Final Regulation

Federal Register / Vol. 68, No. 52 / Tuesday, March 18, 2003 / Rules and Regulations
in a manner that is consistent with the
purpose of this section.
*
*
*
*
*
(d) Positions in Stock. For purposes of
this section, stock includes any position
in stock to which section 1032 applies.
(e) Effective date. This section applies
to gain or loss allocated with respect to
sales or exchanges of stock occurring
after December 6, 1999, except that
paragraph (d) of this section is
applicable with respect to sales or
exchanges of stock occurring on or after
March 29, 2002, and the fourth sentence
of paragraph (a), paragraph (b)(2), and
the third sentence of paragraph (c)(1) of
this section are applicable with respect
to sales or exchanges of stock occurring
on or after March 18, 2003.
David A. Mader,
Assistant Deputy Commissioner of Internal
Revenue.
Approved: March 6, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03–6345 Filed 3–17–03; 8:45 am]
BILLING CODE 4830–01–P

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 9047]
RIN 1545–BA36 and 1545–AW92

Certain Transfers of Property to
Regulated Investment Companies
[RICs] and Real Estate Investment
Trusts [REITs]
AGENCY: Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations and removal of
temporary regulations.
SUMMARY: This document contains final
regulations that apply to certain
transactions or events that result in a
Regulated Investment Company [RIC] or
a Real Estate Investment Trust [REIT]
owning property that has a basis
determined by reference to a C
corporation’s basis in the property.
These regulations affect RICs, REITs,
and C corporations and clarify the tax
treatment of transfers of C corporation
property to a RIC or REIT.
DATES: Effective Date: These regulations
are effective March 18, 2003.
Applicability Dates: For dates of
applicability, see §§ 1.337(d)–5(d),
1.337(d)–6(e) and 1.337(d)–7(f).
FOR FURTHER INFORMATION CONTACT:
Jennifer D. Sledge, (202) 622–7750 (not
a toll-free number).

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SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act
The collection of information
contained in these final regulations has
been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C.
3507(d)) under control number 1545–
1672. This information is required to
obtain a benefit, i.e., to elect to
recognize gain as if the C corporation
had sold the property at fair market
value or to elect section 1374 treatment.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information
displays a valid control number
assigned by the Office of Management
and Budget.
The estimated annual burden per
respondent is 30 minutes.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to
the Internal Revenue Service, Attn: IRS
Reports Clearance Officer,
W:CAR:MP:T:T:SP, Washington, DC
20224, and to the Office of Management
and Budget, ATTN: Desk Officer for the
Department of the Treasury, Office of
Information and Regulatory Affairs,
Washington, DC 20503.
Books or records relating to a
collection of information must be
retained as long as their contents might
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background
This document contains amendments
to 26 CFR part 1. On February 7, 2000,
temporary regulations [TD 8872] (the
2000 temporary regulations) relating to
certain transactions or events that result
in a RIC or REIT owning property that
has a basis determined by reference to
a C corporation’s basis in the property
were published in the Federal Register
(65 FR 5775). A notice of proposed
rulemaking (REG–209135–88) crossreferencing the temporary regulations
was published in the Federal Register
for the same day (65 FR 5805). The 2000
temporary regulations were intended to
carry out the purposes of the repeal of
the General Utilities doctrine as enacted
in the Tax Reform Act of 1986 (the 1986
Act)(Public Law 99–514, 100 Stat.
2085), as amended by the Technical and
Miscellaneous Revenue Act of 1988
(Public Law 100–647, 102 Stat. 3342).
The 1986 Act amended sections 336
and 337 to require corporations to

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12817

recognize gain or loss on the
distribution of property in connection
with complete liquidations other than
certain subsidiary liquidations. Section
337(d) directs the Secretary to prescribe
regulations as may be necessary to carry
out the purposes of the General Utilities
repeal, including rules to ‘‘ensure that
such purposes may not be circumvented
* * * through the use of a regulated
investment company, a real estate
investment trust, or tax-exempt
entity * * *.’’
The 2000 temporary regulations also
reflected the principles set forth in
Notice 88–19 (1988–1 C.B. 486), in
which the IRS announced its intention
to promulgate regulations under the
authority of section 337(d) with respect
to transactions or events that result in a
RIC or REIT owning property that has a
basis determined by reference to a C
corporation’s basis (a carryover basis).
Notice 88–19 provided that the
regulations would apply with respect to
the net built-in gain of C corporation
assets that become assets of a RIC or
REIT by the qualification of a C
corporation as a RIC or REIT or by the
transfer of assets of a C corporation to
a RIC or REIT (a conversion transaction).
The Notice further provided that, where
the regulations apply, the C corporation
would be treated, for all purposes, as if
it had sold all of its assets at their
respective fair market values and
immediately liquidated. The Notice
provided, however, that the regulations
would not allow the recognition of a net
loss and that immediate gain
recognition could be avoided if the C
corporation that qualified as a RIC or
REIT or the transferee RIC or REIT, as
the case may have been, elected to be
subject to tax under section 1374 with
respect to the C corporation property.
Notice 88–19 also indicated that the
regulations would apply retroactively to
June 10, 1987.
A public hearing on the crossreferenced notice of proposed
rulemaking was held on May 10, 2000.
Written or electronic comments
responding to the notice of proposed
rulemaking were received. After
consideration of these comments,
Treasury and the IRS decided to issue
two new sets of temporary regulations.
On January 2, 2002, temporary
regulations [TD 8975] (the 2002
temporary regulations) were published
in the Federal Register (67 FR 8). The
regulations under § 1.337(d)–6T apply
to conversion transactions occurring on
or after June 10, 1987 and before January
2, 2002, and the regulations under
§ 1.337(d)–7T apply to conversion
transactions occurring on or after
January 2, 2002. A notice of proposed

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rulemaking (REG–142299–01 and REG–
209135–88) cross-referencing the
temporary regulations was published in
the Federal Register for the same day
(67 FR 48).
The regulations under § 1.337(d)–6T
provide that, if property of a C
corporation that is not a RIC or REIT
becomes the property of a RIC or REIT
in a conversion transaction, then the C
corporation is subject to deemed sale
treatment, unless the RIC or REIT elects
to be subject to section 1374 treatment.
Thus, the C corporation generally
recognizes gain and loss as if it sold the
property converted to RIC or REIT
property or transferred to the RIC or
REIT (the converted property) to an
unrelated party at fair market value
immediately before the conversion
transaction. If the C corporation
recognizes net gain on the deemed sale,
then the basis of the converted property
in the hands of the RIC or REIT is
adjusted to its fair market value
immediately before the conversion
transaction. The regulations under
§ 1.337(d)–6T do not permit a C
corporation to recognize a net loss on
the deemed sale. Where there is a net
loss, the C corporation recognizes no
gain or loss on the deemed sale, and the
C corporation’s basis in the converted
property carries over to the RIC or REIT.
The regulations under § 1.337(d)–7T
provide that, if property of a C
corporation that is not a RIC or REIT
becomes the property of a RIC or REIT
in a conversion transaction, then the
RIC or REIT will be subject to tax on the
net built-in gain in the converted
property under the rules of section 1374
and the regulations thereunder, unless
the C corporation that qualifies as a RIC
or REIT or transfers property to a RIC or
REIT elects deemed sale treatment. In
most other respects, the regulations
under § 1.337(d)–7T follow the
regulations under § 1.337(d)–6T.
No public hearing was requested or
held on the 2002 temporary regulations.
Written or electronic comments
responding to the notice of proposed
rulemaking were received. After
consideration of all the comments, the
proposed regulations are adopted as
amended (the final regulations) by this
Treasury decision, and the
corresponding temporary regulations are
removed. The revisions are discussed
below.
Explanation and Summary of
Comments
This preamble first discusses a change
in the time for making the section 1374
election under § 1.337(d)–6. This
preamble then discusses the
clarification of the rules concerning the

