Reg-110405-05

Federal Register / Vol. 71, No. 204 / Monday, October 23, 2006 / Proposed Rules
by BIS in reviewing the controls and
developing the report to Congress.
All information relating to the notice
will be a matter of public record and
will be available for public inspection
and copying. In the interest of accuracy
and completeness, BIS requires written
comments. Oral comments must be
followed by written memoranda, which
will also be a matter of public record
and will be available for public review
and copying.
The Office of Administration, Bureau
of Industry and Security, U.S.
Department of Commerce, displays
these public comments on BIS’s
Freedom of Information Act (FOIA) Web
site at http://www.bis.doc.gov/foia. This
office does not maintain a separate
public inspection facility. If you have
technical difficulties accessing this Web
site, please call BIS’s Office of
Administration at (202) 482–0637 for
assistance.
Dated: October 12, 2006.
Christopher A. Padilla,
Assistant Secretary for Export
Administration.
[FR Doc. E6–17713 Filed 10–20–06; 8:45 am]
BILLING CODE 3510–33–P

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG–110405–05]
RIN 1545–BE58

Limitations on Transfers of Built-in
Losses
Internal Revenue Service (IRS),
Treasury.
ACTION: Notice of proposed rulemaking.

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AGENCY:

SUMMARY: This document contains
proposed regulations under section
362(e)(2) of the Internal Revenue Code
of 1986 (Code). The proposed
regulations reflect changes made to the
law by the American Jobs Creation Act
of 2004. These proposed regulations
provide guidance regarding the
determination of the bases of assets and
stock transferred in certain
nonrecognition transactions and will
affect corporations and large
shareholders of corporations, including
individuals, partnerships, corporations,
and tax-exempt entities.
DATES: Written or electronic comments
and requests for a public hearing must
be received by January 22, 2007.
ADDRESSES: Send submissions to
CC:PA:LPD:PR (REG–110405–05),

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Internal Revenue Service, PO Box 7604,
Ben Franklin Station, Washington, DC
20044. Submissions may be hand
delivered to CC:PA:LPD:PR (REG–
110405–05), Courier’s Desk, Internal
Revenue Service, Crystal Mall 4
Building, 1901 S. Bell St., Arlington,
VA. Alternatively, taxpayers may
submit comments electronically directly
to the IRS Internet site at www.irs.gov/
regs or Federal e-Rulemaking Portal at
www.regulations.gov (IRS REG–110405–
05).
FOR FURTHER INFORMATION CONTACT:
Concerning the proposed regulations,
Jay M. Singer, (202) 622–7530 (not tollfree number), or concerning
submissions of comments, Richard A.
Hurst,
[email protected].
SUPPLEMENTARY INFORMATION:
Background
Prior to 1999, Congress grew
concerned that taxpayers were engaging
in corporate nonrecognition transactions
in order to accelerate and duplicate
losses. See S. Rep. No. 201, 106th Cong.,
1st Sess. 46–48 (1999). Congress was
primarily concerned with the
acceleration and duplication of losses
through the assumption of liabilities
(including liabilities to which assets
transferred in a corporate
nonrecognition transaction were
subject). As a result, in 1999, Congress
enacted section 362(d) of the Code to
prevent the bases of assets transferred to
a corporation from being increased
above such assets’ aggregate fair market
value as a result of a liability
assumption. In addition, in 2000,
Congress enacted section 358(h) to
reduce the basis of stock received in
certain corporate nonrecognition
transactions, but not below fair market
value, by the amount of any liabilities
assumed in the transaction.
Following the enactment of sections
362(d) and 358(h), Congress remained
concerned that taxpayers were engaging
in various tax-motivated transactions to
take more than one tax deduction for a
single economic loss. Consequently, in
the American Jobs Creation Act of 2004
(Pub. L. 108–357, 188 Stat. 1418),
Congress enacted section 362(e), which
limits the ability of taxpayers to
duplicate net built-in loss in certain
nonrecognition transactions.
Section 362(e)(1)(A) provides that if
there would be an importation of a net
built-in loss in a transaction described
in section 362(a) or (b), the basis of
certain property acquired in such a
transaction shall be its fair market value
immediately after the transaction.
Section 362(e)(1)(B) provides that

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property is described in section
362(e)(1) if gain or loss with respect to
such property is not subject to tax in the
hands of the transferor immediately
before the transfer, and gain or loss with
respect to such property is subject to tax
in the hands of the transferee
immediately after the transfer. Further,
section 362(e)(1)(C) provides that there
is an importation of net built-in loss in
a transaction if the transferee’s aggregate
adjusted basis in such property would
(but for the application of section
362(e)(1)) exceed the aggregate fair
market value of such property
immediately after the transaction.
Section 362(e)(2)(A) provides that if
property is transferred by a transferor to
a transferee in a transaction described in
section 362(a) and not described in
section 362(e)(1), and if the transferee’s
aggregate adjusted basis in the
transferred property would (but for the
application of section 362(e)(2)) exceed
its aggregate fair market value
immediately after the transfer, then the
transferee’s aggregate adjusted basis in
the transferred property shall not exceed
the fair market value of the property
immediately after the transfer. Further,
section 362(e)(2)(B) provides that this
aggregate reduction in the basis of the
transferred property shall be allocated
among the property in proportion to
their respective built-in losses
immediately before the transaction. As
an alternative to this reduction in the
basis of the transferred assets, section
362(e)(2)(C) provides that if the
transferor and the transferee both so
elect, section 362(e)(2)(A) shall not
apply, and the transferor’s basis in the
stock of the transferee received in
exchange for the property that would
otherwise be subject to basis reduction
under section 362(e)(2)(A) shall not
exceed its fair market value.
Since the enactment of section
362(e)(2), the IRS and Treasury
Department have been exploring issues
concerning the interpretation, scope,
and application of the section and have
proposed these regulations to address
these issues. Additional guidance
regarding the application of section
362(e)(2) to transfers between members
of a consolidated group and the
treatment of transactions that have the
effect of importing losses into the U.S.
tax system (to which section 362(e)(1)
applies) will be addressed in separate
guidance projects.
Explanation of Provisions
1. General Provisions
In general, these proposed regulations
apply to transfers of net built-in loss
property within the U.S. tax system in

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which the Code otherwise would
duplicate the net built-in asset loss in
the stock of the transferee. Such
transfers include exchanges subject to
section 351, capital contributions, and
transfers of paid-in surplus. However,
these proposed regulations do not apply
to a transfer where the duplicated loss
is imported into the U.S. tax system and
the transfer is subject to section
362(e)(1), which addresses certain loss
importation transactions. Property is net
built-in loss property if the transferee
corporation’s aggregate basis in the
property, but for the application of
section 362(e)(2), would exceed the
aggregate fair market value of such
property immediately after the transfer.
If section 362(e)(2) applies to a
transfer, the transferee corporation
receives the property with an aggregate
basis not exceeding the aggregate fair
market value of the property
immediately after the transfer. The
transferee allocates the basis reduction
among the transferred loss properties in
proportion to the amount of loss in each
such property immediately before the
transfer.
Taxpayers have questioned the effect
of any gain taken into account as a
result of the transfer. The IRS and
Treasury Department have determined
that any gain recognized by the
transferor that increases the transferee
corporation’s basis in the transferred
property must be taken into account in
order to determine the full amount of
loss duplication. Accordingly, these
proposed regulations provide that in
determining whether the transferred
property has a net built-in loss in the
hands of the transferee, the bases of
such property first must be increased
under section 362(a) or (b) for any gain
recognized by the transferor on the
transfer of the property.
There also have been questions about
the application of section 362(e)(2) in
the case of multiple transferors. The
legislative history to section 362(e)(2)
contains some potentially conflicting
language that refers to the aggregate
adjusted basis of property contributed
by a transferor or a control group of
which the transferor is a member. See
Conf. Rep. No. 108–755, 108th Cong., 2d
Sess. 635 (2004). However, because the
basis rules in section 362 and section
358 are applied on a transferor-bytransferor basis, applying section
362(e)(2) to an aggregated group of
transferors would undermine Congress’
intent to prevent loss duplication.
Further, section 362(e)(2) specifically
refers to property ‘‘transferred by a
transferor.’’ Accordingly, these
proposed regulations clarify that section
362(e)(2) applies separately to each

