Reg-157711-02

Part IV. Items of General Interest
Notice of Proposed
Rulemaking
Unified Rule for Loss on
Subsidiary Stock
REG–157711–02

(202) 622–7700 or Phoebe Bennett
(202) 622–7770; concerning submissions of comments, Richard Hurst,
[email protected],
(202) 622–7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act

AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking.
SUMMARY: This document contains
proposed regulations under sections 358,
362(e)(2) and 1502 of the Internal Revenue Code (Code). The regulations apply
to corporations filing consolidated returns. The regulations implement aspects
of the repeal of the General Utilities doctrine by redetermining members’ bases
in subsidiary stock and requiring certain
reductions in subsidiary stock basis on a
transfer of the stock. The regulations also
promote the clear reflection of income
by redetermining members’ bases in subsidiary stock and reducing the subsidiary’s
attributes to prevent the duplication of
loss. Additionally, the regulations provide
guidance limiting the application of section 362(e)(2) with respect to transactions
between members of a consolidated group.
DATES: Written or electronic comments
or a request for a public hearing must be
received by April 23, 2007.
ADDRESSES: Send submissions to:
CC:PA:LPD:PR
(REG–157711–02),
room 5203, Internal Revenue Service, PO 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–157711–02), Courier’s Desk, Internal Revenue Service, 1111 Constitution
Avenue, N.W., Washington, DC, or sent
electronically, via the IRS Internet site at
www.irs.gov/regs or via the Federal eRulemaking Portal at www.regulations.gov
(IRS/REG–157711–02).
FOR
FURTHER
INFORMATION
CONTACT:
Concerning
the
proposed regulations,
Theresa Abell

2007–8 I.R.B.

The collection of information contained
in this notice of proposed rulemaking has
been submitted to the Office of Management and Budget for review in accordance
with the Paperwork Reduction Act of 1995
(44 U.S.C. 3507(d)). Comments on the
collection of information should be sent
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, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance
Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of information should be received by
March 26, 2007.
Comments are specifically requested
concerning:
Whether the proposed collection of information is necessary for the proper performance of the functions of the IRS, including whether the information will have
practical utility;
The accuracy of the estimated burden
associated with the proposed collection of
information;
How the quality, utility, and clarity of
the information to be collected may be enhanced;
How the burden of complying with the
proposed collection of information may be
minimized, including through the application of automated collection techniques
or other forms of information technology;
and
Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of services to provide information.
The
collection
of
information in these proposed regulations
is
in
§§1.1502–13(e)(4)(v)
and
1.1502–36(d)(6).
The respondents
are corporations filing consolidated
returns. The collection of information is

537

required to allow a corporation to preserve
a subsidiary’s attributes by foregoing a
stock loss. The collection of information
is required to obtain a benefit.
Estimated total annual reporting and/or
recordkeeping burden: 25 hours.
Estimated average annual burden per
respondent and/or recordkeeper: 15 minutes.
Estimated number of respondents
and/or recordkeepers: 100.
Estimated annual frequency of responses: Once.
An agency may not conduct or sponsor,
and a person is not required to respond to, a
collection of information unless it displays
a valid control number assigned by the Office of Management and Budget.
Books or records relating to the collection of information must be retained as
long as their contents may become material in the administration of any Internal
Revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
The discussion in this preamble begins
with an overview of the history of the
regulatory attempts to address both the
circumvention of General Utilities repeal
and the duplication of loss by consolidated
groups, in particular, in §1.1502–20 (the
Loss Disallowance Rule, or LDR). The
discussion then turns to Rite Aid Corp. v.
United States, 255 F.3d 1357 (Fed. Cir.
2001), which rejected the loss duplication rule in the LDR. Section A.4 of this
preamble discusses the immediate administrative responses to Rite Aid. Section
A.5 of this preamble discusses the legislative response to Rite Aid. Following the
Rite Aid decision, the IRS and Treasury
Department undertook a study to reconsider the issues addressed by §1.1502–20.
Section B of this preamble discusses the
various issues considered in that study,
including both the original noneconomic
and duplicated stock loss specifically addressed by the LDR and certain related
issues with which the Internal Revenue
Service and Treasury Department have
grown concerned since the LDR was promulgated. Section C of this preamble
describes the various approaches that were

February 20, 2007

considered to address noneconomic stock
loss and sets forth the conclusions reached
regarding each. Section D of this preamble describes the various approaches that
were considered to address loss duplication and sets forth the conclusions reached
regarding each. Section E of this preamble
describes the various approaches that were
considered to address the noneconomic
and duplicated loss that can arise from the
general operation of the investment adjustment system and sets forth the conclusions
reached regarding each. Section F of this
preamble describes the specific provisions
of this proposed regulation §1.1502–36.
Section G of this preamble discusses
the proposed removal of §§1.337(d)–1,
1.337(d)–2, and 1.1502–35.
The IRS and Treasury Department are
also proposing regulations to address the
application of section 362(e)(2) to members of consolidated groups. These proposed regulations are described in section
H of this preamble.
Finally, the IRS and Treasury Department are proposing various technical and
administrative revisions to the consolidated return regulations. These proposed
regulations are described in section I of
this preamble.
The IRS and Treasury Department request comments on the proposed regulations and other approaches that could be
adopted, as well as other issues currently
under study. See section J of this preamble for further discussion of comments requested.
A. History of General Utilities Repeal and
Loss Disallowance under §1.1502–20.
1. The repeal of the General Utilities
doctrine.
In 1986, Congress enacted section
337(d), which directs the Secretary to prescribe such regulations as may be necessary or appropriate to carry out the repeal
of the General Utilities doctrine (GU repeal). See Tax Reform Act of 1986, Public
Law 99–514 (100 Stat. 2085 (1986)). The
legislative history states that Congress
was concerned that the General Utilities
doctrine allowed “assets to leave corporate
solution and to take a stepped-up basis in
the hands of the transferee without the
imposition of a corporate-level tax” and
thus “tend[ed] to undermine the corpo-

February 20, 2007

rate income tax.” H.R. Rep. No. 99–426,
99th Cong., 1st Sess. 282 (1985). The
General Utilities doctrine and GU repeal
are discussed extensively in the Treasury
Decisions referenced in this preamble; in
addition, see generally, H.R. Rep. No.
99–426 at 274–282 for a discussion of the
history of the General Utilities doctrine;
see also General Utilities & Operating Co.
v. Helvering, 296 U.S. 200 (1935).
2. The administrative response to GU
repeal: §1.1502–20.
The IRS and Treasury Department first
responded to GU repeal by issuing Notice 87–14, 1987–1 C.B. 445, which set
forth the intent to promulgate regulations
affecting adjustments to members’ bases in
stock of any subsidiary acquired when the
subsidiary held an appreciated asset. Notice 87–14 indicated that, in general, adjustments to subsidiary stock basis would
not reflect gains on such assets. Thus,
Notice 87–14 implied that a tracing-based
regime would be adopted to determine adjustments to members’ bases in shares of
subsidiary stock.
After several years of study, the IRS
and Treasury Department concluded that
any approach relying on the identification
and tracing of appreciation on particular
assets, while theoretically accurate, would
impose substantial administrative burdens
on taxpayers and on the government. See
T.D. 8294, 1990–1 C.B. 66 [55 FR 9426,
9428] (March 14, 1990). As a result, the
tracing-based approach envisioned in Notice 87–14 was implemented only in regulations promulgated under section 337(d).
Those regulations applied only for the period of time between the issuance of Notice 87–14 and the effective date of final regulations under §1.1502–20 (February 1, 1991). See T.D. 8364, 1991–2
C.B. 43 [56 FR 47379] (September 19,
1991), §§1.337(d)–1 and 1.337(d)–2 (as
contained in 26 CFR part 1 revised as of
April 1, 1991).
In lieu of tracing, the LDR used certain
operating presumptions to determine the
extent to which investment adjustments
would be permitted to give rise to allowable stock loss. Because the LDR only
disallowed loss, noneconomic investment
adjustments were able to increase stock
basis and thus reduce gain without limitation. As a result, the LDR reduced

538

the duplication of gain in the tax system.
The IRS and Treasury Department considered the reduction of gain duplication
an important balance to the imprecision
inherent in the LDR’s use of irrebuttable
presumptions.
The study following the issuance of
Notice 87–14 led the IRS and Treasury
Department to consider the issue of loss
duplication by members of consolidated
groups. Their conclusion was that loss
duplication was inappropriate in the consolidated setting. Further, the IRS and
Treasury Department recognized that
there were administrative advantages to
addressing both issues in a single integrated rule. Thus, unlike the regulations
under section 337(d), the LDR was at once
directed at both the circumvention of GU
repeal through the use of noneconomic
stock loss and the duplication of loss. See
T.D. 8294 and T.D. 8364.
3. The Rite Aid opinion.
Ten years after the promulgation of the
LDR, the validity of the duplicated loss
component of the LDR was considered in
Rite Aid, supra. Under the duplicated loss
component of the LDR, Rite Aid had been
disallowed a deduction for an economic
loss on subsidiary stock solely because the
stock loss could be duplicated by the subsidiary after it left the group. The Federal
Circuit stated that the Secretary’s authority
to change the application of a Code provision to a consolidated group was limited to
situations in which the change was necessary to address a problem created by the
filing of a consolidated return. Because
duplicated stock loss occurs and is allowable in the separate return setting, the court
concluded that the duplicated loss component of the LDR was not addressing a problem arising from the filing of a consolidated return. Accordingly, the court held
that the Secretary did not have the authority to change the Code rule allowing a deduction for the stock loss.
4. The administrative response to Rite
Aid.
In response to the Rite Aid decision, on
February 19, 2002, the IRS announced that
it would not continue to litigate the validity
of the duplicated loss rule in §1.1502–20.
See Notice 2002–11, 2002–1 C.B. 526.

2007–8 I.R.B.

On March 7, 2002, the IRS and Treasury
Department promulgated §1.1502–20T(i)
(to suspend the application of the LDR)
and §1.337(d)–2T (to provide an interim
rule addressing noneconomic stock loss).
See T.D. 8984, 2002–1 C.B. 668 [67 FR
11034] (March 12, 2002). Concurrently
with the promulgation of §§1.337(d)–2T
and 1.1502–20T(i), the IRS issued Notice 2002–18, 2002–1 C.B. 644, announcing that loss duplication regulations would
also be promulgated. Following the publication of T.D. 8984, the IRS and Treasury
Department undertook a study of the issues
underlying both noneconomic and duplicated loss on subsidiary stock.
In general, §1.337(d)–2T disallowed
stock loss and reduced stock basis (to
value) upon the disposition or deconsolidation of subsidiary stock by a member
of a consolidated group. However, under
§1.337(d)–2T(c)(2), loss disallowance and
basis reduction were avoided to the extent
the taxpayer could establish that the loss or
basis “is not attributable to the recognition
of built-in gain on the disposition of an
asset.” Section 1.337(d)–2T(c)(2) defined
the term “built-in gain” as gain that is “attributable, directly or indirectly, in whole
or in part, to any excess of value over basis
that is reflected, before the disposition of
the asset, in the basis of the share, directly
or indirectly, in whole or in part.”
On March 14, 2003, the IRS and
Treasury
Department
promulgated
§1.1502–35T as an interim measure to
address the problem of loss duplication in consolidated groups. See T.D.
9048, 2003–1 C.B. 644 [68 FR 12287]
(March 14, 2003). In the preamble to T.D.
9048, the IRS and Treasury Department
announced that the issues addressed in
§1.1502–35T were still under study. The
provisions of §1.1502–35 are discussed in
more detail in section D.1 of this preamble.
Further guidance on the interim rules
was issued August 25, 2004, in the form
of Notice 2004–58, 2004–2 C.B. 520. In
Notice 2004–58, the IRS announced that
it would accept the “basis disconformity”
method as an alternative approach to determining whether stock loss or basis was
attributable to “built-in gain” within the
meaning of §1.337(d)–2T.
Under the basis disconformity method
described in Notice 2004–58, stock loss or
basis is treated as attributable to built-in

2007–8 I.R.B.

gain to the extent of the least of (i) the
net positive investment adjustment applied
to the stock basis (disregarding distributions), (ii) the aggregate gain (net of directly related expenses) recognized on asset dispositions by the subsidiary, and (iii)
the disconformity amount (generally, the
amount by which the basis of the share exceeds the share’s proportionate interest in
the subsidiary’s net inside asset basis; for
this purpose, net inside asset basis is defined as the excess of the sum of the subsidiary’s money, asset basis, loss carryforwards, and deferred deductions over its liabilities). Notice 2004–58 also requested
comments on the general scope of GU repeal and on other approaches that could be
adopted to safeguard the purposes of GU
repeal in the consolidated return context.
5. The legislative response to Rite Aid.
Congress responded to the Rite Aid
opinion on October 22, 2004, in the American Jobs Creation Act (the AJCA), Public Law No. 108–357 (118 Stat. 1418
(2004)). In the AJCA, Congress added a
sentence at the end of section 1502 of the
Code, so that the section now reads:
The Secretary shall prescribe such regulations as he may deem necessary in
order that the tax liability of any affiliated group of corporations making
a consolidated return and of the each
corporation in the group, both during
and after the period of affiliation, may
be returned, determined, computed, assessed, collected, and adjusted, in such
manner as clearly to reflect the income
tax liability and the various factors necessary for the determination of such liability, and in order to prevent avoidance
of such tax liability. In carrying out the
preceding sentence, the Secretary may
prescribe rules that are different from
the provisions of chapter 1 that would
apply if such corporations filed separate
returns.
In the legislative history to the AJCA,
Congress stated that the Secretary is authorized to change the application of a Code
provision when the Secretary determines it
is necessary to clearly reflect the income
tax liability of the group and each corporation in the group, both during and after the
period of affiliation. See H.R. Conf. Rep.
No. 108–755, 108th Cong., 2d Sess. 653
(2004). Congress thus rejected the sugges-

539

tion in the Rite Aid opinion that the Secretary’s authority to change the general application of the Code is limited to promulgating regulations that address problems
created by the filing of a consolidated return.
In the AJCA legislative history, Congress also spoke to the proper scope of
future regulations. Regarding the promulgation of regulations addressing noneconomic stock loss, Congress stated that
“presumptions and other simplifying conventions” could be used to prevent the
circumvention of GU repeal. See H.R.
Conf. Rep. No. 108–755, fn. 595. In addition, Congress indicated two acceptable
methods for addressing loss duplication
by group members. The first would disallow subsidiary stock loss to the extent it
duplicates losses that remain available to
the group. The second would reduce the
subsidiary’s attributes in order to prevent
the subsidiary from using losses outside
the group, to the extent the losses duplicate stock loss. But Congress also stated
its intention that the result of the Rite Aid
decision is to be preserved. The IRS and
Treasury Department interpret this statement to mean that regulations addressing
loss duplication by consolidated groups
must not disallow a deduction for an economic loss on subsidiary stock solely
because the stock loss duplicates unrecognized or unabsorbed losses that later could
be used outside the group.
6. Further administrative response to Rite
Aid.
On March 3, 2005, the IRS and Treasury Department finalized §1.337(d)–2.
See T.D. 9187, 2005–1 C.B. 778 [70 FR
10319] (March 3, 2005). In T.D. 9187,
the IRS and Treasury Department stated
that the issues addressed in §1.337(d)–2
were still under study and that an alternative approach would be proposed. On
March 14, 2006, the IRS and Treasury
Department finalized §1.1502–35. See
T.D. 9254, 2006–13 I.R.B. 662 [71 FR
13008] (March 14, 2006). In T.D. 9254,
the IRS and Treasury Department stated
that both noneconomic and duplicated loss
were still under study, and that regulations
would be proposed adopting a singe integrated approach to addressing both issues.
The results of that study and the proposed

February 20, 2007

integrated approach are described below
in sections D through H of this preamble.
B. Issues Considered in the Post-Rite Aid
Study.
1. GU repeal and noneconomic investment
adjustments under the LDR.
Section 337(d) generally directs the
Secretary to prescribe regulations to prevent the circumvention of GU repeal and,
in particular, section 337(d)(1) directs the
Secretary to promulgate regulations to
prevent the circumvention of GU repeal
through the use of the consolidated return regulations. Congress’ concern stems
from the general operation of the investment adjustment system of §1.1502–32.
The purpose of the investment adjustment system is to promote the clear
reflection of the group’s income. See
§1.1502–32(a)(1). One of the principal ways that the investment adjustment
system promotes clear reflection is by
preventing a subsidiary’s items of income,
gain, deduction and loss from giving rise to
duplicative gain or loss on the subsidiary’s
stock. To that end, the investment adjustment system adjusts members’ bases
in shares of subsidiary stock to reflect
such items once they have been taken into
account by the group. See T.D. 8560,
1994–2 C.B. 200 [59 FR 41666] (August
15, 1994).
Example 1. Economic adjustment to stock basis
prevents duplication. P, the common parent of a consolidated group, purchases all 100 outstanding shares
of S common stock for $100 cash, taking a basis of $1
in each share. At the time, S owns one asset, A1, with
a basis and value of $100. Later, the value of A1 increases to $150. S sells A1 to a nonmember for $150
and recognizes a $50 gain, which the P group takes
into account. Under the investment adjustment system, P increases its basis in its S stock to reflect the
$50 taken into account by the group. As a result, the
basis of each share increases to $1.50, its fair market
value. P can then sell all or any portion of its S stock
for its fair market value without recognizing duplicative gain on the disposition.

The result in Example 1 is that the group
takes its economic gain into account only
once, on the disposition of S’s asset, and
not again on the subsequent disposition of
the S stock. Thus the group’s income is
clearly reflected and there is no circumvention of GU repeal.
The investment adjustment system is
not a tracing regime. Rather, it is a presumptive regime based on certain operating assumptions. A principal assumption

February 20, 2007

is that all of a subsidiary’s items taken into
account represent economic accruals (of
gain or loss) to the group. Another principal assumption is that all such items accrue
equally to all outstanding shares, at least
within a class. When these assumptions
correspond to the facts of a particular situation, as in Example 1, the investment adjustment system produces appropriate results: stock basis, which reflects only the
investment in the stock, increases to reflect economic accrual (the group’s return
on its stock investment), and, as a result,
stock basis can then shelter that return on
the group’s investment, protecting it from
being taken into account again when the
stock is sold.
The assumptions, however, do not correspond to the facts of all situations. For
example, if stock of a subsidiary is purchased for its fair market value when the
subsidiary holds appreciated assets, the
items of income or gain generated when
that appreciation is recognized do not represent an economic accrual on the group’s
investment (because the appreciation was
already reflected in the basis of the stock).
Nevertheless, the presumptive rules of the
investment adjustment system treat such
items as economic accruals and include
them in the investment adjustment to be
applied to the basis of the stock.
Example 2. Noneconomic adjustment to stock basis creates noneconomic stock loss. Assume the same
facts as in Example 1 except that P does not purchase
the stock of S until the value of A1 has increased to
$150. Accordingly, P purchases the stock for $150,
taking a basis of $1.50 in each share. As in Example
1, when S sells A1, the investment adjustment system again increases P’s basis in its S stock to reflect
the $50 taken into account by the group. As a result,
P’s basis in each of its shares increases to $2, even
though the fair market value of each share remains
$1.50. If P were then to sell all or some portion of the
S stock for its fair market value, P would recognize a
$.50 loss on each share ($50 loss in the aggregate).

In this situation, a deduction for the
stock loss would be inappropriate because
neither the group nor its members have
suffered any economic loss. If P were allowed to deduct that noneconomic loss, the
deduction would offset the gain recognized
on S’s asset and, effectively, eliminate the
corporate-level tax on the gain on S’s asset. This is the circumvention of GU repeal that concerned Congress in 1986.
At the time Notice 87–14 was issued,
the IRS and Treasury Department had
identified the creation of noneconomic
stock loss in situations similar to those

540

illustrated in Example 2. Thus, Notice
87–14 referred specifically to investment
adjustments attributable to the disposition
of assets that, at the time of the acquisition of the subsidiary stock, had a fair
market value in excess of adjusted basis. For that reason, §1.337(d)–1, which
implemented Notice 87–14, disallowed
subsidiary stock loss unless the taxpayer
could show that the loss was not attributable to the recognition of appreciation on
assets owned, directly or indirectly, by a
subsidiary when it became a member.
2. Duplicated loss and the clear reflection
of group income under the LDR.
In the study that followed the issuance
of Notice 87–14, the IRS and Treasury Department also considered the issue of loss
duplication by members of a consolidated
group. The specific concern of the IRS and
Treasury Department was the loss duplication that occurs when an economic loss is
reflected in both a member’s basis in subsidiary stock and in the subsidiary’s assets
or operations, and the loss is first recognized with respect to the stock.
Example 3. Duplication of loss. P forms S by
contributing $110 to S in exchange for all 100 outstanding shares of S stock. S uses the cash to purchase an asset, A1. The value of A1 later declines to
$10. If P were then to sell all or some portion of the
S stock for its fair market value, P would recognize a
$1 loss on each share.

In this situation, even though P would
have recognized the group’s economic loss
on its disposition of the S stock, the loss
continues to be reflected in the basis of
A1. As a result, that loss would remain
available for use by P (if the stock sale
did not deconsolidate S) or S (if the stock
sale deconsolidated S). Upon the disposition of A1, the group’s single economic
loss would thus be recognized and taken
into account more than once by the group
and its members or former members.
In contrast, if the duplicated loss had
first been taken into account with respect
to A1, the investment adjustment system
would have prevented a duplicative benefit to the group and its members by reducing P’s basis in S stock by the amount
of the loss. In that case, the group would
have enjoyed the tax benefit attributable to
the loss, but that benefit would not remain
available for another use by the group and
its members or former members.

2007–8 I.R.B.

The IRS and Treasury Department concluded that the duplication of a group’s
tax benefit (represented by a single economic loss) distorts income without regard to whether the duplicated loss is
taken into account first with respect to
the subsidiary’s stock or first with respect
to the subsidiary’s assets and operations.
The IRS and Treasury Department further concluded that, even if the duplicated
loss is used by a former member outside
the group, that duplicative use distorts
the income of the group and its members. Accordingly, the IRS and Treasury
Department decided to promulgate regulations that would complement the investment adjustment system by addressing
the stock-first recognition of a duplicated
loss and that such regulations would apply
to both deconsolidating and nondeconsolidating dispositions. Recognizing the
administrative benefits of addressing both
noneconomic and duplicated stock loss in
a single integrated rule, the IRS and Treasury Department promulgated the LDR as
a single rule with components directed at
both.
The method adopted by the LDR to
address loss duplication was the disallowance of stock loss (or reduction of
stock basis) that duplicated unrecognized
inside loss, such as that illustrated in Example 3. However, groups had several
mechanisms available to recognize or preserve the inside loss and thereby avoid loss
disallowance (by eliminating loss duplication). Inside losses could be recognized
through an actual asset sale or a deemed
asset sale under section 338(h)(10), and,
following the sale, the subsidiary’s unabsorbed losses would be available to
the group. In addition, the LDR allowed
the common parent to elect to reattribute
the subsidiary’s losses (to itself) under
§1.1502–20(g). If the group chose not
to exercise those options, then the stock
loss was denied, but the inside loss was
preserved for a nonduplicative use by the
subsidiary, in or out of the group.
At the time the LDR was promulgated,
the duplication potential illustrated in Example 3 was the principal form of loss duplication with which the IRS and Treasury
Department were concerned. Thus it is the
only form of loss duplication specifically
addressed by the LDR. The anti-abuse rule
in the LDR did, however, provide a limited

2007–8 I.R.B.

mechanism for expanding the scope of that
provision.
3. Noneconomic and duplicated loss
resulting from investment adjustments
allocated to shares with disparate bases.
Since the promulgation of the LDR,
the IRS and Treasury Department have
become increasingly concerned with the
noneconomic and duplicated loss potential
arising from the interaction of §1.1502–32
and the disparate reflection of gain or loss
in members’ bases in individual shares of
subsidiary stock.
As discussed in section B.1 of this preamble, the investment adjustment system
is a presumptive regime that allocates a
subsidiary’s items of income, gain, deduction, and loss taken into account by the
group. It operates in accordance with the
assumption that all such items reflect economic accruals to all shares equally within
each class. When its underlying assumptions correspond to the facts of a particular situation, the investment adjustment
system produces appropriate results, as illustrated in Example 1. But when its underlying assumptions do not correspond
to the facts of a situation because shares
held by members have disparate bases, the
general operation of the investment adjustment system can give rise to both noneconomic and duplicated loss on individual
shares of subsidiary stock.
Example 4. Noneconomic loss. P and M (a member of the P group) form S by contributing property
to S in exchange for all 100 outstanding shares of S
stock. P contributes A1, with a basis and value of
$80, in exchange for 80 shares of S stock. M contributes A2, with a basis of $0 and a value of $20, to
S in exchange for 20 shares of S stock. S then sells
A2 for $20 and recognizes a $20 gain that is taken into
account by the group. As a result, the basis of each
share increases by $.20. P’s basis in each of its shares
is then $1.20 (or, $96 in the aggregate), and M’s basis
in each of its shares is then $.20 (or, $4 in the aggregate), even though the value of each share remains $1.
P then sells all or some portion of its shares to X, a
nonmember, and, under general principles of tax law,
recognizes a $.20 noneconomic loss on each share,
effectively eliminating up to $16 of the gain on A2.
Example 5(a). Duplicated loss, inside recognition precedes stock disposition. P forms S with $100
and receives all 50 shares of S common stock. S uses
the $100 to buy A1, which then declines in value to
$50. P contributes another $50 for a second 50 shares
of common stock. S then sells A1 and recognizes a
loss of $50 that is taken into account on the P group
return. The absorption of the $50 loss results in a
$.50 reduction to the basis of each share (original and
newly issued). P then sells all or some portion of the
original shares to X for $1 each (each with a basis

541

of $1.50) and recognizes a $.50 loss on each share
(up to $25 total). Although the $50 asset loss and
the $25 stock loss both reflect an economic loss of
the group, they are both reflecting the same loss. The
group has actually experienced only $50 of economic
loss. Therefore, the $.50 loss recognized on each of
the original shares (up to $25 total) is duplicative.
Example 5(b). Duplicated loss, stock disposition
precedes inside recognition. The facts are the same
as in Example 5(a), except that, before S sells A1, P
sells 20 of its original 50 shares to X for $20 (aggregate basis $40), recognizing a $20 loss that is taken
into account on the P group return, and S remains a
member of the group. S then sells A1, recognizing
a $50 loss that is taken into account on the P group
return. Although the $50 asset loss and the $20 stock
loss both reflect an economic loss of the group, they
are both reflecting the same loss. As in Example 5(a),
the group has actually experienced only $50 of economic loss. Therefore, $20 of the recognized loss is
duplicative. Alternatively, if P sold all its original 50
shares, P would recognize a $50 loss even though the
entire $50 group loss would remain available to S for
a duplicative use against its separate year income.

The IRS and Treasury Department recognize that, in each case where the disproportionate reflection of an item in a particular share causes an inappropriate stock
loss, whether noneconomic or duplicated,
that loss is offset by unrecognized gain in
other shares. However, that gain can be
deferred indefinitely or even eliminated by
the group. Accordingly, the IRS and Treasury Department do not believe that the
system is appropriately balanced in such
cases.
The IRS and Treasury Department further recognize that these issues could be
addressed by adopting a tracing-based
approach to the allocation of investment
adjustments. However, the complexity
and burden of a tracing-based approach
would render such an approach generally
inadministrable for consolidated taxpayers and for the government. As a result,
the system would be prone to error and,
in practice, inconsistently applied. Moreover, the IRS and Treasury Department
continue to believe that the assumptions
on which the investment adjustment system is based are appropriate for typical
commercial transactions, as the IRS and
Treasury Department understand that typically subsidiaries have only common stock
outstanding, that their stock is wholly
owned by group members, and that members’ bases in shares of subsidiary stock
are uniform, as under the facts of Example 1. See section E.2 of the preamble
of CO–30–92, 1992–2 C.B. 627 [57 FR
53634, 53639] (November 12, 1992).

February 20, 2007

Because a tracing-based approach to
the allocation of investment adjustments
would not be administrable, the IRS and
Treasury Department are not considering
revising the investment adjustment system
to adopt such an approach. Instead, the
IRS and Treasury Department have considered various presumptive approaches
that could be adopted to mitigate the creation of noneconomic and duplicated loss
when members hold subsidiary stock with
disparate bases. The approaches considered and decisions reached are discussed
in section E of this preamble.
4. Redetermination events: changes in
the extent that unrecognized gain or loss
is effectively reflected in the basis of
individual shares.
Because the investment adjustment system adjusts the basis of each share in accordance with its proportionate interest in S’s
assets and operations, the relationship between a share’s basis and its allocable portion of unrecognized appreciation or depreciation determines the extent to which
such amounts are effectively reflected in
the basis of the share. This relationship,
however, is not fixed at the time that stock
is acquired. The reason is that there are
many transactions, referred to here as redetermination events, that alter either the
basis of a share or the interest it represents. These events generally occur in one
of three types of situations.
a. Stock basis is reallocated.
The relationship between the basis of a
share and the interest represented by the
share can be altered whenever stock basis is reallocated among shares, including
when it is allocated to shares of stock of
other members.
Example 6. Intragroup spin-off. P forms S by
contributing $100 to S in exchange for all the stock
of S. S purchases two assets, A1 and A2, for $50
each. Subsequently, A1 appreciates to $75 and A2
depreciates to $25. In a transaction qualifying under
sections 355 and 368(a)(1)(D), S transfers A2 to C in
exchange for all of the C stock and S then distributes
all the C stock to P. Under section 358 and §1.358–2,
P’s basis in the S stock is allocated among the S and C
stock in proportion to the value of the stock of S and
C. As a result, P’s basis in its S stock is $75 (75/100
x $100) and P’s basis in its C stock is $25 (25/100 x
$100). S sells A1 for $75, recognizing a $25 gain that
is taken into account on the P group return. P’s basis
in its S stock increases by $25, from $75 to $100. P
then sells its S stock for $75 and recognizes a $25
loss.

February 20, 2007

In this Example 6, after the reallocation of stock basis, P’s basis in its S stock
reflects the unrecognized appreciation on
A1, just as P’s basis in its S stock reflected
unrecognized appreciation on A1 in Example 2. As a result, P’s reallocated S stock
basis protects the appreciation on A1 from
being recognized as both asset gain and
stock gain. Increasing P’s basis in its S
stock to reflect the recognition of S’s gain
on A1 is not only unnecessary, it inflates
stock basis and thereby gives rise to either
noneconomic loss or noneconomic reduction of gain when the stock is sold.
Basis reallocations, and the consequences described, can occur for a number of reasons, including, for example,
under rules like §1.1502–32(c)(4) (cumulative redetermination of investment
adjustments) and §1.1502–35(b) (basis redetermination to reduce disparity) and the
corresponding provision in these proposed
regulations.
b. Capital transactions expand or contract
the subsidiary’s pool of assets.
The relationship between the basis of a
share and the nature of the interest represented by the share can also be altered by
capital transactions that have no effect on
the basis or value of outstanding shares,
but that nevertheless alter the interest represented by those share. Some common
examples arise in the context of section
351 exchanges, even though, as illustrated
in Example 7(a), a section 351 exchange in
its simplest form cannot give rise to stock
basis that reflects unrecognized appreciation.
Example 7(a). Contribution of appreciated asset
in section 351 exchange. P forms S by contributing
an asset, A1, to S in exchange for all 80 outstanding
shares of S stock. The basis of A1 is $40 and its value
is $80. S sells A1 and recognizes a $40 gain that is
taken into account by the P group. As a result, P’s
aggregate basis in its S shares is increased by $40,
from $40 to $80. Subsequently, P sells its S stock for
$80, the stock’s fair market value, and recognizes $0
on the sale. The group is thus taxed once on its $40
economic gain.

In Example 7(a), P holds appreciated S
stock and S holds an appreciated asset, but
that appreciation is not reflected in either
P’s basis in its S stock or S’s basis in its asset. Each share has a basis of $.50 and an
interest in 1/80 of S’s asset, A1, which has
$40 of unrecognized appreciation (allocable $.50 to each share). If this relationship
between P’s basis in its S shares and the

542

interest represented by the shares remains
constant, as in Example 7(a), the investment adjustment system produces appropriate results. But if there is a change in
that relationship, the underlying assumptions of the investment adjustment system
may no longer correspond to the facts of
the situation and, as a result, the general
operation of the system could produce inappropriate results. Such changes can occur whenever S acquires property in exchange for additional shares of its stock.
Example 7(b). Contribution of appreciated asset
in subsequent section 351 exchange creates disconformity in original shares. The facts are the same as
in Example 7(a), except that, before A1 is sold, P contributes a second asset, A2, to S in exchange for an
additional 20 shares of S stock. A2 has a basis of $0
and a value of $20. S sells both assets and recognizes
a $60 gain that is taken into account by the P group.
As a result, P’s basis in its original shares increases by
$48 ($.60 per share), from $40 to $88 (or, from $.50
to $1.10 per share), and P’s basis in its new shares increases by $12, from $0 to $12 (or, from $0 to $.60
per share). P then sells 20 of its original shares (basis
of $22) for $20, their fair market value, and recognizes a $2 loss.

In Example 7(b), P’s basis in the original S stock reflected no unrecognized appreciation when the stock was issued. After the second contribution, however, P’s
basis in those shares reflects a portion of
the unrecognized appreciation on A2. The
reason is that each share represents an interest in S’s entire pool of assets. When
the pool changes, the nature of the interest represented by the shares changes, even
though the share’s basis and value remain
constant. Thus, in Example 7(b), while
each original share’s basis ($.50) and value
($1) remain constant, the interest represented by each share changed from 1/80 of
an asset with unrecognized appreciation of
$40 (or, $.50 per share), to 1/100 of assets
with unrecognized appreciation of $60 (or,
$.60 per share). This shift causes the basis of each original share to reflect $.10 of
unrecognized appreciation. When the gain
is recognized, $.10 of the gain allocated to
each original share under the investment
adjustment system is a noneconomic increase in the share’s basis. That increase
will give rise to noneconomic stock loss
or gain reduction. Although this (noneconomic) allocation of the (economic) item
results in an offsetting stock gain on the
basis of the new shares, that gain can be
indefinitely deferred and even eliminated.
The principles that increase the reflection of unrecognized appreciation in the

2007–8 I.R.B.

original shares in Example 7(b) can also
cause the reflection of unrecognized appreciation in the basis of shares that are
received in exchange for property that is
not appreciated, including cash. Although
such shares would have a substituted basis (which generally precludes the reflection of unrecognized appreciation, as illustrated in Example 7(a)), the reflection
of unrecognized appreciation is prevented
only if the shares represent, wholly and
solely, the transferee’s interest in its transferred property. If there are previously issued shares outstanding, or if other shares
are issued in the exchange, the shares represent an interest in a pool of assets that
includes more than the transferred assets.
As a result, the interest represented by each
such share may be significantly different
from what it would be if the subsidiary
held only the transferred property.
Example 7(c). Multiple transferors in single section 351 exchange. The facts are the same as in Example 7(a), except that, when P contributes A1 to S in
exchange for 80 shares of S stock, M (another member in the group), also contributes $20 cash to S in
exchange for 20 shares of S stock. S sells A1 for $80
and recognizes a $40 gain that is taken into account
by the group. Accordingly, P’s aggregate basis in its
shares increases by $32 (80/100 x $40), from $40 to
$72, and M’s aggregate basis in its shares increases
by $8 (20/100 x $40), from $20 to $28. M then sells
its shares for $20, their fair market value, and recognizes an $8 noneconomic loss.

Similar changes in the extent to which
unrecognized amounts are reflected in basis can occur whenever the subsidiary’s
pool of assets is increased or decreased by
a capital transaction. The reason is that the
interest represented by each share, and thus
the relationship between a share’s basis
and the interest represented by the share,
changes whenever the subsidiary’s pool of
assets changes. Such transactions include
acquisitive reorganizations (if new shares
are issued) and redemptions.
c. Assets are acquired with a basis that
reflects unrecognized appreciation.
The relationship between the basis of
a share and the nature of the interest represented by the share can also be altered
by transactions in which S acquires assets
with a basis that reflects unrecognized appreciation, such as stock of a new member.
The reason is that, after the lower-tier acquisition, the S shares have an interest in
unrecognized appreciation and the investment adjustment system will increase the

2007–8 I.R.B.

basis of the S shares when those lower-tier
items are recognized.
Example 8. Acquisition of lower-tier subsidiary
with appreciated assets. P forms S by contributing
$100 to S in exchange for all the stock of S. S then
purchases all the stock of T for $100 when T holds
one asset, A1, with a basis of $0 and a value of $100.
T sells A1, recognizing a $100 gain that is taken into
account on the P group return. As a result, both S’s
basis in its T stock and P’s basis in its S stock are
increased by $100, from $100 to $200. P then sells
its S stock, recognizing a $100 loss.

The result is the same noneconomic loss
illustrated in Example 2.
d. Other redetermination events.
The IRS and Treasury Department expect that other transactions and events can
alter the extent to which unrecognized asset appreciation is reflected in stock basis.
Accordingly, the preceding discussion is
not intended to present an exhaustive list
of possible redetermination events.
e. Conclusions regarding redetermination
events.
The IRS and Treasury Department recognize that redetermination events occur
as the result of bona fide business transactions engaged in frequently and routinely
throughout the time a share is held by any
member of the group, and that these transactions are typically not tax-structured
transactions. Still, these events generate
a significant potential for noneconomic
stock loss or gain reduction that facilitates
the circumvention of GU repeal. Accordingly, the IRS and Treasury Department
believe that all such events, whether described in this preamble or not, must be
taken into account in any model that is
adopted to address the circumvention of
GU repeal.
Nevertheless, the IRS and Treasury
Department recognize, and are concerned
that, the factual analysis necessary to
identify all redetermination events for all
members’ shares would be an extensive,
complex, difficult, and, therefore, expensive undertaking and, as such, would
impose a substantial burden on both taxpayers and the government. Moreover,
the nature of the undertaking would make
it prone to error and, as a result, the rule
would be unevenly administered and similarly situated taxpayers would not be
similarly treated.

543

The IRS and Treasury Department recognize that redetermination events can
also create or increase the extent to which
the basis of an individual share duplicates
an inside loss. However, because duplicated loss is measured at the time that
a stock loss is either recognized or preserved for later use, loss duplication rules
by their operation account for redetermination events. Accordingly, regulations
addressing loss duplication do not generally require specific provisions to address
redetermination events.
C. Methods Considered to Implement GU
Repeal.
The IRS and Treasury Department considered a number of approaches to address
the circumvention of GU repeal independently from the issue of loss duplication.
The approaches fall into two broad categories: tracing-based and presumptive approaches.
1. Tracing-based methods.
Under a tracing-based method, the extent to which a member can enjoy the benefit of subsidiary stock basis attributable
to the recognition of an item of income or
gain is determined by the extent to which
the recognized item is reflected in the basis of the share and thus already protected
from duplicative recognition on a later disposition of the stock. The IRS and Treasury Department continue to believe that
tracing is a theoretically correct method
for implementing GU repeal in the consolidated return setting and so considered various tracing-based proposals.
a. Pure tracing.
In general, a tracing approach would
look solely to the connection between a
subsidiary’s recognized items and any appreciation reflected in stock basis in order
to determine the extent to which the group
will be allowed the benefit of stock basis attributable to those items. However,
such an approach would require taxpayers
to create and maintain (and the IRS to examine) records to establish:

•

the identity of every “tainted asset,”
that is, every asset held by the subsidiary and any lower-tier subsidiaries
on every “measuring date,” which

February 20, 2007

includes the date on which the member (or its predecessor) purchased
the share and all subsequent dates on
which the subsidiary has a redetermination event;

•

the “tainted appreciation,” that is, the
appreciation on each tainted asset held
by the subsidiary and any lower-tier
subsidiaries on each measuring date;
and

•

the extent to which tainted appreciation is recognized, whether as income
or gain, and included in an adjustment
to the basis of the share.

In addition, to fully benefit from a tracing regime, taxpayers would need to create and maintain similar records for tainted
assets with unrecognized depreciation on
a measuring date, because the recognition
of that depreciation would be allowed to
reduce the amount of recognized appreciation treated as tainted.
These records would have to be created and maintained for each share of
stock of each subsidiary and each share
of lower-tier subsidiary stock held by a
subsidiary on each measuring date. In
addition, these records would need to be
created and maintained not just for subsidiaries, but for all corporations the stock
of which is acquired by a member, because
the information would be necessary if the
corporation becomes a member at some
later date.
In administering the various temporary
and final regulations promulgated as loss
limitation rules under §1.337(d)–1 and
§1.337(d)–2, the IRS has found that taxpayers encounter substantial difficulty in
attempting to satisfy these requirements.
To begin, taxpayers are generally unable to accurately identify all of a subsidiary’s tainted assets. One reason is simply the vast number of assets implicated.
Another reason is that many assets are
accounted for in mass accounts and thus
cannot be separately identified. Problems
are exacerbated if appropriate records are
not created contemporaneously; taxpayers
have found this a particular concern when
subsidiaries have been acquired with inadequate records.
Furthermore, the commonplace nature
of many redetermination events makes it
difficult to identify all such dates. For

February 20, 2007

example, many taxpayers routinely issue
stock when a member contributes cash or
property to a subsidiary, even if the issuance of stock would not be required for
section 351 to apply, and each such occurrence is a redetermination event.
Valuation also imposes significant financial and administrative burdens on
both taxpayers and the government. These
problems are exacerbated because the corporation’s assets are not themselves the
subject of an arms-length transaction and,
in most cases, the date on which the assets
are actually valued is long after the stock
transaction.
The most problematic aspect of tracing,
however, has typically been establishing
the connection, or lack thereof, between
items taken into account by the group and
particular amounts of tainted appreciation.
If much time has elapsed between a measuring date and the disposition of a tainted
asset, or if an asset is held in a mass account, this can be difficult or even impossible. If tainted appreciation is recognized as
income earned through the wasting or consumption of the appreciation, instead of as
gain on the disposition of the asset, there
are additional difficulties. In those cases,
tracing is possible only if the tainted appreciation generates an identifiable stream
of income. However, this is frequently not
the case. For example, intangible assets,
like patents or goodwill, are the source of
significant tainted appreciation and they
typically do not generate identifiable income streams.
i. Conclusions regarding tracing.
For all the reasons set forth in this preamble, the IRS and Treasury Department
have again, as in 1990, concluded that
tracing is not a viable method for preventing the circumvention of GU repeal
in consolidation. This conclusion, while
arguably based on theoretical concerns in
1990, is now based on several years of administering §1.337(d)–2 (in both its temporary and final form) as a tracing regime.
The IRS found that the difficulties encountered, by taxpayers and the government
alike, in administering §1.337(d)–2 as a
tracing-based rule were overwhelmingly
greater than those encountered in administering it as a presumption-based rule under the basis disconformity method permitted under Notice 2004–58. Accord-

544

ingly, the IRS and Treasury Department
are not proposing to adopt a tracing-based
approach.
ii. Tracing in other contexts.
The IRS and Treasury Department
recognize that tracing-based regimes are
used to implement other provisions in the
Code. For example, section 382(h), which
prescribes the tax treatment of built-in
items recognized by a corporation that
has had an ownership change, and section
1374, which prescribes the tax treatment
of built-in items recognized by an S corporation that was formerly a C corporation,
both use tracing-based regimes. Further,
the IRS and Treasury Department are
proposing regulations implementing section 362(e)(2) in a consolidated return
context that require certain items to be
traced. See section H of this preamble.
The tracing regimes appropriate for
those sections, however, do not present
compliance and administrative concerns
of the scope and magnitude presented by a
tracing regime appropriate for GU repeal
in the consolidated setting for at least three
reasons.
To begin, both sections 382(h) and
1374 apply only for a limited period of
time—five years in the case of section
382(h) and ten years in the case of section
1374—and so whatever burden is imposed
is more limited in nature.
More importantly, sections 382(h) and
1374 are generally concerned only with
the unrecognized appreciation and depreciation in a pool of assets held by a corporation on a single date—the date the C
corporation converts to an S corporation
or the date the S corporation acquires assets of a C corporation in the case of section 1374, and the date a corporation has
an ownership change in the case of section 382(h). Similarly, section 362(e)(2) is
only concerned with net unrecognized depreciation in a pool of assets on the date of
the transaction to which section 362(e)(2)
applies. But the ability to circumvent GU
repeal using the consolidated return provisions can be created any time the subsidiary has a redetermination event. Thus,
any rule implementing GU repeal in the
consolidated context, unlike rules implementing sections 362(e)(2), 382(h), and
1374, must trace the pool of assets held on
all measuring dates, and not just the pool

2007–8 I.R.B.

of assets held when subsidiary stock is acquired (or when assets are transferred).
Finally, unlike regulations implementing GU repeal, regulations implementing
those other sections do not need to take
into account the changing relationship between the basis in a particular share of
stock and the unrecognized appreciation
and depreciation in the corporation’s assets.
For these reasons, any tracing-based
regime appropriately implementing GU
repeal in the consolidated setting would
be much more expansive and complex,
and therefore much less administrable,
than the tracing regimes appropriately implementing sections 382(h) or 1374 (or
proposed to implement section 362(e)(2)).
b. Modified tracing.
The IRS and Treasury Department considered several approaches that could be
adopted to modify a tracing model by limiting the extent to which tracing would be
required, in order to mitigate the administrative burdens of a pure tracing model.
i. Exclusion for items attributable to
after-acquired assets.
Several commentators have suggested
an approach, generally called the “after-acquired asset exception,” which allows taxpayers to identify assets acquired after the
acquisition of subsidiary stock, in order to
treat any gain realized on those assets as
economic to the group. In general, all other
items of gain and income would be deemed
to be noneconomic, that is, attributable to
the recognition of appreciation that was already reflected in basis. Stock loss would
be allowed only to the extent that stock basis was attributable to the amounts deemed
economic to the group. In response to concerns raised by the IRS and Treasury Department about redetermination events, the
proposal was modified to provide that only
assets acquired after the latest measuring
date would be treated as giving rise to economic amounts. The principal advantage
of this approach is that it identifies some
untainted items with no need for valuation.
To begin, the IRS and Treasury Department are concerned with the burden and error potential presented by the need to identify all redetermination events. Moreover,
because these events can occur with considerable frequency in the ordinary course

2007–8 I.R.B.

of business, it is unlikely that a great deal
of time will typically elapse between the
last redetermination date and the date of
a stock disposition. Thus, the amount of
gain recognized on an asset acquired and
sold during such periods of time will not
likely be significant. As a result, it appears
unlikely that this approach would afford
much relief to taxpayers (in terms of administrative burden or reducing the disallowance amount) or to the government (in
terms of administrative burden).
Furthermore, in order to implement GU
repeal appropriately, such an approach
must take into account not only gains, but
also losses, recognized on after-acquired
assets. But the identification of such losses
imposes an additional administrative burden that taxpayers have no incentive to
facilitate. In any event, a requirement to
take losses into account could be easily
manipulated by the timing and structuring
of redetermination events.
ii. Exclusion for items recognized after
prescribed period of time.
Several commentators also suggested a
tracing-based approach that would apply
to investment adjustments taken into account only during a prescribed period of
time following the acquisition of a share.
The chief advantage to this approach is
that, regardless how burdensome the administration of the rule, it would not extend indefinitely.
Like the proposed after-acquired-asset
approach, however, this approach would
need to take redetermination events into
account. The tracing period would then
begin again on the date of each redetermination event. Thus, like the after-acquiredasset exception, this approach is unlikely
to afford much relief to taxpayers (in terms
of administrative or tax burden) or the government (in terms of administrative burden) because the period for tracing may
never close.
Moreover, the IRS and Treasury Department are concerned that such an approach does not adequately respond to GU
repeal. The reason is that noneconomic investment adjustments circumvent GU repeal whenever they are taken into account.
Thus, the IRS and Treasury Department
continue to believe that, in the absence of
any direction from Congress, such as in the
case of section 1374, imposing time limits

545

on the implementation of GU repeal would
be inappropriate. See T.D. 8294.
iii. Exclusion for basis conforming
acquisitions.
Commentators have also suggested
adopting a tracing-based approach that
excepted any stock acquired in either
a section 351 exchange or a qualified
stock purchase for which an election was
made under section 338. The rationale
for this approach is that, by operation of
statute, the basis of stock acquired in these
transactions can reflect no unrecognized
appreciation.
The IRS and Treasury Department
agree that, in certain circumstances, the
structure of a stock acquisition will, by
operation of law, preclude the reflection
of unrecognized appreciation in stock basis. The IRS and Treasury Department
are concerned, however, that many acquisitions under section 351 or section 338
actually do not preclude the reflection of
unrecognized asset appreciation in stock
basis. For example, if subsidiary stock
is acquired in a section 351 exchange in
multiple transactions or by multiple transferors, as illustrated in Example 7(b) and
Example 7(c), respectively, the basis of the
shares received can reflect unrecognized
appreciation. Similarly, because only 80
percent of the stock of a subsidiary need
be acquired to elect section 338 treatment,
the basis of up to 20 percent of a subsidiary’s shares may reflect unrecognized
appreciation. Moreover, even if the initial acquisition precludes the reflection of
unrecognized gain, once there is a redetermination event, the form of the acquisition
no longer prevents the reflection of unrecognized appreciation in stock basis. Thus,
very few, if any, such transactions would
ultimately qualify for this exception.
Thus, like the two previously described
approaches to modified tracing, this approach has the inaccuracy and burden associated with identifying redetermination
dates and a limited potential for relief to
either taxpayers or the government.
iv. Conclusions regarding modified
tracing.
Each approach considered would increase the administrative burden significantly without significantly increasing
precision or relief. Accordingly, the IRS

February 20, 2007

and Treasury Department are not proposing to adopt any of these approaches.
2. Hybrid tracing-presumptive model:
asset tracing.
The IRS and Treasury Department also
considered a hybrid tracing-presumptive
approach that would identify all assets
held when a share is acquired and on each
redetermination date thereafter (again,
the “tainted assets”) and then presume all
items of income, gain, deduction, and loss
traced to those assets to be tainted. The intent was to design an approach that would
be more precise than either a modified
tracing or purely presumptive approach,
while being more administrable than a
pure tracing-based approach. The chief
advantages of this approach are that it may
enhance precision and, like the after-acquired asset exception described in section
C.1.b.i of this preamble, may eliminate
any need for valuation.
However, like the modified tracing approaches described above, this approach
would require the identification of all redetermination events. Furthermore, it would
require the identification of all assets held
at the time of each such event and the tracing of those assets to particular investment
adjustments. Thus, it presents even more
complexity, burden, and expense than
the modified tracing regimes considered.
Furthermore, the IRS and Treasury Department are concerned that this approach
could be easily abused, either by the manipulation of redetermination dates or the
use of intercompany transactions to make
valuation elective. (That is, taxpayers
could selectively engage in intercompany
transactions so that, in effect, some assets
would be valued and not others.)
Finally, the IRS and Treasury Department are not convinced that the approach
in fact significantly enhances the precision
of a pure presumptive model in light of
the fact that there is no actual valuation
(and therefore no actual determination that
there was any gain reflected in stock basis).
For all these reasons, the IRS and Treasury Department concluded that the potential advantages of this hybrid tracing-presumptive approach are outweighed by its
disadvantages. Accordingly, the IRS and
Treasury Department are not proposing to
adopt this approach.

