrendered in the transaction, allocated in the manner
described in Sec. 1.358-2.
(2) Distributions to which section 355 applies. In the case of a
distribution to which section 355 applies in which only nonrecognition
property is received, the sum of the basis of all of the stock and
securities with respect to which the distribution is made plus the
basis of all of the stock and securities received in the distribution
with respect to such stock and securities shall be the same as the
basis of the stock and securities with respect to which the
distribution is made immediately before the transaction, allocated in
the manner described in Sec. 1.358-2.
(3) Exchanges to which section 351 or 361 applies. In the case of
an exchange to which section 351 or 361 applies in which only
nonrecognition property is received, the basis of all of the stock and
securities received in the exchange shall be the same as the basis of
all of the property exchanged for such stock and securities.
(b) Certain exchanges or distributions in which both nonrecognition
property and ``other property'' or money are received--(1) Exchanges or
distributions to which section 351, 356, or 361 applies. If in an
exchange or distribution to which section 351, 356, or 361 applies both
nonrecognition property and ``other property'' or money are received,
the basis of the nonrecognition property held after the transaction
shall be determined as described in paragraph (a) of this section,
decreased by the sum of the money and the fair market value of the
``other property'' (as of the date of the transaction) received and
increased by the sum of the amount treated as a dividend (if any) and
the amount of the gain recognized on the exchange (other than gain
treated as a dividend).
(2) Cases in which loss is recognized. In any case in which a
taxpayer transfers property with respect to which loss is recognized,
such loss shall be reflected in determining the basis of the property
received in the exchange.
(3) Basis of ``other property'' received. The basis of the ``other
property'' is its fair market value as of the date of the transaction.
(c) Other rules. See Sec. 1.460-4(k)(3)(iv)(A) for rules relating
to stock basis adjustments required where a contract accounted for
using a long-term contract method of accounting is transferred in a
transaction described in section 351 or a reorganization described in
section 368(a)(1)(D) with respect to which the requirements of section
355 (or so much of section 356 as relates to section 355) are met.
(d) The application of this section may be illustrated by the
following example:
Example. A purchased a share of stock in Corporation X on Date 1
for $150. Since that date, A has received distributions under
section 301(c)(2) totaling $60, so that A's adjusted basis for the
stock is $90. In a transaction qualifying under section 356, A
exchanged this share for one share in Corporation Y, with a value of
$100, cash of $10, and other property with a fair market value of
$30. The exchange had the effect of the distribution of a dividend.
A's ratable share of the earnings and profits of Corporation X was
$5. A realized a gain of $50 on the exchange ($140 - $90), but the
amount of gain recognized is limited to $40, the sum of the cash
received and the fair market value of the other property. Of the
gain recognized, $5 is taxable as a dividend, and $35 is taxable as
a gain from the exchange of property. The basis to A of the one
share of stock of Corporation Y is $90, that is the adjusted basis
of the one share of stock of Corporation X ($90), decreased by the
sum of the cash received ($10) and the fair market value of the
other property received ($30) and increased by the sum of the amount
treated as a dividend ($5) and the amount treated as a gain from the
exchange of property ($35). The basis of the other property received
is $30.
(e) Effective/applicability date. This section applies to exchanges
and distributions of stock and securities that occur after the date
these regulations are published as final regulations in the Federal
Register, except for exchanges which occur pursuant to a written
agreement that is binding on or before the date these regulations are
published as final in the Federal Register. For exchanges and
distributions that occur on or before the date these regulations are
published as final regulations in the Federal Register, see this
section as contained in 26 CFR part 1 revised April 1, for the year
before these regulations are published as final regulations in the
Federal Register.
Par. 14. Section 1.358-2 is revised to read as follows:
Sec. 1.358-2 Allocation of basis among nonrecognition property in
certain exchanges or distributions.
(a) Introduction--(1) Scope. This section prescribes rules for
allocating basis in the case of an exchange or distribution to which
section 354, 355 or 356 applies. For rules that apply to transfers of
stock and other property where the transfer of stock is described in
section 351 but does not qualify as a reorganization, see Sec. 1.358-
2(g). For transfers of stock described in section 361, see Sec. 1.358-
2(h).
(2) Definitions. As used in this section the term stock means stock
which is not ``other property'' under sections 351, 356, or 361, as
applicable. The term securities means securities (including, where
appropriate, fractional parts of securities) which are not ``other
property'' under sections 356 or 361, as applicable. Stock, or
securities, as the case may be, which differ either because they are in
different corporations or because the rights attributable to them
differ (although they are in the same corporation) are considered
different classes of stock or securities, as the case may be, for
purposes of this section.
(b) Exchanges to which section 354, 355, or 356 applies. If a
shareholder or security holder surrenders one or more shares of stock
or one or more securities in an exchange under the terms of section
354, 355 or 356, the following rules apply:
(1) In general. Except as otherwise provided in this section, the
basis of each share of stock or security received in the exchange shall
be the same as the basis of the share or shares of stock or security or
securities (or allocable portions thereof) exchanged therefor (as
adjusted under Sec. 1.358-1).
(2) More shares of stock or securities received than surrendered.
If more than one share of stock or security is received in exchange for
one share of stock or one security, the basis of the share of stock or
security surrendered shall be allocated to the shares of stock or
securities received in proportion to the fair market value of the
shares of stock or securities received.
[[Page 3520]]
(3) Fewer shares of stock or securities received than surrendered--
(i) In general. If one share of stock or security is received in
exchange for more than one share of stock or security or if a fraction
of a share of stock or security is received, then the basis of the
shares of stock or securities surrendered must be allocated to the
shares of stock or securities (or allocable portions thereof) received
in a manner that reflects, to the greatest extent possible, that a
share of stock or security received is received in respect of shares of
stock or securities that were acquired on the same date and at the same
price. To the extent it is not possible to allocate basis in this
manner, the basis of the shares of stock or securities surrendered must
be allocated to the shares of stock or securities (or allocable
portions thereof) received in a manner that minimizes the disparity in
the holding periods of the surrendered shares of stock or securities
whose basis is allocated to any particular share of stock or security
received.
(ii) Surrendered shares of stock or securities acquired on
different dates or at different prices. If a share of stock or a
security is received in exchange for more than one share of stock or
security and such shares of stock or securities were acquired on
different dates or at different prices, the share of stock or security
received shall be divided into segments based on the relative fair
market values of the shares of stock or securities surrendered in
exchange for such share or security. Each segment shall have a basis
determined under the rules of this section and a corresponding holding
period.
(4) ``Other property,'' money, or more than one class of stock or
securities received. If a shareholder or security holder receives
shares of stock or securities of more than one class, or receives
``other property'' or money in addition to shares of stock or
securities, the rules of Sec. Sec. 1.354-1(d)(1) and 1.355-1(e)(1)
apply for purposes of applying the rules of this section.