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use of loss carryforwards, credits and
credit carryforwards found in the
regulations under both § 1.337(d)–6 and
§ 1.337(d)–7. Finally, this preamble
discusses the clarification of certain
issues related to the special rule for
partnerships found in § 1.337(d)–7.
Time for Making Section 1374 Election
Under § 1.337(d)–6
As explained above, the regulations
under § 1.337(d)–6T provide that, if
property of a C corporation that is not
a RIC or REIT becomes the property of
a RIC or REIT in a conversion
transaction, then the C corporation is
subject to deemed sale treatment, unless
the RIC or REIT elects to be subject to
section 1374 treatment. Under
§ 1.337(d)–6T(c)(4)(ii), the section 1374
election may be filed by the RIC or REIT
with any Federal income tax return filed
by the RIC or REIT on or before March
15, 2003, provided that the RIC or REIT
has reported consistently with such
election for all periods. Commentators
expressed concern that, in the case of a
conversion transaction occurring on
January 1, 2002 (the last date of
applicability of § 1.337(d)–6T), the time
limit for making a section 1374 election
could preclude a RIC or REIT from
extending the due date of its Federal
income tax return beyond March 15,
2003. In response to this comment, the
final regulations under § 1.337(d)–6
extend the time for making the section
1374 election to September 15, 2003.
Use of Loss Carryforwards, Credits and
Credit Carryforwards
Under the 2002 temporary
regulations, recognized built-in gains
and recognized built-in losses that have
been taxed in accordance with these
regulations are treated like other gains
and losses of RICs and REITs that are
not subject to tax under these
regulations. Thus, they are included in
computing investment company taxable
income for purposes of section
852(b)(2), real estate investment trust
taxable income for purposes of section
857(b)(2), net capital gain for purposes
of sections 852(b)(3) and 857(b)(3), gross
income derived from sources within any
foreign country or possession of the
United States for purposes of section
853, and the dividends paid deduction
for purposes of sections 852(b)(2)(D),
852(b)(3)(A), 857(b)(2)(B), and
857(b)(3)(A).
In addition, consistent with section
1374, the 2002 temporary regulations
generally allow RICs and REITs to use
loss carryforwards and credits and
credit carryforwards arising in taxable
years for which the corporation that
generated the attribute was a C

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corporation (and not a RIC or REIT) to
reduce net recognized built-in gain and
the tax thereon, subject to the
limitations imposed by sections
1374(b)(2) and (b)(3) and §§ 1.1374–5
and 1.1374–6. The 2002 temporary
regulations also provide an ordering
rule for applying loss carryforwards,
credits, and credit carryforwards to
reduce net recognized built-in gain (and
the tax thereon) and RIC or REIT taxable
income (and the tax thereon). Under this
ordering rule, loss carryforwards of a
RIC or REIT must be used to reduce net
recognized built-in gain for a taxable
year to the greatest extent possible
before such losses can be used to reduce
investment company taxable income for
purposes of section 852(b) or real estate
investment trust taxable income for
purposes of section 857(b). A similar
rule applies to the use of credits and
credit carryforwards.
A commentator asked whether the use
of loss carryforwards, credits and credit
carryforwards for purposes of section
1374 affected the use of loss
carryforwards, credits and credit
carryforwards for purposes of
subchapter M. In response to this
comment, the final regulations under
§§ 1.337(d)–6 and 1.337(d)–7 clarify that
the use of loss carryforwards, credits
and credit carryforwards for purposes of
the section 1374 tax does not change the
extent to which such loss carryforwards,
credits and credit carryforwards can be
used for purposes of subchapter M.
Special Rule for Partnerships Under
§ 1.337(d)–7
Section § 1.337(d)–7T applies to
property transferred by a partnership to
a RIC or REIT to the extent of any C
corporation partner’s proportionate
share of the transferred property (the
partnership rule). The regulations state
that, if the partnership elects deemed
sale treatment with respect to such
transfer, then any gain recognized by the
partnership on the deemed sale must be
specially allocated to the C corporation
partner.
In response to comments, the
regulations have been revised to clarify
that the principles of section 704(b) and
(c) apply in determining the C
corporation partner’s share of the
transferred property. As revised, the
regulations provide that the principles
of these regulations apply to property
transferred by a partnership to a RIC or
REIT to the extent of any C corporation
partner’s distributive share of the gain
or loss in the transferred property. The
following sections highlight other
specific comments received with respect
to this rule.

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Partnerships With Multiple Corporate
Partners
A commentator expressed concern
that the partnership rule does not
specify whether the C corporation
partner or the partnership is considered
the transferor for purposes of making
the deemed sale election. Further, the
commentator asserted that in the case of
a partnership with multiple corporate
partners, each corporate partner should
be allowed to make (or not make) a
deemed sale election.
Treasury and the IRS believe that
requiring each corporate partner to
make a deemed sale election would be
inconsistent with section 703(b) (which
generally requires that elections be
made at the partnership level) and
would create unnecessary
administrative complexity. Therefore,
the final regulations under § 1.337(d)–7
retain the rule under section 703(b) that
the deemed sale election is made at the
partnership level.
Contribution of Loss Assets by
Partnership
Under the partnership rule, if a
partnership were to elect deemed sale
treatment under § 1.337(d)–7T, any gain
recognized by the partnership on the
deemed sale is allocated to the C
corporation partner. A commentator
expressed concern that if the
contribution by the partnership to a RIC
or REIT includes multiple assets, the
deemed sale may generate losses on
certain assets and gain on others even
though there is an overall net built-in
gain. The commentator suggested that
losses recognized by the partnership
must also be allocated to the C
corporation partner.
Under § 1.337(d)–7T, when a
partnership elects deemed sale
treatment, only net gains are recognized.
If a net gain is recognized, the C
corporation partner will receive the
benefit of offsetting losses (as a result of
the reduction in net gain). The final
regulations under § 1.337(d)–7 have
been modified to clarify that the gain
allocated to the C corporation partner on
a deemed sale transaction is the C
corporation partner’s distributive share
of the net gain in the assets transferred
to the RIC or REIT by the partnership.
Allocation of Gain or Loss on
Subsequent Sale of RIC or REIT Stock
Under section 358, a partnership that
elects deemed sale treatment under
§ 1.337(d)–7T(c) with respect to a
conversion transaction increases its
basis in the RIC or REIT stock by the net
gain recognized on such transaction. A
commentator suggested that the C