February 20, 2007

3. Presumptive-based models.
Recognizing that even the hybrid tracing-presumptive model would present
significant burden and imprecision, the
IRS and Treasury Department considered
various presumptive models that, like the
LDR, would eliminate all elements of
tracing. A principal advantage of such
approaches is that they are readily administrable by both taxpayers and the IRS.
Thus, the rules can apply uniformly and
consistently, with the result that similarly situated taxpayers will be similarly
treated, increasing the overall fairness of
the system. The elimination of any tracing
element, however, increases the importance of limitations, where appropriate, on
the nature and amount of items treated as
noneconomic to a share. The approaches
considered are discussed in this section
C.3 and in section C.4 of this preamble.
a. Basis disconformity under Notice
2004–58.
One model considered was the basis disconformity model described in
Notice 2004–58, presently available as
a method to avoid disallowance under
§1.337(d)–2. As noted in section A.4 of
this preamble, the basis disconformity
model treats as built-in gain (within the
meaning of §1.337(d)–2) the smallest of
three amounts. The first is the basis disconformity amount (which identifies the
minimum amount of built-in gain that
could be reflected in the share), the second is the net positive adjustment amount
(which identifies the actual amount of
stock basis attributable to the consolidated return system), and the total gains
on property dispositions (which responds
to the definition of the term built-in gain
in §1.337(d)–2). A significant advantage
of this approach is that both taxpayers and
the IRS find it readily administrable with
information that taxpayers are already required to maintain.
However, the Notice 2004–58 basis disconformity model, because it is an interpretation of the current loss limitation rule
in §1.337(d)–2, reflects limitations that inhibit the extent to which the rule addresses
the circumvention of GU repeal and promotes the clear reflection of group income.
For example, the model did not account for
the consumption of unrecognized appreci-

546

ation reflected in stock basis (the “wasting
asset” problem). Thus, if unrealized gain
reflected in stock basis was recognized as
income (for example through a lease, instead of a disposition of the property), the
resulting noneconomic stock loss was not
disallowed under the current rule. In addition, the model did not address the problem of basis disparity. (See, for example,
Example 4.)
A more significant concern, however,
is that the basis disconformity approach is
underinclusive in that it can only address
noneconomic stock loss to the extent of
net appreciation reflected in stock basis,
which is, by its nature, reduced by unrecognized depreciation reflected in basis. As
a result, a potentially significant amount
of noneconomic stock loss remained unaddressed, particularly in deconsolidating
dispositions of subsidiary stock.
Example 9. Unrecognized loss reflected in stock
basis. P purchases all the outstanding stock of S for
$150. At the time, S owns one asset, A1, with a basis
of $25 and value of $100, and one asset, A2, with a
basis of $100 and a value of $50. S sells A1 to a nonmember for $100 and recognizes a $75 gain, which
the P group takes into account. Under the investment
adjustment system, P increases its basis in the S stock
by $75, to $225, to reflect the $75 taken into account
by the group. If P then sells the S stock for $150 (its
fair market value), P will recognize a $75 loss. Under the basis disconformity approach, only $25, the
excess of P’s S stock basis ($225) over S’s net inside
asset basis ($100 cash plus S’s $100 basis in A2, or,
$200), of the $75 gain is treated as a noneconomic investment adjustment. Thus, although the entire loss
is noneconomic, only $25 of that loss would be disallowed under this approach.

b. Modified basis disconformity.
The IRS and Treasury Department considered several modifications to the basis
disconformity model, all of which were intended to address the underinclusivity of
that model. One approach suggested by
commentators would mitigate the wasting
assets concern by first, for a prescribed period of time, treating the sum of all property gains and, up to the disconformity
amount, all income as noneconomic (and
thus included in the disallowance amount).
After the prescribed time, all gains and income would be treated as noneconomic,
but only to the extent of the disconformity
amount. Other approaches considered reflected variations on this suggestion.
The IRS and Treasury Department recognize that the model described, and any
similar models, would be readily adminis-

2007–8 I.R.B.

trable, but are concerned that such a model
would not adequately preserve the group’s
ability to deduct economic loss sustained
by the group. The reason is that stock
loss could be attributable to economic investment adjustments (adjustments attributable to the recognition of items of income and gain that were not reflected in
stock basis) that were followed by economic loss (attributable to a decline in the
value of the subsidiary’s assets). For example, assume that P contributed an asset
to S (basis and value of $10), the asset appreciated and S sold it for $100 (recognizing a $90 gain that increased P’s basis in S
stock to $100), S reinvested the $100 in an
asset that declined in value to $10, and P
then sold the stock for $10. P would recognize a $90 loss that would be disallowed
because S had a $90 gain on the disposition
of an asset. Yet the entire loss was an economic loss. As a result, the IRS and Treasury Department are concerned that the result in Rite Aid (that the group receive the
tax benefit of its economic loss) would not
be adequately protected.
Ultimately, the IRS and Treasury Department concluded that the basis disconformity model in Notice 2004–58 would
not be modified, but that elements of the
model would be incorporated in a new approach.
4. The presumptions and simplifying
conventions adopted in these proposed
regulations.
a. Loss limitation model.
As discussed in section A.2 of this
preamble, when the IRS and Treasury
Department rejected a tracing approach
in favor of the presumptive approach in
1990, the decision was made to balance
the use of irrebuttable presumptions by
adopting a loss limitation model. Under a
loss limitation model, losses attributable
to noneconomic investment adjustments
are disallowed, but gain reduction (or
elimination) attributable to noneconomic
investment adjustments is not. The IRS
and Treasury Department believed that
allowing noneconomic gain reduction not
only balanced the benefits and burdens of
the presumptive approach, it also provided
the considerable advantage of reducing
gain duplication in consolidated groups.
Example 10. Noneconomic gain reduction, elimination of gain duplication. P purchases all the stock

2007–8 I.R.B.

If the investment adjustment system did
not adjust stock basis for items attributable
to appreciation reflected in basis, P’s basis
in S stock would remain $150 and, when P
sells the S stock, P would recognize a gain
of $50 (reflecting the $50 appreciation in
A2). When S sells A2, S would recognize
the same $50 of economic gain a second
time. However, because P’s basis in S is
increased by the $50 gain recognized on
the sale of A1, P will recognize no gain
or loss on its sale of S stock. The gain on
A2 is therefore taxed once, when there is a
recognition event with respect to A2.
These proposed regulations adopt a loss
limitation model for the same reasons such
a model was adopted in 1990, in the regulations promulgated under section 337(d)
and the LDR (to balance the use of a presumptive approach).
However, the LDR, as well as
§§1.337(d)–1 and 1.337(d)–2, applied
the loss limitation model by disallowing loss recognized on the disposition of
subsidiary stock and reducing basis on
the deconsolidation of subsidiary stock.
The IRS and Treasury Department recognize that the effect of a loss disallowance
rule can be achieved by applying a basis reduction rule immediately before the
disposition of loss stock. Modifying the
loss limitation model to reduce basis in all
cases simplifies the structure of the rule by
avoiding the need for two distinct rules.

For purposes of this rule, the adjusted
purchase price would be defined as the
holder’s original basis in the stock, adjusted to take into account all redetermination events. The rationale for this rule is
that the adjusted purchase price represents
the maximum amount of unrecognized
gain that could be reflected in stock basis. However, this cap does not establish
that, in fact, there was any appreciation
reflected in stock basis and, therefore, it
could prove to be substantially overinclusive.
The IRS and Treasury Department considered several rules that could be combined with the adjusted purchase price cap
in order to mitigate its potential for overinclusiveness. One approach would combine this cap with the asset tracing model
described in this preamble. Another approach would combine this cap with rules
that treat income items as included in the
basis reduction amount under a different
rate (for example, using a declining percentage over time) or amount (for example, using an annual income cap, perhaps
based on a percentage of the gross items).
The IRS and Treasury Department ultimately concluded that the limitations either imposed unacceptable burdens (because of the need to identify redetermination dates and trace assets) or did not significantly increase the theoretical soundness of the approach, and that the potential for overinclusiveness prevented the approach from responding adequately to the
Congressional mandate to preserve the result in Rite Aid.

b. Amount of basis reduction.

ii. Modified adjusted purchase price cap.

The IRS and Treasury Department considered two basic approaches to determining the amount of basis reduction. One
would be determined with reference to a
share’s adjusted basis and the other would
be determined with reference to the disconformity between the share’s basis and
its allocable portion of the subsidiary’s attributes.

To address the potential overinclusivity of the adjusted purchase price cap, the
IRS and Treasury Department considered
modifying the rule by reducing the cap by
the basis of any tainted assets sold at a
gain. The rationale for this modification
is that the maximum potential amount of
appreciation reflected in basis is reduced
by the basis of tainted assets as they are
sold. While this modification reduced the
potential for overinclusiveness in a theoretically sound manner, it exacerbated the
administrative difficulties by requiring not
only the identification of all redetermination dates, but also of all assets held on
such dates. Moreover, the IRS and Treasury Department ultimately concluded that

of S for $150 when S holds one asset, A1, with a basis of $100. S sells A1 for $150, recognizing $50 of
gain. S uses the $150 proceeds from the sale of A1 to
purchase A2. The value of A2 appreciates to $200,
and P then sells its S stock for $200.

i. Adjusted purchase price cap.
Under this approach, the basis of a
transferred loss share would be reduced
by the amount that the subsidiary’s items
increased the share’s basis, but only to
the extent of the adjusted purchase price.

547

February 20, 2007

the basic premise (that the limitation represented the maximum possible noneconomic income) remained an inadequate response to the Congressional directive that
the group be allowed to deduct its economic loss.
iii. Disconformity cap.
This model would also reduce basis
by the amount that the subsidiary’s items
increased the share’s basis, but only to the
extent of the disconformity amount. For
this purpose, the disconformity amount
would generally be the same as the basis
disconformity amount described in Notice
2004–58. The rationale for this limitation
is that the disconformity amount identifies
the minimum amount of unrecognized
appreciation actually reflected in the basis of a share of subsidiary stock at the
relevant time. Thus, although the amount
of such appreciation could actually be
considerably greater (as in Example 9),
and could even be equal to the adjusted
purchase price (assuming a subsidiary was
purchased with no basis in any of its assets), it is not lower. Not only does the
disconformity cap have the advantage of
identifying an amount of appreciation actually reflected in stock basis, it allows for
the computation of that amount with information taxpayers are already required to
know. Additionally, it avoids the need to
identify redetermination events because,
by computing disconformity immediately
before a transfer, this approach automatically takes the effect of all such events
into account.
iv. Modified disconformity cap.
Because the use of a disconformity
cap raises significant potential for underinclusivity, as illustrated in Example 9,
the IRS and Treasury Department considered increasing the disconformity cap
by the amount of unrecognized loss on
any tainted assets held by the subsidiary.
The rationale for this increase is that those
losses could prevent an equal amount of
recognized tainted appreciation from being treated as noneconomic. Thus, the
rule would not undermine the theoretical
foundation of the disconformity cap.
However, this approach would require
the identification of redetermination dates,
as well as the identification and valuation

February 20, 2007

of all assets held on the last such date. Recognizing the imprecision inherent in this
approach, the IRS and Treasury Department considered increasing the disconformity cap by only a discounted portion of
those unrecognized losses. The IRS and
Treasury Department concluded that this
approach would introduce burden and imprecision much greater than the potential
benefit obtained by increasing the cap on
basis reductions, at least in the majority of
commercially typical cases.
The IRS and Treasury Department also
considered implementing this modification not as a general rule, but only as an
anti-abuse rule, so that it would apply only
in circumstances that indicated a significant amount of tainted income or gain
might be sheltered by unrecognized loss
on tainted assets. For example, such a
rule could require an increase to the disconformity cap if there was a significant
loss in stock, if the subsidiary recognized
significant gain shortly before stock sale,
or if the stock was held for only a short
period of time before it was sold. The IRS
and Treasury Department were concerned,
however, that the increased uncertainty
and burden introduced by such an approach could not be justified in light of the
protections against manipulation that exist
in the Code and other rules of law. For
example, see sections 269, 362(e)(2), and
482, as well as various anti-avoidance and
anti-abuse provisions in the regulations,
including these proposed regulations.
v. Disconformity cap with duplication
rule.
In considering the structural potential
for underinclusivity in the disconformity
cap, the IRS and Treasury Department
observed that the recognition of noneconomic gains in excess of the disconformity
amount causes the subsidiary’s unrecognized losses to be expressed in stock basis.
The facts of Example 9 illustrate this point.
In that example, P purchased S for $150
when S held A1 (basis $25, value $100)
and A2 (basis $100, value $50). S sold A1
and recognized $75 gain, which increased
P’s basis in S to $225. P then sold the
S stock and recognized a $75 loss. At
the time of the stock sale, S’s net asset
basis was $200 (the $100 received for A1
and the basis of A2), which exceeds the
value of the stock by $50. Thus, the basis

548

disconformity amount is $25 (the excess
of the $225 stock basis over the $200 net
asset basis), and so (although there is a
$75 recognized gain), only $25 is disallowed. However, at that point, S’s $200
net asset basis exceeds S’s $150 value by
$50. The $50 of unrecognized loss on A2
is reflected in both P’s basis in S stock
and S’s basis in its assets. That is, the loss
on A2 has been duplicated. As a result,
the underinclusivity of the disconformity
cap can be measured and addressed as
duplicated loss.
The IRS and Treasury Department recognize that addressing this loss as a duplicated loss allows taxpayers to accelerate
the benefit of a subsidiary’s unrecognized
losses (that is, obtain the benefit of the loss
without a recognition event with respect to
its loss assets). However, this approach
allows taxpayers the benefit of their economic loss while limiting any arguably excessive benefit to the ability to accelerate
inside loss. In the end, loss duplication is
prevented. (The IRS and Treasury Department have long recognized that it is appropriate for a group to offset recognized
built-in gains and losses, see §§1.337(d)–1
and 1.337(d)–2, as promulgated in 1990
and again as temporary and final regulations following the Rite Aid decision).
vi. Conclusion.
In light of the concerns raised by any
method that would reduce basis beyond
the disconformity amount, the IRS and
Treasury Department have concluded that
the amount of basis reduction should be
limited to the disconformity amount and
that combining the disconformity cap with
a loss duplication rule to address its underinclusivity provides the most appropriate balancing of interests. Under this approach, the group’s economic loss is appropriately protected and neither the group
nor its members will receive more than one
benefit for the subsidiary’s economic loss.
c. Items applied to reduce basis.
i. Character of items applied to reduce
basis.
In general, the IRS and Treasury Department have concluded, and commentators have generally agreed, that all gains
on property dispositions, as well as various

2007–8 I.R.B.

gain equivalents, should be fully available
to reduce basis under a presumptive rule.
Questions arose, however, regarding
whether income items should also be fully
available to reduce basis. The reasons
for these questions center on the general
difficulty of tracing income items (which
is limited in the best of circumstances)
and the observation that the likelihood
of a particular income item being attributable to tainted appreciation generally
decreases over time. Accordingly, the
IRS and Treasury Department considered
several proposals to limit both the amount
and the rate of inclusion for income items.
All of these approaches would segregate income that could be traced to particular appreciation reflected in stock basis
and treat those amounts in the same manner as items of gain. The net income remaining would be applied to reduce basis
according to prescribed limits. For example, one proposal would apply net income
to reduce basis for a prescribed period of
time following a measuring date, but, after
that time, net income would be so applied
only according to a declining percentage.
The IRS and Treasury Department are
concerned, however, that the approaches
considered could be readily manipulated,
for example, by converting gain into income that cannot be readily traced to particular assets or by delaying the recognition of income items until after the applicable time period. Therefore, any such rule
would inappropriately influence the structure of business transactions and, at the
same time, fail to provide adequate protection for GU repeal. In addition, the
need to account for redetermination dates
would add complexity and diminish the
potential relief afforded under any such approach. Moreover, the IRS and Treasury
Department identified no theoretical basis
for any particular rule and were concerned
that the increased precision may be more
perceived than real.
ii. Capital transfers.
Adjustments to reflect transfers of
capital, whether contributions or distributions, are not adjustments attributable to
the recognition of appreciation or depreciation. Accordingly, these adjustments
do not increase or decrease the extent to
which stock basis is noneconomic or facilitates the circumvention of GU repeal. For

2007–8 I.R.B.

that reason, such amounts are not taken
into account in determining the extent to
which subsidiary stock basis is subject to
reduction.
Commentators have suggested that the
nature of an intercompany cancellation of
indebtedness is similar to that of a capital
contribution and thus should not be taken
into account in determining basis reduction. The IRS and Treasury Department
recognize that this may often be the case,
but are concerned that, under some circumstances, this may not be the case. Because
it will be administratively very difficult to
identify situations in which intercompany
cancellation of indebtedness is not similar to a capital contribution, and to distinguish intercompany cancellation of indebtedness from other arguably similar cases,
these proposed regulations treat items related to intercompany cancellation of indebtedness like all other items of income
or loss. However, the IRS and Treasury
Department continue to study the issue and
invite further comments.
d. Netting of items from different tax
periods.
Under the LDR, there was no cross-year
netting of investment adjustments. Positive investment adjustments were taken
into account in determining the loss disallowance amount, negative investment adjustments were not. The IRS and Treasury
Department have reconsidered whether
items from different tax periods should be
considered together in determining basis
reduction.
The IRS and Treasury Department recognize that the particular circumvention of
GU repeal at issue here is a product of
the manner in which the investment adjustment system adjusts stock basis to reflect a subsidiary’s amounts that are taken
into account by the group. Thus, the IRS
and Treasury Department have concluded
that the appropriate measure of the concern must take into account the net extent
to which the basis of a share has been increased or decreased by the investment adjustment system. Whether a loss is taken
into account in the same year in which a
gain is taken into account or in a separate
year does not change the net effect of the
investment adjustment system. Thus, unlike the LDR, these proposed regulations

549

allow netting of all investment adjustments
made to a share for all periods.
e. Summary and conclusions.
Only a presumptive approach can eliminate the substantial administrative burdens imposed by the tracing-based and
hybrid regimes discussed above. As a
result, only a presumptive approach can
be applied consistently among taxpayers
and thus achieve the overall fairness necessary to these regulations. Importantly, if
presumptions are rebuttable, the administrative burdens associated with a tracing
system are not avoided. In fact, they are
exacerbated, because taxpayers will feel
it necessary to be prepared to establish,
and the government will then need to be
prepared to examine, returns using both
systems. Accordingly, the proposed regulations reflect a presumptive approach that
does not permit the rebuttal of its operating
presumptions. As noted in section A.5 of
this preamble, Congress has specifically
sanctioned the use of presumptions and
other simplifying conventions to address
the circumvention of GU repeal.
To balance the use of irrebuttable presumptions, the proposed regulations adopt
several provisions that are intended to enhance their overall fairness and theoretical soundness. First, the proposed regulations adopt the disconformity amount as
the maximum amount of potential stock
basis reduction. The reason, as discussed,
is that only the disconformity amount both
establishes the fact that the taxpayer had
unrealized gain reflected in stock basis and
identifies the minimum amount of such
gain. Second, the proposed regulations include all items taken into account, from all
years, in the determination of the basis reduction amount. Thus, basis is not reduced
for certain amounts (such as capital transfers) that cannot be attributable to noneconomic investment adjustments. In addition, by presuming all items of income,
gain, deduction and loss as attributable to
appreciation or depreciation reflected in
basis, the proposed regulations avoid the
administrative burden and other concerns
inherent in various tracing and hybrid approaches. Moreover, by presuming all
items to be reflected in basis, the benefits
and burdens inherent in the use of irrebuttable presumptions are fairly balanced between taxpayers and the government. Pre-

February 20, 2007

suming all items of income and gain are
noneconomic favors the fisc, while presuming all items of deduction and loss are
noneconomic favors taxpayers.
D. Loss Duplication.
The IRS and Treasury Department continue to believe that a group’s income is
distorted when the group enjoys more than
one tax benefit from an economic loss.
Further, the IRS and Treasury Department
believe that a subsidiary’s use of a group
loss in a separate return year, after the
group has already recognized the benefit
of the loss, distorts the subsidiary’s separate year income.
Moreover, the IRS and Treasury Department do not believe that the manner
or order in which a group takes its losses
into account affects the extent to which
loss duplication is inappropriate. Thus,
loss duplication is inappropriate and must
be addressed whether arising in situations
like that illustrated in Example 3 (loss reflected in both stock and assets) or in Example 5 (duplication attributable to disparate stock basis). In addition, loss duplication is inappropriate and must be addressed whether the group chooses to recognize loss first as an inside loss, on the
subsidiary’s assets and operations (which
is addressed by §1.1502–32), or as a stock
loss (which is currently addressed, at least
partially, by §1.1502–35).
Accordingly, the IRS and Treasury Department have returned to a fundamental
premise of the LDR and again concluded
that a loss duplication rule that operates
without regard to members’ continued affiliation is a necessary complement to the
investment adjustment system. The IRS
and Treasury Department have also concluded that such a rule must also address
the potential for loss duplication presented
when loss is disproportionately reflected in
the bases of individual shares.
Importantly, as noted in section A.5
of this preamble, Congress has indicated
that it, too, views the prevention of loss
duplication, including in deconsolidating
stock dispositions, as an area that is appropriately addressed by regulation. See
H.R. Conf. Rep. No. 108–755 at 652.
Therefore, the IRS and Treasury Department have reviewed the current rules
and considered alternative approaches to
address the duplication of loss.

February 20, 2007

1. Reconsideration of §1.1502–35.
Loss duplication is currently addressed
in §1.1502–35. That rule generally applies whenever there is a disposition of
loss shares of subsidiary stock. To address the loss duplication problems arising
when loss is disproportionately reflected
in stock basis, the rule first redetermines
members’ bases to reduce that disparity
(to address the problems illustrated in Example 5). Different rules apply depending
on the subsidiary’s status as a group member following the stock disposition. If
the subsidiary remains a member, the full
blending rule of §1.1502–35(b)(1) applies
and all members’ bases in shares of the
subsidiary’s stock are combined and then
allocated evenly to preferred (to value)
and then to common (equally). If the subsidiary ceases to be a member, the basis
redetermination rule of §1.1502–35(b)(2)
applies and members’ bases are redetermined to reduce loss on all members’
shares. However, this rule only redetermines basis to the extent of items of
deduction and loss included in negative
adjustments applied to nonloss shares.
As under the full blending rule, redetermination under this rule first reduces or
eliminates loss on preferred shares and
then equalizes members’ bases in common shares.
The potential for loss duplication following the redetermination of members’
bases is addressed only if the subsidiary
remains a member of the group. In that
case, stock loss (to the extent of loss duplication) is suspended, the suspended loss
is reduced as the subsidiary’s items of deduction and loss are taken into account,
and any suspended loss remaining when
the subsidiary ceases to be a member is allowed at that time. The regulation does
not address the duplication of loss when
the subsidiary ceases to be a member, other
than to prevent the reimportation of duplicated losses back into the group.
The IRS and Treasury Department understand that certain administrability concerns have arisen under §1.1502–35. For
example, taxpayers have commented that
the rules relating to the suspension of loss
in nondeconsolidating dispositions and the
treatment of reimported losses present substantial compliance issues. The experience
of the IRS is consistent with those comments.

550

Moreover, the IRS and Treasury Department have reconsidered the appropriateness of allowing subsidiaries to duplicate group losses after the period of consolidation. Under this approach, former
members can use group losses (that have
already been used by the group) to offset their separate year income. This duplicative use of group losses distorts the
former member’s separate income. Under
section 1502, consolidated return regulations are directed to promote the clear reflection of not only the income of a group,
but also of its members, including former
members. Accordingly, as in 1990, the
IRS and Treasury Department have concluded that a group loss, once used by the
group, should not be available to a former
member for a second, duplicative use outside the group.
For these reasons, the IRS and Treasury Department propose to remove
§1.1502–35 and replace it with a more easily administered and more comprehensive
approach to addressing loss duplication
among members of a consolidated group.
2. Other methods considered for
addressing loss duplication.
As discussed in section D of this preamble, the IRS and Treasury Department have
concluded that loss duplication is an inappropriate distortion of income (of either
a group or its members, including former
members) regardless of the subsidiary’s
status after a transfer of its stock. Accordingly, these proposed regulations address loss duplication in both nondeconsolidating and deconsolidating stock transfers. Several approaches were considered.
a. Disallowance of stock loss.
As a general matter, the IRS and Treasury Department believe that disallowing
duplicative stock loss better implements
single entity principles because it results
in the recognition of the subsidiaries’
economic gain or loss on its assets and
operations, instead of on its stock. However, to preserve the result in Rite Aid,
stock loss could only be disallowed for
nondeconsolidating transfers and additional rules would be necessary to address
both the loss remaining in the group and
the duplication of loss in deconsolidating transfers (which could not be subject
to the loss disallowance rule). Thus, a

2007–8 I.R.B.

rule implementing this approach would
need to include a provision comparable
to §1.1502–35(c), which taxpayers and
the IRS have found to present significant
compliance issues. In addition, this approach would need to include a provision
to address loss duplication in deconsolidating transfers.
b. Loss duplication accounts.
The IRS and Treasury Department also
considered an approach that would allow
stock loss, but identify the amount of loss
duplication and create a suspended account to limit the deductibility of items as
they are taken into account. One advantage of this approach is that it only requires
one set of rules to address both nondeconsolidating and deconsolidating transfers.
This approach also has the advantage of
increasing the precision in identifying
(and disallowing) losses that are actually
duplicated.
However, unless the rule were to use
presumptions to treat items as chargeable
against the loss duplication account, it
would present considerable tracing issues.
In addition, this approach raises administrability issues comparable to those associated with the loss suspension regime in
§1.1502–35(c). These difficulties are exacerbated by the need to have the account
follow the subsidiary, possibly through
subsequent acquisitions, until the account
is eliminated.
The IRS and Treasury Department are
also concerned that, because this approach
would reduce or eliminate duplication only
when inside losses were recognized, taxpayers could avoid the effect of the rule by
waiting until assets appreciated before disposing of them. To mitigate this concern,
the rule could require the subsidiary to take
into account the duplication account, either
ratably over time or at some specified time,
but this could give rise to income in the absence of any loss duplication.
c. Attribute reduction.
The IRS and Treasury Department also
considered a presumptive rule that would
identify the extent of duplicated loss and
then reduce the subsidiary’s attributes
by that amount. This approach, like the
loss duplication account, has the advantage of needing only one set of rules to

2007–8 I.R.B.

govern both deconsolidating and nondeconsolidating transfers. It has the added
advantage of being similar to regimes that
are already familiar to taxpayers, such as
the attribute reduction rules of sections
108 and 1017, and §1.1502–28. Although
attribute reduction could be based on valuation, like the rule in section 362(e)(2),
the IRS and Treasury Department believe
that mandatory valuation would present
a significant administrative burden and
expense for both taxpayers and the IRS.
d. Conclusions.
The IRS and Treasury Department have
concluded that the complexity, administrative burden, and expense of the loss
disallowance and the loss duplication account approaches outweighed their respective advantages. Accordingly, these proposed regulations adopt an attribute reduction rule. The IRS and Treasury Department recognize that the attribute reduction
approach allows taxpayers to accelerate
economic losses of the subsidiary, but believe that this approach best preserves the
result in Rite Aid while addressing loss duplication. In general, the approach adopted
operates as an irrebuttable presumption, to
avoid the burden of mandatory valuation
in all cases, but taxpayers continue to have
several mechanisms available to structure
their transactions to permit valuation (for
example, by using actual or deemed asset
sales).
3. Gain duplication.
Notwithstanding the conclusions regarding duplication of loss, for the reasons
set forth in the LDR preambles, the IRS
and Treasury Department have tentatively
concluded that adequate protections, and
the incentive to use them, already exist
to prevent the duplication of gain. See
T.D. 8294, T.D. 8364 and T.D. 8984. For
example, see sections 332, 336(e) (which
is the subject of another current guidance
project), and 338(h)(10). Accordingly,
the duplication of gain is not addressed in
these proposed regulations, except as a result of the adoption of a loss disallowance
model. The IRS and Treasury Department
continue to study the issues, however, and
invite further comment. See section J of
this preamble for further discussion of the
issues on which comments are requested.

551

E. Noneconomic and Duplicated Loss
from Investment Adjustment System.
For all the reasons discussed in this
preamble, the IRS and Treasury Department believe that the approaches to
noneconomic and duplicated loss that are
adopted in these proposed regulations represent the best approach to the (original)
noneconomic and duplicated loss concerns
described in sections B.1 and B.2 of this
preamble. However, those rules alone
do not adequately address the problem of
noneconomic and duplicated loss attributable to investment adjustments applied to
shares of stock with disparate bases. This
is the concern described in section B.3 of
this preamble and illustrated in Example
4 and Example 5, as well as Example 7(b)
and Example 7(c).
The IRS and Treasury Department believe it is essential to address this concern.
One reason is that stock basis would be
inappropriately eliminated when, in cases
like Example 4, there is noneconomic loss
on one share because appreciated assets
were contributed to a corporation in exchange for other shares. In those cases, the
noneconomic loss should not be allowed,
but a rule that only prevents that loss does
not address the problem that there is insufficient basis on the shares received in the
exchange. The result would be noneconomic gain on the sale of those shares. An
equally important reason is that loss could
otherwise be duplicated when, in cases like
Example 5, loss is disproportionately reflected in the basis of some shares. Although regulations could prevent duplication in such cases (by eliminating inside
loss to the full extent of duplicated stock
loss), allowing a deduction for disproportionate stock loss in such cases permits the
acceleration of a disproportionate amount
of inside loss. To the extent that loss is disproportionately reflected in the basis of an
individual share, acceleration is generally
unwarranted and should be prevented to
the extent possible. Accordingly, the IRS
and Treasury Department have considered
various approaches to mitigating these effects.
1. Revise investment adjustment system to
adopt a tracing approach.
The IRS and Treasury Department recognize that one approach to this problem

February 20, 2007

would be to revise the investment adjustment system so that it would allocate
subsidiaries’ items of income, gain, deduction, and loss to their shares in accordance
with the actual reflection of those items
in the each share’s basis. This approach
would be similar to the section 704(c)
regime applicable to partnerships. However, this approach is a tracing model and,
as discussed in section C of this preamble,
the IRS and Treasury Department do not
believe that tracing is administrable in the
consolidated setting.
Moreover, as noted above, the IRS
and Treasury Department continue to believe that the presumptive-based rules of
§1.1502–32 are not only administrable,
but appropriate in the vast majority of
cases because typically subsidiary stock is
common stock owned entirely by members
with uniform bases. Where subsidiaries
have issued preferred stock, it is generally section 1504(a)(4) stock. In addition,
the investment adjustment system contains some guidance for situations that
do not reflect the general assumptions on
which the rules are based (for example,
the cumulative redetermination rule in
§1.1502–32(c)(4)). In such cases, tracing
would be unnecessary. Moreover, the IRS
and Treasury Department do not believe
that typical commercial transactions generally require groups to alter a subsidiary’s
capital structure in a manner that would
require tracing. Accordingly, the IRS and
Treasury Department are not considering
revising the investment adjustment system
to implement a tracing regime.
2. Presumptive approaches to reduce
basis disparity.
The two presumptive approaches considered to reduce basis disparity were
a full blending rule similar to that in
§1.1502–35(b)(1) and a rule that would
redetermine investment adjustments made
under §1.1502–32, similar to the rule in
§1.1502–35(b)(2).
a. Full basis blending.
Under the full basis blending approach,
all members’ bases are aggregated and
then allocated among members’ shares in
a manner that results in the elimination of
loss on preferred shares and of basis disparity on all other shares, at least within
each class. As a result, members’ bases

February 20, 2007

are aligned with the operating premises of
the investment adjustment system.
Full basis blending not only mitigates
the effects of previous noneconomic investment adjustments, addressing the concern illustrated in Example 4 and Example 5(a), it also prevents the acceleration of
disproportionate amounts of unrecognized
loss, addressing the concern illustrated in
Example 5(b).
A full basis blending rule is, however,
a significant departure from the rules generally applicable under the Code. Commentators have suggested that this departure from generally applicable law may be
more significant than is warranted in light
of the extent to which the concerns can
be addressed under the investment adjustment redetermination approach described
in this preamble.
b. Redetermination of investment
adjustments previously made to stock
basis.
The investment adjustment redetermination approach is less a departure from
Code provisions as it is a departure from
the general operation of §1.1502–32. In
general, this approach would reallocate investment adjustments previously applied
to members’ bases in subsidiary stock with
the goal of reducing, to the greatest extent
possible, the disparity in members’ bases
in subsidiary stock. Thus, like the full
blending approach, this approach would
bring members’ bases closer into alignment with the assumptions underlying the
investment adjustment system. However,
it would do so to a more limited extent than
the full blending rule and in a manner that
is less of a departure from general Code
rules.
i. Recomputation of individual investment
adjustments.
Presently, §1.1502–35(b)(2) addresses
duplicated loss by redetermining investment adjustments when there is a deconsolidating disposition of subsidiary stock.
To achieve the greatest reduction in basis
disparity possible, §1.1502–35(b)(2) in effect deconstructs investment adjustments
in order to remove negative items (that is,
items of deduction and expense) from adjustments to the bases of gain shares and
then apply those items to reduce members’
bases in loss shares. Taxpayers have raised

552

concerns with the complexity and administrability of this approach. The IRS has
observed compliance and audit difficulties
with this approach.
Accordingly, the IRS and Treasury Department have reconsidered whether this
general approach, redetermining investment adjustments, could be adopted in a
simpler form. The principal method considered was a presumptive reallocation of
entire investment adjustments (exclusive
of distributions), instead of the individual
items that comprise them. The approach
is similar to that used in the cumulative
redetermination rule of §1.1502–32(c)(4).
A significant advantage to this simplified
approach is that it is readily administered
with information that taxpayers are already
required to know (§1.1502–32 already requires taxpayers to determine investment
adjustments exclusive of distributions).
The IRS and Treasury Department
recognize that this general approach, in
whichever form adopted, does not address
the acceleration illustrated in Example
5(b) to the extent that full blending would.
However, this approach is less disruptive
to the general determination of basis.
ii. Reallocations to loss shares that are
not transferred.
Presently, §1.1502–35(b)(2) reallocations can result in the reduction of any
member’s basis in a loss share of subsidiary stock. The IRS and Treasury
Department have reconsidered whether
reallocated investment adjustments should
be applied to reduce loss on shares that are
not transferred in the transaction.
The IRS and Treasury Department have
concluded that reallocating investment adjustments to reduce the basis of only
transferred loss shares better implements
the loss disallowance model. The reason
is that this approach allows subsidiary
stock basis to remain intact until there is
a taxable disposition, deconsolidation, or
worthlessness of the share, thereby permitting that basis to enjoy the full protection
of subsequent appreciation as long as it remains in the group and otherwise subject
to the consolidated return system. This
approach has the added benefit of affording the maximum potential to eliminate
disparate reflection of loss on transferred
shares because all the reallocations are
directed to transferred shares. As a result,

2007–8 I.R.B.

this approach reduces the amount of loss
that can be accelerated (as illustrated in
Example 5(b)).
iii. Reallocations of positive and negative
investment adjustments.
Under the basis redetermination rule in
§1.1502–35(b)(2), only negative items are
reallocated. However, the sole purpose of
§1.1502–35, and thus the basis redetermination rules in §1.1502–35(b), is to address
the duplication of loss. (The full blending
approach of §1.1502–35(b)(1) addresses
noneconomic loss attributable to basis disparity as well as loss duplication, but only
incidentally as a result of its broad operation.) The IRS and Treasury Department
believe that, although it is appropriate for
a rule addressing only loss duplication to
reallocate just negative items (or negative
investment adjustments), a rule addressing both noneconomic and duplicated loss
must reallocate both negative and positive
items (or investment adjustments). As
illustrated in Example 4 and Example 5,
reallocations of both positive and negative amounts are necessary to prevent the
noneconomic and duplicated stock loss
that results from the disparate reflection
of unrecognized gain and to do so without
causing inappropriate results to taxpayers
(specifically, noneconomic gain).
For the foregoing reasons, the IRS and
Treasury Department have concluded that
the reallocation of both positive and negative adjustments is appropriate and necessary to balance the use of a presumptive system. Accordingly, these proposed
regulations provide for the reallocation of
both positive and negative investment adjustments to minimize the potential overand under-application of the noneconomic
and duplicated loss rules.
Explanation of Provisions
F. Explanation of the Proposed
Regulations.
1. Overview.
The proposed regulation consists of
three principal rules that apply when a
member transfers a loss share of subsidiary stock. The first rule redetermines
members’ bases in subsidiary stock by
reallocating §1.1502–32 adjustments (to

2007–8 I.R.B.

adjust for disproportionate reflection of
gains and losses in the bases of members’ shares). The second rule reduces
members’ bases in transferred loss shares
(but not below value) by the net positive
amount of all investment adjustments applied to the bases of those shares, but only
to the extent of the share’s disconformity
amount (to address noneconomic stock
loss). The third rule reduces the subsidiary’s attributes to prevent the duplication of a loss recognized on, or preserved
in the basis of, transferred stock.
The three rules generally apply in the
order described. If members transfer stock
of multiple subsidiaries in one transaction,
the basis redetermination and basis reduction rules apply first with respect to transfers of loss shares of stock of the subsidiaries at the lowest tier and then successively to transferred shares at each next
higher tier. These rules are not applied at
any tier until any gain or loss recognized
(even if disallowed) on lower-tier transfers
and any items resulting from lower-tier adjustments (whether required by the basis
redetermination or basis reduction rule or
otherwise) are taken into account and reflected in stock basis. After the basis redetermination and reallocation rules have
applied with respect to all transferred loss
shares, the attribute reduction rule applies
with respect to the highest-tier transferred
loss shares. The attribute reduction rule
then applies successively with respect to
transferred loss shares at each next lower
tier.
For purposes of these proposed regulations, a transfer of stock includes any
event in which gain or loss would be recognized (but for these proposed regulations),
the holder of a share and the subsidiary
cease to be members of the same group, a
nonmember acquires an outstanding share
from a member, or the share is treated as
worthless. This rule allows the proposed
regulations to prescribe one integrated set
of rules that implements a loss limitation
approach and that can be applied to all loss
shares, regardless of the event giving rise
to the application of the section.
2. The basis redetermination rule.
When a member transfers a share of
subsidiary (S) stock and, after the application of all other provisions of the Code
and regulations, the share is a loss share,

553

this rule subjects all members’ shares of S
stock to redetermination.
Under the basis redetermination rule,
investment adjustments (exclusive of distributions) that were previously applied to
members’ bases in S stock are generally
reallocated in a manner that, to the greatest extent possible, first eliminates loss
on preferred shares and then eliminates
basis disparity on all shares. The rule
moves both positive and negative adjustments, and so addresses both noneconomic
and duplicated losses. Because it generally requires adjustments to be made to reduce disparity, it brings members’ bases
closer in line with the fundamental principals underlying the investment adjustment
system. As a result, there is less likelihood for later noneconomic or duplicated
loss attributable to the investment adjustment system.
The rule operates by first removing
positive investment adjustments (up to
the amount of the loss) from the bases of
transferred loss shares. Then, to the extent
of any remaining loss on the transferred
shares, negative investment adjustments
are removed from shares that are not transferred loss shares and applied to reduce
the loss on transferred loss shares. The
positive adjustments removed from the
transferred loss shares are allocated and
applied only after the negative items have
been reallocated. The reason is to preserve
the most flexibility possible in reallocating
positive adjustments, in order to minimize
disparity to the greatest extent. Thus,
the operation of these rules has the effect
of removing basis from transferred loss
shares and using it to reduce disparity in
members’ bases in S shares.
Redetermination is limited in several
respects. First, because the premise of the
rule is that the original allocation of an
item did not represent the most economically appropriate allocation of the item, redeterminations under the rule are limited to
allocations of investment adjustments that
could have been made at the time an item
was taken into account. Accordingly, no
adjustments can be reallocated to shares
that were not held by members in the year
taken into account, as members’ shares
would not have been able to receive those
adjustments in the original allocation.
A related limitation on reallocation is
that an investment adjustment cannot be
reallocated except to the extent that the full

February 20, 2007

effect of the reallocation can be accomplished. Thus, an investment adjustment
can not be reallocated to the extent the
resulting basis has previously been taken
into account (including at a higher tier).
This rule guards against double benefits
from an adjustment (for example, by not
allowing positive adjustments to be moved
from, or negative adjustments be moved
to, shares after the item would have affected basis that was taken into account in
recognizing gain or loss). It also guards
against the loss of a benefit (for example,
by not allocating positive adjustments to
previously transferred shares that can no
longer benefit from the basis).
The principle purpose of the rule is to
reduce loss on transferred shares. However, because its secondary purpose is to
decrease disconformity to the greatest extent possible, in certain fact patterns, the
application of the rule will actually increase loss on some shares. Importantly,
in no fact patterns will the application of
the rule create gain on shares. Overall, the
rule has no effect on the aggregate amount
of gain or loss on members’ bases in subsidiary stock.
In the basis reallocation rule, and in several other provisions of the proposed regulations, there is a direction to allocate items
in a manner that reduces disparity to the
greatest extent possible. The regulations
do not, however, prescribe the manner in
which such determinations are to be made.
The IRS and Treasury Department intend
that taxpayers have flexibility in choosing
the methods and formulas to be employed
in making these determinations and the
IRS will respect any reasonable method or
formula so employed.
The IRS and Treasury Department recognize that the redetermination of basis
imposes a certain administrative burden.
Thus, the rule contains two safe harbors
that excuse taxpayers from reallocating basis in situations in which redetermination
is deemed unnecessary. One safe harbor
is for situations in which redetermination
would have no ultimate effect on the basis
of any share held by a member. This happens, for example, if only common stock
is outstanding and there is no disparity in
the bases of the shares. In such a case, any
redetermination would result in the same
bases the members had before redetermination. The second safe harbor is for situations in which the group disposes of its

February 20, 2007

entire interest in the subsidiary to an unrelated person in one or more fully taxable transactions. In such a case, the group
recognizes all the gains and losses on the
shares and so obtains no benefit from the
disparate reflection of gain or loss. Transfers that are excepted from basis redetermination, like transfers of shares that remain loss shares after application of the
rule, are then subject to the basis reduction
rule.
3. The basis reduction rule.
If, after basis redetermination, any
member’s transferred share is a loss share
(even if the share only became a loss share
as a result of the application of the basis redetermination rule), the basis of that share
is subject to reduction under this rule. This
rule is intended to eliminate stock loss that
is presumed noneconomic. It operates by
reducing the basis of each transferred loss
share (but not below value) by the lesser
of the share’s disconformity amount and
its net positive adjustment.
A share’s disconformity amount is the
excess of its basis over its allocable portion
of S’s net inside attributes, determined at
the time of the transfer. This amount identifies the net amount of unrealized appreciation reflected in the basis of the share.
Because the disconformity amount is computed at the time of the transfer, the disconformity amount reflects the effects of
all prior redetermination events.
The term net inside attributes is defined
as the sum of S’s loss carryovers, deferred
deductions, cash, and asset basis, reduced
by S’s liabilities. This computation is used
in both this basis reduction rule and the attribute reduction rule described in section
F.4 of this preamble. Both rules do, however, have special provisions that modify
the computation of net inside attributes if S
holds lower-tier subsidiary stock. See sections F.3.a and F.4.a of this preamble for
a discussion of rules relating to the stock
of lower-tier subsidiaries for purposes of
basis reduction and attribute reduction, respectively.
A share’s net positive adjustment is
computed as the greater of zero and the
sum of all investment adjustments (excluding distributions) applied to the basis
of the transferred loss share, including by
reason of prior basis reallocations. All
items of income, gain, deduction, and loss

554

are included fully in the net positive adjustment amount. This rule identifies the
extent to which basis has been increased
by the investment adjustment provisions
for items of income, gain, deduction and
loss (whether taxable or not) that have
been taken into account by the group.
a. Special rules applicable when S holds
stock of lower-tier subsidiary.
For purposes of computing the disconformity amount, if S holds stock of
a lower-tier subsidiary (S1) that was not
transferred in the transaction, S’s net inside
attribute amount is computed by treating
S’s basis in S1 stock as “tentatively reduced” by the lesser of the S1 share’s net
positive adjustment and its disconformity
amount. This reduction is made only for
purposes of determining basis reduction to
the S share, and has no other effect. The
purpose of this adjustment is to prevent
S1’s recognized items from giving rise to
noneconomic loss in S stock, for example,
when S1 recognizes gain that is already reflected (indirectly) in P’s basis in S shares.
This problem is illustrated in Example 8
(subsidiary holding lower-tier subsidiary
stock with a basis that reflects lower-tier
unrecognized appreciation).
When determining the disconformity
amount of a share of subsidiary stock, no
tentative reduction is made to the basis of
lower-tier shares that were transferred in
the transaction (without regard to whether
S retained the shares after the transaction,
such as when S1 is transferred because S
and S1 cease to be members of the same
group but S continues to hold S1 stock).
The reason is that the basis reduction rule
applies directly to each transfer, starting
with the lowest-tier transfer, and so any
noneconomic loss in S stock that was
attributable to S1’s items has been eliminated by the time that the basis reduction
rule applies to the S Stock. In addition,
the tentative basis reduction rule does not
apply to shares that are lower tier to any
shares that were transferred in the transaction. The application of the rule to those
shares is unnecessary because, when the
basis reduction rule applied to S1, it eliminated any inappropriate effects from items
that tiered up from subsidiaries that were
lower tier to S1.