(5) Pro rata exchanges to which section 355 or section 356(b)
applies. If a shareholder or security holder surrenders stock in
distributing (as defined in Sec. 1.355-1(b)) for only stock in
controlled and the receipt of the controlled stock would be treated,
within the meaning of section 302(d), as a distribution of property to
which section 301 applies if the controlled stock received were money
or other property, then the basis of the shares received shall be
determined under the rules of paragraph (c) of this section and not the
rules of this paragraph (b). The rules of paragraph (c) and not the
rules of this paragraph (b) also apply to distributions subject to
section 356(b).
(c) Distributions to which section 355 applies. If a shareholder or
security holder receives one or more shares of stock or one or more
securities in a distribution under section 355 (or so much of section
356 as relates to section 355), the following rules apply:
(1) In general. Except as otherwise provided in this section, the
basis of each share of stock or security of the distributing
corporation (as defined in Sec. 1.355-1(b)), as adjusted under Sec.
1.358-1, shall be allocated between the share of stock or security of
the distributing corporation with respect to which the distribution is
made and the share or shares of stock or security or securities (or
allocable portions thereof) received in proportion to their fair market
values.
(2) Fewer shares of stock or securities received than with respect
to which distributed--(i) In general. If one share of stock or security
is received with respect to more than one share of stock or security or
if a fraction of a share of stock or security is received, then the
basis of each share of stock or security of the distributing
corporation must be allocated to the shares of stock or securities (or
allocable portions thereof) received in a manner that reflects that, to
the greatest extent possible, a share of stock or security received is
received with respect to shares of stock or securities acquired on the
same date and at the same price. To the extent it is not possible to
allocate basis in this manner, the basis of each share of stock or
security of the distributing corporation must be allocated to the
shares of stock or securities (or allocable portions thereof) received
in a manner that minimizes the disparity in the holding periods of the
shares of stock or securities with respect to which such shares of
stock or securities are received.
(ii) Distribution upon shares of stock or securities acquired on
different dates or at different prices. If a share of stock or a
security is received with respect to more than one share of stock or
security and such shares or securities were acquired on different dates
or at different prices, the share of stock or security received shall
be divided into segments based on the relative fair market values of
the shares of stock or securities with respect to which the share of
stock or security is received. Each segment shall have a basis
determined under the rules of this section and a corresponding holding
period.
(3) ``Other property,'' money, or more than one class of stock or
securities received. If a shareholder or security holder receives
shares of stock or securities of more than one class, or receives
``other property'' or money in addition to stock or securities, the
rules of Sec. 1.355-1(e)(1) apply for purposes of applying the rules
of this section as though the distribution were an exchange.
(d) Reorganizations in which stock is deemed received. For purposes
of this section, if a shareholder or security holder surrenders a share
of stock or a security in a transaction under the terms of section 354
(or so much of section 356 as relates to section 354) in which such
shareholder or security holder receives no property or receives
property (including property permitted by section 354 to be received
without the recognition of gain or ``other property'' or money) with a
fair market value less than that of the stock or securities surrendered
in the transaction, such shareholder or security holder shall be
treated as provided in paragraphs (1) and (2) of this paragraph (d).
(1) Step one: Deemed issuance. First, the shareholder or security
holder shall be treated as receiving the stock, securities, other
property, and money actually received by the shareholder or security
holder in the transaction and an amount of stock of the issuing
corporation (as defined in Sec. 1.368-1(b)) that has a value equal to
the excess of the value of the stock or securities the shareholder or
security holder surrendered in the transaction over the value of the
stock, securities, other property, and money the shareholder or
security holder actually received in the transaction. If the
shareholder owns only one class of stock of the issuing corporation the
receipt of which would be consistent with the economic rights
associated with each class of stock of the issuing corporation, the
stock deemed received by the shareholder pursuant to the previous
sentence shall be stock of such class. If the shareholder owns multiple
classes of stock of the issuing corporation the receipt of which would
be consistent with the economic rights associated with each class of
stock of the issuing corporation, the stock deemed received by the
shareholder shall be stock of each such class owned by the shareholder
immediately prior to the transaction, in proportion to the value of the
stock of each such class owned by the shareholder immediately prior to
the transaction. The basis of each share of stock or security deemed
received and actually received shall be determined under the rules of
this section.
(2) Step two: Deemed section 368(a)(1)(E) exchange. Second, the
[[Page 3521]]
shareholder or security holder shall then be treated as surrendering
all of its shares of stock and securities in the issuing corporation,
including those shares of stock or securities held immediately prior to
the transaction, those shares of stock or securities actually received
in the transaction, and those shares of stock deemed received pursuant
to paragraph (d)(1) of this section, in a reorganization under section
368(a)(1)(E) in exchange for the shares of stock and securities of the
issuing corporation that the shareholder or security holder actually
holds immediately after the transaction. The basis of each share of
stock and security deemed received in the reorganization under section
368(a)(1)(E) shall be determined under the rules of this section.
(e) Designating which stock or securities were received for, or
with respect to, the stock or securities surrendered or distributed
upon--(1) In general. If a shareholder or security holder that
purchased or acquired shares of stock or securities in a corporation on
different dates or at different prices exchanges such shares of stock
or securities under the terms of section 354, 355, or 356, or receives
a distribution of shares of stock or securities under the terms of
section 355 (or so much of section 356 as relates to section 355), and
the shareholder or security holder is not able to identify which
particular share of stock or security (or allocable portion of a share
of stock or security) is received (or deemed received) in exchange for,
or with respect to, a particular share of stock or security, the
shareholder or security holder may designate subject to the limitations
of this section, which share of stock or security is received in
exchange for, or with respect to, a particular share of stock or
security, provided that such designation is consistent with the terms
of the exchange or distribution (or an exchange deemed to have occurred
pursuant to paragraph (d) of this section), and the other rules of this
section. The designation will be binding for purposes of determining
the Federal tax consequences of any sale or transfer of, or
distribution with respect to, the shares or securities received.
(2) Timing for designation--(i) In exchanges under section 354 or
356. In the case of an exchange under the terms of section 354 or 356
(including a deemed exchange as a result of the application of
paragraph (d) of this section), the designation must be made on or
before the first date on which the basis of a share of stock or a
security received (or deemed received in the reorganization under
section 368(a)(1)(E) in the case of a transaction to which paragraph
(d) of this section applies) is relevant. The basis of the shares or
securities received in an exchange under the terms of section 354 or
section 356, for example, is relevant when such shares or securities
are sold or otherwise transferred.
(ii) In exchanges or distributions under section 355. In the case
of an exchange or distribution under the terms of section 355 (or so
much of section 356 as relates to section 355), the designation must be
made on or before the first date on which the basis of a share of stock
or a security of the distributing corporation or the controlled
corporation (as defined in Sec. 1.355-1(b)) is relevant.