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corporation partner should be allowed
to use this basis increase to offset any
gain or loss recognized by the
partnership on the eventual sale of the
RIC or REIT stock.
Treasury and the IRS agree with this
comment. Accordingly, the final
regulations under § 1.337(d)–7 provide
that any adjustment to the basis of the
RIC or REIT stock held by the
partnership as a result of electing
deemed sale treatment will constitute an
adjustment to the basis of that stock
with respect to the C corporation
partner only.
Partnerships With Tax-Exempt Partners
A commentator expressed concern
that the partnership rule in § 1.337(d)–
7T may have an unintended punitive
effect when the C corporation partner is
a tax-exempt entity. Tax-exempt entities
that are partners in a partnership that
holds debt financed property are subject
to tax under the unrelated business
income tax (UBIT) rules unless certain
criteria are satisfied. One of these
criteria (the fractions rule) requires that:
(1) the tax-exempt partner’s share of
overall partnership income for any tax
year is no greater than its smallest share
of partnership loss in any tax year; and
(2) each allocation with respect to the
partnership has substantial economic
effect within the meaning of section
704(b)(2). The commentator expressed
concern that the special allocation of
gain to the tax-exempt partner that is
required by ‘‘1.337(d)–7T when the
partnership makes a deemed sale
election may violate the fractions rule,
tainting all income from the partnership
for UBIT purposes.
In response to this comment, Treasury
and the IRS have amended the
regulations under section 514 to provide
that allocations that are mandated by
statute or regulation (other than
subchapter K of chapter 1 of the Internal
Revenue Code and the regulations
thereunder) are not considered for
purposes of determining qualification
under the fractions rule. This rule
applies to partnership allocations made
in taxable years beginning on or after
January 1, 2002.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations and, because the
regulations do not impose a collection
of information on small entities, the

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12819

Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Therefore, a
Regulatory Flexibility Analysis is not
required. Pursuant to section 7805(f) of
the Code, these final regulations will be
submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on their
impact on small business.
Drafting Information
The principal author of these
regulations is Jennifer D. Sledge of the
Office of Associate Chief Counsel
(Corporate). Other personnel from
Treasury Department and the IRS
participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping
requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by removing the
entries for ‘‘Section 1.337(d)–5T’’,
‘‘Section 1.337(d)–6T’’, and ‘‘Section
1.337(d)–7T’’ and adding entries in
numerical order to read in part as
follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.337(d)–5 also issued under 26
U.S.C. 337.
Section 1.337(d)–6 also issued under 26
U.S.C. 337.
Section 1.337(d)–7 also issued under 26
U.S.C. 337. * * *
§ 1.337(d)–5T
5]

[Redesignated as § 1.337(d)–

Par. 2. Section 1.337(d)–5T is
redesignated as § 1.337(d)–5 and the
language ‘‘(temporary)’’ is removed from
the end of the section heading.
Par. 3. Newly designated § 1.337(d)–
5 is amended as follows:
1. In paragraph (b)(3), first sentence,
the reference to ‘‘§ 1.337(d)–5T(b)’’ is
removed and ‘‘paragraph (b) of this
section’’ is added in its place.
2. In paragraph (d), third sentence, the
references to ‘‘§ 1.337(d)–5T(b)(1)’’ and
‘‘§ 1.337(d)–6T’’ are removed and
‘‘paragraph (b)(1) of this section’’ and
‘‘§ 1.337(d)–6’’ are added in their places,
respectively.
3. In paragraph (d), fourth sentence,
the reference to ‘‘§ 1.337(d)–6T’’ is

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removed and ‘‘§ 1.337(d)–6’’ is added in
its place.
4. In paragraph (d), last sentence, the
reference to ‘‘§ 1.337(d)–7T’’ is removed
and ‘‘§ 1.337(d)–7’’ is added in its place.
Par. 4. Section 1.337(d)–6 is added to
read as follows:
§ 1.337(d)–6 New transitional rules
imposing tax on property owned by a C
corporation that becomes property of a RIC
or REIT.

(a) General rule—(1) Property owned
by a C corporation that becomes
property of a RIC or REIT. If property
owned by a C corporation (as defined in
paragraph (a)(2)(i) of this section)
becomes the property of a RIC or REIT
(the converted property) in a conversion
transaction (as defined in paragraph
(a)(2)(ii) of this section), then deemed
sale treatment will apply as described in
paragraph (b) of this section, unless the
RIC or REIT elects section 1374
treatment with respect to the conversion
transaction as provided in paragraph (c)
of this section. See paragraph (d) of this
section for exceptions to this paragraph
(a).
(2) Definitions—(i) C corporation. For
purposes of this section, the term C
corporation has the meaning provided
in section 1361(a)(2) except that the
term does not include a RIC or REIT.
(ii) Conversion transaction. For
purposes of this section, the term
conversion transaction means the
qualification of a C corporation as a RIC
or REIT or the transfer of property
owned by a C corporation to a RIC or
REIT.
(b) Deemed sale treatment—(1) In
general. If property owned by a C
corporation becomes the property of a
RIC or REIT in a conversion transaction,
then the C corporation recognizes gain
and loss as if it sold the converted
property to an unrelated party at fair
market value on the deemed sale date
(as defined in paragraph (b)(3) of this
section). This paragraph (b) does not
apply if its application would result in
the recognition of a net loss. For this
purpose, net loss is the excess of
aggregate losses over aggregate gains
(including items of income), without
regard to character.
(2) Basis adjustment. If a corporation
recognizes a net gain under paragraph
(b)(1) of this section, then the converted
property has a basis in the hands of the
RIC or REIT equal to the fair market
value of such property on the deemed
sale date.
(3) Deemed sale date—(i) RIC or REIT
qualifications. If the conversion
transaction is a qualification of a C
corporation as a RIC or REIT, then the
deemed sale date is the end of the last

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day of the C corporation’s last taxable
year before the first taxable year in
which it qualifies to be taxed as a RIC
or REIT.
(ii) Other conversion transactions. If
the conversion transaction is a transfer
of property owned by a C corporation to
a RIC or REIT, then the deemed sale
date is the end of the day before the day
of the transfer.
(4) Example. The rules of this
paragraph (b) are illustrated by the
following example:
Example. Deemed sale treatment on merger
into RIC. (i) X, a calendar-year taxpayer, has
qualified as a RIC since January 1, 1991. On
May 31, 1994, Y, a C corporation and
calendar-year taxpayer, transfers all of its
property to X in a transaction that qualifies
as a reorganization under section
368(a)(1)(C). X does not elect section 1374
treatment under paragraph (c) of this section
and chooses not to rely on § 1.337(d)–5. As
a result of the transfer, Y is subject to deemed
sale treatment under this paragraph (b) on its
tax return for the short taxable year ending
May 31, 1994. On May 31, 1994, Y’s only
assets are Capital Asset, which has a fair
market value of $100,000 and a basis of
$40,000 as of the end of May 30, 1994, and
$50,000 cash. Y also has an unrestricted net
operating loss carryforward of $12,000 and
accumulated earnings and profits of $50,000.
Y has no taxable income for the short taxable
year ending May 31, 1994, other than gain
recognized under this paragraph (b). In 1997,
X sells Capital Asset for $110,000. Assume
the applicable corporate tax rate is 35%.
(ii) Under this paragraph (b), Y is treated
as if it sold the converted property (Capital
Asset and $50,000 cash) at fair market value
on May 30, 1994, recognizing $60,000 of gain
($150,000 amount realized—$90,000 basis). Y
must report the gain on its tax return for the
short taxable year ending May 31, 1994. Y
may offset this gain with its $12,000 net
operating loss carryforward and will pay tax
of $16,800 (35% of $48,000).
(iii) Under section 381, X succeeds to Y’s
accumulated earnings and profits. Y’s
accumulated earnings and profits of $50,000
increase by $60,000 and decrease by $16,800
as a result of the deemed sale. Thus, the
aggregate amount of subchapter C earnings
and profits that must be distributed to satisfy
section 852(a)(2)(B) is $93,200 ($50,000 +
$60,000 ¥ $16,800). X’s basis in Capital
Asset is $100,000. On X’s sale of Capital
Asset in 1997, X recognizes $10,000 of gain,
which is taken into account in computing X’s
net capital gain for purposes of section
852(b)(3).