2007–8 I.R.B.

4. The attribute reduction rule.
If any transferred share remains a loss
share after application of the basis reduction rule, the subsidiary’s attributes (including the consolidated attributes attributable to the subsidiary) are subject to reduction. The attribute reduction rule addresses the duplication of loss by members of consolidated groups. This rule
is intended to insure that the group does
not recognize more than one loss with respect to a single economic loss regardless
of whether the group chooses to dispose of
the subsidiary stock before or after the subsidiary recognizes the loss with respect to
its assets or operations.
Under this rule, S’s attributes are reduced by the “attribute reduction amount,”
which is computed as the lesser of the net
stock loss and the aggregate inside loss.
This amount reflects the total amount of
unrecognized loss that is reflected in both
the basis of the S stock and S’s attributes.
Net stock loss is the excess of the sum of
the bases (after application of the basis reduction rule) of all S shares transferred by
members in the same transaction over the
value of such shares. S’s aggregate inside loss is the excess of S’s net inside attributes over the value of all of the S shares.
The term net inside attributes generally has
the same meaning as in the basis reduction
rule, subject to special rules for lower-tier
subsidiaries (see section F.4.a of this preamble).
Unlike comparable provisions in
§1.1502–35 and the LDR, this rule does
not limit its application to a share’s proportionate interest in the subsidiary’s
aggregate inside loss. The reason is that
when a member recognizes a stock loss, or
preserves a stock loss for later recognition
(for example, when the share is retained
but deconsolidated), the member enjoys
(or preserves for later use) the benefit of
the entire amount of that stock loss. If
basis is uniform, the amount of stock loss
will reflect a proportionate interest in the
subsidiary’s unrecognized loss. But if
basis is disparate, the loss on a particular
share can reflect any amount, even all,
of the subsidiary’s unrecognized loss. In
either case, the potential loss duplication
equals the entire amount by which the
stock loss is duplicated in the subsidiary’s
attributes. Accordingly, the proposed regulations reduce attributes to that extent.

2007–8 I.R.B.

This prevents the duplication (but not acceleration) of loss otherwise available in
situations similar to Example 5(b) by reducing S’s attributes by the entire amount
by which the stock loss duplicates the aggregate inside loss.
A principal goal of this regulation is
to address the issues of noneconomic and
duplicated stock loss in a manner that is
as readily administrable as possible, by
taxpayers and the government. For that
reason, the proposed regulations generally
avoid imposing valuation requirements
whenever possible. However, the proposed regulations do, to the extent possible, use readily available information to
identify the location and amount of loss, to
avoid knowingly creating gain. The order
in which attributes are reduced reflects
these principles.
After S’s attribute reduction amount is
determined, it is first applied to reduce or
eliminate items that represent actual realized losses, such as operating loss carryovers, capital loss carryovers, and deferred deductions. If S’s attribute reduction amount exceeds those items, the excess is then applied to reduce or eliminate
the loss in the basis of property that is publicly traded (other than subsidiary stock,
which is subject to special rules). The reason that the basis of publicly traded property, unlike that of other assets, is only reduced by the amount of loss reflected in
the basis of the property is that such property can be readily and easily valued. Finally, if any attribute reduction amount remains after eliminating those attributes, it
is applied to reduce or eliminate the basis
in assets, other than publicly traded property (which then reflects no loss) and other
than cash and equivalents (which also reflect no loss). This reduction is made proportionately according to the basis in each
property.
The proposed regulations provide a
special rule that applies to the extent a
subsidiary has liabilities that have not
been taken into account as of the time of
the transfer. Under the general rule, if
the attribute reduction amount exceeds attributes available for reduction, that excess
attribute reduction amount has no further
effect. However, a special rule applies if
the attribute reduction amount exceeds the
attributes available for reduction and the
subsidiary has a liability that has not been
taken into account. Typically this will

555

happen when cash or other liquid assets
are held to fund future expenses related
to the liability. Because the assets held
by S do not reflect attributes that can be
reduced, loss can be duplicated later, when
the liability is taken into account. To prevent the duplication of loss in such cases,
the excess attribute reduction amount is
suspended and applied to prevent the deduction or capitalization of payments later
made by S or another person with respect
to the liability.
a. Special rules applicable when S holds
stock of lower-tier subsidiary.
When S holds stock of lower-tier subsidiaries, the attribute reduction amount is
computed in a manner that identifies the
maximum potential amount of loss duplication and attributes are reduced to that extent. However, the rule incorporates two
restrictions to prevent excessive reduction
of attributes that could otherwise result
from this approach. These rules are set
forth in this section 4.a.
First, to facilitate the computation of
S’s attribute reduction amount, all of S’s
shares of S1 stock are treated as a single share (generally referred to as the S1
stock). To identify the maximum potential duplication, the computation of the attribute reduction amount is made treating
S’s basis in S1 stock as its “deemed basis” in that stock. The proposed regulations define deemed basis as the greater of
S’s actual aggregate basis in the S1 shares
(adjusted for any gain or loss recognized
on a transfer of the S1 shares) and the S1
shares’ allocable portion of S1’s net inside attributes. For example, assume P
owns all the stock of S with a basis of
$150, S owns all the stock of S1 with a
basis of $100, and S1 owns an asset with
a basis of $150. S’s deemed basis in S1
stock is $150, the greater of $100 (S’s actual basis in S1 stock) and $150 (the S1
shares’ allocable portion of S1’s net inside attribute amount), which is the maximum amount of inside loss that S can
recognize. The proposed regulation uses
deemed basis not only to identify the maximum potential amount of loss duplication
($150 in the example), but also to reduce
attributes on the assumption that taxpayers
will act in their best interest when deciding how lower-tier attributes will be recog-

February 20, 2007

nized (subject to certain limits discussed in
this section F.4.a).
S’s deemed basis in S1 stock is also
used for purposes of allocating S’s attribute reduction amount between S’s S1
stock and S’s other attributes. However,
for this purpose, deemed basis is treated
as reduced by certain amounts that, by
their nature, do not reflect loss. These
excluded amounts include the value of
S1 shares transferred in the transaction
and the portion of S1’s cash, S1’s cash
equivalents, and the value of S1’s publicly
traded property (net of S1’s liabilities) that
is attributable to S’s nontransferred shares
of S1 stock. The excluded amounts also
include the corresponding amounts with
respect to all shares of stock of lower-tier
subsidiaries. These modifications prevent nonloss assets from inappropriately
increasing the allocation of attribute reduction to S1 stock.
The attribute reduction amount allocated to S’s block of S1 stock is then
apportioned and applied to reduce the
bases of S’s individual shares of S1 stock
in a manner that, to the greatest extent
possible, reduces disparity. This general
rule is subject to two modifications. First,
no allocated amount is apportioned to
any transferred S1 share if gain or loss is
recognized on the transfer of that share.
The reason is that the recognition of gain
or loss (even if not allowed) establishes
that the basis of that share does not reflect
(or no longer reflects) unrecognized loss.
This modification thus directs attribute reduction to other shares that are the source
of the potential duplication. The second
modification is that no allocated amount
that is apportioned to any transferred S1
share is to be applied to reduce the basis
of the share below its value. This modification prevents attribute reduction from
knowingly creating gain on such shares.
To fully implement the loss duplication
rule, any portion of S’s attribute reduction amount that is allocated to S1 stock,
whether or not it is apportioned or applied to reduce the basis of any S1 shares,
tiers down and becomes an attribute reduction amount of S1. The attribute reduction rules then apply to reduce S1’s attributes in the same manner that they apply S’s attribute reduction amount to reduce S’s attributes. However, because the
attribute reduction amount represents the
maximum potential amount of duplication

February 20, 2007

in the lower-tier subsidiary, the proposed
regulations include two modifications to
prevent the reduction of attributes beyond
the amount necessary to eliminate duplicated loss.
The first modification is the conforming
limit rule, which prevents the tier down of
attribute reduction from reducing S1’s net
inside attributes below the sum of the value
of the S1 shares transferred by members
and the aggregate bases that members have
in nontransferred S1 stock (after any reduction to those shares by the direct application of S’s attribute reduction amount).
The second modification is the basis
restoration rule. This rule applies after the
attribute reduction rule has been applied
with respect to all transfers and all resulting reductions (whether as a result of direct
or tier-down attribute reduction) have been
given effect. This rule reverses stock basis reductions made by the attribute reduction rule, but only to the extent necessary to
conform inside (net inside attributes) and
outside (stock) basis at each tier, taking
into account the effect of any prior section
362(e)(2) transactions. Because net inside
attributes can be a negative number, stock
basis may be a negative number even after basis restoration. In such cases, the basis of the share will remain an excess loss
account in the hands of the owning member after the transaction (the regulations
specifically provide that the excess loss account created by this rule is not taken into
account under §1.1502–19). Basis restoration adjustments are made at each tier, but
they do not give rise to any upper-tier adjustments.
With these two modifications, the attribute reduction rule can reduce lower-tier
attributes in an amount that eliminates the
full duplication potential reflected in S’s
basis in S1 stock and S1’s net inside attributes without creating a noneconomic
gain in the corresponding attribute.
b. Election to reduce stock basis and/or
reattribute loss.
Finally, the attribute reduction rule contains an elective provision under which
groups can reduce the potential for loss duplication and thereby reduce or completely
avoid attribute reduction under these regulations. Under this rule, the common parent of a group can elect to reduce stock basis, reattribute attributes, or do some com-

556

bination of basis reduction and attribute
reattribution in order to prevent the reduction of attributes otherwise required under these proposed regulations. The total
amount that can be the subject of the election is limited to the amount that S’s attributes would otherwise be subject to reduction.
The election to reattribute attributes can
only be made if S ceases to be a member of the P group as a result of the transfer. The reason is that the election is not
intended to be merely a mechanism for
changing location of items within a group
(and its continuing members). The election can be made with respect to loss carryforwards and deferred deductions of S
or any of S’s lower-tier subsidiaries, but
only to the extent and in the order that such
attributes would otherwise have been reduced under the attribute reduction rule.
However, P may only reattribute attributes
of lower-tier subsidiaries that would otherwise be reduced as a result of tier-down attribute reduction to the extent that the reattribution does not create an excess loss account in the stock of any lower-tier subsidiary. When this election is made, P is
treated as succeeding to the attributes as
though it had acquired them in a section
381(a) transaction.
Proposed
regulations
under
§1.1502–32 treat the reattributed attributes as absorbed and tiering up to
reduce the basis of shares such that the full
amount tiers up through the transferred
S shares for which the election is made.
This amount is allocated to shares in the
chain with positive basis in a manner
that reduces the disparity in the basis of
the shares to the greatest extent possible.
However, this amount is not allocated
to any lower-tier subsidiary shares that
were transferred in a transfer in which
gain or loss was recognized. The IRS and
Treasury Department recognize and are
concerned with the potential complexity
of this election and request comments
regarding both the administrability and
the benefit of the election, particularly
as it relates to attributes of lower-tier
subsidiaries.
Although the maximum amount of the
election is computed by tentatively applying the attribute reduction rule to S, the
election is actually given effect immediately before the application of the attribute
reduction rule. Thus, to the extent loss du-

2007–8 I.R.B.

plication has not been eliminated by the
election, the attribute reduction rules apply
in their general manner.
5. Over-ride provisions.
These proposed regulations contain
two over-ride provisions. One, found
in the general introductory provisions of
the proposed regulation, requires that the
provisions of these proposed regulations
be interpreted and applied in accordance
with their stated purposes. The other, an
anti-abuse and anti-avoidance rule, provides that “appropriate adjustments” will
be made if a taxpayer acts with a view
to avoid the purposes of this section or
use this section to avoid another rule of
law. The anti-abuse rule includes several
examples that illustrate general principles.
The examples are not intended to specify
particular transactions that will be treated
as abusive in all cases or to prevent the
IRS from treating other transactions as
abusive. This rule is an important safeguard to ensure that only transfers made
in the ordinary course of business enjoy
the benefits and avoid the burdens arising
from the principles adopted in these proposed regulations.
6. Special rules for section 362(e)(2)
transactions.
The IRS and Treasury Department recognize that adjustments made pursuant to
section 362(e)(2) (see discussion in section H of this preamble) alter the extent
to which comparisons of stock basis, net
inside attributes, and value can identify
both the amount of unrecognized appreciation reflected in stock basis and the
amount of duplicated loss. For example,
a reduction to asset basis under section
362(e)(2)(A) increases the disconformity
amount of the shares received in the transaction subject to section 362(e)(2), but this
amount does not represent unrealized appreciation reflected in stock basis. Further,
the reduction to asset basis under section
362(e)(2)(A) decreases the amount of loss
duplication that can exist with respect
to the shares received in the transaction
subject to section 362(e)(2). Similarly,
if stock basis is reduced pursuant to an
election under section 362(e)(2)(C), there
is an increase in the subsidiary’s net inside
attribute amount that reduces the disconformity amount of all shares and increases

2007–8 I.R.B.

aggregate inside loss, even though there
has been neither a decrease in the amount
of unrealized appreciation reflected in
stock basis nor an increase in duplicated
loss.
Accordingly, to adjust for distortions
resulting from basis reduction under section 362(e)(2)(A), the proposed regulations adjust the disconformity amount of
the shares received in the transaction to
which section 362(e)(2) applied by an
amount equal to the amount the basis of
such shares would have been reduced had
an election under section 362(e)(2)(C)
been made. Further, for purposes of computing the attribute reduction amount on a
transfer of any shares received in the section 362(e)(2) transaction, and applying
the conforming limitation on the application of tier-down attribute reduction,
the basis in such shares is reduced by an
amount equal to the amount the basis of
such shares would have been reduced had
an election under section 362(e)(2)(C)
been made. Similarly, to adjust for distortions resulting from basis reduction under
section 362(e)(2)(C), for purposes of computing any share’s disconformity amount
or the subsidiary’s aggregate inside loss,
and for purposes of determining any stock
basis restoration, the proposed regulations
reduce S’s net inside attribute amount by
an amount equal to the amount S’s attributes would have been reduced under
section 362(e)(2)(A) had no election under
section 362(e)(2)(C) been made. Further,
the regulations indicate that the special
application of section 362(e)(2) to intercompany transactions must be taken into
account, so these adjustments only apply
to the extent section 362(e)(2) has actually
resulted in some basis reduction.
The IRS and Treasury Department recognize that the computations in these proposed regulations may need to take other
items into account. Accordingly, the proposed regulations provide that the Commissioner will make appropriate adjustments to account for changes in the relationship between stock basis, net inside attributes, and value that are not the result of
either §1.1502–32 or these proposed regulations and that are not otherwise adjusted
under these proposed regulations. In addition, the proposed regulations provide that
taxpayers may seek a written determination regarding the treatment of comparable
items or adjustments.

557

7. Special rules considered but not
adopted.
a. Discounting of losses that are limited
by section 382 or other provisions.
The IRS and Treasury Department considered whether losses could be included
in the computation of the net inside attribute amount at a reduced rate if their
use was limited, for example, by section
382. Ultimately no administrable and precise method was identified for determining
the extent to which losses could be considered properly excluded (or included at a
reduced rate), except in the most extreme
cases. Accordingly, the proposed regulations do not provide special rules for limited losses. As a result, losses are fully included in net inside attributes.
The IRS and Treasury Department recognize that this approach is extremely favorable to taxpayers as it reduces the disconformity amount (and thus the extent to
which stock basis may be reduced) with
the only potential cost being the elimination of the losses under the attribute reduction rule. The IRS and Treasury Department believe that this taxpayer-favorable result, when produced in the ordinary
course of business, is not an inappropriate
result as part of the overall balance reached
by these regulations. Taxpayers that engage in transactions that have no bona
fide purpose other than to acquire limited
losses to avoid the purposes of the proposed regulations, however, will be subject to the anti-avoidance rule and the benefits of the transaction will be eliminated.
b. Exceptions for basis conforming
acquisitions.
Practitioners had suggested that any
proposed regulations addressing noneconomic loss contain an exception for transactions such as section 351 exchanges and
acquisitions subject to a section 338 election. These proposed regulations do not
explicitly contain such an exception. One
reason is that such an exception would
introduce the complexity and burden of
identifying all redetermination events. A
more important reason, however, is that
such an exception is unnecessary under
the basis disconformity model because,
by measuring disconformity immediately
before the transfer of loss shares, this rule
automatically excludes situations from

February 20, 2007

basis reduction when there is inside/outside conformity. Thus, the effect of this
suggestion is accomplished and no special
rules are necessary.
c. Shadow account for reduced basis.
The proposed regulations do not contain a mechanism, suggested by practitioners, for restoring basis to transferred shares
that are retained by a member and later
sold at a gain (for example, when a member retains S shares but S ceases to be
a member). The IRS and Treasury Department are concerned that such a rule
would add undue complexity to the regulatory scheme. Moreover, such a rule
would be inconsistent with a fundamental
principle underlying these proposed regulations, specifically, that a transfer (as defined in these proposed regulations) is the
appropriate time for these proposed regulations to apply. Thus, the basis reduction rules do not permanently reduce the
basis of lower-tier subsidiary stock unless
the stock is transferred in the transaction.
And, moreover, similar to the general application of other provisions of the Code
and regulations, subsequent events should
not reverse the effects of such application.
8. Effective date.
The proposed regulations would be applicable as of the date they are published as
final regulations in the Federal Register.
G. Sections 1.337(d)–1, 1.337(d)–2, and
1.1502–35.
Because proposed §1.1502–36 addresses both noneconomic and duplicated
loss on subsidiary stock, the IRS and Treasury Department are also proposing the
removal of §§1.337(d)–1, 1.337(d)–2, and
1.1502–35, except to the extent necessary to address losses suspended under
§1.1502–35(c) and losses reimported under §1.1502–35(g)(3).
Additionally, the IRS and Treasury
Department intend to publish temporary
regulations that will modify the anti-abuse
provisions of §1.1502–35. First, the temporary regulations will restate the loss
reimportation rule as a principle-based
rule. This change responds to comments
received about the administrability of the
current provision. Second, the temporary

February 20, 2007

regulations will modify the loss reimportation rule to provide that a duplicated
loss on subsidiary stock is subject to the
loss reimportation rule even if the group
deconsolidates the subsidiary before selling loss shares of the subsidiary stock.
These modifications are reflected in these
proposed regulations.
These proposed regulations also revise
several regulations solely to reflect the removal of §§1.337(d)–1, 1.337(d)–2, and
1.1502–35 (other than with respect to loss
suspension and loss reimportation), and
the addition of §1.1502–36.
The proposed regulations described in
this section G would be applicable as of the
date they are published as final regulations
in the Federal Register.
H. Suspension of Section 362(e)(2) in
Consolidation.
1. Background.
As part of the AJCA, Congress enacted section 362(e)(2) to address certain
instances of loss duplication. Very generally, that provision provides that if loss
property is transferred to a corporation in
a section 351 exchange (or as a capital
contribution or paid-in surplus), the transferee’s aggregate basis in the assets will
be limited to the properties’ fair market
value. However, section 362(e)(2) also
permits the parties to elect to limit the
basis of the stock received (or treated as
received) in the exchange to its fair market value, so that the loss is preserved in
the basis of the transferred property. Section 362(e)(2)(C). See REG–110405–05,
2006–48 I.R.B. 1004 [71 FR 62067] (October 23, 2006), (“the 2006 proposal”) for
a more detailed explanation of the general
application of section 362(e)(2).
Practitioners have questioned whether
it is necessary to apply section 362(e)(2) to
intercompany transactions where there is
a consolidated return rule addressing loss
duplication. The IRS and Treasury Department recognize that loss duplication in
consolidated groups is generally addressed
by §1.1502–32 (when losses are recognized on a subsidiary’s assets or operations) and, currently, by §1.1502–35 (or
by this proposed §1.1502–36 when it is finalized). In general, the IRS and Treasury believe that these regulations together
address loss duplication in a manner that

558

is most consistent with single entity principles. Nevertheless, the IRS and Treasury Department are concerned that, if section 362(e)(2) were not to apply to intercompany transfers, members of consolidated groups may be able to reduce gain
under circumstances that separate taxpayers could not. Accordingly, the IRS and
Treasury Department have tentatively concluded that section 362(e)(2) should be applied to intercompany transactions. However, the IRS and Treasury are concerned
with the administrative burden imposed
by section 362(e)(2) and are continuing to
study whether its provisions should be applicable to such transfers. Comments are
invited on this issue.
2. Suspension of section 362(e)(2) for
intercompany transactions.
Although the IRS and Treasury Department have tentatively concluded that section 362(e)(2) should remain applicable to
transfers between members of a consolidated group, as noted, the IRS and Treasury Department are concerned with the
significant complexity and administrative
burden that section 362(e)(2) adds in the
consolidated return context. For example,
if an election is made to reduce stock basis under section 362(e)(2)(C), a portion of
the items attributable to the transferred loss
assets can produce duplicative reductions
unless traced and treated as duplicative of
the section 362(e)(2) reduction to stock basis.
Moreover, the IRS and Treasury Department recognize that basis reductions
are not necessary in intercompany section
362(e)(2) transactions as long as duplication can effectively be eliminated by the
general operation of the investment adjustment system. Accordingly, these proposed regulations would suspend application of section 362(e)(2) until the occurrence of a “section 362(e)(2) application
event,” and then apply the principles of
section 362(e)(2) only to the extent the investment adjustment system has not eliminated and can no longer effectively eliminate any remaining duplication. The IRS
and Treasury Department expect that this
suspension will often effectively eliminate
the application of section 362(e)(2) to most
intercompany transactions.
Nevertheless, in order to apply section 362(e)(2) upon the occurrence of a

2007–8 I.R.B.

section 362(e)(2) application event, the
group must determine the extent to which
an intercompany transaction resulted in
loss duplication that would have been
prevented by section 362(e)(2), and track
the extent to which this duplication is effectively eliminated while the transferor
and the transferee are members. Accordingly, these proposed regulations require
the group to identify the amount and location of basis in the transferred assets
that would have been eliminated had section 362(e)(2)(A) applied at the time of
the intercompany transaction. This is the
amount of the net built-in loss that is duplicated as a result of the section 362(e)(2)
transaction. The regulations refer to this
amount of duplication as the “section
362(e)(2) amount.”
The duplicated loss is reflected in both
the transferor’s basis in the transferee
stock (or securities), and in the transferee’s basis in the property received. The
duplication is initially reflected in the basis
of the transferee stock (or securities) to the
extent the basis would have been reduced
under section 362(e)(2)(C), if such an
election was made and section 362(e)(2)
was not suspended by these temporary regulations. The duplication is also initially
reflected in the transferee’s basis in the
property received to the extent the basis
of such property would have been reduced
under section 362(e)(2)(A) if no election
was made under section 362(e)(2)(C) and
section 362(e)(2) was not suspended by
these temporary regulations. Over time
this amount can be reflected in other
attributes of the transferee (such as unabsorbed losses) to the extent such attributes
are attributable to the transferee’s basis in
the property received.
3. Elimination of the section 362(e)(2)
amount.
Because the investment adjustment system reduces stock basis as a subsidiary’s
attributes are taken into account, the duplication is eliminated to this extent, and
the section 362(e)(2) amount must be eliminated to this extent. Further, if the basis of the stock (or securities) received in
the intercompany section 362(e)(2) transaction is reduced as the result of a section 362(e)(2)(C) election, as a result of attribute reduction under these proposed regulations, or is otherwise eliminated with-

2007–8 I.R.B.

out the recognition of gain or loss, the duplication is similarly eliminated. Accordingly, these types of basis reductions result
in an elimination of all or a portion of the
section 362(e)(2) amount. The proposed
regulations provide specific guidance regarding how much of any remaining section 362(e)(2) amount is reflected in the
basis of the subsidiary’s stock (or securities) or the subsidiary’s attributes as the
section 362(e)(2) amount is eliminated.
4. Application of section 362(e)(2) to
intercompany transactions.
Upon the occurrence of a section
362(e)(2) application event, the regulations apply section 362(e)(2) only to the
extent necessary. A section 362(e)(2)
application event occurs when all or a
portion of the duplicated amount can no
longer be effectively eliminated by the
operation of the investment adjustment
system, and can involve either the stock
(or securities) of the transferee or the
assets transferred in the intercompany
section 362(e)(2) transaction. Such an
event is defined to include any transfer (as defined in proposed §1.1502–36)
of the transferee’s stock received in the
exchange, any satisfaction of a security
received in the exchange, any transaction
in which a nonmember acquires any of the
transferred assets with substituted basis
or succeeds to any attributes attributable
to such basis, or any other transaction the
result of which prevents all or a portion of
any remaining section 362(e)(2) amount
reflected in stock basis and attributes from
being effectively eliminated by the operation of the investment adjustment system
when taken into account.
Further, if the transferor and the
transferee in the intercompany section
362(e)(2) transaction continue to be members of the same group (including as
members of another group), the investment adjustment system can continue
to effectively eliminate the duplication.
Accordingly, these proposed regulations
provide a subgroup exception implicit in
the definition of section 362(e)(2) application events that allows the transferor and
transferee to become members of a new
group without triggering the application of
section 362(e)(2). In such a case, the transferor and transferee will continue to track
the section 362(e)(2) amount reflected in

559

stock basis and attributes, and apply these
provisions upon the occurrence of a section 362(e)(2) event.
Given the fact that section 362(e)(2)
is applied in this context only to the extent necessary, the scope of its application varies slightly depending upon the
type of section 362(e)(2) application event
that occurs. If the application event involves a transaction in which a nonmember acquires some or all of the transferee’s
attributes that reflect a section 362(e)(2)
amount, section 362(e)(2) applies to the
extent such attributes reflect all or part of
any remaining section 362(e)(2) amount.
In such a case, the resulting reduction in
attributes is applied to the attributes involved in the application event that reflect
the section 362(e)(2) amount. If the application event involves all or part of the
transferee stock (or securities) received in
the section 362(e)(2) transaction, section
362(e)(2) applies to the extent such stock
(or securities) reflect all or part of any remaining section 362(e)(2) amount. Further, in this case, the resulting reduction in
attributes is applied proportionately to the
transferee’s attributes that reflect the section 362(e)(2) amount (based on the relative section 362(e)(2) amount reflected).
The reduction in the transferee’s attributes
is not a noncapital, nondeductible expense.
As is provided in section 362(e)(2)(C),
the transferor and transferee may elect to
reduce the basis in the transferee stock
(or securities) received in the intercompany section 362(e)(2) transaction instead
of reducing the transferee’s attributes.
Similar to the provisions of the proposed
regulations under section 362(e)(2), the
reduction in the basis of the transferee
stock (or securities) received in the intercompany section 362(e)(2) transaction
is equal to the amount of the reduction
in the transferee’s attributes absent the
election. Further, if this election is made,
the type of section 362(e)(2) application
event dictates which shares (or securities) receive the basis reduction. If the
application event involves a transaction
in which a nonmember acquires some or
all of the transferee’s attributes, the reduction is applied proportionately to all of
the transferee stock (or securities) held by
members immediately before the application event (based on the relative section
362(e)(2) amount reflected). However,
if the application event involves all or

February 20, 2007

a part of the transferee stock (or securities) received in the intercompany section
362(e)(2) transaction, the reduction is
applied proportionately to the stock (or
securities) so involved (based on the relative section 362(e)(2) amount reflected).
The reduction in the basis of the stock of
the transferee as a result of this election is
treated as a nondeductible basis recovery
item.
Under the proposed regulations, the
election to reduce stock basis (in lieu of
attributes) under section 362(e)(2)(C) may
be made for the intercompany transaction
on either the group return for the year
of the intercompany section 362(e)(2)
transaction or the year in which the first
section 362(e)(2) application event occurs. In either case, the election has effect
only if and to the extent there is a section
362(e)(2) application event, is irrevocable once made, and applies to all section
362(e)(2) application events with respect
to such intercompany section 362(e)(2)
transaction (even if the application event
occurs at a time when the transferor and
transferee are members of another consolidated group).
5. Special allocations under §1.1502–32.
The proposed regulations also include a
special allocation provision in §1.1502–32
that requires all items taken into account
by a group (including tier-ups of such
amounts) that reflect a section 362(e)(2)
amount to be allocated entirely to members’ shares. In other words, such items
are allocated as if any shares held by
nonmembers were not outstanding. The
reason for these special allocation rules
is to prevent the general §1.1502–32 allocation of items to dilute the elimination
of duplication where shares of subsidiary
stock are held by nonmembers.
6. Other considerations.
In the 2006 proposal, the IRS and Treasury Department proposed regulations
that would provide that the tracing rules
in §1.358–2(a)(2) will not apply to stock
received in a section 362(e)(2) transaction
if the transferor and transferee elect to
apply section 362(e)(2)(C). The IRS and
Treasury requested comments regarding
whether that treatment is appropriate. As
noted in section H.4 of this preamble,
these proposed regulations would allow

February 20, 2007

the making of a section 362(e)(2)(C) election to be deferred until the year of the first
section 362(e)(2) application event. The
IRS and Treasury Department are aware of
the potential difficulty and administrative
burden associated with retroactively not
applying the provisions of §1.358–2(a)(2).
The IRS and Treasury Department continue to study this issue, and invite comments regarding whether the proposed
revision to §1.358–2(a)(2)(viii) regarding
section 362(e)(2)(C) elections should apply to intercompany transactions.
These proposed regulations would be
applicable as of the date they are published
as final regulations in the Federal Register.
I. Other Revisions to the Consolidated
Return Regulations.
The IRS and Treasury Department are
also proposing various technical and administrative revisions to the consolidated
return regulations.
1. Removal of §1.1502–13(f)(6)(ii).
Section 1.1502–13(f)(6)(ii) prevents a
member from recognizing gain on the
qualified disposition of parent stock.
However, §1.1502–13(f)(6)(ii) only applies to dispositions of parent stock occurring prior to May 16, 2000. Thus, the provision has no current applicability. Nevertheless, gain on dispositions of parent
stock occurring on or after May 16, 2000,
may qualify to be prevented by §1.1032–3,
which has fewer conditions to its application than did §1.1502–13(f)(6)(ii). To
avoid confusion, the IRS and Treasury
Department propose replacing the current
provisions in §1.1502–13(f)(6)(ii) (and
references to that provision) with a reference to §1.1032–3.
2. Modification of exception to definition
of deconsolidation in §1.1502–19.
Section 1.1502–19 provides rules for
the determination and recapture of excess
loss accounts. In general, an excess loss
account is recaptured (taken into account)
when there is a disposition of the stock
to which the account relates. Section
1.1502–19(c) defines the term disposition for purposes of §1.1502–19. Under
that section, the term disposition includes
transfers, cancellations, deconsolidations,

560

and worthlessness. The term deconsolidation is defined in §1.1502–19(c)(1)(ii).
In general, the termination of a consolidated group will give rise to the deconsolidation of the members of the group.
However, §1.1502–19(c)(3)(i)(A) provides that, if a group terminates because
a member of another group has acquired
either the assets of the common parent of
the terminating group (in a reorganization
described in section 381(a)(2)) or the stock
of the common parent, the members of the
acquired group that become members of
the acquiror’s group are not treated as deconsolidated. Thus, there is no recapture
of excess loss accounts in the shares of
stock of subsidiaries of the acquired group
that, after the acquisition, are held by a
member of the acquiring group.
The exception to deconsolidation treatment in §1.1502–19(c)(3)(i)(A) (and
therefore to the recapture of excess loss
accounts) is warranted because its conditions ensure that the consolidated return
provisions will continue to apply to the
members of the acquired group. Thus,
the provisions of §1.1502–19 are able to
continue to regulate the determination
and recapture of the excess loss accounts.
However, for the continued application
of the consolidated return provisions
to the acquired group, it is only necessary that the acquiror be a member of a
group following the acquisition. Its status prior to the acquisition is immaterial.
The IRS and Treasury Department have
therefore decided to revise the rule in
§1.1502–19(c)(3)(i)(A) to require only
that the acquiror be a member of a group
following the qualified acquisition.
Thus, under the proposed regulations,
the exception to deconsolidation treatment
provided in §1.1502–19(c)(3)(i)(A) would
be available when the acquisition is by a
stand-alone corporation or a member of an
affiliated, nonconsolidated group.
3. Clarification of “substantially all”
standard in §1.1502–19(c)(1)(iii)(A).
Section 1.1502–19(c)(1)(iii) defines
the term “worthless” for purposes of excess loss account recapture (resulting in
the inclusion of the excess loss account
in income). The definition of worthlessness in §1.1502–19(c)(1)(iii) is adopted
for determining the time when subsidiary
stock with positive basis may be treated as

2007–8 I.R.B.

worthless (and therefore deductible). See
§1.1502–80(c).
Section 1.1502–19(c)(1)(iii)(A) generally provides that a share of subsidiary
stock will be treated as worthless when
substantially all the subsidiary’s assets
are treated as disposed of, abandoned,
or destroyed for federal tax purposes.
This provision prevents an excess loss
account from being included in income
(and a worthless stock deduction from being taken) until the subsidiary’s activities
have been taken into account by the group.
As a result, the group’s income is clearly
reflected and single entity treatment is
promoted.
The current regulations do not, however, define the term “substantially all”
for purposes of §1.1502–19(c)(1)(iii)(A).
Particular concerns have arisen because
the term is used in many other areas of
tax law, most notably in the area of corporate reorganizations. Because different
policies are operative in those areas, the
thresholds appropriate in those areas are
not necessarily appropriate for purposes of
§1.1502–19(c)(1)(iii)(A) and the consolidated return provisions that incorporate it.
The IRS and Treasury Department
believe that the single entity purpose of
these consolidated return provisions is
best effected by treating a subsidiary’s
stock as worthless only once the subsidiary has recognized all items of income, gain, deduction, and loss attributable to its assets and operations. Accordingly, these proposed regulations clarify
§1.1502–19(c)(1)(iii)(A) by providing
that stock of a subsidiary will be treated
as worthless when the subsidiary has disposed of, abandoned, or destroyed (for
Federal tax purposes) all its assets other
than its corporate charter and those assets, if any, that are necessary to satisfy
state law minimum capital requirements
to maintain corporate existence.

The regulations do not specify whether a
group structure change that is also a triangular reorganization is subject to the basis
rules applicable to group structure changes
(under §1.1502–31) or to triangular reorganizations (under §1.1502–30). Because
it is appropriate to conform the basis of
the stock of the former common parent to
its net asset basis in the case of any group
structure change, the IRS and Treasury Department intend the rules of §1.1502–31
to control the determination of stock basis when a transaction is a group structure change, without regard to whether the
transaction is also a triangular reorganization. Accordingly, the proposed regulations add a rule to clarify that §1.1502–31
governs the determination of basis in all
cases to which it applies, even those that
also qualify as triangular reorganizations.

4. Triangular reorganizations that are
also group structure changes.

Section 1.1502–32(b)(3)(ii)(C)(2) provides that, if the amount of a discharge
of indebtedness exceeds the amount
of the related attribute reduction under
§1.1502–28, that excess is treated as applying to reduce attributes to the extent
of certain expired losses. In general, this
section only applies to losses that expired
without tax benefit, that were taken into
account as noncapital, nondeductible expenses when they expired, and that would

Sections 1.1502–30 and 1.1502–31 provide special rules for determining the basis of stock following, respectively, a triangular reorganization and a group structure change. The provisions both generally
adopt net asset basis rules, but, in the case
of a triangular reorganization, taxpayers
can elect other rules in certain transactions.

2007–8 I.R.B.

5. Allocations of investment adjustments
to prevent or minimize excess loss
accounts.
Under §1.1502–32(c)(2)(i), positive investment adjustments allocated to a member’s shares of a class of common stock
are allocated first to equalize and eliminate excess loss accounts and then equally
to all the member’s other shares in that
class. In the case of a negative adjustment,
that section provides for the reduction of
a member’s positive basis in shares of a
class of common stock before the creation
or increase of an excess loss account in
any such share. However, the current rule
does not require that negative adjustments
must be made first to equalize excess loss
accounts before applying them equally to
all shares. The proposed regulations add
such a provision in order to better reflect
the member’s investment in its shares of
subsidiary stock.
6. Expired losses and attribute reduction
under §1.1502–28.

561

have been reduced had they not expired.
The effect of this rule is to create a positive adjustment to the extent of the expired
losses. The purpose of the rule, as stated
in T.D. 8560, is to more fully integrate
expired losses into the investment adjustment system.
As currently written, however, the rule
does not explicitly state whether this special treatment of expired losses is available
to all members’ expired losses or only to
the debtor-subsidiary’s expired losses. Allowing such treatment for all members’
expired losses is beyond the intended
scope of relief and undermines the purpose
of sections 108 and 1017, and §1.1502–28.
Accordingly, §1.1502–32(b)(3)(ii)(C)(2)
is revised to state explicitly that such treatment is intended only for the debtor-subsidiary’s expired losses. The regulation
is also revised to clarify that all available
attributes, not just those of the debtor-subsidiary, must be reduced before this special
rule for certain expired losses can apply.
7. Applicability of other rules of law,
anti-duplicative adjustments rules.
Many of the consolidated return rules
include provisions stating that other rules
of law continue to apply. These provisions are generally unnecessary in light
of §1.1502–80(a), which provides that the
provisions of the Code continue to apply to
taxpayers filing a consolidated return unless specifically provided otherwise in the
consolidated return regulations. However,
these provisions often also contain statements that the consolidated return provisions modify other rules of law and that duplicative adjustments should not be made
as a result of the consolidated return provisions. To simplify the regulations and
remove any potential negative implication
from the absence of such a provision in a
particular provision, these proposed regulations incorporate all of these principles
in §1.1502–80(a) and remove similar provisions from other sections of the consolidated return regulations.
8. Retention of, and nonsubstantive
revisions to, §1.1502–80(c).
Section 1.1502–80(c) provides that
subsidiary stock is not treated as worthless until the earlier of the time that
the subsidiary ceases to be a member of the group and the time that the

February 20, 2007

stock is worthless within the meaning
of §1.1502–19(c)(1)(iii). This rule, with
its companion rule postponing the inclusion in income of excess loss accounts,
prevents a group from recognizing any
amount (whether loss or gain) on subsidiary stock until the subsidiary has taken
into account all of its operating income,
gain, deduction, and loss. Thus, the rule
promotes single entity treatment by enabling the group to continue treating its
investment in subsidiary stock as an investment in the subsidiary’s assets and
operations until the subsidiary has either
taken all of its items into account or ceased
to be a member of the group.
Following the Rite Aid decision, practitioners have submitted comments suggesting that §1.1502–80(c) should be removed
from the consolidated return regulations.
The suggestion was based on the observation that §1.1502–80(c) prevented inappropriate disallowance under the LDR and,
since the LDR no longer applies to stock
dispositions, §1.1502–80(c) is no longer
necessary. While it is correct that there is
no longer an LDR-based justification for
the rule in §1.1502–80(c), the LDR was
neither the only nor the principal purpose
for the rule. The principal purpose of the
rule was, and is, to promote single entity
treatment. And, with its companion rule
governing the inclusion of excess loss accounts, this rule continues to do that.
In addition, the IRS and Treasury Department recognize that, to the extent a
subsidiary’s attributes would survive a
worthlessness event (for example, when
a subsidiary survives and is owned by
its creditors following a bankruptcy),
§1.1502–80(c) benefits the group by postponing the time that the subsidiary’s stock
is treated as worthless. Because section
382(g)(4)(D) could subject S’s losses to
a zero section 382 limitation if P were
to treat S’s stock as worthless during
bankruptcy, a court might prevent P from
treating S’s stock as worthless in an earlier
year, effectively denying P any worthlessness deduction. See In re Prudential
Lines, Inc., 928 F.2d 565 (2d Cir. 1991),
cert. denied, 112 S.Ct. 82 (1991).
Accordingly, the IRS and Treasury Department have rejected the suggestion to
remove §1.1502–80(c). The proposed regulations do, however, revise the language
of the current rule solely for the purpose

February 20, 2007

of clarifying its operation. No substantive
change is intended.
9. Effective dates.
The proposed regulations described in
this section I would be applicable as of the
date they are published as final regulations
in the Federal Register.
J. Request for Comments.
As described in this preamble, many approaches and combinations of approaches
were considered with respect to both
noneconomic and duplicated loss and, although the IRS and Treasury Department
believe the approach adopted in these proposed regulations best responds to and
balances the Congressional mandates,
comments are requested concerning both
the approach adopted in these proposed
regulations and other possible approaches.
As noted in section D of this preamble,
the IRS and Treasury Department are continuing to study, and invite comments on,
the issue of gain duplication by consolidated groups. Comments are specifically
requested concerning the circumstances
under which gain duplication should be
addressed and the mechanisms that could
be adopted to do so. For example, comments could address whether a gain duplication rule could or should parallel the
approach to loss duplication suggested in
the proposed regulations, or whether some
other approach would be more appropriate or administrable. Comments are also
requested regarding limitations that may
be necessary or appropriate to address
concerns such as attribute churning and
conversion. In addition, comments are
requested concerning the noneconomic
reduction of stock gain (that is, the appropriateness of the continued use of a loss
disallowance model) and the reduction
of noneconomic stock gain (that is, the
reduction of basis through the absorption
of built-in losses or net built-in losses),
and the extent to which it would be appropriate to address gain duplication without
addressing these issues.
As noted in section H of this preamble, the IRS and Treasury Department are
continuing to study the application of section 362(e)(2) in the consolidated setting.
Comments are specifically requested concerning the general application of section

562

362(e)(2) to intercompany transactions, as
well as the administrability and appropriateness of the proposed rules suspending
the application of section 362(e)(2) to
intercompany transactions and specially
allocating items attributable to intercompany section 362(e)(2) transactions.
Although these regulations are generally proposed to be applicable when published as final regulations in the Federal
Register, the IRS and Treasury Department invite comments regarding the extent
to which it would be appropriate and desirable to allow taxpayers to elect to apply
these provisions retroactively.
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. It is hereby certified that these 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 primarily will affect affiliated
groups of corporations that have elected
to file consolidated returns, which tend to
be larger entities. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is
not required. Pursuant to section 7805(f),
this regulation has been submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.
Comments and Requests for 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.
The IRS and Treasury Department request
comments on the clarity of the proposed
regulations and how they can be made easier to understand. All comments will be
available for public inspection and copying. A public hearing will be scheduled
if requested in writing by any person that
timely submits written comments. If a
public hearing is scheduled, notice of the
date, time, and place for the public hearing
will be published in the Federal Register.

2007–8 I.R.B.