(3) Failure to designate. If the shareholder fails to make a
designation in a case in which the shareholder is not able to identify
which share of stock is received in exchange for, or with respect to, a
particular share of stock, then the shareholder will not be able to
identify which shares are sold or transferred for purposes of
determining the basis of property sold or transferred under section
1012 and Sec. 1.1012-1(c) and, instead, will be treated as selling or
transferring the share received in respect of the earliest share
purchased or acquired.
(f) Applicability of section to certain overlap situations--(1)
Exchanges described in both section 1036 and section 354 or 356. The
rules of paragraphs (a) through (e) of this section shall 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
1036 and section 354 or 356.
(2) Exchanges described in both section 351 and section 354 or 356.
The rules of paragraphs (a) through (e) of this section shall 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 section 354 or 356, unless liabilities of the shareholder or
security holder are assumed in connection with the exchange.
(g) Section 351 exchanges--(1) In general. Except as provided in
paragraph (g)(2) of this section, if in an exchange to which section
351 applies property is transferred to a corporation and the transferor
receives more than one share of stock, then the aggregate basis of the
property transferred (as adjusted under Sec. 1.358-1) shall be
allocated among all of the shares of stock received in proportion to
the fair market values of each share of stock.
(2) Stock and property transferred in an exchange without a
liability assumption. If in an exchange to which section 351 applies
stock or stock and property is transferred to a corporation and no
liability is assumed by the transferee in the exchange, then the basis
of the stock transferred (as adjusted under Sec. 1.358-1) shall be
allocated pursuant to paragraphs (b)(1) through (b)(3) of this section.
Such rules also apply to other property, money or more than one class
of stock or securities received.
(3) Transactions in which stock is deemed received. For purposes of
this paragraph (g), if a shareholder transfers property to a
corporation in a transaction to which section 351 applies, and such
shareholder receives no property or property (including property
permitted by section 351 to be received without the recognition of gain
or ``other property'' or money) in such corporation with a fair market
value less than that of the property transferred in the transaction,
such shareholder shall be treated as provided in paragraphs (3)(i) and
(ii) of this paragraph (g).
(i) Step one: Deemed issuance. First, the shareholder shall be
treated as receiving the stock, other property, and money actually
received by the shareholder in the transaction and an amount of stock
of the transferee corporation that has a value equal to the excess of
the value of the property the shareholder transferred in the
transaction over the value of the stock, other property, and money the
shareholder actually received in the transaction. If the shareholder
owns only one class of stock of the transferee corporation the receipt
of which would be consistent with the economic rights associated with
each class of stock of the transferee corporation, the stock deemed
received by the shareholder pursuant to the previous sentence shall be
stock of such class. If the shareholder owns multiple classes of stock
of the transferee corporation the receipt of which would be consistent
with the economic rights associated with each class of stock of the
transferee corporation, the stock deemed received by the shareholder
shall be stock of each such class owned by the shareholder immediately
prior to the transaction, in proportion to the value of the stock of
each such class owned by the shareholder immediately prior to the
transaction.
(ii) Step two: Deemed section 368(a)(1)(E) exchange. Second, the
shareholder shall then be treated as surrendering all of its shares of
stock in the transferee corporation, including those shares of stock
held immediately
[[Page 3522]]
prior to the transaction, those shares of stock actually received in
the transaction, and those shares of stock deemed received pursuant to
paragraph (3)(i) of this paragraph (g), in a reorganization under
section 368(a)(1)(E) in exchange for the shares of stock of the
transferee corporation that the shareholder actually holds immediately
after the transaction. The basis of each share of stock deemed received
in the reorganization under section 368(a)(1)(E) shall be determined
under the rules of this section.
(h) Section 361 exchanges. If in an exchange to which section 361
applies property is transferred to a corporation and the transferor
receives stock or securities of more than one class or receives both
stock and securities, then the basis of the property transferred (as
adjusted under Sec. 1.358-1) shall be allocated among all of the stock
and securities received in proportion to the fair market values of the
stock of each class and the securities of each class.
(i) Examples. The application of this section is illustrated by the
following examples:
Example 1. More shares of stock received than surrendered. (i)
Facts. J, an individual, acquired 20 shares of Corporation X stock
on Date 1 for $3 each and 10 shares of Corporation X stock on Date 2
for $6 each. On Date 3, Corporation Y acquires the assets of
Corporation X in a reorganization under section 368(a)(1)(A).
Pursuant to the terms of the plan of reorganization, J receives 2
shares of Corporation Y stock in exchange for each share of
Corporation X stock. Therefore, J receives 60 shares of Corporation
Y stock. Pursuant to section 354, J recognizes no gain or loss on
the exchange. J is not able to identify which shares of Corporation
Y stock are received in exchange for each share of Corporation X
stock.
(ii) Analysis. Under paragraph (b)(2) of this section, J has 40
shares of Corporation Y stock each of which has a basis of $1.50 and
is treated as having been acquired on Date 1 and 20 shares of
Corporation Y stock each of which has a basis of $3 and is treated
as having been acquired on Date 2. Under paragraph (e) of this
section, on or before the date on which the basis of a share of
Corporation Y stock received becomes relevant, J may designate which
of the shares of corporation Y stock have a basis of $1.50 and which
have a basis of $3.
Example 2. More shares of stock received than surrendered. (i)
Facts. The facts are the same as in Example 1, except that instead
of receiving 2 shares of Corporation Y stock in exchange for each
share of Corporation X stock, J receives 1\1/2\ shares of
Corporation Y stock in exchange for each share of Corporation X
stock. Therefore, J receives 45 shares of corporation Y stock.
Again, J is not able to identify which shares (or portions of
shares) of Corporation Y stock are received in exchange for each
share of Corporation X stock.
(ii) Analysis. Under paragraph (b)(2) of this section, J has 30
shares of Corporation Y stock each of which has a basis of $2 and is
treated as having been acquired on Date 1 and 15 shares of
Corporation Y stock each of which has a basis of $4 and is treated
as having been acquired on Date 2. Under paragraph (e) of this
section, on or before the date on which the basis of a share of
Corporation Y stock received becomes relevant, J may designate which
of the shares of Corporation Y stock received have a basis of $2 and
which have a basis of $4.
Example 3. More than one class of stock received. (i) Facts. J,
an individual, acquired 10 shares of Class A stock of Corporation X
on Date 1 for $3 each, 10 shares of Class A stock of Corporation X
on Date 2 for $9 each, and 10 shares of Class B stock of Corporation
X on Date 3 for $3 each. On Date 4, J surrenders all of J's shares
of Class A stock in exchange for 20 shares of new Class C stock and
20 shares of new Class D stock in a reorganization under section
368(a)(1)(E). Pursuant to section 354, J recognizes no gain or loss
on the exchange. On the date of the exchange, the fair market value
of each share of Class A stock is $6, the fair market value of each
share of Class C stock is $2, and the fair market value of each
share of Class D stock is $4. The terms of the exchange do not
specify that shares of Class C stock or shares of Class D stock of
Corporation X are received in exchange for particular shares of
Class A stock of Corporation X.