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transferor. Thus, each transferor’s
transfer is measured separately, and the
determination of whether that transfer is
subject to these provisions is made
solely by reference to the property
transferred by such transferor.
Consequently, the treatment of one
transferor is unaffected by the transfer of
property by any other transferor for
purposes of section 362(e)(2).
In addition, these proposed
regulations clarify that, even if part of a
transaction is subject to section
362(e)(1), section 362(e)(2) can apply to
the portion of the transaction that is not
described in section 362(e)(1).
2. Application of Section 362(e)(2) to
Transfers Outside of the U.S. Tax
System
Under general principles of law, the
Code applies to all transactions without
regard to whether such application has
any current U.S. tax consequences. In
the case of transfers that are wholly
outside the U.S. tax system, section
362(e)(2) applies but does not have
relevance unless and until the assets
transferred or the stock received in the
exchange enter the U.S. tax system.
Such assets or stock may subsequently
enter the U.S. tax system either directly
or indirectly. For example, the assets or
stock could directly enter the U.S. tax
system through a transfer of all or a
portion of such assets or stock to a U.S.
person, or as a result of the original
transferor or original transferee
becoming a U.S. person. Further, the
assets or stock could indirectly enter the
U.S. tax system, for example, through a
transfer of all or a portion of such assets
or stock to a CFC, or as a result of the
original transferor or original transferee
becoming a CFC. However, in many
cases the U.S. tax treatment of a transfer
that is wholly outside the U.S. tax
system will never become relevant. The
IRS and Treasury Department recognize
that, if a transferor does not anticipate
the transfer becoming U.S. tax relevant,
it is not likely to undertake the
valuation and record-keeping that
section 362(e)(2) would generally
require. If circumstances change at some
later date, the administrative burden of
reconstructing appropriate records may
be substantial.
The IRS and Treasury Department
have determined that relief is
appropriate when transactions are
consummated with no plan or intention
to enter the U.S. tax system. Thus, if
assets are transferred in a transaction
that is potentially subject to section
362(e)(2) more than two years before
entering the U.S. tax system, then,
solely for purposes of section 362(e)(2),
these proposed regulations generally

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presume that the aggregate fair market
value of the transferred assets equals
their aggregate adjusted basis in the
hands of the transferee immediately
after the transfer. This presumption
applies only if neither the original
transfer nor the later entry of any
portion of the assets into the U.S. tax
system was undertaken with a view to
reducing the U.S. tax liability of any
person or duplicating loss by avoiding
the application of section 362(e)(2).
If a transfer subject to section
362(e)(2) occurs within the two-year
period immediately before becoming
U.S. tax relevant, the IRS and Treasury
Department do not believe that relief
from the administrative burden is either
necessary or appropriate. Thus, in such
a case, the fair market value
presumption does not apply, and
section 362(e)(2) applies to the original
transfer. The proposed regulations
provide the relevant parties a means by
which to make an election under section
362(e)(2)(C), if desired, at the time of
entry into the U.S. tax system.
3. General Application of Section
362(e)(2) to Reorganizations
Taxpayers have questioned whether a
transaction described in both sections
362(a) and 362(b) may be subject to
section 362(e)(2). The IRS and Treasury
Department believe that, if there is a
duplication of loss in a transaction
described in section 362(a) (and not
subject to section 362(e)(1)),
Congressional intent requires that the
transaction be recognized as described
in section 362(a) notwithstanding that it
is also described in section 362(b). The
proposed regulations clarify that section
362(e)(2) can apply to such transactions.
4. Exception for Transactions in Which
Net Built-in Loss Is Eliminated Without
Recognition
In certain transactions, the transferor’s
duplicated basis in the transferee stock
or securities is eliminated by operation
of statute without recognition or benefit.
For example, in a transaction meeting
the requirements of both sections 351
and 368(a)(1)(D), the transferor
ordinarily receives stock with an
aggregate basis equal to that of the
transferred property. As a result, where
the transferred property has a net-built
in loss, but for section 362(e)(2), the
transferor would receive the transferee
stock with an adjusted basis that
duplicates the built-in loss in the
transferred property. However, if the
transferor distributes the transferee
stock pursuant to a section 368(a)(1)(D)
acquisitive reorganization or pursuant to
section 355, no taxpayer will recognize
the duplicated loss because the

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distributee will determine its basis in
the transferee stock by reference to its
basis in surrendered stock of the
transferor.
The IRS and Treasury Department
have concluded that, even if a
transaction is described in section
362(e)(2), if there is no duplicated loss
that can be recognized, section 362(e)(2)
should not apply. Accordingly, these
proposed regulations provide that
section 362(e)(2) will not apply to
transactions to the extent that loss
duplication is prevented or eliminated
where the transferor distributes the
transferee stock and/or securities
received in the transaction without
recognizing gain or loss, and, upon
completion of the transaction, no person
holds any asset with a basis determined
in whole or in part by reference to the
transferor’s basis in the transferee stock
and/or securities.

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5. Application of Section 362(e)(2) to
Transfers in Exchange for Securities
In certain transactions, net built-in
loss also can be duplicated in securities
received without the recognition of gain
or loss. For example, a U.S. transferor
duplicates a net built-in loss when it
transfers property with a net built-in
loss to a U.S. controlled corporation in
exchange for stock and securities and all
or part of the securities are retained
following the distribution of the stock of
the controlled corporation pursuant to
section 355. Such a transaction is
described in section 362(a) but not
section 362(e)(1) and, accordingly, may
be subject to section 362(e)(2).
Although the statute is silent about
the treatment of securities received in
such a property transfer, the IRS and
Treasury Department have concluded
that Congressional intent would be
circumvented if section 362(e)(2) were
treated as not applying to both stock and
securities received in transactions to
which section 362(e)(2) applies.
Accordingly, these proposed regulations
apply section 362(e)(2) to transfers in
exchange for both stock and securities to
the extent necessary to eliminate loss
duplication.
Because the section applies equally to
transfers in exchange for both stock and
securities, the IRS and Treasury
Department have concluded that
taxpayers must be allowed to make an
election under section 362(e)(2)(C) for
both stock and securities. Accordingly,
these proposed regulations allow the
transferor and transferee to elect to
apply section 362(e)(2)(C) to the
transferee stock and securities received
in the exchange.