Drafting Information
The principal authors of these
regulations are Theresa Abell and
Phoebe Bennett of the Office of Associate Chief Counsel (Corporate). However, other personnel from the IRS and
Treasury Department participated in their
development.
*****
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 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1502–36 also issued under 26
U.S.C. 1502 * * *
Section 1.1502–36 also issued under 26
U.S.C. 337(d). * * *
§1.337(d)–1 [Removed]
Par. 2. Section 1.337(d)–1 is removed.
§1.337(d)–2 [Removed]
Par. 3. Section 1.337(d)–2 is removed.
Par. 4. Section 1.358–6 is amended by:
1. Revising paragraph (e).
2. Adding new paragraph (f)(3).
The revision and addition read as follows:
§1.358–6 Stock basis in certain triangular
reorganizations.
*****
(e) Cross-reference regarding triangular reorganizations involving members of
a consolidated group. For rules relating to
stock basis adjustments made as a result
of a triangular reorganization in which P
and S, or P and T, as applicable, are, or become, members of a consolidated group,
see §1.1502–30. However, if a transaction is a group structure change, even if it
is also a triangular reorganization, stock
basis adjustments are determined under
§1.1502–31.
*****
(f) * * *

2007–8 I.R.B.

(3) Special rule for triangular reorganizations involving members of a consolidated group. Paragraph (e) of this section
shall apply to all transfers on or after the
date these regulations are published as final regulations in the Federal Register.
Par. 5. Section 1.1502–13 is amended
by:
1.
Revising paragraphs (a)(4),
(f)(6)(ii), and (j)(5)(i)(A).
2. Adding new paragraph (e)(4).
3. Revising the last sentence of paragraph (f)(6)(iv)(A).
4. Removing the second sentence in
paragraph (f)(6)(v).
5. Adding a new last sentence to paragraph (l)(1).
The revisions and additions read as follows:
§1.1502–13 Intercompany transactions.
(a) * * *
(4) Application of other rules of law.
See §1.1502–80(a) regarding the general
applicability of other rules of law and a
limitation on duplicative adjustments.
*****
(e) * * *
(4) Intercompany section 362(e)(2)
transactions—(i) Purpose and scope.
This paragraph (e)(4) provides simplifying
rules for intercompany transactions that
are subject to section 362(e)(2) (intercompany section 362(e)(2) transactions). The
purpose of this paragraph (e)(4) is to suspend the application of section 362(e)(2)
during the period of time that the duplication resulting from the intercompany
section 362(e)(2) transaction (the section
362(e)(2) amount, as defined in paragraph
(e)(4)(ii)(A) of this section) can effectively be eliminated by the operation of
the investment adjustment provisions of
§1.1502–32. The amount and location of
this duplication is identified and tracked
while in the consolidated group. When
this duplication can no longer effectively
be eliminated by the investment adjustment provisions, the principles of section
362(e)(2) apply to the extent necessary to
eliminate all or a portion of any remaining section 362(e)(2) amount (as defined
in paragraph (e)(4)(ii)(B) of this section)
reflected in B’s attributes or stock. For
purposes of this paragraph (e)(4), any
reference to B stock received in an intercompany section 362(e)(2) transaction

563

refers to B stock or B securities received
(or deemed received) without the recognition of gain or loss.
(ii) Identification and elimination of
section 362(e)(2) amount—(A) Section
362(e)(2) amount. The section 362(e)(2)
amount is the amount of duplication resulting from an intercompany section
362(e)(2) transaction, and is equal to
the amount by which B’s basis in the
assets received in an intercompany section 362(e)(2) transaction would have,
but for the application of this paragraph
(e)(4), been eliminated under section
362(e)(2)(A) (absent an election under
section 362(e)(2)(C)). Such amount is initially reflected in both the basis of the B
stock received in the transaction and B’s
basis in the assets received. Each share
of B stock initially reflects the section
362(e)(2) amount to the extent the basis
would have been reduced under section
362(e)(2)(C) if such an election was made
and this paragraph (e)(4) did not apply.
B’s basis in each asset received initially
reflects the section 362(e)(2) amount to the
extent the basis in such asset would have
been reduced under section 362(e)(2)(A)
if no election was made under section
362(e)(2)(C) and this paragraph (e)(4) did
not apply. However, over time the section
362(e)(2) amount may be reflected in B’s
basis in assets, deferred items, or other
unabsorbed losses (B’s attributes).
(B) Remaining section 362(e)(2)
amount. The remaining section 362(e)(2)
amount is the portion of the section
362(e)(2) amount that has not been eliminated.
(C) Elimination of section 362(e)(2)
amount—(1) Elimination caused by reduction in B’s attributes. The section
362(e)(2) amount is eliminated as B’s attributes that reflect the section 362(e)(2)
amount are taken into account by the
group (including as a result of attribute reduction under paragraph (e)(4)(iv) of this
section, or §1.1502–36(d) to the extent it
did not reduce the basis in B stock that reflects the section 362(e)(2) amount). The
portions of B’s attributes that reflect a section 362(e)(2) amount are generally taken
into account by the group proportionately.
However, because any reduction in B’s
attributes under paragraph (e)(4)(iv) of
this section is applied to reduce attributes
that reflect the section 362(e)(2) amount,
the section 362(e)(2) amount is elimi-

February 20, 2007

nated to the extent of the full amount of
such reduction. If the section 362(e)(2)
amount is eliminated because B’s attributes that reflect the section 362(e)(2)
amount are taken into account, each share
of B stock received in the intercompany
section 362(e)(2) transaction that is held
by a member is treated as proportionately
reflecting the remaining section 362(e)(2)
amount (based on the section 362(e)(2)
amount reflected before the elimination).
(2) Elimination caused by reduction in
basis in B stock. The section 362(e)(2)
amount is also eliminated to the extent the
basis in B stock that reflects the section
362(e)(2) amount is reduced under paragraph (e)(4)(v) of this section, is reduced
under §1.1502–36(d), or is otherwise eliminated (other than under §1.1502–32) without the recognition of gain or loss. The
portion of the basis in a share of B stock
that reflects a section 362(e)(2) amount is
so reduced or eliminated before any other
portion of the basis in such a share. If the
section 362(e)(2) amount is eliminated as
provided in this paragraph (e)(4)(ii)(C)(2),
each of B’s attributes that reflected the section 362(e)(2) amount is treated as proportionately reflecting the remaining section 362(e)(2) amount (based on the section 362(e)(2) amount reflected before the
elimination).
(iii) Section 362(e)(2) application
event. A section 362(e)(2) application
event is any transaction or event that results in—
(A) A transfer (within the meaning of
§1.1502–36(f)(11)) of any of the B stock
that was received in the intercompany section 362(e)(2) transaction;
(B) Any satisfaction (actual or deemed)
of a security received in an intercompany
section 362(e)(2) transaction without the
recognition of gain or loss;
(C) Any nonmember holding an asset
with a substituted basis that reflects all or a
portion of the remaining section 362(e)(2)
amount or succeeding to an attribute that
reflects all or a portion of the remaining
section 362(e)(2) amount; or
(D) Any other transaction the result
of which prevents all or a portion of any
remaining section 362(e)(2) amount reflected in stock basis or attributes from being effectively eliminated by the operation
of the investment adjustment provisions
of §1.1502–32 when taken into account.

February 20, 2007

(iv) General rule. In the case of an
intercompany section 362(e)(2) transaction, no adjustment to B’s attributes shall
be made under section 362(e)(2) until
immediately before a section 362(e)(2)
application event (as defined in paragraph
(e)(4)(iii) of this section). At that time,
unless an election is made under paragraph (e)(4)(v) of this section, B reduces
its attributes that reflect the remaining
section 362(e)(2) amount as provided in
this paragraph (e)(4)(iv).
(A) Amount of reduction. If the application event involves B’s attributes that reflect all or a portion of the remaining section 362(e)(2) amount, the amount of the
reduction is equal to the remaining section 362(e)(2) amount reflected in the attributes so involved. If the application
event involves all or a portion of the B
stock received in the intercompany section
362(e)(2) transaction, the amount of the reduction is equal to the remaining section
362(e)(2) amount reflected in the B stock
so involved.
(B) Application of reduction. If the application event involves B’s attributes that
reflect all or a portion of the remaining
section 362(e)(2) amount, the reduction
is applied to reduce each attribute so
involved by the full amount of the remaining section 362(e)(2) amount reflected
in each such attribute. If the application
event involves all or a portion of the B
stock received in the intercompany section 362(e)(2) transaction, the reduction
is applied proportionately (based on the
remaining section 362(e)(2) amount reflected in each attribute prior to reduction)
to all of B’s attributes that reflect the remaining section 362(e)(2) amount.
(C) Effect of the reduction.
Any
reduction to B’s attributes under this
paragraph (e)(4)(iv) is not a noncapital, nondeductible expense described in
§1.1502–32(b)(2)(iii).
(v) Election to reduce the basis in B
stock. In lieu of reducing B’s attributes
as provided in paragraph (e)(4)(iv) of this
section, S and B may elect to reduce the
basis in the B stock received in the intercompany section 362(e)(2) transaction as
provided in this paragraph (e)(4)(v).
(A) Amount of reduction. The basis in
the B stock is reduced by an amount equal
to the amount B would otherwise be required to reduce its attributes under paragraph (e)(4)(iv) of this section.

564

(B) Application of reduction. If the
application event involves B’s attributes
that reflect all or a portion of the remaining section 362(e)(2) amount, the reduction is applied proportionately (based on
the remaining section 362(e)(2) amount reflected in the B stock prior to reduction)
to all of the B stock received in the intercompany section 362(e)(2) transaction
that is held by members immediately before the application event. If the application event involves all or a portion of
the B stock received in the intercompany
section 362(e)(2) transaction, the reduction is applied proportionately (based on
the remaining section 362(e)(2) amount
reflected in the B stock prior to reduction) to the B stock so involved. Any reduction in the basis of the B stock under
this paragraph (e)(4)(v) is applied immediately before the section 362(e)(2) application event.
(C) Effect of the reduction. Any reduction to the basis of the B stock under this paragraph (e)(4)(v) is a nondeductible basis recovery item described in
§1.1502–32(b)(3)(iii)(B).
(D) Election. The election is made in
the manner described in regulations implementing section 362(e)(2). The election
must be made for an intercompany section
362(e)(2) transaction on or with the group
return for either the year in which the intercompany section 362(e)(2) transaction
or the first section 362(e)(2) application
event occurs. The election is irrevocable
and applicable for all section 362(e)(2) application events with respect to such intercompany section 362(e)(2) transaction
(even if the event occurs while S and B are
members of another consolidated group).
If the election is made on or with the return
for the year of the intercompany section
362(e)(2) transaction, it has effect only if
and to the extent there is a remaining section 362(e)(2) amount when there is a section 362(e)(2) application event.
(vi) Examples. The application of this
paragraph (e)(4) is illustrated by the following examples:
Example 1. Section 362(e)(2) amount reflected
in asset basis. (i) Facts. P owns the sole outstanding share of S stock. S owns Asset 1 with a basis of
$100 and a value of $20. On January 1, year 1, S contributes Asset 1 to newly formed B in exchange for 10
shares of B stock in a transaction to which section 351
applies. At the end of year 1, B’s only item is a $10
depreciation deduction with respect to Asset 1, which
gives rise to a $10 loss that is absorbed by the group.

2007–8 I.R.B.

On January 1, year 2, S sells all 10 shares of B stock
for $18. After applying and giving effect to all generally applicable rules of law, S’s basis in each share
of B stock is $9 (the original $10 basis reduced by $1
loss attributable to the depreciation on Asset 1). No
election is made under section 362(e)(2)(C).
(ii) Suspension of section 362(e)(2) in year 1. S’s
contribution of Asset 1 to B is an intercompany transaction to which section 362(e)(2) applies. Under the
general rules of section 362(e)(2)(A), B’s basis in Asset 1 would be reduced by $80 to its value, $20. However, as described in this paragraph (e)(4), the transfer is an intercompany section 362(e)(2) transaction
and therefore, under paragraph (e)(4)(iv) of this section, no adjustment is made under section 362(e)(2)
until there is a section 362(e)(2) application event.
The $80 reduction that B would have had in its basis
in Asset 1 is a section 362(e)(2) amount described in
paragraph (e)(4)(ii)(A) of this section. This amount
is reflected ratably in S’s basis in the 10 shares of B
stock, and in B’s basis in Asset 1. There is no section
362(e)(2) application event in year 1 and so there is
no section 362(e)(2) adjustment in year 1.
(iii) Application of section 362(e)(2) on sale of
B stock. S’s sale of the B stock is a transfer within
the meaning of §1.1502–36(f)(11) and therefore a
section 362(e)(2) application event under paragraph
(e)(4)(iii)(A) of this section. Accordingly, under
paragraphs (e)(4)(iv)(A) and (e)(4)(iv)(B) of this
section, because the section 362(e)(2) application
event was caused by the transfer of B stock received
in the intercompany section 362(e)(2) transaction,
B must reduce its basis in Asset 1 that reflects the
remaining section 362(e)(2) amount by an amount
equal to the remaining section 362(e)(2) amount
reflected in the B stock involved in the application
event. Because S sold all of the B stock received
in the intercompany section 362(e)(2) transaction
and this stock reflects all of the section 362(e)(2)
amount, B must reduce its basis in Asset 1 by the full
amount of the remaining section 362(e)(2) amount
immediately before the application event. Although
there was originally an $80 section 362(e)(2) amount,
$8 of that amount ($80/$100 x $10) was eliminated
under paragraph (e)(4)(ii)(C)(1) of this section when
the loss attributable to the depreciation deduction on
Asset 1 was absorbed in year 1. Thus, at the time of
the sale, the remaining section 362(e)(2) amount is
only $72 ($80 less $8), and B’s basis in Asset 1 is
reduced by such amount, to $18. Under paragraph
(e)(4)(iv)(C) of this section, the reduction in the basis
of Asset 1 is not a noncapital, nondeductible expense
described in §1.1502–32(b)(2)(iii) and so has no
effect on S’s basis in its B shares. See §1.1502–36
for additional rules relating to loss on shares of subsidiary stock.
Example 2. Section 362(e)(2) amount reflected in
unabsorbed loss. (i) Facts. The facts are the same as
in Example 1, except that during year 1 B sells Asset
1 to an unrelated nonmember for $20, and recognizes
an $80 loss that is not absorbed by the group.
(ii) Suspension of section 362(e)(2) in year 1. As
in paragraph (ii) of Example 1, S’s contribution of
Asset 1 to B is an intercompany section 362(e)(2)
transaction, the section 362(e)(2) amount is $80, and
there is no section 362(e)(2) adjustment in year 1.
This amount is reflected ratably in S’s basis in the 10
shares of B stock, and initially in B’s basis in Asset 1.
Further, because the $80 loss recognized on the sale

2007–8 I.R.B.

of Asset 1 is not absorbed by the group, at the end
of year 1 the remaining section 362(e)(2) amount is
$80, reflected ratably in S’s basis in the 10 shares of
B stock, and in B’s unabsorbed $80 loss.
(iii) Application of section 362(e)(2) on sale of B
stock. As in paragraph (iii) of Example 1, S’s sale
of the 10 shares of B stock is a section 362(e)(2) application event that involves all of the B stock received in the intercompany section 362(e)(2) transaction. Accordingly, immediately before the application event, B must reduce the unabsorbed loss carryover that reflects the remaining section 362(e)(2)
amount by an amount equal to the remaining section
362(e)(2) amount reflected in the B stock involved in
the application event, $80 (all of the remaining section 362(e)(2) amount). The reduction of the loss carryover is not a noncapital, nondeductible expense described in §1.1502–32(b)(2)(iii) and so has no effect
on S’s basis in its B shares. See §1.1502–36 for additional rules relating to loss on shares of subsidiary
stock.
Example 3. Section 362(e)(2) amount reflected in
unabsorbed loss, partial application. (i) Facts. The
facts are the same as in Example 2, except that on
January 1, year 2, S only sells two shares of the B
stock to an unrelated nonmember for $4.
(ii) Suspension of section 362(e)(2) in year 1.
S’s contribution of Asset 1 to B is an intercompany
section 362(e)(2) transaction, the section 362(e)(2)
amount is $80, and there is no section 362(e)(2) adjustment in year 1. This amount is reflected ratably
in S’s basis in the 10 shares of B stock, and initially
in B’s basis in Asset 1. Further, because the $80 loss
recognized on the sale of Asset 1 is not absorbed by
the group, at the end of year 1 the remaining section
362(e)(2) amount is $80, reflected ratably in S’s basis
in the 10 shares of B stock, and in B’s unabsorbed
$80 loss.
(iii) Application of section 362(e)(2) on sale of B
stock. S’s sale of two of the shares of B stock is a
section 362(e)(2) application event that involves two
shares of the B stock received in the intercompany
section 362(e)(2) transaction. Accordingly, immediately before the application event, B must reduce the
unabsorbed loss carryover that reflects the remaining
section 362(e)(2) amount by an amount equal to the
remaining section 362(e)(2) amount reflected in the B
stock involved in the application event, $16 ($8 of the
remaining section 362(e)(2) amount reflected in each
share). The loss carryover is reduced from $80 to $64.
This reduction is not a noncapital, nondeductible expense described in §1.1502–32(b)(2)(iii) and so has
no effect on S’s basis in its B shares. Additionally, under paragraph (e)(4)(ii)(C)(1) of this section, $16 of
the remaining section 362(e)(2) amount is eliminated,
and, thereafter, the $64 remaining section 362(e)(2)
amount is ratably reflected in S’s basis in the remaining 8 shares of B stock and in B’s $64 loss carryover. Because no election is made under section
362(e)(2)(C) in the year of the intercompany section 362(e)(2) transaction or in the year of the stock
sale, the first section 362(e)(2) application event, no
such election can be made with respect to the remaining shares received in the intercompany section
362(e)(2)(C) transaction. See §1.1502–36 for additional rules relating to loss on shares of subsidiary
stock.
(iv) Application of section 362(e)(2) on sale of B
stock, section 362(e)(2)(C) election. If S and B elect

565

under paragraph (e)(4)(v) of this section to reduce
S’s basis in the B stock received in the intercompany section 362(e)(2) transaction, under paragraph
(e)(4)(v)(A) of this section S will reduce its basis in
the B stock by $16 (an amount equal to the amount
that B would otherwise be required to reduce its
loss carryover, or the remaining section 362(e)(2)
amount reflected in the two shares of B stock sold).
Under paragraph (e)(4)(v)(B) of this section, this $16
reduction is applied proportionately to the two shares
of B stock sold immediately before the application
event, reducing the basis of each share to $2. The
reduction in the basis of the two B shares sold is
a nondeductible basis recovery item described in
§1.1502–32(b)(3)(iii)(B), and will affect P’s basis in
its share of S stock. Additionally, under paragraph
(e)(4)(ii)(C)(2) of this section, $16 of the remaining
section 362(e)(2) amount is eliminated, and, thereafter, the $64 remaining section 362(e)(2) amount
is ratably reflected in S’s basis in the remaining 8
shares of B stock and in B’s $80 loss carryover. S
recognizes no gain or loss on the sale of these two
shares of B stock. Under paragraph (e)(4)(v)(D) of
this section, S and B’s election to reduce S’s basis in
the B stock is irrevocable and applicable to all future
section 362(e)(2) application events with respect to
this intercompany section 362(e)(2) transaction, such
as subsequent dispositions of B stock to an unrelated
nonmember.
Example 4. Section 362(e)(2) amount reflected
in unabsorbed loss, subgroup exception. (i) Facts.
The facts are the same as in Example 3, except that
S does not sell any shares of B stock, and on January
1, year 2, P sells the sole share of the S stock to P1,
the common parent of another consolidated group.
(ii) Suspension of section 362(e)(2) in year 1.
S’s contribution of Asset 1 to B is an intercompany
section 362(e)(2) transaction, the section 362(e)(2)
amount is $80, and there is no section 362(e)(2) adjustment in year 1. This amount is reflected ratably
in S’s basis in the 10 shares of B stock, and initially
in B’s basis in Asset 1. Further, because the $80 loss
recognized on the sale of Asset 1 is not absorbed by
the group, at the end of year 1 the remaining section
362(e)(2) amount is $80, reflected ratably in S’s basis
in the 10 shares of B stock, and in B’s unabsorbed
$80 loss.
(iii) No section 362(e)(2) application event on
sale of S stock. P’s sale of the S stock is not an application event described in paragraph (e)(4)(iii) of
this section. Further, because S and B continue to be
members of the same consolidated group, there is no
transfer (within the meaning of §1.1502–36(f)(11)) of
the 10 shares of B stock. Accordingly, there is no
application event and, under paragraph (e)(4)(iv) of
this section, no section 362(e)(2) adjustment is required. However, adjustments will be required if a
section 362(e)(2) application event occurs at a time
when there is a remaining section 362(e)(2) amount.

*****
(f) * * *
(6) * * *
(ii) Gain stock. For dispositions of P
stock occurring before May 16, 2000, see
§1.1502–13(f)(6)(ii) as contained in 26
CFR part 1 in effect on April 1, 2000. For

February 20, 2007

dispositions of P stock occurring on or
after May 16, 2000, see §1.1032–3.
*****
(iv) * * * (A) * * * If P grants M an
option to acquire P stock in a transaction
meeting the requirements of §1.1032–3, M
is treated as having purchased the option
from P for fair market value with cash contributed to M by P.
*****
(j) * * *
(5) * * * (i) * * *
(A) The acquisition of either the assets
of the common parent of the terminating
group in a reorganization described in section 381(a)(2), or the stock of the common
parent of the terminating group; or
*****
(l) * * * (1) * * * Paragraphs (a)(4),
(e)(4), (f)(6)(ii), (f)(6)(iv)(A), and
(j)(5)(i)(A) of this section apply to all
transfers on or after the date these regulations are published as final regulations in
the Federal Register.
*****
Par. 6. Section 1.1502–19 is amended
by:
1.
Revising paragraphs (a)(3),
(c)(1)(iii)(A), and (c)(3)(i)(A).
2. Adding a new last sentence to paragraph (h)(1).
The revisions and addition read as follows:
§1.1502–19 Excess loss accounts.
(a) * * *
(3) Application of other rules of law.
See §1.1502–80(a) regarding the general
applicability of other rules of law and a
limitation on duplicative adjustments. In
addition, for purposes of this section, the
definitions in §1.1502–32 apply.
*****
(c) * * *
(1) * * *
(iii) * * *
(A) All of S’s assets (other than its corporate charter and those assets, if any, necessary to satisfy state law minimum capital requirements to maintain corporate existence) are treated as disposed of, abandoned, or destroyed for Federal income
tax purposes (for example, under section

February 20, 2007

165(a) or §1.1502–80(c), or, if S’s asset is
stock of a lower-tier member, the stock is
treated as disposed of under this paragraph
(c)). An asset of S is not considered to
be disposed of or abandoned to the extent
the disposition is in complete liquidation
of S under section 332 or is in exchange for
consideration (other than in satisfaction of
indebtedness);
*****
(3) * * * (i) * * *
(A) The acquisition of either the assets
of the common parent of the terminating
group in a reorganization described in section 381(a)(2), or the stock of the common
parent of the terminating group; or
*****
(h) * * * (1) * * * Paragraphs (a)(3),
(c)(1)(iii)(A), and (c)(3)(i)(A) of this section apply to all transfers on or after the
date these regulations are published as final regulations in the Federal Register.
*****
§1.1502–20 [Removed]
Par. 7. Section 1.1502–20 is removed.
Par. 8. Section 1.1502–21 is amended
by:
1. Removing the last sentence of paragraph (b)(1).
2. Removing paragraph (b)(3)(v).
3. Revising paragraphs (b)(2)(ii)(A),
(b)(2)(iv)(B)(2), (h)(6), and (h)(8).
4. Adding new paragraph (h)(1)(iii).
The revisions and addition read as follows:
§1.1502–21 Net operating losses.
*****
(b) * * *
(2) * * *
(ii) Special rules—(A) Year of departure from group. If a corporation ceases
to be a member during a consolidated
return year, net operating loss carryovers
attributable to the corporation are first
carried to the consolidated return year,
then are subject to reduction under section
108 and §1.1502–28 (regarding discharge
of indebtedness income that is excluded
from gross income under section 108(a)),
and then are subject to reduction under
§1.1502–36 (regarding transfers of loss
shares of subsidiary stock). Only the

566

amount that is neither absorbed nor reduced under section 108 and §1.1502–28
or under §1.1502–36 may be carried to
the corporation’s first separate return year.
For rules concerning a member departing
a subgroup, see paragraph (c)(2)(vii) of
this section.
*****
(iv) * * *
(B) * * *
(2) Special rules—(i) Carryback to a
separate return year. If a portion of the
CNOL attributable to a member for a taxable year is carried back to a separate return year, the percentage of the CNOL attributable to each member, as of immediately after such portion of the CNOL is carried back, is recomputed pursuant to paragraph (b)(2)(iv)(B)(2)(v) of this section.
(ii) Excluded discharge of indebtedness
income. If during a taxable year a member realizes discharge of indebtedness income that is excluded from gross income
under section 108(a) and such amount reduces any portion of the CNOL attributable to any member pursuant to section
108 and §1.1502–28, the percentage of
the CNOL attributable to each member as
of immediately after the reduction of attributes pursuant to sections 108 and 1017,
and §1.1502–28, shall be recomputed pursuant to paragraph (b)(2)(iv)(B)(2)(v) of
this section.
(iii) Departing member. If during a taxable year a member that had a separate net
operating loss for the year of the CNOL
ceases to be a member, the percentage of
the CNOL attributable to each member as
of the first day of the following consolidated return year shall be recomputed pursuant to paragraph (b)(2)(iv)(B)(2)(v) of
this section.
(iv) Reduction of attributes for stock
loss. If during a taxable year a member does not cease to be a member of the
group and any portion of the CNOL attributable to any member is reduced pursuant to §1.1502–36, the percentage of the
CNOL attributable to each member immediately after the reduction of attributes pursuant to §1.1502–36 shall be recomputed
pursuant to paragraph (b)(2)(iv)(B)(2)(v)
of this section.
(v) Recomputed percentage. The recomputed percentage of the CNOL attributable to each member shall equal
the unabsorbed CNOL attributable to the

2007–8 I.R.B.

member at the time of the recomputation
divided by the sum of the unabsorbed
CNOL attributable to all of the members
at the time of the recomputation. For purposes of the preceding sentence, a CNOL
that is reduced pursuant to section 108 and
§1.1502–28, or under §1.1502–36, or that
is otherwise permanently disallowed or
eliminated, shall be treated as absorbed.
(vi) Examples. For purposes of the
examples in this section, unless otherwise
stated, all groups file consolidated returns,
all corporations have calendar taxable
years, the facts set forth the only corporate
activity, value means fair market value
and the adjusted basis of each asset equals
its value, all transactions are with unrelated persons, and the application of any
limitation or threshold under section 382
is disregarded. * * *
*****
(h) * * * (1) * * *
(iii) Paragraphs (b)(2)(ii)(A) and
(b)(2)(iv)(B)(2) of this section apply to
taxable years the original return for which
the due date (without regard to extensions)
is on or after the date these regulations
are published as final regulations in the
Federal Register.
*****
(6) Certain prior periods. Paragraphs
(b)(1), (b)(2)(iv)(A), (b)(2)(iv)(B)(1),
and (c)(2)(vii) of this section shall apply
to taxable years for which the due date
of the original return (without regard to
extensions) is after March 21, 2005. Sections 1.1502–21T(b)(1), (b)(2)(iv), and
(c)(2)(vii), as contained in 26 CFR part
1 revised as of April 1, 2004, shall apply to taxable years for which the due
date of the original return (without regard to extensions) is on or before March
21, 2005, and after August 29, 2003.
For taxable years for which the due date
of the original return (without regard to
extensions) is on or before August 29,
2003, see paragraphs (b)(1), (b)(2)(ii)(A),
(b)(2)(iv), and (c)(2)(vii) of this section
and §1.1502–21T(b)(1) as contained in 26
CFR part 1 revised as of April 1, 2003.
*****
(8) Losses treated as expired under §1.1502–35(f)(1).
For rules regarding losses treated as expired under
§1.1502–35(f) on and after March 10,
2006, see §1.1502–21(b)(3)(v) as contained in 26 CFR part 1 in effect on April

2007–8 I.R.B.

1, 2006. For rules regarding losses treated
as expired before March 10, 2006, see
§1.1502–21T(h)(8) as contained in 26
CFR part 1 in effect on April 1, 2005.
Par. 9. Section 1.1502–30 is amended
by:
1. Revising paragraph (b)(4).
2. Adding a new second sentence to
paragraph (c).
The revision and addition read as follows:
§1.1502–30 Stock basis after certain
triangular reorganizations.
*****
(b) * * *
(4) Application of other rules of law.
If a transaction otherwise subject to this
section is also a group structure change
subject to §1.1502–31, the provisions of
§1.1502–31 and not this section apply to
determine stock basis. See §1.1502–80(a)
regarding the general applicability of other
rules of law and a limitation on duplicative
adjustments. See §1.1502–80(d) for the
non-application of section 357(c) to P.
*****
(c) * * * However, paragraph (b)(4) of
this section applies to reorganizations occurring on or after the date these regulations are published as final regulations in
the Federal Register.
*****
Par. 10. Section 1.1502–31 is amended
by:
1. Revising paragraph (a)(2).
2. Adding a new last sentence to paragraph (h)(1).
The revision and addition read as follows:
§1.1502–31 Stock basis after a group
structure change.
(a) * * *
(2) Application of other rules of law. If
a transaction subject to this section is also a
triangular reorganization otherwise subject
to §1.1502–30, the provisions of this section and not those of §1.1502–30 apply to
determine stock basis. See §1.1502–80(a)
regarding the general applicability of other
rules of law and a limitation on duplicative
adjustments.
*****

567

(h) * * * (1) * * * In addition, paragraph
(a)(2) of this section applies to group structure changes that occurred on or after the
date these regulations are published as final regulations in the Federal Register.
*****
Par. 11. Section 1.1502–32 is
amended by:
1.
Revising paragraphs (a)(2),
(b)(3)(ii)(C)(2),
(b)(3)(iii)(C),
(b)(3)(iii)(D), (c)(1), (c)(2)(i), the
first sentence in paragraph (c)(2)(ii)(A)
introductory text, the first sentence in
paragraph (c)(3), and the first sentence
in paragraph (c)(4)(i) introductory text.
2. Adding new paragraph (h)(9).
The revisions and addition read as
follows:
§1.1502–32 Investment adjustments.
(a) * * *
(2) Application of other rules of law.
See §1.1502–80(a) regarding the general
applicability of other rules of law and a
limitation on duplicative adjustments.
*****
(b) * * *
(3) * * *
(ii) * * *
(C) * * *
(2) Expired loss carryovers. If the
amount of the discharge exceeds the
amount of the attribute reduction under
sections 108 and 1017, and §1.1502–28,
the excess nevertheless is treated as applied to reduce tax attributes to the extent
a loss carryover attributable to S expired without tax benefit, the expiration
was taken into account as a noncapital,
nondeductible expense under paragraph
(b)(3)(iii) of this section, and the loss carryover would have been reduced had it not
expired.
*****
(iii) * * *
(C) Loss suspended under §1.1502–
35(c).
For losses suspended by
§1.1502–35(c) prior to the date these
regulations are published as final regulations in the Federal Register, see
§1.1502–32(b)(3)(iii)(C) as contained in
26 CFR part 1 revised as of April 1, 2006.
(D) Reimported losses disallowed under §1.1502–35. Any loss or deduction
the use of which is disallowed pursuant
to §1.1502–35(b) (other than duplicating

February 20, 2007

items that are carried back to a consolidated return year of the group), and with
respect to which no waiver described in
paragraph (b)(4) of this section is filed, is
treated as a noncapital, nondeductible expense incurred during the taxable year that
such loss would otherwise be absorbed.
For losses or deductions disallowed under §1.1502–35(g)(3)(iii) prior to the date
these regulations are published as final
regulations in the Federal Register, see
§1.1502–32(b)(3)(iii)(D) as contained in
26 CFR part 1 revised as of April 1, 2006.
*****
(c) Allocation of adjustments among
shares of stock—(1) In general—(i) Distributions. The portion of the adjustment
under paragraph (b) of this section that is
described in paragraph (b)(2)(iv) of this
section (negative adjustments for distributions) is allocated to the shares of S stock
to which the distribution relates.
(ii) Special allocations in the case of
certain loss transfers and reallocations of
investment adjustments subject to prior
use limitation—(A) Losses attributable to
transfers subject to section 362(e)(2)—(1)
In general. If a nonmember holds shares
of S stock, any amounts that directly or indirectly reflect a section 362(e)(2) amount
(as defined in §1.1502–13(e)(4)(ii)(A)) are
allocated to members’ shares of S stock
under the general principles of this paragraph (c), except that such allocations are
made as though the shares of S stock held
by nonmembers were not outstanding.
(2) Example. The application of this
paragraph (c) is illustrated by the following example:
Example. (i) Facts. P owns four of the five outstanding shares of the stock of M. X, a nonmember,
owns the remaining outstanding share of M stock. On
January 1, year 1, M contributes Asset 1 to S, a newly
formed subsidiary, in exchange for five shares of S

stock in a transaction to which section 351 applies.
At the time of the transfer, M’s basis in Asset 1 is
$100 and its value is $20. At the end of year 1, S’s
only item is a $10 depreciation deduction with respect to Asset 1, which gives rise to a $10 loss that
is absorbed by the group. At the beginning of year
2, M sells one of its S shares to X for $3.60, and M
and S elect to reduce M’s basis in the S stock under
§1.1502–13(e)(4)(v) by the amount of the remaining
section 362(e)(2) amount ($72) (computed in paragraph (iii)(C) of this Example) reflected in the share.
See §1.1502–13(e)(4). Accordingly, M’s basis in the
S share is reduced by $14.40 (the portion of the $72
remaining section 362(e)(2) amount reflected in the
share (computed in paragraph (iii)(C) of this Example)), to $3.60. M recognizes no gain or loss on the
sale of the S share. At the end of year 2, S’s only
item is an additional $10 depreciation deduction with
respect to Asset 1, which gives rise to an additional
$10 loss that is absorbed by the group. At the end of
year 2, M’s only item is a $14.40 nondeductible basis
recovery item resulting from the election to reduce its
basis in the S share. See, §1.1502–13(e)(4)(v)(C).
(ii) Application of section 362(e)(2) and
§1.1502–13(e)(4) to the transfer of Asset 1. M’s
contribution of Asset 1 to S is a transaction described
in section 362(e)(2). Under the general rules of
section 362(e)(2)(A), S’s basis in Asset 1 would be
limited to its value ($20) and would thus be reduced
by $80, from $100 to $20. However, the transfer is
an intercompany section 362(e)(2) transaction and
therefore, under §1.1502–13(e)(4)(iv), no adjustment
is made to S’s basis in Asset 1 under section 362(e)(2)
until there is a section 362(e)(2) application event
(within the meaning of §1.1502–13(e)(4)(iii)). There
is no section 362(e)(2) application event in year 1 and
so there is no section 362(e)(2) adjustment in year 1.
The $80 reduction that S would have had in its basis
in Asset 1 is a section 362(e)(2) amount described in
§1.1502–13(e)(4)(ii)(A). This $80 section 362(e)(2)
amount is initially reflected ratably ($16 per share)
in M’s basis in each of the five shares of S stock
received in the transaction, and in S’s basis in Asset
1. Further, under §1.1502–13(e)(4)(ii)(C)(1), the
section 362(e)(2) amount reflected in an attribute is
generally eliminated proportionately as the attribute
is taken into account. Accordingly, $8 ($80/$100 x
$10) of the year 1 Asset 1 depreciation deduction is
attributable to the section 362(e)(2) amount.
(iii) Treatment of year 1 item. (A) Allocation of
item among shares of S stock. Although no adjustment is made under section 362(e)(2) during year 1,

Item

if any shares of S stock are held by nonmembers, any
items taken into account that are attributable to the
section 362(e)(2) amount must be specially allocated
under the rules of this paragraph (c)(1)(ii). Because
M owns all the shares of S stock, the special allocation rules of this paragraph (c)(1)(ii) have no application to the allocation of S’s depreciation deduction
to M’s shares. Accordingly, the entire $10 of depreciation on Asset 1 is included in the remaining adjustment to the S shares under the general rules in
paragraphs (c)(2) through (c)(4) of this section. As
a result, $2 is allocated to, and decreases the basis in,
each share of S stock held by M from $20 to $18.
(B) Allocation of tiered-up item among shares
of M stock. Under paragraph (a)(3)(iii) of this section, adjustments to M’s basis in S stock tier up and
are taken into account in determining adjustments
to higher-tier stock. However, because X, a nonmember, holds a share of M stock, any portion of
the tiering-up adjustment that is attributable to a section 362(e)(2) amount is specially allocated under this
paragraph (c)(1)(ii). In this case, $8 of the adjustment
to M’s basis in S stock (80/100 x $10) is attributable to a section 362(e)(2) amount and thus $8 of the
tiered-up adjustment is indirectly attributable to a section 362(e)(2) amount. As a result, $8 of the tiered-up
adjustment must be allocated as though X’s share of
M stock was not outstanding. Accordingly, $2 (1/4)
of the $8 of the tiered-up adjustment is allocated to
each of P’s four shares of M stock and no portion
of that amount is allocated to X’s share of M stock.
However, the remaining $2 of the tiered-up adjustment not attributable to a section 362(e)(2) amount
is included in the remaining adjustment allocated to
all outstanding shares under the general rules in paragraphs (c)(2) through (c)(4) of this section. Thus,
$.40 (1/5) of the $2 of the tiered-up adjustment is allocated to each outstanding share. (Although $.40 is
allocated to X’s share of M stock, that allocation does
not affect X’s basis in the share because X is not a
member of the group. See paragraph (c)(1)(iv) of this
section.) The allocation of the tiered up year 1 item
is thus:

Allocation
P’s shares of M stock
(4/5)

X’s share of M stock
(1/5)

Tiered-up section 362(e)(2) amount
($8 of the $10 depreciation on Asset 1)

$8.00
($2.00 per share)

N/A

Tiered-up non-section 362(e)(2) amount
($2 of the $10 depreciation on Asset 1)

$1.60
($.40 per share)

$.40
($.40 per share)

$9.60
($2.40 per share)

$.40
($.40 per share)

Total allocation:

February 20, 2007

568

2007–8 I.R.B.

(C) Remaining section 362(e)(2) amount. After
the year 1 items have been taken into account, the remaining section 362(e)(2) amount with respect to the
S shares is $72 ($80 less $8 eliminated due to Asset 1 depreciation being taken into account). Under
§1.1502–13(e)(4)(ii)(C)(1), this $72 remaining section 362(e)(2) amount is reflected proportionately in
the five S shares held by M, or $14.40 per share.
(iv) Treatment of year 2 items. (A) Elimination of a portion of the section 362(e)(2) amount.
Under §1.1502–13(e)(4)(ii)(C)(2), S’s remaining
section 362(e)(2) amount is eliminated to the extent
of the reduction in M’s basis in the S stock under
§1.1502–13(e)(4)(v). Accordingly, S’s remaining

section 362(e)(2) amount is reduced by $14.40, to
$57.60. This remaining section 362(e)(2) amount
is reflected proportionately in the four remaining S
shares held by M, or $14.40 per share.
(B) Allocation of item among shares of S stock.
Because X owns a share of S stock in year 2, the
special allocation rule in paragraph (c)(1)(ii) of this
section applies to the allocation of the portion of the
year 2 depreciation deduction attributable to a section
362(e)(2) amount. Under that rule, $6.40 (57.60/90
x $10) of the item attributable to a section 362(e)(2)
amount must be allocated as though only the four
shares of S stock held by M were outstanding. Accordingly, $1.60 (1/4) of the $6.40 of the $10 depreci-

Item

ation deduction is allocated to each of M’s four shares
of S stock and no portion of that amount is allocated to
X’s share of S stock. However, the remaining $3.60
of the $10 depreciation deduction not attributable to a
section 362(e)(2) amount is included in the remaining
adjustment allocated to all outstanding shares under
the general rules in paragraphs (c)(2) through (c)(4)
of this section. Thus, $.72 (1/5) of the $3.60 of the
$10 depreciation deduction is allocated to each outstanding S share. (Although $.72 is allocated to X’s
share of S stock, that allocation does not affect X’s
basis in the share because X is not a member of the
group. See paragraph (c)(1)(iv) of this section.) The
allocation of S’s year 2 item is thus:

Allocation
M’s shares of S stock
(4/5)

X’s share of S stock
(1/5)

Section 362(e)(2) amount
($6.40 of the $10 depreciation on Asset 1)

$6.40
($1.60 per share)

N/A

Non-section 362(e)(2) amount
($3.60 of the $10 depreciation on Asset 1)

$2.88
($.72 per share)

$.72
($.72 per share)

$9.28
($2.32 per share)

$.72
($.72 per share)

Total allocation:
(C) Adjustments to the basis of shares of M stock.
The adjustment to the basis of M stock includes two
items: M’s $14.40 nondeductible basis recovery
item resulting from the reduction in M’s basis in
the S stock under §1.1502–13(e)(4)(v); and $9.28
tiered-up adjustment from the adjustment made to its
basis in the S stock. The full amount of the $14.40
nondeductible basis recovery item, and $6.40 of
the $9.28 tiered-up adjustment is attributable to the

section 362(e)(2) amount. Therefore $20.80 ($14.40
plus $6.40) must be allocated entirely to P’s shares
of M stock. Accordingly, $5.20 (1/4) of the $20.80 is
allocated to each of P’s four shares of M stock. The
remaining $2.88 of the tiered-up adjustment not attributable to a section 362(e)(2) amount is included in
the remaining adjustment allocated to all outstanding
shares under the general rules in paragraphs (c)(2)
through (c)(4) of this section. Thus, approximately

Item

$.58 (1/5) of the $2.88 of the tiered-up adjustment
is allocated to each outstanding share. (Although
approximately $.58 is allocated to X’s share of M
stock, that allocation does not affect X’s basis in the
share because X is not a member of the group. See
paragraph (c)(1)(iv) of this section.) The allocation
of M’s year 2 items is thus:

Allocation
P’s shares of M stock
(4/5)

X’s share of M stock
(1/5)

Nondeductible basis recovery
($14.40 reduction in S stock basis)

$14.40
($3.60 per share)

N/A

Tiered-up section 362(e)(2) amount
($6.40 of the $9.28 tiered-up adjustment)

$6.40
($1.60 per share)

N/A

Tiered-up non-section 362(e)(2) amount
($2.88 of the $9.28 tiered-up adjustment)

$2.30
(approx. $.58 per share)

$.58
(approx. $.58 per share)

$23.10
(approx. $5.78 per share)

$.58
(approx. $.58 per share)

Total allocation:
(D) No duplicative adjustments to the basis
of shares of M stock. A portion of the $2.88 of
the tiered-up adjustment not attributable to a section 362(e)(2) amount duplicates a portion of the
$14.40 nondeductible basis recovery item resulting from the reduction in M’s basis in the S stock
under §1.1502–13(e)(4)(v). Consequently, under
§1.1502–80(a), such portion of the tiered-up adjustment is not applied to reduce P’s basis in its shares
of M stock. The election to reduce M’s basis in the
S stock eliminated $14.40 of the remaining section
362(e)(2) amount. Accordingly, at the S level, $1.60
($14.40/$90 x $10) of the Asset 1 year 2 depreciation
deduction is associated with this amount. This por-

2007–8 I.R.B.

tion was allocated to all outstanding shares of S stock
under the general rules in paragraphs (c)(2) through
(c)(4) of this section ($.32 per share ($1.60/5)). At the
M level, $1.28 (4 x $.32) of the tiered-up non-section
362(e)(2) amount reflects depreciation on this $14.40
of Asset 1 basis. So, at the M level, approximately
$.26 ($1.28/5) of this tiered-up amount is allocated
to each outstanding share. This approximately $.26
per share amount would duplicate a portion of the
$14.40 nondeductible basis recovery item if it were
applied to reduce P’s basis in the M shares. Accordingly, although approximately $5.78 of the items are
allocated to each M share held by P, P’s basis in each

569

share of M stock is only reduced by approximately
$5.52 ($5.78 less $.26).

(B) Losses reattributed pursuant to
an election under §1.1502–36(d)(6). If
a member transfers (within the meaning of §1.1502–36(f)(11)) loss shares of
S stock and the common parent elects
under §1.1502–36(d)(6) to reattribute S
attributes, the resulting noncapital, nondeductible expense is allocated to all loss
shares of S stock transferred by members in the transaction in proportion to the

February 20, 2007

loss in the shares, and such amount tiers
up to any higher tiers under the general
rules of this section. If lower-tier subsidiary attributes that would otherwise be
reduced as a result of tier-down attribute
reduction under §1.1502–36(d)(5)(ii)(D)
are reattributed, the resulting noncapital,
nondeductible expense is allocated to the
shares of the lower-tier subsidiary (and
any tier up of such amount is allocated to
the shares of higher tier subsidiaries) that
will cause the full amount of this expense
to be applied to reduce the basis of the loss
shares of S stock transferred by members
in the transaction. However, this noncapital, nondeductible expense (and any tier up
of such amount) is not allocated to shares
(other than S shares) transferred in a transfer in which gain or loss was recognized.
Further, this noncapital, nondeductible
expense (and any tier up of such amount)
is allocated among lower-tier shares with
positive basis in a manner that reduces the
disparity in the basis of the shares to the
greatest extent possible. The tier up of
this amount is allocated to the loss shares
of S stock transferred by members in the
transaction in proportion to the loss in the
shares, and such amount tiers up to any
higher tiers under the general rules of this
section. For example, suppose P owns
M1, P and M1 own M2, M2 owns S, M1
and S own S1, and M1 and S1 own S2. If
S sells a portion of the S1 shares at a gain
and M2 sells all of the S stock at a net loss
(after adjusting the basis for the gain recognized by S on the sale of the S1 shares),
and P elects under §1.1502–36(d)(6) to
reattribute attributes of S2, the resulting
noncapital, nondeductible expense is allocated entirely to the S2 shares held by S1,
the tier up of this amount is allocated entirely to the S1 shares held by S (excluding
the S1 shares sold), and the tier up of this
amount is allocated to the loss shares of S
stock sold by M2. This amount then tiers
up from M2 to M1 and P, and from M1 to
P under the general rules of this section.
(C) Reallocations of investment adjustments subject to prior use limitation. If the
reallocation of an investment adjustment
under §1.1502–36(b)(2) is subject to the
limitation in §1.1502–36(b)(2)(iii)(B)(2)
due to prior use, no amount of such reallocation (including as a tiered-up amount)
shall be allocated to any share whose prior
use resulted in the application of the limitation.