(ii) Analysis. Under paragraph (b)(4) of this section, because
the terms of the exchange do not specify that shares of Class C
stock or shares of Class D stock of Corporation X are received in
exchange for particular shares of Class A stock of Corporation X, a
pro rata portion of the shares of Class C stock and shares of Class
D stock received will be treated as received in exchange for each
share of Class A stock based on the fair market value of the
surrendered shares of Class A stock. Therefore, J is treated as
receiving one share of Class C stock and one share of Class D stock
in exchange for each share of Class A stock. Under paragraph (b)(2)
of this section, J has 10 shares of Class C stock, each of which has
a basis of $1 and is treated as having been acquired on Date 1 and
10 shares of Class C stock, each of which has a basis of $3 and is
treated as having been acquired on Date 2. In addition, J has 10
shares of Class D stock, each of which has a basis of $2 and is
treated as having been acquired on Date 1 and 10 shares of Class D
stock, each of which has a basis of $6 and is treated as having been
acquired on Date 2. J's basis in each share of Class B stock remains
$3. Under paragraph (e) of this section, on or before the date on
which the basis of a share of Class C stock or Class D stock
received becomes relevant, J may designate which of the shares of
Class C stock have a basis of $1 and which have a basis of $3, and
which of the shares of Class D stock have a basis of $2 and which
have a basis of $6.
Example 4. Money received in addition to stock. (i) Facts. J, an
individual, acquired 10 shares of stock of Corporation X on Date 1
for $2 each (Block 1), 10 shares of stock of Corporation X on Date 2
for $4 each (Block 2), and 20 shares of stock of Corporation X on
Date 3 for $6 each (Block 3). On Date 4, Corporation Y acquires the
assets of Corporation X in a reorganization under section
368(a)(1)(A). Pursuant to the terms of the plan of reorganization, J
surrenders all of J's shares of Corporation X stock for 40 shares of
Corporation Y stock and $200 of cash. The distribution of $200 of
cash does not have the effect of a distribution of a dividend. On
the date of the exchange, the fair market value of each share of
stock of Corporation X is $10, and the fair market value of each
share of Corporation Y stock is $5. The terms of the exchange do not
specify that shares of Corporation Y stock or cash are received in
exchange for particular shares of stock of Corporation X.
(ii) Analysis. Under paragraph (b)(4) of this section and under
Sec. 1.356-1(b), because the terms of the exchange do not specify
that shares of Corporation Y stock or cash are received in exchange
for particular shares of stock of Corporation X, a pro rata portion
of the shares of Corporation Y stock and cash received will be
treated as received in exchange for each share of stock of
Corporation X surrendered based on the fair market value of such
stock. Therefore, J is treated as receiving one share of Corporation
Y stock and $5 of cash in exchange for each share of stock of
Corporation X. J realizes a gain of $80 on the exchange of Block 1,
$50 of which is recognized under Sec. 1.356-1(a). J realizes a gain
of $60 of the exchange of Block 2, $50 of which is recognized under
Sec. 1.356-1(a). J realizes a gain of $80 on the exchange of the
Block 3 shares of stock of Corporation X, all of which is recognized
under Sec. 1.356-1(a). Under paragraph (b)(1) of this section, J
has 10 shares of Corporation Y stock, each of which has a basis of
$2 and is treated as having been acquired on Date 1, 10 shares of
Corporation Y stock, each of which has a basis of $4 and is treated
as having been acquired on Date 2, and 20 shares of Corporation Y
stock, each of which has a basis of $5 and is treated as having been
acquired on Date 3. Under paragraph (e) of this section, on or
before the date on which the basis of a share of Corporation Y stock
received becomes relevant, J may designate which of the shares of
Corporation Y stock received have a basis of $2, which have a basis
of $4, and which have a basis of $5.
Example 5. Money received in addition to stock. (i) Facts. The
facts are the same as in Example 4, except that the terms of the
plan of reorganization specify that J receives 40 shares of stock of
Corporation Y in exchange for J's Block 1 and Block 2 shares of
stock of Corporation X and $200 of cash in exchange for J's Block 3
shares of stock of Corporation X.
(ii) Analysis. Under paragraph (b)(4) of this section and under
Sec. 1.356-1(b), because the terms of the exchange specify that J
receives 40 shares of stock of Corporation Y in exchange for J's
Block 1 and Block 2 shares of stock of Corporation X and $200 of
cash in exchange for J's Block 3 shares of stock of Corporation X
and such terms are economically reasonable and the distribution is
not dividend equivalent, such terms control. J realizes a gain of
$80 on the exchange of Block 1, none of which is recognized under
section 354. J realizes a
[[Page 3523]]
gain of $60 on the exchange of Block 2, none of which is recognized
under section 354. J realizes a gain of $80 on the exchange of the
Block 3 shares of stock of Corporation X, all of which is recognized
under section 302(a). Under paragraph (b)(2) of this section, J has
20 shares of Corporation Y stock, each of which has a basis of $1
and is treated as having been acquired on Date 1, and 20 shares of
Corporation Y stock, each of which has a basis of $2 and is treated
as having been acquired on Date 2. Under paragraph (e) of this
section, on or before the date on which the basis of a share of
Corporation Y stock received becomes relevant, J may designate which
of the shares of Corporation Y stock received have a basis of $1 and
which have a basis of $2.
Example 6. Stock and securities received as nonrecognition
property. (i) Facts. J, an individual, acquired 10 shares of stock
of Corporation X on Date 1 for $2 each, and a security issued by
Corporation X to J on Date 2 with a principal amount of $100 and a
basis of $100. On Date 3, Corporation Y acquires the assets of
Corporation X in a reorganization under section 368(a)(1)(A).
Pursuant to the terms of the plan of reorganization, J surrenders
all of J's shares of Corporation X stock in exchange for 10 shares
of Corporation Y stock and surrenders J's Corporation X security in
exchange for a Corporation Y security. The distribution of neither
the Y stock nor the Y security has the effect of a distribution of a
dividend. On the date of the exchange, the fair market value of each
share of stock of Corporation X is $10, the fair market value of J's
Corporation X security is $100, the fair market value of each share
of Corporation Y stock is $10, and the fair market value and
principal amount of the Corporation Y security received by J is
$100.
(ii) Analysis. Under paragraph (b)(4) of this section and under
Sec. 1.354-1(d), because the terms of the exchange specify that J
receives 10 shares of stock of Corporation Y in exchange for J's
shares of Class A stock of Corporation X and a Corporation Y
security in exchange for its Corporation X security and such terms
are economically reasonable, such terms control. Pursuant to section
354, J recognizes no gain on either exchange. Under paragraph (b)(1)
of this section, J has 10 shares of Corporation Y stock, each of
which has a basis of $2 and is treated as having been acquired on
Date 1, and a security that has a basis of $100 and is treated as
having been acquired on Date 2.