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6. Election To Reduce Stock Basis
Section 362(e)(2)(C) permits
transferors and transferees that engage
in transactions to which section
362(e)(2) applies to elect to reduce the
transferor’s basis in the stock received
instead of reducing the transferee
corporation’s basis in the property
transferred. As described in this
preamble, section 362(e)(2)(C) provides
that if the election is made, section
362(e)(2)(A) shall not apply, and the
transferor’s basis in the transferee stock
received in the exchange shall not
exceed its fair market value immediately
after the exchange. The statutory
language might be interpreted to require
the transferor to reduce its basis in the
stock received by an amount that is
larger than the amount by which the
transferee otherwise would have been
required to reduce its aggregate basis in
the assets under section 362(e)(2)(A).
For example, assume a corporation, P,
contributes a trade or business to a
subsidiary, S, in a transaction to which
section 351 applies. The assets of the
business have an aggregate adjusted
basis of $100 and a value of $90, and the
business has $20 of associated
contingent liabilities. Even if section
358(h)(2)(A) applies to prevent section
358 from reducing P’s basis in the S
stock by the amount of the contingent
liabilities, section 362(e)(2)(C) might be
interpreted to limit P’s basis in the S
stock to $70 (notwithstanding that
section 362(e)(2)(A) would only require
a $10 reduction in the basis of the assets
in the hands of S). Thus, a section
362(e)(2)(C) election might result in a
larger basis reduction in the stock than
would be required in the assets absent
an election.
The IRS and Treasury Department
believe that, because section 362(e)(2) is
intended to prevent the duplication of
net built-in loss in the transferred assets,
the amount of basis reduction resulting
from an election under section
362(e)(2)(C) should not be any larger
than what is necessary to eliminate the
duplication of loss in the transferred
assets. Therefore, these proposed
regulations clarify that the amount of
the reduction in the basis of the
transferee stock (and securities) as a
result of an election to apply section
362(e)(2)(C) is equal to the net built-in
loss in the transferred assets in the
hands of the transferee. In other words,
under the proposed regulations, the
amount of the reduction in the basis of
the transferee stock (and securities)
resulting from such an election equals
the amount of the reduction in the basis
of the assets required by section
362(e)(2)(A) absent the election.

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These proposed regulations also
implement Notice 2005–70, 2005–41
IRB 694, see § 601.601(d)(2), which
instructs taxpayers how to elect to apply
section 362(e)(2)(C). These proposed
regulations revise and expand upon the
procedures in Notice 2005–70 to
provide more methods and time periods
in which to make the section
362(e)(2)(C) election. Specifically, the
regulations expand the classifications of
persons who can attach the required
election statement to a tax return
(including an information return).
The ‘‘protective election’’ referenced
in Notice 2005–70 also is included in
the proposed regulations because the
IRS and Treasury Department anticipate
that, at the time of the transaction,
taxpayers may not always be able to
determine with reasonable certainty
whether section 362(e)(2) applies to a
transfer.
The IRS and Treasury Department
request comments on whether the
instructions provided in these proposed
regulations adequately address the
needs of taxpayers. In particular, the IRS
and Treasury Department invite
comments regarding whether,
alternatively, a separate form should be
developed and made available to enable
taxpayers to make the section
362(e)(2)(C) election prior to and apart
from filing it with a U.S. return.
The basis tracing provisions in
§ 1.358–2 apply to certain transfers to
which section 351 and either section
354 or section 356 apply. However, the
IRS and Treasury Department believe
that the basis tracing provisions in
§ 1.358–2 should not apply to a transfer
to which section 362(e)(2) also applies
if the transferor and transferee make an
election to apply section 362(e)(2)(C).
The IRS and Treasury Department
believe that the statutory language in
section 362(e)(2)(C) and the policy of
preventing loss duplication precludes
the application of the basis tracing
provisions because basis tracing could
allow the transferor to hold transferee
stock or securities with a basis in excess
of fair market value even after a
reduction under section 362(e)(2)(C).
Accordingly, these proposed regulations
provide that the provisions of § 1.358–
2(a)(2) will not apply to a transaction to
which section 362(e)(2) applies if the
transferor and transferee elect to apply
section 362(e)(2)(C). The IRS and
Treasury Department request comments
regarding whether this treatment is
appropriate.
7. Transfers by Partnerships and S
Corporations
The proposed regulations also provide
that, where the transferor is a

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partnership and a section 362(e)(2)(C)
election is made, any reduction to the
partnership’s basis in the transferee
stock received is treated as an
expenditure of the partnership, as
described in section 705(a)(2)(B). The
proposed regulations provide a similar
rule applicable to transfers by S
corporations that elect to apply section
362(e)(2)(C).
The IRS and Treasury Department are
further exploring how the provisions of
section 362(e)(2) apply to partnerships.
The IRS and Treasury Department invite
comments on this general issue and
specifically invite comments regarding
the transfer of a partnership interest in
exchange for stock in a section 351
transaction to which section 362(e)(2)
applies. For example, individuals A and
B contribute cash to form a partnership,
PRS. PRS purchases property that
subsequently decreases in value. A
contributes his PRS interest to a
corporation in a transaction that
qualifies under section 351. PRS does
not make an election under section 754.
Comments are invited regarding the
interaction of section 362(e)(2) and the
partnership provisions under these and
similar facts.

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8. Application of Section 336(d) to
Property Previously Transferred in a
Section 362(e)(2) Transaction
Commentators have questioned how
section 362(e)(2) interacts with other
Code sections. Specifically, some have
asked how section 362(e)(2) applies
when section 336(d) might be
implicated. Section 336(d) provides
various limitations on a liquidating
corporation’s ability to recognize loss
when it distributes property acquired in
a section 351 transaction or as a
contribution to capital. The IRS and
Treasury Department believe that,
generally, sections 336(d) and 362(e)(2)
are fully compatible where the parties
do not make an election to apply section
362(e)(2)(C). However, where an
election has been made, the two
sections may operate to deny part or all
of an economic loss. The IRS and
Treasury Department invite comments
regarding this issue.
9. Application to Section 304
Transactions
In response to inquiries, the proposed
regulations contain an example
demonstrating how section 362(e)(2)
applies to a section 351 transaction
treated as occurring under section 304.
The IRS and Treasury Department are
considering whether the regulations
should deem an election to apply
section 362(e)(2)(C) to have been made
in section 304 transactions. The IRS and

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Treasury Department invite comments
regarding this issue.
Proposed Effective Date
These proposed regulations are
proposed to apply to transactions
occurring after the date these
regulations are published as final
regulations in the Federal Register.
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
has also been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations, and, because the
regulations do not impose a collection
of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Code, 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 a 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
rules and how they can be made easier
to understand. All comments will be
available for public inspection and
copying. A public hearing may be
scheduled if requested in writing by any
person who timely submits written
comments. If a public hearing is
scheduled, notice of the date, time, and
place of the hearing will be published
in the Federal Register.
Drafting Information
The principal authors of these
regulations are Jay M. Singer and Filiz
A. Serbes of the Office of Associate
Chief Counsel (Corporate), IRS.
However, other personnel from the IRS
and Treasury Department participated
in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
proposed to be amended as follows:

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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 1.362–4 also issued under 26
U.S.C. 362. * * *
Par. 2. Section 1.358–2 is amended by
revising paragraphs (a)(2)(viii) and
adding a new sentence at the end of
paragraph (d) to read as follows:
§ 1.358–2 Allocation of basis among
nonrecognition property.

(a) * * *
(2) * * *
(viii) This paragraph (a)(2) shall not
apply to determine the basis of a share
of stock or security received by a
shareholder or security holder in an
exchange described in both section 351
and either section 354 or section 356, if,
in connection with the exchange, the
shareholder or security holder
exchanges property for stock or
securities in an exchange to which
neither section 354 nor section 356
applies, the shareholder or security
holder exchanges property for stock or
securities to which it elects to apply
section 362(e)(2)(C), or liabilities of the
shareholder or security holder are
assumed.
*
*
*
*
*
(d) * * * Paragraph (a)(2)(viii) of this
section applies to exchanges and
distributions of stock occurring after the
date these regulations are published as
final regulations in the Federal Register.
Par. 3. In § 1.362–3, the section
heading is added and reserved to read
as follows:
§ 1.362–3 Limitations on loss importation.
[Reserved].

Par. 4. Section 1.362–4 is added to
read as follows:
§ 1.362–4 Limitations on built-in loss
duplication.