February 20, 2007

(iii) Remaining adjustment. The remaining adjustment is that portion of
the adjustment described in paragraphs
(b)(2)(i) through (b)(2)(iii) of this section
(adjustments for taxable income or loss,
tax-exempt income, and noncapital, nondeductible expenses) that is not specially
allocated under paragraph (c)(1)(ii) of
this section. The remaining adjustment
is allocated among the shares of S stock
as provided in paragraphs (c)(2) through
(c)(4) of this section. If the remaining
adjustment is positive, it is allocated first
to any preferred stock to the extent provided in paragraph (c)(3) of this section,
and then to the common stock as provided
in paragraph (c)(2) of this section. If the
remaining adjustment is negative, it is allocated only to common stock as provided
in paragraph (c)(2) of this section.
(iv) Nonmember shares. No adjustment
under this section that is allocated to a
share for the period it is owned by a nonmember affects the basis of the share.
(v) Cross-references. See paragraph
(c)(4) of this section for the reallocation
of adjustments, and paragraph (d) of this
section for definitions. See §1.1502–19(d)
for special allocations of basis determined
or adjusted under the Code with respect to
excess loss accounts.
(2) Common stock—(i) Allocation
within a class. The remaining adjustment
described in paragraph (c)(1)(iii) of this
section that is allocable to a class of common stock generally is allocated equally
to each share within the class. However,
if a member has an excess loss account in
shares of a class of common stock at the
time of a positive remaining adjustment,
the portion of the adjustment allocable to
the member with respect to the class is allocated first to equalize and eliminate that
member’s excess loss account and then to
increase equally its basis in the shares of
that class. Similarly, any negative remaining adjustment is allocated first to reduce
the member’s positive basis in shares of
the class before creating or increasing its
excess loss account. After positive basis
is eliminated, any remaining portion of
the negative adjustment is allocated first
to equalize, to the greatest extent possible,
and then to increase equally, the member’s
excess loss accounts in the shares of that
class. Distributions and any adjustments
or determinations under the Internal Revenue Code (for example, under section

570

358, including any modifications under
§1.1502–19(d)) are taken into account
before the allocation is made under this
paragraph (c)(2)(i).
(ii) Allocation among classes—(A)
General rule. If S has more than one class
of common stock, the extent to which the
remaining adjustment described in paragraph (c)(1)(iii) of this section is allocated
to each class is determined, based on consistently applied assumptions, by taking
into account the terms of each class and all
other facts and circumstances relating to
the overall economic arrangement. * * *
*****
(3) Preferred stock. If the remaining adjustment described in paragraph (c)(1)(iii)
of this section is positive, it is allocated
to preferred stock to the extent required
(when aggregated with prior allocations to
the preferred stock during the period that
S is a member of the consolidated group)
to reflect distributions described in section
301 (and all other distributions treated as
dividends) to which the preferred stock becomes entitled, and arrearages arising, during the period that S is a member of the
consolidated group. * * *
*****
(4) Cumulative redetermination—(i)
General rule. A member’s basis in each
share of S preferred and common stock
must be redetermined whenever necessary
to determine the tax liability of any person.
See paragraph (b)(1) of this section. The
redetermination is made by reallocating
S’s adjustments described in paragraphs
(c)(1)(ii) and (c)(1)(iii) of this section (adjustments for specially allocated losses
and remaining adjustments, respectively)
for each consolidated return year (or other
applicable period) of the group by taking
into account all of the facts and circumstances affecting allocations under this
paragraph (c) as of the redetermination
date with respect to all of S shares. * * *
*****
(h) * * *
(9) Allocations of investment adjustments, including adjustments attributable to certain loss transfers;
certain
conforming
amendments.
Paragraphs
(a)(2),
(b)(3)(ii)(C)(2),
(b)(3)(iii)(C),
(b)(3)(iii)(D),
(c)(1),
(c)(2)(i), (c)(2)(ii)(A), (c)(3), and (c)(4)(i)
of this section are applicable on or after

2007–8 I.R.B.

the date these regulations are published as
final regulations in the Federal Register.
*****
Par. 12. Section 1.1502–33 is amended
by:
1. Revising paragraph (a)(2).
2. Adding a new last sentence to paragraph (j)(1).
The revision and addition read as follows:
§1.1502–33 Earnings and profits.
(a) * * *
(2) Application of other rules of law.
See §1.1502–80(a) regarding the general
applicability of other rules of law and a
limitation on duplicative adjustments.
*****
(j) * * * (1) * * * However, paragraph
(a)(2) of this section applies with respect to
determinations of the earnings and profits
of a member in consolidated return years
beginning on or after the date these regulations are published as final regulations in
the Federal Register.
*****
Par. 13. Section 1.1502–35 is amended
by:
1. Revising paragraphs (a), (b) and (h).
2. Removing and reserving paragraphs
(f) and (g).
3. Adding new paragraph (l).
The revisions and addition read as follows:
§1.1502–35 Transfers of subsidiary stock
and deconsolidations of subsidiaries.
(a) Losses on subsidiary stock transferred or deconsolidated prior to the date
that these regulations are published as final regulations in the Federal Register.
If a member disposed of a loss share of
stock of a subsidiary (S), or if S ceased to
be a member (deconsolidated) when any
member held loss shares of S stock, and
if the disposition or deconsolidation occurred prior to the date that these regulations are published as final regulations in
the Federal Register, see §1.1502–35, as
contained in 26 CFR part 1, revised as of
April 1, 2007. For transfers and deconsolidations on or after the date that these regulations are published as final regulations
in the Federal Register, see §1.1502–36.
(b) Anti-loss reimportation rule applicable on or after the date that these regu-

2007–8 I.R.B.

lations are published as final regulations
in the Federal Register—(1) Conditions
for application. This paragraph (b) applies
when—
(i) A member of a group (the selling
group) recognized and was allowed a loss
with respect to a share of stock of S, a subsidiary or former subsidiary in the selling
group;
(ii) That stock loss was duplicated (in
whole or in part) in S’s attributes (duplicating items) at the earlier of the time that
the loss was recognized or that S ceased to
be a member; and
(iii) Within ten years of the date that S
ceased to be a member, there is a reimportation event. For this purpose, a reimportation event is any event after which a duplicating item becomes directly or indirectly
reflected in the attributes of any member of
the selling group, including S, or, if not reflected in the attributes, would be properly
taken into account by any member of the
selling group (for example, as the result of
a carryback) (reimported items).
(2) Effect of application. Immediately
before the time that a reimported item (or
any portion of a reimported item) would be
properly taken into account (but for the application of this paragraph (b)), such item
(or such portion of the item) is reduced to
zero and no deduction or loss is allowed,
directly or indirectly, with respect to that
item.
(3) Operating rules. For purposes of
this paragraph (b)—
(i) The terms “member”, “subsidiary”,
and “group” include their predecessors and
successors to the extent necessary to effectuate the purposes of this section;
(ii) The determination of whether a loss
is duplicative is made under the principles
of §1.1502–35, as contained in 26 CFR
part 1, revised as of April 1, 2006; and
(iii) The reduction of a reimported item
(other than duplicating items that are carried back to a consolidated return year of
the selling group) is a noncapital, nondeductible expense with in the meaning of
§1.1502–32(b)(2)(iii).
(4) Period of applicability. The provisions of this paragraph (b) apply to a
reimported item if its related stock loss is
recognized on or after the date that these
regulations are published as final regulations in the Federal Register. The provisions of this paragraph (b) (other than paragraph (b)(1)(i)) also apply to a reimporta-

571

tion event if its related stock loss is recognized on or after March 7, 2002, and is recognized in either a disposition (described
in paragraph (g)(3)(i)(A) of this section,
as contained in 26 CFR part 1, revised as
of January 1, 2007) or a disposition otherwise subject to this section. For prior law,
see paragraph (g)(3) of this section, as contained in 26 CFR part 1, revised as of January 1, 2007.
*****
(h) Application of other rules of law.
See §1.1502–80(a) regarding the general
applicability of other rules of law and a
limitation on duplicative adjustments.
*****
(l) Effective date. Paragraphs (a), (b),
and (h) of this section apply with respect
to stock transfers, deconsolidations of subsidiaries, determinations of worthlessness,
and stock dispositions on or after the date
these regulations are published as final
regulations in the Federal Register. For
rules applicable prior to the date these regulations are published as final regulations
in the Federal Register, see §1.1502–35
as contained in 26 CFR part 1 in effect on
April 1, 2007.
§1.1502–35T [Removed]
Par. 14. Section 1.1502–35T is removed.
Par. 15. Section 1.1502–36 is added to
read as follows:
§1.1502–36 Unified rule for loss on
subsidiary stock.
(a) In general—(1) Scope. This section provides rules for adjusting members’
bases in stock of a subsidiary (S) and for
reducing S’s attributes when a member
(M) transfers a loss share of S stock. See
paragraph (f) of this section for definitions
of the terms used in this section, including
transfer and loss share.
(2) Purpose. The rules in this section
have two principal purposes. The first
is to prevent the consolidated return provisions from reducing a group’s consolidated taxable income through the creation
of noneconomic loss on S stock. The second is to prevent members (including former members) of the group from collectively obtaining more than one tax benefit
from a single economic loss. Additional
purposes are set forth in other paragraphs

February 20, 2007

of this section. The rules of this section
must be interpreted and applied in a manner that is consistent with and reasonably
carries out the purposes of this section.
(3) Overview—(i) General application
of section. This section applies when M
transfers a share of S stock and, after giving effect to all applicable rules of law
other than this section, the share is a loss
share. Paragraph (b) of this section applies first to require certain redeterminations of all members’ bases in shares of
S stock. If the transferred share is a loss
share after any basis redetermination required by paragraph (b) of this section,
paragraph (c) of this section applies to require certain reductions in M’s basis in the
transferred loss share. If the transferred
share is a loss share after any reduction
required by paragraph (c) of this section,
paragraph (d) of this section applies to require certain reductions in S’s attributes.
Paragraphs (e), (f), and (g) of this section
provide general operating rules (predecessor/successor rules, effects of prior section
362(e)(2) transactions), definitions, and an
anti-abuse rule, respectively.
(ii) Stock of multiple subsidiaries transferred in the transaction—(A) Order of application—(1) Transferred shares in lowest tier. If shares of stock of more than one
subsidiary are transferred in a transaction
and no transferred shares of stock of the
lowest-tier subsidiary (S2) are loss shares,
any gain recognized with respect to the
S2 shares immediately adjusts members’
bases in subsidiary stock under the principles of §1.1502–32. However, if any of the
transferred S2 shares are loss shares, first
paragraph (b) of this section and then paragraph (c) of this section apply with respect
to the S2 shares. After giving effect to any
adjustments required under paragraphs (b)
and (c) of this section, gain or loss is computed on all transferred S2 shares. Any
adjustments under paragraphs (b) and (c)
of this section, any gain or loss recognized
on transferred S2 shares (whether allowed
or disallowed), and any other related or
resulting adjustments are then applied to
adjust members’ bases in subsidiary stock
under the principles of §1.1502–32.
(2) Application of paragraphs (b) and
(c) of this section to higher-tier stock.
After giving effect to any lower-tier
adjustments described in paragraph
(a)(3)(ii)(A)(1) of this section, transfers in the next higher tier in which

February 20, 2007

shares are transferred, and then in each
next higher tier successively, are subject
to the treatment described in paragraph
(a)(3)(ii)(A)(1).
(3) Application of paragraph (d) of this
section. After paragraphs (b) and (c) of
this section have been applied with respect
to all transferred loss shares and after
giving effect to all adjustments (whether
required by paragraphs (b) and (c) of this
section, by the recognition of gain on a
transfer, or otherwise), paragraph (d) of
this section applies with respect to the
highest-tier shares that are then transferred
loss shares. Paragraph (d) then applies
with respect to transferred loss shares in
each next lower tier successively.
(B) Example. The rules of this paragraph (a)(3) are illustrated by the following example:
Example. M owns all the outstanding shares of
S stock and one of the two outstanding shares of S2
stock, S owns all the outstanding shares of S1 stock,
and S1 owns the other outstanding share of S2 stock.
As part of one transaction, M sells all the S shares and
its S2 share, and S1 sells its S2 share. The sales are
to unrelated individuals, S and S1 do not elect to file
a consolidated return after the transaction, the S and
S1 shares are loss shares and the S2 shares are gain
shares. Each share is transferred within the meaning
of this section, the S and S2 shares because S and S2
cease to be owned by M, and M and S1, respectively,
as a result of taxable dispositions, and the S1 shares
because S and S1 cease to be members of the same
group. This section applies to the transfer of the S and
S1 (loss) shares, but not to the transfer of the S2 (gain)
shares. Accordingly, immediately before the transaction, after giving effect to other rules of law, the following occurs. First, the gain recognized on the transferred S2 shares tiers up to adjust members’ bases in
all upper-tier subsidiary shares under the principles
of §1.1502–32. Then, if S’s transferred S1 shares are
still loss shares, paragraphs (b) and (c) of this section
apply to those shares. The loss on the S1 shares is not
recognized in the transfer (because there is no taxable
disposition of the shares) and so only the adjustments
to the bases of the S1 shares required by paragraphs
(b) and (c) of this section tier up to adjust M’s basis
in the S stock. Then, if M’s transferred shares of S
stock are still loss shares, paragraphs (b) and (c) of
this section apply with respect to those shares. If, after giving effect to any adjustments under paragraphs
(b) and (c) of this section, any of the S shares are still
loss shares, paragraph (d) of this section applies with
respect to the transfer of those shares. If any transferred S1 shares are still loss shares after the application of paragraph (d) of this section with respect to
the transfer of S shares, paragraph (d) applies with respect to the transfer of the S1 shares.

(4) Other rules of law and coordination
with deferral and disallowance provisions.
This section applies and has effect immediately upon the transfer of a loss share even
if the loss is deferred, disallowed, or oth-

572

erwise not taken into account under any
other applicable rules of law. For example, if M sells loss shares of S stock to another member in an intercompany transaction, every member’s bases in shares of S
stock and all of S’s attributes may be adjusted under this section even though M’s
loss is deferred under §§1.267(f)–1 and
1.1502–13, and S remains a member. See
§1.1502–80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments.
(5) Nomenclature, factual assumptions
adopted in this section. Unless otherwise
stated, for purposes of this section, the following nomenclature and assumptions are
adopted. P is the common parent of a consolidated group and X is a nonmember of
the P group. If a corporation has preferred
stock outstanding, it is stock described in
section 1504(a)(4). The examples set forth
the only facts and activities relevant to
the example. All transactions are between
unrelated persons and are independent of
each other. Tax liabilities and their effect, and the application of any loss disallowance or deferral provision of the Code
or regulations, including but not limited to
section 267, are disregarded. All persons
report on a calendar year basis and use the
accrual method of accounting. All parties
comply with filing and other requirements
of this section and all other provisions of
the Code and regulations.
(b) Basis redetermination to reduce
disparity—(1) In general—(i) Purpose
and scope. The rules of this paragraph
(b) reduce (but do not increase) the extent
to which there is disparity in members’
bases in shares of S stock. These rules are
intended to prevent the operation of the
investment adjustment system from creating noneconomic or duplicated loss when
members hold S shares with disparate
bases, and they operate by reallocating
previously applied investment adjustments. The provisions of this paragraph
(b) do not alter the aggregate amount of
basis in shares of S stock held by members
or the aggregate amount of investment
adjustments applied to shares of S stock.
(ii) Exemptions from basis redetermination—(A) No potential for redetermination. Notwithstanding the general rule
in paragraph (b)(2) of this section, basis
redetermination will not be required if redetermination would not result in a change
to any member’s basis in any share of S

2007–8 I.R.B.

stock. For example, if S has only one class
of stock outstanding and there is no disparity in members’ bases in S shares, no
member’s basis would be changed by the
application of this paragraph (b). Accordingly, under this paragraph (b)(1)(ii)(A),
no redetermination would be required.
Similarly, if S has preferred and common
stock outstanding, there is no gain or loss
on any member’s preferred shares, and
there is no disparity in members’ bases
in the common stock, no member’s basis
would be changed by the application of
this paragraph (b). Accordingly, under
this paragraph (b)(1)(ii)(A), no redetermination would be required.
(B) Disposition of entire interest.
Notwithstanding the general rule in paragraph (b)(2) of this section, basis redetermination will not be required if, within the
group’s taxable year in which the transfer
occurs, every share of S stock held by a
member is transferred to a nonmember in
one or more fully taxable transactions.
(iii) Transfers of stock of subsidiaries
at multiple tiers. If stock of subsidiaries
at multiple tiers is transferred in a transaction, see paragraph (a)(3)(ii) of this section
regarding the order of application of this
section.
(iv) Investment adjustment. For purposes of this paragraph (b), the term investment adjustment means the adjustment
for items described in §1.1502–32(b)(2),
excluding §1.1502–32(b)(2)(iv) (distributions). The term includes all such
adjustments reflected in the basis of the
share, whether originally applied directly
by §1.1502–32 or otherwise. The term
therefore includes investment adjustments
reallocated to the share, and it does not include investment adjustments reallocated
from the share, whether pursuant to this
section or any other provision of law. It
also includes the proportionate amount of
investment adjustments reflected in the
basis of a share after the basis is apportioned among shares, for example in a
transaction qualifying under section 355.
(2) Basis redetermination rule. If M
transfers a loss share of S stock, all members’ bases in all their shares of S stock are
subject to redetermination under this paragraph (b). The adjustments are made in accordance with the following:
(i) Decreasing the bases of transferred
loss shares—(A) Removing positive investment adjustments from transferred loss

2007–8 I.R.B.

shares. M’s basis in each of its transferred
loss shares of S stock is first reduced, but
not below value, by removing positive investment adjustments previously applied
to the basis of the share. The positive
investment adjustments removed from
transferred loss shares are reallocated under paragraph (b)(2)(ii) of this section
after negative investment adjustments are
reallocated under paragraph (b)(2)(i)(B)
of this section.
(B) Reallocating negative investment
adjustments. If a transferred share is
still a loss share after applying paragraph
(b)(2)(i)(A) of this section, M’s basis in
the share is reduced, but not below value,
by reallocating and applying negative investment adjustments to the transferred
loss share from shares held by members
that are not transferred loss shares. Reductions under this paragraph (b)(2)(i)(B)
are made first to M’s bases in transferred
loss shares of S preferred stock and then
to M’s bases in transferred loss shares of
S common stock.
(ii) Increasing the bases of gain preferred and all common shares—(A) Preferred stock. After the application of paragraph (b)(2)(i) of this section, the positive investment adjustments removed from
transferred loss shares are reallocated and
applied to increase, but not above value,
members’ bases in gain shares of S preferred stock.
(B) Common stock. Any positive investment adjustments removed from transferred loss shares and not applied to S preferred shares are then reallocated and applied to increase members’ bases in shares
of S common stock. Reallocations are
made to shares of common stock without
regard to whether a particular share is a
loss share or a transferred share, and without regard to the share’s value.
(iii) Operating rules—(A) In general.
All reallocations (both to and from members’ shares of S stock) are made in a
manner that reduces basis disparity among
shares of preferred stock and among shares
of common stock to the greatest extent
possible (that is, causes the ratio of the basis to the value of each member’s share to
be as equal as possible).
(B) Limits on reallocation—(1) Restriction to outstanding shares. Investment adjustments can only be reallocated
to shares that were held by members in the

573

period to which the adjustment is attributable.
(2) Limitation by prior use of allocation—(i) In general. In order to prevent
the reallocation of investment adjustments
from either increasing or decreasing members’ aggregate bases in subsidiary stock,
no investment adjustment (positive or
negative) may be reallocated under this
paragraph (b)(2) to the extent that it was
(or would have been) used prior to the
time that it would otherwise be reallocated under this paragraph (b)(2). For this
purpose, an investment adjustment was
used (or would have been used) to the
extent that it was reflected in (or would
have been reflected in) the basis of a share
of subsidiary stock and the basis of that
share has already been taken into account,
directly or indirectly, in determining income, gain, deduction, or loss (including
by affecting the application of this section
to a prior transfer of subsidiary stock) or in
determining the basis of any property that
is not subject to §1.1502–32. However,
notwithstanding the general rule, if the
prior use was in an intercompany transaction, an investment adjustment may be
reallocated to the extent that §1.1502–13
has prevented the gain or loss on the transaction from being taken into account. (In
that case, appropriate adjustments must be
made to the prior intercompany transaction.) Further, if an investment adjustment
was reflected in (or would have been reflected in) the basis of a share that has
been taken into account, but the basis of
that share would not change as a result
of the reallocation (for example, because
the reallocation would be among shares
that are all lower-tier to the share with
the previously used basis), the investment adjustment may be reallocated. See
§1.1502–32(c)(1)(ii)(C) regarding special
allocations applicable if the reallocation of
an investment adjustment is limited under
this paragraph (b)(2)(iii)(B)(2).
(ii) Example. The application of this
paragraph (b)(2)(iii)(B)(2) is illustrated by
the following example:
Example. (i) Facts. P owns all 20 shares of M
stock, and 10 shares of S stock. M owns the remaining 10 shares of S stock. In year 1, S recognizes $200
of income that results in a $10 positive investment adjustment being allocated to each share of S stock. The
group does not recognize any other items. The $100
positive adjustment to M’s basis in the S stock tiers
up, and results in a $5 positive adjustment to each
share of M stock. In year 2, P sells one share of M

February 20, 2007

stock and recognizes a gain. In year 3, M sells one
loss share of S stock, and paragraph (b) of this section applies and requires a reallocation of the year 1
positive investment adjustment.
(ii) Application of limitation by prior use. M’s
basis in the transferred loss share of S stock reflects a
$10 positive investment adjustment attributable to S’s
year 1 income. Under the general rule of this paragraph (b), that $10 would be subject to reallocation
to reduce basis disparity. However, that $10 adjustment had originally tiered up to adjust P’s basis in
its M shares and, as a result, $.50 of that adjustment
was reflected in P’s basis in each share of M stock.
When P sold the share of M stock, the basis of that
share (including the tiered up $.50) was used in determining the gain on the sale. Accordingly, $.50 of the
$10 investment adjustment originally allocated to the
S share that tiered-up to the M share was previously
used and therefore cannot be reallocated in a manner
that would (if it were the original allocation) affect
the basis of the sold share. Thus, taking into account
the special allocations in §1.1502–32(c)(1)(ii)(C), up
to $9.50 of the adjustment to M’s transferred S share
could be allocated to P’s shares of S stock (leaving
$.50 on M’s transferred S share, all of which would
be treated as tiered up to P’s transferred M share). Alternatively, all $10 could be reallocated to M’s other
S shares (because the tier up to P’s M shares would
have been the same regardless which of M’s shares
of S stock were adjusted.)
(iii) Application of limitation where adjustment
would have been used. The facts are the same as in
paragraph (i) of this Example except that M does not
sell any shares of S stock and, in year 3, P sells a loss
share of S stock. As in paragraph (i) of this Example, when P sold the share of M stock, the basis of
that share was used in determining the gain on the
share. When P sells the loss share of S stock, the
$10 positive investment adjustment from S’s year 1
income cannot be reallocated in a manner that, if it
were the original adjustment, would have caused any
amount to be reflected in the basis of the transferred
share. If this $10 positive investment adjustment had
originally been allocated to the S shares held by M,
$.50 of the $10 investment adjustment would have
tiered up to the M share that P sold, would have been
reflected in P’s basis, and would have been used in
determining the gain or loss on the sale. Accordingly, taking into account the special allocations in
§1.1502–32(c)(1)(ii)(C), up to $9.50 of the $10 adjustment to P’s transferred S share could be allocated
to M’s shares of S stock (all of which would tier up
to P’s 19 retained M shares). Alternatively, all $10
could be reallocated to P’s other S shares.

(C) Order of reallocation. In general,
reallocations are made first with respect to
the earliest available adjustments. However, the overall application of this paragraph (b) to a transaction must be made in
a manner that reduces basis disparity to the
greatest extent possible.
(3) Examples. The general application
of this paragraph (b) is illustrated by the
following examples:
Example 1. Transfer of stock received in section 351 exchange. (i) Redetermination to prevent
noneconomic loss. (A) Facts. For many years, P has

February 20, 2007

owned two assets, Asset 1 and Asset 2. On January
1, year 1, P receives four shares of S common stock
(the Block 1 shares) in exchange for Asset 1, which
has a basis and value of $80. The exchange qualifies under section 351 and, therefore, under section
358, P’s aggregate basis in the Block 1 shares is $80
($20 per share). On July 1, year 1, P receives another share of S common stock (the Block 2 share)
in exchange for Asset 2, which has a basis of $0 and
value of $20. This exchange also qualifies as a section 351 exchange and, under section 358, P’s basis
in the Block 2 share is $0. P’s Block 1 and Block
2 shares are the only outstanding shares of S stock.
On October 1, year 1, S sells Asset 2 for $20. On December 31, year 1, P sells one of its Block 1 shares for
$20. After applying and giving effect to all generally
applicable rules of law (other than this section), P’s
basis in each Block 1 share is $24 (P’s original $20
basis increased under §1.1502–32 by $4 (the share’s
allocable portion of the $20 gain recognized on the
sale of Asset 2)). In addition, P’s basis in its Block
2 share is $4 (P’s original $0 basis increased under
§1.1502–32 by $4 (the share’s allocable portion of the
$20 gain recognized on the sale of Asset 2)). P’s sale
of the Block 1 share is a transfer of a loss share and
therefore subject to the provisions of this section.
(B) Basis redetermination under this paragraph
(b). Under this paragraph (b), P’s bases in all its
shares of S stock are subject to redetermination. First,
paragraph (b)(2)(i)(A) of this section applies to reduce P’s basis in the transferred loss share, but not
below value, by removing positive investment adjustments applied to the basis of the share. Accordingly,
P’s basis in the transferred Block 1 share is reduced
by $4 (the amount of the positive investment adjustment applied to the share), from $24 to $20. No further reduction to the basis of the share is required under this paragraph (b) because the basis of the share
is then equal to value. Under paragraph (b)(2)(ii)(B)
of this section, the positive investment adjustment removed from the transferred loss share is reallocated
and applied to increase P’s bases in its S shares in
a manner that reduces basis disparity to the greatest
extent possible. Accordingly, the $4 positive investment adjustment removed from the Block 1 share is
reallocated and applied to the basis of the Block 2
share, increasing it from $4 to $8.
(C) Application of paragraphs (c) and (d) of this
section. Because P’s sale of the Block 1 share is no
longer a transfer of a loss share after the application
of this paragraph (b), paragraphs (c) and (d) of this
section do not apply.
(ii) Redetermination to prevent duplicated loss.
(A) Facts. The facts are the same as in paragraph
(i)(A) of this Example 1, except that, at the time of
the second contribution, the value of Asset 1 had declined to $20 and so, instead of contributing Asset 2,
P contributed Asset 3 to S in exchange for the Block
2 share. At the time of that exchange, Asset 3 had
a basis and value of $5. On October 1, year 1, S
sells Asset 1 for $20, recognizing a $60 loss that is
absorbed by the group. On December 31, year 1, P
sells one of its Block 1 shares for $5. After applying
and giving effect to all generally applicable rules of
law (other than this section), P’s basis in each Block
1 share is $8 (P’s original $20 basis decreased under
§1.1502–32 by $12 (the share’s allocable portion of
the $60 loss recognized on the sale of Asset 1)). P’s
basis in its Block 2 share is an excess loss account of

574

$7 (its original basis of $5 reduced by $12, the share’s
portion of the loss recognized on Asset 1). P’s sale
of the Block 1 share is a transfer of a loss share and
therefore subject to the provisions of this section.
(B) Basis redetermination under this paragraph
(b). Under this paragraph (b), P’s bases in all its
shares of S stock are subject to redetermination.
There are no positive investment adjustments and so
there is no adjustment under paragraph (b)(2)(i)(A) of
this section. However, under paragraph (b)(2)(i)(B)
of this section, P’s basis in the transferred Block 1
share is reduced, but not below value, by reallocating
negative investment adjustments from shares that are
not transferred loss shares. In total, there were $48
of negative investment adjustments applied to shares
that are not transferred loss shares. Accordingly, P’s
basis in the Block 1 share is reduced by $3, from
$8 to its value of $5. Under paragraph (b)(2)(i)(B)
of this section, the negative investment adjustments
applied to the transferred share are reallocated from
(and therefore cause an increase in the basis of) S
shares that are not transferred loss shares in a manner
that reduces basis disparity to the greatest extent
possible. Accordingly, the $3 negative investment
adjustment reallocated and applied to the transferred
Block 1 share is reallocated entirely from the Block
2 share, increasing the basis in the Block 2 share
from an excess loss account of $7 to an excess loss
account of $4.
(C) Application of paragraphs (c) and (d) of this
section. Because P’s sale of the Block 1 share is no
longer a transfer of a loss share after the application
of this paragraph (b), paragraphs (c) and (d) of this
section do not apply.
(iii) Nonapplicability of redetermination rule to
sale of entire interest. The facts are the same as in
paragraph (ii)(A) of this Example 1, except that, on
December 31, year 1, P sells all its shares of S stock
for $25. Under paragraph (b)(1)(ii)(B) of this section, this paragraph (b) does not apply to redetermine
P’s basis in its S shares because every S share held
by a member is transferred to a nonmember in a fully
taxable transaction. However, the sale of the Block 1
shares is a transfer of loss shares and therefore subject
to paragraphs (c) and (d) of this section. Paragraphs
(c)(7) and (d)(3)(i)(A) of this section apply netting
principles to prevent adjustments under either paragraph (c) or paragraph (d) of this section.
Example 2. Redetermination increases basis of
transferred loss share. (i) Facts. On January 1, year
1, P owns all 10 outstanding shares of S common
stock. Five of the shares have a basis of $20 per share
(the Block 1 shares) and five of the shares have a basis
of $10 per share (the Block 2 shares). S’s only asset,
Asset 1, has a basis of $50. S has no other attributes.
On October 1, year 1, S sells Asset 1 for $100. On December 31, year 2, S sells one Block 1 share and one
Block 2 share to X for $10 per share. After applying
and giving effect to all generally applicable rules of
law (other than this section), P’s basis in each Block
1 share is $25 (P’s original $20 basis increased under §1.1502–32 by $5 (the share’s allocable portion
of the $50 gain recognized on the sale of Asset 1)),
and P’s basis in each Block 2 share is $15 (P’s original $10 basis increased by $5). P’s sale of the Block
1 and Block 2 shares is a transfer of loss shares and
therefore subject to the provisions of this section.
(ii) Basis redetermination under this paragraph
(b). Under this paragraph (b), P’s bases in all its

2007–8 I.R.B.

shares of S stock are subject to redetermination. First,
paragraph (b)(2)(i)(A) of this section applies to reduce P’s basis in the transferred Block 1 and Block
2 shares, but not below value, by removing the positive investment adjustments applied to the bases of
the transferred loss shares. Accordingly, the basis of
the Block 1 share is reduced by $5, from $25 to $20.
The basis of the Block 2 share is also reduced by $5,
from $15 to $10. (Although the Block 1 share is still
a loss share, there is no reduction to its basis under
paragraph (b)(2)(i)(B) of this section because there
were no negative investment adjustments to shares
that are not transferred loss shares.) Next, paragraph
(b)(2)(ii)(B) of this section applies to reallocate and
apply the $10 of positive investment adjustments removed from the transferred loss shares to increase P’s
bases in its S shares in a manner that reduces basis disparity to the greatest extent possible. Accordingly, of
the $10 positive investment adjustments to be reallocated, $6 is reallocated and applied to the basis of
the Block 2 share (increasing it from $10 to $16) and

$4 is reallocated and applied equally to the basis of
each of the four retained Block 2 shares (increasing
the basis of each from $15 to $16). After giving effect to the reallocations under this paragraph (b), P’s
basis in each retained Block 1 share is $25, P’s basis
in the transferred Block 1 share is $20, and P’s basis
in each Block 2 share is $16.
(iii) Application of paragraph (c) of this section.
After the application of this paragraph (b), P’s sale
of the Block 1 and Block 2 shares is still a transfer
of loss shares and, accordingly, subject to paragraph
(c) of this section. No adjustment is required to the
basis of the Block 1 share under paragraph (c) of this
section because, after its basis is redetermined under
this paragraph (b), the net positive adjustment to the
basis of the share is $0. See paragraph (c)(3) of this
section. However, paragraph (c) of this section reduces P’s basis in the transferred Block 2 share (by
the lesser of its net positive adjustment and its disconformity amount, or $6, from $16 to $10, its value).

Preferred

(iv) Application of paragraph (d) of this section.
After the application of paragraph (c) of this section,
P’s sale of the Block 1 share is still a transfer of a
loss share and, accordingly, subject to paragraph (d)
of this section. No adjustment is required under paragraph (d) of this section because there is no aggregate
inside loss. See paragraph (d)(3)(iii) of this section.
Because P’s sale of the Block 2 share is no longer a
transfer of a loss share after the application of paragraph (c) of this section, paragraph (d) of this section
does not apply to the transfer of the Block 2 share.
Example 3. Application to outstanding common
and preferred shares. (i) Facts. P owns all the stock
of M and all eight outstanding shares of S common
stock. S also has two shares of nonvoting preferred
stock outstanding; the preferred shares have a $100
annual, cumulative preference as to dividends (per
share). M owns one of the preferred shares (PS1) and
P owns the other (PS2). On January 1, year 1, the
bases and values of the outstanding S shares are:

Common

PS1
(M)

PS2
(P)

CS1
(P)

CS2
(P)

CS3
(P)

CS4
(P)

CS5
(P)

CS6
(P)

CS7
(P)

CS8
(P)

Basis

1250

975

1025

710

550

400

375

250

215

100

Value

1000

1000

375

375

375

375

375

375

375

375

As of January 1, year 1, there are no arrearages
on the preferred stock. In year 1, S has a $1100 capital loss and $100 of ordinary income. The loss is
absorbed by the group and the resulting negative adjustment of $1000 is allocable entirely to the common
stock. See §1.1502–32(c)(1).
In year 2, S has $700 of ordinary income and a
$100 ordinary loss. Also, on October 1, year 2, S declares a dividend of $200 ($100 with respect to each

of the preferred shares). Thus, there is a net positive investment adjustment for year 2 of $400. See
§1.1502–32(b)(2). Under §1.1502–32(c)(1), a negative adjustment of $100 is first allocated to each
of the preferred shares to reflect the dividend declaration. Then, $400 of the $600 remaining adjustment (the adjustment computed without taking distributions into account) is allocated $200 to each of the
preferred shares to reflect its entitlement to dividends

Preferred

accruing in year 1 and year 2. See §1.1502–32(c)(3).
(The year 2 investment adjustment to each preferred
share is therefore a positive $100.) Finally, under
§1.1502–32(c)(2), the remaining $200 of the investment adjustment is allocated to the common stock,
equally to all outstanding shares. After applying and
giving effect to all generally applicable rules of law
(other than this section), the adjusted bases and the
values of the shares as of January 1, year 3, are:

Common

PS1
(M)

PS2
(P)

CS1
(P)

CS2
(P)

CS3
(P)

CS4
(P)

CS5
(P)

CS6
(P)

CS7
(P)

CS8
(P)

Basis

1250

975

1025

710

550

400

375

250

215

100

Year 1
§1.1502–32 adjustments

N/A

N/A

-125

-125

-125

-125

-125

-125

-125

-125

Year 2
§1.1502–32 adjustments

+100

+100

+25

+25

+25

+25

+25

+25

+25

+25

Adjusted basis

1350

1075

925

610

450

300

275

150

115

0

Value

1100

1100

275

275

275

275

275

275

275

275

Unrecognized gain/(loss)

(250)

25

(650)

(335)

(175)

(25)

0

125

160

275

On January 1, year 3, M sells PS1 for $1100 and
P sells CS2 for $275. The sales of PS1 and CS2 are
transfers of loss shares and therefore subject to the
provisions of this section.
(ii) Basis redetermination under this paragraph
(b). Under this paragraph (b), all members’ bases
in shares of S stock are subject to redetermination in
accordance with the following:
(A) Removing positive investment adjustments
from transferred loss shares.
First, paragraph
(b)(2)(i)(A) of this section applies to reduce M’s ba-

2007–8 I.R.B.

sis in PS1 and P’s basis in CS2, but not below value,
by removing the positive investment adjustments
applied to the bases of the shares. Accordingly, M‘s
basis in PS1 is reduced by $200 (the investment
adjustment applied to the share without regard to the
distribution), from $1350 to $1150, and P’s basis in
CS2 is reduced by $25, from $610 to $585.
(B) Reallocating negative investment adjustments
from shares that are not transferred loss shares. Because the transferred shares remain loss shares after
the removal of positive investment adjustments,

575

their bases are further reduced under paragraph
(b)(2)(i)(B) of this section, but not below value, by
negative investment adjustments applied to shares
that are not transferred loss shares. Reallocations are
made first to preferred shares and then to the common shares, in a manner that reduces basis disparity
to the greatest extent possible. The remaining loss on
PS1 is $50, the remaining loss on CS2 is $310, and
the total amount of negative investment adjustments
applied to shares that are not transferred loss shares
is $875 (the sum of the adjustments made to all com-

February 20, 2007

mon shares other than CS2). Thus, $50 of negative
investment adjustments are reallocated to the basis
of PS1 and $310 of negative investment adjustments
are reallocated to the basis of CS2, reducing each to
its value ($1100 and $275, respectively). The negative investment adjustments are reallocated from
the shares that are not transferred loss shares in a
manner that reduces basis disparity to the greatest
extent possible. Accordingly, of the $360 reallocated
negative investment adjustments, $125 is reallocated
from each of CS7 and CS8, and $110 is reallocated

from CS6. As a result, the basis of CS6 increases
to $260, the basis of CS7 increases to $240, and the
basis of CS8 increases to $125.
(C) Increasing basis by reallocated positive investment adjustments. Under paragraph (b)(2)(ii)(A)
of this section, the $225 of positive investment adjustments removed from the transferred loss shares are
then reallocated and applied to increase the basis of
preferred shares, but not above value. Accordingly,
$25 of that amount is reallocated to PS2, increasing
its basis from $1075 to $1100, its value. The remain-

Preferred

ing $200 is allocated among the common shares in
a manner that reduces basis disparity to the greatest
extent possible. Accordingly, of the $200 positive investment adjustment that is reallocated to common
shares, $150 is reallocated to CS8, $35 is reallocated
to CS7, and $15 is reallocated to CS6, increasing the
basis of each to $275.
(D) Summary of reallocation adjustments. The
adjustments made under this paragraph (b) are therefore:

Common

PS1
(M)

PS2
(P)

CS1
(P)

CS2
(P)

CS3
(P)

CS4
(P)

CS5
(P)

CS6
(P)

CS7
(P)

CS8
(P)

Adjusted basis before
redetermination

1350

1075

925

610

450

300

275

150

115

0

Removing positive
adjustments from transferred
loss shares

-200

-25

Reallocating negative
adjustments

-50

-310

+110

+125

+125

+15

+35

+150

Applying positive
adjustments removed from
transferred shares

+25

Basis after redetermination

1100

1100

925

275

450

300

275

275

275

275

Value

1100

1100

275

275

275

275

275

275

275

275

0

0

(650)

0

(175)

(25)

0

0

0

0

Gain/(loss)

(iii) Application of paragraphs (c) and (d) of this
section. Because M’s sale of PS1 and P’s sale of
CS2 are no longer transfers of loss shares after the
application of this paragraph (b), paragraphs (c) and
(d) of this section do not apply.
(iv) Higher-tier effects. The adjustments made to
PS1 give rise to a $250 nondeductible basis recovery item (a noncapital, nondeductible expense under
§1.1502–32(b)(3)(iii)(B)) that will be included in the
year 3 investment adjustment to be applied to reduce
P’s basis in its M stock.

(c) Stock basis reduction to prevent
noneconomic loss—(1) In general. The
rules of this paragraph (c) reduce M’s basis
in a transferred share of S stock in order
to prevent noneconomic stock loss and
thereby promote the clear reflection of the
group’s income. The effect of these rules
is to limit the reduction to M’s basis in the
S share to the amount of net unrealized
appreciation reflected in the share’s basis
immediately before the transfer. These
rules also limit the reduction to M’s basis
in the S share to the portion of the share’s
basis that is attributable to investment
adjustments made pursuant to the consolidated return regulations.
(2) Basis reduction rule—(i) In general.
If M transfers a share of S stock and, after
the application of paragraph (b) of this sec-

February 20, 2007

tion, the share is a loss share, M’s basis in
the share is reduced, but not below value,
by the lesser of—
(A) The share’s net positive adjustment
(see paragraph (c)(3) of this section); and
(B) The share’s disconformity amount
(see paragraph (c)(4) of this section).
(ii) Transactions that adjusted stock or
asset basis. See paragraph (e)(2) of this
section for special rules that may apply if a
prior transaction, such as an exchange subject to section 362(e)(2), adjusted the basis
in any share of S stock or S’s attributes in
a manner that altered a share’s disconformity amount.
(iii) Transfers of stock of subsidiaries
at multiple tiers. If stock of subsidiaries
at multiple tiers is transferred in a transaction, see paragraph (a)(3)(ii) of this section
regarding the order of application of this
section.
(3) Net positive adjustment. A share’s
net positive adjustment is the greater of—
(i) Zero; and
(ii) The sum of all investment adjustments reflected in the basis of the share.

576

The term investment adjustment has the
same meaning as in paragraph (b)(1)(iv) of
this section.
(4) Disconformity amount. A share’s
disconformity amount is the excess, if any,
of—
(i) M’s basis in the share; over
(ii) The share’s allocable portion of S’s
net inside attribute amount (as defined in
paragraph (c)(5) of this section).
(5) Net inside attribute amount. S’s net
inside attribute amount is determined as
of the time immediately before the transfer, taking into account all applicable rules
of law other than this section (except as
specifically provided otherwise in this section). S’s net inside attribute amount is the
sum of S’s net operating and capital loss
carryovers, deferred deductions, money,
and basis in assets other than money (for
this purpose, S’s basis in any share of
lower-tier subsidiary stock is S’s basis in
that share, adjusted to reflect any gain or
loss recognized in the transaction and any
other related or resulting adjustments), reduced by the amount of S’s liabilities. See
paragraph (f) of this section for definitions
of the terms “allocable portion”, “deferred
deduction”, “liability”, and “loss carry-

2007–8 I.R.B.

over”. See paragraph (c)(6) of this section
for special rules regarding the computation
of S’s net inside attribute amount for purposes of this paragraph (c) if S holds stock
of a subsidiary.
(6) Determination of S’s net inside attribute amount if S owns stock of a lowertier subsidiary—(i) Overview. If a loss
share of S stock is transferred when S holds
a share of stock of another subsidiary (S1)
and the S1 share is not transferred in the
same transaction, S’s net inside attribute
amount is determined by treating S’s basis
in its S1 share as tentatively reduced under
this paragraph (c)(6). The purpose of this
rule is to reduce the extent to which S1’s
investment adjustments increase noneconomic loss on S stock (as a result of S1’s
recognition of items that are indirectly reflected in members’ bases in S stock).
(ii) General rule for nontransferred
shares of lower-tier subsidiary. Solely
for purposes of determining the disconformity amount of a share of S stock, S’s
basis in a share of S1 stock is treated as
reduced by the share’s tentative reduction
amount. The tentative reduction amount is
the lesser of the S1 share’s net positive adjustment and the S1 share’s disconformity
amount, computed under the principles of
paragraphs (c)(3) and (c)(4) of this section, respectively.
(iii) Multiple tiers of nontransferred
shares. If S directly or indirectly owns
non-transferred shares of stock of subsidiaries in multiple tiers, then, subject
to the limitations in paragraph (c)(6)(iv)
of this section (regarding nontransferred
shares that are lower-tier to transferred
shares), the rules of this paragraph (c)(6)
first apply to determine the tentatively
reduced basis of stock of the subsidiary
at the lowest tier. These rules then apply
successively to determine the tentatively
reduced basis of nontransferred shares of
stock of subsidiaries at each next higher
tier that is lower tier to S. The tentative reductions are treated as noncapital,
nondeductible expenses that tier up under
the principles of §1.1502–32, tentatively
reducing the basis of stock and the net
positive adjustments of subsidiaries that
are lower tier to S.
(iv) Nonapplicability of tentative basis
reduction rule to transferred shares. The
tentative basis reduction rule in this paragraph (c)(6) does not apply to any share
of stock of a lower-tier subsidiary (S1)

2007–8 I.R.B.

that is transferred in the same transaction
in which the S share is transferred. Further, for purposes of determining the S
share’s disconformity amount, the tentative basis reduction rule in this paragraph
(c)(6) does not apply with respect to stock
of any other subsidiary (S2) to the extent
it is lower tier to the transferred S1 share.
However, the tentative basis reduction rule
may apply to S2 stock for purposes of computing the disconformity amount of the
transferred S1 share. The purpose of this
rule is to prevent tentative adjustments under this paragraph (c)(6) to the extent that
this paragraph (c) has already applied to
shares of subsidiary stock, without regard
to whether the basis of those shares was reduced under this paragraph (c).
(v) Example. The rules of this paragraph (c)(6) are illustrated by the following example:
Example. (i) Facts. P owns the sole outstanding
share of S stock, S owns the sole outstanding share
of S1 stock, S1 owns the sole outstanding share of S2
stock, S2 owns the sole outstanding share of S3 stock,
and S3 owns the sole outstanding share of S4 stock.
The S and S1 shares are loss shares, and the S3 share
is a gain share. In one transaction, P sells its S share to
X, S1 issues new shares in an amount that prevents S
and S1 from being members of the same group, and
S2 sells the S3 share to an unrelated individual. S1
and S2 elect to file a consolidated return following
the transaction, as do S3 and S4.
(ii) General applicability of section. The transaction is a transfer of the S and S3 shares (by reason of
the sales) and of the S1 share (because S and S1 cease
to be members of the same group). The transfer of
the S3 share is not a transfer of a loss share and so
this section does not apply to that transfer. This section does, however, apply to the transfer of the S and
S1 loss shares. Under paragraph (a)(3)(ii)(A) of this
section, the application of this section begins with the
application of paragraph (b) to the transfer of the loss
share of S1 stock, the lowest-tier subsidiary the stock
of which is transferred in the transaction.
(iii) Application of paragraphs (b) and (c) to
transfer of S1 stock. First, the gain recognized on the
transfer of S3 stock tiers up to adjust the basis of each
upper-tier share. Then, because the transferred S1
share is still a loss share under these facts, paragraph
(b) of this section applies to S’s transfer of S1 stock.
However, no adjustment is required under paragraph
(b) of this section because redetermination would
change no member’s basis in a share (members
hold only one share of S1 stock). See paragraph
(b)(1)(ii)(A) of this section. The S1 share is still a
loss share and so it is then subject to the provisions
of this paragraph (c). In determining basis reduction
under this paragraph (c), the disconformity amount
of the S1 share is computed by treating S1’s basis in
S2 stock as tentatively reduced under this paragraph
(c)(6). In determining the disconformity amount
of the S1 share, this tentative reduction rule has no
application with respect to S2’s basis in the S3 share
(because the S3 share is transferred in the transac-

577

tion) or with respect to S3’s basis in the S4 share
(because the S4 stock is lower tier to the transferred
S3 share). After the application of this paragraph (c)
to the transfer of the S1 share, paragraph (b) of this
section applies to P’s transfer of the S share if the
share is still a loss share.
(iv) Application of section to transfer of S stock.
First, assuming the S share has remained a loss share,
paragraph (b) of this section applies to P’s transfer
of S stock. However, no adjustment is required under paragraph (b) of this section, either because there
is no potential for redetermination (members hold
only one share of S stock) or because P transfers
the group’s entire interest in S to a nonmember in
a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section.
The transferred share is still a loss share and therefore subject to the provisions of this paragraph (c). In
determining the disconformity amount of the S share,
S’s net inside attributes are determined by taking into
account S’s actual basis in the S1 stock. The tentative reduction rule of this paragraph (c)(6) does not
apply to S’s basis in the S1 share because the S1 share
is transferred in the transaction. All other shares are
lower tier to the transferred S1 share and are therefore not subject to tentative reduction for purposes of
determining the disconformity amount of the S share.