Example 7. Fewer shares of stock received than surrendered. (i)
Facts. J, an individual, acquired 10 shares of Corporation X stock
on Date 1 for $2 each and 10 shares of Corporation X stock on Date 2
for $5 each. On Date 3, Corporation Y acquires the stock of
Corporation X in a reorganization under section 368(a)(1)(B).
Pursuant to the terms of the plan of reorganization, J receives one
share of Corporation Y stock in exchange for every 2 shares of
Corporation X stock. Pursuant to section 354, J recognizes no gain
or loss on the exchange. J is not able to identify which portion of
each share of Corporation Y stock is received in exchange for each
share of Corporation X stock.
(ii) Analysis. Under paragraph (b)(3) of this section, J has 5
shares of Corporation Y stock each of which has a basis of $4 and is
treated as having been acquired on Date 1 and 5 shares of
Corporation Y stock each of which has a basis of $10 and is treated
as having been acquired on Date 2. Under paragraph (e) of this
section, on or before the date on which the basis of a share of
Corporation Y stock received becomes relevant, J may designate which
of the shares of Corporation Y stock received have a basis of $4 and
which have a basis of $10.
Example 8. Exchange described in sections 351 and 354. (i)
Facts. J, an individual, acquired 10 shares of Corporation X stock
on Date 1 for $3 each and 10 shares of Corporation X stock on Date 2
for $6 each. On Date 3, Corporation Z, a newly formed, wholly owned
subsidiary of Corporation Y, merges with and into Corporation X with
Corporation X surviving. As part of the plan of merger, J receives
one share of Corporation Y stock in exchange for each share of
Corporation X stock. In connection with the transaction, Corporation
Y assumes a liability of J. In addition, after the transaction, J
owns stock of Corporation Y satisfying the requirements of section
368(c). J's transfer of the Corporation X stock to Corporation Y is
an exchange described in sections 351 and 354.
(ii) Analysis. Under paragraph (f)(2) of this section, because,
in connection with the transfer of the Corporation X stock to
Corporation Y, Corporation Y assumed a liability of J, the rules of
paragraph (g) this section apply to determine J's basis in the
Corporation Y stock received in the transaction.
Example 9. Reorganization in which stock is deemed received. (i)
Facts. Each of Corporation X and Corporation Y has a single class of
stock outstanding, all of which is owned by J, an individual. J
acquired 100 shares of Corporation X stock on Date 1 for $1 each and
100 shares of Corporation Y stock on Date 2 for $2 each. On Date 3,
Corporation Y acquires the assets of Corporation X in a
reorganization under section 368(a)(1)(D). Pursuant to the terms of
the plan of reorganization, J surrenders J's 100 shares of
Corporation X stock but does not receive any additional Corporation
Y stock. Immediately before the effective time of the
reorganization, the fair market value of each share of Corporation X
stock and each share of Corporation Y stock is $1. Pursuant to
section 354, J recognizes no gain or loss.
(ii) Analysis. Under paragraph (d) of this section, J is deemed
to have received shares of Corporation Y stock with an aggregate
fair market value of $100 in exchange for J's Corporation X shares.
Given the number of outstanding shares of stock of Corporation Y and
their value immediately before the effective time of the
reorganization, J is deemed to have received 100 shares of stock of
Corporation Y in the reorganization. Under paragraph (b)(1) of this
section, each of those shares has a basis of $1 and is treated as
having been acquired on Date 1. Then, the stock of Corporation Y is
deemed to be recapitalized in a reorganization under section
368(a)(1)(E) in which J receives 100 shares of Corporation Y stock
in exchange for those shares of Corporation Y stock that J held
immediately prior to the reorganization and those shares J is deemed
to have received in the reorganization. Under paragraph (b)(3) of
this section, immediately after the reorganization, J holds 50
shares of Corporation Y stock each of which has a basis of $2 and is
treated as having been acquired on Date 1 and 50 shares of
Corporation Y stock each of which has a basis of $4 and is treated
as having been acquired on Date 2. Under paragraph (e) of this
section, on or before the date on which the basis of any share of
J's Corporation Y stock becomes relevant, J may designate which of
the shares of Corporation Y have a basis of $2 and which have a
basis of $4.
Example 10. Reorganization in which stock is deemed received.
(i) Facts. Corporation X has a single class of stock outstanding,
all of which is owned by J, an individual. J acquired 100 shares of
Corporation X stock on Date 1 for $1 each. Corporation Y has two
classes of stock outstanding, common stock and nonvoting preferred
stock. On Date 2, J acquired 100 shares of Corporation Y common
stock for $2 each and 100 shares of Corporation Y preferred stock
for $4 each. On Date 3, Corporation Y acquires the assets of
Corporation X in a reorganization under section 368(a)(1)(D).
Pursuant to the terms of the plan of reorganization, J surrenders
J's 100 shares of Corporation X stock but does not receive any
additional Corporation Y stock. Immediately before the effective
time of the reorganization, the fair market value of each share of
Corporation X stock is $10, the fair market value of each share of
Corporation Y common stock is $10, and the fair market value of each
share of Corporation Y preferred stock is $20. Pursuant to section
354, J recognizes no gain or loss.
(ii) Analysis. Under paragraph (d) of this section, J is deemed
to have received shares of Corporation Y stock with an aggregate
fair market value of $1,000 in exchange for J's Corporation X
shares. Consistent with the economics of the transaction and the
rights associated with each class of stock of Corporation Y owned by
J, J is deemed to receive additional shares of Corporation Y common
stock. Because the value of the common stock indicates that the
liquidation preference associated with the Corporation Y preferred
stock could be satisfied even if the reorganization did not occur,
it is not appropriate to deem the issuance of additional Corporation
Y preferred stock. Given the number of outstanding shares of common
stock of Corporation Y and their value immediately before the
effective time of the reorganization, J is deemed to have received
100 shares of common stock of Corporation Y in the reorganization.
Under paragraph (b)(1) of this section, each of those shares has a
basis of $1 and is treated as having been acquired on Date 1. Then,
the common stock of Corporation Y is deemed to be recapitalized in a
reorganization under section 368(a)(1)(E) in which J receives 100
shares of Corporation Y common stock in exchange for those shares of
Corporation Y common stock that J held immediately prior to the
reorganization and those shares of Corporation Y common stock that J
is deemed to have received in the reorganization. Under paragraph
(b)(3) of this section, immediately after the reorganization,
[[Page 3524]]
J holds 50 shares of Corporation Y common stock, each of which has a
basis of $2 and is treated as having been acquired on Date 1, and 50
shares of Corporation Y common stock, each of which has a basis of
$4 and is treated as having been acquired on Date 2. Under paragraph
(e) of this section, on or before the date on which the basis of any
share of J's Corporation Y common stock becomes relevant, J may
designate which of those shares have a basis of $2 and which have a
basis of $4.