(c) Election of section 1374
treatment—(1) In general—(i) Property
owned by a C corporation that becomes
property of a RIC or REIT. Paragraph (b)
of this section does not apply if the RIC
or REIT that was formerly a C
corporation or that acquired property
from a C corporation makes the election
described in paragraph (c)(4) of this
section. A RIC or REIT that makes such
an election will be subject to tax on the

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net built-in gain in the converted
property under the rules of section 1374
and the regulations thereunder, as
modified by this paragraph (c), as if the
RIC or REIT were an S corporation.
(ii) Property subject to the rules of
section 1374 owned by a RIC, REIT, or
S corporation that becomes property of
a RIC or REIT. If property subject to the
rules of section 1374 owned by a RIC,
a REIT, or an S corporation (the
predecessor) becomes the property of a
RIC or REIT (the successor) in a
continuation transaction, the rules of
section 1374 apply to the successor to
the same extent that the predecessor
was subject to the rules of section 1374
with respect to such property, and the
10-year recognition period of the
successor with respect to such property
is reduced by the portion of the 10-year
recognition period of the predecessor
that expired before the date of the
continuation transaction. For this
purpose, a continuation transaction
means the qualification of the
predecessor as a RIC or REIT or the
transfer of property from the
predecessor to the successor in a
transaction in which the successor’s
basis in the transferred property is
determined, in whole or in part, by
reference to the predecessor’s basis in
that property.
(2) Modification of section 1374
treatment—(i) Net recognized built-in
gain for REITs—(A) Prelimitation
amount. The prelimitation amount
determined as provided in § 1.1374–
2(a)(1) is reduced by the portion of such
amount, if any, that is subject to tax
under section 857(b)(4), (5), (6), or (7).
For this purpose, the amount of a REIT’s
recognized built-in gain that is subject
to tax under section 857(b)(5) is
computed as follows:
(1) Where the tax under section
857(b)(5) is computed by reference to
section 857(b)(5)(A), the amount of a
REIT’s recognized built-in gain that is
subject to tax under section 857(b)(5) is
the tax imposed by section 857(b)(5)
multiplied by a fraction the numerator
of which is the amount of recognized
built-in gain (without regard to
recognized built-in loss and recognized
built-in gain from prohibited
transactions) that is not derived from
sources referred to in section 856(c)(2)
and the denominator of which is the
gross income (without regard to gross
income from prohibited transactions) of
the REIT that is not derived from
sources referred to in section 856(c)(2).
(2) Where the tax under section
857(b)(5) is computed by reference to
section 857(b)(5)(B), the amount of a
REIT’s recognized built-in gain that is
subject to tax under section 857(b)(5) is

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the tax imposed by section 857(b)(5)
multiplied by a fraction the numerator
of which is the amount of recognized
built-in gain (without regard to
recognized built-in loss and recognized
built-in gain from prohibited
transactions) that is not derived from
sources referred to in section 856(c)(3)
and the denominator of which is the
gross income (without regard to gross
income from prohibited transactions) of
the REIT that is not derived from
sources referred to in section 856(c)(3).
(B) Taxable income limitation. The
taxable income limitation determined as
provided in § 1.1374–2(a)(2) is reduced
by an amount equal to the tax imposed
under sections 857(b)(5), (6), and (7).
(ii) Loss carryforwards, credits and
credit carryforwards—(A) Loss
carryforwards. Consistent with
paragraph (c)(1)(i) of this section, net
operating loss carryforwards and capital
loss carryforwards arising in taxable
years for which the corporation that
generated the loss was not subject to
subchapter M of chapter 1 of the
Internal Revenue Code are allowed as a
deduction against net recognized builtin gain to the extent allowed under
section 1374 and the regulations
thereunder. Such loss carryforwards
must be used as a deduction against net
recognized built-in gain for a taxable
year to the greatest extent possible
before such losses can be used to reduce
other investment company taxable
income for purposes of section 852(b) or
other real estate investment trust taxable
income for purposes of section 857(b)
for that taxable year.
(B) Credits and credit carryforwards.
Consistent with paragraph (c)(1)(i) of
this section, minimum tax credits and
business credit carryforwards arising in
taxable years for which the corporation
that generated the credit was not subject
to subchapter M of chapter 1 of the
Internal Revenue Code are allowed to
reduce the tax imposed on net
recognized built-in gain under this
paragraph (c) to the extent allowed
under section 1374 and the regulations
thereunder. Such credits and credit
carryforwards must be used to reduce
the tax imposed under this paragraph (c)
on net recognized built-in gain for a
taxable year to the greatest extent
possible before such credits and credit
carryforwards can be used to reduce the
tax, if any, on other investment
company taxable income for purposes of
section 852(b) or on other real estate
investment trust taxable income for
purposes of section 857(b) for that
taxable year.
(iii) 10-year recognition period. In the
case of a conversion transaction that is
a qualification of a C corporation as a

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RIC or REIT, the 10-year recognition
period described in section 1374(d)(7)
begins on the first day of the RIC’s or
REIT’s first taxable year. In the case of
other conversion transactions, the 10year recognition period begins on the
day the property is acquired by the RIC
or REIT.
(3) Coordination with subchapter M
rules—(i) Recognized built-in gains and
losses subject to subchapter M.
Recognized built-in gains and losses of
a RIC or REIT are included in
computing investment company taxable
income for purposes of section
852(b)(2), real estate investment trust
taxable income for purposes of section
857(b)(2), capital gains for purposes of
sections 852(b)(3) and 857(b)(3), gross
income derived from sources within any
foreign country or possession of the
United States for purposes of section
853, and the dividends paid deduction
for purposes of sections 852(b)(2)(D),
852(b)(3)(A), 857(b)(2)(B), and
857(b)(3)(A). In computing such income
and deduction items, capital loss
carryforwards and net operating loss
carryforwards that are used by the RIC
or REIT to reduce recognized built-in
gains are allowed as a deduction, but
only to the extent that they are
otherwise allowable as a deduction
against such income under the Internal
Revenue Code (including section
852(b)(2)(B)).
(ii) Treatment of tax imposed. The
amount of tax imposed under this
paragraph (c) on net recognized built-in
gain for a taxable year is treated as a loss
sustained by the RIC or the REIT during
such taxable year. The character of the
loss is determined by allocating the tax
proportionately (based on recognized
built-in gain) among the items of
recognized built-in gain included in net
recognized built-in gain. With respect to
RICs, the tax imposed under this
paragraph (c) on net recognized built-in
gain is treated as attributable to the
portion of the RIC’s taxable year
occurring after October 31.
(4) Making the section 1374 election—
(i) In general. A RIC or REIT makes a
section 1374 election with the following
statement: ‘‘[Insert name and employer
identification number of electing RIC or
REIT] elects under § 1.337–6(c) to be
subject to the rules of section 1374 and
the regulations thereunder with respect
to its property that formerly was held by
a C corporation, [insert name and
employer identification number of the C
corporation, if different from name and
employer identification number of the
RIC or REIT].’’ However, a RIC or REIT
need not file an election under this
paragraph (c), but will be deemed to
have made such an election if it can