(a) Purpose and scope. The purpose of
this section is to prevent the duplication
of net built-in loss in transactions
described in section 362(e)(2). Section
362(e)(2) applies to transfers of net
built-in loss property described in
section 362(a) but only to the extent not
described in section 362(e)(1).
(b) Application—(1) In general. If
property is transferred in any
transaction described in section 362(a)
but not section 362(e)(1), and, in the
hands of the transferee, the transferred
property would otherwise have a net
built-in loss immediately after the
transfer, then the transferee corporation
receives such property with an aggregate

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adjusted basis not exceeding the
aggregate fair market value of such
property immediately after the transfer.
If multiple built-in loss properties are
transferred, the aggregate reduction in
basis shall be allocated among the builtin loss properties so transferred in
proportion to the relative amount of
built-in loss in each property.
(2) Multiple transferors. If more than
one transferor transfers property to a
corporation in a transaction described in
section 362(a), whether and the extent
to which this section applies is
determined separately for each
transferor.
(3) Transactions described in section
362(e)(1). A transfer of property to a
corporation is described in section
362(e)(1) only if and to the extent that
the transferred property described in
section 362(e)(1)(B) (section 362(e)(1)(B)
property) would otherwise have a net
built-in loss in the hands of the
transferee. Thus, if a transferor transfers
net built-in loss section 362(e)(1)(B)
property together with property not
described in section 362(e)(1)(B), the
transfer of the net built-in loss section
362(e)(1)(B) property is described in
section 362(e)(1). Accordingly, the net
built-in loss section 362(e)(1)(B)
property is not taken into account for
purposes of determining whether
section 362(e)(2) applies to the transfer
of the other property. Alternatively, if a
transferor transfers net built-in gain
section 362(e)(1)(B) property together
with property not described in section
362(e)(1)(B), no portion of the transfer is
described in section 362(e)(1).
(4) Net built-in loss—(i) In general.
Transferred property has a net built-in
loss if its aggregate adjusted basis
exceeds its aggregate fair market value.
(ii) Basis adjustments for gain
recognized on the transfer. For purposes
of determining whether the transferred
property has a net built-in loss in the
hands of the transferee, the bases of
such property first must be increased
under section 362(a) or (b) for any gain
recognized by the transferor on the
transfer of such property.
(5) Application of section 362(e)(2) to
reorganizations. Section 362(e)(2) can
apply to a transfer regardless of whether
the basis of the property would, but for
section 362(e)(2), be determined under
section 362(b).
(6) Exception for transactions in
which net built-in loss is eliminated
without recognition. Section 362(e)(2)
does not apply to a transfer of property
to the extent that—
(i) The transferor distributes, without
recognizing gain or loss, all of the
transferee stock received in exchange for
the transferred property; and

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(ii) Upon completion of the
transaction, no person holds transferee
stock or any other asset with a basis
determined in whole or in part by
reference to the transferor’s basis in the
transferee stock.
(7) Transfers where neither party is a
U.S. person, a person otherwise required
to file a U.S. return, or a CFC. If
property is transferred in a transaction
described in section 362(a) but not
section 362(e)(1), then, solely for
purposes of section 362(e)(2), the
aggregate fair market value of the
transferred property shall be deemed to
equal the aggregate adjusted basis of
such property in the hands of the
transferee immediately after the transfer
if—
(i) Neither party to the transfer was a
United States (U.S.) person (as defined
in section 7701(a)(30)) on the date of the
transfer;
(ii) Neither party to the transfer was
required to file a return of tax under
Subtitle A of the Internal Revenue Code
(including an information return) for the
year of the transfer;
(iii) Neither party to the transfer was
a controlled foreign corporation (CFC),
as defined in section 957, on the date of
the transfer;
(iv) The transfer occurred more than
two years prior to the date on which the
transferor, transferee, or transferred
assets are first described in paragraph
(c)(5)(iii) of this section; and
(v) Neither the transfer nor the later
entry into the U.S. tax system was
entered into with a view to reducing the
U.S. Federal income tax liability of any
person or duplicating loss by avoiding
the application of section 362(e)(2).
(c) Section 362(e)(2)(C) election to
apply limitation to transferor’s stock
basis—(1) In general. If section 362(e)(2)
applies to a transfer, the transferor and
the transferee may make a joint election
to reduce the transferor’s basis in the
transferee stock instead of reducing the
transferee’s basis in the property
received under paragraph (b) of this
section. Once made, the election is
irrevocable. If the election is made, the
transferor’s basis in the transferee stock
is reduced upon receipt by the
transferor. The transferor and the
transferee may make a protective
election under this section, which will
have no effect if section 362(e)(2) does
not apply to the transfer, but which will
otherwise be binding and irrevocable.
(2) Stock and securities to which this
section applies. For purposes of this
section, the term stock means stock and
securities received without the
recognition of gain or loss in a
transaction to which section 362(e)(2)
applies. See, for example, transactions

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described in sections 368(a)(1)(D) and
355.
(3) Amount of basis reduction. If an
election is made pursuant to paragraph
(c)(1) of this section, the amount of the
basis reduction in the transferee stock
received by the transferor in the
transaction is equal to the total amount
by which the aggregate basis of the
transferred property would have been
reduced under paragraph (b) of this
section had such election not been
made.
(4) Allocation of basis reduction. The
transferor shall allocate the amount of
the basis reduction under this paragraph
(c) among all transferee stock received
in the transaction in proportion to fair
market value.
(5) Procedures for making the
election—(i) In general. To make an
election to apply section 362(e)(2)(C)—
(A) Prior to filing the election
statement as described in paragraph
(c)(5)(ii) or (c)(5)(iii) of this section, the
transferor and transferee must execute a
written, binding agreement electing to
apply section 362(e)(2)(C); and
(B) An election statement must be
filed pursuant to paragraph (c)(5)(ii) or
(c)(5)(iii) of this section.
(ii) Election statement where the
transferor or transferee is a U.S. person,
a person otherwise required to file a
U.S. return for the year of the transfer,
or a CFC on the date of the transfer—
(A) Transferor is a U.S. person or a
person otherwise required to file a U.S.
return for the year of the transfer. If the
transferor is a U.S. person on the date
of the transfer or a person otherwise
required to make a return of tax under
Subtitle A of the Internal Revenue Code
(including an information return) for the
year of the transfer, the election
statement is filed by including the
following statement on or with the
transferor’s timely filed original return
(including extensions) for the taxable
year in which the transfer occurred:
‘‘[insert name and tax identification
number of transferor] certifies that
[insert name and tax identification
number of transferor] and [insert name
and tax identification number, if any, of
transferee] elect to apply section
362(e)(2)(C) with respect to a transfer of
property described in section
362(e)(2)(A) on [insert date(s) of
transfer(s)].’’
(B) Transferor is a CFC on the date of
the transfer. If, on the date of the
transfer, the transferor is a CFC that is
not required to make a return of tax
under Subtitle A of the Internal Revenue
Code (including an information return)
for the year of the transfer, the election
statement is filed by including the
following statement on or with the