Example 11. Distribution to which section 355 applies. (i)
Facts. J, an individual, acquired 5 shares of Corporation X stock on
Date 1 for $4 each and 5 shares of Corporation X stock on Date 2 for
$8 each. Corporation X owns all of the outstanding stock of
Corporation Y. The fair market value of the stock of Corporation X
is $1,800. The fair market value of the stock of Corporation Y is
$900. In a distribution to which section 355 applies, Corporation X
distributes all of the stock of Corporation Y pro rata to its
shareholders. In the distribution, J receives 2 shares of
Corporation Y stock with respect to each share of Corporation X
stock. Pursuant to section 355, J recognizes no gain or loss on the
receipt of the shares of Corporation Y stock. J is not able to
identify which share of Corporation Y stock is received in respect
of each share of Corporation X stock.
(ii) Analysis. Under paragraph (c)(1) of this section, because J
receives 2 shares of Corporation Y stock with respect to each share
of Corporation X stock, the basis of each share of Corporation X
stock is allocated between such share of Corporation X stock and two
shares of Corporation Y stock in proportion to the fair market value
of those shares. Therefore, each of the 5 shares of Corporation X
stock acquired on Date 1 will have a basis of $2 and each of the 10
shares of Corporation Y stock received with respect to those shares
will have a basis of $1. In addition, each of the 5 shares of
Corporation X stock acquired on Date 2 will have a basis of $4 and
each of the 10 shares of Corporation Y stock received with respect
to those shares will have a basis of $2. Under paragraph (e) of this
section, on or before the date on which the basis of a share of
Corporation Y stock received becomes relevant, J may designate which
of the shares of Corporation Y stock have a basis of $1 and which
have a basis of $2.
Example 12. Designation of stock surrendered and received. (i)
Facts. J, an individual, acquired 20 shares of Corporation X stock
on Date 1 for $2 each and 20 shares of Corporation X stock on Date 2
for $4 each. Corporation X has 80 shares of stock outstanding.
Corporation X owns 40 shares of stock of Corporation Y, which
represents all of the outstanding stock of Corporation Y. The fair
market value of the stock of Corporation X is $80. The fair market
value of the stock of Corporation Y is $40. Corporation X
distributes all of the stock of Corporation Y in a transaction to
which section 355 applies. In the transaction, J surrenders 20
shares of stock of Corporation X in exchange for 20 shares of stock
of Corporation Y. J retains 20 shares of Corporation X stock.
Pursuant to section 355, J recognizes no gain or loss on the receipt
of the shares of Corporation Y stock. J is not able to identify
which shares of Corporation X stock are surrendered. In addition, J
is not able to identify which shares of Corporation Y stock are
received in exchange for each surrendered share of Corporation X. In
addition, the receipt of Y stock is not dividend equivalent.
(ii) Analysis. Under paragraph (b)(1) of this section, J has 20
shares of Corporation Y stock each of which is treated as received
in exchange for one share of Corporation X stock. The basis of the
20 shares of Corporation X stock that are retained by J will remain
unchanged. Under paragraph (e) of this section, on or before the
date on which the basis of a share of Corporation X or Corporation Y
stock becomes relevant, J may designate which shares of Corporation
X stock J surrendered in the exchange and which share of the
Corporation Y stock received is received for each share of
Corporation X stock surrendered. Therefore, it is possible that a
share of Corporation Y stock would have a basis of $2 and be treated
as having been acquired on Date 1, or would have a basis of $4 and
be treated as having been acquired on Date 2.
Example 13. Surrendered shares of stock or securities acquired
on different dates or at different prices. (i) Facts. J, an
individual, acquired 10 shares of Corporation X stock on Date 1 for
$3 each, 10 shares of Corporation X stock on Date 2 for $18 each, 10
shares of Corporation X stock on Date 3 for $6 each, and 10 shares
of Corporation X stock on Date 4 for $9 each. On Date 5, Corporation
Y acquires the assets of Corporation X in a reorganization under
section 368(a)(1)(A). Pursuant to the terms of the plan of
reorganization, J receives a \3/4\ share of Corporation Y stock in
exchange for each share of Corporation X stock. Therefore, J
receives 30 shares of Corporation Y stock. Pursuant to section 354,
J recognizes no gain or loss on the exchange. J is not able to
identify which shares of Corporation Y stock are received in
exchange for each share (or portions of shares) of Corporation X
stock.
(ii) Analysis. Under paragraph (b)(3) of this section, J has 7
shares of Corporation Y stock each of which has a basis of $4 and is
treated as having been acquired on Date 1, 7 shares of Corporation Y
stock each of which has a basis of $24 and is treated as having been
acquired on Date 2, 7 shares of Corporation Y stock each of which
has a basis of $8 and is treated as having been acquired on Date 3,
and 7 shares of Corporation Y stock each of which has a basis of $12
and is treated as having been acquired on Date 4. In addition, J has
two shares of Corporation Y stock, each of which is divided into two
equal segments under paragraph (b)(3) of this section. The first of
those two shares has one segment with a basis of $2 that is treated
as having been acquired on Date 1 and a second segment with a basis
of $12 that is treated as having been acquired on Date 2. The second
of those two shares has one segment with a basis of $4 that is
treated as having been acquired on Date 3 and a second segment with
a basis of $6 that is treated as having been acquired on Date 4.
Under paragraph (e) of this section, on or before the date on which
a share of Corporation Y stock received becomes relevant, J may
designate which of the shares of Corporation Y stock have a basis of
$4, which have a basis of $24, which have a basis of $8, which have
a basis of $12, and which share has a split basis of $2 and $12, and
which share has a split basis of $4 and $6.
Example 14. Shareholder election and terms of the exchange. (i)
Facts. J, an individual, acquired 10 shares of stock of widely-held
Corporation X on Date 1 for $2 each, 10 shares of stock of
Corporation X on Date 2 for $4 each, and 10 shares of stock of
Corporation X on Date 3 for $6. On Date 5, Corporation X and
Corporation Y sign a binding contract pursuant to which, in a
reorganization under section 368(a)(1)(A), Corporation X will be
merged with and into Corporation Y on Date 6. The fair market value
of each share of Corporation X stock is $10 and the fair market
value of each share of Corporation Y stock is $5. In exchange for
each share of stock of Corporation X, the shareholders of
Corporation X may elect to receive 2 shares of stock of Corporation
Y or $10 cash. If, however, the elected consideration is
oversubscribed, by default a pro-rata mix of consideration will be
received for the corresponding shares of stock of Corporation X (the
default pro-rata term). J elects to receive 2 shares of stock of
Corporation Y in exchange for each of the 10 shares of stock of
Corporation X acquired on Date 1, and $10 cash for each of the
remaining 20 shares of stock of Corporation X. Neither of the
elections is oversubscribed by the shareholders of Corporation X.