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12821

demonstrate that it informed the
Internal Revenue Service prior to
January 2, 2002 of its intent to make a
section 1374 election. An election under
this paragraph (c) is irrevocable.
(ii) Time for making the election. An
election under this paragraph (c) may be
filed by the RIC or REIT with any
Federal income tax return filed by the
RIC or REIT on or before September 15,
2003, provided that the RIC or REIT has
reported consistently with such election
for all periods.
(5) Example. The rules of this
paragraph (c) are illustrated by the
following example:
Example. Section 1374 treatment on REIT
election. (i) X, a C corporation that is a
calendar-year taxpayer, elects to be taxed as
a REIT on its 1994 tax return, which it files
on March 15, 1995. As a result, X is a REIT
for its 1994 taxable year and would be subject
to deemed sale treatment under paragraph (b)
of this section but for X’s timely election of
section 1374 treatment under this paragraph
(c). X chooses not to rely on § 1.337(d)–5. As
of the beginning of the 1994 taxable year, X’s
property consisted of Real Property, which is
not section 1221(a)(1) property and which
had a fair market value of $100,000 and an
adjusted basis of $80,000, and $25,000 cash.
X also had accumulated earnings and profits
of $25,000, unrestricted capital loss
carryforwards of $3,000, and unrestricted
business credit carryforwards of $2,000. On
July 1, 1997, X sells Real Property for
$110,000. For its 1997 taxable year, X has no
other income or deduction items. Assume the
highest corporate tax rate is 35%.
(ii) Upon its election to be taxed as a REIT,
X retains its $80,000 basis in Real Property
and its $25,000 accumulated earnings and
profits. X retains its $3,000 of capital loss
carryforwards and its $2,000 of business
credit carryforwards. To satisfy section
857(a)(2)(B), X must distribute $25,000, an
amount equal to its earnings and profits
accumulated in non-REIT years, to its
shareholders by the end of its 1994 taxable
year.
(iii) Upon X’s sale of Real Property in 1997,
X recognizes gain of $30,000 ($110,000—
$80,000). X’s recognized built-in gain for
purposes of applying section 1374 is $20,000
($100,000 fair market value as of the
beginning of X’s first taxable year as a REIT—
$80,000 basis). Because X’s $30,000 of net
income for the 1997 taxable year exceeds the
net recognized built-in gain of $20,000, the
taxable income limitation does not apply. X,
therefore, has $20,000 net recognized built-in
gain for the year. Assuming that X has not
used its $3,000 of capital loss carryforwards
in a prior taxable year and that their use is
allowed under section 1374(b)(2) and
§ 1.1374–5, X is allowed a $3,000 deduction
against the $20,000 net recognized built-in
gain. X would owe tax of $5,950 (35% of
$17,000) on its net recognized built-in gain,
except that X may use its $2,000 of business
credit carryforwards to reduce this tax,
assuming that X has not used the credit
carryforwards in a prior taxable year and that
their use is allowed under section 1374(b)(3)

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and § 1.1374–6. Thus, X owes tax of $3,950
under this paragraph (c).
(iv) For purposes of subchapter M of
chapter 1 of the Internal Revenue Code, X’s
earnings and profits for the year increase by
$26,050 ($30,000 capital gain on the sale of
Real Property—$3,950 tax under this
paragraph (c)). For purposes of section
857(b)(2) and (b)(3), X’s net capital gain for
the year is $23,050 ($30,000 capital gain
reduced by $3,000 capital loss carryforward
and further reduced by $3,950 tax).

(d) Exceptions—(1) Gain otherwise
recognized. Paragraph (a) of this section
does not apply to any conversion
transaction to the extent that gain or loss
otherwise is recognized on such
conversion transaction. See, for
example, sections 336, 351(b), 351(e),
356, 357(c), 367, 368(a)(2)(F), and 1001.
(2) Re-election of RIC or REIT status—
(i) Generally. Except as provided in
paragraphs (d)(2)(ii) and (iii) of this
section, paragraph (a)(1) of this section
does not apply to any corporation that—
(A) Immediately prior to qualifying to
be taxed as a RIC or REIT was subject
to tax as a C corporation for a period not
exceeding two taxable years; and
(B) Immediately prior to being subject
to tax as a C corporation was subject to
tax as a RIC or REIT for a period of at
least one taxable year.
(ii) Property acquired from another
corporation while a C corporation. The
exception described in paragraph
(d)(2)(i) of this section does not apply to
property acquired by the corporation
while it was subject to tax as a C
corporation from any person in a
transaction that results in the acquirer’s
basis in the property being determined
by reference to a C corporation’s basis
in the property.
(iii) RICs and REITs previously subject
to section 1374 treatment. If the RIC or
REIT had property subject to paragraph
(c) of this section before the RIC or REIT
became subject to tax as a C corporation
as described in paragraph (d)(2)(i) of
this section, then paragraph (c) of this
section applies to the RIC or REIT upon
its requalification as a RIC or REIT,
except that the 10-year recognition
period with respect to such property is
reduced by the portion of the 10-year
recognition period that expired before
the RIC or REIT became subject to tax
as a C corporation and by the period of
time that the corporation was subject to
tax as a C corporation.
(e) Effective date. This section applies
to conversion transactions that occur on
or after June 10, 1987, and before
January 2, 2002. In lieu of applying this
section, taxpayers generally may apply
§ 1.337(d)–5 to determine the tax
consequences (for all taxable years) of
any conversion transaction that occurs

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on or after June 10, 1987 and before
January 2, 2002, except that RICs and
REITs that are subject to section 1374
treatment with respect to a conversion
transaction may not rely on § 1.337(d)–
5(b)(1), but must apply paragraphs
(c)(1)(i), (c)(2)(i), (c)(2)(ii), and (c)(3) of
this section, with respect to built-in
gains and losses recognized in taxable
years beginning on or after January 2,
2002. Taxpayers are not prevented from
relying on § 1.337(d)–5 merely because
they elect section 1374 treatment in the
manner described in paragraph (c)(4) of
this section instead of in the manner
described in § 1.337(d)–5(b)(3) and (c).
For conversion transactions that occur
on or after January 2, 2002, see
§ 1.337(d)–7.
§ 1.337(d)–6T

[Removed]

Par. 5. Section 1.337(d)–6T is
removed.
Par. 6. Section 1.337(d)–7 is added to
read as follows:
§ 1.337(d)–7 Tax on property owned by a C
corporation that becomes property of a RIC
or REIT.

(a) General rule—(1) Property owned
by a C corporation that becomes
property of a RIC or REIT. If property
owned by a C corporation (as defined in
paragraph (a)(2)(i) of this section)
becomes the property of a RIC or REIT
(the converted property) in a conversion
transaction (as defined in paragraph
(a)(2)(ii) of this section), then section
1374 treatment will apply as described
in paragraph (b) of this section, unless
the C corporation elects deemed sale
treatment with respect to the conversion
transaction as provided in paragraph (c)
of this section. See paragraph (d) of this
section for exceptions to this paragraph
(a).
(2) Definitions—(i) C corporation. For
purposes of this section, the term C
corporation has the meaning provided
in section 1361(a)(2) except that the
term does not include a RIC or REIT.
(ii) Conversion transaction. For
purposes of this section, the term
conversion transaction means the
qualification of a C corporation as a RIC
or REIT or the transfer of property
owned by a C corporation to a RIC or
REIT.
(b) Section 1374 treatment—(1) In
general—(i) Property owned by a C
corporation that becomes property of a
RIC or REIT. If property owned by a C
corporation becomes the property of a
RIC or REIT in a conversion transaction,
then the RIC or REIT will be subject to
tax on the net built-in gain in the
converted property under the rules of
section 1374 and the regulations
thereunder, as modified by this