(7) Netting of gains and losses taken
into account—(i) General rule. Solely for
purposes of computing the basis reduction
required under this paragraph (c), the basis
of each transferred loss share of S stock
is treated as reduced proportionately (as
to loss) by the amount of gain taken into
account by members with respect to all
transferred gain shares of S stock, provided
that—
(A) The gain and loss shares are transferred in the same transaction; and
(B) The gain is taken into account in the
year of the transaction.
(ii) Example. The netting rule of this
paragraph (c)(7) is illustrated by the following example:
Example. Disposition of gain and loss shares. (i)
Facts. P owns the only two outstanding shares of S
common stock. Share A has a basis of $54 and Share
B has a basis of $100. In the same transaction, P sells
the two S shares to X for $60 each. P realizes a gain
of $6 on Share A and a loss of $40 on Share B. P’s
sale of Share B is a transfer of a loss share and therefore subject to the provisions of this section. (No adjustment is required under paragraph (b) of this section because P transfers the group’s entire interest in
S to a nonmember in a fully taxable transaction. See
paragraph (b)(1)(ii)(B) of this section.) The transfer
is then subject to the provisions of this paragraph (c).
However, for this purpose, P treats its basis in Share
B as reduced by the $6 gain taken into account with
respect to Share A. Thus, solely for purposes of computing the basis reduction required with respect to P’s
basis in Share B, P’s basis in Share B is treated as $94
($100 less $6). If, after the application of this paragraph (c), the sale of Share B is still a transfer of a
loss share, then the transfer is subject to paragraph
(d) of this section. (Although the basis of Share B

February 20, 2007

is not reduced by gain for purposes of paragraph (d)
of this section, paragraph (d)(3)(i)(A) of this section
applies netting principles to limit adjustments under
paragraph (d) of this section.)
(ii) Allocation of gain amount to determine net
loss. The facts are the same as in paragraph (i) of
this Example, except that, in addition to Share A and
Share B, a third share of S stock, Share C, is outstanding. P’s basis in Share C is $80. P sells all three shares
of S stock to X for $60 each. P’s sales of Share B
and Share C are transfers of loss shares and therefore
subject to the provisions of this section. (No adjustment is required under paragraph (b) of this section
because P transfers the group’s entire interest in S
to a nonmember in a fully taxable transaction. See
paragraph (b)(1)(ii)(B) of this section.) The transfer
is then subject to the provisions of this paragraph (c).
However, for this purpose, P treats its bases in Share
B and Share C as reduced by the $6 gain taken into
account on Share A. The gain is allocated to Share
B and Share C proportionately based on the amount
of loss in each share. Thus, $4 of gain ($40/$60 x
$6) is treated as allocated to Share B and $2 of gain
($20/$60 x $6) is treated as allocated to Share C. Accordingly, P computes the basis reduction required
under this paragraph (c) by treating its basis in Share
B as $96 ($100 less $4) and its basis in Share C as $78
($80 less $2). If, after the application of this paragraph (c), the sales of Share B and Share C are still
transfers of loss shares, then the transfers are subject
to paragraph (d) of this section. (Although the bases
of Share B and Share C are not reduced by gain for
purposes of paragraph (d) of this section, paragraph
(d)(3)(i)(A) of this section applies netting principles
to limit adjustments under paragraph (d) of this section.)
(iii) Disposition of stock with deferred gain. The
facts are the same as in paragraph (i) of this Example,
except that P sells the gain share to a member. Under
§1.1502–13, P’s gain recognized on Share A is not
taken into account in the taxable year of the transfer
and therefore cannot be treated as reducing P’s loss
recognized on Share B.

(8) Examples. The application of this
paragraph (c) is illustrated by the following examples.
Example 1. Appreciation reflected in stock basis
at acquisition. (i) Appreciation recognized as gain.
(A) Facts. On January 1, year 1, P purchases the sole
outstanding share of S stock for $100. At that time,
S owns two assets, Asset 1 with a basis of $0 and
a value of $40, and Asset 2 with a basis and value
of $60. In year 1, S sells Asset 1 for $40. On December 31, year 1, P sells its S share for $100. After
applying and giving effect to all generally applicable
rules of law (other than this section), P’s basis in the S
share is $140 (P’s original $100 basis increased under
§1.1502–32 to reflect the $40 gain recognized on the
sale of Asset 1). P’s sale of the S share is a transfer
of a loss share and therefore subject to the provisions
of this section.
(B) Application of paragraph (b) of this section.
No adjustment is required under paragraph (b) of
this section, either because redetermination would
change no member’s basis in a share (members hold
only one share of S stock) or because P transfers the
group’s entire interest in S to a nonmember in a fully
taxable transaction. See, respectively, paragraphs

February 20, 2007

(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After
the application of paragraph (b) of this section, P’s
sale of the S share is still a transfer of a loss share
and therefore subject to this paragraph (c).
(C) Basis reduction under this paragraph (c).
Under this paragraph (c), P’s basis in the S share is
reduced, but not below value, by the lesser of the
share’s net positive adjustment and disconformity
amount. The share’s net positive adjustment is the
greater of zero and the sum of all investment adjustments applied to the basis of the share, computed
without taking distributions into account. There are
no distributions. The only investment adjustment to
the share is the $40 adjustment attributable to the
gain recognized on the sale of Asset 1. Thus, the
share’s net positive adjustment is $40. The share’s
disconformity amount is the excess, if any, of its basis ($140) over its allocable portion of S’s net inside
attribute amount. S’s net inside attribute amount is
the sum of S’s money ($40 from the sale of Asset 1)
and S’s basis in Asset 2 ($60), or $100. The share
is the only outstanding S share and so its allocable
portion of the $100 net inside attribute amount is the
entire $100. Thus, the share’s disconformity amount
is $40, the excess of $140 over $100. The lesser
of the net positive adjustment ($40) and the share’s
disconformity amount ($40) is $40. Accordingly, the
basis in the share is reduced by $40, from $140 to
$100, immediately before the sale.
(D) Application of paragraph (d) of this section.
Because P’s sale of the S share is no longer a transfer
of a loss share after the application of this paragraph
(c), paragraph (d) of this section does not apply.
(ii) Appreciation recognized as income (instead of
gain). The facts are the same as in paragraph (i)(A) of
this Example 1, except that, instead of selling Asset 1,
the value of Asset 1 is consumed in the production of
$40 of income in year 1 (reducing the value of Asset 1
to $0). Because the net positive adjustment includes
items of income as well as items of gain, the results
are the same as those described in paragraph (i) of this
Example 1.
(iii) Post-acquisition appreciation eliminates
stock loss. The facts are the same as in paragraph
(i)(A) of this Example 1 except that, in addition, the
value of Asset 2 increases to $100 before the stock
is sold. As a result, P sells the S share for $140.
Because P’s sale of the S share is not a transfer of a
loss share, this section does not apply to the transfer,
notwithstanding that P’s basis in the S share was
increased by the gain recognized on Asset 1.
(iv) Distributions. (A) Facts. The facts are the
same as in paragraph (i)(A) of this Example 1 except
that, in addition, S distributes a $10 dividend before
the end of year 1. As a result, the value of the share
decreases and P sells the share for $90. After applying and giving effect to all generally applicable rules
of law (other than this section), P’s basis in the S share
is $130 (P’s original $100 basis increased by $30 under §1.1502–32 (the net of the $40 gain recognized
on the sale of Asset 1 and the $10 dividend declared
and distributed)). P’s sale of the S share is a transfer
of a loss share and therefore subject to the provisions
of this section.
(B) Application of paragraph (b) of this section.
No adjustment is required under paragraph (b) of
this section, either because redetermination would
change no member’s basis in a share (members hold
only one share of S stock) or because P transfers the

578

group’s entire interest in S to a nonmember in a fully
taxable transaction. See, respectively, paragraphs
(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After
the application of paragraph (b) of this section, P’s
sale of the S share is still a transfer of a loss share
and therefore subject to this paragraph (c).
(C) Basis reduction under this paragraph (c).
Under this paragraph (c), P’s basis in the S share is
reduced, but not below value, by the lesser of the
share’s net positive adjustment and disconformity
amount. The share’s net positive adjustment is $40
(the sum of all investment adjustments applied to
the basis of the share, computed without taking distributions into account). The share’s disconformity
amount is the excess of its basis ($130) over its allocable portion of S’s net inside attribute amount. S’s
net inside attribute amount is the sum of S’s money
($30, the $40 sale proceeds minus the $10 distribution) and S’s basis in Asset 2 ($60), or $90. The share
is the only outstanding S share and so its allocable
portion of the $90 net inside attribute amount is the
entire $90. The lesser of the share’s net positive
adjustment ($40) and its disconformity amount ($40)
is $40. Accordingly, the basis in the share is reduced
by $40, from $130 to $90, immediately before the
sale.
(D) Application of paragraph (d) of this section.
Because P’s sale of the S share is no longer a transfer
of a loss share after the application of this paragraph
(c), paragraph (d) of this section does not apply.
Example 2. Loss of appreciation reflected in basis. (i) Facts. On January 1, year 1, P purchases the
sole outstanding share of S stock for $100. At that
time, S owns two assets, Asset 1 with a basis of $0
and a value of $40, and Asset 2 with a basis and value
of $60. The value of Asset 1 declines to $0 and P sells
its S share for $60. After applying and giving effect to
all generally applicable rules of law (other than this
section), P’s basis in the S share remains $100. P’s
sale of the S share is a transfer of a loss share and
therefore subject to the provisions of this section.
(ii) Application of paragraph (b) of this section.
No adjustment is required under paragraph (b) of
this section, either because redetermination would
change no member’s basis in a share (members hold
only one share of S stock) or because P transfers the
group’s entire interest in S to a nonmember in a fully
taxable transaction. See, respectively, paragraphs
(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After
the application of paragraph (b) of this section, P’s
sale of the S share is still a transfer of a loss share
and therefore subject to this paragraph (c).
(iii) Basis reduction under this paragraph (c).
Under this paragraph (c), P’s basis in the S share
($100) is reduced immediately before the sale, but
not below value ($60), by the lesser of the share’s
net positive adjustment and disconformity amount.
There were no adjustments to P’s basis in the share
and so the share’s net positive adjustment is $0.
Thus, although the share’s disconformity amount is
$40 (the excess of P’s basis in the share ($100) over
the share’s allocable portion of S’s net inside attribute amount ($60)), no basis reduction is required
under this paragraph (c).
(iv) Application of paragraph (d) of this section.
After the application of this paragraph (c), P’s sale
of the S share is still a transfer of a loss share, and,
accordingly, subject to paragraph (d) of this section.
No adjustment is required under paragraph (d) of this

2007–8 I.R.B.

section because there is no aggregate inside loss. See
paragraph (d)(3)(iii) of this section.
Example 3. Items accruing after S becomes a
member. (i) Recognition of loss accruing after S becomes a member. (A) Facts. On January 1, year 1,
P purchases the sole outstanding share of S stock for
$100. At that time, S owns two assets, Asset 1, with
a basis of $0 and a value of $40, and Asset 2, with a
basis and value of $60. In year 1, S sells Asset 1 for
$40. Also in year 1, the value of Asset 2 declines and
S sells Asset 2 for $20. On December 31, year 1, P
sells its S share for $60. After applying and giving
effect to all generally applicable rules of law (other
than this section), P’s basis in the S share is $100 (P’s
original $100 basis, unadjusted under §1.1502–32 because the $40 gain recognized on the sale of Asset 1
offsets the $40 loss on the sale of Asset 2). P’s sale of
the S share is a transfer of a loss share and therefore
subject to the provisions of this section.
(B) Application of paragraph (b) of this section.
No adjustment is required under paragraph (b) of
this section, either because redetermination would
change no member’s basis in a share (members hold
only one share of S stock) or because P transfers the
group’s entire interest in S to a nonmember in a fully
taxable transaction. See, respectively, paragraphs
(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After
the application of paragraph (b) of this section, P’s
sale of the S share is still a transfer of a loss share
and therefore subject to this paragraph (c).
(C) Basis reduction under this paragraph (c). Under this paragraph (c), P’s basis in the S share ($100)
is reduced immediately before the sale, but not below
value ($60), by the lesser of the share’s net positive
adjustment and disconformity amount. The share’s
net positive adjustment is $0. Thus, although the
share has a disconformity amount of $40 (the excess of P’s basis in the share ($100) over the share’s
allocable portion of S’s net inside attribute amount
($60)), no basis reduction is required under this paragraph (c).
(D) Application of paragraph (d) of this section.
After the application of this paragraph (c), P’s sale
of the S share is still a transfer of a loss share, and,
accordingly, subject to paragraph (d) of this section.
No adjustment is required under paragraph (d) of this
section because there is no aggregate inside loss. See
paragraph (d)(3)(iii) of this section.
(ii) Recognition of gain accruing after S becomes
a member. (A) Facts. The facts are the same as in
paragraph (i)(A) of this Example 3, except that neither P nor S sells anything in year 1. In addition, in
year 2, the value of Asset 1 declines to $0, the value
of Asset 2 returns to $60, and S creates Asset 3 (with a
basis of $0). In year 3, S sells Asset 3 for $40. On December 31, year 3, P sells its S share for $100. After
applying and giving effect to all generally applicable
rules of law (other than this section), P’s basis in the
S share is $140 (P’s original $100 basis increased under §1.1502–32 to reflect the $40 gain recognized on
the sale of Asset 3 in year 3).
(B) Application of paragraph (b) of this section.
No adjustment is required under paragraph (b) of
this section, either because redetermination would
change no member’s basis in a share (members hold
only one share of S stock) or because P transfers the
group’s entire interest in S to a nonmember in a fully
taxable transaction. See, respectively, paragraphs
(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After

2007–8 I.R.B.

the application of paragraph (b) of this section, P’s
sale of the S share is still a transfer of a loss share
and therefore subject to this paragraph (c).
(C) Basis reduction under this paragraph (c). Under this paragraph (c), P’s basis in the S share ($140)
is reduced immediately before the sale, but not below
value ($100), by the lesser of the share’s net positive
adjustment and disconformity amount. The share’s
net positive adjustment is $40 (the year 3 investment
adjustment). The share’s disconformity amount is the
excess of its basis ($140) over its allocable portion
of S’s net inside attribute amount. S’s net inside attribute amount is $100, the sum of S’s money ($40
from the sale of Asset 3) and its basis in its assets
($60 (the sum of Asset 1’s basis of $0 and Asset 2’s
basis of $60)). S’s $100 net inside attribute amount
is allocable entirely to the sole outstanding S share.
Thus, the share’s disconformity amount is the excess
of $140 over $100, or $40. The lesser of the share’s
net positive adjustment ($40) and its disconformity
amount ($40) is $40. Accordingly, the basis in the
share is reduced by $40, from $140 to $100, immediately before the sale.
(D) Application of paragraph (d) of this section.
Because P’s sale of the S share is no longer a transfer
of a loss share after the application of this paragraph
(c), paragraph (d) of this section does not apply.
(iii) Recognition of income earned after S becomes a member. The facts are the same as in
paragraph (ii)(A) of this Example 3, except that instead of creating Asset 3, S earns $40 of income from
services provided in year 3. Because the net positive
adjustment includes items of income as well as items
of gain, the results are the same as those described in
paragraph (ii) of this Example 3.
Example 4.
Computing the disconformity
amount. (i) Unrecognized loss reflected in stock
basis. (A) Facts. P owns the sole outstanding share
of S stock with a basis of $100. S owns two assets,
Asset 1 with a basis of $20 and a value of $60, and
Asset 2 with a basis of $60 and a value of $40. In
year 1, S sells Asset 1 for $60. On December 31,
year 1, P sells the S share for $100. After applying
and giving effect to all generally applicable rules of
law (other than this section), P’s basis in the S share
is $140 (P’s original $100 basis increased under
§1.1502–32 to reflect the $40 gain recognized on the
sale of Asset 1). P’s sale of the S share is a transfer
of a loss share and therefore subject to the provisions
of this section.
(B) Application of paragraph (b) of this section.
No adjustment is required under paragraph (b) of
this section, either because redetermination would
change no member’s basis in a share (members hold
only one share of S stock) or because P transfers the
group’s entire interest in S to a nonmember in a fully
taxable transaction. See, respectively, paragraphs
(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After
the application of paragraph (b) of this section, P’s
sale of the S share is still a transfer of a loss share
and therefore subject to this paragraph (c).
(C) Basis reduction under this paragraph (c). Under this paragraph (c), P’s basis in the S share ($140)
is reduced immediately before the sale, but not below
value ($100), by the lesser of the share’s net positive
adjustment and disconformity amount. The share’s
net positive adjustment is $40 (the year 1 investment
adjustment). The share’s disconformity amount is the
excess of its basis ($140) over its allocable portion

579

of S’s net inside attribute amount. S’s net inside attribute amount is the sum of S’s money ($60 from
the sale of Asset 1) and S’s basis in Asset 2 ($60),
or $120. S’s net inside attribute amount is allocable
entirely to the sole outstanding S share. Thus, the
share’s disconformity amount is the excess of $140
over $120, or $20. The lesser of the share’s net positive adjustment ($40) and its disconformity amount
($20) is $20. Accordingly, the basis in the share is
reduced by $20, from $140 to $120, immediately before the sale.
(D) Application of paragraph (d) of this section.
After the application of this paragraph (c), P’s sale
of the S share is still a transfer of a loss share, and,
accordingly, subject to paragraph (d) of this section.
Paragraph (d) of this section reduces the basis of Asset 2 by $20 because the loss is duplicated.
(ii) Loss carryover. The facts are the same as in
paragraph (i)(A) of this Example 4, except that Asset
2 has a basis of $0 (rather than $60) and S has a $60
loss carryover (as defined in paragraph (f)(6) of this
section). The analysis of the application of this paragraph (c) is the same here as in paragraph (i)(C) of this
Example 4. Furthermore, the analysis of the application of this paragraph (c) would also be the same if the
$60 loss carryover were subject to a section 382 limitation from a prior ownership change, or if, instead,
it were subject to the limitation in §1.1502–21(c) on
losses carried from separate return limitation years.
However, under each alternative fact pattern, paragraph (d) of this section reduces the loss carryover by
$20 because the loss is duplicated.
(iii) Liabilities. The facts are the same as in paragraph (i)(A) of this Example 4, except that S borrows
$100 before P sells the S share. S’s net inside attribute
amount remains $120, computed as the sum of S’s
money ($160 ($60 from the sale of Asset 1 plus the
$100 borrowed cash)) plus S’s basis in Asset 2 ($60),
minus its liabilities ($100). Thus, the S share’s disconformity amount remains the excess of $140 over
$120, or $20. The results are the same as in paragraph
(i) of this Example 4.
Example 5. Computing the allocable portion of
the net inside attribute amount. (i) Facts. On January 1, year 1, P owns all five outstanding shares of
S stock with a basis of $20 per share. S owns Asset
with a basis of $0. In year 1, S sells Asset for $100.
On December 31, year 1, P sells one of its S shares,
Share 1, for $20. After applying and giving effect to
all generally applicable rules of law (other than this
section), P’s basis in Share 1 is $40 (P’s original $20
basis increased by $20 under §1.1502–32 to reflect
the share’s allocable portion of the $100 gain recognized on the sale of Asset). P’s sale of Share 1 is a
transfer of a loss share and therefore subject to the
provisions of this section.
(ii) Application of paragraph (b) of this section.
No adjustment is required under paragraph (b) of
this section because redetermination would change
no member’s basis in a share (S has only one class
of stock outstanding and there is no disparity in the
basis of the shares). See paragraph (b)(1)(ii)(A) of
this section. After the application of paragraph (b) of
this section, P’s sale of Share 1 is still a transfer of a
loss share and therefore subject to this paragraph (c).
(iii) Basis reduction under this paragraph (c).
Under this paragraph (c), P’s basis in Share 1 ($40) is
reduced immediately before the sale, but not below
value ($20), by the lesser of the share’s net positive

February 20, 2007

adjustment and disconformity amount. Share 1’s net
positive adjustment is $20 (the year 1 investment
adjustment). Share 1’s disconformity amount is the
excess of its basis ($40) over its allocable portion
of S’s net inside attribute amount. S’s net inside
attribute amount is the sum of S’s money ($100 from
the sale of Asset), and Share 1’s allocable portion of
S’s net inside attribute amount is $20 (1/5 x $100).
Thus, Share 1’s disconformity amount is the excess
of $40 over $20, or $20. The lesser of the share’s
net positive adjustment ($20) and its disconformity
amount ($20) is $20. Accordingly, the basis in the
share is reduced by $20, from $40 to $20, immediately before the sale.
(iv) Application of paragraph (d) of this section.
Because P’s sale of Share 1 is no longer a transfer of
a loss share after the application of this paragraph (c),
paragraph (d) of this section does not apply.
Example 6. Liabilities. (i) In general. (A) Facts.
On January 1, year 1, P purchases the sole outstanding
share of S stock for $100. At that time, S owns Asset,
with a basis of $0 and value of $100, and $100 cash.
S also has a $100 liability. In year 1, S distributes $60
to P and earns $20. The value of Asset declines to $60
and, on December 31, year 1, P sells the S share for
$20. After applying and giving effect to all generally
applicable rules of law (other than this section), P’s
basis in the S share is $60 (P’s original $100 basis
decreased under §1.1502–32 by $40 (the net of the
$60 distribution and the $20 income earned)). P’s
sale of the S share is a transfer of a loss share and
therefore subject to the provisions of this section.
(B) Application of paragraph (b) of this section.
No adjustment is required under paragraph (b) of
this section, either because redetermination would
change no member’s basis in a share (members hold
only one share of S stock) or because P transfers the
group’s entire interest in S to a nonmember in a fully
taxable transaction. See, respectively, paragraphs
(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After
the application of paragraph (b) of this section, P’s
sale of the S share is still a transfer of a loss share
and therefore subject to this paragraph (c).
(C) Basis reduction under this paragraph (c). Under this paragraph (c), P’s basis in the S share ($60)
is reduced immediately before the sale, but not below
value ($20), by the lesser of the share’s net positive
adjustment and disconformity amount. The share’s
net positive adjustment is $20 (the year 1 investment
adjustment computed without taking the distribution
into account). The share’s disconformity amount is
the excess of its basis ($60) over its allocable portion of S’s net inside attribute amount. S’s net inside attribute amount is negative $40, computed as
the sum of S’s money ($60 ($100 minus the $60 distribution plus the $20 income earned)) plus S’s basis
in Asset ($0), minus S’s liability ($100). S’s net inside attribute amount is allocable entirely to the sole
outstanding S share. Thus, the share’s disconformity
amount is the excess of $60 over negative $40, or
$100. The lesser of the share’s net positive adjustment ($20) and its disconformity amount ($100) is
$20. Accordingly, the basis in the share is reduced by
$20, from $60 to $40, immediately before the sale.
(D) Application of paragraph (d) of this section.
After the application of this paragraph (c), the S share
is still a loss share and, accordingly, S’s attributes are
subject to reduction under paragraph (d) of this section. No adjustment is required under paragraph (d)

February 20, 2007

of this section, however, because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section.
(ii) Excluded cancellation of indebtedness income—insufficient attributes available for reduction
required by sections 108 and 1017, and §1.1502–28.
(A) Facts. The facts are the same as in paragraph
(i)(A) of this Example 6, except that P does not sell
the S share. Instead, in year 4, Asset is destroyed in
a fire and S spends its $60 on deductible expenses
that are not absorbed by the group. S’s loss becomes
part of the consolidated net operating loss (CNOL).
In year 5, S becomes insolvent and S’s debt is discharged. Because of S’s insolvency, S’s discharge of
indebtedness income is excluded under section 108
and, as a result, S’s attributes are subject to reduction
under sections 108 and 1017, and §1.1502–28. S’s
only attribute is the portion of the CNOL attributable
to S ($60) and it is reduced to $0. There are no
other consolidated attributes. In year 5, the S stock
becomes worthless under section 165(g), taking into
account the provisions of §1.1502–80(c). After applying and giving effect to all generally applicable
rules of law (other than this section), P’s basis in the
S share is $60 (P’s original $100 basis decreased under §1.1502–32 by the year 1 investment adjustment
of $40 (the net of the $60 distribution and the $20
income earned). The investment adjustment for year
5 is $0 ($60 tax exempt income from the excluded
COD applied to reduce attributes minus $60 noncapital, nondeductible expense from the reduction of S’s
portion of the CNOL). Under paragraph (f)(11)(i)(D)
of this section, a share is transferred on the last day of
the taxable year during which it becomes worthless
under section 165(g), taking into account the provisions of §1.1502–80(c). Accordingly, P transfers a
loss share of S stock on December 31, year 5, and
the transfer is therefore subject to the provisions of
this section.
(B) Application of paragraph (b) of this section. No adjustment is required under paragraph
(b) of this section because redetermination would
change no member’s basis in a share. See paragraph
(b)(1)(ii)(A) of this section. After the application of
paragraph (b) of this section, P’s transfer of the S
share is still a transfer of a loss share and therefore
subject to this paragraph (c).
(C) Basis reduction under this paragraph (c).
Under this paragraph (c), P’s basis in its S share
($60) is reduced immediately before the sale, but
not below value ($0), by the lesser of the share’s net
positive adjustment and disconformity amount. The
share’s net positive adjustment is $20 (the year 1
investment adjustment computed without taking the
distribution into account). The share’s disconformity
amount is the excess of its basis ($60) over its allocable portion of S’s net inside attribute amount. S’s
net inside attribute amount is $0 (S’s basis in Asset).
(The attribute reduction required under sections 108
and 1017 and §1.1502–28 is given effect before the
application of this section; therefore, S’s portion of
the CNOL was eliminated under section 108 and
§1.1502–28.) S’s net inside attribute amount is allocable entirely to the sole outstanding S share. Thus,
the share’s disconformity amount is the excess of $60
over $0, or $60. The lesser of the share’s net positive
adjustment ($20) and its disconformity amount ($60)
is $20. Accordingly, the basis in the share is reduced

580

by $20, from $60 to $40, immediately before the
transfer.
(D) Application of paragraph (d) of this section.
After the application of this paragraph (c), the S share
is still a loss share, and, accordingly, S’s attributes are
subject to reduction under paragraph (d) of this section. No adjustment is required under paragraph (d)
of this section, however, because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section.
(iii) Excluded cancellation of indebtedness income—full attribute reduction under sections 108
and 1017, and §1.1502–28 (using attributes attributable to another member). (A) Facts. The facts
are the same as in paragraph (ii)(A) of this Example
6 except that P loses the $60 distributed in year 1
and the loss is not absorbed by the group. Thus,
as of December 31, year 5, the CNOL is $120, attributable $60 to S and $60 to P. As a result, under
§1.1502–28(a)(4), after the portion of the CNOL
attributable to S is reduced to $0, the remaining $40
of excluded COD applies to the portion of the CNOL
attributable to P, reducing it from $60 to $20. After
applying and giving effect to all generally applicable
rules of law (other than this section), P’s basis in the
S share at the end of year 5 is $100 (P’s original $100
basis decreased under §1.1502–32 by $40 at the end
of year 1 and then increased under §1.1502–32 by
$40 at the end of year 5 ($100 tax exempt income
from the excluded COD applied to reduce attributes
minus $60 noncapital, nondeductible expense from
the reduction of S’s portion of the CNOL). Under
paragraph (f)(11)(i)(D) of this section, a share is
transferred on the last day of the taxable year during
which it becomes worthless under section 165(g),
taking into account the provisions of §1.1502–80(c).
Accordingly, P transfers a loss share of S stock on
December 31, year 5, and the transfer is therefore
subject to the provisions of this section.
(B) Application of paragraph (b) of this section. No adjustment is required under paragraph
(b) of this section because redetermination would
change no member’s basis in a share. See paragraph
(b)(1)(ii)(A) of this section. After the application of
paragraph (b) of this section, P’s transfer of the S
share is still a transfer of a loss share and therefore
subject to this paragraph (c).
(C) Basis reduction under this paragraph (c). Under this paragraph (c), P’s basis in the S share ($100)
is reduced immediately before the sale, but not below
value ($0), by the lesser of the share’s net positive
adjustment and disconformity amount. The share’s
net positive adjustment is $60 (the sum of the year 1
investment adjustment computed without taking the
distribution into account ($20) and the year 5 investment adjustment ($40)). The share’s disconformity
amount is the excess of its basis ($100) over its allocable portion of S’s net inside attribute amount. S’s
net inside attribute amount is $0 (S’s basis in Asset).
S’s net inside attribute amount is allocable entirely
to the sole outstanding S share. The share’s disconformity amount is therefore $100. The lesser of the
share’s net positive adjustment ($60) and its disconformity amount ($100) is $60. Accordingly, P’s basis
in the share is reduced by $60, from $100 to $40, immediately before the transfer.
(D) Application of paragraph (d) of this section.
After the application of this paragraph (c), the S share
is still a loss share, and, accordingly, S’s attributes are

2007–8 I.R.B.

subject to reduction under paragraph (d) of this section. No adjustment is required under paragraph (d)
of this section, however, because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section.
Example 7. Lower-tier subsidiary (no transfer of
lower-tier stock). (i) Facts. P owns the sole outstanding share of S stock with a basis of $160. S owns two
assets, Asset A with a basis and value of $100, and
the sole outstanding share of S1 stock with a basis of
$60. S1 owns one asset, Asset 1, with a basis of $20
and value of $60. In year 1, S1 sells Asset 1 to X for
$60, recognizing $40 of gain. On December 31, year
1, P sells its S share to Y, a member of another consolidated group, for $160. After applying and giving effect to all generally applicable rules of law (other than
this section), P’s basis in the S share is $200 (P’s original $160 basis increased under §1.1502–32 by $40
(to reflect the tiering up of the increase to S’s basis in
the S1 share under §1.1502–32 by $40 (to reflect the
gain recognized on S1’s sale of Asset 1)). P’s sale of
the S share is a transfer of a loss share and therefore
subject to the provisions of this section. (S does not
transfer the S1 share because S and S1 are members
of the same group following the transfer. See paragraph (f)(11) of this section.)
(ii) Application of paragraph (b) of this section.
No adjustment is required under paragraph (b) of
this section, either because redetermination would
change no member’s basis in a share (members hold
only one share of S stock) or because P transfers the
group’s entire interest in S to a nonmember in a fully
taxable transaction. See, respectively, paragraphs
(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After
the application of paragraph (b) of this section, P’s
sale of the S share is still a transfer of a loss share
and therefore subject to this paragraph (c).
(iii) Basis reduction under this paragraph (c). (A)
In general. Under this paragraph (c), P’s basis in
the S share ($200) is reduced immediately before the
sale, but not below value ($160), by the lesser of
the share’s net positive adjustment and disconformity
amount. The S share’s net positive adjustment is $40.
The share’s disconformity amount is the excess, if
any, of the basis of the share ($200) over the share’s
allocable portion of S’s net inside attribute amount.
S’s net inside attribute amount is the sum of S’s basis
in Asset A ($100) plus S’s basis in the S1 share.
(B) S’s basis in the S1 share. Although S’s actual
basis in the S1 share is $100 (S’s original $60 basis
increased by S1’s year 1 positive $40 investment adjustment), for purposes of computing the S share’s
disconformity amount, S’s basis in the S1 share is
tentatively reduced by the lesser of the S1 share’s
net positive adjustment and its disconformity amount.
The S1 share’s net positive adjustment is $40 (the
year 1 investment adjustment). The S1 share’s disconformity amount is the excess, if any, of its basis
($100) over its allocable portion of S1’s net inside attribute amount. S1’s net inside attribute amount is
$60 (its cash received on the sale of Asset 1) and it is
entirely attributable to S’s S1 share. The S1 share’s
disconformity amount is therefore the excess of $100
over $60, or $40. The lesser of the S1 share’s net positive adjustment ($40) and its disconformity amount
($40) is $40. Accordingly, for purposes of computing
the disconformity amount of the S share, S’s basis in
its S1 share is tentatively reduced by $40, from $100
to $60.

2007–8 I.R.B.

(C) The disconformity amount of P’s S share. S’s
net inside attribute amount is treated as the sum of its
basis in Asset A ($100) and its (tentatively reduced)
basis in its S1 share ($60), or $160. S’s net inside
attribute amount is allocable entirely to P’s S share.
Thus, the S share’s disconformity amount is the excess of $200 over $160, or $40.
(D) Amount of reduction. P’s basis in its S share
is reduced by the lesser of the S share’s net positive
adjustment ($40) and disconformity amount ($40), or
$40. Accordingly, P’s basis in the S share is reduced
by $40, from $200 to $160, immediately before the
sale.
(E) Effect on S’s basis in its S1 share. The transaction has no effect on S’s basis in the S1 share. Thus,
S owns the S1 share with a basis of $100, S’s original
$60 basis in the share plus the $40 adjustment for the
gain recognized on the sale of Asset 1 in year 1.
(iv) Application of paragraph (d) of this section.
Because P’s sale of the S share is no longer a transfer
of a loss share after the application of this paragraph
(c), paragraph (d) of this section does not apply.

(d) Attribute reduction to prevent duplication of loss—(1) In general. The rules
of this paragraph (d) reduce S’s attributes
to the extent they duplicate a net loss on
shares of S stock transferred by members
in a single transaction. This rule furthers
single entity principles by preventing S
from using deductions and losses to the
extent that the group or its members (including former members) have either used,
or preserved for later use, a corresponding
loss in S shares. This rule applies without
regard to whether S ceases to be a member
after the transfer of its shares.
(2) Attribute reduction rule—(i) General. If a transferred share is a loss share
after the application of paragraph (c) of
this section, S’s attributes are reduced by
S’s attribute reduction amount. S’s attribute reduction amount is determined under paragraph (d)(3) of this section and applied in accordance with the provisions of
paragraphs (d)(4), (d)(5), and (d)(6) of this
section.
(ii) Transfers of stock of subsidiaries
at multiple tiers. If stock of subsidiaries
at multiple tiers is transferred in a transaction, this paragraph (d) (other than
paragraph (d)(6) to the extent necessary to
make the election to reattribute attributes)
applies only after paragraphs (b) and (c)
of this section have applied with respect to
all transfers of loss shares. See paragraph
(a)(3)(ii) of this section regarding the order of application of this section.
(3) Attribute reduction amount—(i)
General. S’s attribute reduction amount
is the lesser of—

581

(A) The net stock loss (see paragraph
(d)(3)(ii) of this section); and
(B) S’s aggregate inside loss (see paragraph (d)(3)(iii) of this section).
(ii) Net stock loss. The net stock loss is
the excess, if any, of—
(A) The aggregate basis of all shares
of S stock transferred by members in the
transaction (taking into account any adjustments required under paragraphs (b)
and (c) of this section, any gain or loss recognized at lower tiers, and any other related or resulting adjustments); over
(B) The aggregate value of those shares.
(iii) Aggregate inside loss—(A) General. S’s aggregate inside loss is the excess, if any, of—
(1) S’s net inside attribute amount; over
(2) The value of all outstanding shares
of S stock.
(B) Net inside attribute amount. S’s
net inside attribute amount generally has
the same meaning as in paragraph (c)(5)
of this section. However, if S holds stock
of a lower-tier subsidiary, the provisions
of paragraph (d)(5) of this section (and not
the provisions of paragraph (c)(6) of this
section) modify the computation of S’s net
inside attribute amount for purposes of this
paragraph (d).
(iv) Transactions that adjusted stock or
asset basis. See paragraph (e)(2) of this
section for special rules that may apply if a
prior transaction, such as an exchange subject to section 362(e)(2), adjusted the basis
in any share of S stock or S’s attributes in
a manner that altered the potential for loss
duplication.
(v) Lower-tier subsidiaries. See paragraph (d)(5) of this section for special rules
relating to the application of this paragraph
(d) if S owns shares of stock of a subsidiary.
(4) Application of attribute reduction—(i) Attributes available for reduction. S’s attributes available for reduction
under this paragraph (d) are—
(A) Category A. Net operating loss carryovers;
(B) Category B. Capital loss carryovers;
(C) Category C. Deferred deductions;
(D) Category D. Basis in publicly
traded property (other than stock of a
subsidiary), but only to the extent of the
amount, if any, that each such property’s
basis exceeds its value; and
(E) Category E. Basis of assets excluding—

February 20, 2007

(1) Money and cash equivalents, and
(2) The basis of publicly traded property (other than stock of a subsidiary).
(ii) Rules of application—(A) In general. S’s attribute reduction amount is allocated and applied to reduce the attributes
in each category in the order that the categories are set forth in paragraph (d)(4)(i)
of this section. If the amount to be allocated and applied to any category equals
or exceeds the amount of attributes in the
category, the attributes in that category are
reduced to zero and any excess is then allocated and applied to the attributes in the
next category. If the amount to be allocated and applied is less than the amount of
attributes in any category other than Category A or Category B, it is allocated and
applied proportionately to all attributes in
the category based on the amount of each
attribute. If the amount to be allocated and
applied to attributes in Category E exceeds
the amount of attributes in that category,
then—
(1) To the extent of any liabilities of
S (or a lower-tier subsidiary) that are not
taken into account for tax purposes before the transfer, such excess is suspended
and allocated and applied proportionately
to reduce any amounts that would be deductible or capitalizable as a result of such
liabilities later being taken into account
by S or another person; solely for purposes of this paragraph (d)(4)(ii)(A)(1), liability means any liability or obligation
that would be required to be capitalized as
an assumed liability by a person that purchased all of S’s assets and assumed all of
S’s liabilities in a single transaction; and
(2) To the extent such excess is greater
than any amount suspended by paragraph
(d)(4)(ii)(A)(1) of this section, it is disregarded and has no further effect.
(B) Order of reduction of loss carryovers. With respect to attributes in Category A and Category B, the attribute reduction amount is applied first to reduce losses
carried from the first taxable year in which
a loss carryover arose, and then to reduce
loss carryovers that arose in each next successive year.
(C) Time and effect of attribute reduction. In general, the reduction of attributes
is effective immediately before the transaction in which there is a transfer of a
loss share of S stock. If the reduction to
a member’s basis in a share of S stock
exceeds the basis of that share, the ex-

February 20, 2007

cess is an excess loss account to which
the member owning the share succeeds
(and such excess loss account is not taken
into account under §1.1502–19 or otherwise as a result of the transaction). The
reductions to attributes required under this
paragraph (d)(4), including by reason of
paragraph (d)(5)(ii)(D) of this section (tier
down of attribute reduction amounts to
lower-tier subsidiaries), are not noncapital, nondeductible expenses described in
§1.1502–32(b)(2)(iii). Accordingly, such
reductions have no effect on the basis of
stock of upper-tier subsidiaries.
(5) Special rules applicable if S holds
stock of a lower-tier subsidiary (S1) immediately before a transfer of loss shares of
S stock—(i) Computation of S’s attribute
reduction amount. For purposes of determining S’s attribute reduction amount under paragraph (d)(3) of this section—
(A) Single share. All of S’s shares of S1
stock held immediately before the transaction (whether or not transferred in, or held
by S immediately after, the transaction) are
treated as a single share (generally referred
to as the S1 stock); and
(B) Deemed basis. S’s basis in its S1
stock is treated as its deemed basis in the
stock, which is equal to the greater of—
(1) The sum of S’s basis in each share
of S1 stock (adjusted to reflect any gain or
loss recognized on the transfer of any S1
shares in the transaction, whether allowed
or disallowed); and
(2) The portion of S1’s net inside attribute amount allocable to S’s shares of S1
stock.
(C) Multiple tiers. If S owns (directly
or indirectly) stock of subsidiaries in multiple tiers (whether or not transferred in,
or held by S, directly or indirectly, immediately after, the transaction), S’s deemed
basis in such stock is determined first with
respect to shares of stock of the lowest-tier
subsidiary or subsidiaries. Deemed basis
is then determined with respect to the basis
of stock of subsidiaries in each next higher
tier.
(ii) Allocation and application of S’s attribute reduction amount—(A) Allocation
of attribute reduction amount between S1
stock and other assets. For purposes of
allocating S’s attribute reduction amount,
S’s basis in S1 stock is treated as equal
to its deemed basis in the S1 stock (determined under paragraph (d)(5)(i)(B) of this
section), reduced by—

582

(1) The value of S’s transferred shares
of S1 stock,
(2) The excess of the sum of S1’s
money, S1’s cash equivalents, the value of
S1’s publicly traded property (other than
stock of a subsidiary) and S1’s transferred
shares of lower-tier subsidiary (S2) stock,
and all corresponding S2 amounts (net of
S2’s liabilities) that are allocable to S1’s
nontransferred shares of S2 stock, over
the total amount of S1’s liabilities, to the
extent that such excess is allocable to S’s
nontransferred shares of S1 stock, and
(3) The corresponding amounts with respect to shares of stock of all lower tier
subsidiaries.
(B) Application of attribute reduction
amount to S’s S1 stock. The attribute reduction amount allocated to S’s S1 stock
(the allocated amount) is apportioned
among, and applied to reduce S’s bases
in, S’s individual S1 shares in accordance
with the following—
(1) No allocated amount is apportioned
to a share of transferred S1 stock if gain or
loss is recognized on its transfer;
(2) The allocated amount is apportioned
among all of S’s other shares of S1 stock
in a manner that, when applied to those
shares, reduces the disparity in S’s bases
in the S1 shares to the greatest extent possible;
(3) The allocated amount that is apportioned to any S1 share transferred in a
transfer in which no gain or loss was recognized is applied only to the extent necessary to reduce the basis of that share to,
but not below, the value of the share; and
(4) The allocated amount that is apportioned to S1 shares not transferred in the
transaction is applied to reduce the bases
of such shares without limitation.
(C) Further effects of allocated amount.
Any portion of the allocated amount that
is not applied to reduce S’s basis in a
share of S1 stock has no effect on any
other attributes of S, it is not a noncapital, nondeductible expense of S, and it
does not cause S to recognize income or
gain. However, as provided in paragraph
(d)(5)(ii)(D) of this section, such amounts
continue to be part of the allocated amount
for purposes of the tier down rule in paragraph (d)(5)(ii)(D) of this section.
(D) Tier down of attribute reduction
amount—(1) General rule. The portion of
S’s attribute reduction amount that is allocated to S1 stock (the allocated amount)

2007–8 I.R.B.

is an attribute reduction amount of S1.
Thus, subject to the basis conforming
limitation in paragraph (d)(5)(ii)(D)(2) of
this section, the allocated amount applies
to reduce S1’s attributes under the provisions of this paragraph (d). The allocated
amount is an attribute reduction amount
of S1 that must be allocated to S1’s assets even if its application to S’s basis
in S1 stock is limited under paragraph
(d)(5)(ii)(B) of this section and even if
its application to S1’s attributes is limited
under paragraph (d)(5)(ii)(D)(2) of this
section.
(2) Conforming limitation on reduction of lower-tier subsidiary’s attributes.
Notwithstanding the general rule in paragraph (d)(5)(ii)(D)(1) of this section, and
subject to any modification in paragraph
(e)(2) of this section, the application of
S’s attribute reduction amount to S1’s
attributes (the tier down amount) is limited such that, when combined with any
attribute reduction amount computed with
respect to a transfer of S1 stock, the total
amount of reduction to S1’s attributes does
not exceed the excess of—
(i) The portion of S1’s net inside attributes that is allocable to all S1 shares
held by members immediately before the
transaction; over
(ii) The sum of the value of all S1 shares
transferred by members in the transaction
and the sum of all members’ bases in any
other shares of S1 stock held immediately
before the transaction (after any reduction
under this section, including this paragraph
(d)).
(iii) Stock basis restoration. After this
paragraph (d) has applied with respect to
all shares of subsidiary stock transferred
in the transaction, basis is restored under this paragraph (d)(5)(iii). In general,
under this paragraph (d)(5)(iii), reductions otherwise required under paragraph
(d)(5)(ii)(B) of this section are reversed to
the extent necessary to restore members’
bases in subsidiary stock to conform the
basis of each member’s share of subsidiary
stock to the share’s allocable portion of the
subsidiary’s net inside attribute amount as
defined in paragraph (c)(5) of this section, without regard to paragraph (c)(6)
of this section. The restoration adjustments are first made at the lowest tier and
then at each next higher tier successively.
Restoration adjustments do not tier up
to affect the bases of higher-tier shares.

2007–8 I.R.B.