The distribution of cash does not have the effect of a distribution
of a dividend.
(ii) Analysis. Under paragraph (b)(4) of this section and under
Sec. 1.356-1(b), because the receipt does not have the effect of
dividend, and the terms of the exchange specify that J receives 2
shares of stock of Corporation Y in exchange for each of the 10
shares of stock of Corporation X acquired on Date 1, and $10 cash
for each of the remaining 20 shares of stock of Corporation X, and
such terms are economically reasonable, such terms control. J
realizes a gain of $80 on the exchange of the 10 shares of stock of
Corporation X acquired on Date 1, none of which is recognized under
Sec. 1.356-1(a). J realizes a gain of $60 on the exchange of the 10
shares of stock of Corporation X acquired on Date 2 and realizes $40
on the exchange of the 10 shares of stock of Corporation X acquired
on Date 3, all of which is recognized under Sec. 1.356-1(a). Under
paragraph (b)(2) of this section, J has 20 shares of stock of
Corporation Y, each of which has a basis of $1 and is treated as
having been acquired on Date 1.
Example 15. Shareholder election and terms of the exchange. (i)
Facts. The facts are the same as in Example 14, except that the cash
election is oversubscribed and, pursuant to the default pro-rata
term, for each of the shares of stock of Corporation X that J
acquired on Date 2 and Date 3, J receives 1 share of stock of
Corporation Y and $5 cash.
(ii) Analysis. Under paragraph (b)(4) of this section and under
Sec. 1.356-1(b), because the terms of the exchange specify that J
receives 2 shares of stock of Corporation Y in exchange for each of
the 10 shares of stock
[[Page 3525]]
of Corporation X acquired on Date 1, and 1 share of stock of
Corporation Y and $5 cash for each of the remaining 20 shares of
stock of Corporation X, and such terms are economically reasonable,
such terms control. J realizes a gain of $80 on the exchange of the
10 shares of stock of Corporation X acquired on Date 1, none of
which is recognized under Sec. 1.356-1(a). J realizes a gain of $60
on the exchange of the 10 shares of stock of Corporation X acquired
on Date 2, $50 of which is recognized under Sec. 1.356-1(a), and
$40 on the exchange of the 10 shares of stock of Corporation X
acquired on Date 3, all of which is recognized under Sec. 1.356-
1(a). Of the 40 shares of stock of Corporation Y received by J, 20
of the shares each has a basis of $1 and is treated as having been
acquired on Date 1 under paragraph (b)(2) of this section, and 10 of
the shares each has a basis of $4 and is treated as having been
acquired on Date 2 and 10 of the shares each has a basis of $6 and
is treated as having been acquired on Date 3 under paragraph (b)(1)
of this section.
Example 16. Exchange described in section 351 in which only
stock is received. (i) Facts. J transfers Asset I, Asset II, and 50
shares of Corporation X stock in exchange for 110 shares of
Corporation Y in an exchange to which section 351 applies. At the
time of the exchange, Asset I has a fair market value of $220 and a
basis of $400, Asset II has a fair market value of $330 and a basis
of $200, and the 50 shares of Corporation X stock each have a fair
market value of $22 ($550 total) and a basis of $10 ($250 total).
The fair market value of each share of Corporation Y stock is $10.
(ii) Analysis. Pursuant to section 351(a), J recognizes no gain
or loss on the exchange. Under paragraph (g)(2) of this section, J
has 55 shares of Corporation Y stock each of which has a basis of
$10.91 ($600 total, the aggregate basis of Asset I and Asset II).
Under paragraph (g)(2) of this section, J has 55 shares of
Corporation Y stock each of which has a basis of $4.55 ($250 total).
Example 17. Exchange described in section 351 in which ``other
property'' is received. (i) Facts. The facts are the same as Example
1, except J receives 100 shares of Corporation Y stock and $100 in
the exchange.
(ii) Analysis. Pursuant to section 351(b), J recognizes gain,
but no loss, on the exchange, but not in excess of the amount of
money received. Under Sec. 1.351-2, J realizes a loss of $180 on
Asset I, none of which is recognized, a gain of $130 on Asset II,
$30 of which is recognized, and a gain of $300 on shares of
Corporation X stock, $50 of which is recognized. Under paragraph
(g)(2) of this section, J has 50 shares of Corporation Y stock each
of which has a basis of $11.60 ($580 total), and 50 shares of
Corporation Y stock each of which has a basis of $5.00 ($250 total).
(j) Effective/applicability date. This section applies to exchanges
and distributions of stock and securities that occur after the date
these regulations are published as final regulations in the Federal
Register, except for exchanges which occur pursuant to a written
agreement that is binding on or before the date these regulations are
published as final in the Federal Register. For exchanges and
distributions of stock and securities that occur on or before the date
these regulations are published as final regulations in the Federal
Register, see this section as contained in 26 CFR part 1 revised April
1, for the year before these regulations were published as final
regulations in the Federal Register.
Par. 15. Section 1.358-6 is amended by revising paragraphs
(c)(1)(i)(B), (c)(3)(ii), and (f)(3) to read as follows:
Sec. 1.358-6 Stock basis in certain triangular reorganizations.
* * * * *
(c) * * *
(1) * * *
(i) * * *
(B) P transferred the T assets (and liabilities which S assumed or
to which the T assets acquired by S were subject) to S in a transaction
in which P received no property and P 's basis in S stock was
determined under section 358. See Sec. 1.358-2(g)(3) (allocation of
basis in a section 351 transaction in which stock is deemed received).
* * * * *
(3) * * *
(ii) P transferred the T stock to S in a transaction in which P
received no property and P's basis in its S stock was determined under
section 358. See Sec. 1.358-2(g)(3) (allocation of basis in a section
351 transaction in which stock is deemed received).
* * * * *
(f) * * *
(3) This section applies to exchanges that occur after the date
these regulations are published as final regulations in the Federal
Register, except for exchanges which occur pursuant to a written
agreement that is binding on or before the date these regulations are
published as final in the Federal Register. For exchanges that occur on
or before the date these regulations are published as final regulations
in the Federal Register, see this section as contained in 26 CFR part 1
revised April 1, 2008, for the year before the date these regulations
are published as final regulations in the Federal Register.
Par. 16. Section 1.368-1 is amended by adding a sentence to the end
of paragraph (a) and by revising paragraph (e)(9) to read as follows:
Sec. 1.368-1 Purpose and scope of exception of reorganization
exchanges.
(a) * * * For purposes of determining whether a transaction
qualifies as a reorganization under section 368(a), to the extent the
terms of the exchange specify that a particular property is received in
exchange for a particular property, such terms shall control provided
such terms are economically reasonable.