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timely filed original return (including
extensions) of each one of the
transferor’s controlling U.S.
shareholders, as defined in § 1.964–
1(c)(5), for the taxable year within
which the transfer occurred: ‘‘[insert
name and tax identification number of
controlling U.S. shareholder filing
return] certifies that [insert name and
tax identification number, if any, of
transferor (the CFC)] and [insert name
and tax identification number, if any, of
transferee] elect to apply section
362(e)(2)(C) with respect to a transfer of
property described in section
362(e)(2)(A) on [insert date(s) of
transfer(s)]. [insert name(s) and tax
identification number(s) of any other
controlling U.S. shareholder(s) of the
CFC, or, if none, state that there are no
other controlling U.S. shareholders of
the CFC].’’
(C) Transferor is not a U.S. person on
the date of the transfer, a person
otherwise required to file a U.S. return
for the year of the transfer, or a CFC on
the date of the transfer, and transferee
is a U.S. person on the date of the
transfer or a person otherwise required
to file a U.S. return for the year of the
transfer. If the transferor is not
described in paragraph (c)(5)(ii)(A) or
(c)(5)(ii)(B) of this section and the
transferee is a U.S. person on the date
of the transfer or otherwise required to
make a return of tax under Subtitle A of
the Internal Revenue Code (including an
information return) for the year of the
transfer, the election statement is filed
by including the following statement on
or with the transferee’s timely filed
original return (including extensions)
for the taxable year in which the transfer
occurred: ‘‘[insert name and tax
identification number of transferee]
certifies that [insert name and tax
identification number, if any, of
transferor] and [insert name and tax
identification number of transferee]
elect to apply section 362(e)(2)(C) with
respect to a transfer of property
described in section 362(e)(2)(A) on
[insert date(s) of transfer(s)].’’
(D) Transferor is not a U.S. person on
the date of the transfer, a person
otherwise required to file a U.S. return
for the year of the transfer, or a CFC on
the date of the transfer, and transferee
is a CFC on the date of the transfer. If
the transferor is not described in
paragraph (c)(5)(ii)(A) or (c)(5)(ii)(B) of
this section, and, on the date of the
transfer, the transferee is a CFC that is
not required to make a return of tax
under Subtitle A of the Internal Revenue
Code (including an information return)
for the year of the transfer, the election
statement is filed by including the
following statement on or with the

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timely filed original return (including
extensions) of each one of the
transferee’s controlling U.S.
shareholders as defined in § 1.964–
1(c)(5) for the taxable year within which
the transfer occurred: ‘‘[insert name and
tax identification number of controlling
U.S. shareholder filing return] certifies
that [insert name and tax identification
number, if any, of transferor] and [insert
name and tax identification number, if
any, of transferee (the CFC)] elect to
apply section 362(e)(2)(C) with respect
to a transfer of property described in
section 362(e)(2)(A) on [insert date(s) of
transfer(s)]. [insert name(s) and tax
identification number(s) of any other
controlling U.S. shareholder(s) of the
CFC, or, if none, state that there are no
other controlling U.S. shareholders of
the CFC].’’
(iii) Election where neither the
transferor nor the transferee is a U.S.
person on the date of the transfer, a
person otherwise required to file a U.S.
return for the year of the transfer, or a
CFC on the date of the transfer. If the
parties to a transfer to which section
362(e)(2) applies are not described in
any of the classifications set forth in
paragraph (c)(5)(ii) of this section, then
the election statement under this
paragraph (c) is made as described in
this paragraph (c)(5)(iii).
(A) Transferor later becomes a U.S.
person, a person otherwise required to
file a U.S. return, or a CFC. If the
transferor later becomes a U.S. person,
a person otherwise required to make a
return of tax under Subtitle A of the
Internal Revenue Code (including an
information return), or a CFC, an
election statement under this paragraph
(c) is filed as described in this paragraph
(c)(5)(iii)(A).
(1) If the transferor becomes a U.S.
person or a person otherwise required to
make a return of tax under Subtitle A of
the Internal Revenue Code (including an
information return), the election
statement is filed by including the
statement described in paragraph
(c)(5)(ii)(A) of this section on or with the
transferor’s timely filed original return
(including extensions) for the taxable
year in which the transferor first
becomes a U.S. person or a person
otherwise required to make a return.
(2) If the transferor becomes a CFC
that is not required to make a return of
tax under Subtitle A of the Internal
Revenue Code (including an
information return), the election
statement is filed by including the
statement described in paragraph
(c)(5)(ii)(B) of this section on or with the
timely filed original return (including
extensions) of each one of the
transferor’s controlling U.S.

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shareholders, as defined in § 1.964–
1(c)(5), for the taxable year within
which the transferor becomes a CFC.
(B) Transferee later becomes a U.S.
person, a person otherwise required to
file a U.S. return, or a CFC. If the
transferor is not described in paragraph
(c)(5)(iii)(A) of this section, and the
transferee later becomes a U.S. person,
a person otherwise required to make a
return of tax under Subtitle A of the
Internal Revenue Code (including an
information return), or a CFC, an
election statement under this paragraph
(c) is filed as described in this paragraph
(c)(5)(iii)(B).
(1) If the transferee becomes a U.S.
person or a person otherwise required to
make a return of tax under Subtitle A of
the Internal Revenue Code (including an
information return), the election
statement is filed by including the
statement described in paragraph
(c)(5)(ii)(C) of this section on or with the
transferee’s timely filed original return
(including extensions) for the taxable
year in which the transferee first
becomes required to make a return.
(2) If the transferee becomes a CFC
that is not required to make any return
of tax under Subtitle A of the Internal
Revenue Code (including an
information return), the election
statement is filed by including the
statement described in paragraph
(c)(5)(ii)(D) of this section on or with the
timely filed original return (including
extensions) of each one of the
transferee’s controlling U.S.
shareholders as defined in § 1.964–
1(c)(5) for the taxable year within which
the transferee becomes a CFC.
(C) A U.S. person, a person otherwise
required to file a U.S. return, or a CFC
later acquires the transferred assets or
transferee stock in a transferred basis
transaction. If neither the transferor nor
the transferee is described in paragraph
(c)(5)(iii)(A) or (c)(5)(iii)(B) of this
section and a U.S. person, a person
otherwise required to make a return of
tax under Subtitle A of the Internal
Revenue Code (including an
information return), or a CFC not
required to make a return of tax under
Subtitle A of the Internal Revenue Code
(including an information return) later
acquires, in a transferred basis
transaction, any portion of the assets
that were transferred in a prior
transaction to which section 362(e)(2)
applied (section 362(e)(2) assets) or
stock of the transferee corporation
received in such prior transaction
(section 362(e)(2) stock), then the
election statement under this paragraph
(c) is filed as described in this paragraph
(c)(5)(iii)(C).

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(1) If a U.S. person or a person
otherwise required to make a return of
tax under Subtitle A of the Internal
Revenue Code (including an
information return) later acquires, in a
transferred basis transaction, any
portion of the section 362(e)(2) assets or
section 362(e)(2) stock, the election
statement is filed by including the
following statement on or with such
acquiror’s timely filed original return
(including extensions) for the taxable
year in which the acquiror first acquires
any portion of the section 362(e)(2)
assets or section 362(e)(2) stock: ‘‘[insert
name and tax identification number of
the acquiror] certifies that [insert name
and tax identification number, if any, of
transferor] and [insert name and tax
identification number, if any, of
transferee] elect to apply section
362(e)(2)(C) with respect to a transfer of
property described in section
362(e)(2)(A) on [insert date(s) of
transfer(s)].’’
(2) If no person described in
paragraph (c)(5)(iii)(C)(1) of this section
has acquired any portion of the section
362(e)(2) assets or section 362(e)(2)
stock, and a CFC not required to make
a return of tax under Subtitle A of the
Internal Revenue Code (including an
information return) later acquires, in a
transferred basis transaction, any
portion of the section 362(e)(2) assets or
section 362(e)(2) stock, the election
statement is filed by including the
following statement on or with each of
the CFC’s controlling U.S. shareholders’
timely filed original returns (including
extensions) for the taxable year within
which the CFC first acquires any portion
of the section 362(e)(2) assets or section
362(e)(2) stock: ‘‘[insert name and tax
identification number of controlling
U.S. shareholder filing return] certifies
that [insert name and tax identification
number, if any, of transferor] and [insert
name and tax identification number, if
any, of transferee] elect to apply section
362(e)(2)(C) with respect to a transfer of
property described in section
362(e)(2)(A) on [insert date(s) of
transfer(s)]. [insert name(s) and tax
identification number(s) of any other
controlling U.S. shareholder(s) of the
CFC, or, if none, state that there are no
other controlling U.S. shareholders of
the CFC].’’
(6) Transfers by partnerships. If the
transferor is a partnership, for purposes
of applying section 705 (determination
of basis of partner’s interest), any
reduction under this section to the
transferor’s basis in the stock received
in exchange for the transferred property
is treated as an expenditure of the
partnership described in section
705(a)(2)(B).