Rather, restoration is computed and applied separately at each tier. For purposes
of this rule–
(A) A subsidiary’s net inside attribute
amount is determined by treating the basis
in stock of a lower-tier subsidiary as the
actual basis of the stock, as adjusted under
this section;
(B) The net inside attribute amount is
treated as decreased by any attribute reduction amount suspended under paragraph
(d)(4)(ii)(A)(1) of this section (liabilities
not taken into account); and
(C) If a subsidiary received property
in a prior intercompany section 362(e)(2)
transaction and the stock of such subsidiary was reduced as the result of
an election under section 362(e)(2)(C)
(taking into account the provisions of
§1.1502–13(e)(4)), the net inside attribute
amount must be reduced as provided in
paragraph (e)(2) of this section.
(6) Elections to reduce the potential for
loss duplication—(i) In general. Notwithstanding the general operation of this
paragraph (d), the common parent of the
group of which S is a member immediately before the transaction (P) may make
an irrevocable election to reduce the potential for loss duplication, and thereby
avoid or reduce attribute reduction. Under this paragraph (d)(6), P may elect to
reduce members’ bases in transferred loss
shares of S stock, or reattribute S’s attributes (including attributes of lower-tier
subsidiaries) to the extent such attributes
would otherwise be subject to reduction
under this paragraph (d), or both. The
combined amount of stock basis reduction and reattribution of attributes may
not exceed S’s attribute reduction amount,
tentatively computed without regard to
any election under this paragraph (d)(6).
(ii) Order of application—(A) Stock of
one subsidiary transferred in the transaction. If shares of stock of only one
subsidiary are transferred in the transaction, any stock basis reduction and
reattribution of attributes (including from
lower-tier subsidiaries) is deemed to occur
immediately before the application of this
paragraph (d), based on the tentatively
computed attribute reduction amount. If a
transferred share is still a loss share after
giving effect to this election, the provisions of this paragraph (d) then apply with
respect to that share.

583

(B) Stock of multiple subsidiaries transferred in the transaction. If shares of stock
of more than one subsidiary are transferred
in the transaction and elections under this
paragraph (d)(6) are made with respect to
transfers of stock of subsidiaries in multiple tiers, effect is given to the elections
from the lowest tier to the highest tier
in the manner provided in this paragraph
(d)(6)(ii)(B). The scope of the election for
the transfer at the lowest tier is determined
by tentatively applying paragraph (d) with
respect to the transferred loss shares of
this lowest-tier subsidiary immediately after applying paragraphs (b) and (c) of this
section to the stock of such subsidiary.
The effect of any stock basis reduction
or reattribution of losses immediately tiers
up (under the principles of §1.1502–32)
to adjust members’ bases in all higher-tier
shares. The process is repeated for elections for each next higher-tier transfer.
(iii) Special rules for reattribution
elections—(A) In general. Because the
reattribution election is intended to provide the group a means to retain certain
S attributes, and not to change the location of attributes where S continues to
be a member, the election to reattribute
attributes may only be made if S becomes
a nonmember (within the meaning of
§1.1502–19(c)(2)) as a result of the transaction. The election to reattribute S’s
attributes can only be made for attributes
in Category A, Category B, and Category
C. Attributes subject to the election will be
reattributed to P in the same order, manner,
and amount that they would otherwise be
reduced under paragraph (d)(4) of this section. P succeeds to reattributed attributes
as if such attributes were succeeded to in
a transaction described in section 381(a).
Any owner shift of the subsidiary (including any deemed owner shift resulting from
section 382(g)(4)(D) or section 382(l)(3))
in connection with the transaction is not
taken into account under section 382
with respect to the reattributed attributes.
The reattribution of S’s attributes is a
noncapital, nondeductible expense described in §1.1502–32(b)(2)(iii).
See
§1.1502–32(c)(1)(ii)(B) regarding special
allocations applicable to such noncapital,
nondeductible expense. If P elects to reattribute S attributes (including attributes
of a lower-tier subsidiary) and reduce S
stock basis, the reattribution is given effect
before the stock basis reduction.

February 20, 2007

(B) Insolvency limitation. If S, or any
higher-tier subsidiary, is insolvent within
the meaning of section 108(d)(3) at the
time of the transfer, S’s losses may be
reattributed only to the extent they exceed
the sum of the separate insolvencies of
any subsidiaries (taking into account only
S and its higher-tier subsidiaries) that are
insolvent. For purposes of determining
insolvency, liabilities owed to higher-tier
members are not taken into account, and
stock of a subsidiary that is limited and
preferred as to dividends and that is not
owned by higher-tier members is treated
as a liability to the extent of the amount of
preferred distributions to which the stock
would be entitled if the subsidiary were
liquidated on the date of the disposition.
(C) Limitation on reattribution from
lower-tier subsidiaries. P’s ability to
reattribute attributes of lower-tier subsidiaries is limited under this paragraph
(d)(6)(iii)(C) in order to prevent circular computations of the attribute reduction amount. Accordingly, attributes that
would otherwise be reduced as a result of
tier down attribute reduction under paragraph (d)(5)(ii)(D) of this section may
only be reattributed to the extent that the
reduction in the basis of any lower-tier
subsidiary stock resulting from the noncapital, nondeductible expense (as allocated under §1.1502–32(c)(1)(ii)(B)) will
not create an excess loss account in any
such stock.
(iv) Special rules for stock basis reduction elections. An election to reduce basis in S stock is effective for all members’
bases in loss shares of S stock that are
transferred in the transaction. The reduction is allocated among all such shares in
proportion to the amount of loss on each
share. This reduction in S stock basis is
a noncapital, nondeductible expense of the
transferring member. The attribute reduction amount (determined under paragraph
(d)(3)(i) of this section) is treated as reduced by the amount of any reduction in
the basis of the S stock under this paragraph (d)(6). Accordingly, the election
to reduce stock basis under this paragraph
(d)(6) is treated as reducing or eliminating the duplication even if the shares of S
stock are loss shares after giving effect to
the election.
(v) Form and manner of election. An
election under this paragraph (d)(6) is
made in the form of a statement titled

February 20, 2007

“Section 1.1502–36 Election to Reattribute Attributes,” “Section 1.1502–36
Election to Reduce Stock Basis,” or “Section 1.1502–36 Election to Reattribute
Attributes and Reduce Stock Basis,” as applicable. The statement must include the
name and employer identification number
of the subsidiary the stock of which is
transferred, the name and employer identification number of any lower-tier subsidiary whose attributes are reattributed,
and the amount by which the group is
electing to reattribute attributes and/or
reduce stock basis. The statement must
be included on or with the group’s timely
filed original return for the taxable year
of the transfer of the subsidiary stock to
which the election relates.
(7) Examples. The application of this
paragraph (d) is illustrated by the following examples:
Example 1. Computation of attribute reduction
amount. (i) Transfer of all S shares. (A) Facts. P
owns all 100 of the outstanding shares of S stock with
a basis of $2 per share. S owns land with a basis of
$100, has a $120 loss carryover, and has no liabilities.
Each share has a value of $1. P sells 30 of the S shares
to X for $30. As a result of the sale, P and S cease to
be members of the same group. Accordingly, P transfers all 100 S shares. See paragraphs (f)(11)(i)(A)
and (f)(11)(i)(B) of this section. P’s transfer of the
S shares is a transfer of loss shares and therefore subject to the provisions of this section.
(B) Application of paragraphs (b) and (c) of this
section. No adjustment is required under paragraph
(b) of this section because redetermination would not
change any member’s basis in an S share (there is
only one class of stock outstanding and there is no
disparity in the bases of the shares). See paragraph
(b)(1)(ii)(A) of this section. No adjustment is required under paragraph (c) of this section because the
net positive adjustment is $0. See paragraph (c)(3) of
this section. Thus, after the application of paragraph
(c) of this section, P’s transfer of the S shares is still
a transfer of loss shares and, accordingly, subject to
this paragraph (d).
(C) Attribute reduction under this paragraph (d).
Under this paragraph (d), S’s attributes are reduced
by S’s attribute reduction amount. Paragraph (d)(3)
of this section provides that S’s attribute reduction
amount is the lesser of the net stock loss and S’s
aggregate inside loss. The net stock loss is the excess of the aggregate bases of the transferred shares
($200) over the aggregate value of the transferred
shares ($100), or $100. S’s aggregate inside loss is
the excess of its net inside attribute amount ($220, the
sum of the $100 basis of the land and the $120 loss
carryover) over the value of all outstanding S shares
($100), or $120. The attribute reduction amount is
therefore the lesser of the net stock loss ($100) and
the aggregate inside loss ($120), or $100. Under
paragraph (d)(4) of this section, S’s $100 attribute
reduction amount is allocated and applied to reduce
S’s $120 loss carryover to $20. Under paragraph
(d)(4)(ii)(C) of this section, the reduction of the loss

584

carryover is not a noncapital, nondeductible expense
and has no effect on P’s basis in the S stock.
(ii) Transfer of less than all S shares. (A) Facts.
The facts are the same as in paragraph (i)(A) of this
Example 1, except that P only sells 20 S shares to X.
P’s sale of the 20 S shares is a transfer of loss shares
and therefore subject to the provisions of this section.
(B) Application of paragraphs (b) and (c) of this
section. No adjustment is required under paragraph
(b) or paragraph (c) of this section for the reasons set
forth in paragraph (i)(B) of this Example 1. Thus,
after the application of paragraph (c) of this section,
P’s transfer of the S shares is still a transfer of loss
shares and, accordingly, subject to this paragraph (d).
(C) Attribute reduction under this paragraph (d).
Under this paragraph (d), S’s attributes are reduced
by S’s attribute reduction amount. Paragraph (d)(3)
of this section provides that S’s attribute reduction
amount is the lesser of the net stock loss and S’s
aggregate inside loss. The net stock loss is the excess of the aggregate bases of the transferred shares
($40) over the aggregate value of the transferred
shares ($20), or $20. S’s aggregate inside loss is
the excess of its net inside attribute amount ($220)
over the value of all outstanding S shares ($100), or
$120. The attribute reduction amount is therefore the
lesser of the net stock loss ($20) and the aggregate
inside loss ($120), or $20. Under paragraph (d)(4)
of this section, S’s $20 attribute reduction amount is
allocated and applied to reduce S’s $120 loss carryover to $100. Under paragraph (d)(4)(ii)(C) of this
section, the reduction of the loss carryover is not a
noncapital, nondeductible expense and has no effect
on P’s basis in the S stock.
Example 2. Proportionate allocation of attribute
reduction amount. (i) Facts. P owns the sole outstanding share of S stock with a basis of $150. S owns
land with a basis of $100, a factory with a basis of
$20, and rental property with a basis of $30. P sells
its S share for $90. P’s sale of the S share is a transfer
of a loss share and therefore subject to the provisions
of this section.
(ii) Application of paragraphs (b) and (c) of this
section. No adjustment is required under paragraph
(b) of this section, either because redetermination
would not change any member’s basis in a share
(members hold only one share of S stock) or because P transfers the group’s entire interest in S to a
nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B)
of this section. No adjustment is required under
paragraph (c) of this section because the net positive
adjustment is $0. See paragraph (c)(3) of this section.
Thus, after the application of paragraph (c) of this
section, P’s sale of the S share is still a transfer of a
loss share and, accordingly, subject to this paragraph
(d).
(iii) Attribute reduction under this paragraph (d).
Under paragraph (d)(3) of this section, S’s attribute
reduction amount is determined to be $60, the lesser
of the net stock loss ($60) and S’s aggregate inside
loss ($60, the excess of S’s $150 net inside attribute
amount (the $100 basis of the land plus the $20 basis
of the factory plus the $30 basis of the rental property) over the $90 value of the S share). Under paragraph (d)(4) of this section, the $60 attribute reduction amount is allocated and applied proportionately
to reduce S’s attributes as follows:

2007–8 I.R.B.

Available attributes

Attribute amount

Allocable portion of attribute
reduction amount

Adjusted attribute amount

$100

(100/150 x $60) $40

$60

Category E
Basis of land
Basis of factory

$20

(20/150 x $60) $8

$12

Basis of rental property

$30

(30/150 x $60) $12

$18

$150

$60

$90

Total attributes
Example 3. Publicly traded property. (i) Facts.
The facts are the same as in paragraph (i) of Example 2, except that, instead of the factory and rental
property, S holds two shares of publicly traded stock,
Share X (basis and value of $20) and Share Y (basis
of $30 and value of $5). P’s sale of the S share is
a transfer of a loss share and therefore subject to the
provisions of this section.
(ii) Application of paragraphs (b) and (c) of this
section. No adjustment is made under paragraph (b)

Available attributes

or paragraph (c) of this section for the reasons set
forth in paragraph (ii) of Example 2. Thus, after the
application of paragraph (c) of this section, P’s sale
of the S share is still a transfer of a loss share and,
accordingly, subject to this paragraph (d).
(iii) Attribute reduction under this paragraph (d).
Under paragraph (d)(3) of this section, S’s attribute
reduction amount is determined to be $60, the lesser
of the net stock loss ($60) and S’s aggregate inside
loss ($60, the excess of S’s $150 net inside attribute

Attribute amount

amount (the $20 basis of Share X plus the $30 basis
of Share Y plus the $100 basis of the land) over the
$90 value of the S share). Although S has $150 of attributes, S’s attributes available for reduction include
the basis of publicly traded property only to the extent it exceeds the value of the property. That loss on
publicly traded property is a Category D attribute. S’s
attribute reduction amount is allocated and applied to
reduce S’s attributes as follows:

Application of attribute reduction amount

Adjusted attribute amount

Category D
Loss in Share Y

$25

$25

$0

$100

$35

$65

$125

$60

$65

Category E
Basis of land

Total attributes

Attributes after application of paragraph (d)
Attribute

Amount

Basis of Share X

$20

Basis of Share Y

$5

Basis of land
Example 4. Attributes attributable to liability not
taken into account. (i) S operates one business. (A)
Facts. On January 1, year 1, P forms S by exchanging $100 and land with a basis of $50 for the sole
outstanding share of S stock. In year 1, S earns $500,
spends $100 to build a factory on its land, and purchases $450 of publicly traded property. S also earns
a section 38 general business credit of $50. However, pollution generated by S’s business gives rise to
a substantial environmental remediation liability under Federal law. Before any amounts have been taken
into account with respect to the environmental remediation liability, P sells its S share to X for $150. At
the time of the sale, the value of the publicly traded
property was $450. If X had purchased S’s assets and
assumed S’s liabilities directly, X would have been
required to capitalize any expenses related to environmental remediation. After giving effect to all other

2007–8 I.R.B.

$65
provisions of law, P’s basis in the S share is $650 (the
original basis of $150 increased by the $500 of income earned). The sale is therefore a transfer of a
loss share of subsidiary stock and subject to this section.
(B) Application of paragraphs (b) and (c) of this
section. No adjustment is required under paragraph
(b) of this section, either because redetermination
would not change any member’s basis in a share (P
holds only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember
in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section.
No adjustment to basis is made under paragraph (c)
of this section because, although the net positive
adjustment is $500, the disconformity amount is $0.
See paragraph (c)(3) of this section. Thus, after the
application of paragraph (c) of this section, P’s sale

585

of the S share is still a transfer of a loss share and,
accordingly, subject to this paragraph (d).
(C) Attribute reduction under this paragraph (d).
Under paragraph (d)(3) of this section, S’s attribute
reduction amount is the lesser of the net stock loss
($500) and the aggregate inside loss. The aggregate
inside loss is $500, computed as the excess of S’s net
inside attribute amount ($650, the sum of $100 (basis
in factory), $50 (basis in land), $450 (basis in publicly
traded property), and $50 (cash remaining after purchases)) over the value of the S share ($150). Thus,
S’s attribute reduction amount is $500, the lesser of
the net stock loss ($500) and the aggregate inside loss
($500). Under paragraph (d)(4) of this section, S’s
$500 attribute reduction amount is allocated and applied to reduce S’s attributes as follows:

February 20, 2007

Available attributes

Attribute amount

Allocable portion of attribute
reduction amount

Adjusted attribute amount

Category D
Loss on publicly traded property

$0

$0

$0

$100

$100

$0

$50

$50

$0

Category E
Basis of factory
Basis of land
Under the general rule of this paragraph (d), the remaining $350 attribute reduction amount would have
no further effect (and would not be applied to reduce S’s general business tax credit). However, S
has a liability that has not been taken into account,
and, therefore, under paragraph (d)(4)(ii)(A)(1) of
this section, the remaining $350 attribute reduction
amount is suspended and allocated and applied to reduce any amounts that would be deductible or capitalizable as a result of the liability later being taken into
account. If the liability is satisfied for an amount that
is less than $350, under paragraph (d)(4)(ii)(A)(2) the
remaining portion of that $350 is disregarded and has
no further effect.
(ii) S operates more than one business. (A) Facts.
The facts are the same as in paragraph (i)(A) of Example 4, except that S operates a business providing
environmental remediation services. Prior to P’s sale
of the S share, S transfers its environmental remediation services business and its $50 of cash to S1 in
exchange for the sole outstanding share of S1 stock.
(S’s basis in the assets transferred in connection with
the environmental remediation business is $0.)
(B) Application of paragraphs (b) and (c) of this
section. No adjustment is made under paragraph (b)
or paragraph (c) of this section for the reasons set
forth in paragraph (i)(B) of this Example 4. Thus,
after the application of paragraph (c) of this section,
P’s sale of the S share is still a transfer of a loss share
and, accordingly, subject to this paragraph (d).
(C) Attribute reduction under this paragraph (d).
(1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S’s attribute reduction amount is the lesser of the net stock loss
($500) and the aggregate inside loss. The aggregate
inside loss is the excess of S’s net inside attribute
amount over the value of the S share. Under paragraph (d)(5)(i)(B) of this section, S’s net inside attribute amount is determined by using S’s deemed basis in the S1 share ($50, the greater of its basis ($50)
and S1’s net inside attribute amount ($50)). Accordingly, S’s net inside attribute amount is $650 (the sum
of $100 (basis in factory), $50 (basis in land), $450
(basis in publicly traded property), and $50 (deemed
basis in S1 stock). The aggregate inside loss is $500,
computed as the excess of S’s net inside attribute
amount ($650) over the value of the S share ($150).
Thus, S’s attribute reduction amount is $500, computed as the lesser of the net stock loss ($500) and
the aggregate inside loss ($500).
(2) Allocation, apportionment, and application of
attribute reduction amount. Under paragraphs (d)(4)
and (d)(5)(ii) of this section, S’s $500 attribute reduction amount is allocated proportionately (by basis)
between its assets and the S1 share. Under paragraph

February 20, 2007

(d)(5)(ii)(A) of this section, for this purpose, S’s basis in its S1 share is its deemed basis ($50) reduced
by S1’s cash ($50), or, $0. As a result, no portion of
S’s attribute reduction amount is allocated to the S1
share and the entire attribute reduction amount is allocated as set forth in paragraph (i)(C) of this Example
4. In addition, as in paragraph (i)(C) of this Example
4, under paragraph (d)(4)(ii)(A)(1) of this section, the
remaining $350 excess attribute reduction amount is
suspended and applied to the extent of S’s environmental remediation liability to reduce any amounts
that would be deductible or capitalizable as a result
of such liability later being taken into account. Alternatively, assume that S1 had liabilities for employee
medical expenses that had not been taken into account
for tax purposes, the $350 excess attribute reduction
amount would be suspended and then allocated and
applied as S’s and S1’s liabilities are taken into account. In either case, under paragraph (d)(4)(ii)(A)(2)
of this section, to the extent the suspended amount exceeds the liabilities taken into account, that excess is
disregarded and has no further effect.
Example 5. Wholly owned lower-tier subsidiary
(no lower-tier transfer). (i) Application of conforming limitation. (A) Facts. P owns the sole outstanding share of S stock with a basis of $250. S owns
Asset with a basis of $100 and the only two outstanding shares of S1 stock (Share A has a basis of $40 and
Share B has a basis of $60). S1 owns Asset 1 with a
basis of $50. P sells its S share to P1, the common
parent of another consolidated group, for $50. The
sale is a transfer of a loss share and therefore subject
to this section.
(B) Application of paragraphs (b) and (c) of this
section. No adjustment is required under paragraph
(b) of this section, either because redetermination
would not change any member’s basis in a share
(members hold only one share of S stock) or because P transfers the group’s entire interest in S to a
nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B)
of this section. No adjustment is required under
paragraph (c) of this section because, although there
is a $50 disconformity amount, the net positive adjustment is $0. See paragraph (c)(3) of this section.
Thus, after the application of paragraph (c) of this
section, P’s sale of the S share is still a transfer of a
loss share and, accordingly, subject to this paragraph
(d).
(C) Attribute reduction under this paragraph (d).
(1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S’s attribute reduction amount is the lesser of P’s net stock loss
and S’s aggregate inside loss. P’s net stock loss is
$200 ($250 basis minus $50 value). S’s aggregate

586

inside loss is the excess of S’s net inside attribute
amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i) of this section, S’s
net inside attribute amount is $200, computed as the
sum of S’s basis in Asset ($100) and its deemed basis
in the S1 stock (treated as a single share) ($100, computed as the greater of S’s $100 total basis in the S1
shares and S1’s $50 basis in Asset 1). S’s aggregate
inside loss is therefore $150 ($200 net inside attribute
amount minus $50 value of the S share). Accordingly,
S’s attribute reduction amount is $150, the lesser of
the net stock loss ($200) and the aggregate inside loss
($150).
(2) Allocation, apportionment, and application
of S’s attribute reduction amount. Under paragraphs
(d)(4) and (d)(5)(ii) of this section, S’s $150 attribute
reduction amount is allocated proportionately (by
basis) between Asset (basis $100) and the S1 stock
(treated as a single share) (deemed basis $100).
Accordingly, $75 of the attribute reduction amount
($100/$200 x $150) is allocated to Asset and $75 of
the attribute reduction amount ($100/$200 x $150)
is allocated to the S1 stock. The $75 allocated to
Asset is applied to reduce S’s basis in Asset to $25.
The $75 allocated to the S1 stock is first apportioned
between the shares in a manner that reduces disparity
to the greatest extent possible. Thus, of the total
$75 allocated to the S1 stock, $27.50 is apportioned
to Share A and $47.50 is apportioned to Share B.
The application of the apportioned amounts reduces
the basis of each share to $12.50. As a result, immediately after the allocation, apportionment, and
application of S’s attribute reduction amount, S’s
basis in Asset is $25 and S’s basis in each of the S1
shares is $12.50.
(3) Tier down of S’s attribute reduction amount,
application of conforming limitation. Under paragraph (d)(5)(ii)(D) of this section, any portion of S’s
attribute reduction amount allocated to S1 stock is an
attribute reduction amount of S1 (regardless of the extent, if any, to which it is apportioned and applied to
reduce the basis of any shares of S1 stock). Under
the general rules of this paragraph (d), the $75 allocated to the S1 stock would be applied to reduce S1’s
basis in Asset 1 to $0. However, under paragraph
(d)(5)(ii)(D)(2) of this section, S1’s attributes can be
reduced by only $25 as a result of tier down attribute
reduction, the excess of the portion of S1’s net inside attribute amount that is allocable to all S1 shares
held by members immediately before the transaction
($50) over the sum of the aggregate value of S1 shares
transferred by members in the transaction (none) and
the aggregate amount of members’ bases in nontransferred S1 shares, after reduction under this paragraph
($25). Thus, of S1’s $75 tier down attribute reduc-

2007–8 I.R.B.

tion amount, only $25 is applied to reduce S1’s basis
in Asset 1, from $50 to $25. The remaining $50 of
allocated amount has no further effect.
(4) Basis restoration. Under paragraph (d)(5)(iii)
of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock,
any reduction made to the basis of a share of subsidiary stock under paragraph (d)(5)(ii)(B) of this section is reversed to the extent necessary to conform
the basis of that share to the share’s allocable portion of the subsidiary’s net inside attribute amount.
S1’s net inside attribute amount after the application
of this paragraph (d) is $25 and thus each of the two
S1 share’s allocable portion of S1’s net inside attribute amount is $12.50. Accordingly, the basis of
each share (as reduced by this paragraph (d)) is already conformed with its allocable portion of S1’s net
inside attribute amount and no restoration will be required or permitted under paragraph (d)(5)(iii) of this
section.
(ii) Application of basis restoration rule. (A)
Facts. The facts are the same as in paragraph (i)(A)
of this Example 5, except that S’s basis in Share A is
$15 and S’s basis in Share B is $35, and S1’s basis
in Asset 1 is $100.
(B) Basis redetermination and basis reduction under paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) or paragraph (c)
of this section for the reasons set forth in paragraph
(i)(B) of this Example 5. Thus, after the application
of paragraph (c) of this section, P’s transfer of the S
share is still a transfer of a loss share and, accordingly,
subject to this paragraph (d).
(C) Attribute reduction under this paragraph (d).
(1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S’s attribute reduction amount is the lesser of P’s net stock loss
and S’s aggregate inside loss. P’s net stock loss is
$200 ($250 basis minus $50 value). S’s aggregate
inside loss is the excess of S’s net inside attribute
amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i) of this section, S’s
net inside attribute amount is $200, computed as the
sum of S’s basis in Asset ($100) and its deemed basis in the S1 stock (treated as a single share) ($100,
computed as the greater of S’s $50 total basis in the
S1 shares and S1’s $100 basis in Asset 1). S’s aggregate inside loss is therefore $150 ($200 net inside
attribute amount minus $50 value of the S share). Accordingly, S’s attribute reduction amount is $150, the
lesser of the net stock loss ($200) and the aggregate
inside loss ($150).
(2) Allocation, apportionment, and application
of S’s attribute reduction amount. Under paragraphs
(d)(4) and (d)(5)(ii) of this section, S’s $150 attribute
reduction amount is allocated proportionately (by
basis) between Asset (basis $100) and the S1 stock
(treated as a single share) (deemed basis $100).
Accordingly, $75 of the attribute reduction amount
($100/$200 x $150) is allocated to Asset and $75 of
the attribute reduction amount ($100/$200 x $150)
is allocated to the S1 stock. The $75 allocated to
Asset is applied to reduce S’s basis in Asset to $25.
The $75 allocated to the S1 stock is first apportioned
between the shares in a manner that reduces disparity
to the greatest extent possible. Thus, of the total
$75 allocated to the S1 stock, $27.50 is apportioned
to Share A and $47.50 is apportioned to Share B.
The application of the apportioned amounts reduces

2007–8 I.R.B.

the basis of each share to an excess loss account of
$12.50. As a result, immediately after the allocation, apportionment, and application of S’s attribute
reduction amount, S’s basis in Asset is $25 and
S’s basis in each of the S1 shares is an excess loss
account of $12.50.
(3) Tier down of S’s attribute reduction
amount, application of limitation. Under paragraph (d)(5)(ii)(D) of this section, any portion of S’s
attribute reduction amount allocated to S1 stock is an
attribute reduction amount of S1 (regardless of the
extent, if any, to which it is apportioned and applied
to reduce the basis of any shares of S1 stock). Accordingly, under the general rules of this paragraph
(d), the $75 allocated to the S1 stock is applied to
reduce S1’s basis in Asset 1 from $100 to $25.
(4) Basis restoration. Under paragraph (d)(5)(iii)
of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock,
any reduction made to the basis of a share of subsidiary stock under paragraph (d)(5)(ii)(B) of this section is reversed to the extent necessary to conform
the basis of that share to the share’s allocable portion of the subsidiary’s net inside attribute amount.
S1’s net inside attribute amount after the application
of this paragraph (d) is $25 and thus each of the two
S1 share’s allocable portion of S1’s net inside attribute amount is $12.50. Accordingly, the reductions
to Share A and to Share B under this paragraph (d) are
reversed to restore the basis of each share to $12.50.
Thus, $25 of the $27.50 attribute reduction applied to
reduce the basis of Share A and $25 of the $47.50 attribute reduction applied to reduce the basis of Share
B are reversed, restoring the basis of each share to
$12.50.
Example 6.
Multiple blocks of lower-tier
subsidiary stock outstanding. (i) Excess loss account taken into account (transfer of upper-tier
share causes disposition within the meaning of
§1.1502–19(c)(1)(ii)(B)). (A) Facts. P owns the sole
outstanding share of S stock with a basis of $200.
S holds all five outstanding shares of S1 common
stock (shares A, B, C, D, and E). S has an excess
loss account of $20 in share A and a positive basis of
$20 in each of the other shares. The only investment
adjustment applied to any S1 share was a negative
$20 investment adjustment applied to share A when
it was the only outstanding share, and this amount
tiered up and adjusted P’s basis in the S share. S1
owns one asset with a basis of $250. P sells its S
share to P1, the common parent of a consolidated
group, for $20. The sale of the S share is a disposition
of share A under §1.1502–19(c)(1)(ii)(B) (after the
transaction, S1 will no longer be a member of the
P group). Under paragraph (a)(3)(i) of this section,
before the application of this section, S’s excess loss
account in share A is taken into account, increasing
S’s basis in share A to $0 and P’s basis in its S share
to $220. After giving effect to the recognition of
the excess loss account, P’s sale of the S share is a
transfer of a loss share and therefore subject to the
provisions of this section.
(B) Basis redetermination and basis reduction under paragraphs (b) and (c) of this section. No adjustment is made under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (members hold only one share
of S stock) or because P transfers the group’s entire
interest in S to a nonmember in a fully taxable trans-

587

action. See, respectively, paragraphs (b)(1)(ii)(A)
and (b)(1)(ii)(B) of this section. No adjustment is
made under paragraph (c) of this section because,
even though there is a disconformity amount of $120,
the net positive adjustment is zero. See paragraph
(c)(3) of this section. Thus, after the application of
paragraph (c) of this section, P’s sale of the S share
remains a transfer of a loss share and, accordingly,
subject to this paragraph (d).
(C) Attribute reduction under this paragraph (d).
(1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S’s attribute reduction amount is the lesser of P’s net stock loss and
S’s aggregate inside loss. P’s net stock loss is $200
(the S share’s $220 basis minus its $20 value). S’s
aggregate inside loss is the excess of S’s net inside
attribute amount over the value of the S share. Under
paragraphs (d)(3)(iii)(B) and (d)(5)(i) of this section,
S’s net inside attribute amount is $250, S’s deemed
basis in the S1 stock (treated as a single share) ($250,
computed as the greater of S’s $80 total basis in the S1
shares ($0 basis of share A plus $20 of basis in each
of the four other shares) and S1’s $250 basis in its asset). S’s aggregate inside loss is therefore $230 ($250
net inside attribute amount minus $20 value of the S
share). Accordingly, S’s attribute reduction amount
is $200, the lesser of the net stock loss ($200) and the
aggregate inside loss ($230).
(2) Allocation, apportionment, and application
of S’s attribute reduction amount. Under paragraphs
(d)(4) and (d)(5)(ii) of this section, S’s $200 attribute
reduction amount is allocated entirely to the S1
stock (treated as a single share) and then apportioned
among the shares in a manner that reduces disparity
to the greatest extent possible. Thus, $24 is apportioned to share A and $44 is apportioned to each of
the other shares. Because there is no transfer of the
S1 shares, the apportioned amounts are applied fully
to reduce the basis of each share to an excess loss
account of $24.
(3) Tier down of S’s attribute reduction amount.
Under paragraph (d)(5)(ii)(D) of this section, the
$200 of S’s attribute reduction amount allocated to
the S1 shares is an attribute reduction amount of S1
(regardless of the extent, if any, to which it is apportioned and applied to reduce the basis of any shares
of S1 stock). Accordingly, under the general rules
of this paragraph (d), S1’s $200 attribute reduction
amount is allocated and applied to reduce S1’s basis
in its asset from $250 to $50.
(4) Basis restoration. Under paragraph (d)(5)(iii)
of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock,
any reduction made to the basis of a share of subsidiary stock under paragraph (d)(5)(ii)(B) of this section is reversed to the extent necessary to conform
the basis of that share to the share’s allocable portion of the subsidiary’s net inside attribute amount.
S1’s net inside attribute amount after the application
of this paragraph (d) is $50 and thus each of the five
S1 share’s allocable portion of S1’s net inside attribute amount is $10. Accordingly, the reductions
to the bases of S1 stock under this paragraph (d) are
reversed to restore (to the extent possible) the basis
of each share to $10. Thus, $24 of the $24 attribute
reduction applied to reduce the basis of share A is reversed, restoring the basis of share A to $0, and $34 of
the $44 attribute reduction applied to reduce the basis

February 20, 2007

of each other share is reversed, restoring the basis of
each of those shares to $10.
(ii) Sale of gain share to member. (A) Facts. The
facts are the same as in paragraph (i)(A) of this Example 6, except that P owns shares A, B, C, and D, S
owns share E, S has a liability of $20, and S1’s basis in its asset is $500. Also, as part of the transaction, S sells share E to P for $40. Unlike under
the facts of paragraph (i)(A) of this Example 6, there
is no disposition of share A within the meaning of
§1.1502–19(c)(1)(ii)(B) (because the share continues
to be held by P, and S1 continues to be a member of
the P group). As a result, the share A excess loss account is not taken into account. Although S’s sale of
share E is a transfer of that share, the share is not a
loss share and thus the transfer is not subject to this
section. P’s sale of the S share, however, is a transfer
of a loss share and therefore subject to the provisions
of this section.
(B) Transfer in lowest tier (gain share). S’s sale
of share E is the lowest tier transfer in the transaction. Under paragraph (a)(3)(ii)(A)(1) of this section,
because there are no transfers of loss shares at that
tier, no adjustments are required under paragraphs (b)
and (c) of this section. However, S’s gain recognized
on the transfer of share E is computed and immediately adjusts members’ bases in subsidiary stock under the principles of §1.1502–32 (because P and S
are not members of the same group immediately after
the transaction, the sale is not subject to §1.1502–13).
Accordingly, P’s basis in its S share is increased by
$20, from $200 to $220.
(C) Transfers in next higher (the highest) tier (application of paragraphs (b) and (c) of this section).
The next higher tier transfer is P’s sale of the S stock.
Because the sale is a transfer of a loss share, first
paragraph (b) of this section and then paragraph (c)
of this section apply to the transfer. No adjustments
are required under paragraph (b), either because there
is no potential for redetermination (members hold
only one share of S stock) or because P transfers
the group’s entire interest in S to a nonmember in
a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section.
Under paragraph (c) of this section, P’s basis in its S
share is decreased by $20, the lesser of the disconformity amount ($200, computed as the excess of stock
basis ($220) over S’s net inside attribute amount ($20,
the $40 value of the transferred share E minus the
$20 liability)) and the net positive adjustment ($20).
Thus, after the application of paragraph (c) of this section, P’s basis in the S share is $200, and the sale remains a transfer of a loss share. There are no higher
tier transfers and, therefore, P’s transfer of the S share
is then subject to this paragraph (d).
(D) Attribute reduction under this paragraph (d).
(1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S’s attribute reduction amount is the lesser of P’s net stock loss and
S’s aggregate inside loss. After the application of
paragraph (c) of this section, P’s net stock loss is $180
(the S share’s $200 basis minus its $20 value). S’s
aggregate inside loss is the excess of S’s net inside
attribute amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i) of this section, S’s net inside attribute amount is $80, computed
as $100 (S’s deemed basis in share E (the greater of
S’s basis in share E, adjusted for the gain recognized,
($40) and share E’s allocable portion of S1’s net in-

February 20, 2007

side attribute amount ($100, representing 1/5 of S1’s
$500 basis in its asset))) minus S’s liability ($20). Accordingly, S’s net aggregate inside loss is $60 ($80
net inside attribute amount minus $20 value of the S
stock). S’s attribute reduction amount is therefore the
lesser of $180 and $60, or $60.
(2) Allocation, apportionment, and application of
S’s attribute reduction amount. Under paragraphs
(d)(4) and (d)(5)(ii) of this section, S’s $60 attribute
reduction amount is allocated entirely to its S1 stock,
share E. However, under paragraph (d)(5)(ii)(B)(1)
of this section, none of the allocated amount is apportioned to, or applied to reduce the basis of share
E, because share E was transferred in a transfer in
which gain or loss was recognized. Under paragraph
(d)(5)(ii)(C) of this section, the $60 allocated amount
not apportioned to share E has no effect on S or S’s
attributes.
(3) Tier down of S’s attribute reduction amount.
Notwithstanding the fact that no portion of the allocated amount was apportioned to or applied to reduce
the basis of share E, the entire $60 allocated amount
tiers down and is an attribute reduction amount of S1.
See paragraphs (d)(5)(ii)(C) and (d)(5)(ii)(D) of this
section. Under the general rules of this paragraph (d),
S1’s $60 attribute reduction amount is allocated and
applied to reduce S1’s basis in its asset from $500 to
$440.
(4) Basis restoration. Under paragraph (d)(5)(iii)
of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock,
any reduction made to the basis of a share of subsidiary stock under paragraph (d)(5)(ii)(B) of this section is reversed to the extent necessary to conform
the basis of that share to the share’s allocable portion of the subsidiary’s net inside attribute amount.
No reduction was made to the basis of any share of
subsidiary stock under paragraph (d)(5)(ii)(B) of this
section. Therefore, no stock basis is increased under
the basis restoration rule in paragraph (d)(5)(iii) of
this section.
Example 7. Allocation of attribute reduction if
lower-tier subsidiary has nonloss assets or liabilities.
(i) S1 holds cash. (A) Facts. P owns the sole outstanding share of S stock with a basis of $800. S owns
Asset 1 with a basis of $400 and the sole outstanding
share of S1 stock with a basis of $300. S1 holds Asset 2 with a basis of $50, and $100 cash. P sells its
S share to P1, the common parent of a consolidated
group, for $100.
(B) Application of paragraphs (b) and (c) of this
section. No adjustment is required under paragraph
(b) of this section, either because redetermination
would change no member’s basis in a share (members hold only one share of S stock) or because P
transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively,
paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. No adjustment is required under paragraph (c)
of this section because the net positive adjustment is
$0. See paragraph (c)(3) of this section. Thus, after
the application of paragraph (c) of this section, P’s
sale of the S share is still a transfer of a loss share
and, accordingly, subject to this paragraph (d).
(C) Attribute reduction under this paragraph (d).
(1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S’s attribute reduction amount is the lesser of P’s net stock loss and
S’s aggregate inside loss. P’s net stock loss is $700

588

(the S share’s $800 basis minus its $100 value). S’s
aggregate inside loss is the excess of S’s net inside
attribute amount over the value of the S share. Under
paragraphs (d)(3)(iii)(B) and (d)(5)(i) of this section,
S’s net inside attribute amount is the sum of its basis in Asset 1 of $400 and its deemed basis in the S1
share. S’s deemed basis in the S1 share is $300, the
greater of S’s basis in the S1 share ($300) and S1’s net
inside attribute amount ($150, S1’s $50 basis in Asset
2 plus S1’s $100 cash). Therefore, S’s net inside attribute amount is $700 and S’s aggregate inside loss
is $600 ($700 net inside attribute amount less $100
value). S’s attribute reduction amount is $600, the
lesser of the net stock loss ($700) and the aggregate
inside loss ($600).
(2) Allocation, apportionment, and application of
S’s attribute reduction amount. Under paragraphs
(d)(4) and (d)(5)(ii)(A) of this section, S’s $600 attribute reduction amount is allocated proportionately
(by basis) between S’s basis in Asset 1 ($400) and its
deemed basis in the S1 share. For purposes of allocating the attribute reduction amount, S’s deemed basis
in the S1 share is reduced by S1’s $100 cash (from
$300 to $200). Thus, the $600 is allocated $400 to
Asset 1 ($400/$600 x $600) and $200 to the S1 share
($200/$600 x $600). The $400 allocated to Asset 1 is
applied to reduce S’s basis in Asset 1 to $0. The $200
allocated to the S1 share is apportioned and applied
to reduce S’s basis in the S1 share to $100.
(3) Tier down of S’s attribute reduction amount.
Under paragraph (d)(5)(ii)(D) of this section, any portion of S’s attribute reduction amount allocated to the
S1 stock is an attribute reduction amount of S1 (regardless of the extent, if any, to which it is apportioned and applied to reduce the basis of any shares of
S1 stock). Accordingly, under the general rules of this
paragraph (d), the $200 allocated to the S1 share is an
attribute reduction amount of S1 that is allocated and
applied entirely to reduce S1’s basis in Asset 2 from
$50 to $0. The remaining $150 S1 attribute reduction
amount is disregarded and has no further effect.
(4) Basis restoration. Under paragraph (d)(5)(iii)
of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock,
any reduction made to the basis of a share of subsidiary stock under paragraph (d)(5)(ii)(B) of this section is reversed to the extent necessary to conform the
basis of that share to the share’s allocable portion of
the subsidiary’s net inside attribute amount. S1’s net
inside attribute amount after the application of this
paragraph (d) is $100 and thus the S1 share’s allocable portion of S1’s net inside attribute amount is
$100. Accordingly, the basis of the share (as reduced
by this paragraph (d)) is already conformed with its
allocable portion of S1’s net inside attribute amount
and no restoration will be required or permitted under
paragraph (d)(5)(iii) of this section.
(ii) S1 borrows cash. The facts are the same as
in paragraph (i)(A) of this Example 7 except that S1
borrows $50 from X, an unrelated person, immediately before P sells the S share. The computation of
the attribute reduction amount is the same as in paragraph (i)(C) of this Example 7 (because the $50 cash
from the loan proceeds and the $50 liability offset in
the computation of S’s net inside attribute amount).
However, under paragraph (d)(5)(ii)(A) of this section, for purposes of allocating the attribute reduction
amount, deemed basis is reduced by the amount of
S1’s cash, but only to the extent it exceeds S1’s liabil-

2007–8 I.R.B.

ities. S1’s cash ($150, the original $100 plus the $50
loan proceeds) exceeds its liability ($50) by $100, so
S’s deemed basis in the S1 share is reduced by $100
(from $300 to $200) for allocation purposes. The results are the same as in paragraph (i) of this Example
7.
(iii) S1 borrows cash and invests in non-publicly
traded property. (A) Facts. The facts are the same
as in paragraph (ii) of this Example 7 except that S1
uses its $150 (the original $100 plus the $50 loan
proceeds) to purchase Asset 3, an asset that is not
publicly traded.
(B) Application of paragraphs (b) and (c) of this
section. No adjustment is required under paragraph
(b) or paragraph (c) of this section for the reasons set
forth in paragraph (i)(B) of this Example 7. Thus,
after the application of paragraph (c) of this section,
P’s sale of the S share is still a transfer of a loss share
and, accordingly, subject to this paragraph (d).
(C) Attribute reduction under this paragraph (d).
(1) Computation of attribute reduction amount. The
attribute reduction amount is the same as computed in
paragraph (i)(C)(1) of this Example 7 (because $50 of
the basis in S1’s assets and the $50 liability offset in
the computation of S1’s net inside attribute amount
of $150).
(2) Allocation, apportionment, and application of
S’s attribute reduction amount. Under paragraphs
(d)(4) and (d)(5)(ii)(A) of this section, S’s $600 attribute reduction amount is allocated proportionately
(by basis) between S’s basis in Asset 1 ($400) and its

deemed basis in the S1 share. For purposes of allocating the attribute reduction amount, deemed basis
is only reduced for allocation purposes by cash, cash
equivalents, and the value of publicly traded property (reduced by liabilities). Thus, there is no reduction to the basis of the S1 share for purposes of allocating the attribute reduction amount. Accordingly,
S’s $600 attribute reduction amount is allocated $343
($400/$700 x $600) to Asset 1 and $257 ($300/$700
x $600) to the S1 share.
(3) Tier down of S’s attribute reduction amount,
application of conforming limitation. Under paragraph (d)(5)(ii)(D) of this section, any portion of S’s
attribute reduction amount allocated to the S1 stock is
an attribute reduction amount of S1 (regardless of the
extent, if any, to which it is apportioned and applied
to reduce the basis of any shares of S1 stock). Thus,
the entire $257 of S’s attribute reduction amount allocated to the S1 share is an attribute reduction amount
of S1. Under the general rules of this paragraph (d),
the entire amount is allocated to, and would be applied to reduce, S1’s bases in Asset 2 and Asset 3, reducing the basis of each asset to $0. However, under
paragraph (d)(5)(ii)(D)(2) of this section, the reduction is limited to the excess of S1’s net inside attribute
amount ($150) over S’s basis in the S1 share after reduction under this paragraph (d) ($43). Thus, of the
$257 attribute reduction amount allocated to the S1
share, only $107 is applied proportionately to reduce
S1’s bases in Asset 2 by $26.75 ($50/$200 x $107), to
$23.25, and Asset 3 by $80.25 ($150/$200 x $107),

to $69.75. The remaining $150 S1 attribute reduction
amount is disregarded and has no further effect.
(4) Basis restoration. Under paragraph (d)(5)(iii)
of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock,
any reduction made to the basis of a share of subsidiary stock under paragraph (d)(5)(ii)(B) of this section is reversed to the extent necessary to conform
the basis of that share to the share’s allocable portion of the subsidiary’s net inside attribute amount.
S1’s net inside attribute amount after the application
of this paragraph (d) is $43 ($23.25 basis in Asset 2
plus $69.75 basis in Asset 3 minus $50 liability) and
thus the S1 share’s allocable portion of S1’s net inside attribute amount is $43. Accordingly, the basis
of the share (as reduced by this paragraph (d)) is already conformed with its allocable portion of S1’s net
inside attribute amount and no restoration will be required or permitted under paragraph (d)(5)(iii) of this
section.
Example 8. Election to reduce stock basis or reattribute attributes under paragraph (d)(6) of this section. (i) Deconsolidating sale. (A) Facts. P owns
the sole outstanding share of M stock with a basis of
$1,000. M owns all 100 outstanding shares of S stock
with a basis of $2.10 per share ($210 total). M sells
all its S shares to X for $1 per share (total $100) and
makes no election under paragraph (d)(6) of this section. At the time of the sale, S has no liabilities and
the following:

Category

Attribute

Attribute amount

Category A

NOL

$10

Category E

Basis of Asset 1

$20

Basis of Asset 2

$180

Total Category E
(B) Application of paragraphs (b) and (c) of this
section. No adjustment is made under paragraph (b)
of this section, either because redetermination would
change no member’s basis in a share (S has only
one class of stock outstanding and there is no disparity in the basis of the shares) or because P transfers
the group’s entire interest in S to a nonmember in
a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section.
No adjustment is required under paragraph (c) of this

$200
section because the net positive adjustment is $0. See
paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, M’s transfer of
the S shares is still a transfer of loss shares and, accordingly, subject to this paragraph (d).
(C) Attribute reduction under this paragraph
(d). (1) Computation of attribute reduction amount.
Under paragraph (d)(3) of this section, S’s attribute
reduction amount is the lesser of the net stock loss
($110, P’s aggregate basis in the transferred S shares

Category

Attribute

Category A

NOL

$10

$10

$0

Category E

Basis of Asset 1

$20

(20/200 x $100) $10

$10

Basis of Asset 2

$180

(180/200 x $100) $90

$90

$200

$100

$100

Total Category E
(D) Results. The P group realizes a $110 loss
on M’s sale of the S shares, which reduces P’s basis
in the M share from $1,000 to $890. The reduction

2007–8 I.R.B.