* * * * *
(e) * * *
(9) This section applies to exchanges that occur after the date
these regulations are published as final regulations in the Federal
Register, except for exchanges which occur pursuant to a written
agreement that is binding on or before the date these regulations are
published as final in the Federal Register. For effective dates for
transactions that occur on or before the date these regulations are
published as final regulations in the Federal Register, see paragraph
(e) of this section, as contained in 26 CFR part 1 revised April 1, for
the year before these regulations are published as final regulations in
the Federal Register.
* * * * *
Par. 17. Section 1.861-12 is added to read as follows:
Sec. 1.861-12 Characterization rules and adjustments for certain
assets.
(a) through (c)(2)(v) [Reserved]. For further guidance, see Sec.
1.861-12T(a) through (c)(2)(v).
(c)(2)(vi) Adjustments in respect of redeemed stock for taxpayers
using the tax book value method. Solely for purposes of apportioning
expenses on the basis of the tax book value of assets, the adjusted
basis of any other class of stock in a 10 percent owned corporation
owned directly by a taxpayer that is a redeemed shareholder (as defined
in Sec. 1.302-5(b)(1)) with respect to such corporation shall be
increased by the amount of any loss that has not been taken into
account under Sec. 1.302-5(a)(3) as of the close of the redeemed
shareholder's taxable year (unrecovered loss). If the redeemed
shareholder does not own directly any shares in the 10 percent owned
corporation as of the end of the taxable year, but is treated for
purposes of section 302(b) as owning shares actually owned by another
member of the redeemed shareholder's affiliated group, as defined in
section Sec. 1.861-11(d)(1) and Sec. 1.861-11T(d)(6) with respect to
the redeemed shareholder, then, solely for purposes of this paragraph
(c)(2)(vi), the adjusted basis of the shares in the 10 percent owned
corporation, if any, that are owned by such other corporation or
corporations shall be increased by the amount of the redeemed
shareholder's unrecovered loss (and allocated among such corporations,
if applicable, in proportion to their relative adjusted bases (as
adjusted pursuant to this
[[Page 3526]]
paragraph and Sec. 1.861-12T(c)(2)) in the stock of the redeeming
corporation). These adjustments are to be made annually and are
noncumulative.
(vii) Examples. Certain of the rules of this paragraph (c)(2) may
be illustrated by the following examples:
Examples 1 and 2. [Reserved]. For further guidance, see Sec.
1.861-12T(c)(2)(vii), Examples 1 and 2.
Example 3. X, an unaffiliated domestic corporation that was
organized on January 1, 2000, owns all of the stock of Y, a foreign
corporation with a functional currency other than the U.S. dollar
since January 1, 2000. The Y stock held by X includes Class A and
Class B common stock. X's adjusted basis in the Class A and Class B
common stock is $25,000 and $50,000, respectively. Y has earnings
and profits for the 2008 taxable year of $40,000. During the 2008
taxable year, Y redeems all of the Class A common stock held by X
for $40,000. Because X still owns all of the outstanding stock of Y,
the redemption is treated as a distribution with respect to the
stock of Y under section 301. Under Sec. 1.302-5(a)(3), X's $
25,000 adjusted basis in the redeemed shares of Class A common stock
is treated as a loss recognized on the date of the redemption, none
of which is taken into account in 2008. Under paragraph (c)(2)(vi)
of this section, solely for purposes of apportioning expenses on the
basis of the tax book value of assets, X's adjusted basis in its
remaining Class B common stock of Y is considered to be $75,000
($50,000 adjusted basis in the Class B common stock plus $ 25,000
unrecovered basis in the redeemed Class A common stock).
(c)(2)(viii) Effective/applicability date. Paragraph (c)(2)(vi) and
Example 3 apply to transactions that occur after the date these
regulations are published as final regulations in the Federal Register.
(c)(3) through (j) [Reserved]. For further guidance, see Sec.
1.861-12T(c)(3) through (j).
Sec. 1.1002-1 [Redesignated as Sec. 1.1001-6]
Par. 18. Section 1.1002-1 is redesignated as 1.1001-6 and amended
by revising paragraph (c) and adding a new paragraph (e) to read as
follows:
Sec. 1.1001-6 Sales or exchanges.
* * * * *
(c) Certain exceptions to general rule. Exceptions to the general
rule are made, for example, by sections 351(a), 354, 361(a), 721, 1031,
1035, and 1036. These sections describe certain specific exchanges of
property in which at the time of the exchange particular differences
exist between the property parted with and the property acquired, but
such differences are more formal than substantial. As to these, the
Internal Revenue Code provides that such differences shall not be
deemed controlling, and that gain or loss shall not be recognized at
the time of the exchange. The underlying assumption of these exceptions
is that the new property is substantially a continuation of the old
investment still unliquidated; and, in the case of reorganizations,
that the new enterprise, the new corporate structure and the new
property are substantially continuations of the old still unliquidated.
Solely for purposes of determining whether the exceptions to the
general rule under sections 354 and 361 apply to an exchange, to the
extent the terms of the exchange specify that a particular property is
received in exchange for a particular property, such terms shall
control provided such terms are economically reasonable.
* * * * *
(e) Effective/applicability date. This section applies to exchanges
that occur after the date these regulations are published as final
regulations in the Federal Register. For exchanges that occur on or
before the date these regulations are published as final regulations in
the Federal Register, see this section as contained in 26 CFR part 1
revised April 1, for the year before these regulations are published as
final regulations in the Federal Register.
Par. 19. Section 1.1016-2 is amended by adding paragraphs (e) and
(f) to read as follows:
Sec. 1.1016-2 Items properly chargeable to capital account.
* * * * *
(e) Solely for purposes of determining basis in stock, in the case
of a shareholder capital contribution to which section 118 applies, the
principles of Sec. 1.358-2(g)(3) (allocation of basis in a section 351
transaction in which stock is deemed received) shall apply.
(f) This section applies to transactions that occur after the date
these regulations are published as final regulations in the Federal
Register. For exchanges that occur on or before the date these
regulations are published as final regulations in the Federal Register,
see this section as contained in 26 CFR part 1 revised April 1, for the
year before these regulations are published as final regulations in the
Federal Register.
Par. 20. Section 1.1374-10, the first sentence of paragraph (a) is
revised to read as follows:
Sec. 1.1374-10 Effective date and additional rules.
(a) In general. For transactions to which Sec. 1.302-5 applies
[Reserved]. Sections 1.1374-1 through 1.1374-9, other than Sec.
1.1374-3(b) and (c) Examples 2 through 4, apply for taxable years
ending on or after December 27, 1994, but only in cases where the S
corporation's return for the taxable year is filed pursuant to an S
election or a section 1374(d)(8) transaction occurring on or after
December 27, 1994. * * *
* * * * *
Linda M. Kroening,
(Acting) Deputy Commissioner for Services and Enforcement.
[FR Doc. E9-1100 Filed 1-16-09; 8:45 am]
BILLING CODE 4830-01-P