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(7) Transfers by S corporations. If the
transferor is an S corporation, for
purposes of applying section 1367
(adjustments to basis of stock of
shareholders, etc.), any reduction under
this section to the transferor’s basis in
the stock received in exchange for the
transferred property is treated as an
expense of the S corporation described
in section 1367(a)(2)(D).
(d) Examples. The following examples
illustrate paragraphs (a) through (c) of
this section. Unless otherwise indicated,
all transferred property is subject to tax
under Subtitle A of the Internal Revenue
Code in the hands of the transferor, and,
accordingly, section 362(e)(1) does not
apply to the transaction. In addition, all
assets are capital assets in the hands of
the transferor and have been held for
more than one year.
Example 1. Property transfer qualifying
under section 351. (i) Facts. Individual A
owns Asset 1 with a basis of $90 and a fair
market value of $60, and Asset 2 with a basis
of basis of $110 and a fair market value of
$120. In a transaction qualifying under
section 351, A transfers Asset 1 and Asset 2
to newly formed corporation X in exchange
for all of the X common stock. A and X do
not elect to apply section 362(e)(2)(C) to
reduce A’s basis in the X stock received.
(ii) Analysis. Under section 362(a), X
would otherwise receive Asset 1 and Asset 2
with an aggregate basis of $200 ($90+$110),
which exceeds their aggregate fair market
value of $180 ($60+$120). As a result, the
assets have a net built-in loss of $20, and this
section applies to the transfer. Under
paragraph (b)(1) of this section, X reduces its
basis in Asset 1 by $20 to $70 and, under
section 362(a), takes a basis in Asset 2 of
$110. Under section 358(a), A receives X
stock with a basis of $200.
(iii) Election to apply section 362(e)(2)(C).
The facts are the same as in paragraph (i) of
this Example 1, except that A and X elect to
apply section 362(e)(2)(C) to reduce A’s basis
in the X stock received. Under paragraph
(c)(3) of this section, A reduces its basis in
the X stock received by the amount X would
have been required to reduce its basis in the
transferred assets had the election to apply
section 362(e)(2)(C) not been made.
Accordingly, A receives X stock with an
aggregate basis of $180, and, under section
362(a), X receives Asset 1 with a basis of $90
and Asset 2 with a basis of $110.
Example 2. Property transfer qualifying
under section 351 and described in section
368(a)(1)(B). (i) Facts. Corporation P owns all
of the outstanding stock of corporations S1
and S2. In a transaction qualifying under
section 351 and described in section
368(a)(1)(B), P transfers all 10 shares of its S2
stock to S1 in exchange for an additional 10
shares of S1 voting stock. At the time of the
transfer, each share of the S2 stock has a
basis of $10 and a fair market value of $7.
P and S1 do not elect to apply section
362(e)(2)(C) to reduce P’s basis in its S1
stock.
(ii) Analysis. Under section 362, S1 would
otherwise receive the 10 shares of S2 stock

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62073

with a basis of $10 per share, which exceeds
their fair market value of $7 per share. As a
result, the S2 stock has a net built-in loss of
$30, and this section applies to the transfer.
Under paragraph (b)(1) of this section, S1
reduces its basis in the S2 stock by $30 to
$70. Under section 358(a), P receives the
additional 10 shares of S1 stock with a basis
of $10 per share.
(iii) Election under section 362(e)(2)(C). (A)
The facts are the same as in paragraph (i) of
this Example 2, except that P and S1 elect to
apply section 362(e)(2)(C) to reduce P’s basis
in its S1 stock received. Under paragraph
(c)(3) of this section, P reduces its basis in
the S1 stock received by the amount S1
would have been required to reduce its basis
in the transferred S2 stock had the election
to apply section 362(e)(2)(C) not been made.
Accordingly, under paragraph (c)(4) of this
section, P receives the additional 10 shares
of S1 stock each with a basis of $7. Under
section 362, S1 receives the 10 shares of S2
stock each with a basis of $10.
(B) The facts are the same as in paragraph
(i) of this Example 2, except that five shares
of the S2 stock have a basis of $10 each, five
shares have a basis of $5 each, and P and S1
elect to apply section 362(e)(2)(C) to reduce
P’s basis in its S1 stock. The $75 ((5 × $10)
+ (5 × $5)) aggregate basis in the S2 stock
exceeds the $70 aggregate fair market value
of the S2 stock, and this section applies to
the transfer. Under paragraph (c)(3) of this
section, P reduces its basis in the S1 stock
received by the amount S1 would have been
required to reduce its basis in the transferred
S2 stock had the election to apply section
362(e)(2)(C) not been made. Accordingly,
under paragraph (c)(4) of this section and
§ 1.358–2(a)(2)(viii), P receives the additional
10 shares of S1 stock each with a basis of $7.
Under section 362, S1 receives five shares of
the S2 stock with a basis of $10 each and five
shares of the S2 stock with a basis of $5 each.
Example 3. Property transfer qualifying
under section 351 and described in section
368(a)(1)(A). (i) Facts. Individual A owns all
of the outstanding stock of corporation X and
corporation Y, which owns Asset 1 with an
adjusted basis of $250 and a fair market value
of $210. A also owns Asset 2 with an
adjusted basis of $120 and a fair market value
of $130. In a transaction qualifying as a
reorganization described in section
368(a)(1)(A), Y merges with and into X.
Pursuant to the same plan, A transfers Asset
2 to X in exchange for additional X stock. Y’s
transfer of Asset 1 to X in the merger coupled
with A’s transfer of Asset 2 to X in exchange
for X stock qualifies as a section 351
contribution.
(ii) Analysis. Under paragraph (b)(2) of this
section, the potential application of section
362(e)(2) is determined separately for each
transferor. Y is treated as having transferred
Asset 1 to X in exchange for X stock, and X
would otherwise take Asset 1 with a basis of
$250, which exceeds its fair market value of
$210. As a result, Asset 1 has a built-in loss
of $40. Under paragraph (b)(6) of this section,
section 362(e)(2) does not apply to Y’s
transfer of property to X because Y
distributes all of the X stock received in the
exchange without recognizing gain or loss
pursuant to section 361(c), and, upon