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paragraph (b), as if the RIC or REIT were
an S corporation.
(ii) Property subject to the rules of
section 1374 owned by a RIC, REIT, or
S corporation that becomes property of
a RIC or REIT. If property subject to the
rules of section 1374 owned by a RIC,
a REIT, or an S corporation (the
predecessor) becomes the property of a
RIC or REIT (the successor) in a
continuation transaction, the rules of
section 1374 apply to the successor to
the same extent that the predecessor
was subject to the rules of section 1374
with respect to such property, and the
10-year recognition period of the
successor with respect to such property
is reduced by the portion of the 10-year
recognition period of the predecessor
that expired before the date of the
continuation transaction. For this
purpose, a continuation transaction
means the qualification of the
predecessor as a RIC or REIT or the
transfer of property from the
predecessor to the successor in a
transaction in which the successor’s
basis in the transferred property is
determined, in whole or in part, by
reference to the predecessor’s basis in
that property.
(2) Modification of section 1374
treatment—(i) Net recognized built-in
gain for REITs—(A) Prelimitation
amount. The prelimitation amount
determined as provided in § 1.1374–
2(a)(1) is reduced by the portion of such
amount, if any, that is subject to tax
under section 857(b)(4), (5), (6), or (7).
For this purpose, the amount of a REIT’s
recognized built-in gain that is subject
to tax under section 857(b)(5) is
computed as follows:
(1) Where the tax under section
857(b)(5) is computed by reference to
section 857(b)(5)(A), the amount of a
REIT’s recognized built-in gain that is
subject to tax under section 857(b)(5) is
the tax imposed by section 857(b)(5)
multiplied by a fraction the numerator
of which is the amount of recognized
built-in gain (without regard to
recognized built-in loss and recognized
built-in gain from prohibited
transactions) that is not derived from
sources referred to in section 856(c)(2)
and the denominator of which is the
gross income (without regard to gross
income from prohibited transactions) of
the REIT that is not derived from
sources referred to in section 856(c)(2).
(2) Where the tax under section
857(b)(5) is computed by reference to
section 857(b)(5)(B), the amount of a
REIT’s recognized built-in gain that is
subject to tax under section 857(b)(5) is
the tax imposed by section 857(b)(5)
multiplied by a fraction the numerator
of which is the amount of recognized

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built-in gain (without regard to
recognized built-in loss and recognized
built-in gain from prohibited
transactions) that is not derived from
sources referred to in section 856(c)(3)
and the denominator of which is the
gross income (without regard to gross
income from prohibited transactions) of
the REIT that is not derived from
sources referred to in section 856(c)(3).
(B) Taxable income limitation. The
taxable income limitation determined as
provided in § 1.1374–2(a)(2) is reduced
by an amount equal to the tax imposed
under section 857(b)(5), (6), and (7).
(ii) Loss carryforwards, credits and
credit carryforwards —(A) Loss
carryforwards. Consistent with
paragraph (b)(1)(i) of this section, net
operating loss carryforwards and capital
loss carryforwards arising in taxable
years for which the corporation that
generated the loss was not subject to
subchapter M of chapter 1 of the
Internal Revenue Code are allowed as a
deduction against net recognized builtin gain to the extent allowed under
section 1374 and the regulations
thereunder. Such loss carryforwards
must be used as a deduction against net
recognized built-in gain for a taxable
year to the greatest extent possible
before such losses can be used to reduce
other investment company taxable
income for purposes of section 852(b) or
other real estate investment trust taxable
income for purposes of section 857(b)
for that taxable year.
(B) Credits and credit carryforwards.
Consistent with paragraph (b)(1)(i) of
this section, minimum tax credits and
business credit carryforwards arising in
taxable years for which the corporation
that generated the credit was not subject
to subchapter M of chapter 1 of the
Internal Revenue Code are allowed to
reduce the tax imposed on net
recognized built-in gain under this
paragraph (b) to the extent allowed
under section 1374 and the regulations
thereunder. Such credits and credit
carryforwards must be used to reduce
the tax imposed under this paragraph
(b) on net recognized built-in gain for a
taxable year to the greatest extent
possible before such credits and credit
carryforwards can be used to reduce the
tax, if any, on other investment
company taxable income for purposes of
section 852(b) or on other real estate
investment trust taxable income for
purposes of section 857(b) for that
taxable year.
(iii) 10-year recognition period. In the
case of a conversion transaction that is
a qualification of a C corporation as a
RIC or REIT, the 10-year recognition
period described in section 1374(d)(7)
begins on the first day of the RIC’s or

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REIT’s first taxable year. In the case of
other conversion transactions, the 10year recognition period begins on the
day the property is acquired by the RIC
or REIT.
(3) Coordination with subchapter M
rules—(i) Recognized built-in gains and
losses subject to subchapter M.
Recognized built-in gains and losses of
a RIC or REIT are included in
computing investment company taxable
income for purposes of section
852(b)(2), real estate investment trust
taxable income for purposes of section
857(b)(2), capital gains for purposes of
sections 852(b)(3) and 857(b)(3), gross
income derived from sources within any
foreign country or possession of the
United States for purposes of section
853, and the dividends paid deduction
for purposes of sections 852(b)(2)(D),
852(b)(3)(A), 857(b)(2)(B), and
857(b)(3)(A). In computing such income
and deduction items, capital loss
carryforwards and net operating loss
carryforwards that are used by the RIC
or REIT to reduce recognized built-in
gains are allowed as a deduction, but
only to the extent that they are
otherwise allowable as a deduction
against such income under the Internal
Revenue Code (including section
852(b)(2)(B)).
(ii) Treatment of tax imposed. The
amount of tax imposed under this
paragraph (b) on net recognized built-in
gain for a taxable year is treated as a loss
sustained by the RIC or the REIT during
such taxable year. The character of the
loss is determined by allocating the tax
proportionately (based on recognized
built-in gain) among the items of
recognized built-in gain included in net
recognized built-in gain. With respect to
RICs, the tax imposed under this
paragraph (b) on net recognized built-in
gain is treated as attributable to the
portion of the RIC’s taxable year
occurring after October 31.
(4) Example. The rules of this
paragraph (b) are illustrated by the
following example:
Example. Section 1374 treatment on REIT
election. (i) X, a C corporation that is a
calendar-year taxpayer, elects to be taxed as
a REIT on its 2004 tax return, which it files
on March 15, 2005. As a result, X is a REIT
for its 2004 taxable year and is subject to
section 1374 treatment under this paragraph
(b). X does not elect deemed sale treatment
under paragraph (c) of this section. As of the
beginning of the 2004 taxable year, X’s
property consisted of Real Property, which is
not section 1221(a)(1) property and which
had a fair market value of $100,000 and an
adjusted basis of $80,000, and $25,000 cash.
X also had accumulated earnings and profits
of $25,000, unrestricted capital loss
carryforwards of $3,000, and unrestricted
business credit carryforwards of $2,000. On