Attribute amount

($210) less the aggregate value of the transferred
shares ($100)) and S’s aggregate inside loss. S’s
aggregate inside loss is $110 (S’s $210 net inside
attribute amount (the $10 NOL plus the $20 basis of
Asset 1 plus the $180 basis of Asset 2) less the $100
value of all outstanding S shares). Thus, the attribute
reduction amount is $110.
(2) Application of attribute reduction amount. S’s
$110 attribute reduction amount is applied as follows:

Allocation of attribute reduction amount

of S’s attributes is not a noncapital, nondeductible
expense of S and does not tier up to reduce the basis

589

Adjusted attribute
amount

of the S shares or M share. Immediately after the
transaction, the entities own the following:

February 20, 2007

Entity

Asset

P

M share

$890

X

100 S shares

$100

S

Asset 1

$10

Asset 2

$90

(E) Election to reduce stock basis. The facts are
the same as in paragraph (i)(A) of this Example 8 except that P elects under paragraph (d)(6) of this section to reduce M’s bases in the S shares by the full
attribute reduction amount of $110, in lieu of S reducing its attributes. The election is effective for

Basis

all transferred loss shares and is allocated to such
shares in proportion to the loss in each share. Accordingly, the basis of each of the 100 transferred shares
is reduced from $2.10 to $1.00. After giving effect
to the election, the S shares are not loss shares and
this section has no further application to the trans-

fer. The reduction of M’s bases in the S shares pursuant to the election under paragraph (d)(6) of this
section is a noncapital, nondeductible expense of M
that will reduce P’s basis in the M share. See paragraph (d)(6)(iv) of this section. Immediately after the
transaction, the entities own the following:

Entity

Basis/Attribute

P

M share

$890

X

100 S shares

$100

S

NOL

$10

Asset 1

$20

Asset 2

$180

(F) Election to reattribute losses. The facts are
the same as in paragraph (i)(A) of this Example 8 except that P elects under paragraph (d)(6) of this section to reattribute S’s attributes. Although S’s attribute reduction amount is $110, P can only reattribute attributes in Category A, Category B, and Category C. P can therefore elect to reattribute $10 of attributes (the NOL), and, as a result, will reduce S’s
NOL to $0. The reattribution of the $10 NOL is a
noncapital, nondeductible expense of S, and under
§1.1502–32(c)(1)(ii)(B) this expense is allocated to
the loss shares of S stock sold in proportion to the
loss in the shares, or $.10 per share. Further, this expense tiers up under the general rules of §1.1502–32
and reduces P’s basis in the M stock by $10. After
giving effect to the election, the P group would real-

ize a $100 loss on M’s sale of the S shares. M could
recognize the $100 stock loss (in which case S’s basis
in Asset 1 and Asset 2 would be reduced to $10 and
$90, respectively, as in paragraph (i)(C)(2) of this Example 8) or P could elect to reduce M’s basis in the S
shares by all or any portion of the $100 stock loss (in
which case S’s attribute reduction amount would be
reduced by the amount of the reduction in the basis
of the S stock, and S’s basis in Asset 1 and Asset 2
would be reduced proportionately).
(ii) Nondeconsolidating sale. (A) Facts. The
facts are the same as in paragraph (i)(A) of this Example 8, except that M only sells 20 S shares (for a
total of $20).
(B) Application of paragraphs (b) and (c) of this
section. No adjustment is required under paragraph

Category

Attribute

Category A

NOL

$10

$10

$0

Category E

Basis of Asset 1

$20

(20/200 x $12) $1.20

$18.80

Basis of Asset 2

$180

(180/200 x $12) $10.80

$169.20

$200

$12

$188

Total Category E
(D) Results. The P group realizes a $22 loss on
M’s sale of the S shares, which reduces P’s basis in
the M share from $1,000 to $978. The reduction of

February 20, 2007

Attribute amount

(b) or paragraph (c) of this section for the reasons set
forth in paragraph (i)(B) of this Example 8. Thus,
after the application of paragraph (c) of this section,
M’s sale of the S shares is still a transfer of loss shares
and, accordingly, subject to this paragraph (d).
(C) Attribute reduction under this paragraph
(d). (1) Computation of attribute reduction amount.
Under paragraph (d)(3) of this section, S’s attribute
reduction amount is the lesser of the net stock loss
($22, P’s aggregate basis in the transferred S shares
($42) less the aggregate value of the transferred
shares ($20)) and S’s $110 aggregate inside loss (as
calculated in paragraph (i)(C)(1) of this Example 8).
Thus, the attribute reduction amount is $22.
(2) Application of attribute reduction amount. S’s
$22 attribute reduction amount is applied as follows:

Allocation of attribute reduction amount

S’s attributes is not a noncapital, nondeductible expense of S and does not tier up to reduce the bases of

590

Adjusted attribute
amount

the S shares or M share. Immediately after the transaction, the entities have the following:

2007–8 I.R.B.

Entity

Asset

P

M share

X

20 S shares

S

Asset 1

$18.80

Asset 2

$169.20

(E) Election to reduce stock basis. The facts are
the same as in paragraph (ii)(A) of this Example 8,
except that P elects under paragraph (d)(6) of this section to reduce M’s bases in the S shares by the full attribute reduction amount of $22, in lieu of S reducing
its attributes. The election is effective for all trans-

Basis
$978
$20

ferred loss shares and is allocated to such shares in
proportion to the loss in each share. Accordingly, the
basis of each of the 20 transferred shares is reduced
from $2.10 to $1.00. The P group realizes no loss
on M’s sale of the S shares. The reduction of M’s
basis in the S shares pursuant to the election under

Entity

paragraph (d)(6) of this section is a noncapital, nondeductible expense of M that will reduce P’s basis in
the M share. Immediately after the transaction, the
entities have the following:

Basis/Attribute

P

M share

X

20 S shares

$20

S

NOL

$10

Asset 1

$20

Asset 2

$180

(F) Election to reattribute attributes. The facts
are the same as in paragraph (ii)(A) of this Example
8. Because S remains a member of the P group following M’s sale of S stock, P cannot elect under paragraph (d)(6) of this section to reattribute any portion
of S’s attributes in lieu of attribute reduction.
Example 9. Transfers at multiple tiers, gain and
loss shares. (i) Facts. P owns the sole outstanding
share of S stock with a basis of $700. S owns Asset
1 (basis of $170) and all ten outstanding shares of S1
common stock ($170 basis in share 1, $10 basis in
share 2, and $15 basis in each of share 3 through share
10). S1 owns the sole outstanding share of S2 ($0
basis), the sole outstanding share of S3 ($60 basis),
and the sole outstanding share of S4 ($100 basis).
S2’s sole asset is Asset 2 ($75 basis). S3’s sole asset
is Asset 3 ($75 basis). S4’s sole asset is Asset 4 ($80
basis). In one transaction, P sells its S share to P1 (the
common parent of a different consolidated group) for
$240, S sells S1 share 1 to X for $20, S transfers S1
share 2 to a partnership in a section 721 transaction,
and S1 sells its S2 share to Y for $50. No election is
made under paragraph (d)(6) to reduce stock basis or
reattribute attributes.
(ii) Transfer in lowest tier (only gain share). S1’s
sale of the S2 share is a transfer of the S2 share and
that is the lowest tier in which there is a transfer.
There is no transfer of a loss share at that tier, and
thus this section does not apply to that transfer. The
gain recognized on the transfer of the S2 share is
computed and is applied to adjust the bases of members’ shares of subsidiary stock under the principles
of §1.1502–32. Accordingly, $5 is allocated to each
of S1 shares, increasing the basis of share 1 to $175,
the basis of share 2 to $15, and the basis of each other
share to $20. The $50 applied to S’s bases in S1
shares then tiers up to increase P’s basis in the S share
from $700 to $750.
(iii) Transfers in next higher tier (loss share). S’s
sale of the S1 share 1 and S’s transfer of the S1 share 2
to a partnership are both transfers of stock in the next

2007–8 I.R.B.

$978

higher tier. However, only the S1 share 1 is a loss
share and so this section only applies with respect to
the transfer of that share.
(A) Basis redetermination under paragraph (b) of
this section. Under paragraph (b)(2)(i)(A) of this section, members’ bases in S1 shares are redetermined
by first removing the positive investment adjustments
applied to the bases of transferred loss shares. Accordingly, the $5 positive investment adjustment applied to the basis of S1 share 1 is removed, reducing the basis of S1 share 1 from $175 to $170. Because there were no negative adjustments made to the
bases of S1 shares, there are no negative adjustments
that can be reallocated to further reduce the basis of
S1 share 1. Finally, under paragraph (b)(2)(ii)(B),
the positive investment adjustment removed from S1
share 1 is reallocated and applied to increase the bases
of other S1 shares in a manner that reduces disparity
to the greatest extent possible. Accordingly, the entire $5 is reallocated and applied to increase the basis
of S1 share 2, from $15 to $20. After basis is redetermined under paragraph (b) of this section, S1 share 1
is still a loss share and therefore subject to basis reduction under paragraph (c) of this section.
(B) Basis reduction under paragraph (c) of this
section. No adjustment is required to the basis of S1
share 1 under paragraph (c) of this section because, although the disconformity amount is $149 (the excess
of the $170 stock basis over the share’s $21 allocable portion of S1’s net inside attribute amount ($210,
determined under paragraph (c)(5) of this section as
S1’s basis in the stock of S2 (adjusted for the gain recognized) ($50), S3 ($60), and S4 ($100))), the share’s
net positive adjustment is $0 (because the $5 positive investment adjustment originally allocated to S1
share 1 was reallocated to S1 share 2 under paragraph
(b) of this section). See paragraph (c)(3) of this section.
(C) Computation of loss, adjustments to stock basis. S recognizes a loss of $150 on the sale of the S1
share 1 ($170 adjusted basis minus $20 amount real-

591

ized). P’s basis in its S share is therefore decreased
by the $150 loss recognized by S (on the sale of the
S1 share) and increased by the $50 gain that tiered up
from S1 (as a result of S1’s sale of the S2 share). Following these adjustments, P’s basis in the S share is
$600 and the sale of the S share is still a transfer of a
loss share.
(iv) Transfer in highest tier (loss share). The sale
of the S share is a transfer in the next higher tier,
which is the highest tier in this transaction. Because
the sale is a transfer of a loss share, it is subject to this
section.
(A) Basis redetermination and basis reduction
under paragraphs (b) and (c) of this section. No
adjustment is required under paragraph (b) of this
section, either because there is no potential for
redetermination (members hold only one share of
S stock) or because P transfers the group’s entire
interest in S to a nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A)
and (b)(1)(ii)(B) of this section. In addition, no
adjustment is required under paragraph (c) of this
section because, although the disconformity amount
is $230 (the excess of the $600 stock basis over the
$370 allocable portion of S’s net inside attribute
amount ($370, determined under paragraph (c)(5) of
this section as S’s basis in the stock of S1 (adjusted
for the loss recognized) ($200) and Asset 1 ($170))),
the share’s net positive adjustment is $0. See paragraph (c)(3) of this section. Accordingly, the sale of
the S share is still a transfer of a loss share. Because
there are no higher-tier loss shares transferred in
the transaction, this paragraph (d) then applies with
respect to the transfer of the S share.
(B) Attribute reduction under this paragraph (d).
(1) Computation of S’s attribute reduction amount.
Under paragraph (d)(3) of this section, S’s attribute
reduction amount is the lesser of P’s net stock loss
and S’s aggregate inside loss. P’s net stock loss is
$360 (the S share’s $600 adjusted basis minus $240
amount realized). S’s aggregate inside loss is the ex-

February 20, 2007

cess of S’s net inside attribute amount over the value
of the S share. S’s net inside attribute amount is the
sum of its bases in its assets, treating its S1 shares as
a single share (the S1 stock) and treating S’s deemed
basis in the S1 stock as its basis in that stock. Under paragraph (d)(5)(i)(C) of this section, when subsidiaries are owned in multiple tiers, deemed basis is
first determined for shares at the lowest tier, and then
for stock in each next higher tier. S1’s deemed basis
in the S2 stock is $75 (the greater of $50 (S1’s basis
in the S2 share ($0) increased by the $50 gain recognized) and $75 (S2’s basis in Asset 2)). S1’s deemed
basis in the S3 stock is $75 (computed as the greater
of $60 (S1’s basis in the S3 share) and $75 (S3’s basis in Asset 3)). S1’s deemed basis in the S4 stock
is $100 (computed as the greater of $100 (S1’s basis in the S4 share) and $80 (S4’s basis in Asset 4)).
Accordingly, S1’s net inside attribute amount is $250
($75 deemed basis in the S2 stock plus $75 deemed
basis in the S3 stock plus $100 deemed basis in the
S4 stock). S’s deemed basis in the S1 stock is the
greater of the sum of S’s actual basis in each share
of S1 stock (adjusted for any gain or loss recognized)
and S1’s net inside attribute amount. S’s actual basis
in the S1 stock, adjusted for the loss recognized, is
$200 (the sum of S’s $170 basis in the S1 share 1 and
S’s $20 basis in each other S1 share, reduced by the
$150 loss recognized). Thus, S’s deemed basis in the
S1 stock is $250, the greater of $200 (aggregate basis
in S1 shares, adjusted for loss recognized) and $250
(S1’s net inside attribute amount). As a result, S’s net
inside attribute amount is $420, the sum of $250 (S’s
deemed basis in S1 stock) and $170 (S’s basis in Asset 1). Accordingly, the aggregate inside loss is $180,
the excess of S’s net inside attribute amount ($420)
over the value of all of the S stock ($240). S’s attribute reduction amount is therefore $180, the lesser
of the net stock loss ($360) and the aggregate inside
loss ($180).
(2) Allocation, apportionment, and application of
S’s attribute reduction amount. Under paragraphs
(d)(4) and (d)(5)(ii) of this section, S’s $180 attribute
reduction amount is allocated proportionately (by basis) between Asset 1 and its S1 stock. Under paragraph (d)(5)(ii)(A) of this section, for purposes of
allocating S’s $180 attribute reduction amount, S’s
deemed basis in the S1 stock is reduced by the value
of any transferred S1 shares (and other items that are
not relevant here). Additionally, for this purpose, S’s
deemed basis in S1 stock is reduced by S’s nontransferred S1 shares’ allocable portion of the value of
S1’s transferred shares of each lower-tier subsidiary’s
stock (and other items that are not relevant here). Accordingly, for purposes of allocating S’s attribute reduction amount, S’s deemed basis in the S1 stock
must be reduced by $80 (the $40 value of the two
transferred S1 shares, and S’s eight nontransferred S1
shares’ $40 allocable portion of the $50 value of the
transferred S2 share), to $170. Thus, $90 of the attribute reduction amount ($170/$340 x $180) is allocated to Asset 1 and $90 of the attribute reduction
amount ($170/$340 x $180) is allocated to the S1
stock. Under paragraph (d)(5)(ii)(B)(1) of this section, none of the $90 allocated to the S1 stock is apportioned to share 1 because loss is recognized on the
transfer of share 1. Under paragraph (d)(5)(ii)(B)(2)
of this section, the $90 allocated amount is apportioned among the other nine shares of S1 stock in
a manner that reduces disparity to the greatest ex-

February 20, 2007

tent possible. Accordingly, of the total $90 allocated
amount, $10 is apportioned to each of the remaining
shares of S1 stock. Under paragraph (d)(5)(ii)(B)(3)
of this section, however, an apportioned amount cannot be applied to reduce the basis of a transferred
share below its value. Because the basis of share 2 is
already equal to its value, none of the $10 apportioned
to share 2 is applied to reduce its basis. The amounts
apportioned to the remaining S1 shares, however, are
applied to reduce the bases of those shares without
limitation, reducing the basis of each from $20 to $10.
As a result, immediately after the allocation and application of S’s attribute reduction amount, S’s basis
in Asset 1 is $80 ($170 minus $90), its basis in share
1 is $170, its basis in share 2 is $20, and its basis in
each other share of S1 stock is $10. Under paragraph
(d)(5)(ii)(D) of this section, the entire $90 of S’s attribute reduction amount that was allocated to the S1
stock is an attribute reduction amount of S1, regardless of the fact that none of the allocated amount was
apportioned to share 1 and none of the amount apportioned to share 2 was applied to reduce the basis of
share 2.
(v) Attribute reduction under this paragraph (d)
in next lower tier. (A) Computation of S1’s attribute
reduction amount. S’s sale of share 1 is a transfer of a
loss share and is in the next lower tier. Thus, this paragraph (d) next applies with respect to S’s transfer of
share 1. S1’s attribute reduction amount will include
both the $90 attribute reduction amount that tiered
down from S and any attribute reduction amount resulting from the application of this paragraph (d) with
respect to S’s transfer of the S1 share 1 (S1’s direct attribute reduction amount). Under paragraph (d)(3) of
this section, S1’s direct attribute reduction amount is
the lesser of the net stock loss on transferred S1 shares
and S1’s aggregate inside loss. The net stock loss on
transferred S1 shares is $150, computed as the excess of S’s $190 adjusted bases in transferred shares
of S1 stock ($170 in share 1 plus $20 in share 2) over
the value of those shares ($40). S1’s aggregate inside
loss is $50, the excess of S1’s $250 net inside attribute
amount (as calculated in paragraph (iv)(B)(1) of this
Example 10) over the $200 value of all outstanding
S1 shares (extrapolated from the amount realized on
the sale of share 1). Therefore, S1’s direct attribute
reduction amount is $50, the lesser of the $150 net
stock loss and S1’s $50 aggregate inside loss. S1’s
total attribute reduction amount is thus $140, the sum
of the $90 attribute reduction amount that tiered down
from S and the $50 direct attribute reduction amount
computed with respect to the transfer of share 1.
(B) Allocation, apportionment, and application of
S1’s attribute reduction amount. Under paragraphs
(d)(4) and (d)(5)(ii) of this section, S1’s $140 attribute reduction amount is allocated proportionately
(by basis) among the S2 stock, the S3 stock, and
the S4 stock. As described in paragraph (iv)(B)(2)
of this Example 10, under paragraph (d)(5)(ii)(A) of
this section, for purposes of allocating S1’s $140 attribute reduction amount, S1’s deemed basis in the
S2 stock is reduced by the value of the transferred S2
share. Accordingly, for purposes of allocating S1’s
attribute reduction amount, S1’s deemed basis in the
S2 stock must be reduced by $50 (the value of the
transferred S2 share), to $25. Thus, $17.50 of S1’s
attribute reduction amount ($25/$200 x $140) is allocated to the S2 stock, $52.50 of S1’s attribute reduction amount ($75/$200 x $140) is allocated to the

592

S3 stock, and $70 of S1’s attribute reduction amount
($100/$200 x $140) is allocated to the S4 stock. Under paragraph (d)(5)(ii)(B)(1) of this section, none of
the amount allocated to S2 stock is apportioned to the
S2 share because gain was recognized on the transfer of the S2 share. However, the $52.50 allocated
to the S3 stock is apportioned and applied to reduce
the basis in the S3 share, from $60 to $7.50, and the
$70 allocated to the S4 stock is apportioned and applied to reduce the basis of the S4 share, from $100
to $30. (Note: Although the conforming limitation
in paragraph (d)(5)(ii)(D)(2) of this section limits the
application of tier down attribute reduction such that
the total amount of attribute reduction applied to reduce S1’s attributes does not exceed $130 (the excess
of S1’s $250 net inside attribute amount over $120,
the value of the transferred S1 shares ($40) plus the
basis of the nontransferred S1 shares after reduction
($80)), this limitation does not apply because only
$122.50 ($52.50 plus $70) of attribute reduction is
applied to reduce S1’s attributes.) Under paragraph
(d)(5)(ii)(D) of this section, the attribute reduction
amount allocated to the S2 stock, the S3 stock, and the
S4 stock becomes an attribute reduction amount of
S2, S3, and S4, respectively (even though the amount
allocated to S2 stock was not apportioned or applied
to reduce the basis of the S2 share).
(vi) Attribute reduction under this paragraph (d)
in lowest tier. Although the sale of the S2 share is a
transfer of subsidiary stock at the next lower tier, the
S2 share is not a loss share. Thus, this paragraph (d)
does not apply with respect to that transfer. However,
S2, S3, and S4 have attribute reduction amounts that
tiered down from S1 and that are applied to reduce
attributes under the provisions of this paragraph (d).
(A) Tier down of S1’s attribute reduction amount
to S2. Under the general rules of this paragraph (d),
S2’s $17.50 attribute reduction amount is allocated
and applied to reduce S2’s basis in Asset 2 from $75
to $57.50.
(B) Tier down of S1’s attribute reduction amount
to S3. Under the general rules of this paragraph (d),
S3’s $52.50 of attribute reduction amount is allocated
and applied to reduce S3’s basis in Asset 3 from $75
to $22.50.
(C) Tier down of S1’s attribute reduction amount
to S4, application of conforming limitation. Under
the general rules of this paragraph (d), S4’s $70 attribute reduction amount is allocated to, and would
be applied to reduce, S4’s basis in Asset 4. However, under paragraph (d)(5)(ii)(D)(2) of this section,
the reduction is limited to the excess of S4’s net inside attribute amount ($80) over the basis of the S4
share ($30, after reduction under this paragraph (d)).
As a result, only $50 (the excess of $80 over $30) of
S4’s $70 attribute reduction amount is applied to S4’s
basis in Asset 4, reducing it from $80 to $30. The
remaining $20 of S4’s attribute reduction amount is
disregarded and has no further effect.
(vii) Application of basis restoration rule. After all adjustments required under this paragraph (d)
have been given effect, reductions made to the basis of subsidiary stock under this paragraph (d) are
subject to reversal under the basis restoration rule in
paragraph (d)(5)(iii) of this section. Under this rule,
adjustments are reversed (and basis is restored) only
to the extent necessary to conform the basis of each
share with its allocable portion of the subsidiary’s net
inside attribute amount. The restoration adjustments

2007–8 I.R.B.

are first made at the lowest tier and then at each next
higher tier successively.
(A) Basis restoration at lowest tier. No restoration is permitted with respect to the S2 share because
the basis of the S2 share was not reduced under paragraph (d)(5)(ii)(B) of this section. S3’s net inside
attribute amount ($22.50, after reduction under this
paragraph (d)) exceeds S1’s basis in the S3 share
($7.50, after reduction under this paragraph (d)) by
$15. To conform S1’s basis in the S3 share to S3’s
net inside attribute amount, the $52.50 reduction to
the basis of the S3 share under paragraph (d)(5)(ii)(B)
of this section is reversed by $15 (restoring basis to
$22.50). The restoration of S1’s basis in the S3 share
does not tier up to affect the basis in stock of any

other subsidiary. S1’s basis in the S4 share ($30, after reduction under this paragraph (d)) is already conformed with S4’s net inside attribute amount ($30, after reduction under this paragraph (d)) and no restoration will be required or permitted under paragraph
(d)(5)(iii) of this section.
(B) Basis restoration at next higher tier. Each
share of S1 stock has an allocable portion of S1’s
net inside attribute amount equal to $10.25 (1/10 x
$102.50, the sum of S1’s adjusted bases in its S2 stock
($50, $0 plus $50 gain recognized), S3 stock ($22.50
after restoration), and S4 stock ($30)). Neither S’s
basis in S1 share 1 nor S’s basis in S1 share 2 was
reduced under this paragraph (d). Accordingly, the
basis of neither share is subject to restoration under

paragraph (d)(5)(iii) of this section. However, S’s basis in each of its other shares of S1 stock was reduced
by $10, from $20 to $10. Accordingly, the reduction
to the basis of each of those shares is reversed to the
extent of $.25, to restore the basis of each such share
to $10.25 (its allocable portion of S1’s net inside attribute amount).
(vii) Results. After the application of this section,
P recognizes a loss of $360 on the sale of the S share,
S recognizes a loss of $150 on the sale of S1 share
1, and S1 recognizes a $50 gain on the sale of the S2
share. Immediately after the transaction, the entities
each directly own the following:

Entity

Asset

Basis

P1

S share

$240

$240

P

Proceeds of the sale of S share

$240

$240

S

Proceeds of sale of Share 1 of S1 stock

$20

$20

Partnership interest received for Share 2

$20

$20

Shares 3 through 10 of S1 stock
S1

Value

$82
($10.25 per share)

Proceeds of sale of S2 share

$50

The S3 share

$22.50

The S4 share

$30

$50

S2

Asset 2

$57.50

S3

Asset 3

$22.50

S4

Asset 4

$30

X

Share 1 of S1 stock

$20

$20

Y

The S2 share

$50

$50

Partnership

Share 2 of S1 stock

$20

$20

(e) Operating rules—(1) Predecessors,
successors. This section applies to predecessor or successor persons, groups, and
assets to the extent necessary to effectuate
the purposes of this section.
(2) Adjustments for prior transactions
that altered stock basis or other attributes.
In certain situations, M’s basis in S stock
or S’s attributes are adjusted in a manner
that alters the relationship between stock
basis and inside attributes. Such adjustments affect the extent to which this relationship identifies unrecognized asset gain
reflected in stock basis and the extent to
which loss is duplicated. The provisions
of this paragraph (e)(2) modify the computations in paragraphs (c) and (d) of this
section to adjust for the effects of such adjustments.
(i) Reductions to S’s basis in assets
or other attributes pursuant to section 362(e)(2)(A). If S’s attributes have

2007–8 I.R.B.

been reduced under section 362(e)(2)
(taking into account the provisions of
§1.1502–13(e)(4)), then the disconformity amount of the S shares received
(or deemed received) in the transaction
to which section 362(e)(2) applied is reduced by the amount that the basis in such
shares would have been reduced under
section 362(e)(2)(C) (taking into account
the provisions of §1.1502–13(e)(4)) had
such an election been made. In addition,
for purposes of determining the attribute
reduction amount under paragraph (d) of
this section resulting from the transfer
of any S shares received (or deemed received) in a transaction to which section
362(e)(2) applied, and for purposes of
applying paragraph (d)(5)(ii)(D)(2) of this
section (conforming limitation) to S, the
basis in such shares is treated as reduced
by the amount the basis in such shares
would have been reduced under section

593

362(e)(2)(C) (taking into account the provisions of §1.1502–13(e)(4)) had such an
election been made.
(ii) Reductions to the basis of any share
of S stock pursuant to an election under section 362(e)(2)(C). If the basis of
any share of S stock has been reduced
as the result of an election under section 362(e)(2)(C) (taking into account the
provisions of §1.1502–13(e)(4)), then,
for purposes of computing either any S
share’s disconformity amount or S’s aggregate inside loss, and for purposes of
applying paragraph (d)(5)(iii) of this section (stock basis restoration) to S, S’s net
inside attribute amount is reduced by the
amount that S’s attributes would have
been reduced under section 362(e)(2)(A)
(taking into account the provisions of
§1.1502–13(e)(4)) in the absence of
an election under section 362(e)(2)(C)

February 20, 2007

(taking into account the provisions of
§1.1502–13(e)(4)).
(iii) Other adjustments. The Commissioner shall make such adjustments as
appropriate if the relationship between a
member’s basis in a share of S stock and
the share’s allocable portion of S’s net
inside attributes has been altered, other
than by the operation of §1.1502–32 or
this section, provided that such change
is not otherwise addressed in this section. Taxpayers may request a written
determination from the Commissioner determining that other adjustments to M’s
basis in S stock or S’s attributes are to be
adjusted in a manner consistent with the
principles of this paragraph (e)(2) for purposes of making the computations under
paragraphs (c) and (d) of this section.
(iv) Example. The application of this
paragraph (e)(2) is illustrated by the following example:
Example. Adjustments for intercompany section
362(e)(2) transaction. (i) Adjustments for reduction
of S’s basis in assets. (A) Facts. In an intercompany
section 362(e)(2) transaction (within the meaning
of §1.1502–13(e)(4)(i)), P contributes Asset 1 to
newly formed S in exchange for the sole outstanding
share of S stock. At the time of the contribution, P’s
basis in Asset 1 was $100 and its value was $20.
Accordingly, S’s basis in Asset 1 would have been
reduced by $80 under section 362(e)(2) and that $80
is a section 362(e)(2) amount within the meaning
of §1.1502–13(e)(4)(ii)(A). P sells the S share for
$20 in year 3. As of the time of the sale, no portion of the section 362(e)(2) amount has been taken
into account and thus the entire $80 is a remaining
section 362(e)(2) amount reflected in S’s basis in
Asset 1 and P’s basis in the share of S stock. P’s
sale of the S share is a section 362(e)(2) application
event within the meaning of §1.1502–13(e)(4)(iii)
and therefore, immediately before the sale, S’s
basis in Asset 1 is reduced by $80 pursuant to
section 362(e)(2) and §1.1502–13(e)(4)(iv). Under §1.1502–13(e)(4)(iv)(C), this reduction is not
a noncapital, nondeductible expense described in
§1.1502–32(b)(2)(iii), and does not affect P’s basis
in the S share. The sale is also a transfer of a loss
share and therefore subject to the provisions of this
section.
(B) Application of paragraph (b) of this section.
No adjustment is required under paragraph (b) of this
section, either because there is no potential for redetermination (members hold only one share of S stock)
or because P transfers the group’s entire interest in S
to a nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B)
of this section. After the application of paragraph (b)
of this section, P’s sale of the S share is still a transfer
of a loss share and therefore subject to paragraph (c)
of this section.
(C) Basis reduction under paragraph (c) of this
section. In determining the reduction of basis under
paragraph (c) of this section, the share’s disconformity amount is reduced by $80, the amount that the

February 20, 2007

basis in the S share would have been reduced under
§1.1502–13(e)(4)(v) had such an election been made.
The disconformity amount (and the net positive adjustment) are $0 and so no basis adjustment will be
made under paragraph (c) of this section. The transferred share is still a loss share and so is therefore
subject to paragraph (d) of this section.
(D) Attribute reduction under paragraph (d) of
this section. In determining the attribute reduction
amount under paragraph (d)(3) of this section, P’s
basis in the transferred share is treated as reduced by
$80, the amount that the basis in the S share would
have been reduced under §1.1502–13(e)(4)(v) had
such an election been made. As a result, P recognizes
an $80 loss on the sale of the S stock, but, for purposes of applying paragraph (d) of this section, the
net stock loss and, therefore, the attribute reduction
amount are $0.
(ii) Adjustments for election to reduce stock basis
under section 362(e)(2)(C). The facts are the same as
in paragraph (i) of this Example, except that P and S
elect to reduce P’s basis in the S share by $80 under
§1.1502–13(e)(4)(v). As a result, the basis of Asset
1 remains $100 and, immediately before the sale of
the S stock, P’s basis in the S share is reduced to $20.
Because the share is then not a loss share, this section does not apply to the transfer. If, instead, the
share were sold for less than $20, it would be a loss
share and the transfer would be subject to this section.
In that case, for purposes of computing the S share’s
disconformity amount, S’s aggregate inside loss, and
applying paragraph (d)(5)(iii) of this section, S’s net
inside attributes would be treated as reduced by $80,
the amount that S’s attributes would have been reduced under §1.1502–13(e)(4)(iv) had the election
under §1.1502–13(e)(4)(v) not been made.

(3) Plural, singular. All terms used
in this section include both the plural and
singular as the context may require.
(f) Definitions. In addition to the definitions in other paragraphs of this section and in §1.1502–1, the following definitions apply for purposes of this section.
(1) Allocable portion has the same
meaning as in §1.1502–32(b)(4)(iii)(B).
Thus, for example, within a class of stock,
each share has the same allocable portion
of the net inside attribute amount and, if
there is more than one class of stock, the
net inside attribute amount is allocated
to each class by taking into account the
terms of each class and all other facts and
circumstances relating to the overall economic arrangement.
(2) Deferred deduction means any deduction for expenses or loss that would
be taken into account under general tax
accounting principles as of the time of the
transfer of the share, but that is nevertheless not taken into account immediately after the transfer by reason of the application
of a deferral provision. Such provisions
include, for example, sections 267(f) and

594

469, and §1.1502–13. Deferred deduction
also includes equivalent amounts, such as
negative adjustments under section 475
(mark to market accounting method for
dealers in securities) and section 481 (adjustments required by changes in method
of accounting).
(3) Distribution has the same meaning
as in §1.1502–32(b)(3)(v).
(4) Higher tier, lower tier. A subsidiary
(S1) (and its shares of stock) is higher
tier with respect to another subsidiary (S2)
(and its shares of stock) if investment adjustments made to the bases of shares of
S2 stock under §1.1502–32 affect the investment adjustments made to the bases
of shares of S1 stock. A subsidiary (S1)
(and its shares of stock) is lower tier with
respect to another subsidiary (S) (and its
shares of stock) if investment adjustments
made to the bases of shares of S1 stock
affect the investment adjustments made to
the bases of shares of S stock. The term
lowest-tier subsidiary generally refers to
a subsidiary that owns no stock of another subsidiary. The term highest-tier
subsidiary generally refers to a subsidiary
the stock of which is not lower tier to any
shares transferred in the transaction.
(5) Liability means a liability that has
been incurred within the meaning of section 461(h), except to the extent otherwise
provided in paragraph (d)(4)(ii)(A)(1) of
this section.
(6) Loss carryover means any net operating or capital loss carryover attributable to S that is or, under the principles of
§1.1502–21, would be carried to S’s first
taxable year, if any, following the year of
the transfer.
(7) Loss share, gain share. A loss share
is a share of stock with a basis that exceeds
its value. A gain share is a share of stock
with a value that exceeds its basis.
(8) Preferred stock, common stock. Preferred stock and common stock have the
same meanings as in §1.1502–32(d)(2) and
(3), respectively.
(9) Publicly traded property. Property
is publicly traded property if it is traded on
an established market within the meaning
of §1.1273–2(f).
(10) Transaction includes all the steps
taken pursuant to the same plan or arrangement.
(11) Transfer—(i) Definition. Except
as provided in paragraph (f)(11)(ii) of this
section, for purposes of this section, M

2007–8 I.R.B.

transfers a share of S stock on the earliest
of—
(A) The date that M ceases to own the
share as a result of a transaction in which,
but for the application of this section, M
would recognize gain or loss with respect
to the share;
(B) The date that M and S cease to be
members of the same group;
(C) The date that a nonmember acquires
the share from M; and
(D) The last day of the taxable year during which the share becomes worthless under section 165(g), taking into account the
provisions of §1.1502–80(c).
(ii) Excluded transactions. Notwithstanding paragraph (f)(11)(i) of this section, M does not transfer a share of S stock
if—
(A) M ceases to own the share as a result
of a section 381(a) transaction in which
any member acquires assets from S or in
which S acquires assets from M, provided
that, in either case, M recognizes no gain
or loss with respect to the share; or
(B) M ceases to own the share as a result of a distribution of the share to a nonmember in a transaction to which section
355 applies, provided M does not recognize any gain or loss with respect to the
share as a result of the distribution of the
share.
(12) Value means the amount realized,
if any, or otherwise the fair market value.
(g) Anti-abuse rule—(1) General rule.
If a taxpayer acts with a view to avoid
the purposes of this section or to apply the
rules of this section to avoid the purposes
of any other rule of law, appropriate adjustments will be made to carry out the purposes of this section or such other rule of
law.
(2) Examples. The following examples
illustrate the principles of the anti-abuse
rule in this paragraph (g). No implication
is intended regarding the potential applicability of any other anti-abuse rules:
Example 1. Stuffing gain asset to eliminate loss.
(i) Facts. On January 1, year 1, P owns Asset 1 with
a basis of $0 and a value of $100. On that same date,
P purchases the sole outstanding share of S stock for
$100. At that time, S owns Asset 2 with a basis of
$0 and a value of $100. In year 1, S sells Asset 2 for
$100. In year 2, with a view to avoiding the basis
reduction rule in paragraph (c) of this section upon
the sale of the S share, P contributes Asset 1 to S in a
transaction to which section 351 applies and receives
an additional share of S stock with a basis of $0 under
section 358. On December 31, year 2, P sells its two
S shares for $200. After applying and giving effect

2007–8 I.R.B.

to all generally applicable rules of law (other than
this section), P’s basis in the original share of S stock
is $200 (P’s original $100 basis, increased by $100
under §1.1502–32 to reflect the $100 gain recognized
on the sale of Asset 2), and P’s basis in the other share
of S stock is $0.
(ii) Analysis. Absent the application of this paragraph (g), P would not recognize any net gain or loss
on the sale of the two S shares. Under paragraph
(c)(7) of this section, for purposes of computing the
basis reduction required by paragraph (c) of this section, P’s basis in the original share of S stock would
be treated as reduced by the gain recognized on the
other share of S stock. Further, P would not recognize any net stock loss within the meaning of paragraph (d)(3)(ii) of this section. Accordingly, this section would not apply to the transfer of the S shares.
However, because P contributed Asset 1 to S with a
view to avoiding the basis reduction rule in paragraph
(c) of this section, the contribution of Asset 1 is disregarded for purpose of applying this section. Accordingly, this section applies to the sale of the S share
without regard to the contribution of Asset 1, and the
basis of the original S share is reduced by $100 under
paragraph (c) of this section. P recognizes no gain or
loss on the sale of the original S share, and $100 of
gain on the sale of the other S share.
Example 2. Loss Trafficking. (i) Facts. On January 1, year 1, P purchases the sole outstanding share
of S stock for $100. At that time, S owns one asset, Asset 1, with a basis of $0 and a value of $100.
In year 1, S sells Asset 1 for $100 and, with a view
to eliminating the disconformity amount, S purchases
the sole outstanding share of X stock, a corporation
with a $100 NOL and an asset with a basis and value
of $1, from an unrelated party for $1. In year 2, X
is liquidated into S in a transaction to which section
332 applies. On December 31, year 2, P sells its S
share for $100. After applying and giving effect to
all generally applicable rules of law (other than this
section), P’s basis in the S share is $200 (P’s original
$100 basis, increased under §1.1502–32 to reflect the
$100 gain recognized on the sale of Asset 1). P’s sale
of the S share is a transfer of a loss share and therefore subject to the provisions of this section.
(ii) Analysis. No adjustment is required under
paragraph (b) of this section, either because there
is no potential for redetermination (members hold
only one share of S stock) or because P transfers
the group’s entire interest in S to a nonmember in
a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section.
Under paragraph (c) of this section, P’s basis in the
S share ($200) is reduced, but not below the share’s
value ($100), by the lesser of the share’s net positive
adjustment and disconformity amount. The share’s
net positive adjustment is the greater of zero and the
sum of all investment adjustments applied to the basis
of the share, computed without taking distributions
into account. There are no distributions. The only investment adjustment to the S share is the $100 positive adjustment attributable to the gain recognized
on the sale of Asset 1. The share’s net positive adjustment is therefore $100. The share’s disconformity amount is the excess, if any, of its basis ($200)
over its allocable portion of S’s net inside attribute
amount. Because S purchased the X stock and liquidated X with a view to avoiding the purposes of this
section (to utilize X’s attributes to minimize the dis-

595

conformity amount of the S loss share), the attributes
acquired from X are disregarded for purposes of applying this section. Accordingly, S’s net inside attribute amount is limited to S’s money ($100 from
the sale of Asset 1, less $1 for the purchase of the
X stock), or $99. The loss share’s allocable portion
of the $99 net inside attribute amount is $99. The
loss share’s disconformity amount is therefore the excess of $200 over $99, or $101. The lesser of the
share’s net positive adjustment ($100) and disconformity amount ($101) is $100. As a result, the basis in
the loss share is reduced by $100, and P recognizes
no gain or loss on the sale of the S share.
Example 3. Use of a partnership to prevent current attribute reduction. (i) Facts. P owns 100 shares
of S stock with a basis of $10 each. S owns Asset 1
with a basis of $1000 and a value of $100. In year
1, with a view to preventing a current reduction in
the basis of Asset 1, S and M form a partnership. S
contributes Asset 1 and M contributes Asset 2. On
December 31, year 1, P sells 20 S shares for $1 each.
After applying paragraph (c) of this section, P’s basis in each transferred S share is still $10, and P recognizes a $180 loss (a $9 loss on each transferred S
share).
(ii) Analysis. No adjustment is required under
paragraph (b) of this section because S has only one
class of stock outstanding and there is no disparity in
the bases of the shares. See paragraph (b)(1)(ii)(A)
of this section. No adjustment is required under paragraph (c) of this section because the net positive adjustment is $0. See paragraph (c)(3) of this section.
Absent the application of this paragraph (g), under
paragraph (d) of this section S’s attribute reduction
amount of $180 would be applied to reduce S’s basis in the partnership interest. Because S acted with
a view to avoiding a current reduction in the basis of
Asset 1 under paragraph (d) of this section, this section is applied by treating S as if it held Asset 1 at the
time of the stock sale.
Example 4. Creation of an intercompany receivable to mitigate attribute reduction. (i) Facts. P owns
100 shares of S stock each with equal basis that exceeds value. S owns cash and Asset 1 with a basis that
exceeds value. In year 1, with a view to mitigating a
reduction in the basis of Asset 1, S lends the cash to
M. On December 31, year 1, P sells 20 S shares and
recognizes a loss.
(ii) Analysis. No adjustment is required under
paragraph (b) of this section because S has only one
class of stock outstanding and there is no disparity in
the bases of the shares. See paragraph (b)(1)(ii)(A)
of this section. No adjustment is required under paragraph (c) of this section because the net positive adjustment is $0. See paragraph (c)(3) of this section.
Absent the application of this paragraph (g), under
paragraph (d) of this section S’s attribute reduction
amount would be applied to proportionately reduce
the basis in S’s assets. Accordingly, S’s basis in both
its intercompany receivable and Asset 1 would be reduced. Because S acted with a view to mitigating the
reduction in the basis of Asset 1 under paragraph (d)
of this section, this section is applied without regard
to the intercompany receivable. Accordingly, S’s basis in Asset 1 is reduced by the full attribute reduction
amount.

(h) Effective date. This section applies to all transfers on or after the date

February 20, 2007

these regulations are published as final
regulations in the Federal Register. For
rules applicable on and after March 10,
2006, and before the date these regulations
are published as final regulations in the
Federal Register, see §§1.1502–35 and
1.337(d)–2 as contained in 26 CFR part 1
in effect on January 1, 2007. For rules applicable on and after March 3, 2005 and before March 10, 2006, see §§1.337(d)–2T,
1.1502–20 and 1.1502–35T as contained
in 26 CFR part 1 in effect on April 1,
2005. For rules applicable before March
3, 2005, see §§1.337(d)–2T, 1.1502–20,
and 1.1502–35T as contained in 26 CFR
part 1 in effect on April 1, 2004.
Par. 16. Section 1.1502–80 is amended
by:
1. Revising paragraphs (a) and (c).
2. Adding new paragraph (g).
The revisions and addition read as follows:
§1.1502–80 Applicability of other
provisions of law.
(a) In general. The Internal Revenue
Code, or other law, shall be applicable to
the group to the extent the regulations do
not exclude its application. To the extent
not excluded, other rules operate in addition to, and may be modified by, these regulations. Thus, for example, in a transaction to which section 381(a) applies, the
acquiring corporation will succeed to the
tax attributes described in section 381(c).

Section

Furthermore, sections 269 and 482 apply
for any consolidated year. However, in a
recognition transaction otherwise subject
to section 1001, for example, the rules of
section 1001 continue to apply, but may be
modified by the intercompany transaction
regulations under §1.1502–13. Nothing in
these regulations shall be interpreted or applied to require an adjustment to a member’s basis in subsidiary stock or other attributes to the extent the adjustment would
have the effect of duplicating another adjustment required under the Code or other
rule of law, including other provisions of
these regulations.
*****
(c) Deferral of section 165—(1) General rule. Subsidiary stock is not treated as
worthless under section 165 until immediately before the earlier of the time—
(i) The stock is worthless within the
meaning of §1.1502–19(c)(1)(iii); and
(ii) The subsidiary for any reason ceases
to be a member of the group.
(2) Cross reference. See §1.1502–36
for additional rules relating to stock loss.
*****
(g) Effective dates. Paragraphs (a) and
(c) of this section are applicable on or after
the date these regulations are published as
final regulations in the Federal Register.
Par. 17. Section 1.1502–91 is amended
by revising paragraph (h)(2) to read as follows:

§1.1502–91 Application of section 382
with respect to a consolidated group.
*****
(h) * * *
(2) Disposition of stock or an intercompany obligation of a member. Gain or loss
recognized by a member on the disposition
of stock (including stock described in section 1504(a)(4) and §1.382–2T(f)(18)(ii)
and (iii)) of another member is treated as
a recognized gain or loss for purposes of
section 382(h)(2) (unless disallowed) even
though gain or loss on such stock was not
included in the determination of a net unrealized built-in gain or loss under paragraph (g)(1) of this section. Gain or loss
recognized by a member with respect to
an intercompany obligation is treated as
recognized gain or loss only to the extent
(if any) the transaction gives rise to aggregate income or loss within the consolidated group. The first sentence of this
paragraph (h)(2) is applicable on or after
the date these regulations are published as
final regulations in the Federal Register.
*****
Par. 18. For each section listed in the table, remove the language in the “Remove”
column and add in its place the language
in the “Add” column as set forth below:

Remove

Add

§1.267(f)–1(k)

§1.337(d)–2; §1.1502–35

§1.1502–36

§1.597–4(g)(2)(v)

§§1.337(d)–2 and 1.1502–35(f)

§1.1502–36

§1.1502–11(b)(3)(ii)(c)

§§1.337(d)–2 and 1.1502–35

§1.1502–36

§1.1502–12(r)

§§1.337(d)–2 and 1.1502–35

§1.1502–36

§1.1502–15(b)(2)(iii)

§§1.337(d)–2, 1.1502–35, or

§1.1502–36

§1.1502–32(b)(3)(iii)(B)

§1.1502–35(b) or (f)(2)

Mark E. Matthews,
Deputy Commissioner
for Services and Enforcement.
(Filed by the Office of the Federal Register on January 16,
2007, 10:51 a.m., and published in the issue of the Federal
Register for January 23, 2007, 72 F.R. 2963)

Update to Revenue Procedure
2001–31, Filing Summary of
Archer MSAs, Electronically
Announcement 2007–15
The Tax Relief and Healthcare Act of
2006 (P.L. 109–432) requires trustee/custodians to file Form 8851, Summary
of Archer MSAs. Revenue Procedure

February 20, 2007

596

2001–31 contains procedures for filing
Form 8851. Currently, this revenue procedure is being revised but will not be
available by March 20, 2007, the due date
of Form 8851. Numerous changes are being made to the revenue procedure. This
announcement details the major changes
so filers can use this announcement along
with Revenue Procedure 2001–31 to file

2007–8 I.R.B.