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completion of the transaction, no person
holds X stock or any other asset with a basis
determined in whole or in part by reference
to Y’s basis in the X stock received in the
exchange. As a result, under section 362, X
receives Asset 1 with a basis of $250. A’s
transfer of Asset 2 to X is not subject to
section 362(e)(2) because X receives Asset 2
with a basis of $120, which is less than its
fair market value of $130.
Example 4. Property transfers qualifying
under section 351 and described in section
368(a)(1)(D), followed by a section 355
distribution. (i) Facts. Individual A and
individual B each own 50 percent of
corporation X. X owns Asset 1 with an
adjusted basis of $120 and a fair market value
of $70, Asset 2 with an adjusted basis of $160
and a fair market value of $110, and Asset
3 with an adjusted basis of $220 and a fair
market value of $240. In a transaction
qualifying under section 351(a) and
described in section 368(a)(1)(D), X transfers
Asset 1, Asset 2, and Asset 3 to Y, a newly
formed corporation, in exchange for all of the
Y stock, and then distributes all of the Y
stock to A in exchange for all of A’s X stock
in a distribution qualifying under section
355. At the time of the transaction, A has no
plan or intention to dispose of his Y stock,
and B has no plan or intention to dispose of
his X stock.
(ii) Analysis. The aggregate adjusted basis
of the properties transferred to Y ($120 +
$160 + $220 = $500) exceeds their aggregate
fair market value ($70 + $110 + $240 = $420).
As a result, the assets have a total net builtin loss of $80. Under paragraph (b)(6) of this
section, section 362(e)(2) does not apply to
this transfer of property because X distributes
all of the Y stock received in the exchange
without recognizing gain or loss under
section 361(c), and, upon completion of the
transaction, no person holds Y stock or any
other asset with a basis determined in whole
or in part by reference to X’s basis in the Y
stock received in the exchange. A’s basis in
the Y stock is determined under section 358
by reference to his basis in the X stock he
surrenders.
(iii) Section 355(e). (A) The facts are the
same as in paragraph (i) of this Example 4,
except that, one year after the section 355
distribution, Y is acquired pursuant to a plan,
resulting in the application of section 355(e)
to the transaction. X and Y do not elect to
apply section 362(e)(2)(C).
(B) Analysis. Due to the application of
section 355(e), section 361(c) will not apply
and X will not be granted nonrecognition
treatment on the distribution of the Y stock.
As a result, paragraph (b)(6) of this section
does not apply, and section 362(e)(2) applies
to X’s transfer of assets to Y. Under paragraph
(b)(1) of this section, Y reduces its basis in
Asset 1 and Asset 2 by the amount of the net
built-in loss in the transferred assets, or $80
($500 ¥ $420). The $80 basis reduction is
allocated between Asset 1 and Asset 2 in
proportion to their respective built-in losses.
Prior to reduction, Asset 1 had a built-in loss
of $50 ($120 ¥ $70), and Asset 2 had a builtin loss of $50 ($160 ¥ $110). As a result, the
basis of Asset 1 is reduced by $40 (50/100 ×
$80), and the basis of Asset 2 is reduced by
$40 (50/100 × $80), and Y receives Asset 1

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with a basis of $80 ($120 ¥ $40) and Asset
2 with a basis of $120 ($160 ¥ $40).
(iv) Retained stock and securities without
a section 362(e)(2)(C) election. (A) The facts
are the same as in paragraph (i) of this
Example 4, except that X transfers Asset 1,
Asset 2, and Asset 3 to Y in exchange for an
equal amount of Y stock and Y securities. For
a valid business purpose, X retains Y stock
and Y securities each worth 1 percent of the
total consideration. X and Y do not elect to
apply section 362(e)(2)(C).
(B) Analysis. The aggregate basis of the
properties transferred ($120 + $160 + $220 =
$500) exceeds their aggregate fair market
value ($70 + $110 + $240 = $420) by $80
($500 ¥ $420), and this section applies to the
transfer. Under paragraph (b)(6) of this
section, section 362(e)(2) applies to X’s
transfer of assets to Y in exchange for the Y
stock and the Y securities to the extent X
does not distribute the Y stock and Y
securities without the recognition of gain or
loss. Accordingly, section 362(e)(2)(A)
applies to the extent property was exchanged
for the retained Y stock and Y securities (2
percent of the total). Under paragraph (b)(1)
of this section, Y reduces its basis in Asset
1 and in Asset 2 by 2 percent of the amount
of the net built-in loss in the transferred
assets ($80), or $1.60. The $1.60 basis
reduction is allocated between Asset 1 and
Asset 2 in proportion to their respective
built-in losses before reduction under
paragraph (b)(1) of this section. Prior to
reduction, Asset 1 had a built-in loss of $50
($120 ¥ $70), and Asset 2 had a built-in loss
of $50 ($160 ¥ $110). As a result, the basis
of Asset 1 is reduced by $.80 (50/100 ×
$1.60), the basis of Asset 2 is reduced by $.80
(50/100 × $1.60), and Y receives Asset 1 with
a basis of $119.20 ($120 ¥ $.80) and Asset
2 with a basis of $159.20 ($160 ¥ $.80).
(v) Retained stock and securities with a
section 362(e)(2)(C) election. (A) The facts are
the same as in paragraph (iv)(A) of this
Example 4, except that X and Y elect to apply
section 362(e)(2)(C) to reduce X’s basis in its
retained Y stock and retained Y securities.
(B) Analysis. Under paragraph (b)(6) of this
section, section 362(e)(2) applies to X’s
transfer of assets to Y in exchange for the Y
stock and the Y securities to the extent X
does not distribute the Y stock and Y
securities without the recognition of gain or
loss. Under paragraph (c) of this section, the
election to apply section 362(e)(2)(C) applies
to both the retained Y stock and the retained
Y securities. Accordingly, under paragraph
(c)(3) of this section, X reduces its basis in
the retained Y stock and the retained Y
securities by the amount Y would have been
required to reduce its basis in the transferred
assets had the election to apply section
362(e)(2)(C) not been made. As described in
paragraph (iv)(B) of this Example 4, under
paragraphs (b)(1) and (b)(6) of this section, Y
would have been required to reduce its basis
in the transferred assets by $1.60.
Accordingly, X is required to reduce its basis
in the retained Y stock and Y securities by
$1.60, and, under paragraph (c)(4) of this
section, this $1.60 basis reduction is
allocated between the retained Y stock and
Y securities in proportion to fair market
value. Because X retained Y stock and Y

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securities with equal values, X holds the
retained Y stock with an adjusted basis of
$1.70 ((($500/2) × .01) ¥ $.80) and the
retained Y securities with an adjusted basis
of $1.70 ((($500/2) × .01) ¥ $.80).
Example 5. Transfer of contingent
liabilities subject to section 358(h)(2)(A) with
section 362(e)(2)(C) election. (i) Facts.
Corporation P owns Asset 1 with a basis of
$800 and a fair market value of $700. Asset
1 constitutes a trade or business for purposes
of section 358(h)(2)(A). Contingent liabilities
of $200 are associated with the Asset 1
business. P transfers Asset 1 to newly formed
corporation S in exchange for all of the S
stock and assumption of the contingent
liabilities in a transaction qualifying under
section 351. P and S elect to apply section
362(e)(2)(C).
(ii) Analysis. Under section 362(a), S
would otherwise receive Asset 1 with a basis
of $800, which exceeds it fair market value
of $700. As a result, Asset 1 has a net builtin loss of $100, and this section applies to the
transfer. Under paragraph (c)(3) of this
section, P reduces its basis in the S stock
received by the amount S would have been
required to reduce its basis in Asset 1 had the
election to apply section 362(e)(2)(C) not
been made ($100). Accordingly, A receives S
stock with an aggregate basis of $700, and,
under section 362(a), S receives Asset 1 with
a basis of $800.
Example 6. Property transfer qualifying
under section 351 with boot. (i) Facts.
Individual A owns Asset 1 with a basis of
$80 and a fair market value of $100, and
Asset 2 with a basis of $30 and a fair market
value of $25. In a transaction qualifying
under section 351, A transfers Asset 1 and
Asset 2 to newly formed corporation N in
exchange for 10 shares of N stock and $25.
A and N do not elect to apply section
362(e)(2)(C) to reduce A’s basis in the N stock
received.
(ii) Analysis. Under paragraph (b)(4)(iii) of
this section, for purposes of determining
whether the transferred property has a net
built-in loss in the hands of the transferee,
the transferee’s basis in the transferred
property must be adjusted for any gain
recognized by the transferor on the transfer.
Section 351(b) requires transferors in
transactions otherwise qualifying under
section 351(a) for nonrecognition treatment
to recognize gain (but not loss) to the extent
the transferor receives other property or
money in addition to the stock permitted to
be received. For purposes of computing the
amount of gain recognized under section
351(b), the consideration is allocated pro rata
among the transferred properties according to
their fair market values. As a result, to
compute the amount of gain recognized on
the transfer, A is treated as having received
eight shares of N stock and $20 in exchange
for Asset 1, and two shares of N stock and
$5 in exchange for Asset 2. Under section
351(b), A must recognize $20 of gain for the
cash received in exchange for Asset 1. Thus,
under section 362(a), N would otherwise
have a basis of $100 in Asset 1 and $30 in
Asset 2. N’s total basis in Asset 1 and Asset
2 of $130 ($100 + $30) would exceed the total
fair market value of Asset 1 and Asset 2 of
$125 ($100 + $25). As a result, this section