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12823

July 1, 2007, X sells Real Property for
$110,000. For its 2007 taxable year, X has no
other income or deduction items. Assume the
highest corporate tax rate is 35%.
(ii) Upon its election to be taxed as a REIT,
X retains its $80,000 basis in Real Property
and its $25,000 accumulated earnings and
profits. X retains its $3,000 of capital loss
carryforwards and its $2,000 of business
credit carryforwards. To satisfy section
857(a)(2)(B), X must distribute $25,000, an
amount equal to its earnings and profits
accumulated in non-REIT years, to its
shareholders by the end of its 2004 taxable
year.
(iii) Upon X’s sale of Real Property in 2007,
X recognizes gain of $30,000 ($110,000—
$80,000). X’s recognized built-in gain for
purposes of applying section 1374 is $20,000
($100,000 fair market value as of the
beginning of X’s first taxable year as a REIT—
$80,000 basis). Because X’s $30,000 of net
income for the 2007 taxable year exceeds the
net recognized built-in gain of $20,000, the
taxable income limitation does not apply. X,
therefore, has $20,000 net recognized built-in
gain for the year. Assuming that X has not
used its $3,000 of capital loss carryforwards
in a prior taxable year and that their use is
allowed under section 1374(b)(2) and
§ 1.1374–5, X is allowed a $3,000 deduction
against the $20,000 net recognized built-in
gain. X would owe tax of $5,950 (35% of
$17,000) on its net recognized built-in gain,
except that X may use its $2,000 of business
credit carryforwards to reduce the tax,
assuming that X has not used the credit
carryforwards in a prior taxable year and that
their use is allowed under section 1374(b)(3)
and § 1.1374–6. Thus, X owes tax of $3,950
under this paragraph (b).
(iv) For purposes of subchapter M of
chapter 1 of the Internal Revenue Code, X’s
earnings and profits for the year increase by
$26,050 ($30,000 capital gain on the sale of
Real Property—$3,950 tax under this
paragraph (b)). For purposes of section
857(b)(2) and (b)(3), X’s net capital gain for
the year is $23,050 ($30,000 capital gain
reduced by $3,000 capital loss carryforward
and further reduced by $3,950 tax).

(c) Election of deemed sale
treatment—(1) In general. Paragraph (b)
of this section does not apply if the C
corporation that qualifies as a RIC or
REIT or transfers property to a RIC or
REIT makes the election described in
paragraph (c)(5) of this section. A C
corporation that makes such an election
recognizes gain and loss as if it sold the
converted property to an unrelated party
at fair market value on the deemed sale
date (as defined in paragraph (c)(3) of
this section). See paragraph (c)(4) of this
section concerning limitations on the
use of loss in computing gain. This
paragraph (c) does not apply if its
application would result in the
recognition of a net loss. For this
purpose, net loss is the excess of
aggregate losses over aggregate gains
(including items of income), without
regard to character.

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(2) Basis adjustment. If a corporation
recognizes a net gain under paragraph
(c)(1) of this section, then the converted
property has a basis in the hands of the
RIC or REIT equal to the fair market
value of such property on the deemed
sale date.
(3) Deemed sale date—(i) RIC or REIT
qualifications. If the conversion
transaction is a qualification of a C
corporation as a RIC or REIT, then the
deemed sale date is the end of the last
day of the C corporation’s last taxable
year before the first taxable year in
which it qualifies to be taxed as a RIC
or REIT.
(ii) Other conversion transactions. If
the conversion transaction is a transfer
of property owned by a C corporation to
a RIC or REIT, then the deemed sale
date is the end of the day before the day
of the transfer.
(4) Anti-stuffing rule. A C corporation
must disregard converted property in
computing gain or loss recognized on
the conversion transaction under this
paragraph (c), if—
(i) The converted property was
acquired by the C corporation in a
transaction to which section 351
applied or as a contribution to capital;
(ii) Such converted property had an
adjusted basis immediately after its
acquisition by the C corporation in
excess of its fair market value on the
date of acquisition; and
(iii) The acquisition of such converted
property by the C corporation was part
of a plan a principal purpose of which
was to reduce gain recognized by the C
corporation in connection with the
conversion transaction. For purposes of
this paragraph (c)(4), the principles of
section 336(d)(2) apply.
(5) Making the deemed sale election.
A C corporation (or a partnership to
which the principles of this section
apply under paragraph (e) of this
section) makes the deemed sale election
with the following statement: ‘‘[Insert
name and employer identification
number of electing corporation or
partnership] elects deemed sale
treatment under § 1.337(d)-7(c) with
respect to its property that was
converted to property of, or transferred
to, a RIC or REIT, [insert name and
employer identification number of the
RIC or REIT, if different from the name
and employer identification number of
the C corporation or partnership].’’ This
statement must be attached to the
Federal income tax return of the C
corporation or partnership for the
taxable year in which the deemed sale
occurs. An election under this
paragraph (c) is irrevocable.

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(6) Examples. The rules of this
paragraph (c) are illustrated by the
following examples:
Example 1. Deemed sale treatment on
merger into RIC. (i) X, a calendar-year
taxpayer, has qualified as a RIC since January
1, 2001. On May 31, 2004, Y, a C corporation
and calendar-year taxpayer, transfers all of its
property to X in a transaction that qualifies
as a reorganization under section
368(a)(1)(C). As a result of the transfer, Y
would be subject to section 1374 treatment
under paragraph (b) of this section but for its
timely election of deemed sale treatment
under this paragraph (c). As a result of such
election, Y is subject to deemed sale
treatment on its tax return for the short
taxable year ending May 31, 2004. On May
31, 2004, Y’s only assets are Capital Asset,
which has a fair market value of $100,000
and a basis of $40,000 as of the end of May
30, 2004, and $50,000 cash. Y also has an
unrestricted net operating loss carryforward
of $12,000 and accumulated earnings and
profits of $50,000. Y has no taxable income
for the short taxable year ending May 31,
2004, other than gain recognized under this
paragraph (c). In 2007, X sells Capital Asset
for $110,000. Assume the applicable
corporate tax rate is 35%.
(ii) Under this paragraph (c), Y is treated
as if it sold the converted property (Capital
Asset and $50,000 cash) at fair market value
on May 30, 2004, recognizing $60,000 of gain
($150,000 amount realized—$90,000 basis). Y
must report the gain on its tax return for the
short taxable year ending May 31, 2004. Y
may offset this gain with its $12,000 net
operating loss carryforward and will pay tax
of $16,800 (35% of $48,000).
(iii) Under section 381, X succeeds to Y’s
accumulated earnings and profits. Y’s
accumulated earnings and profits of $50,000
increase by $60,000 and decrease by $16,800
as a result of the deemed sale. Thus, the
aggregate amount of subchapter C earnings
and profits that must be distributed to satisfy
section 852(a)(2)(B) is $93,200 ($50,000 +
$60,000¥$16,800). X’s basis in Capital Asset
is $100,000. On X’s sale of Capital Asset in
2007, X recognizes $10,000 of gain which is
taken into account in computing X’s net
capital gain for purposes of section 852(b)(3).
Example 2. Loss limitation. (i) Assume the
facts are the same as those described in
Example 1, but that, prior to the
reorganization, a shareholder of Y
contributed to Y a capital asset, Capital Asset
2, which has a fair market value of $10,000
and a basis of $20,000, in a section 351
transaction.
(ii) Assuming that Y’s acquisition of
Capital Asset 2 was made pursuant to a plan
a principal purpose of which was to reduce
the amount of gain that Y would recognize
in connection with the conversion
transaction, Capital Asset 2 would be
disregarded in computing the amount of Y’s
net gain on the conversion transaction.