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Federal Register / Vol. 71, No. 204 / Monday, October 23, 2006 / Proposed Rules

mstockstill on PROD1PC76 with PROPOSALS

applies to the transfer. Under paragraph
(b)(1) of this section, N reduces its basis in
Asset 2 by $5 to $25 and, under section
362(a), takes a basis in Asset 1 of $100. Under
section 358(a), A receives N stock with a
basis of $105.
Example 7. Property transfer subject to
both sections 362(e)(1) and 362(e)(2). (i)
Facts. Foreign corporation FP transfers Asset
1 and Asset 2 to a domestic corporation DS
in a transaction that qualifies under section
351. Asset 1 is not property described in
section 362(e)(1)(B) and has a basis of $80
and a fair market value of $50. Asset 2 is
property described in section 362(e)(1)(B)
and has a basis of $120 and a value of $110.
Section 367(b) does not apply to the transfer
of Asset 1 or Asset 2.
(ii) Analysis. Under paragraphs (b)(1) and
(b)(3) of this section, a transfer is described
in section 362(e)(1), and thus not subject to
this section, only if and to the extent there
is a transfer of property described in section
362(e)(1)(B) that otherwise would have a net
built-in loss in the hands of the transferee.
Because Asset 2 is property described in
section 362(e)(1)(B) and DS would otherwise
receive Asset 2 with a basis of $120 and a
value of $110, FP’s transfer of property to DS
is described in section 362(e)(1) only to the
extent of the transfer of Asset 2. Asset 1 is
not property described in section
362(e)(1)(B), and under section 362(a), DS
would receive Asset 1 with a basis ($80) in
excess of its fair market value ($50).
Accordingly, this section applies solely to the
transfer of Asset 1. Under paragraph (b)(1) of
this section, DS reduces its basis in Asset 1
by $30 to $50. Under section 358(a), FP
receives the DS stock with a basis of $200.
Example 8. Section 304 sale of built-in loss
stock. (i) Facts. Individual A owns all the
stock of corporation X and corporation Y. A
sells all his X stock to Y for $60. Under
section 304, A is treated as though he
transferred the X stock to Y in exchange for
Y stock in a transaction to which section 351
applies. Then, Y is treated as redeeming the
Y stock it was treated as having issued to A
in the section 351 transaction. At the time of
the transaction, A holds X stock with a basis
of $90 and a fair market value of $60. A and
Y do not elect to apply section 362(e)(2)(C)
to reduce A’s basis in the Y stock deemed
received.
(ii) Analysis. Under section 362(a), Y
would otherwise receive X stock with an
aggregate basis of $90, which exceeds its
aggregate fair market value of $60. As a
result, the X stock has a net built-in loss of
$30, and, under paragraph (b)(1) of this
section, Y reduces its basis in the X stock
received by $30 to $60. Under section 358(a),
A receives the deemed issued Y stock with
a basis of $90.

(e) Effective date. This section applies
to transactions occurring after the date
these regulations are published as final
regulations in the Federal Register.
Par. 5. Section 1.705–1(a)(9) is added
to read as follows:
§ 1.705–1 Determination of basis of
partner’s interest.

(a) * * *

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(9) For basis adjustments necessary to
coordinate sections 705 and 362(e)(2),
see § 1.362–4(c)(6).
*
*
*
*
*
Par. 6. In § 1.1367–1, a new sentence
is added at the end of paragraph (c)(2)
to read as follows:
§ 1.1367–1 Adjustments to basis of
shareholder’s stock in an S corporation.

*

*
*
*
*
(c) * * *
(2) * * * For basis adjustments
necessary to coordinate sections 1367
and 362(e)(2), see § 1.362–4(c)(7).
*
*
*
*
*
Mark E. Matthews,
Deputy Commissioner for Services and
Enforcement.
[FR Doc. E6–17649 Filed 10–20–06; 8:45 am]
BILLING CODE 4830–01–P

DEPARTMENT OF HOMELAND
SECURITY
Coast Guard
33 CFR Part 165
[USCG–2006–25767; CGD09–06–123]

Safety Zones; U.S. Coast Guard Water
Training Areas, Great Lakes
Coast Guard, DHS.
Notice of public meetings.

AGENCY:
ACTION:

SUMMARY: This document provides the
times and locations of for the additional
public meetings which will be held by
the Coast Guard to discuss issues
relating to the proposed permanent
safety zones located in the Great Lakes
to conduct live gunnery training
exercises. These meetings will be open
to the public and are in addition to the
four currently scheduled public
meetings.

The Coast Guard will hold five
additional public meetings as follows:
Monday, October 30, 2006 in Rochester,
NY; Wednesday November 1,
Waukegan, IL (Milwaukee, WI /
Chicago, IL area); Friday November 3, in
Charlevoix, MI; Monday, November 6,
in Erie, PA; and Wednesday, November
8, Sturgeon Bay, WI. If you are unable
to attend, you may submit comments to
the Docket Management Facility by
November 13, 2006.
ADDRESSES: The Coast Guard will hold
additional public meetings at the
following addresses:
1. Rochester, NY: Rochester Fast Ferry
Terminal, 1000 N. River Street,
Rochester, NY 14612, (877) 283–7327;
DATES:

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62075

2. Chicago, IL/ Milwaukee, WI:
Genesee Theatre, 203 N. Genesee Street,
Waukegan, IL 60085, (847) 782–2366;
3. Charlevoix, MI: Charlevoix Public
Library, 220 W. Clinton Street,
Charlevoix, MI 49720, (231) 547–2651;
4. Erie, PA: Port of Erie Cruise Boat
Terminal, 1 Holland Street, Erie PA
16507, (814) 455–7557; and
5. Sturgeon Bay, WI: Stoneharbor
Resort, 107 North First Avenue,
Sturgeon Bay, WI (877) 746–0700.
You may submit your comments and
related material by one of the following
means:
(1) By mail to the Docket Management
Facility (USCG–2006–2567), U.S.
Department of Transportation, room PL–
401, 400 Seventh Street, SW.,
Washington, DC 20590–0001.
(2) By delivery to room PL–401 on the
Plaza level of the Nassif Building, 400
Seventh Street, SW., Washington, DC
between 9 a.m. and 5 p.m. Monday
through Friday, except Federal holidays.
The telephone number is 202–366–
9329.
(3) By fax to the Docket Management
Facility at 202–493–2251.
(4) Electronically through the Web
site for the Docket Management System
at http://dms.dot.gov.
The Docket Management Facility
maintains the public docket for the
rulemaking. Comments and material
received from the public will become
part of this docket and will be available
for inspection or copying at room PL–
401, located on the Plaza level of the
Nassif Building at the same address
between 9 a.m. and 5 p.m., Monday
through Friday, except Federal holidays.
You may electronically access the
public docket by performing a ‘‘Simple
Search’’ for docket number 25767 on the
Internet at http://dms.dot.gov.
Electronic forms of all comments
received into any of our dockets can be
searched by the name of the individual
submitting the comment (or signing the
comment, if submitted on behalf of an
association, business, labor unit, etc.)
and is open to the public without
restriction. You may review the
Department of Transportation’s
complete Privacy Act Statement in the
Federal Register published on April 11,
2000 (65 FR 19477–78), or you may visit
http://dms.dot.gov.
FOR FURTHER INFORMATION CONTACT: For
further information concerning this
notice and the public meeting, contact
Commander Gustav Wulfkuhle, Chief
Enforcement Branch, Ninth Coast Guard
District, Cleveland, Ohio at (216) 902–
6091. If you have any questions on
viewing or submitting material to the
docket, call Renee V. Wright, Program

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