(d) Exceptions—(1) Gain otherwise
recognized. Paragraph (a) of this section
does not apply to any conversion
transaction to the extent that gain or loss
otherwise is recognized on such

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conversion transaction. See, for
example, sections 336, 351(b), 351(e),
356, 357(c), 367, 368(a)(2)(F), and 1001.
(2) Re-election of RIC or REIT status—
(i) Generally. Except as provided in
paragraphs (d)(2)(ii) and (iii) of this
section, paragraph (a)(1) of this section
does not apply to any corporation that—
(A) Immediately prior to qualifying to
be taxed as a RIC or REIT was subject
to tax as a C corporation for a period not
exceeding two taxable years; and
(B) Immediately prior to being subject
to tax as a C corporation was subject to
tax as a RIC or REIT for a period of at
least one taxable year.
(ii) Property acquired from another
corporation while a C corporation. The
exception described in paragraph
(d)(2)(i) of this section does not apply to
property acquired by the corporation
while it was subject to tax as a C
corporation from any person in a
transaction that results in the acquirer’s
basis in the property being determined
by reference to a C corporation’s basis
in the property.
(iii) RICs and REITs previously subject
to section 1374 treatment. If the RIC or
REIT had property subject to paragraph
(b) of this section before the RIC or REIT
became subject to tax as a C corporation
as described in paragraph (d)(2)(i) of
this section, then paragraph (b) of this
section applies to the RIC or REIT upon
its requalification as a RIC or REIT,
except that the 10-year recognition
period with respect to such property is
reduced by the portion of the 10-year
recognition period that expired before
the RIC or REIT became subject to tax
as a C corporation and by the period of
time that the corporation was subject to
tax as a C corporation.
(e) Special rule for partnerships. The
principles of this section apply to
property transferred by a partnership to
a RIC or REIT to the extent of any C
corporation partner’s distributive share
of the gain or loss in the transferred
property. If the partnership were to elect
deemed sale treatment under paragraph
(c) of this section in lieu of section 1374
treatment under paragraph (b) of this
section with respect to such transfer,
then any net gain recognized by the
partnership on the deemed sale must be
allocated to the C corporation partner,
but does not increase the capital
account of any partner. Any adjustment
to the partnership’s basis in the RIC or
REIT stock as a result of deemed sale
treatment under paragraph (c) of this
section shall constitute an adjustment to
the basis of that stock with respect to
the C corporation partner only. The
principles of section 743 apply to such
basis adjustment.

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Federal Register / Vol. 68, No. 52 / Tuesday, March 18, 2003 / Rules and Regulations
(f) Effective date. This section applies
to conversion transactions that occur on
or after January 2, 2002. For conversion
transactions that occurred on or after
June 10, 1987, and before January 2,
2002, see §§ 1.337(d)–5 and 1.337(d)–6.
§ 1.337(d)–7T

§ 1.514(c)–2 Permitted allocations under
section 514(c)(9)(E).

*

*
*
*
*
(e) * * *
(1) * * *
(v) Allocations made in taxable years
beginning on or after January 1, 2002,
that are mandated by statute or
regulation other than subchapter K of
chapter 1 of the Internal Revenue Code
and the regulations thereunder.
PART 602—[AMENDED]
Par. 9. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.

Par. 10. In § 602.101, paragraph (b) is
amended by removing the entries for
‘‘1.337(d)–5T’’, ‘‘1.337(d)–6T’’, and
‘‘1.337–7T’’ and adding entries in
numerical order to the table to read as
follows:
OMB Control numbers.

*
*
(b) * * *

*

*

CFR part or section where
identified or described

Current OMB
control No.

*
*
*
*
1.337(d)–5 ............................
1.337(d)–6 ............................
1.337(d)–7 ............................
*

*

*

*

*
1545–1672
1545–1672
1545–1672
*

David A. Mader,
Assistant Deputy Commissioner of Internal
Revenue.
Approved: March 7, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03–6221 Filed 3–13–03; 1:16 pm]
BILLING CODE 4830–01–P

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16:08 Mar 17, 2003

[MO 175–1175a; FRL–7467–8]

AGENCY: Environmental Protection
Agency (EPA).
ACTION: Direct final rule.

Par. 8. In § 1.514(c)–2, paragraph
(e)(1)(v) is added to read as follows:

*

40 CFR Part 52

Approval and Promulgation of
Implementation Plans; State of
Missouri

[Removed]

Par. 7. Section 1.337(d)–7T is
removed.

§ 602.101

ENVIRONMENTAL PROTECTION
AGENCY

SUMMARY: EPA is announcing it is
approving a revision to the Missouri
State Implementation Plan (SIP). This
revision pertains to the revision of a
Missouri air program rule which
controls volatile organic compound
emissions in the Kansas City area. The
effect of this approval is to ensure
Federal enforceability of the State air
program rules and to maintain
consistency between the State-adopted
rules and the approved SIP.
DATES: This direct final rule will be
effective May 19, 2003, unless EPA
receives adverse comments by April 17,
2003. If adverse comments are received,
EPA will publish a timely withdrawal of
the direct final rule in the Federal
Register informing the public that the
rule will not take effect.
ADDRESSES: Comments may be mailed to
Wayne Kaiser, Environmental
Protection Agency, Air Planning and
Development Branch, 901 North 5th
Street, Kansas City, Kansas 66101.
Copies of documents relative to this
action are available for public
inspection during normal business
hours at the above-listed Region 7
location. The interested persons
wanting to examine these documents
should make an appointment with the
office at least 24 hours in advance.
FOR FURTHER INFORMATION CONTACT:
Wayne Kaiser at (913) 551–7603.
SUPPLEMENTARY INFORMATION:
Throughout this document whenever
‘‘we,’’ ‘‘us,’’ or ‘‘our’’ is used, we mean
EPA. This section provides additional
information by addressing the following
questions:

What is a SIP?
What is the Federal approval process for a
SIP?
What does Federal approval of a State
regulation mean to me?
What is being addressed in this document?
Have the requirements for approval of a SIP
revision been met?
What action is EPA taking?

What Is a SIP?
Section 110 of the Clean Air Act
(CAA) requires States to develop air
pollution regulations and control

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12825

strategies to ensure that State air quality
meets the national ambient air quality
standards established by EPA. These
ambient standards are established under
section 109 of the CAA, and they
currently address six criteria pollutants.
These pollutants are: carbon monoxide,
nitrogen dioxide, ozone, lead,
particulate matter, and sulfur dioxide.
Each State must submit these
regulations and control strategies to us
for approval and incorporation into the
Federally-enforceable SIP.
Each Federally-approved SIP protects
air quality primarily by addressing air
pollution at its point of origin. These
SIPs can be extensive, containing State
regulations or other enforceable
documents and supporting information
such as emission inventories,
monitoring networks, and modeling
demonstrations.
What Is the Federal Approval Process
for a SIP?
In order for State regulations to be
incorporated into the Federallyenforceable SIP, States must formally
adopt the regulations and control
strategies consistent with State and
Federal requirements. This process
generally includes a public notice,
public hearing, public comment period,
and a formal adoption by a Stateauthorized rulemaking body.
Once a State rule, regulation, or
control strategy is adopted, the State
submits it to us for inclusion into the
SIP. We must provide public notice and
seek additional public comment
regarding the proposed Federal action
on the State submission. If adverse
comments are received, they must be
addressed prior to any final Federal
action by us.
All State regulations and supporting
information approved by EPA under
section 110 of the CAA are incorporated
into the Federally-approved SIP.
Records of such SIP actions are
maintained in the Code of Federal
Regulations (CFR) at title 40, part 52,
entitled ‘‘Approval and Promulgation of
Implementation Plans.’’ The actual State
regulations which are approved are not
reproduced in their entirety in the CFR
outright but are ‘‘incorporated by
reference,’’ which means that we have
approved a given State regulation with
a specific effective date.
What Does Federal Approval of a State
Regulation Mean to Me?
Enforcement of the State regulation
before and after it is incorporated into
the Federally-approved SIP is primarily
a State responsibility. However, after the
regulation is Federally approved, we are
authorized to take enforcement action

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